Unravelling of Feltex makes sorry tale

Peter Thomas is trying to steer the carpet-maker through tough times. Picture / Kenny Rodger

One of Auckland's largest carpet retailers has a message of hope for Feltex.

Cavendish Carpets - a family-owned business that has been selling carpet out of Manukau for the past 15 years - says executives at the debt-laden carpet-maker are now answering the phone.

Cavendish owner Richard Wickett, who set up the retailer with his mother in 1991, said: "They used to be suits in ivory towers. You can put a face to just about any name that pops up now."

Years ago, executives did not take calls and it was even difficult to get their phone numbers. Retailers also had to put up with invoice errors, delayed payments and investigations of mistakes.

"Nowadays, Feltex's accounts are clean," Wickett said.

The Cavendish comments are echoed by other retailers.

Feltex has held industry meetings to discuss and fix problems encountered by retailers and it is running a tighter range of products with better supply.

It has also cut the number of salesmen and, as a result, many are dealing with just one instead of four - with obvious benefits to service and Feltex's bottom line.

"Each rep is on 60-odd grand plus a company car," one retailer said. "So you are looking at a quarter of a million dollars worth of salaries for four reps to come into your shop."

That is where the good news ends - shareholders are unlikely to enjoy any of these gains.

Feltex's woes have been well traversed but, for the sake of completeness, it was one of New Zealand's oldest manufacturers and returned to the NZX in 2004, after a 15-year break, at $1.70 a share. It promised strong, sustainable profit growth, thanks to its recent attention to costs, its control of the Australasian market, product innovation and established customer relationships.

But the mainly mum and dad investors who bought Feltex shares were sorely disappointed. On April Fool's Day last year, Feltex warned that profits would be a third less than projected at the time of its float.

It has since been criticised by the stock exchange for failing to properly inform the market of its problems and, although it never admitted liability, the company paid up $150,000 in settlement.

Feltex has also revised its earnings forecasts four more times. The latest came last month when it said reorganisation costs were higher than it expected and - more worrying - that it was in breach of its banking covenants and it needed new equity.

The shares have since slumped, closing yesterday at 23c, wiping more than $216 million from Feltex's market value.

The key reasons put forward for Feltex's problems are many, depending often on whom one talks to. But all sources agree the company was hit by a sharp and sudden downturn in the Australian housing market at the start of 2004.

After that things get murky.

Some talk of a failure to get new product in time and a failure of the company's information systems, resulting in its machines producing well in excess of demand.

Others say company shakeups - including the axing of almost 50 senior executives and the closure of a Melbourne yarn plant - after the April 1 profit warning denuded Feltex of the key relationships and skills needed to drive the business.

Whatever the explanation, the numbers are as stark as they are disheartening.

Feltex's value is hard to discern since it has such a poor record of delivering on its promises. As a result, potential investors will be sceptical about its ability to deliver on management expectations of earnings.

Nevertheless, informed observers say it can be optimistically valued debt-free as a multiple of around six times this year's trading profits - earnings before interest, tax depreciation and amortisation.

Feltex has already promised in the year to June trading profits will be around $20 million, suggesting the company is conservatively worth around $120 million.

This is less than the total value of its $129 million borrowing.

Typically companies like Feltex should be funded at maximum of 50 per cent debt and minimum 50 per cent equity. Or its bank borrowings loans should represent no more than half its total value. For Feltex, this means debt should be no more than $60 million.

Such a capital structure would protect Feltex from the cyclical swings in demand for its products. As the market turns, the company could raise additional funds to help it weather the downturn.

In short, Feltex needs $60 million more to reduce its debt to put it on an even keel. Even if it gets that capital injection - and this is by no means certain - its bank, the ANZ, looks as if it will have to take a loss.

However one looks at it, the existing Feltex shares are worth little. Even if the company is worth more than $129 million it has borrowed, capital raisings in similar straitened circumstances set a bleak example.

In 2001, when it was clear Air New Zealand needed cash to repair the damage inflicted by the airline's failed investment in Ansett, its local shares were trading at around $1.20.

But when the Government agreed to put up as much as $1 billion, the shares slumped 77 per cent. If a similar scenario plays out here, Feltex's shares are worth just over 5c.

Much of what happens to the shares now depends on what happens between now and September, when the current banking agreements expire.

At an operational level, Feltex chairman Tim Saunders has been unequivocal that Feltex will continue to be able to service its debt obligations.

He said yesterday: "Feltex is meeting its internal revenue and profitability targets. It is cashflow positive and is meeting all its financial obligations.

"This is largely as a result of the benefits that have flowed from the major restructuring the company undertook in the financial year just ended."

Analysts from ABN Amro agree, forecasting a cashflow from operations - after its debt-servicing obligations - of $210,000 this year and $11 million next year.

These forecasts depend on growing sales yet the market is not giving the company a huge boost.

According to its float documents, its prospects are determined by building and renovation cycles, economic confidence in the commercial sector, home sizes and the use of alternative flooring products.

In New Zealand, the picture on these factors are mixed.

Darren Gibbs, chief economist at Deutsche Bank, said lower migrant numbers and higher interest rates were affecting a housing market yet to reach the bottom of its cycle.

"I would think that for the remainder of this year and even into next year, building will remain relatively subdued so that's clearly not helping them [carpet-makers]."

The house renovation market had been relatively strong but, in the commercial marketplace, business confidence was feeling the squeeze of higher costs and a weaker dollar.

An analyst who did not want to be named said Feltex had claimed it would be relatively unaffected by a downturn in the building cycle because of renovation sales.

"But the problem was that didn't really eventuate and they started to feel the pinch in Australia first and then secondly in New Zealand."

Changes to import tariffs in recent years had also raised competition in the Australian market, where Feltex generated three-quarters of its $300.2 million sales last year.

"So there's been a situation where these synthetic manufacturers from off-shore have just been undercutting the hell out of all the domestic manufactures, including Feltex."

Meanwhile, housing approvals in the key New South Wales market had fallen to levels last seen 30 years ago.

Simon Tennent, executive director of housing and economics for Australia's Housing Industry Association, said total house building had fallen from 172,000 in the year to June 2004 to 148,400 in the past year.

The association forecasts a slight rise to 152,300 homes for this year but only if interest rates do not rise.

"Our view is we had an interest rate rise earlier this year, all the talk is we're going to get another one before the end of the year so the outlook for the industry - it's not dire but by no means is it as strong as what we've had," Tennent said.

"A bit of a mixed bag but another soft year we think for Australia."

Meanwhile, Brendan O'Donovan, chief economist at Westpac, said makers of oil-based synthetic carpet, of which Feltex is one, were suffering from rising oil prices. The price of a barrel of oil had risen from as little as US$10 ($16) about six years ago to about US$75 a barrel.

Clearly, the market is not going to give the business a huge boost.

So Feltex has three options:

* Finding an outside investor.

* ANZ converting half of its debt into equity.

* ANZ and/or Feltex directors calling in the receivers.

The first option is the one favoured by the directors as it holds out the best chances of restoring some value to shareholders.

Saunders reckons the company may find an investor, saying yesterday: "Interest is being expressed by more than one party."

But observers say that as every day passes, the chances decrease of existing shareholders recouping anything.

The numbers suggest the bank is in charge and its only interest is to recoup its debt.

Interest in the business appears to be weak. Investment bankers and market observers were amazed the company agreed to enter talks with the Talley family, which is known for its investments in primary industry rather than manufacturing.

The highest offer is likely to come from a company that has most to gain from assimilating Feltex within its own operations and cutting costs - this means Feltex rivals.

Feltex said it had rejected one offer because the bidder "sought to significantly revise the fundamental terms and structure of the proposal in ways which the board believed would have been unfair to shareholders and other stakeholders in the company".

Most took this as a sign that the bidder did not like what it had seen when it was given access to the company's finances.

Rivals such as Godfrey Hirst - which last year proposed an share merger that sources said would have left Feltex investors with as much as 60c a share - may decide to bide their time and wait until the company is put into receivership and then pick up the pieces they want.

Whatever happens, NZ retailers such as Richard Wickett of Cavendish Carpets want Feltex to survive.

"Generally feeling through the trade, and talking to other retailers, is that they want to give Feltex as much support as they possibly can because they are a home-grown company."