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Company Update | City Chic & Family Zone

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Analyst: Jonathan Wilson, Portfolio Manager, Smaller Companies

This week’s Company Update covers two small cap AGMs, being Model Portfolio holding City Chic (CCX) and Clime Direct watchlist stock Family Zone (FZO). Both were broadly positive and thesis-reaffirming, with shares closing higher post AGM.

City Chic (CCX, market cap $1.5bn) is well-positioned with healthy inventories leading into Christmas trade in both Australia and the US (85% of Group revenue). However, there are some temporary supply issues within the earlier stage Europe and UK markets (15% of revenue), which CCX recently entered via acquisitions of Evans (UK, Dec 2020) and Navabi (EU, Jul 2021).

Per management commentary, the experience so far is it has taken 3 seasons to test and learn about customer demand in new geographies. To date, CCX has executed very well in this regard, so we are confident performance in the UK/EU businesses will improve markedly over the next two years as supply issues resolve.

Positively, Avenue (US, 50% revenue), is trading “strongly at above pre-acquisition levels (Jul 2020)”. In Australia, all 90 stores have reopened with reponed stores seeing ‘high double-digit comparable sales’, which ‘has not slowed the strong performance of growth online’.

CCX will ramp up marketplace partnerships with Walmart in the US, David Jones, The Iconic, and eBay in AU, and Very in the UK, with all marketplaces expected to be live in 2H22. These partnerships will enhance CCX’s awareness in each respective market. Generally, third party channels have been effective means for capturing new customers, with a high degree of loyalty thereafter.

Management didn’t provide guidance due to ongoing COVID uncertainty, however, indicated earnings would be more weighted to 2H22 due to lockdown store closures in AU, marketplace go-lives in 2H22, and seasonality as sales mix shifts more to the Northern Hemisphere.

In sum, we are happy to stay on the long term investment journey with CCX. To date execution of the plus-size, global, online strategy has been impeccable notwithstanding external disruptions. The Group boasts 1.2m active customers, up by over 300% in the last 2 years. The operating model is lean with 16 wholly-owned brands delivering high gross margins, with higher average price-points that are more conducive to profitable online sales (now 78% of total). With a massive range of over 5,000 products and a centralised, inventory-light model, CCX is able to address the needs of the plus-size consumer in a highly capital-efficient manner.

The balance sheet remains strong with $71.5m net cash and no debt drawn under the existing $40m debt facility, providing dry powder for future acquisitions or other customer acquisition strategies. Shares are trading on an FY22 free-cash-flow yield of about 3%, which we think is reasonable for a business with a significant global growth runway.

 

Family Zone (FZO, market cap $420m) provided a positive update with the usually quieter month of October adding $1.2m of Annualised Recurring Revenue (ARR). ARR now stands at $47.2m. FZO finished October with proof of concept (POC) trials in the US encompassing 744k Students. FZO typically converts 90% of POC trials within a 3 month period, so we could see FZO exit December 2021 with ARR exceeding $50m.

Although ARR converts to revenue with a lag, we estimate FZO will be at cash-flow break-even around this level, which allows the business to aggressively pursue growth opportunities in the US and UK markets.

For a quick background, FZO specialises in cyber-security solutions for children, with end-customers traditionally being schools and school districts, but soon also parent community of school children with the release of Parent Controls in 2022. For schools FZO offers Firewall, Content Filtering, Classroom Management and Student Monitoring tools. Parent Controls is derived from this suite, enabling content filtering and monitoring of children to continue in the home environment.

In Aug 2021 FZO acquired Smoothwall, a UK-based specialist in student monitoring solutions that detect high-risk students and allow proactive intervention. Smoothwall accounts for 38% of UK schools covering over 6 million students.

The acquisition complements FZO’s US business, which covers Content Filtering, Classroom, and Parent Control solutions. FZO’s strong traction in the US is what initially caught our eye, with the business growing from a standing start in the US in 2018 to a 10% share of US schools now, covering 4 million students.

For us, the growth opportunity is interesting because FZO has the scope to cross-sell solutions in the UK and US, and also market Parent Controls at very little additional cost, given the existing relationship with schools. Sound execution on this strategy should yield powerful operating leverage. Across the US and UK schools markets, FZO has a TAM of $800m, while the parent communities represent a TAM of close to $10bn.

 

Per AGM commentary, early signs are good, with US deals so far in 2Q22 achieving Average Revenue per Student of $11.7, more than double the group blended average of $5.20 currently.

 

 

Ownership Disclosures: 
Our fund partner Clime Asset Management (Clime) owns (FZO & CCX) on behalf of various mandates where it acts as an investment manager.

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