Inditex: how to elegantly disappoint the market

The coronavirus restrictions have been an interesting setback for lovers of tracksuits and robes, but a terrifying one for Inditex's business. With the confinements and restrictions of 2020, the 'retail' group has also had to figure out how to secure a chain of clothing sales on a global scale. The results presented this Wednesday were not up to par. However, the company has held its own on the stock market. What is the secret of elegance when it comes to disappointing the market? The action celebrates the robustness and versatility of the parent company of brands such as Zara, Oysho or Bershka —especially now that the worst is over and the company is collecting hopes of recovery on the stock market. Of course, there are also doubts about whether it has more travel in the stock market and there will always be noise about its ability to face an increasingly competitive market.

The profit of the company led by Pablo Isla plummeted 70% in the last fiscal year. Closing at 1,106 million euros, the number was well below the 1,330 million expected by the market. The same for EBITDA: the 4,552 million euros (-40% compared to 2019) did not even come close to the 4,758 million expected by the consensus of analysts collected by Bloomberg. And it is that sales were no consolation either: the 28% drop in revenue, to 20,402 million euros, has disappointed the market, which expected 20,958 million in 2020. The company fell up to 2% on the stock market that day, but finally managed to get off the ground, rising 0.69% on Wednesday. In the year, earn 15%.

These results must be matched with one of the company's flagship strengths: cash generation. In a balance without debt, the net financial position at the end of the year was 7,560 million euros, 35% more than in the same period of the previous year. On the other hand, the gross margin fell from 15,806 million to 11,390 million in 2020, although, at a constant rate, it rose 170 basis points to represent 57.6% of sales. All this in a year in which Inditex assumed extraordinary expenses of 394 million euros for covid-19.

To begin with, the market understands that the fourth quarter, mired in the third wave of covid-19, was not easy. "These were weak results and below our estimates, affected by store closures associated with the covid-19 restrictions, which have increased since mid-December," explains the Sabadell analysis team, which has a recommendation to 'sell'. In other words, it was the final stretch of the year that weighed on the annual accounts. As of January 31, 2021, 30% of stores were in total closure (compared to 8% as of October 31, 2020, for example) and 52% had restrictions.

The covid-19 has accelerated the online fashion trend. Internet sales giants such as Asos or Zalando have had a 2020 rally on the stock market precisely because of this consumer environment. Such is the rise of these platforms that, about a month ago, Credit Suisse analysts (with a 'sell' advice on Inditex) predicted that Zara or H&M would end up selling their models at Zalando. The Spanish brand of Mango, for example, already does it in Zalando. “Both Inditex and H&M use third-party distributors in China, mainly Alibaba, and H&M is now on Myntra,” the analysts explained in the report, referring to the Indian retail platform. “We believe that their reluctance to use third-party platforms in Europe will change, given the number of customers and visits to which they are not now exposed”, they concluded, concluding that, in the future, few brands will sell solely through their own means. Everything, in an environment of strong competition and, ultimately, consolidation: right at the start of this year, Asos took over the Arcadia brands (including Topshop) and let its physical stores die to absorb them on the web. For its part, Boohoo did a similar deal with Debenham's.

In this environment of growing competition, Inditex has no choice but to step on the accelerator. With almost five decades of history since its foundation in 1975 by the Galician couple Rosalía Mera and Amancio Ortega (1963 if Confecciones Goa is counted), Inditex has been a pioneer in the entry of the economic model into globalization. Today, the capital is still controlled by Ortega, one of the richest men in the world, but since 2011 he has had another management team at the helm. With eight independent clothing chains (Zara, Zara Home, Bershka, Pull&Bear, Stradivarius, Uterqüe, Oysho and MassimoDutti), the group has a presence in 216 markets and employs 176,611 people worldwide (according to the latest data available for 2019). .

With all this history in tow, the mission for the 'online' has been brewing for a long time. The most important milestone was the beginning of the integration that physical stores have been promoting for years with the online platform, betting on proximity logistics. This allows, among other issues, that, if the customer orders a shirt that is in a nearby store, it can be sent from there and that the order does not have to go through logistics areas in another more distant point. A change in the functioning of the inventory that underlined its relevance during confinement, when part of the workforce continued to work on the exit of merchandise from the store to online orders. The company took advantage of the presentation of results to highlight that it had already completed the 100% implementation and in all formats of RFID and SINT technology for the single management of inventory, while continuing to advance in the internal digitization of the operation of the company.

Online sales soared by 77% in 2020, reaching 6,612 million euros. Inditex's goal for 2022 was for virtual sales to reach 25% of total revenue. In the midst of the pandemic, these have reached up to 32.4% of income, when in 2019 they had been 14%. Although Inditex highlights that visits to its website have increased by 50% and that active applications have reached 132 million, it must also be understood that the increase in 'online' comes from the very nature of confinement. In addition, this trend occurs at a time when Inditex is immersed in a full effort to optimize its stores, reducing its commercial area for the first time in its history in 2020. Square meters fell by 5% to 4, 82 million, at 2018 levels, but the group argues that this trend occurs within this optimization effort, with 751 stores absorbed in 2020. In this environment, China has been one of the countries that has reduced the most, leaving to be in 2020 the geography with the most premises. However, Inditex also defends that the gross commercial space in "key locations" grew by 2%. In addition, it says to continue growing, since in 2020 it opened in 29 new markets.

Beyond platforms such as Asos or Zalando, which in the end have a different business model (they manage their own brands, but above all they have the presence of third parties), analysts point to the stalking of other listed companies such as the Swedish H&M or the Japanese Fast Retailling. The former has just recovered from the blow to the stock market from the pandemic, while the latter (owner of the Uniqlo brand) has hit all-time highs in 2021. In this environment, Credit Suisse once again put its finger in the wound after the results. With his buy recommendation, he said that he had been surprised by the sharp drop in stores in China (243 fewer), of which only 39 had been from Zara. "Non-Zara stores have been halved to 210, which reinforces our fears about the competitiveness of non-Zara formats, due to low selling prices and high maintenance costs, especially in markets dependent on air freight", they specified. "Our main concerns are the loss of market share 'online' and the loss of momentum in physical stores."

Instead, Barclays analysts, who have a 'hold' advice on the Spanish listed company, explained in their latest report to clients that they were "confident that Inditex will continue to increase market share in the coming months thanks to its multi-format strategy ". However, they also considered that "the recovery of margins and sales will probably be slower than those of their peers in the sector, including H&M (where they recommend 'buy'), due to Inditex's classification within the most 'fashion' fashion and higher-end price positioning.

The debate in the market is extensive. Jie Zhang, an analyst at Alphavalue, with a 'buy' advice on the Spanish company, defends the virtues of the Inditex model, which focuses on "the proximity model, with a design, production and sales cycle that barely lasts between 4 and 6 weeks". “This makes the group more flexible and faster than its peers in the sector”, adds the expert. In this environment, analysts look at inventory—that is, the accumulated clothing waiting to be sold—and its ratio to sales. The smaller, the better for the margin. "The group has industry-leading inventory management (at constant rates, this fell by 9% in 2020 despite store closures and reduced traffic)," says Zhang, who also highlights that the peso 32% of the 'online' in the case of Inditex, compared to 28% of H&M. In addition, gross margin (at constant rate) increased by 170 basis points to 57.6% of sales – compared to 50% for H&M. In fact, the analyst argues that the difference in valuation compared to the Swedish group only makes Inditex, with a solid and healthy balance sheet, more attractive.

"I think it's wrong to focus only on the 'online' issue, Inditex's strength is not only the digital pillar, for that you already have Zalando or Asos," explains Elena Fernández-Trapiella, an analyst at Bankinter, with a recommendation of 'buy '. “What is unique about Inditex is that integration between the physical store and the online platform —it is a model with many advantages, which in the long run provides very sustainable growth in sales and a lot of resilience in margins”, qualifies the expert, who underlines the low cost in expanding this way of working, improves control over inventory levels, and gives the versatility of being able to have stores as a showcase and support for the brand while also serving as logistics centers, facilitating delivery times. "Virtually, the stores are open 24 hours a day because the inventory of that location is always available on the web," the analyst exemplifies.

"Inditex is light years ahead of H&M, which is indeed copying that business model and for now it is trying to reach those margins and growth," says Fernández-Trapiella. Like Zhang, the analyst stresses that H&M's sales inventories, for example, are much larger than Inditex's, which generates more working capital cost.

In short, the pulse of Inditex's long-term share continues to be, with and without covid-19, the defense and expansion of market share in a changing world. Analysts have their discrepancies, although Inditex, despite being one of the oldest players in the sector, continues to stand out for its versatility and solidity. Investors seem confident in the company's ability to pick up the macroeconomic recovery —hence the parsimony with which the very negative results of last Wednesday have been taken.

"It is true that numerically the benefit has been somewhat below our estimates, however there are very positive issues for the future, while these results are from the past," explains Beatriz Rodríguez, GVC Gaesco analyst with buying advice. On the one hand, the analyst highlights that, despite the fact that 15% of stores are still closed, in the first week of March sales are only 4% of their normalized level before covid-19. Inditex expects that by April 12 all its stores will be open and, in the results, it highlighted the good reception that the premises are having again after the openings. "The digitalization strategy, not only for sales, but also for logistics control, inventory, etc., is progressing better than expected," the analyst considers. “Inditex will emerge stronger in the textile sector”. Rodríguez, who also welcomes the evolution of online sales and digitization, celebrates that, at an ESG level (environment, society and good governance), Inditex has stood out for protecting employment. The expert believes that the 'retail' is a good value to bet on the recovery. "In the end, it is a cyclical company linked to consumption," she points out. “The normalization from September augurs a very good season at the end of the year.

"The benefit has been somewhat below our estimates, however, there are very positive issues for the future"

In fact, analysts believe that the company will continue to increase shareholder compensation. The board has proposed a dividend of 0.7 euros per share, 0.22 euros as an ordinary dividend and 0.48 euros as an extraordinary dividend, with which it recovers its dividend policy, with a 60% payout ' Ordinary and extraordinary dividends. The payment, therefore, is doubled compared to what was made in November of last year. With a dividend yield of 2%, Inditex has never been a star bet on the list of the best Ibex 35 dividends, but at least in its case the market blindly trusts the sustainability of the payment. "A solid and sustainable cash generation capacity suggests a gradual increase in shareholder remuneration in the medium term," the Bankinter analyst stressed in this week's report to clients.

This is one of the reasons analysts' recommendations are so tepid, with 47% advising 'buy', 41% 'hold' and 11% 'sell'. The market has been anticipating recovery expectations and, at 30 euros per share, the company has already exceeded the target price of the consensus of 36 Bloomberg analysts. For example, Alantra's own analysts, after seeing the disappointing results, considered that the valuations were excessive, and put scissors. "At the stock market level, Inditex has already recovered a lot, investors have long anticipated the recovery - a recovery that is yet to come, but in which there is a lot of confidence - so the valuation is a bit tight", explains the Renta 4 analyst, Iván San Félix ('hold' advice). In the long term, San Félix considers that Inditex has been able to understand the environment it faces and celebrates the business model it has achieved after all these years. In the short term, to assess the potential on the stock market, the analyst believes that "the greatest risk is that stores take longer to open than expected."