I thought Zalando shares should be up more than 10% today…
This is more of an educational comment rather than a view really because I haven’t formed strong views yet on Zalando. When I got the company’s release I thought the shares today should probably be up more than 10%. Why? Well because the level of upgrade vs. previous analysts’ estimates was c11-13% give or take so if shares were to support their current EV/EBIT multiple the stock should be up 11-13% mathematically. Of course it is never pure maths. Zalando reported strong 3Q sales and EBIT and said that for the full year it maintains its sales growth guidance towards the top end of 20-25% (so no change there) but the margin will now be 5-6% vs. 4-5.5% previously. This is an extra 75bps people will factor in their models. This is an extra more than EUR20m on top of an existing FY16 EBIT estimate of around EUR175m.
…but they aren’t. Is it “travel and arrive”?
When trading commenced and the stock was up only 4% I was very tempted to buy it. I didn’t, got scared a bit and then stock moved to +1% and I was completely put off thinking that there is a material “travel and arrive” here but is there really? I mean on July 18 it was trading at EUR27 and now it is 43% higher so it is enormous in just 3 months. Indeed BUT since July 18, when sentiment was already extremely low for the shares, as documented by an 18% short interest according to Markit, the company raised margin guidance twice (on the 18th of July and today 19th of October) worth combined more than 30% increase on EPS estimates. So with shares being up 43% since then it doesn’t sound too unreasonable. Especially if you think that prior to the 18th of July shares were down 27% YTD so really this 43% share price increase mostly erases previous losses. Stock is up 7% YTD vs. ASOS up 46% (sterling has depreciated by c20% though so in EUR terms the outperformance is more moderate) and I still like ASOS a lot. So why get scared with Zalando’s share price at this level?
Can Zalando move higher post today?
I think I got scared due to behavioural biases. Current share price is a historical high (but absolute numbers should mean nothing. The valuation is not that bad actually) but momentum guys will say that this is actually a good thing. In valuation terms Zalando seems to grow sales at a level similar to ASOS with an EBIT margin 1% higher than ASOS now, being of similar PE (c70x) and EV/Sales (c2x). And I still do like ASOS as I mentioned in my post yesterday especially if it pulls back a bit temporarily. So I should have probably bought the stock in the morning. It is now back up 6+% (damn it!) as I write (I write so slow) and I am still very tempted but better if I write in the disclosure I don’t own this stock and then do a bit more research so that I feel comfortable with the longer term.
Zalando operates only in Europe, so their Total Addressable Market is a lot smaller than ASOS’s, which has to be factored in the valuation (I think Zalando deserves a discount to ASOS longer term unless ASOS starts doing badly in the US, which I cannot foresee, but not every investor may think the same after today). The growth opportunities in Europe are still ample for Zalando. I think Zalando shares can achieve new highs, it is an innovative company with a good business model and operates right in the centre of a growing online fashion theme that I like. Like ASOS. Although their business models have distinct differences. Zalando’s track record is young and did have some very volatile margin outcomes a few quarters back. To be fair to management they have multiple times mentioned that sometimes excess growth can be captured by compromising near term margin. I get the idea and they do seem to control it but building rapport with investors needs time. Worth exploring the buy opportunity but it is not for the faint hearted.
Author: Chris Chaviaras
Disclaimer: The author has no position on Zalando currently.