Do ASOS shares overreact today? Buy or Sell?

Oh don’t be too greedy! If you invested at the beginning of the year you are still up 44% after today’s move or if you invested a year ago you are up 67% and 5y ago you have more than tripled your money. You are only losing money if you invested two weeks ago but if your time horizon with ASOS is two weeks and you have started panicking then you deserve it and I suggest trying the casino next time! So should you be taking profit (most of you) after today’s share price move or there is further upside?

Why is ASOS down 7% today as I write?

Investors have been piling up on ASOS shares for a while on good sales performance, even more positive momentum with customers, stabilisation in margins and more recently expectations of material FX tailwinds due to weak sterling. As it always happens with this stock shares overreact both up and down. For the stock to go higher, specifically today, you needed an upgrade in either the sales growth guidance for FY17 or the margin guidance or both. Instead you got served an unchanged growth guidance and a material increase in capex from £87m to £120-140, which will at best stay as high in FY18 if not higher assuming investment in a new US warehouse. Boom! The way to go Helen (Mrs Ashton is the CFO)! So no EPS upgrades today, higher capex spend, “expensive stock” on a PE multiple and very good performer recently so…makes sense?

Is this the end of the share price run?

Please take a deep breath and reread what I wrote before and think whether the reasons the stock got higher prior to today cease to exist. I really think they are still there and actually got stronger. Sales performance is good and can get better, ASOS engages with a lot more customers who spend increasingly more time and money with ASOS , through mobile primarily, where ASOS excels, margins are stable and within the management’s absolute control at the moment and FX tailwinds are there, more phased into the next 1-2 years rather than now but they are there. So no this is not the end of the run.

Can ASOS shares move higher after today?

Yes. For three reasons other than the fact that their customers continue to love their product.

  1. The sales growth guidance is conservative. I heard twice Mrs Ashton during the analysts presentation earlier today say that this is an initial guidance and will be revised as the year progresses. Of course it will. Higher. Why? Well look at the customer growth. Customer growth accelerated to 25% from 18% 6 months ago and c10% a year ago. Increased marketing spend, reduced prices and improved customer experience delivers. I would treat customer growth as a leading indicator and the starting point for total sales growth. On top I reckon we will be getting FX tailwinds, increased average basket size as price investments yield fruit. So that 20-25% can be more 25-30% I believe unless something radically negative happens that I don’t foresee.
  2. Increased capex is good when ROIC and growth are high. Be worried when a growing business doesn’t spend much, not the other way around. I know I know you worry they splash the cash! That £173m cash is tempting. You worry they make their HQ at Mornington Crescent a playground hence the return on investment will be zero on quite a few £m spent there over the next three years. I wonder what Google’s investors did say when they first discovered that Google’s offices were a playground and how happy they are with the share price since then! ASOS is its people and keeping them happy is a great investment if you ask me. Generally a retailer’s asset is their people as retailers are light on tangible assets so I have no issue with a great working environment. And look at the numbers anyway. Return on Invested Capital was 47% in FY16. Even if it just stays at the 30-40% region tell me this is not a great return or, put simply, money well spent. If suddenly they were buying a few Lear jets to travel around then yes I would have got worried but they don’t.
  3. Brexit affects ASOS the least vs. any other UK consumer discretionary name. Let’s not forget what will likely be the big cause of volatility over the next few months. Actually it benefits them as ASOS exports more than 60% of its product and is a natural net buyer of non-sterling currency. Doesn’t sound too bad! Let alone that their core customer wouldn’t care much about political developments so there shouldn’t be big mood swings affecting their shopping habits unless of course they lose their jobs (too big a debate to open it up now).

Keep calm and focus on what matters…

No I don’t give ASOS management a carte blanche and none of you should but it really doesn’t smell trouble to me, quite the opposite, other than the near term retreat that I find reasonable. Mr Beighton (CEO) appears to be on top of operations, Mrs Ashton confident with her numbers and I bet Q1 and Q2 sales growth will be comfortably ahead of the top end of guidance. They still have my vote of confidence because I think I can understand the reason shares are down today. Can they be down a bit more? Of course, they always overshoot either way. I wonder how US investors will react when they see Nick, Helen and Greg (CEO, CFO and IR) over the next few days in the US. Usually they understand growth stocks a lot better than European investors but they may be also tempted to let the stock pull back a bit before they go back in. I may wait until the team is back in London but I cannot see any reason the stock won’t cross comfortably above £50 again very soon but if you can time a small correction well you can make good money! But don’t be greedy. Oh yes I forgot the very high valuation, c65x PE. Ohh yikes too much right? If it doesn’t smell trouble it is irrelevant. You could have bought ASOS a lot cheaper than that 2y ago and lose money over a few months period or a lot more expensive than that 3+ years ago and made money. The PE has fluctuated between 30-100x

Author: Chris Chaviaras

Disclaimer: The author has no position on ASOS shares currently.

8 thoughts on “Do ASOS shares overreact today? Buy or Sell?”

  1. Hi Chris,

    Let me first start by saying that I really liked your post on ASOS.
    I was wondering if you could elaborate more on your 2nd point, where you wrote “… and is a natural net buyer of non-sterling currency…” .

    What do you mean by that? Also, any views regarding the sensitivity of ASOS to FX moves (lower, upper barriers)?

    1. Thank you very much for your comment. Regarding my point about ASOS being a natural non sterling buyer what I mean is that ASOS sells 60% of its product in non-sterling currencies, primarily US$, EUR and AUD. At the same time it only purchases 20% of its goods in non-sterling currency, again mostly in EUR and $. As a result at every period in time ASOS is left with a lot of EUR and $. Given the sterling’s weakness this foreign FX is now worth a lot more £. ASOS is an exporter in that matter. Regarding a sensitivity analysis please take a look at the table in the mail I sent to you (I could not paste the table in this comment unfortunately!). Assuming 1% depreciation of the £ then the gross profit improves by £6.6m or 1% using the most recent FY16 published numbers (as of today). Now you can easily see how big the FX tailwind for ASOS is given the c20% sterling depreciation vs the $ and the EUR. Before we get too excited though there are two caveats before we can say that the EBIT can improve by tenths of millions of sterling and the stock can double just because of that: 1. we need to take into account opex in non-sterling which is not known but certainly partially offset the tailwinds and 2. more importantly management usually uses the FX tailwinds to reinvest back into the customer proposition with lower prices, better delivery proposition etc. that cost in the near term but deliver longer term growth. Nonetheless the FX tailwind is material and can give management material leeway to deliver more comfortably in its strategy in my view.

  2. great piece Chris, I couldn’t agree more. You want them to spend at such returns. The US roll out – as you ve highlighted in the past – is the next leg to the growth. Hard to find many (any?) genuine growth stories these days, I think the multiple will hold for now…

  3. Hey Chris, even though I like your post on ASOS, I think it is missing a couple of valid points (that a cheering sell-side community around ASOS is simply missing). So its great that ASOS grew another 26% in FY16, but there were several red flags well hidden in numbers:
    (1) While not a bad thing per se, ASOS reported a £13m increase of deferred tax assets in FY16, which is boosting FY16 EPS (needed as EPS are hit severely by the trademark settlement), but will have a reverse effect in future periods.
    (2) ASOS reported 50bps opex leverage, mainly driven by an 80bps improvement of “Other operating costs” (mainly office running costs, transaction and legal costs), i.e. that leverage is not driven by the business itself. A 40bps warehousing cost improvement is more than offset by 30bps of distribution investment and 40bps higher marketing spent (which has to go up further with ASOS pushing into the US and EU markets, where the ASOS brand is almost unknown).
    (3) Return rates in second half of 2016 exceeded 50% (540bps higher than in 2015) as ASOS offers now free delivery to mainly all countries and the company pushing deeper into the German speaking market (Zalando sees ~60% return rates there). Higher return rates actually more than offset improvements in orders, basket value and order frequency, as ASOS is reporting those figures before returns (Zalando and YOOX do the right thing adjusting for returns). If ASOS would do similar adjustments, none of those metrics would have shown improvements in ’16 (rather the opposite is true).
    (4) ASOS had a huge 1,000bps (10%) increase in payables/COGS (now 51% vs. last years of ~40%). Adjust for the significant increase of payables, FCF would have been negative in FY16. Even if assumed that suppliers will adopt to new payment terms, this one-off won’t be repeatable in 2017 and will weigh on FCF (but ASOS doesn’t speak FCF and points investors to meaningless ROIC).

    Guidance of “broadly stable” margins seems weak as not every penny should be reinvested in price (price investments are generally rather complicated as they are not reversible), but draw your own conclusions from here.

    1. Hi there I like your comment it enhances a good dialogue. I will start by agreeing that sell side is consensus Buy. But that’s not necessarily wrong but I get where you are coming from. But that doesn’t mean plenty on the buy side don’t dislike ASOS or that too many own it. Let’s discuss the red flags you see though:

      1. Re deferred tax: I think your comment should be quite the opposite. Deferred tax asset means the company has overpaid tax in previous years (stemming from losses). These taxes are eventually returned to the business in the form of tax relief, and the over-payment is, therefore, an asset for the company. So that should have a positive impact on EPS in future periods not a negative one right? It won’t move the needle anyway as it gets realized as lower effective tax in future years.

      2/3. Re margins and return rates: I agree with increased marketing and with the other numbers you refer to, but I see nothing wrong. They control their margin completely at this stage. If they wanted to show better margin they could have avoided improving the service proposition this year and wait till next using some of the operational gearing. But they have told investors they are not going to do so. Anyone investing in ASOS knows what they have to deal with regarding that matter. But if Zalando can make 5-6% EBIT margin being so big in Germany (with traditionally high returns) I cannot see why ASOS cannot, especially after the Eurohub is a lot better than three times less efficient that Barnsley that currently is. I am not sure how high returns at ASOS are as they don’t report them. I estimate them at around 40% if not a bit less so not sure where you get that 50% or more from. I can stand corrected though if it is the case.

      4. Re payables: I think the ratio of payables/COGS could have some flaws. Payables is a photograph, a number taken on the 31st of Aug 2016, vs COGS being a flow over the year. We don’t compare apples with apples here I think. Also we cannot isolate payables without looking at inventories. Inventories are up 33% y/y, as ASOS is planning for increased sales growth, which of course gives rise to increased payables. The mentioned ratio ignores inventories that have increased a lot. I think you are right to say that ASOS got better payable terms last year, if I recall well, but they are still paying in line or still better than many other retailers. Have a look at Inditex and do the same analysis. It will raise the same “red flag” but there’s nothing wrong to have improved WC when you grow and inventory turns are faster.

      4. Re FCF generation: FCF is very low at ASOS you are absolutely right. But we have to look at the terminal FCF and margin potential to value ASOS appropriately. I don’t think that anyone buys ASOS on a FCF basis at this stage though. Otherwise they can cut capex and show great FCF generation but they then killed growth. Focusing on ROIC is right. Does the money you spend generate good returns? Just to exaggerate so I make my point, say you are a small business with a great idea and make a profit of £10 in a given year but needed to spend £100 for future growth in that same year. If that £100 gives you more than 40% return p.a. then why not tolerate a -£90m FCF in Y1 assuming you can find the money to fund the negative FCF.
      In terms of reinvestment they don’t reinvest in price only. Actually they did say in the analysts presentation that they only have Australia left where they will do price investments but generally with the rest they are happy where they are in pricing. But even if they weren’t and needed to do more price investment the product is such fast fashion that prices will never be sticky. What Inditex a lot of times calls “fashion mix” is what moves the dial materially. That’s my view of course.

      Thank you again,
      Chris

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