(Bearish) Letter from America

Brexit continues to make the headlines even in the US. Many key US corporations reported earnings yesterday and some, who offer a readacross to UK names, were pretty disappointing. The most important in my view was that of the world’s largest manufacturer of appliances, Whirlpool, who announced a pretty bad quarter and the stock was down 11%. Q3 EPS fell 5% short of analysts’ expectations but more importantly the company provided a pretty cautious outlook. Now why do I bother writing about it? Well it reinforces my view that the UK consumer should brace for some pretty challenging Christmas ahead (see http://hereticinvestor.com/is-christmas-coming-this-year/)

Why do I say so?

Well Whirpool’s management says so. The weakness in Q3 (July-September) was due to “temporary U.S. demand softness as well as Brexit-related currency volatility and demand weakness in the U.K.” Brexit makes the headlines already in the US corporations’ releases with severe effects on share prices. It is important to keep an eye on what the manufacturers say because there is a big readacross for the retailers who sell their stuff. It is the first actual tangible warning about demand the way I see. Whirpool’s sales in Europe, Middle East and Africa were down 13% in Q3 (-6% ex FX) and ongoing profits down 32%! These are some big moves!! EMEA is c25% of Whirpool’s sales. I am not sure how big the UK is for them but the fact that it features as one of the two main reasons, which resulted to the company profit warning, makes it serious.

Implications about the housing market and the wider UK economy

I don’t want to read too much from one company’s results but if demand for appliances is so negative then it means that the housing market is not at its best. If the housing market, a major constituent of the British consumers’ wealth, is getting softer then the implications about the wider consumer demand are pretty grim. I can’t quantify that at the moment but sense check that. Because of Whirlpool’s weakness yesterday (together with Sherwin-Williams, a paint manufacturer, whose shares were also down 11% on the day), Home Depot and Lowes, the two biggest DIY companies in the US were down 3.5%. It will be interesting to see what the two companies actually report on the 15th and 16th of November (Q3). Home Depot is used as a yardstick for investors’ sentiment on Kingfisher here in the UK so weakness there may easily negatively impact Kingfisher here albeit with a lag.

Do Sprint and Apple results matter for Dixons Carphone?

Sprint was another name that reported results yesterday and the stock fell 6%. I believe this is more “travel and arrive” though as the stock is up 80% YTD with Sprint actually raising guidance substantially expecting EBIT of $1.2-1.7bn vs. $1-1.5bn before. Dixons Carphone has a deal with Sprint to operate 500 new Sprint stores, which can actually be very profitable in the next 3 years if indications about Sprint’s profitability continue to be positive. One bad thing though was that Sprint’s net additions of postpaid subscribers were 344k, versus estimates of 403k new customers. Dixons Carphone will need to help Sprint reverse that with their valuable “Know How” (as they did with Best Buy mobile), otherwise profitability may eventually struggle.

The news on Apple are mixed. Apple sold 46.5 million iPhones in the quarter ending September. That’s better than analysts’ expectations for 44.6 million iPhones but still 3% down y/y. iPhone 7 participated only in the last two weeks of the quarter so it is early to assess its success, which is important for Carphone, but nonetheless iPhones do seem to struggle (despite Samsung’s phones exploding…)

Conclusion/My view

As I said in my post about Christmas in the UK I find the upcoming festive season to be challenging from a UK consumer’s demand perspective and I still expect UK retailers’ shares to touch their post Brexit lows. We are not yet at the point of maximum pain. Big tickets will suffer the most. I am very surprised how well Kingfisher’s shares hold up vs. most other UK retailers!

In anticipation of the Chancellor of the Exchequer’s  November budget…

I believe there is no way Mr Hammond will not announce fiscal stimulus although I am not an economist. We can debate what the Budget may look like at a slightly later stage (we still have a month ahead of us) as this can be another catalyst for consumer names but till then the news is not bright…

Author: Chris Chaviaras

Disclaimer: The author doesn’t hold any shares of the aforementioned companies

Can Zalando shares continue to achieve new historical highs post today?

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.

One caveat

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.

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.

When passion about investing becomes an heretic dialogue

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