Tag Archives: ASOS

ZALANDO + ASOS = Love For Ever?

As I was landing in Athens yesterday evening (March 14) and going over my regular Close Of Business (COB) share price checking, I couldn’t help but notice a material and sudden 3% jump of ASOS shares at 3:57pm GMT, 33mins before COB. Wow what hapened there? The move can be explained by a 3:57pm announcement that Mr Anders Holch Povlsen bought 1m shares (c1.2% of the entire company) through his investment vehicle Aktieselskabet, with Tybourne Capital being the seller. The largest shareholder of ASOS increased his stake even more to above 29%, just shy of 30% at which level he would be obliged to do a tender offer for ASOS. 

This is big news and there are a few scenarios why Mr Povlsen increased his already big stake at ASOS. I doubt he wants to do a tender offer and I doubt he just thinks ASOS is undervalued and he can sneak in an extra 1% of the company at a good price as if that would make any difference to him. I also doubt that he was sitting at a pile of cash he had nothing to do with (although he is indeed a wealthy man) and thought “hah let’s buy more ASOS”. I believe he is thinking a lot more strategically. After all he is the owner of well known brands like Jack & Jones and Vera Moda with thousands of stores around the world and he needs to partner with big online platforms. Should investors start entertaining the scenario of ASOS and Zalando merging together!?

It actually makes sense for both Mr Povlsen and the rest of the shareholders at both companies if you think about it. I can think of 8 very good reasons why:

  1. The bargaining power with third party brands would increase…materially. The merged entity would be the undisputed global leader in online fashion and THE priority platform for third party brands. With more than 30 million active customers globally, active specifically on Fashion, any fashion brand would be crazy not to have the merged entity as the no1 parner of choice. Even investors’ concerns about the impact of Amazon Fashion on both ASOS and Zalando would diminish as Amazon would find it very difficult to compete with such a proposition.
  2. ASOS and Zalando operate in complementary geographies. Zalando is very strong in Continental Europe, ASOS is extremely strong in the UK and Australia and strong in the US, Russia and some markets Zalando would need time and money to invest with unguaranteed results.
  3. ASOS is strong in fashion and curation, Zalando is strong in technology. The combination can be explosive!
  4. Infrastructure efficiencies. Infrustructure, which is a bottleneck for both companies, is also complementary and material economies of scale can be achieved. Zalando has extended and automated warehousing in Germany where ASOS is now trying to build up (ASOS would no longer need to go through warehouse maturity and potential sales disruption). ASOS is building up the US (Zalando is not present there) and has a mechanised warehouse in the UK where Zalndo cannot break through despite years of investment.
  5. Operational leverage. The merged company could leverage costs better (marketing, personell etc) and achieve a combined higher EBIT margin than the sum of the parts currently.
  6. Talent acquisition and career development, a major factor for growth companies, would become easier. Who wouldn’t want to work for such a company? It would be the Google of fashion.
  7. The two companies have an overlapping shareholder basis which could make a merger technically feasible. Anders Holch Povlsen owns 29% of ASOS and 10% of Zalando. Baillie Gifford owns 9% of ASOS and 7% of Zalando. Capital Group owns 10% of ASOS and some part of Zalando (although it is not a top7 shareholder there).
  8. It increases stock liquidity  (particularly important for Zalando who has some Private Equities as shareholders) and makes it easier for some shareholders to divest their shareholding (of a larger Group) and many large cap long onlys to come in. Let alone the new company would be a large cap name, elegible as an investment with more funds (a dual listing in FTSE100 and Xetra DAX would be possible). The merged company would enter a more mature phase with its ownership structure and likely more stable one, which would make it a more appealing investment. 

How could the shareholder structure shape up?

If a meger was to happen I would bet money that Mr Povlsen wouldn’t sell a single share owning c18% of the merged company. I remember him telling me a few years ago “Chris I am not an investor. Investors buy and sell. I only buy”. I would dare to say that he would have a leeway to even own 11% more. Baillie Gifford would still own c7% of the merged conpany. Capital as a major ASOS shareholder would also be happy with a merger and could even increase its stake from a c5% initial stake. Maybe Kinnevik, a couple of hedge funds and the founders on either side of the trade (if they want to be less involved) could sell with their stake being picked up by Mr Povlsen and other long onlys (in the short term of course plenty of hedge funds would get involved). Given the shareholder structure I would expect an “all share merger” with a c38%/62% ratio based on current market caps ASOS/Zalando if such an event was to happen. 

What could the Board of Directors look like?

Admittedly there are a few cultural differences in the business philosophy of the two companies. ASOS focuses on customer engagement more with Zalando being the tech freaks. ASOS has a British BoD and Zalando a German one. Different mentalities yes but I don’t think that the gap cannot be bridged if the owners want it and when the potential success can be so mutually beneficial.

Let me speculate on who could manage the merged entity in an assumed merger. In a scenario where there are two CEOs then I can see Nick Beighton and Rubin Ritter filling up the two positions. Rubin can act as a COO as well given his experience. Helen Ashton would stay as the CFO given she is very thorough, numbers focused and well liked by investors. In another scenario though where the merged company goes for single handed roles then Nick Beighton could be the CEO given his extensive (successful) experience at ASOS, longer than anyone else from both ASOS’s and Zalando’s Management Boards. (A technical complication could be that usually with mergers the larger company places the CEO, i.e. Zalando in this case). Rubin Ritter would then be the CFO as he is the one dealing well with the company’s financials from Zalando’s trio and is Zalando’s main face with investors. David Schneider who deals “with fashion” at Zalando would likely find that this is the bread and butter within ASOS while Robert Gentz could be redeployed but cannot claim either the CEO or the CFO role in my view.

The merged company would then need a Strategy team (ASOS doesn’t have one at the moment), which Birgit Haderer (Opp) at Zalando could fulfill (she has been a Goldman Sachs banker in the past). The Head of IR role would stay with Greg Feehely at ASOS who has won plenty of “Best IR” awards during his career at ASOS and has ample of experience dealing with investors and analysts. 

It makes sense right?

The merged company (ZALASOS!?!?) 🙂 would have sales of more than 5bn, EBIT of 300m, growth of c25% with plenty of efficiencies to be extracted and material growth and margin opportunities. It would make sense right?

Author: Chris Chaviaras

Disclaimer: This is not an advice to buy or sell shares at either ASOS or Zalando. Do your own research before you reach any conclusions. I don’t currently own any shares of the two companies and I don’t plan to do so for at least the next 72 hours.

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.

Is Christmas coming this year?

I remember a phrase a CEO of a well-known British retailer told me a few years ago, ahead of an uncertain Christmas trading period. “It may be late, but it always comes”. Fact. I don’t dispute facts, not for a second. But what kind of Christmas will we be having this year? From a consumer point of view of course… It certainly looks challenging to me. Why do Christmas matter so much? Some retailers make the bulk of their profits that period and for all it is an extremely important trading period that defines momentum into the beginning of the following year.

Uncertainty over Brexit will hit consumer confidence and hence spending

Britain will be invoking Article 50 to exit EU for all we know. Will it be a “soft” exit or a “hard” one? I certainly don’t claim to know more than you do but news headlines are already increasing and they will get fiercer with time. I know for a fact that uncertainty doesn’t help consumers’ psychology and when the mood is not great then spending probably takes a hit. Let’s try to quantify that towards the end of this article.

The sterling weakness will cause price inflation for the consumer and margin erosion for the retailers

The sterling has fallen off a cliff. Now other than boosting my adrenaline to the limits by me spread betting on the “cable” (no I certainly won’t be doing that again), it hasn’t really touched on people’s everyday lives. But it will! An economist would probably say this is a good thing for the economy (nominal growth!). Well I am an equities guy I don’t see it that way. Inflation will put strain in people’s purchasing power. I bet the retailers will seek to pass on some of the cost pressure they feel from the strengthening USD to the consumers otherwise margins will also fall off a cliff. In 2011 (when cotton prices skyrocketed and many apparel retailers raised prices by 5-10% to offset the cost) the price elasticity of demand worked in their favor. But in 2011 things were improving and the savings ratio was more than double what it is today (see later on in this post). Now things are uncertain at best. Uncertainty and higher retail prices. Not a great combination!

So what will retailers need to do? The £/$ is down c20% post Brexit and most apparel retailers source 2/3 of their product from the Far East paying in US$. If they keep their prices stable then they can suffer up to a 500bps margin erosion. Alternatively they can raise prices by 5% and maintain their level of absolute profitability (assuming that consumers don’t buy less product after the price increases which is very unlikely) or they need to raise prices by 13% to maintain the level of gross margin they had (check the example’s table below). Now of course we need to take into account negotiations with suppliers who could be supportive and get some of the hit but the point doesn’t change. The movements are very big and the retailers will need to mitigate the damage through both suppliers and consumers. Otherwise here is an exercise for you. Go put a reduction of 500bps of margin (or even half that) to any retailer’s revenue that you can find in their annual report and see what happens to profitability. It can be an Armageddon!

In the example I am using a potential retailer who makes a 60% gross margin (usually apparel retailers have a bought in margin as high), with 66% of their Cost of Goods Sold (COGS) sourced in USD assuming that sales grow only by the amount of price inflation with volume growth being zero (economic theory will tell you that rising prices will cause volume declines).

sterling-impact-on-margin

Consumers are not even aware (well most of them I reckon)

The other very important thing is that a really challenging Christmas period is kind of not widely expected, either by the retailers or the consumers. The UK is a nation of spenders, granted that, and “Brexit” has been voted by the majority of the British people so in the view of most consumers Brexit is not a disaster, hence the mood has not yet worsened. Also unemployment at 4.9% is close to historical lows. Consumer confidence is actually close to all-time highs. Only 19% of the Brits expect the situation to get a lot worse in the next 12 months (see http://www.gfk.com/en-gb/insights/infographic/uk-august-2016-consumer-confidence-landscape ). If I am right this is very likely about to change. I don’t want to sound too gloomy but emotions will gradually give the baton to the reality of price inflation and uncertainty. Take a look at the consumer confidence chart in this link (hit http://www.tradingeconomics.com/united-kingdom/consumer-confidence and click Max in the graph). From July’s blues post Brexit to September’s “it is all fine” it is too much emotion too soon. Even if the mood settles somewhere in the middle it is not great news.

What is very alarming is the close to historically low savings ratio (% of net disposable income the UK households save at a certain time). What does it mean? Consumers have very little leeway in retaining their spending level if their income gets squeezed. This could warrant abrupt behaviour on their spending patterns. Put simply, the consumer has not saved much for a rainy day. I don’t want to be too cliché but last time the savings ratio was so low was just before Lehman’s bankruptcy. Well sure but now we are not faced with such a radically negative event like a big investment bank’s collapse (dejavu?), are we? Anyhow I really can’t see where the positive news are coming from for the consumer. And before I get accused of thinking that 52% of the UK population made the wrong decision, I don’t claim that. I don’t know that. But I am certain we won’t find out whether Brexit was a good or a bad choice this Christmas or maybe even next Christmas.

uk-savings-ratio-sa

Many UK consumer discretionary share prices can hit or cross their post Brexit lows

So what kind of sales declines should we expect to see? Well go back to a time when consumer confidence was falling rapidly with a combination of a savings ratio as low as it is today. You have to look at the 2008 era (I know Lehman’s collapse time. Darn so much coincidence making me so cliché). Back then, for a period of 5-6 quarters non Food LFLs (Like for Likes is a measure looking at sales coming from existing stores) were down 4%. DIYers like Homebase and B&Q were recording LFLs of down up to 10%. Well from experience I can say that every percent of sales decline can cause on average a negative swing of c3-4% on earnings all else equal. So we may be looking for earnings declines of more than 10% and for some retailers a lot more than that. Let’s look at the valuation.

The share prices of many UK consumer discretionary companies like Next, M&S, Kingfisher, Dixons Carphone, Sports Direct etc. have actually been weak for the last couple of weeks, if you check their price charts, and their forward Price/Earnings ratios hover around 11x, which many may see inexpensive. But before someone calls the UK retail space cheap and a “buying opportunity” we need to define where earnings estimates are heading. There is a high risk that earnings are heading south in a potentially big way as we established above (sure there will be particular names  which could actually differ). The market is usually early to spot uncertain times, hence the 11x PE from c15x a year or so ago but there is still room for downside to the P/E levels if investors start factoring in a deteriorating consumers environment. There can be a multiple contraction of 1x, which can translate to another c10% downside to share prices.

If we add both together then for some retailers we can see share price declines of 20% or so. It has started already, as many companies have already lost 5-10% of their local highs. Whether there is some sort of recovery in the next few days, time will show, but my verdict is that shares of many UK retailers can touch their post Brexit lows before we start fishing for buying opportunities!

Conclusion: I would exert extreme caution with UK consumer stocks right now and for the next few quarters.

Let’s leave it there for the time being, this post is a lot bigger than I wanted it to be initially. The fun part about UK consumer discretionary stocks is that they are almost all unique cases. Self-help stories, restructuring cases, distressed plays or growth names. Every one of them is treated differently by investors who have diverging expectations. I will be touching on specific names at later posts. The overwhelming theme though is that sales declines, maybe major ones, will be very difficult to avoid and reliance on cost cutting will intensify. UK consumer names who are exporters, like ASOS and Boohoo, who benefit enormously from a weak sterling, will fare a lot better. They don’t come cheap (how expensive is expensive? Is a whole new topic) but they are severely less impacted by the UK consumer’s upcoming troubles. But I have told you that a lot later than you would have liked to if you look at their share price charts.

Of course there are names worth owning in the midterm because they can react to a potentially tough environment or they have a particular good story behind them. Also worth remembering that a good company does not necessarily make a good investment and a bad company does not necessarily make a bad investment.

But many retailers will find that they need to keep pedalling hard just to stay still.

One caveat…

It’s getting cold out there so some may want to play the short term benefit UK apparel names may experience. Don’t fall into that trap!

Author: Chris Chaviaras

Disclaimer: The author has no open positions on any UK consumer shares at the moment.