Zara's Shrinking Profit Margins Expose a Fashion Behemoth
December 13 2017 - 5:29AM
Dow Jones News
By Jeannette Neumann
MADRID--Shrinking profit margins at the parent company of Zara
have exposed a rare weakness in the armor of a fashion behemoth
that has largely resisted the headwinds currently battering the
industry.
Inditex SA, the Spanish company that owns Zara and brands such
as Massimo Dutti and Bershka, on Wednesday reported a net profit of
EUR2.34 billion ($2.75 billion) during the nine months that ended
Oct. 31, a 6% increase from a year earlier. Sales at Inditex
climbed 10% to EUR17.96 billion for the period. Like-for-like sales
accelerated in the run-up to the holiday season.
But Inditex's gross profit margin declined 30 basis points to
59.4% in the fiscal third quarter from a year earlier.
The full-year gross profit margin at Inditex, whose full name is
Industria de Diseño Textil SA, has continued to fall from its
fiscal year 2013 peak of 59.8%. While Inditex's profits outstrip
those of competitors such as Hennes & Mauritz, analysts and
investors have questioned whether the slide at Inditex is due to
short-term factors such as currency movements or reflects long-term
challenges to its winning model.
The company, the world's largest fashion retailer by sales,
sources and produces the bulk of its garments close to home, which
allows it to design and deliver new items to stores in as little as
two weeks. That rapid-fire turnaround has transformed Zara's parent
company into one of the world's most profitable retailers.
But Zara, and Inditex's seven other brands, including
Pull&Bear and Stradivarius, haven't been completely immune to
the ills affecting American clothing companies such as Gap Inc, and
J. Crew Group Inc., which have been hammered by consumers shifting
to online shopping.
Most analysts attribute the shrinking margins to adverse
currency moves that they expect to abate in 2018. Analysts at
Macquarie Group estimate Inditex's gross margin will begin to rise
next fiscal year to 57% and maintain roughly that level
thereafter.
"If there is one company which has proven its ability to
outperform even in a hostile market environment, this is Inditex,"
said Macquarie analyst Andreas Inderst.
Investor concerns about profitability have pushed Inditex's
shares down 5% year-to-date through Dec. 12, less than the decline
of many of its peers. On Wednesday, though, Inditex shares were up
around 3% in morning trading in Madrid, erasing some of those
losses.
Zara's parent company generates more than half its sales in more
than five dozen non-euro currencies, but produces most of its
product in Spain, so the weakening of those currencies in
comparison to the euro has chipped away at reported revenue in
euros.
Inditex executives said Wednesday that without the negative
currency impact, the gross margin would have increased in the
fiscal third quarter, but they declined to say by how much.
A few analysts, however, think price cuts aimed at buoying sales
have hurt Inditex's margin. They also believe sales at stores open
at least a year are no longer offsetting the cost of increasing
online sales. Online sales, they say, are less profitable than
those at brick-and-mortar stores because of the added cost of
delivery.
"While we retain our admiration for Inditex's business model,
our confidence in the sustainability of exceptional revenue growth
is declining as competition mounts," Berenberg Bank analysts wrote
in a research report.
Inditex executives say the company is constantly adjusting
prices but says it doesn't have a strategy of slashing prices of
its cheapest garments. "Our pricing policy is very much stable in
all the different geographies," Inditex Chairman and Chief
Executive Pablo Isla told analysts Wednesday.
Société Générale conducted an extensive study on Zara's prices
in 10 countries and found that the retail giant had in fact cut its
lowest prices in 2017 compared with 2016 but that Inditex was also
raising its top-end prices to widen its appeal and boost sales.
Write to Jeannette Neumann at jeannette.neumann@wsj.com
(END) Dow Jones Newswires
December 13, 2017 05:14 ET (10:14 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.