EUR 850.00 For Business Accounts Only

Morningstar | H&M's Profitability Hurt by Investments Needed to Bring Brand Back on Track; Maintaining FVE

We maintain our no-moat rating and SEK 147 fair value estimate for Hennes & Mauritz as the company reported full-year revenue in line with our expectations but an operating margin of 7.4% versus our forecast of 8.3%. This was driven by a lower-than-expected gross margin--52.7% for the full year versus our 53% forecast--and higher operating expenses in relation to sales at 45.3% versus the 44.7% we expected. Operating costs included items related to logistics systems replacement and related disruptions of SEK 560 million, around 3.6% of operating income. We continue to view the next three years as investment-heavy for H&M with an operating margin around 8%. We view the shares as fairly valued.

Inventories were up 12% year on year versus 5% growth in revenue for the year, signaling that the inventory problem has not been completely solved. Despite that, management expressed confidence in the improving quality of the inventories and expects the cost of markdowns to decrease 1% in the first quarter of 2019. Online and newer brands failed to live up to internal expectations, delivering 21% and 20% growth, respectively, versus the target of above 25% for the year. Gross margins have been affected by quality and price investments, which we see as reasonable, considering intensifying competitive pressures in the industry. Investing in free online delivery is one more way that the company is improving the customer value proposition, with a hit to operating margins. We think H&M can use its scale cost advantage to deliver a better value proposition to customers, spurring sales. Inefficient retail outlet closures and rent renegotiations could help address the problem of a bloated cost base down the road.

The company proposed an unchanged dividend of SEK 9.75 (equal to a yield of 7% on current share price). It increased its long-term debt position by SEK 10.5 billion and now has a net debt position of 0.33 times EBITDA.

The company expects to open net 175 stores in 2019 versus 229 in 2018, a 3.5% increase versus 4.8% in 2018, with H&M openings largely focused on areas outside Europe and the United States (50 net H&M store closures are planned in Europe) and other brands, such as COS, & Other Stories, Monki, Weekday, and Arket.