Morningstar | H&M's Sales Accelerate but Profits Still Impacted by Investments; Fair Value Estimate Maintained
We are maintaining our fair value estimate of SEK 153 per share for H&M as the company reported a slight decline in operating profit in the second quarter. Although revenue increased by 11% in SEK and 6% in local currencies, margins remained under pressure. Gross margin declined to 55.4% from 56.1% a year ago, despite reduction of markdown costs in the quarter by 1 percentage point, negatively impacted by a strengthening USD (major sourcing currency) and H&M’s investments in customer quality/value proposition (which we regard positively, given the competitiveness of the market and H&M’s scale advantages against peers). Selling expenses as percentage of sales also increased by 60 basis points, as the company opened new stores and invested in online offering and loyalty programs. Stock in trade grew slightly less than sales (4% at constant currencies versus 6% sales growth). Sales growth further accelerated in June to 12% in local currencies--hence our assumption for 4% revenue growth at constant currencies may be conservative.Operating cash flow was practically unchanged for the first six months of the year, but free cash flow (that excludes investments in tangible and intangible assets) grew by 26% as tangible asset investments were reduced. H&M also scaled back its store opening plans to net 130 additions (lower by 45 stores than previously announced through a mix of less openings and more closures and implying 2.6% store count growth) as online channels are prioritized.
We continue to view the actions that H&M’s management is taking to improve performance, such as developing online capabilities in various markets, integrating online and offline offerings, and improving customer quality/value proposition as reasonable. While being dilutive to earnings now, we believe the company would be able to reap the benefits of these investments over time with margins improving to 10% by 2023 (versus 7.4% last year).
H & M Hennes & Mauritz is engaged in the sale of clothing and cosmetics in Sweden and internationally. Co.'s stores offer basics, tailored classics, sportswear, and maternity clothes for women; basics, leisurewear, and seasonal fashions for men; denim and street fashions; and fashion wear for children and teenagers, as well as accessories, underwear, and shoes. Co. also provides makeup and body care products; and home fashion products, which include interior textiles for the bedroom, bathroom, living room, and kitchen. Co. has approximately 3,132 stores, including 110 franchise stores, 85 COS stores, 79 Monki stores, 21 Weekday stores, 8 & Other Stories stores and 3 Cheap Monday stores.
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