EUR 850.00 For Business Accounts Only

Morningstar | Prada's Cost of Turnaround Higher Than Expected, but Shares Starting to Look Attractive

We plan to reduce our fair value estimate for narrow-moat Prada by a mid-single-digit percentage, as the company reported full-year revenue and operating profit below our estimates. The shares have lost over 50% of their value since their peak in 2018, and we believe they are starting to look attractive as concerns about brand traction in a more challenging macro environment and the cost of the turnaround resurface in investors’ minds. We continue to factor in demand improvement and margin expansion through operating leverage for the company.

Annual revenue came at EUR 3,142 million, 2% lower than we estimated, with constant-currency growth of 6%, decelerating in the second half of the year. Operating profit came at EUR 324 million, significantly below the EUR 396 million we expected and EUR 378 million consensus estimates. The bulk of the miss came from gross margin, which declined to 72% versus the 74% we expected (140-basis-point decline was driven by negative currency development and hedging) and increase in marketing and general administrative costs (which were 7% and 8% higher than we estimated, respectively). Despite the gross margin decline, discounting discipline increased, with markdowns representing only 7% of sales.

We anticipated that a brand relaunch and development of e-commerce infrastructure would need additional investments; however, this step-up was higher than we expected. Selling expenses remained well controlled, expanding 1% (versus 3% revenue growth at actual exchange rates).

Net operating working capital increased by 17% versus a 3% increase in sales in actual exchange rates. Although management explained it by the need to supply retail channels with inventory, elevated inventory levels could be a concern. The company plans to discontinue discounts in its own stores, which we see as beneficial for brand prestige; however, that may exacerbate the inventory problem.

Capital expenditures were significantly higher than we expected at 9% of sales (versus our 7% forecast) and increased 13% from the prior year. Main areas of investments were renovations, IT logistics hub development, and unplanned investments needed to support some suppliers.

The second half of the year saw deceleration for Prada (7% annual growth at constant currency versus 10% in the first half) but especially Miu Miu (2% annual growth at constant currency versus 8% growth in the first half). Ready to wear remained the strongest-growing category, increasing 10% in 2018, although also deteriorating from 20% growth in the first half. Leather goods, which contribute 57% to the company’s revenue, grew 6% in 2018 at constant currency (8% in the first half). All geographies saw growth deceleration in the second half, with a notable slowdown in China (8% growth in 2018 versus 17% growth in the first half). So far, companies with weaker brand traction seem to be bearing the brunt of any slowdown in luxury goods demand.