EUR 850.00 For Business Accounts Only

Morningstar | Zalando Aims to Become a Go-To Fashion Aggregator Platform; Shares Attractive

We are maintaining our fair value estimate of EUR 37.5 for no-moat Zalando as the company reported stronger-than-expected full-year profits and shared its long-term targets on capital markets day. We think the shares still offer value, but after very strong positive reaction to the results and growth targets (shares up over 20%) margin of error has shrunk.

While annual revenue came in line with our forecast, adjusted group EBIT came at EUR 173 million, versus the EUR 155 million we expected. This compares with Zalando’s previous forecast of EUR 150 million-EUR 190 million. For 2019 the company is guiding for GMV growth of 20%-25% and sales growth at a lower end of this target (versus our forecast for 25% GMV and 21% revenue growth) and adjusted EBIT at EUR 175 million-225 million, significantly below the EUR 261 million we expected. It announced a mid-term plan for GMV growth to EUR 20 billion by 2023-24 from EUR 6.6 billion in 2018, implying a 20%-25% annual growth. Since the partner program is expected to contribute higher share of GMV, revenue growth is expected to grow at a 15%-20% pace, largely matching our 17%-18% revenue growth expectations over the forecast time horizon. Zalando expects to deliver operating margins of 2%-4% over the next three years, with continuous growth investments and platform transition (partner program delivers lower margins before the scale is built), which is clearly below our 4%-5% forecast. Nonetheless, the management believes 10%-13% sustainable long-term operating margins are achievable (once the business model matures). This is higher than 9% we expect in our long-term forecast. Margins should be supported by better scale of administrative and marketing expenses, higher margins for the scaled partner program (commission-based businesses take longer to leverage the fixed costs versus traditional wholesale models but deliver stronger margins as they scale thanks to higher gross margin contribution), and marketing services.

Management is also reduced its capital expenditure forecast from over 5% of revenue to 4%-5% as capacity expansion could be built out more efficiently.

Zalando is increasingly moving to the platform operating model, where brands remain in control of the inventory, while Zalando charges a fee for brand placement on its platform and other services provided, such as fulfillment and market intelligence. Management expects the Partner Program to reach 40% of GMV from over 10% currently by 2023-24. The business model where control over pricing and inventory is retained by the brand and excessive discounting is avoided may be an attractive proposition for the brands (especially the premium ones, that Zalando looks to increase). It also allows Zalando to grow in a capital-light manner without taking extra inventory risk. Ultimately, Zalando aims to be a platform-aggregator for fashion purchases. We believe that online players, such as Zalando, have significant informational advantages over brick-and-mortar fashion retailers, which could help them build loyalty with consumers over time through a better targeted offer, as well as make them attractive partners to brands seeking customer access, fulfillment services, and market intelligence.

We note that in 2018 growth in active customers remained solid at 14% for the year and reached 26.4 million, or around 6% of addressable market population. Customer engagement also developed positively with average orders per active customer increasing to 4.4 from 3.9 in 2017. Conversion rate also improved to 3.7% from 3.5% a year ago. Zalando claims to account for around 25% share of fashion wallet at its active customers. Average basket size was a drag, as expected, driven down by warm weather encouraging more spending on lower ticket items and away from warmer higher ticket items (such as winter coats and jackets). Increased promotional activity also weighed on the basket size, dampening fulfillment economics (fulfillment costs swelled to 28% of revenue from 26% in 2017).