Cube Midcap Report (14 Oct 2020) – ASOS looks good

Cube Midcap Report (14 Oct 2020) – ASOS looks good

Good morning, it’s Roland here with the Midcap Report.


ASOS

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Market cap £5.4 billion
RNS Final results
Writer disclosure No position.

The pandemic has been good for online fashion retailers who’ve been able to pivot to casual wear quickly. ASOS certainly seems to have made the most of this opportunity. Today’s final results show that pre-tax profit rose four-fold to £142.1m last year, helped by a “net Covid-19 tailwind” of £45m.

Here’s a summary of the group’s financial performance for the year to 31 August:

ASC FY20 results summary

What can we learn from this? Let’s take a step-by-step look at these figures.

Revenue: Sales rose by 19% to £3,263m. That’s an improved performance from last year, when sales rose by 13%. The group’s expansion was evenly distributed across global markets, with growth in each geographic segment varying between 18% and 22%.

Active customer numbers rose by 3.1m to 23.4m. My sums suggest this means average customer spend rose from £135 to £139.

These are obviously decent figures, but in my view this is more evolution than revolution. Remember that most of ASOS’s bricks and mortar rivals were closed for around three months during this period.

Gross profit: ASOS has always lagged rival Boohoo in this area and has struggled to maintain its gross margins in recent years. The downward trend continues:

  • FY18: 51.2%
  • FY19: 48.8%
  • FY20: 47.4%

For contrast, Boohoo’s last-reported gross margin was 55%.

ASOS says that gross margin fell due to changes in product mix towards casual wear, increased freight and duty costs relating to its new US warehouse and discounting to help sell occasion wear during lockdown — I guess the group was stuck with too much of this stock when lockdown struck.

Pre-tax profit +339% to £142.1m: This is where the big gains were achieved, despite ASOS’s shrinking gross margin. Management say that they’ve cut costs and controlled investment more tightly. Marketing spend was also cut to “avoid stimulating demand we could not service” due to capacity restrictions.

However, the narrative suggests to me that the biggest single factor driving profit growth was a reduction in return rates. According to ASOS, the impact of COVID-19 on sales and return rates generated £45m of additional profit, despite the group incurring “material incremental costs”. I’ve always though that the cost of handling returns must be high for online retail, but this seems like a remarkable figure to me.

Of course, this reduction in return rates isn’t likely to repeat and could well reverse. Indeed, the firm says that it’s already seeing signs of “normalising customer returns rates”. I read that as suggesting that margins are likely to fall.

Cash generation: Very strong. The group transformed last year’s £90m net debt position into a year-end net cash position of £407.5m. This was aided by a £89m benefit from a delayed peak stock build, which the firm says will unwind going in FY21. I’d guess the reduction in returns rates is a factor here, too — significant distribution/warehouse spend was avoided.

Earnings per share: A figure of 125.6p per share appears to be comfortably ahead of consensus forecasts I can see for 112p.

Outlook: ASOS shares are down by nearly 8% as I write and this is why. The company says that the economic uncertainty facing its target 20-something market means that the outlook is uncertain.

However, what really grabbed me was the firm’s guidance. This was limited to a statement that underlying profit excluding the COVID-19 tailwind should improve.

My reading of this unusual statement is that pre-tax profit is expected to rise from a baseline of around £97m (£142m minus a COVID tailwind of £45m). On that basis, I think it’s fair to suggest that actual pre-tax profit could fall this year.

My view

I’m not surprised ASOS shares are falling today. Although the firm’s earnings are up strongly and appear to be ahead of expectations, management are making it clear that repeating this performance could be difficult.

I think there’s also a second concern, around profitability. Although the group’s operating margin rose from 1.3% to 4.6% last year, ASOS is still far less profitable than rival Boohoo, whose operating margin sits around 7.5%. In my view, the company’s commentary suggests that margins could slip again this year, if return rates normalise.

Today’s results value ASOS shares at around 40 times trailing earnings. With limited visibility on forward earnings and the risk of lower margins this year, my feeling is that the stock looks fully valued at around £50.

I’d need a much stronger view on growth to tempt me in at this price, despite the group’s improved operational performance.


I’m afraid I’ve run out of time to cover housebuilder Barratt Developments trading update today. I don’t think it contained any major surprises.

I hope you found this shortened report useful — thanks for reading. As always we appreciate all feedback on these reports, both good or bad, so please use the thumbs below to share your views!

Thanks,

Roland

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