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investment action
Based on my current outlook and analysis on Inditex (OTCPK:IDEXY), I recommend a Buy rating.I believe ITX will continue to grow at a lower percentage over the next 2 years, driven by strong spending The strength seen so far, execution on expanding U.S. operations, and potential rate cuts that could further boost consumer confidence in spending. IDX’s valuation isn’t very high either. At its current forward price-to-earnings ratio of 24x, it trades at a historical average multiple, which makes it a bargain considering its growth profile (low double-digit growth) is better than the high single-digit growth of the past.
Basic information
IDX is a fashion retailer that owns several well-known brands. For example, they operate Zara, Bershka, Pull & Bear, etc. These brands have operations around the world. As of fiscal 2023, 51% of ITX’s revenue comes from Europe, 20% from the Americas, and 16% from Spain. 13% are from the rest of the world. IDX is also a very large player in terms of size, with a total of 5,692 locations, 64% of which are in Europe and 36% in the rest of the world.
review
ITX’s sales in Q4 2023 (reported March 13) increased 9% on a reported basis and 12% on a constant currency basis. Gross profit margin expanded 90 basis points to 53.8%, 100 basis points higher than market consensus. Healthy revenue growth, gross margin expansion and a fixed cost structure (operating expenses as a percentage of sales) led to strong EBIT of €1.617 billion compared with the fourth quarter of 2022, compared with consensus expectations of 1.603 billion euros. In terms of margins, EBIT margin expanded to 15.6% compared with 14.1% in the fourth quarter of 2022.
Given the growth opportunities in the US, I believe ITX can continue to grow at this rate. As I mentioned above, the Americas is IDX’s second largest market in terms of revenue, but in terms of store mix, the Americas only account for about 13% of ITX’s store base. Of those, there are less than 100 stores in the United States (according to the earnings call). Assume similar unit economics across the Americas. According to the latest data (data for January 23), sales per store in the United States are approximately 8.6 million euros, making it the highest performing region and approximately 1.6 times higher than the group average. I believe the potential is huge because if we compare the number of stores of ITX in the United States with the number of stores of H&M, the difference is staggering. ITX has less than 100 stores in the United States, but peers like H&M have about 500 stores GAP has 401 stores. The opportunities here are huge. If we simply assume that ITX can grow to the level of its peers (i.e. 450 stores), it represents an additional revenue opportunity of approximately €3.9 billion (11% of FY23 revenue). Add this to the business’s historical growth rate (like-for-like and constant currency compound annual growth rates of around high-single-digit percentages since 2011), and we can easily achieve low- to moderate-income growth in the foreseeable future. Management clearly takes this seriously, as they have repeatedly mentioned investments in the U.S. during the past few earnings calls.
Of course, we’re pursuing smart and responsible growth, which is why we’ve announced 30 projects over the next three years, including store openings, expansions, renovations and relocations, that will allow us to not only grow our most important store in the U.S. The influence of metropolitan areas (Boston, New York, San Francisco) needs to expand into new areas. Annual General Meeting of Shareholders in July 23
In terms of execution, it’s encouraging that the 30 projects for 2023-25 announced by Zara last year are said to remain on track, with management now also seeing opportunities in other concepts, notably citing Massimo Dutti. Strong execution is not only reflected in store construction, but also in the online space. I think the online space is a key area in the current digital world.
Our product proposition is highly appreciated by our customers. Where our fashion is likely to succeed through bricks-and-mortar stores, coupled with our online presence is broader than ever. ’23 was very positive for us. Q423 call
To support this growth plan, ITX announced increased capital expenditures. Ordinary capital expenditure of €1.8 billion in 2024 will be invested primarily in store optimization to complement investments in store expansion. In the latest conference call, management also announced a €900 million logistics expansion plan for 2024 and 2025. I think this move in capex is necessary because it will put ITX on a stronger footing in the long run.
Returning to the near-term outlook, growth momentum remains strong, with management mentioning that between February 1 and March 11, the group delivered constant currency growth of 11%, which was well ahead of initial consensus expectations (consensus expectations ) Sales in the first quarter of 2024 will be approximately 8.05 billion euros, a growth of approximately 6%). A big reason for consensus expectations for single-digit growth (down from double-digit growth) is the higher base in FY23. To put things in perspective, the comparison hurdle is high with growth of 36% in Q1 2022, 16% in Q2 2022, 13% in Q1 2023, and 14% in Q2 2023. If we assume that ITX will return to high-single-digit constant currency growth in fiscal 2024, that means growth needs to fall back to mid-single digits to “balance” the high growth in fiscal 2022/23. But this does not appear to be the case, as low-digit growth continued in the first quarter of 2024, indicating that underlying demand strength is much stronger than expected. Through capex investments and U.S. expansion plans, I think short-term growth will likely remain in the lower percentage range.
Valuation
author’s works
I believe ITX can grow 11% in FY24 and FY25 due to strong demand strength so far and execution of US expansion plans. I would also like to point out that inflation in the economies where ITX is located has fallen from last year’s peak, and central banks in these economies have also signaled interest rate cuts. I see this as a catalyst for further support for consumer spending in the near term, providing additional macro support for my growth assumptions. That said, I don’t expect margins to reach the levels of the past few years as ITX will increase investments (in preparation for future expansion in the US); therefore, this will dampen margin expansion in the near term. I assume margins will expand slightly by just 25 basis points over the next two years to 15.5% from 15% in FY23. In terms of valuation, ITX is trading at 24x forward earnings today, which is its historical average, and I’m not making any aggressive assumptions that it will rise. If it does rise, that will be a bonus for investors.
risk
ITX is ramping up capital spending plans and focusing on the United States amid a bleak economic outlook. While things are better than last year, we’re still not out of the woods. Inflation, while down from last year, has proven to be sticky. Housing inflation also shows no sign of any significant recovery. If the Fed is forced to raise interest rates, it will affect consumer demand and ITX’s growth may be lower than expected. Coupled with rising operating expenses, this may lead to earnings decline rather than growth.
final thoughts
My recommendation is a Buy rating as I expect IDX to continue growing at a low-teens rate over the next two years. The outlook is driven by healthy consumer spending, U.S. strategic expansion plans and potential interest rate cuts. Execution is in place so far and early trading updates (Q1 2024) are encouraging. Furthermore, IDX’s valuation is not expensive as it trades at its historical average price-to-earnings ratio.
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