Morningstars Fair Value Estimat: 346 SEK
Investeringsanalyse, Bridget Weishaar, 26-03-2015
H&M's fast-fashion model presents investors with an attractive top-line growth story and minimized inventory risk. In our opinion, flexible planning of the product range and quick decision-making give the company a leg up in meeting customer preferences and achieving better sell-through--the basis for our narrow moat rating. Furthermore, the pricing and product lines appear to work in multiple markets.
We see new stores and distribution channels as the major growth drivers. H&M currently operates more than 3,500 stores globally. However, with six brands, an e-commerce platform only in its early stages, and a product offering that has proved attractive in a variety of markets, we think there is room for further market penetration. We note that Inditex, perhaps the closest competitor, operates more than 6,600 stores and is still growing. As such, we think H&M's strategy to increase store count by 10%-15% annually and invest in rolling out e-commerce is sound and will result in little cannibalization or comparable sales pressure.
In our opinion, the main competitive advantage of H&M is its ability to deliver on trend fashions at an affordable price. The time from an order being placed to store delivery ranges from a few weeks to six months, with basics and children's wear sustaining a higher volume and longer lead time. We believe this mixed production model allows the company to maximize low-cost production in basics, where demand is easier to predict, with quick response for high-fashion products, where it makes sense to sacrifice some production cost efficiencies for speed to market and increased full-price sell-through. As a result, operating margins in the mid-to-high teens are ahead of other specialty retailers including Gap, Abercrombie & Fitch, and American Eagle, which average in the high single digits to low teens.
That being said, we think the fast-fashion story has become well understood and expectations for performance are high, leading to a pricey valuation. Furthermore, we think margins will be under pressure from IT investments, labor costs, and the impact of the U.S. dollar strength on sourcing costs. We would wait for a wider margin of safety.
Bulls and bears say
Bulls say
- With six brands, an e-commerce platform in the early stages, and a store footprint roughly half the size of Inditex, there is much room for additional top-line growth.
- Economies of scale and a well-honed fast-fashion model give H&M a cost advantage over competitors.
- Rapid response manufacturing and frequent shipments help to minimize inventory risk, one of the biggest challenges facing retailers.
Bears say
- New store openings could slow as markets become more penetrated, real estate more difficult to find, and the pace of openings more difficult to manage.
- H&M faces competition from other fast-fashion retailers, including Inditex and Forever 21, as well as from traditional retailers trying to leverage an open to buy.
- Further margin expansion could be limited by rising labor costs and technology investments which might not fully be offset by price increases.
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