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ASOS - record first half but recent demand has slumped

Sophie Lund-Yates, Equity Analyst | 8 April 2020 | A A A
ASOS - record first half but recent demand has slumped

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ASOS plc Ordinary 3.5p

Sell: 3,318.00 | Buy: 3,322.00 | Change -69.00 (-2.04%)
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First half performance was ahead of ASOS' expectations. Revenue rose 21% to £1.6bn, ignoring the impact of exchange rates, and combined with lower non-strategic costs, pre-tax profit reached a record £30.1m.

However, demand has been significantly impacted since lockdown began, and group sales have declined around 20-25% in the last three weeks. ASOS has responded with a number of cash saving measures and changes to work habits.

ASOS intends to sell new shares to raise money and boost its liquidity, and is also in discussions to secure a £60-80m 12-month extension to its revolving credit facility. It also hopes to adjust the financial conditions set by its lenders, including the rule that net debt must be kept below a certain level in relation to cash profits.

The shares rose 27.2% following the announcement.

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Our view

ASOS is in a sticky situation, and demand has slumped in recent weeks. Given the uncertainties around the coronavirus outbreak it's impossible to say what the outcome's going to be, but here's what we know so far.

ASOS is lucky, it can continue to trade. Compared to high street rivals who have been forced to close, the group's digital-only set up is a good place to be. And expensive warehouse issues have been ironed out, meaning exceptional costs are coming down.

The pre-tax profit beat in the first half proves ASOS has a much better grip on operating costs too. This is an important milestone, operating margins had been a paltry 1%. They're now in the region of 2%.

But we do have concerns.

Improvements to operating margins have mostly come from cutting back on things like marketing and staff spending. Cuts like these can't go on forever. And we see big pressures on gross margins (sales revenue minus the cost of the goods sold).

In order to keep up with rivals ASOS is discounting its stock. That's a great tool to get the tills ringing, but not so great for margins. Gross profit per order is down about 3% compared to last year, at £17.10.

The big increases in inventory could make this worse. A huge pile of new stock at a time when trading has taken a drastic turn for the worse means ASOS could be stuck with items it can't sell, and would require extra price cuts to shift.

ASOS' new international infrastructure could present a challenge too. International growth is an important part of the group's future success. When things are going well it can leverage these big facilities to service increased sales rattling through the warehouse, which in turn boosts operating margins. But when sales are lacklustre, the expansion just adds additional fixed costs. The extent of the damage will depend how long the disruption lasts, but if things carry on for longer than anticipated ASOS' already thin margins could come under real strain once more.

Moves to raise new cash through a proposed placing and increased debt facilities means the balance sheet is protected from imminent danger. The group still carries a little more net debt than is ideal though, and is something to keep an eye on longer-term. If profits struggle, servicing the interest payments on debt becomes more difficult.

Overall it's too soon to say what the damage from coronavirus is going to look like. ASOS is in a better position than many retailers, but longer-term there are challenges, and margins continue to trouble us.

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Half year results

COVID-19 and finance update

ASOS said it's impossible to predict the impact of the outbreak, but has stress tested a number of scenarios. These suggest there is "sufficient liquidity" under the existing £350m revolving credit facility.

The proposed placing of new shares would represent up to around 18.8% of the existing issued share capital.

Discretionary costs and capital expenditure have been reduced, and the group is using government support including payment deferrals and job retention schemes, where available.

All warehouses remain open, but at lower capacity as social distancing measures have been introduced. Head office staff are working from home where possible.

The group's Chinese supply chains are seeing little disruption, but European sourcing is being closely monitored.

Half year results (constant currency)

Active customers increased by 2m to 22.3m, and there was an increase in average basket size. Stronger trading was led by improved performance over the festive season continuing into January and February.

Regions where demand is falling because of lockdowns are responding well to discounting. There's been an increase in demand for beauty, loungewear and lingerie too.

Performance in the UK was better than expected, with website traffic up 18%, sales were up 20%. The group gained market share over Black Friday, and introduced a number of different payment options, including "pay later" services. There was a 6% increase in average basket value and small rise average selling price.

US sales were up 24%, helped by the resolution of warehouse issues. Trainers sold particularly well, and active customers were up 19% to 3.1m. Performance was helped by improved delivery options.

Within Europe, sales rose 22% helped by a 26% increase in traffic and the use of discounting to encourage reactivation of accounts as well as new customers. Issues with the automation of the Euro Hub have also been resolved. Active customers rose 18% to 8.7m, and there was a 1% rise in average basket value.

The Rest of World division saw sales increase 20%, driven by a strong Black Friday performance.

Group gross margin fell to 47% from 48.7%. That reflects increased freight and duty costs in the US, as well as the increase in promotional discounting activity.

Operating expenses increased 13% to £0.7bn, although operating costs as percentage of sales has fallen. Net debt rose by £73.1m to £163.6m, reflecting the seasonal increase in stock investment.

Nick Beighton, CEO said: "the short-term outlook remains highly uncertain". However, the group believes the additional liquidity headroom will help it cope with the expected short-term disruption.

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