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ASOS - full year guidance upgraded

Nicholas Hyett, Equity Analyst | 21 August 2020 | A A A
ASOS - full year guidance upgraded

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ASOS plc Ordinary 3.5p

Sell: 4,481.00 | Buy: 4,486.00 | Change -1.00 (-0.02%)
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On 12 August ASOS upgraded its expectations for full year sales and profits, now set to come in significantly ahead of previous market expectations. Revenue is now expected to grow 17-19%, while pre-tax profit should come in between £130-£150m.

The improvement reflects strong trading patterns, as well as lower than expected returns rates following the end of lockdowns. The group said there's been a significant drop in returns since April, and it's noticing more "deliberate" purchasing patterns, which lowers the likelihood of a return.

The shares rose 13.3% on the day of the announcement.

View the latest ASOS share price and how to deal

Our view

ASOS was able to keep trading throughout the lockdown. Compared to high street rivals who were forced to close, the group's digital-only set up is a good place to be. Sales did slump initially, but the full year revenue outlook is now anything but disappointing.

ASOS has been working on improving its margins recently, and the group's first half results prove it has a much better grip on operating costs too. This is an important milestone, as operating margins had been a paltry 1%. The current strong trading patterns - and crucially - lower returns rates means we can expect meaningful improvements on this front this year.

However, it would be a mistake to say this positive step in the right direction means ASOS can rest on its laurels. How long these tailwinds last is unknowable at this point, and there are a couple of things to be mindful of.

Past improvements in operating margins have mostly come from cutting back on things like marketing and staff spending. Neither are long term solutions and don't address the issue of gross margin pressure (sales revenue minus the cost of the goods sold) in the future.

In order to keep up with rivals ASOS had also been discounting its stock. That's a great tool to get the tills ringing, but not so great for margins. Promotional activity has been scaled back over lockdown, but the group may have to go back to it once conditions normalise.

ASOS' 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.

Moves to raise new cash through a proposed placing and increased debt facilities means the balance sheet is in reasonable shape. The group still carries a little more net debt than is ideal though, and we'll be encouraged if it can deliver on its intention to return to net cash by year end.

Overall it's impossible to see a full year profit and sales upgrade as anything other than good news. We continue to think ASOS is in a better position than many traditional retailers, but longer-term there are challenges, and margins continue to trouble us.

ASOS key facts

  • Current 12m forward P/E ratio: 49.3
  • Ten year average 12m forward P/E ratio: 54.1
  • Prospective yield: 0%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Trading update (constant exchange rates) 15 July 2020

ASOS' total revenue for the four months ending 30 June rose 9% to £1.0bn, excluding the impact of exchange rates. This reflects improving demand, increased warehouse capacity and a beneficial returns policy as customers have bought more deliberately.

ASOS' sales have "improved materially" since the group reported falls of between 20% and 25% when lockdown measures were first introduced in March.

In the four months ending 30 June sales in the UK and US fell 1% £329.2m and 2% to £124.9m respectively. Both regions skewed heavily towards lockdown categories and were heavily impacted by supply restrictions.

In the EU and Rest of the World the recovery was more pronounced, and sales grew 20% to £328.0m and 18% to £201.2m respectively. This reflects the easing of lockdowns and a return to a more normal product mix.

ASOS has seen a shift away from its core occasion led categories, such as dresses and formalwear, towards "lockdown categories" such as activewear, casualwear and face + body. Last year occasion led categories accounted for around 48% of sales while the lockdown categories were just 23%.

However, sales in lockdown categories have grown by 50%, but as they tend to be cheaper, Asos' average selling prices have fallen by 9%. Lower prices weighed on gross margins, which fell by 0.7 percentage points in the quarter.

Despite the recovery in sales, growth was held back by the need to protect employees through social distancing. ASOS also reduced marketing spending and promotional activity during the period to avoid stimulating demand it couldn't satisfy. As a result profitability was protected at the expense of some growth. The group's active customer base rose by 0.7m to 23m during the period.

ASOS has extended its £350m revolving credit facility until July 2023, with the option to extend by a further year if required.

Given the improvement in trading since April, the group now expects to deliver positive free cash flow for the year and to end with a "very strong" net cash balance.

ASOS will repay all taxpayer money received as part of the furlough scheme.

Find out more about ASOS shares including how to invest

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