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ASOS - acquires Arcadia brands

Sophie Lund-Yates, Equity Analyst | 1 February 2021 | A A A
ASOS - acquires Arcadia brands

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ASOS plc Ordinary 3.5p

Sell: 2,333.00 | Buy: 2,336.00 | Change 13.00 (0.56%)
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ASOS has acquired the Topshop, Topman, Miss Selfridge and HIIT brands (intellectual property only). The cost of £265m will be paid from ASOS' existing cash reserves, and the deal is due to complete on 4 February 2021.

The brands generated revenues of around £265m in 2020. Growth of these brands on the ASOS platform was more than eight times higher than their respective online sites. The acquired names made an unaudited cash profit (EBITDA) loss of around £2.2m in the year ended 29 August 2020.

ASOS expects any EBITDA benefit to be offset by integration costs this year. It also expects around £20m of one-off restructuring and transaction costs. Around 300 staff members will join ASOS and £30m of stock is being purchased upfront.

The group highlighted the brands' presence in the UK, US and Germany which are key markets for growth. Their complementary operating models means the deal is expected to benefit ASOS' margins, generate a double-digit return on capital, as well as deliver £265m in sales from 2022.

The shares rose 2.6% following the announcement.

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Our view

A digital only set up means ASOS can keep trading during lockdowns. And trade it has. Another double digit climb in sales in Q1 is no mean feat.

Perhaps most dizzying is the improvement in operating margins at the full year. We've been watching these like a hawk since they dipped to a paltry 1% not too long ago. 4.8% might not shoot the lights out but it's a significant step in the right direction. (That margin surge is likely temporary though - on which more later).

It's also hard not to commend the group for its improvements in customer engagement. In today's saturated marketplace this shouldn't be overlooked. Trendy (and less expensive) rivals like boohoo are snapping at ASOS' heels, so the fact that it's been able to keep millennial eyes on its screens is good going.

That will be helped further by the (in our view) sensible acquisition of popular brands. The likes of Topshop resonate well with younger shoppers - and has already been doing well on ASOS' website. The fact the deal is fully cash funded, and relatively straightforward to integrate, lowers execution risk too.

But it's not a case of "job done".

A rough economic outlook and disruption to way of life means mapping future demand is pretty much an impossible task.

There's also the issue of continued gross margin (sales revenue minus the cost of the goods sold) pressure. A highly competitive environment means ASOS continues to slap sales stickers on stock, and a long-term shift away from more profitable going-out or office wear will make this a bigger problem. And with spending being ramped back up, the shopping list is getting longer, which could put a ceiling on profit growth.

A lower rate of returns is saving the group a lot of money, which will help stem some margin outflow. But this isn't likely to be a long-term tailwind. Operating margins could dip in the medium term.

The planned response leans heavily on new, more efficient warehouses. When things are going well ASOS can leverage these big facilities to service increased sales, boosting profits as they go. But - and this is a big but - if sales were to turn sour, the expansion just adds additional fixed costs, and margins will wither.

ASOS' medium-term is going to be governed by external forces. It's put in a lot of leg work and we're genuinely impressed by improvements to its proposition. For those prepared to take a bit more risk, we think ASOS' has operationally turned a corner, and could offer potential. Keep in mind though, an unclear medium-term picture of demand patterns means ups and downs should be expected.

ASOS key facts

  • Price/Earnings ratio: 31.8
  • Ten year average P/E ratio: 54.0
  • Prospective yield (next 12 months): 0%

All ratios are sourced from Refinitiv. 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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First quarter trading details (all figures at constant currency) 13 January 2021

Revenue of £1.4bn was up 24% in the first quarter. Overall demand is still suppressed, but was better than ASOS had expected as more people continue to shop online. New national restrictions mean returns rates have declined again, which helps reduce costs. ASOS expects a net positive £40m impact from COVID on pre-tax profit in the first half.

ASOS' active customer base rose by 1.1m to 24.5m. Growth in new customers offset weaker trading patterns from some existing customers.

Gross margins dipped 90 basis points, because of changing demand patterns, with customers shunning occasion-led shopping in favour of lockdown category items. There were also higher costs, including: investment in customer acquisition, and higher freight costs because of Covid disruption.

In the UK revenue rose 36% to £554.1m and was the best performing region. Sales were boosted by the closure of non-essential shops during the peak festive period. ASOS has signed a lease on a 4th fulfilment centre, in Lichfield.

EU sales were up 18% to £390.7m. Growth was less impressive here because some markets saw clothes shops continue to trade during lockdowns. Growth in the US was only slightly lower, at 17%, reaching £156.8m. The automation of the US fulfilment centre will begin this year.

Rest of World sales of £224.2m rose 20%, driven by Australia and the Middle East North Africa region.

ASOS expects Brexit tariff costs of around £15m this financial year. Full year capital expenditure forecasts have been upped by £20m to around £190m, which will fund increased investment in automating US operations.

The group said it had a "strong net cash and balance sheet position", despite negative working capital movements.

Find out more about ASOS shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.