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ASOS - Partner fulfilment to pump profit margins

Nicholas Hyett, Equity Analyst | 10 November 2021 | A A A
ASOS - Partner fulfilment to pump profit margins

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ASOS plc Ordinary 3.5p

Sell: 990.00 | Buy: 993.00 | Change 2.50 (0.25%)
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ASOS is targeting £7bn worth of sales over the next 3-4 years, with operating profit margins of at least 4%. This reflects a compound annual growth rate of 15-20%.The group plans to support this initiative by building out its own-brand offerings to add £1bn to revenue, doubling the size of ASOS in the US and EU, increasing Partner fulfilment to 5% of merchandise volume and embarking on cost saving efforts worth £50m-£100m.

Longer-term, the group plans to grow Partner fulfilment to 25% of merchandise volume. Growth in this higher-margin part of the business together with maturation of international divisions and cost cutting efforts is expected to increase operating profit margins to at least 8% in the long-term.

More information about the group's strategy will be made available on the group's website later in the day.

The shares were broadly flat following the announcement

View the latest ASOS share price and how to deal

Our view

After disappointing markets with a lacklustre forecast for next year's sales, ASOS came back with rosier, longer-term forecasts at its investor event. While the targets were ambitious, it left investors uninspired. The next year will be a challenge for ASOS and that's not lost on the market.

The tailwinds provided by COVID, including a huge boost to online shopping and reduced returns rates, are starting to unwind. Added to the problems are global supply chain constraints, which as well as rising costs, means ASOS is struggling to get hold of enough of the right stock.

The main thing to watch is margins. While they aren't at dangerous levels, 5.3% is a bit thin, which doesn't leave a lot of breathing room. With disruption expected to continue, and spending set to ramp up, some damage coming down the pipes. The group's targeting operating margins of just 4% over the next three to four years, suggesting management's buckling up for a bumpy ride.

Then there's the issue of demand. ASOS has said that demand has remained fairly strong, even as high streets in core markets have reopened. But we wonder exactly how that's going to shape up over the longer-term. The pandemic has chivvied ASOS' bricks and mortar rivals to up their own digital offerings, so the group's going to have to peddle a bit harder than it's used to if it's to grow market share and drum up interest for its growing own-brand offerings.

ASOS is also reliant on a growing partnership fulfilment arm, where brands supply inventory and ASOS collects a commission. Progress in this higher-margin part of the business is key if the group's to achieve sustainable operating margins above 8% in the future. But the pandemic may have pushed brands to ramp-up their direct-to-consumer offerings, which could set ASOS' plans back.

All of these strategic turning points come at a time when the CEO and Chair are leaving the business. Any change of senior leadership brings an element of transition and strategic risk.

But we'd be lying if we said ASOS doesn't have some fundamental strengths.

The pandemic has permanently increased online shopping demand in our view. While impossible to say for sure, ASOS' head start here should, in theory, mean it benefits. This is probably why ASOS feels comfortable it can deliver £7bn of annual revenue, and double the size of the combined US and Europe business over the next 3-4 years. We believe the addressable market is there, but it will require near-perfect execution of expansion plans. That's an area ASOS has fallen short of before and there are no guarantees.

A balance sheet with almost £200m of net cash is a luxury in the retail sector, and gives it opportunity to pounce on acquisitions to help propel growth if they arise. It also gives ASOS space to stomach a degree of disruption.

ASOS has some exciting growth prospects. Its strong proposition and growth plans in the US mean the long-term picture is still attractive in our view. But looking to the near-term, the group will be disrupted by supply chain and costs problems, and we think ups and downs are likely. These question marks are reflected in a price to earnings ratio of 22.7, which is significantly lower than average.

ASOS key facts

  • Price/Earnings ratio: 22.7
  • 10-Year Average Price/Earnings ratio:52.4
  • Prospective dividend 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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Full Year Results (11 October 2021)

Full year revenue rose 22% to £3.9bn, reflecting the benefit of lockdown restrictions on trading. Underlying pre-tax profit rose 36%, to £193.6m.

Next year ASOS expects sales to rise 10-15%, with mid-single-digit growth in the first half. That's because the group will be lapping the exceptional demand seen this year, and supply chain problems will affect some stock availability. Pre-tax profit will be up to 43% lower because of higher freight and labour costs, and rising return rates.

CEO Nick Beighton is stepping down with immediate effect, having served as CEO for six years. Mat Dunn, currently Chief Financial Officer, will take on the additional role of Chief Operating Officer and "lead the business on a day-to-day basis", while a permanent successor is found.

Sales in the UK rose 36% to £1.7bn, with reduced customer churn and good growth in new customers. ASOS said the 1.4m new customers are of a high quality - they are engaged and more likely to return than average. The average shop was larger overall, but average selling prices were smaller because of heightened demand for casual-wear.

Total sales of £1.2bn in the EU were 15% up year-on-year, although this had slowed to just 4% in the final quarter. Similar to other regions, average selling prices were lower. Shipping and Brexit-relating issues meant stock availability was weak, and meant ASOS couldn't serve increased demand in some markets.

Total sales in the US - which rose 21% to £466.2m- were helped by wholesale sales from the Topshop brands. Global shipping and customs delays held performance back, but things are starting to improve.

There was a 3% rise in active customers in Rest of World. Sales growth was the most muted in this region, rising 6% to £607.0m.

Group underlying operating margins rose to 5.3% from 4.6%.

ASOS experienced the negative effects of increased inventories and adverse working capital movements. Free cash flow was £35.9m, compared to £258.5m last year, while net cash was £199.5m compared to £407.5m.

The group invested £286.4m on buying the Topshop brands in the year.

Next year, capital expenditure is expected to rise to about £210m. This will be spent on automating warehouses, and increased customer experience and data tech.

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.

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