Inditex: Low-Teens Growth Is Possible Over The Next 2 Years

seekingalpha04-06

A buy rating is recommended for Inditex based on strong spending, US expansion, and potential rate cuts.ITX is a fashion retailer with global presence and a large number of locations.ITX has shown ...

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I believe ITX can continue to grow in a low-teen percentage range for the next 2 years, driven by the strong spending strength seen so far, execution in ramping up US operations, and potential rate cut(s) that would further improve consumers’ confidence in spending. IDX valuation isn’t very demanding either. At the current 24x forward PE, it is trading at its historical average multiple, which could be argued that it is cheap given the growth profile (low-teens growth) is better than the high-single-digits growth in the past. Basic Information IDX is a fashion retailer that has multiple famous brands under its belt. For instance, they operate Zara, Bershka, Pull & Bear, etc. These brands have a global presence, and as of FY23, ITX generates 51% of revenue from Europe, 20% from the Americas, 16% from Spain, and 13% from the rest of the world. By size, IDX is also a very large player, with a total of 5,692 locations, split 64% in Europe and 36% in the rest of the world. Review ITX grew sales by 9% on a reported basis and 12% on a constant currency basis in its Q423 quarter (reported on March 13). Gross margin saw expansion by 90bps to 53.8%, which is 100bps ahead of what consensus was expecting. Healthy top line growth, gross margin expansion, and flat cost structure (operating expense as a percentage of sales) vs. Q422 led to an EBIT outperformance, coming in at EUR1.617 billion vs. the consensus of EUR1.603 billion. In margin terms, EBIT margin expanded to 15.6% vs. 14.1% in Q422. I am positive that ITX is able to continue growing at this rate given the growth opportunity in the US. As I noted above, Americas is IDX's second-largest market by revenue, but from a store mix basis, Americas is only ~13% of the ITX store base. Of which, less than 100 stores are in the US (as per the earnings call). Suppose the entire Americas region has similar unit economics. Using the latest figures available (Jan’23 numbers), sales per America’s store are ~EUR8.6 million, which is the highest performing region, ~1.6x better than the group’s average. I believe the potential is huge because, if we compare the number of stores ITX has in the US to that of H&M, the difference is astounding. ITX has <100 stores in the US, but peers like H&M have ~500 stores and GAP has 401 stores. The opportunity set is huge here. If we simply assume ITX is able to grow to peers’ level (i.e., 450 stores), it represents an additional revenue opportunity of ~EUR3.9 billion (11% of FY23 revenue). Add this to the historical growth rates of the business (like-for-like and constant currency CAGR of ~high single-digit percentage since 2011), and we can easily bridge to low-to-mid-teens top line growth for the foreseeable future. Management is evidently on top of this, as they have constantly mentioned investing in the US over the past few earnings calls. What we aspire to, of course, is sensible and responsible growth, and that's why we've announced for the coming three years, 30 projects, including opening of stores, expansion of stores, refurbishments, and relocations, which are going to allow us to improve not just our presence in the most significant metropolitan areas of the United States, Boston, New York, San Francisco, but also to reach new areas. AGM July’23 In terms of execution, it was encouraging to hear that the 30 projects announced last year for Zara over 2023–25 were said to remain on track, and management now also sees opportunities for other concepts, in particular referencing Massimo Dutti. The strong execution was not only seen via store builds but also in the online space, which I see as a key area in the current digitalized world. Our product proposition is very well appreciated by our customers. And the areas where our fashion is likely to be successful through physical store, plus our online operations are wider than ever. '23 has been very positive for us. Q423 call To support this growth plan, ITX has announced a step-up in CAPEX. 2024 ordinary capex of EUR1.8 billion is set to be largely invested in store optimizations to complement investments in store expansion. In the latest call, management also announced a logistics expansion plan of EUR900 million for 2024 and 2025. I view this step up in CAPEX as necessary, as it will secure a stronger foundation for ITX over the long term. Coming back to the near-term outlook, growth momentum remains strong, as management mentioned that in the period between February 1 and March 11, the group saw 11% constant currency growth, which was much ahead of what consensus was originally expecting (consensus expected ~EUR8.05 billion in 1Q24 sales, which is ~6% growth). A big part of why consensus expected single-digit growth (a step down from double-digit growth) is because FY23 was a high base. For perspective, 1Q22 saw 36% growth, 2Q22 saw 16% growth, 1Q23 saw 13% growth, and 2Q23 saw 14% growth, so the comparison hurdles are high. If we assume ITX would trend back towards its high single-digits like-for-like constant currency growth in FY24, it suggests that growth needs to come back down to mid-single-digits to “balance” the high growth in FY22/23. But that appears not to be the case since 1Q24 continues to see low-teen growth, suggesting that the underlying demand strength is a lot stronger than expected. With the capex investments and US expansion plans, I see a possible case for near-term growth to stay elevated in the low-teen percentage range. Valuation   Author's work I believe ITX can grow at 11% for FY24 and FY25 because of the strong demand strength and execution of the US expansion plans so far. I would further note that the economies that ITX is in have seen inflation come down from its peak last year, and central banks in these economies are signaling their intention to cut interest rates. I see this as a catalyst to further support consumer spending over the near term, providing additional macro support to my growth assumptions. That said, I am not expecting the same level of margin expansion seen over the past few years because ITX is going to ramp up investments (to prepare for future US expansion); hence, that would dampen margin expansion in the near term. I assumed a modest margin expansion of just 25bps over the next 2 years, from 15% in FY23 to 15.5%. For valuation, ITX trades at 24x forward PE today, which is its historical average, and I am not making any aggressive assumptions that it would trade up. If it does trade up, it would be a bonus to investors. Risk ITX is ramping up its capex plans and focusing on the US at a time when the economic outlook is not the most positive. While it has gotten better than last year, we are still not out of the woods yet. Inflation, while down vs. last year, has proven to be sticky. Housing inflation has not seen any signs of a major recovery either. If the Fed is forced to raise rates, it will impact consumer demand, and ITX might see poorer than expected growth, coupled with higher operating expenses, which could cause earnings to fall instead of grow. Final thoughts My recommendation is a buy rating as I expect IDX to continue growing at a low-teen pace over the next two years. This outlook is driven by healthy consumer spending, a strategic US expansion plan, and potential rate cuts. Execution has been on point so far and early trading updates (for 1Q24) have been encouraging. Also, IDX's valuation is not expensive as it is trading at its historical average PE multiple.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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