Zalando SE: Fighting 'Crazy' Competition

seekingalpha05-15

Zalando SE is facing severe competition from companies that are adopting aggressive growth strategies, often at the expense of current profitability.PDD Holdings, the company behind the Temu app, is ...

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CinebergIn a fight, who wins — the smart guy or the crazy guy?","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"LU1023057109.AUD":"BGF CHINA \"A2\" (AUDHDG) ACC","IE00BFSS7M15.SGD":"Janus Henderson Balanced A Acc SGD-H","LU0109391861.USD":"富兰克林美国机遇基金A Acc","LU0238689110.USD":"贝莱德环球动力股票基金","LU0072462426.USD":"贝莱德全球配置 A2","LU1988902786.USD":"FULLERTON LUX FUNDS GLOBAL ABSOLUTE ALPHA \"I\" (USD) ACC","LU0417517546.SGD":"Allianz US Equity Cl AT Acc SGD","AMZN":"亚马逊","LU0052756011.USD":"TEMPLETON GLOBAL BALANCED \"A\" (USD) INC","BK4553":"喜马拉雅资本持仓","LU0640476718.USD":"THREADNEEDLE (LUX) US CONTRARIAN CORE EQ \"AU\" (USD) ACC","SG9999002562.SGD":"LionGlobal Asia Pacific SGD","LU0353189680.USD":"富国美国全盘成长基金Cl A Acc","LU2237443622.USD":"Aberdeen Standard SICAV I - Global Dynamic Dividend A Acc USD","LU0308772762.SGD":"Blackrock Global Allocation A2 SGD-H","SG9999002463.SGD":"LionGlobal China Growth SGD","IE00BMPRXR70.SGD":"Neuberger Berman 5G Connectivity A Acc SGD-H","LU0348805143.USD":"ALLIANZ ENHANCED ALL CHINA EQUITY \"A\" (USD) INC","SFTBY":"软银集团","LU0307460666.USD":"EASTSPRING INVESTMENTS CHINA EQUITY \"A\" ACC","LU2257852520.SGD":"JPMorgan Funds - Asia Growth A (acc) SGD","LU0588546209.SGD":"Eastspring Investments - China Equity Fund AS SGD","03160":"华夏日股对冲","LU0348825331.USD":"ALLIANZ CHINA EQUITY \"A\" (USD) INC","LU0029864427.USD":"TEMPLETON GLOBAL \"A\" (USD) INC","LU0823426308.USD":"法巴中国股票基金","LU0175139822.USD":"AB FCP I Global Equity Blend A USD","BK4550":"红杉资本持仓","LU1981816686.USD":"EASTSPRING INV ASIAN MULTI FACTOR EQUITY \"A\" (USD) ACC","LU0466842654.USD":"HSBC ISLAMIC GLOBAL EQUITY INDEX \"A\" (USD) ACC","LU0130102774.USD":"Natixis Harris Associates US Equity RA USD","LU0320765059.SGD":"FTIF - Franklin US Opportunities A Acc SGD","LU0327786744.USD":"Janus Henderson Horizon China Opportunities A2 USD","LU0979878070.USD":"FULLERTON LUX FUNDS - ASIA ABSOLUTE ALPHA \"A\" (USD) ACC","LU0516423174.USD":"FULLERTON LUX FUNDS - ASIA FOCUS EQUITIES \"I\" (USD) ACC","GOOGL":"谷歌A","LU0965509283.SGD":"AB LOW VOLATILITY EQUITY PORTFOLIO \"AD\" (SGDHDG) INC","LU0861579265.USD":"联博低波幅策略股票基金A","LU0198837287.USD":"UBS (LUX) EQUITY SICAV - USA GROWTH \"P\" (USD) ACC","BHOOY":"Boohoo Group Plc","IE00BFSS8Q28.SGD":"Janus Henderson Balanced A Inc SGD-H","GOOG":"谷歌","LU0130103400.USD":"Natixis Harris Associates Global Equity RA USD","LU0823426480.USD":"法巴中国股票经典Dis","LU0354030511.USD":"ALLSPRING  U.S. LARGE CAP GROWTH \"I\" (USD) ACC","LU0289941410.SGD":"AB FCP I Dynamic Diversified AX SGD","LU0256863811.USD":"ALLIANZ US EQUITY \"A\" INC","ASOMY":"ASOS plc","ZLNDY":"ZALANDO SE","LU0348723411.USD":"ALLIANZ GLOBAL HI-TECH GROWTH \"A\" (USD) INC"},"translate_title":"Zalando SE：与“疯狂”比赛作斗争","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"AMZN":1,"ZLNDY":1,"SFTBY":1,"BHOOY":1,"ASOMY":1,"GOOG":0.71,"GOOGL":0.69,"03160":0.6},"content_text":"Zalando SE is facing severe competition from companies that are adopting aggressive growth strategies, often at the expense of current profitability.PDD Holdings, the company behind the Temu app, is losing significant money on each order but has seen its share price soar.Zalando's financials have been impacted, with lower margins and slower revenue growth, with the intense competition even threatening its viability.Zalando and some of its e-commerce peers are now trading at close to distressed valuations, as uncertainty and risks have significantly increased.   CinebergIn a fight, who wins — the smart guy or the crazy guy? - Masayoshi Son There is an interesting anecdote that when SoftBank's (OTCPK:SFTBY) CEO Masayoshi Son was discussing investing in WeWork with Adam Neumann, he asked him who would win in a fight, a smart guy or a crazy guy. Neumann responded that he thought the crazy guy would win, to which Son replied he was right and that he thought Adam Neumann and his co-founder were not crazy enough. While this strategy did not work great for either WeWork or SoftBank, it did help Amazon (AMZN) become the retail giant it is today. Jeff Bezos famously said, \"Your margin is my opportunity\", and as recently as 2013 there were articles from important publications questioning whether Amazon would ever make money, and saying its behavior was challenging \"mainstream finance theory\". Certainly, an elegant way of saying they were behaving like a \"crazy\" company. We bring this up because we think this is what is crushing shares of e-commerce companies like Zalando SE (OTCPK:ZLNDY). It appears investors are betting on the \"crazy\" participants, while punishing companies like Zalando that focus more on profitability. PDD Holdings (PDD), the Chinese company behind the Temu app, is rumored to be losing about 30% to 35% on each U.S. order, and an average of 40% on orders globally. In the last five years, PDD's share price has gained more than 500%, while Zalando's shares have lost 38% of their value. It will be difficult for Zalando to remain profitable when competitors are willing to lose money to gain market share. While Amazon has become profitable in large part thanks to its AWS Cloud segment, and North American retail division, its international operations still delivered a trailing twelve months operating loss of $0.5 billion, even if Q1 2024 was profitable. Data by YChartsCompetitive Advantage Zalando had built a competitive advantage by being one of the first e-commerce fashion retailers to achieve a critical mass in Europe, with ~50 million customers. According to the company, many customers prefer to place an order with just one platform, instead of buying directly from each brand. This advantage was working well for the company before the competitive landscape changed drastically.   Zalando Investor PresentationIn fact, the company was so confident of its trajectory, that it made significant investments in its logistics network and fulfillment services. This differentiated the company as it gave it more control of the shipments, and enabled Zalando to monetize the fulfillment services by offering them to other companies. While this made the company standout, and prepared it for future growth, it also added risk and costs which could become problematic if the capacity went underutilized.   Zalando Investor PresentationZalando's Financials The story the financials tell us is that this strategy was working well after the post-Covid e-commerce boom. However, once some customers started to return to physical stores and malls, and e-commerce competition intensified, growth stalled. Growth stalling was particularly harmful to Zalando, as they had made heavy investments that are now underutilized. The company was counting on leveraging scale, and instead the underutilization of these investments made the net operating profit after tax (\"NOPAT\") deeply negative. As can be seen, the company has previously operated relatively close to operational break-even, and was starting to deliver noticeable profitability during the post-Covid ecommerce boom period. Data by YChartsThe problem we see is that the previous strategy will be difficult to implement as the competitive landscape has drastically changed. This aggressive competition is clearly having an impact on the company's financials, as we can see if we look at the operating margin and the revenue growth rate. Margins are now significantly below pre-Covid levels. At the same time, its revenue growth rate has materially deteriorated and is significantly below its historical average. Data by YChartsAccording to the company, it was adjusted EBIT profitable in 2023, but that is excluding stock-based compensation, restructuring charges, acquisition expenses, and other non-operating one-time effects. Strategy Moving Forward The company appears fully aware that its previous strategy has been rendered obsolete, which prompted management to launch what they call \"Strategy 2024\". In a nutshell, they are looking to improve profitability by increasing gross profit margin and implementing cost improvements in key areas The company believes it can double its adjusted EBIT margin by 2028 through efficiency initiatives and cost improvements such as increased utilization, automation, and use of artificial intelligence. We do not think these traditional measures will be enough to counter the rise of aggressive competition from the likes of Amazon, Temu, and Shein. They sound more like a model \"fine-tuning\", instead of the drastic strategic change needed in response to the disruptive competition they are facing.   Zalando Investor PresentationGoogle Trends Using Google Trends to gauge interest in Zalando, we can see that worldwide interest peaked around 2017, and the current interest is at about half that all-time high. Meanwhile, interest in Temu has skyrocketed, and it gets about twice the number of searches. Google TrendsEven just looking at its home market of Germany, things do not look great for the company. Interest peaked even earlier, around 2013, and searches for the company are at less than half the all-time high. More concerning for the company, interest on Temu is already at half the level of Zalando's, and increasing rapidly. Google TrendsDifferentiation Unfortunately, the aggressive price competition is turning into a race to the bottom in terms of quality and customer service. Reading through Zalando's Google Play app comments, many mention experiencing poor customer service. At the same time, as these platforms increasingly open up to third-party resellers, the same articles start appearing everywhere. It is easy to find online discussions of people finding the same products on Temu and Amazon, just at different price points. We believe this is resulting in a bifurcation, where customers are purchasing cheap items online, and returning to physical stores or buying directly from brands when they want to be sure of the product's quality. Valuation It is very difficult to accurately value the company at this point, as uncertainty is high on whether they will be profitable in the future or not. We are therefore gauging their valuation using their Price/Sales multiple, but view the company as highly speculative at this point with enormous uncertainty regarding its fair value. Zalando is trading at a significant discount to its historical Price/Sales ratio; however, we believe this is warranted given how the competitive environment has evolved. Its competitors are clearly willing to lose money to gain market share, and have deep pockets. These include the likes of Amazon, PDD, and Shein, all of which have vastly superior economic resources compared to Zalando. Data by YChartsOf course, these challenges are not unique to Zalando, and other similar online fashion retailers are trading at distressed valuation levels. For example, ASOS Plc (OTCPK:ASOMY) and boohoo group plc (OTCPK:BHOOY) are trading with even lower Price/Sales ratios, and at only a small fraction of what they once commanded. Given the very low valuation multiple, we are rating shares as a \"Hold\", but see these companies as highly speculative currently, and the chances of a successful turnaround as relatively low. To become a \"Buy\", we would need to see solid evidence that they can reignite revenue growth, improve capacity utilization, and return to a positive NOPAT or at least close to breakeven. Data by YChartsRisks We see significant risks investing in Zalando SE and some of its peers, as extremely aggressive competition from deep pocketed participants like Amazon and Chinese retailers threatens their survival. While Zalando currently has good amounts of cash and short-term investments, it also carries significant long-term debt. Its economic resources are significantly less than those of the e-commerce giants it is competing against. This is reflected in a deteriorating Altman Z-Score, which is currently below the 3.0 threshold. This places the company above the \"distress\" zone, but below the \"safe\" zone. Data by YChartsConclusion Zalando and several of its small e-commerce peers are facing extremely aggressive competition. This has resulted in decreased profit margins, and it has also affected their revenue growth. As a result, many of these companies are now trading at close to distressed valuation multiples. While a turnaround remains a possibility, we think it is highly unlikely, and therefore believe an investment to be highly speculative. The valuation appears low, but given the elevated risks and very high uncertainty, we prefer to avoid the shares.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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