ASOS Plc: Becoming Stronger With Every Quarter

seekingalpha10-16

The new CEO is driving much-needed change for a struggling retailer.With improved operations, the company is reporting the best H1 free cash flow since 2017.Topshop divestiture and bond rollover are ...

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Get published, earn money, and unlock exclusive SA Premium access. Click here to find out more » Klaus Vedfelt/DigitalVision via Getty Images ASOS Plc (OTCPK:ASOMF, OTCPK:ASOMY), a leading European retail e-commerce fashion player, is nearing profitability. With CEO José Ramos Calamonte at the helm, the company seems to be gaining traction. The company is reporting inventory right-sizing ahead of plan and the best free cash flow since 2017. Despite this, the stock price remains almost perfectly flat after losing 90% of value by pandemic mistakes. Trading below 0.3 forward revenues and with a strengthened balance sheet, shares start to look attractive. Industry and Company Overview The United Kingdom, ASOS domestic market, has the highest online shopping penetration in Europe. During the pandemic, apparel and footwear e-commerce saw a significant boost as customers were forced to shop online. However, when restrictions eased, many ended with excess inventory. Like others, ASOS also made mistakes in this environment. The company implemented an all-for-growth strategy by growing stock size and making acquisitions in anticipation of higher demand, and then facing a sharp decline when restrictions were lifted and customers came back to in-store buying. An additional setback came from exiting the Russian market following the start of the war in Ukraine. This led to poor financial results in 2022 and 2023. For H1 of 2023, ASOS reported: £1.8 billion in revenue, a poor 36.1% gross margin, and a staggering 258.8 million cash outflow. What's important to notice here: in other years, the company was always profitable from operations. To be exact, excluding poor 2022 and 2023, ASOS was bringing£146 million of cash from operations on average, annually. Own elaboration of company financial statements (ASOS annual reports 2013-2021) This data implies that the business model is valid. The last results suggest that the company might be coming back from this bumpy road. Recent Performance Free cash flow H1 2020 - H1 2024 (company presentation) In H1 2024 the company reported: £1.5B in revenue, 40% gross margin, and had only a 21.1 million cash outflow. This year's first half, ASOS right-sized inventory below£600 million ahead of schedule, made more than 80% of it younger than 12 months and achieved a 10% year-over-year increase in stock turnover. Inventory size (company presentation H1 2024) Why is this important? The inventory build-up was caused by described overstocking in the pandemic environment and has been dragging company results ever since. Nobody wants to buy out-of-fashion clothes. Especially young Gen Z and Y people the company is targeting. They want to be original or even ahead of fashion. Having now 80% of inventory younger than 12 months, the company made sure that they can. Following this, a 10% increase in stock turnover, indicates that less obsolete inventory is resulting in more frequent purchases. The company also shortened its own-brand stock delivery period to just over two weeks, which is crucial because now ASOS can react to trends more promptly. Own-brand average gross margin (company presentation H1 2024) Having a relevant product delivered in time probably contributed to margin improvement, as the relevant product has a better chance to be sold at full price than an obsolete one. ASOS estimates that gross margins for own-label products are around 58%, compared to 50.6% for Boohoo or 40% for Zalando. This is huge in terms of profitability. Also, own brands are what differentiates ASOS from competitors like Zalando, which sells only third-party brands. Way To Grow Again That is all fine, but can ASOS grow sales from here, or is it destined to decline? Last month, the company took steps to solve the problem of debt. Before, ASOS had a huge debt repayment of 700M due in April 2026, casting a shadow on the company's future. Now by divesting majority stake in Topshop and rolling over part of convertible bonds to 2028 the company improved balance sheet by at least £135m and secured cash for potential investments necessary to impose growth again. Programs like \"Test and React\" aiming to test the market with small quantities of own-label products and a recently announced AI collaboration with Microsoft, can help further expand the share of own brands in the product mix and give a way to grow margins. Now let's talk sales. ASOS is shipping to 196 countries and has above 23 million active users. In its domestic UK market (69 million people), ASOS reaches 12% of the total population (8.16 million active customers), which equates to around 40% of its target Gen Z and Y audience of \"fashion loving 20 something\", (18-44 years old population). This significant penetration brings ~40% of company revenues while the rest comes from EU, US and Rest of the world segments where market penetration is significantly lower. ASOS website demographics (similarweb, helplama) The company has only 7% reach of target audience in the EU and a mere 3% in the US. This low penetration already brings more than the UK in revenue terms, and as we can see, there is room for much more. While in the UK the core audience is estimated to be around 20 million, in the EU it is ~140 million and in the US ~100 million, making both of those markets 7 and 5 times bigger respectively. Revenue wise, the EU and US are also bigger. The UK is $31b market, while the EU and US are both above $100b markets. Expanding reach in those markets would translate to immediate revenue growth. The company has taken initial steps to gain market share in the U.S. through a strategic partnership with Nordstrom. While this partnership has not yielded significant results yet, introducing new brands like Veja might be one of the ways to attract new customers from demanding EU and US markets. There is also a growing Indian e-commerce apparel market where ASOS just partnered with the country's largest retailer, Reliance Retail, a few months ago. The Indian market alone is 15B big, while the whole Rest of the World segment brought ASOS only 330 million. This segment was losing sales but growing basket value, which means that fewer customers were buying more on average. If guided wisely, the Indian market can become an important revenue stream for ASOS with its whopping 20% projected CAGR. The main headwind for the company in the EU and US markets will be stiff competition coming from the 3rd generation of fast fashion retailers like Temu or Shein. 40% of US consumers and 26% of UK consumers have shopped at Shein or Temu in the past 12 months. These companies, with their ultra-low prices and rapid turnover, have captured the attention. On the other hand, ASOS is more in the mid-market segment, and it can attract more aspiring customers, not necessarily hard clashing with Temu or Shein. Another headwind is freight costs, which stay elevated. As tailwinds, we see dropping inflation, and growing consumer confidence, which in return could result in more consumer spending. There is also a sportswear boom and ASOS has a lot of reliable sport brands to make use of it. The biggest advantage and also challenge will be balancing between own products and third-party brands to create a truly unique offering. With further partnerships, new brand introductions and a disciplined approach to future investments, it is possible, in my opinion, for ASOS to repeat success in new markets, compete and grow again. Valuation Now, how can we value this potential? Coherent Market Insights predicts a 15.5% CAGR for the UK e-commerce fashion market. As shown before, ASOS revenues (excluding 2022, and 2023) were growing at a 20% pace year-over-year. I do not expect such high revenue growth in the coming years, given restricted consumption and more uncertain macroeconomic factors than ever. However, with a proven business model, I assume that ASOS turnaround plan is working, and the company will become cash flow positive this year. I also expect it to return to pre-COVID profitability next year, and then grow a little 5% annually, which is conservative taking into account the historical 20% growth pace. DCF model based on company filings (own elaboration) With these assumptions plus a WACC of 10% and an EV/EBITDA exit multiple of 9, DCF model suggests an equity value per share of£6.41, which is more than 45% from current share price (£4.41). But… Risks And Summary There is no free lunch in the market. The risks remain, and I have identified at least three crucial points that, if proven wrong, can disrupt the valuation: 1. Debt: The company has £671 million in debt, part of it due in April 2026, and the rest in 2027 and 2028. In our model, we assume part of this will be repaid by cash, part through new share issuance (dilution), and part refinanced. Divesting a 75% stake in Topshop to strengthen its cash position may serve as confirmation of this prediction, or at least the cash part of it. 2. Dilution: Debt brings the risk of dilution, as the company has frequently used equity offerings for financing. In my model, I assumed an issuance of 36 million additional shares, but this number could be much higher if the company decides to pay off all of its debt this way. I consider this scenario unlikely at the current share price, given that ASOS throughout its history has only issued shares when the price was at its peak. 3. Revenue Decline: Revenues have been in continuous decline from nearly £4 billion in 2022 down to a projected £3.2 billion in 2024. It remains to be seen whether the sweet spot for profitability and growth has been found with this year's results, or if ASOS revenues will decline further. I'm assuming 5% growth from 2025. If revenues keep on declining, the model will be incorrect for obvious reasons. Conclusion The company's business model has been successful in the past and, I believe, it can be successful again. The new CEO appears to have a clear strategy and even better execution. Taking all of the above into account, I give ASOS a buy rating. It is not a strong buy only because, as Charlie Munger once said, \"it is a goddamn retailer\". Full-year 2024 results, coming in November, should serve as first confirmation or contradiction to my thesis.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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