One of the UK's biggest online success stories is undoubtedly clothing retailer Asos (ASC). Its relentless rise has rewarded shareholders handsomely. Those who bought its shares when the one-stop fashion shop for trendy 20-somethings floated on the Alternative Investment Market in 2001 and stayed for the long haul will have made once-in-a-lifetime returns, with the share price rising by 136 times. Even latecomers have done well. So far this year the share price has risen 23 per cent. However, there comes a time when shares in even the greatest company can be overrated. And, for Asos, that time is now.
- Strong profit growth
- International expansion
- Shares priced for perfection
- Share rating demands industry-leading profit margins
- Consensus buy rating
- Growth requires heavy spending
OK, we have form. We have called the top on Asos shares before; most notably in February 2011 when we recommended selling them at 1,676p. Even so, let's look at the share rating now. The combination of the 72 times forecast earnings (see table) and the price-to-sales ratio of 3.8 times forecast sales is a worry. In particular, the price-to-sales ratio prompts the questions: what's the ideal trading performance that Asos must produce to justify such a ratio and how far is Asos from that ideal?
Spanish group Inditex, which owns the Zara chain, and the Swedish affordable fashion retailer H&M provide a glimpse of the ideal because each has got to where Asos wants to be. And each company's shares are rated similarly. Zara trades on 27 times earnings with a sales multiple of 3.7, and H&M shares trade on 23 times earnings with a sales multiple of three. So Asos's shares have a similar price/sales multiple but a far higher price/earnings ratio.
The difference is explained by the profit margins. Inditex and H&M make meaty profit margins in the high teens, while Asos's - at around 8 per cent - are quite skinny for a fashion retailer. Granted, that's partly a function of Asos's comparative immaturity. It's still growing fast and the costs of that growth reduce margins. Even so, to get to Inditex's and H&M's margins is a tall order. And, arguably, to justify its share price Asos would have to make even higher margins. After all, with its shares trading on a price/sales multiple of 3.8 times, even an operating profit margin of 20 per cent would filter down to a price/earnings multiple of about 24 times.
Meanwhile, Asos's shares are priced for perfection, reflected by the fact that almost all City analysts who follow Asos reckon its shares are a 'buy'. Paradoxically, this is bearish. It implies that all the good news is in the share price. And broker Espirito Santo, one of the few who rate the shares a 'sell', reckons the share price is being driven by sales upgrades, rather than profit outperformance.
| ASOS (ASC) | ||||
|---|---|---|---|---|
| ORD PRICE: | 3,395p | MARKET VALUE: | £2.80bn | |
| TOUCH: | 3,395-3,403p | 12-MONTH HIGH/LOW: | 3,409p | 1,325p |
| DIVIDEND YIELD: | NIL | PE RATIO: | 72 | |
| NET ASSET VALUE: | 130p | NET CASH: | £27.9m | |
| Year to 31 Aug | Turnover (£m) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|---|
| 2009 | 165 | 14.1 | 13.6 | nil |
| 2010 | 223 | 20.3 | 20.0 | nil |
| 2011 | 403 | 12.6 | 11.7 | nil |
| 2012 | 553 | 40.0 | 38.1 | nil |
| 2013* | 740 | 52.0 | 47.0 | nil |
| % change | +34 | +30 | +23 | - |
Normal market size: 1,000 Matched bargain trading Beta: 1.0 *Peel Hunt estimates (profits & earnings not comparable with historic figures) | ||||
That said, Asos boasts profit and sales growth that is the envy of every major high-street retailer. In the three months to 28 February 2013, retail sales grew 37 per cent year on year, with 28 per cent growth in the UK and 45 per cent in the rest of the world. Broker Peel Hunt reckons the medium-term outlook for Asos remains "exciting and compelling", but feels the market is getting too hot about the short-term possibilities. With resources on the ground required in China and Russia this year - coupled with many more investments, such as higher marketing costs - the broker thinks operating margins won't improve and sales performance is unlikely to materially outperform the £1bn target for 2014-15.
True, there are catalysts for further growth. New in-country warehouses, websites and management could improve Asos's cash flow and boost earnings. New fulfilment centres in the US and China, for instance, should begin operations in 2013-14, improving service and delivery times for shoppers; in China, currently shoppers have to wait 12 days for free standard delivery. This is also good for costs. In the US, no in-country warehousing means delivery costs eat up 30 per cent of sales, compared with 8 per cent in the UK.
