Time to return these fast fashion shares

Asos’s weakening position has been evident for some time. The shares once traded at over £70 a pop, but now sit below the £5 mark. The post-Covid-19 trading landscape is not a comfortable one for the Topshop and Miss Selfridge brand owner, with its target market (those in their 20s) badly hit by cost of living pressures and forced to return goods at levels that are materially detrimental to profits.

The challenging situation was evident in changes made to Calamonte’s bonus plan in November. The revenue weighting in the company’s calculation of executive bonuses was cut from 30 per cent to 15 per cent, and gross margin and active customer number targets were replaced with a “cost mitigation” objective. This wasn’t surprising, given the challenging context, but it did highlight that the immediate future for the company is one focused on cost-cutting rather than growth.

Fast-fashion travails

The fast-fashion sector has lost its lustre after the pandemic boom times, as the return of the high street hits online-focused retailers. The comedown for the listed players has been brutal. While Boohoo’s (BOO) annual results this week were better than expected, the company still plunged to a £91mn loss, as cash profits halved and revenues fell by 11 per cent.

Asos hasn’t been exempt, especially as it  lives at the budget end of the spectrum with a customer base that is struggling.

The admission in Asos’s latest results, which covered the six months to 28 February, that there is “a small number of customers that have a disproportionately negative impact on Asos’s profitability”, to the tune of over £100mn, was quite something. In 2022, this group made up around 6 per cent of active customers and resulted in a loss of £6 per order. This is, clearly, no mere pocket change. Management’s statement that it is now “using a more personalised approach to incentivise positive behaviours” doesn’t sound very encouraging as a solution.

But quite apart from concerns around financial performance and struggling customers, there are several other issues that investors keen on the sector need to consider before they take the plunge. Serious ethical issues in supply chains have been in the spotlight, notably at Boohoo. ‘Buy now pay later’ schemes such as the Klarna payment method – which can be used with Asos – have been criticised for incentivising young people to fall into debt by purchasing items they can’t afford. And now the Competition and Markets Authority is investigating Asos and Boohoo about potential ‘greenwashing’ and possible breaches of consumer protection law.

The outlook for Asos is further clouded by the increasing pressure on established operators from new market players. Chinese company Shein, for example, is taking market share in the US to the detriment of both Asos and Boohoo, and has become a notable operator in the UK market, too. Analysts at broker Stifel say that “Shein remains the winner in US fast fashion, with search trends continuing to grow, likely supported by the retailer having the cheapest delivery costs”.

Driving change?

The stock market’s reaction to Asos’s latest results put into focus the uncomfortable position the company finds itself in. The share price cratered by more than a fifth on the day after management pointed to “deliberate actions on capital allocation to improve profitability and a challenging trading backdrop” as the reasons behind weaker-than-expected postings. Another 20 per cent was then wiped off the shares just as this article went to press, amid concerns a rights issue may be on the cards.

Revenues fell by 8 per cent to £1.84bn in the first half of 2022-23 and were down by 15 per cent in January and February. This was a sharp contrast to other retailers who have grown their top lines via chunky price increases in these inflationary conditions. Pre-tax losses widened from £16mn to £291mn, with previously intimated stock write-offs and property impairments contributing £178mn. Annual free cash outflow is forecast to come in at a chunky £100mn (at the bottom of the company’s previous guidance range). This was emphatically not what the doctor ordered.

Key performance indicators (excluding Russia, which Asos exited in March 2022) were poor. Active customer numbers were down by 2 per cent year on year, with premier customer numbers slumping by 7 per cent due to higher subscription prices and changes to minimum order values. Meanwhile, shipped order volumes contracted by 11 per cent, and website visits fell by 5 per cent as customers returned to stores on reopened high streets.

Management attributed around half of the sales fall to its ‘driving change’ agenda, which is intended to restructure the business for the future by boosting profitability and cutting costs.

There have, it must be said, been some encouraging signs of promise within this new strategy. Inventory reduction is ahead of plan. Topshop sales grew by 12 per cent, year on year. And according to Kantar data, the company has grown its market share among the 16-35 demographic. Ties have been broken with underperforming brands, and delivery charges have been updated across markets. The board has been shaken up, too.

According to management, Asos is on track to deliver over £300mn of cost savings this year, £100mn of which came in the first half. This will drive around £200mn of “profitability benefits” in the second half, when a return to profitability and positive cash generation is expected. The board forecasts an annual 100 basis point improvement in the adjusted gross margin, which was up by 300 basis points in February, year on year.

But gross margin has been heading downwards for a long time (see chart). Fundamentally, we are not convinced that there is the potential at Asos for significantly stronger margins over the medium term.

Stifel analysts are likewise dubious. They said they “continue to believe Asos’s path to a reasonable sustainable profit margin and return on capital employed will take longer than the consensus expects”.

And as demonstrated by the half-year results, the focus on profitability is hitting the top line. For the full year to August, the consensus position, according to analysts’ forecasts from data provider FactSet, is for a 5 per cent year-on-year sales contraction.

Balance sheet and valuation

The state of the balance sheet is another major concern. The rise in net debt at the half-year point, from £63mn last year to £432mn this time around, was notable (Boohoo, by contrast, has pivoted to a net cash position). While the company obtained an extension of its £350mn revolving credit facility out to November next year, there was only £100mn undrawn at 28 February. It is a distinct possibility that Asos will have to raise new capital, a far from ideal situation for a struggling company in a challenging economic climate.

For analysts at broker Peel Hunt, who cut their target price from 750p to 550p on the back of the latest results, “the shares will remain under the shadow of balance sheet concerns until Asos can demonstrate genuine recovery”. At the time, the broker rated the shares at 14 times 2023-24’s forward earnings. While this is well below the consensus five-year average of 37 times, and will have fallen further this week, it still looks too demanding a rating for an underperforming company that is trying to engineer a turnaround in the context of a struggling customer base.

Analysts at investment bank Shore Capital, meanwhile, argue that “there are concerns regarding Asos’s ability to protect its brand’s equity, particularly in relation to deep discounting to clean inventory. This could pose challenges in selling products at full price in the future”. They add: “Consequently, we view Asos as a particularly vulnerable player in the current context, and we expect consensus free cash flow to be downgraded below management’s guidance.”

We agree with this caution. If only Asos shares could be returned like its clothes. Sell.