Industria de Diseno Textil SA

MAD:ITX

Earnings Call Transcript 2022-Q2

[Marcos López, Capital Markets Director]

Good morning to everybody. A warm welcome to all of those attending the presentation of Inditex's results for the half year 2022.

I am Marcos López, Capital Markets Director. The presentation will be chaired by Inditex's CEO, Oscar Garcia Maceiras. Also with us is our CFO, Ignacio Fernández.

The presentation will be followed by a Q&A session, starting with the questions received on the telephone and then those received through the webcast platform. Before we start, we will take the disclaimer as read.

Please, Oscar.

[Oscar Garcia Maceiras, CEO]

Good morning, and welcome to our results presentation. It is my pleasure to join you today.

In the first half of 2022, we have continued to develop our unique fashion proposition. During my presentation, I will share with you 4 factors that, in my opinion, explain our current position: our product offering, an increasingly optimized customer experience, our focus on sustainability and the talent and commitment of our people.

As for our fashion proposition, we are constantly listening to our customers. So through creativity, quality and design, we can offer the best products in our collections. The second factor that explains our current position is the unique nature of our optimized customer experience. This is something we have been working very hard on, as you know.

As a third point, today, all our decisions are framed through our sustainability strategy. We continue to develop important sustainability projects in areas such as raw materials, manufacturing, distribution and circularity. We maintain our road map with very ambitious goals. The fourth factor, which provides color on our current situation and our very singular nature, is our people. We are a group of 165,000 professionals, 170 nationalities, fully engaged, committed and passionate.

These are the reasons why sales, EBITDA and net income in the first half of 2022 have reached historic highs. We have had a very strong sales performance in the first half of 2022. And this performance has continued beyond this period with Autumn/Winter collections very well received by our customers. The execution of the business model was very strong. Our operating performance places us in a robust financial position.

We have generated significant free cash flow, taking our net cash position to €9.2 billion. Based on the expansion of our fully integrated platform, we continue to see lower capital intensity going into the future, all this in conjunction with a well-established dividend policy.

Let me highlight some key figures for the year, thus far, marked by a strong execution of the model. Sales reached €14.8 billion, 24.5% higher versus the first half of 2021. Sales were positive in all key geographical areas. To put the strength of the operating performance into context, we have generated the strongest first half gross margin in 7 years. The control of operating expenses was rigorous as they grew well below sales growth.

On the bottom line, net income increased 41% to €1.8 billion. The net income, excluding the provision for the pause of operations in the Russian Federation and Ukraine, would have been €2 billion, 55% higher. And our operations continue to generate strong cash flow. Our diversified presence in 215 markets with low market penetration allow us to enjoy significant global growth opportunities. We have complete confidence in the ability to grow our unique business model.

Now I will hand you over to Ignacio to go into detail behind the headline numbers.

[Ignacio Fernández, CFO]

Thank you, Oscar. As can see in our release, Inditex had a very strong execution in the first half of 2022. As Oscar mentioned a few moments ago, sales, EBITDA and net income all reached historic highs in the period.

Sales have progressed strongly. We have managed the supply chain actively, and this has driven a healthy gross margin. Operating expenses have, of course, been managed rigorously. As mentioned, we have taken extraordinary charge of €216 million in order to provision all expected expenses in the Russian Federation and Ukraine for 2022. Net income increased 41% to €1.8 billion. The net income, excluding the provision, would have been €2 billion, 55% higher.

Sales have progressed very nicely at plus 24.5%, reaching €14.8 billion and grew 25% in constant currency. Sales have been positive across all key regions. Over the first half of 2022, Inditex's traffic and store sales increased significantly and continue to do so with the store differentiation being key.

Online sales progress, satisfactory. They were already positive in the second quarter of this year. Based on current exchange rate, we expect a 0.5% positive currency impact on sales for the full year 2022.

As we have already commented, sales have been positive across all key regions. Let me elaborate a little bit on this subject. We enjoy a global presence with operation in 215 markets and with a low market share in a highly fragmented sector. We have previously mentioned that the United States is now our second-largest market.

In the first half of 2022, the gross margin reached 57.9% and demonstrated a healthy execution of the business model. Gross profit reached €8.6 billion and grew 24.5%. As a side note, this is the highest first half gross margin achieved in 7 years. Based on current information, we expect a stable gross margin of plus/minus 50 basis points for 2022.

There has been very rigorous control of operating expenses across all departments and business areas. Operating expenses increased below sales growth over the first half of 2022. Including all lease charge, operating expenses grew 7 percentage points below sales growth.

The strong execution over this period can be clearly seen in the evolution of working capital. As you can see in this table, the working capital has grown 25% to €4 billion. In the face of possible supply chain tensions entering the second half of 2022, Inditex has temporarily accelerated Autumn/Winter inventory inflows in order to increase product availability without any change to commitment levels. Due to this reason, inventory as of the 31st of July 2022 increased 43%.

The Autumn/Winter inventory is considered to be of high quality and is consistent with the strong sales trends in previous quarters and the sales performance going into the second half of 2022. As of the 11th of September 2022, inventory levels were 33% higher. This assumes, in conjunction with the strong cash flow, took the net cash position to €9.2 billion.

And now over to Marcos.

[Marcos López, Capital Markets Director]

Thank you. Over the first half of 2022, we have continued with very strong expansion and have opened stores in 24 different markets. We have progressed with optimization activities across all concepts. We are pleased with execution of the concepts over the first half, as you can see in this chart.

Store sales across all concepts have been robust. Online sales are recovering the high levels of 2021. Zara has generated an exceptional performance over the period. All the formats have progressed strongly, especially Pull&Bear, Stradivarius and Bershka. The performance of Oysho should be seen in the light of the strong comparable from last year.

Back to you, Oscar.

[Oscar Garcia Maceiras, CEO]

Thank you, Marcos. I would like to comment on some initiatives this season, which are driving the increasing levels of differentiation we are seeing.

We continue providing the latest fashion in a fully integrated way. A good example of this is the seamless store and online execution that can be seen in the Zara Into the Night collection; or the Zara Man smart-casual collection; Zara Kids back to school; Zara Home, a modernist escape created by Vincent Van Duysen; the Pull&Bear's the power of colour; Massimo Dutti's Leather Skills collection; Bershka's new metallic collection; Stradivarius: A Matter of Attitude; and finally, Oysho's cycling collection.

I would like to highlight a key store project of this season: the Zara and Zara Home store at Battersea in London to open in October. London Battersea is one of the most ambitious urban development projects of recent times and will reshape living, transport, culture, retail and leisure south of the River Thames. We are very proud to be participating in initiatives that move cities and people forward.

The store in Battersea will offer the latest fashions with the most up-to-date image. Apart from the 3 key sections of women, men and children's wear, it includes dedicated spaces for lingerie, shoes and handbags, the region's collection, athletics, newborns and Zara Home. It also includes all the features of our digital store mode, allowing a complete digital experience. Customers can also use clothing recycling points, helping us to push forward in terms of circularity.

We continue to deliver upon our long-term goals. We offer a unique fashion proposition defined by creativity, design, quality and beauty. The continuous optimization of the customer experience is key to our approach. These features continue to be at the center of everything we do. We remain at an early stage in the development of all of these exciting potential. Sustainability and digitalization also remain at the core of our strategy.

The level of dedication and passion of our teams all around the globe on a daily basis will always be key for our competitive edge. I would like to reiterate that our main priority is always to invest in the future profitable growth of the business. Additionally, we will, of course, continue with our dividend policy.

As part of Inditex Sustainability Innovation Hub, we are participating in an innovative start-up, CIRC, which develops a technology that provides a solution for one of the challenge facing our industry: the industrial scale recycling of textile products composed of polyester and cotton. The technology developed by CIRC makes possible to convert these mixtures, regardless of the ratio of their composition and color, into new fibers, such as cellulose pulp for viscose and lyocell.

As part of our drive towards sustainability, Inditex is a partner in the Regenerative Production Landscape Collaborative program in which the Laudes Foundation and other organizations, government actors and the private and civil sector collaborate to promote regenerative agriculture and ecosystem restoration in an area of 300,000 hectares in the states of Madhya Pradesh and Odisha in India.

The strength of the fully integrated business model has been clear in recent times. We plan to continue developing these key long-term advantages in order to maximize organic growth. The goal is to increase our differentiation in order to provide a unique customer experience. A key focus is on high-quality stores with the aim that they be fully integrated digital and eco-efficient. As part of the strategy, we also expect online sales to exceed 30% of group sales by 2024.

Stable gross margins have always been a key focus for us. As we continue to invest in the business, we expect to deliver higher returns and lower capital intensity. We expect capital expenditure of €1.1 billion for 2022, which will drive differentiation, digitalization and sustainability.

We enjoy a global presence with operations in 215 markets with low market share in what remains a highly fragmented sector. Based on our unique fashion proposition and the factors that I have mentioned earlier, the model is operating at full pace, and we enjoy very significant opportunities through both organic growth and expansion.

A dividend of €0.93 per share for the full year 2021 was approved in July 2022. An interim dividend of €0.465 per share was paid on the 2nd of May of 2022. The final dividend of €0.465 will be paid on the 2nd of November 2022. Inditex dividend policy of 60% ordinary payout and bonus dividends remains in place. As a reminder, the Board of Directors also proposed a total bonus dividend of €0.40 per share to be paid in relation to the fiscal 2022 results.

Autumn/Winter collections have been very well received by our customers. And store and online sales in constant currency between the 1st of August and 11th of September 2022 increased 11% versus the record period in 2021.

Thank you for attending. That concludes our presentation for today. We will be happy to answer any questions you may have.

[James O’Shaughnessy, Senior IR Manager]

[Operator Instructions] The first question comes from Anne Critchlow from Societe Generale.

[Anne Critchlow, Societe Generale]

I've got three, if that's all right. Firstly, on current trading, which looks very strong, does that reflect, to any degree, a much larger summer sale year-on-year?

And then the second question is about price inflation. I think you said mid-single digit for Spring/Summer. Just wondered if you expect that to strengthen further into Autumn/Winter.

And then finally, please, could you talk a bit about the customer reaction to the introduction of paid for returns? Do you think there has been any impact on online sales growth from that?

[Marcos López, Capital Markets Director]

Well, first of all, to qualify the trading update, we can tell you that it's fully composed of Autumn/Winter sales, okay? So there is no -- there are no other aspects. We're very, very satisfied. As we mentioned in the presentation, the collections are high quality, and we have set the inventory at the start of the season just to deliver on that goal.

On the second question about price inflation, what we have mentioned, if you remember in the first half, is that we try to have a very stable pricing policy. But when there are temporary impacts coming from inflation in specific markets, what we do is try to adjust that to basically absorb that into the gross margin. And this is why we have very much, we believe, that mid-single digit will be the same action we will have for the Autumn/Winter as we had for the Spring/Summer.

And regarding your third question about the customer reaction to -- in online to the fact that we are now having some charges for returns, there's been no impact at all. In fact, it's been extremely well accepted. We have now, in a significant number of markets, the effects are -- in terms of customer reaction, we haven't had any significant setback at all.

And in fact, what we're having is 2 very positive effects: the number of returns to stores has increased; and the period in which the customers return the product is now shorter. So I understand that also from a sustainability perspective, customers understand that this is a trend that will go on in the coming years across the industry.

[James O’Shaughnessy, Senior IR Manager]

The next question comes from Richard Chamberlain at RBC.

[Richard Chamberlain, RBC]

Can I just ask about the inventory increase, please, at the half year and then the [Indiscernible]. How much of that was accounted for by forward buying, more buying inventory and demand? And I guess, sort of linked to that, how do you see your full price sales ratios now compared to before the pandemic? Is there potential for those to normalize now?

[Marcos López, Capital Markets Director]

Thank you, Richard. I think that during the presentation, we made very, very clear that in the face of supply tensions going into the second half, we had temporarily accelerated Autumn/Winter inventory inflows in order to increase product availability. But in our case, without changing our committed levels at all, I mean the proximity sourcing remains in place and is a key part of our proposition.

This is something -- the increasing inventory at the beginning of the season is something that you're hearing widely from other market participants. But in our case, what we can tell is that 43% increase in inventory is very much in line with the sales trends we have seen in previous quarters and also with a strong trading update of 11%. And this is why we have qualified that number and mentioned that just 42 days later, the inventory is just down to 33%. So very much consistent with what we have in terms of trading right now.

[James O’Shaughnessy, Senior IR Manager]

The next question comes from Warwick Okines at Exane BNP.

[Warwick Okines, BNP Paribas Exane]

In the first half, Zara grew much faster than the younger concepts and has done since COVID. Do you think the group mix has permanently shifted towards Zara? Or do you see brands like Massimo Dutti getting back to pre-COVID revenues?

[Oscar Garcia Maceiras, CEO]

Thank you. Thank you for your question, Warwick. Well, we are very happy with all of the performance of all of our concepts. They continue to grow year after year with double-digit EBIT margins and with very strong online growth. We are targeting different segments of the market, but all of concepts share the same business model and the same way of reacting to fashion trends to provide with the customer wants now fresh high-quality fashion. We consider that we are covering the different segments of the market.

And it's the business model that underpins this strong performance. And this business model is progressing at full pace and has great growth potential going forward. Just a reminder, last year, all our concepts grew and all had high PBT as a percentage of sales above 15%.

[James O’Shaughnessy, Senior IR Manager]

The next question comes from James Grzinic from Jefferies.

[James Grzinic, Jefferies]

Just a couple of quick ones from me. The first one, when you talk to supply chain tensions, I presume you mean Asian sourcing, the commodity sourcing out of Asia rather than anything linked to proximity sourcing. Just to clarify that.

And secondly, can you perhaps update us on the current trading conditions in China? How many of your stores are being constrained by closures or whether that's largely passed now? That would be very helpful.

[Marcos López, Capital Markets Director]

Thank you, James. You're absolutely right, when we're referring to supply chain tensions, we're talking about the long haul. That's the case of Asia. This is why we have decided to temporarily anticipate the inflows to be well stocked into the Autumn/Winter season. And as I mentioned, this is absolutely the key part of our inventory right now, and this is what we're selling.

Regarding China, I prefer to talk about Asia as a whole. You see that we have had a positive performance in that area. Obviously, it's not exactly the same in those markets where there have been restrictions and in those where they haven't. But again, we can see that we've had a very, very strong trading across the board that continues into the Autumn/Winter season.

[James O’Shaughnessy, Senior IR Manager]

The following question comes from Nick Coulter from Citi.

[Nick Coulter, Citigroup]

Congratulations on the results. I'll apologize in advance for this question as it's on depreciation. But the implied number for the second quarter is down quite substantially. I know there'll be puts and takes, but are there any moving parts that you would call out, please?

[Marcos López, Capital Markets Director]

As you know, Nick, in depreciation, you had the, well, the usual depreciation of the asset base and also it's regarding the leases, right? And these is -- these are the moving parts. But all in all, you shouldn't read anything specific into a quarter.

[James O’Shaughnessy, Senior IR Manager]

The next question comes from Adam Cochrane at Deutsche Bank.

[Adam Cochrane, Deutsche Bank]

A question for me on the price increases and gross margin. The mid-single-digit price increases that you took at the beginning of the year, and you still saw some gross margin pressure in the first half over the period. As we look at the second half and input costs going up, energy costs going up, is the mid-single-digit price increase going to be enough to hold the gross margin in the second half of the year given that it didn't appear to do so in the first half of the year?

[Marcos López, Capital Markets Director]

Thank you for your question. I think it's a very relevant one. As you have seen in the gross margin, there are a number of moving parts, that there are some tensions is clear. We talked about that during the first quarter conference call. This is why we mentioned that when there are temporary inflationary pressures or there are some currency movements, we just adjust that into the pricing, but within a general thinking of a stable pricing policy.

In any case, the gross margin of the first half, 57.9%, is the highest gross margin over a first half in 7 years. And within that context, we are providing a stable guidance for the second half of the year, talking about plus/minus 50 basis points. So all in all, this frames our thinking about the gross margin for the whole year.

[James O’Shaughnessy, Senior IR Manager]

The next question comes from Rebecca McClellan from Santander.

[Rebecca McClellan, Santander]

My question is about the Autumn/Winter collection, which there seems to be a sort of a really big sort of penetration of suiting and smartwear and jackets, et cetera, et cetera. Is -- theoretically, that should drive a positive price mix across the season. Is that within the 5%, the mid-single-digit price increase? Or is that mid-single-digit price increase like-for-like? And would the mix effect come over and above that?

[Marcos López, Capital Markets Director]

Well, the sales mix is a combination. But again, what is driving our trading update 11% growth up to the 11th of September is clearly the quality of our collections, the execution of the model. During the presentation, we have illustrated a number of very relevant collections that we have right now into the stores: the Atelier collection, which involves a lot of artisan work, embroidery, brocade, et cetera, et cetera, which provides a lot of embellishment.

Second, we have also made very clear the collaboration we've had with Narciso Rodriguez, which is a very beautiful collection. We have illustrated it as well. And obviously, just to wrap up with the collection, Into the Night in which we have used Kate Moss as an ambassador of that collection.

It's clearly the level of newness, the quality, the design, the artful part of what we do and obviously the execution that is driving our sales, right? So obviously, pricing, our thinking is always about stable pricing. Sometimes we have to adjust based on temporary factors. But again, the main driver of our sales is clearly the collections and the willingness of people to buy the product that we offer, which we believe is clearly outstanding.

[James O’Shaughnessy, Senior IR Manager]

The next question comes from Georgina Johanan from JPMorgan.

[Georgina Johanan, JPMorgan]

My question is about looking ahead into next year. I appreciate it's very early days, but of course, there are headwinds in terms of U.S. dollar pressure, and several other competitors have referenced kind of increasing OpEx inflation from here. As things stand with these external pressures, do you think it's possible and are likely that Inditex can hold its EBIT margin into 2023? Or should we just be mindful of that in our modeling of those external pressures, please?

[Oscar Garcia Maceiras, CEO]

Thanks for your question, Georgina. Well, you know that our sector is highly fragmented. As we mentioned during the presentation, we operate in 215 markets with low market shares and with a unique fully integrated model. While macro and consumer concerns are understandable, we remain totally focused on our collections, and we have a strong confidence in our long-term growth opportunities.

And we prefer to comment with data. You have seen the sales growth so far this year, plus 24.5% in the first half of 2022 and plus 11% at the beginning of the second half of the year. So again, we remain confident in our business model and our capacity of having a very good execution of it.

[James O’Shaughnessy, Senior IR Manager]

That completes the Q&A session for today. There have been a couple of questions on the webcast platform now. Let's go ahead.

The first of which is, can you please provide us with more information about what you're doing with stores globally?

[Oscar Garcia Maceiras, CEO]

Thank you for the question. Well, as we mentioned in our release, we have opened stores in 24 markets over these first 6 months of the year with some very relevant openings such -- to give you two examples, such as Zara Plaza España, Madrid and Zara [Plus Wendong] in Qatar.

Additionally, we have had enlargements, refurbishments and relocations in 50 different markets over this period. And a good example would be our store at Santa Catarina in Porto, which was the first Zara store opened outside of Spain in 1988. And of course, we have continued upgrading the image in the store in far more places around the world.

And finally, well, we have covered it during our presentation, we have very exciting new projects like Zara and Zara Home at Battersea in London to open in October, as we mentioned again in our presentation.

[James O’Shaughnessy, Senior IR Manager]

Could you provide some color, please, on a geographical basis, namely the Americas and perhaps Central Europe, in particular?

[Oscar Garcia Maceiras, CEO]

Well, our performance has been very strong across all geographies with the only exception, of course, of those markets subject to restrictions. The sales progression in the first half was very positive from a global basis, up 24.5%.

We have not seen any weakness in Central or Eastern Europe, and we are very happy with our performance in the Americas in first half 2022. You know that the U.S. is already our second-biggest market, and we see big growth opportunities in that market. We continue to see a strong demand globally for our collections with high components of fashion, quality and sustainability.

[James O’Shaughnessy, Senior IR Manager]

Thank you, Oscar. That completes the webcast questions.

[Oscar Garcia Maceiras, CEO]

Thank you to all of those participating in the presentation today. For any additional questions you may have, please get in touch with our Capital Markets Department, and we will welcome you back in December for the 2022 9 months results. Thank you again.