H & M Hennes & Mauritz AB

STO:HM B

Earnings Call Analysis

Improved Cost Control Enhances Sales Focus

In Q1, the company demonstrated robust cost management, yielding strong bottom-line results. These savings are being diverted to increase marketing efforts while prioritizing areas of highest return on investment. A key objective is optimally curated merchandise assortments that resonate with customers. This strategic focus is aimed at driving sales, with enhanced marketing designed to broaden the customer base and bolster long-term stability. Europe saw varied regional performance, with Eastern Europe, especially Poland, exhibiting considerable growth, and Germany recuperating from previous softening demand.

Refurbishing Stores to Drive Customer Excitement and Sales

The company is embarking on an ambitious plan to refurbish 250 of its retail locations, representing about 5% of its total store count, though these stores are likely more significant in terms of sales as many are flagships. Refurbishments are not limited to flagships but also include regular mall stores, reflecting a belief in the strength of the physical retail network. This strategic move, part of a longer-term effort to optimize the retail portfolio, aims to inspire and excite customers, maintain competitiveness in the fashion industry, and appeal to a wide range of locations.

Optimizing Operating Costs to Support Profitable Selling

Efforts to manage operating costs have been effective, as demonstrated by recent quarterly results showing operational leverage even on moderate sales developments. Key to this has been enhancing space productivity, improving sales per square meter, and shifting emphasis from less valued customer experiences to those positively impacting customer interaction, such as availability of products, simplified checkout processes, and a general boost to the in-store experience. While the company has addressed a good portion of operational efficiency opportunities, it acknowledges that this is a continuous process with more potential for improvement.

Strong Performance in Eastern Europe and Adjusted Focus on Marketing Spend

Regional performance in Europe has been particularly noteworthy in Eastern Europe, with countries like Poland seeing a robust upward trend over several periods. The company is satisfied with its operational cost control and bottom-line results, which provides leeway to prioritize top-line growth, primarily through reassessing and potentially increasing its marketing spend. This strategy reflects a shift from the past cautious approach, with a clear emphasis on optimizing marketing investment toward channels with the best return on investment, ultimately driving sales and customer engagement.

Future Strategy Geared Towards Top-Line Growth

Moving forward, the company is setting its sights on top-line growth, aiming to attract more customers and solidify its customer base. The strategy involves both clearing stock efficiently and using markdowns to activate the customer base rather than just to offload inventory. Confidence in the stock composition exiting the first quarter backs this tactical approach, indicating that markdowns in the coming quarter will primarily serve to engage customers more so than in the past.

Earnings Call Transcript 2024-Q1

[Operator]

Good afternoon, and welcome everyone, to the H&M Group's conference call 3-months report for 2024. [Operator Instructions] Please be advised that today's conference call is being recorded.Today, I am pleased to present Joseph Ahlberg, Head of Investor Relations. I will now hand you over to our speakers. Please begin.

[Joseph Ahlberg, executive]

Thank you, and hi, everyone. Thank you all for joining us today. Welcome to this telephone conference in connection with the H&M Group's first quarter results 2024. With me today is our CEO, Daniel Erver; and our CFO, Adam Karlsson.We will start with a short summary of the first quarter. After that, we will be happy to answer your questions. Please ask 1 question at the time, so we can answer them one-by-one. You find the report at hmgroup.com Investor Relations.Now, I'll hand over to you, Daniel.

[Daniel Erver, executive]

Thank you, Joseph. Hello, everyone. We see that the business continued to develop in the right direction in the first quarter, with an improved gross margin of 51.5%, an operating profit of SEK 2.1 billion, 7% lower inventory and strong operational cash flow. The increase in profit is related to good operational cost control, as well as the cost and efficiency program, and the continued normalization of the external factors that influence our purchasing costs.If we move to sales for the quarter, it was gradually improved during February with well-received spring collections, and this is a signal that we are on the right track. Sales for the 1st of March to the 25th of March increased by 2% in local currencies, compared to last year.We are fully focused on driving profitable growth going forward. Our stronger gross margin enabled us to further strengthen the customer offering through improved quality as well as better prices. We strengthened and broader all parts of the assortment and our design organization's most important mission is to create attractive collections for a wide -- attractive collections for a wide and fashion interested audience.Another example of ongoing improvement is increased production in local markets and strength and work with digitalization and AI. In this way, customers get access to more relevant fashion regardless of which sales channel they choose to meet us in. We have a strong position in the market with billions of visits per year to both our physical and digital stores, which means that we have the opportunity for direct relationships with our customers through all of our brands.We are in a market that is expected to grow by more than 5% until 2028. We work continuously to offer an inspiring experience in both our stores and online. The stores are an important part of our brand building, and we therefore, continue to invest to upgrade our stores and elevate the customer experience.This year, we are refurbishing around 250 stores globally. For example, in cities such as New York, London, Berlin and Stockholm. I recently attended the H&M store opening in SoHo, New York and on King's Road in Chelsea, and it was great to see how well the stores were received by customers who formed long queues outside.These stores offer a refined shopping experience, with strong collections with accessories that complement, an exclusive H&M beauty and exclusive H&M beauty products. Customers are offered styling tips from our store team and RFID makes it possible for customers to find both products and sizes more easily, as well as automatically provide information to staff on what needs to be restocked.Today, we are also launching our annual and sustainability report, where we talk about our progress during 2023. Among other things our absolute amount of greenhouse gas emissions decreased by 22% during last year. Besides this, the development of greenhouse gas emissions in relation to sales also decreased with 23%, compared to the base year 2019.To achieve our ambitious climate goals, we are also investing in some of the most important areas such as projects to improve our supplier's energy efficiency, and their transition to renewable energy. We also make investment in innovation within sustainability. We have co-founded the recently launched Syre. They are driving innovation of rapid up-scaling of textile to textile recycling of polyester. Through Syre, we aim to move towards the closed loop of recycled materials and by doing so, contributing to a more sustainable fashion industry.I'm glad and humbled to have been entrusted with leading the H&M Group. Me and all of my colleagues' main focus is to create the best customer offer for our customers. Our progresses remain to strengthen the product assortment, always offer the best price, create inspiring experiences in both our physical and digital environment, combined with strengthening our brands. We see great opportunities with our customer offering, our digital and physical presence and our direct relationship with our customers for profitable and sustainable growth.In times, where households living costs are high, it's more important than ever to offer customers unbeatable value for money. In this situation, our customer offering is more relevant than ever, and our top priority is to strengthen sales, and therefore, we remain committed to our targets of achieving an operating margin of 10% for the full year 2024.Thank you very much for listening, and we are now happy to take your questions.

[Operator]

[Operator Instructions] Our first question for today comes from Fredrik Ivarsson of ABG Sundal Collier.

[Fredrik Ivarsson, analyst]

First question relates to the top line development. Just curious to hear, Daniel, what kind of measures you're taking to improve the underlying momentum if you've done any like significant changes lately that we should be aware of? That's my first question.

[Daniel Erver, executive]

Okay. This is Daniel. When it comes to the top line development, we saw a gradual increase in the second part of the first quarter, and we see a continued positive momentum in March. We do believe that there is more potential for top line growth, and we are focused with all of our teams to make sure that we drive top line growth by providing the best possible customer offer, where we have a big focus on making sure that we have relevant collections and the best value for money in the market, given the current market conditions.And we see coming out over the first quarter and coming into the second quarter that our spring collections have been well received, especially on women's wear and our cost collections have been really well received by customers. So focus remains on making sure we have the best customer proposition with the great value for money and relevant collections for our customers.

[Fredrik Ivarsson, analyst]

And a follow-up, as you mentioned, costs and I think you mentioned that in the annual report as well, you say costs performed well and contributes to profitability. Can you give some ballpark figures on where cost is at in terms of sales and margins? I recall you mentioned a number around SEK 10 billion on your Capital Markets Day in 2018. So if we could get an update on that, it will be very helpful.

[Joseph Ahlberg, executive]

This is Joseph, Fredrik. So we are not disclosing individual brands. As you know, we've shared the growth area of portfolio brands as a whole, where we have a growth in the quarter -- first quarter of 8%, both in Swedish krona and in local currency.

[Fredrik Ivarsson, analyst]

Can you give a ballpark figure on margins for the portfolio brands?

[Joseph Ahlberg, executive]

No, we're not sharing margins for per growth area. We only share as a total for the group. But with the positive selling development, we also see margin improvements from portfolio brands. So we're happy with that development as well.

[Fredrik Ivarsson, analyst]

Okay. Fair enough. And last question from my side, if you've seen any or made any like initial learning's from the new e-com platform you tested in Denmark? I appreciate it. It's still early, but do you say anything on it.

[Daniel Erver, executive]

This is Daniel. It's still early. We are in a piloting testing phase for a selected amount -- not the entire digital traffic goes to the up-ticked side, but part of the customer base gets the new updated experience. We -- the aim with it is to raise the level of inspiration to drive over time, more organic traffic to the site, and we see positive tendencies when it comes to the fashion perception and the engagement from our customers. So we are looking at -- and currently looking at plans for how we will scale that experience moving forward.

[Operator]

Our next question comes from Richard Chamberlain of RBC.

[Richard Chamberlain, analyst]

I've got 2 questions, please. The first one is wondering, if you can just comment on your thoughts on pricing at the moment. And in particular, any thoughts of needing to become more price competitive in markets like the U.S. and then, I guess, the potential sort of margin implication of that? That's the first question.

[Daniel Erver, executive]

This is Daniel. We see that we are very satisfied with the development of the gross margin through both positive development of internal work through how we have partnered with suppliers, how we work to increase flexibility, but then also a normalization of the macro factors affecting the purchasing costs.With that, we see an opportunity in investing in the customer offer, and we are always looking at adjusting prices to make sure we have the most competitive price on the market and that work we're doing also looking into 2024 and the remainders of 2024, where we see an opportunity to further invest through the improved gross margin.When it comes to the U.S. specifically, as we have mentioned before, that is one market where we see opportunity for more sales growth, so looking at Q1 and looking at the end of 2023. And we have looked at different areas of potential and identify the plan to how to move forward. One of those is to make sure that we really have a competitive price position. So U.S. is one of those markets where we put extra emphasis on making sure that we have the best value for money and have a strong competitive offer.

[Richard Chamberlain, analyst]

And the second question is on H&M, the H&M brand. In particular, I see you're trialing a more premium format, for instance, here in London in Southwest London. I appreciate it's only just opened. I wondered how scalable you think that sort of more premium format is and what you hope to learn from trialing a more premium offer is quite a premium location that you've opened that H&M store in?

[Daniel Erver, executive]

This is Daniel again. The value proposition of H&M is to create exciting friction for the customer between elevated fashion and the best price. And I think that is where we want to make what's inaccessible for the many accessible for the many by having that friction between what's premium but at a very competitive price. And we -- to build this brand position, we work in different ways.One is to evaluate different types of store formats where we see that the physical experience is a really good way to build and build the brand. And we try different formats. The format in Chelsea, the format in SoHo are what we call formats that really are about positioning the brand. In that side, it's a curated assortment. It's an elevated assortment with -- in those, we see that there is a higher spending power. So we can have a little bit more of a price elasticity, but those formats also serve as inspiration for how we develop the format for the rest of the portfolio.So the format, as such as what you saw in Chelsea is not what we're going to scale, but we take influences from that format in how we build a scalable format development for the full portfolio and scaling component of it in how -- where we really put focus on the product and elevating the product is part of the ambitions for the 250 stores that we are refurbishing for 2024.We also see that, it's important to regain credibility and win the customer's heart in our most important cities. We put also an extra emphasis on some of the key cities across the globe where London is one and New York is another one and like we mentioned Berlin and Stockholm are also important cities where we invest during 2024.

[Operator]

Our next question comes from Daniel Schmidt of Danske Bank.

[Daniel Schmidt, analyst]

A couple of questions for me. Just coming back to the question on the U.S. to start with, and you were fairly clear saying in connection with the Q4 that you will be investing in price in the U.S., that you've gone too far up, and that you're gradually going to see that coming through in the spring collection, those price investments. Have you seen any sort of feedback on that exercise so far?

[Daniel Erver, executive]

Yes, this is Daniel. We have gradually started to adjust prices to make sure we have the most competitive offer. And the first outcome of those adjustments we see are positive. We also see that we see gradual improvement from low levels from the U.S. in Q1 and also coming into the in Q2. But it's still on the level where there's a lot of areas of improvement. But we see the first indications of the price adjustments are positive, or well received by our customers.

[Daniel Schmidt, analyst]

Okay. Because I think you were minus 7% in North America in the quarter, but you did see a positive trend basically through the quarter into the second quarter?

[Daniel Erver, executive]

Yes. We saw a positive trend in during the quarter and also that indication remains for the start of this quarter.

[Daniel Schmidt, analyst]

Yes. Okay. And then just secondly, given that you're up quite a lot in earnings year-over-year, despite the fact that the top line is down in the quarter and markdowns are higher, what do you think is sort of in order to get to the 10%, which is the million-dollar question, what top line do you need to see in the coming 3 quarters, given the performance that you did have in Q1?

[Daniel Erver, executive]

This is Daniel. Coming out of Q1, we are, as you mentioned, happy with the bottom line development, given a top line development that still is where we want it to be. That's connected to really good work with the operational costs with good effect on the gross margin. We see that that -- those -- has been really important to build confidence in the 10% target, that we achieve the gross margin improvements and that we achieve the operational cost control. We need to continue to see a positive development of sales. We think it's good that we see a first positive indication in the second core in the second part of the first quarter and see a positive growth to last year in March up until the 25th of March. We need to see a continued development for the rest of the year combined with keeping control of the cost base, but that we think we have shown over the last few quarters that we have a good control of both the COGS development and the OpEx development.

[Daniel Schmidt, analyst]

Okay. And in that equation, are you guys incorporating sort of external factors turning from a tailwind to a headwind as we get into the second half of this year?

[Adam Karlsson, executive]

Adam here. Yes, we are obviously monitoring the external factors. We see that they will, for the goods that will be sold during Q1, still remain positive. But, of course, there are uncertainties ahead. The implications of the disturbance in the Red Sea, for example. So we factor that in, obviously, but short term for Q1, we predict the external factors to remain positive for the goods to be sold.

[Daniel Schmidt, analyst]

You mean Q2, right?

[Adam Karlsson, executive]

Q2, sorry, yes.

[Daniel Schmidt, analyst]

Yes. Okay. So as we get to the summer, that might change, of course, given where we are in terms of external factors, as I understand it.

[Operator]

Our next question comes from Sreedhar Mahamkali from UBS.

[Sreedhar Mahamkali, analyst]

Daniel, I think from a sales point of view which is my question here on sales it's reassuring to see the return to positive development, but I guess to realize your long-term ambition 10% to 15% growth in industry as you say, is growing 5%. Can you please talk about what changes you probably need to make to realize that ambition? Is it design? Is it sourcing? Is it merchandising? And which of these areas do you see for improvement?On a related point on proposition, I know you've talked about intention to have the best price continue to deliver you talked about sharpening price in the U.S., how do you differentiate versus players who are say super focused on prices like sheen, and for example? Those are the kind of 2 related questions on sales. Please.

[Daniel Erver, executive]

Daniel, here. So starting with your first question of potential for growth, we are positive that we see a positive momentum, but we think there is more potential for growth looking ahead and that's what we put all focus on to really make sure that we focused, the organization towards driving sustainable and profitable growth. It comes back to the focuses that, we mentioned in the report also where we start, with the most important for our customers and for us is to develop a really attractive assortment that excites a wide and fashion interested audience. So product assortment development, making sure we have the right designs, we pick the right trends, we offer a relevant fashion at the best price for our customers is the most important.To help us with that work, we also see potential to 1 part of that is to really elevate creativity have strong creative designers that understand fashion and can interpret fashion for our customers. Another part is to build stronger capabilities. And here we see opportunities within our supply chain setup, where we worked for some time on increasing the near shoring capabilities to improve flexibility and shorten lead times.We also work on how we use the data and use data integrated into our design and product development processes to become more precise on making sure we truly produce and supply towards the identified demand that we have in the market. So in those areas that will be a continued -- its been focused, but it would be continued focus to really strengthen the design organization, the product organization and as well as strengthen the capabilities in our supply chain.Then we see, as we mentioned, a strength of being an omni-player where we can meet the customer both in a physical and a digital channel and using the strength of our more than 4,000 stores with our wide online presence and how those 2 channels can support each other is another very important focus and looking at the SoHo store, the Chelsea store, we provide more services and more opportunities for our staff to service the customer with our full omni assortment also in the physical location.So those will also be important efforts. And then of course, it would be about how we tell exciting stories through communication and branding to our customers to get them excited about H&M brands, and see traffic coming from that excitement over time. So those areas would be the focus to get the long-term higher growth ambitions moving forward.On your second question about our position and how we differentiate, we talk a lot about where we want to offer the best combination of fashion and quality at the best price in a sustainable way and we believe that that business position, that business idea and that value proposition is very strong and it's up to us how well we execute on it that will determine our success. So when it comes to differentiation it is a lot about making sure that we have the most relevant fashion for our customers and that we have that relevant fashion at the most competitive price for the value we offer and that means that we need to work on making sure that we have really attractive quality for the customers, the relevant pieces, but also that our customers can be confident that they are sourced in a responsible way, that we work on our ambitious climate goals to make sure that we are shopping with H&M is being part of making the transformation over time to more sustainable fashion future.So the differentiation comes a lot with how we build in value to our customer offering and making sure that that value is bigger than the price we ask from the customer, and we think we can offer the customer a lot of value when it comes to how we inspire, how we guide, how we help them navigate all the fantastic beauty of fashion, but in a simple and fun way at the best price.

[Operator]

Our next question comes from Warwick Okines from BNP Paribas.

[Warwick Okines, analyst]

2 questions please. The first is can we just go back to the Q1 results and perhaps you could give a bit more color on what the biggest contributing factors were to the increase in gross margin, please.

[Adam Karlsson, executive]

Adam here. As we mentioned before, we worked diligently with our old sourcing setup to ensure that we partner up with the best suppliers, and that we together and find ways to support our gross margin journey. So that is what we've done on the internal side and also, as Daniel mentioned, worked with a healthy mix of near-shoring sourcing combined with the kept value sourcing from Far East.In combination then, obviously, we've had a quite dramatic shift of the external factors impacting the sourcing costs. 1.5 years ago, we had very elevated levels of freight costs, we had raw material costs and a negative currency effect affecting us. So there are 2 major factors, both what we've done, continued our work with the supply chain development and also, of course, headwind turned to tailwind on the external factors.

[Warwick Okines, analyst]

My second question is just coming back on prices. I'm not quite clear what the net effect is for this year. Lower markdown, some selective price increases and I imagine still a slightly inflationary market. So is your ambition to have lower pricing at the end of this year compared with the start of this year?

[Daniel Erver, executive]

This is Daniel. To create some clarity, at the end of this year we believe we'll have lower prices than where we were at the beginning of this year. Yes.

[Operator]

Our next question comes from Nicolas Champ of Barclays.

[Nicolas Champ, analyst]

I have 2 questions. The first one is, could you please update on the impact of the increase in freight cost going forward? I think you recently concluded your annual negotiation with freight carriers. So is it possible to have a bit more color on the impact of the increase in freight cost for this year, please?

[Joseph Ahlberg, executive]

Joseph here. We have been working very closely to monitor all the effects connected to the Red Sea situation, including what this will mean for freight prices for the year. And we've been in a very close dialogue with our shipping partners to try to mitigate these effects as much as possible.Looking at the quarters ahead for Q2, we still will have a strong tailwind year-over-year connected to freight costs. And then from Q3 and Q4, it will, to our assessment at this point, be a slight increase in cost year-over-year, but at very manageable levels.

[Nicolas Champ, analyst]

Okay. My second question is, you confirmed this morning you plan to close down a net 60 stores this year. When do you expect to come to an end to the rationalization process of your store network? I mean, when do you expect to see a space contribution to be positive to your top-line growth?

[Daniel Erver, executive]

We confirm our plans and to start with a broad picture, we will always work actively with our store portfolio. We always evaluate each location to ensure that the format and the location is continuously relevant for the customer demand. So that will never stop. But what we can see is that the net closure level will come down over the year, and we are also having somewhat of a rational effect here. We usually close a lot of stores in the beginning of the year, and then we have more openings towards the end of the year. So, we expect the net negative effect to normalize during Q2 and Q3, and then become neutral towards the end of the year.

[Operator]

Our next question comes from James Grzinic of Jefferies.

[James Grzinic, analyst]

I had 2, please. The first one is, I presume Q1 underlying X calendar was around a minus 4%, perhaps, in terms of your sales momentum, and that then turned into a plus 2% now. Is it worth calling out any external factors? Whether, for example, do you think that is really quite representative of the scale of the improvement in the momentum of the business? I presume largely because of how designs have been received, by the sound of it.

[Joseph Ahlberg, executive]

Joseph here. Yes. For February, we had a positive calendar effect with a leap year extra day of trading. So that added for the month, some extra sales year-over-year, of course, and close to 1% for the full quarter in calendar -- positive calendar effect connected to that extra day. But we did also, excluding that effect we saw an improvement compared to the trend that we saw in December and January for our sales.Then in March, we do see that, there is some increased demand in Central European markets, possibly connected on year-on-year improvement on weather, but hopefully, as well, some positive sentiment connected to the economic recovery. But we are following that with a positive outlook.

[James Grzinic, analyst]

I presume a follow-up from that. So if I look at the regional split of performance, it sounds like current trading is still not dissimilar from what we saw in Q1. So Central Europe stronger than the balance of the markets?

[Adam Karlsson, executive]

Adam here. Yes. But as we mentioned, we have a positive trend out of Q2 in particular than the U.S. -- Q1, sorry, I keep saying Q2. I'm ahead of the game here. Q1. So that's -- we believe that the difference between the regions might converge during the spring.

[James Grzinic, analyst]

Understood. My second question was around gross margin again. You're talking about re-ensuring, reassuring, becoming a bigger part of the maximum sourcing. I would like your help in terms of getting my head around seeing that dynamic, but then at the same time seeing your markdown rate slightly increasing. And I thought that, I would hope that markdown would reduce because of reassuring. So I'm not so sure what I'm missing really in terms of that disconnect?

[Daniel Erver, executive]

Daniel here. We are increasing our reassuring capabilities significantly, but still the majority is sourced from other sources than reassuring. So it's still an increase but on low levels. I think it's hard at this point to put a one-to-one relationship between the markdown costs and the reassuring ambition. What we do see with the assortments that are being reassured is that we have a competitive sold margin, due to lower reduction costs.So when we evaluate the effect on reassuring, we recognize we have some higher costs on sourcing, but we mitigate it by reducing the reduction costs on individual, on a piece-by-piece, assortment-by-assortment level. But it's still on a low level that we intend to increase over time.

[James Grzinic, analyst]

Understood. And I presume that is a very important function to try and keep full price-sales ratios. You seem to be set on driving design content up considerably in the future. So in order to sense check the gross margin achieved, in order to sort of square that circle, I presume.

[Daniel Erver, executive]

Yes. And I think then just to go back to your comment also to create clarity, when we look at Q1 and the reduction levels, we also use markdowns both, of course, to solve stock that isn't productive and overstock, but we also use it to activate customers. And I think we've been through a climate where we've needed to use markdowns also to activate the customer base. So that's part of the increase of reduction levels in Q1.

[James Grzinic, analyst]

Very clear. Just sorry, 1 follow-up on that specific point that you make. Have you also been more active on social media in recent weeks? You seem to have been. Are you starting to dial up the investment in marketing?

[Daniel Erver, executive]

Yes. We are -- we are -- as we said, we put full focus on increasing top-line growth. We still think there is potential in top-line growth. And as we mentioned, it's an important component of achieving our 10% target for the year. And we continuously evaluate the different paths to drive top-line. We come out of Q1 with a really strong development on the cost base, and we can use part of those cost savings that are not of costs that affect the customer to what actually affects the customer. And performance marketing and marketing is one of those. So we reinvest and shift costs from overhead costs, and costs that doesn't support the customer to driving top-line. So that's part of the increased activity in social media.

[Operator]

[Operator Instructions] Our next question comes from Georgina Johanan from JPMorgan.

[Georgina Johanan, analyst]

I've got 2, please. The first one was just a clarification question. If I heard you correctly, I think you said freight would be a small, manageable headwind in the second half and interested to hear your view. But on my calculations, FX will be broadly neutral into H2. So assuming that price investment is coming through in the second half, is it fair to assume that the gross margin actually moves lower year-on-year in the second half, please? That was my first question.

[Joseph Ahlberg, executive]

And this is Joseph speaking. And, yes, we say that, the gross margin is a result of many, many factors, including pricing, markdown activities, the external conditions and so on. And so it's difficult to predict the outcome on the gross margin based on individual components. But you are correct in the statement that freight will turn to a headwind towards the end of the year, even though at a fairly slow headwind, so to speak, it's not a strong one. And when it comes to FX, we also have your view that it at current levels, it has a neutral impact year-over-year on our gross margin.

[Georgina Johanan, analyst]

So I suppose, I'll ask another way, are the internal initiatives that are going on in the business going to be enough to therefore support the price investment in the second half of the year on a year-on-year basis or not?

[Adam Karlsson, executive]

Adam here, our commitment to a normalized gross margin and that stays, and I think we are well on track. So as Joseph said, we need to handle the external factors with creating an assortment where we can continue to see the momentum towards full price selling and offering a very strong assortment that the customer appreciates. So, our commitment to a normalization of gross margin remains for the full marginal headwinds, as we see now on the freight side.

[Georgina Johanan, analyst]

And then my second question, and apologies if I missed this, but just in terms of pricing, where you talk about the price investment, are they to be focused on the U.S. or actually now should we expect it to be broader geographically?

[Daniel Erver, executive]

This is Daniel. We look at always adjusting the prices in all our markets to make sure that we are competitive in each and every one of our markets, given the competitive landscape. So with that said, it means that we look at all our markets to make sure that we are competitive on prices and we look at all our markets in using the positive momentum out of Q1 or where we need to invest and adjust to make sure that we are competitive. But we have an additional focus on the U.S, given the performance.

[Georgina Johanan, analyst]

And just 1 very quick final one, if I may. Just on the markdowns into the second quarter, I think you said expect them to be slightly up year-on-year. Is that, given that you're seeing a kind of encouraging trend on top line, are those markdowns to encourage sales or are those markdowns to clear excess stocks? Just to understand the balance there, please.

[Daniel Erver, executive]

We will do both in the quarter. We'll both clear stock, but also use it to activate customers. The delta to last year that we're indicating is more related to activating the customer based than clearing stock. We're happy with the composition of the stock coming out of Q1.

[Operator]

Our next question comes from Adam Cochrane of Deutsche Bank.

[Adam Cochrane, analyst]

And well done on the first set of results there, Daniel. 2 questions. Firstly, on the refurbishments, the 250 stores is, let's say, 5% of the store count. I'm assuming it's slightly higher by sales proportion, given that they're flagships. But can you just quickly describe some of the changes that you're making in those stores? And is that something then that you'd have to look at for the remainder of the estate? What is the overall quality of the estate as you see it today? Is that an area where you can see further investment either being wanted or required?And that leads me on to the second question, which is on operating costs. You've done a great job on managing them. Is there anything that you're doing with the store refurbishments and learning's that mean that you can have a more efficient operating model, whether it's inventory levels or costs per store that the refurbs might lead you to get?

[Daniel Erver, executive]

I will take -- Daniel here. I will take the first question, and that's about the refurbishment. To be clear, it's across the portfolio, but it's focused on our key cities and most important cities. But it means we're also touching stores that are not necessarily flagship stores. It's stores where we believe we're at the right time in a location where we want to be, and that can be everything from a flagship store to a regular mall store.We believe the physical store network and presence is a tremendous asset. We have gone through quite a few years of optimizing the portfolio to make sure that we have a healthy portfolio in the right locations. We will continue to do that work, but we gradually see that we're able to ramp up the ambitions both for adding new stores, but also refurbishing the existing portfolio. And to stay competitive as a fashion brand and give inspiration and excitement for the customer, we need to touch the store portfolio and update it. And we are gradually increasing those ambitions, and those ambitions will stay for the year to come to make sure that we have a really competitive portfolio of stores. I'm then handing over to Adam for the OpEx question on operating those stores.

[Adam Karlsson, executive]

Yes, Adam here. With those refurbishments, we also focus a lot on the space productivity that will be key, and that has been sort of the overarching theme for our portfolio work throughout the last couple of years. One key lever is obviously the improvement of sales per square meter that will generate OpEx leverage on that selling.On a more activity level, we always try to optimize the operating model of our stores to ensure, as Daniel said before, that we take away resources put to things that the customer doesn't appreciate and move it to activities that the customer sees as positive for both the experience, availability, finding what you look for, and also simplifying the checkout process and so forth. So macro view is that, we have a store portfolio enabling a higher space productivity. And then on the sort of activity level, we're also moving down resources, not adding towards what the customer appreciates, to help us drive profitable selling overall.

[Adam Cochrane, analyst]

So on operating costs, how much of the opportunity do you think you have now addressed? I know there's an annualization impact of the benefits that are yet to come. When you look at the store model or the whole business model, is there still plenty to go for or is it operational leverage on sales that will really be the bigger driver from here on in?

[Adam Karlsson, executive]

Adam here, I think the Q1 is yet another sort of receipt of our work with the tightening operational costs that we can get OpEx leverage already on very moderate sales development. And that is then an attribute to the portfolio work that we've done to the logistics improvement, that we have a very productive stock. So all of these things come together. But obviously, these are things that we're never done with.So we will continue to work with those. But as Daniel started saying, our focus is now to get that leverage through increased selling. So that is how we now gear our focus and steer our resources.

[Operator]

Our next question comes from Paul Rossington of HSBC.

[Paul Rossington, analyst]

And well done on the results. Just a quick question for me, please. Could you perhaps comment on any difference in regional performance within Europe at all, whether that's Northern Europe versus Southern Europe or particular territories, but any color on the European performance would be great?

[Joseph Ahlberg, executive]

Paul, this is Joseph. I think it's worth highlighting our strong performance in Eastern Europe, where we have seen really strong development over a number of quarters. So Poland, for instance, is one market worth highlighting, which is important for us and where we are seeing strong development.

[Paul Rossington, analyst]

And are you able to reference, perhaps, your performance in Germany at all? It is obviously a significant market for you?

[Joseph Ahlberg, executive]

Yes, Germany, we call it out in Q4 as a market where we saw some soft demand tendencies. We're more encouraged by the more recent development where the consumer is looking to be activated and we see good receipts for our activities in the market.

[Operator]

Our next question comes from Daniel Schmidt of Danske Bank.

[Daniel Schmidt, analyst]

Yes, a follow-up from me, Daniel, Adam and Joseph. You mentioned that you're taking more costs from overhead and reinvesting that in marketing and to drive customer traffic, simply. I think you mentioned last year, especially after the summer, that you've been cautious on marketing spend. Are you in a situation where you feel that you under-invested in marketing last year and you need to catch up? Or how do you view the trend in marketing? What's the trend in marketing spend that you've seen in the past couple of quarters?

[Daniel Erver, executive]

This is Daniel. Thank you for the question. We see, coming out of Q1, again, strong receipts that we are having a good cost control, both on the sourcing side and on OpEx. That gives us an opportunity to really focus on driving sales. There are many levers in increasing sales. First and foremost, it is really about making sure that we have the best possible assortment. That's the main focus. But, of course, there's also opportunities to make sure that when we have a very competitive assortment, how do we invite the customer to meet us? That's where we're starting to gradually increase marketing spend.But we are following very closely the return on investment of the different channels and the different market spends so that we optimize the investment towards where we have the strongest ROI.

[Daniel Schmidt, analyst]

And do you see -- are you more focused on that now, it sounds like, than you were a couple of months ago? Is that a correct interpretation?

[Daniel Erver, executive]

We are really satisfied with the cost control and the bottom line results coming out of Q1. The game moving forward will be about increasing top line. So with that said, yes, that is an increased focus to make sure that we gain more customers and build a stronger customer base for the future.

[Operator]

Thank you. At this time, we currently have no further questions. So I'll hand back to the management team for any further remarks.

[Daniel Erver, executive]

Thank you. I think then, thank you very much for participating in the conference call. And we wish you all a really, really nice day.

[Joseph Ahlberg, executive]

Thank you for all your questions. Have a good day. Thank you.

[Operator]

Thank you for joining today's call. You may now disconnect your lines.