Zalando SE

XETRA:ZAL

Earnings Call Transcript 2024-Q1

[Operator]

A wonderful good morning, ladies and gentlemen. Welcome to the Zalando SE publication of the Q1 results 2024 Conference Call. My name is France, the Chorus Call operator. I would like to remind you that all participants will be in a listen-only mode and that the conference is being recorded. The presentation will be followed by a question-and-answer session. [Operator Instructions] At this time, it is my pleasure to turn the conference over to Patrick Kofler, Director, Investor Relations. Please go ahead, sir.

[Patrick Kofler, executive]

Thank you, and good morning. from my side as well, and welcome to our Q1 2024 earnings call. Today, I'm joined by our CFO, Sandra Dembeck. Sandra will briefly walk you through the financial developments of the quarter and is available for questions afterwards. As usual, this call is being recorded. The live webcast as well as the replay of the call will be available on our Investor Relations website later today. Sandra, with that said, I will now hand it over to you. Please go ahead. .

[Sandra Dembeck, executive]

Thanks, Patrick. Good morning, everyone, and hello also from my side. Thanks for joining this morning's call. We're very excited about our updated strategy that we presented to you in March. And so before we jump into the Q1 results, let me do a brief recap. So with our updated strategy, we are moving from platform to ecosystem, and this is allowing us to cover a larger share of the fashion market. In our consumer business, we are evolving into the go-to destination for quality, fashion and lifestyle shopping and inspiration.

And in B2B, with sales, we are building the operating system to enable fashion and life cyle e-commerce across Europe on and off Zalando. And with our updated strategy, we all sent it to you our new midterm guidance until 2028. It reflects our ambition to return to strong growth and to continue our margin expansion. So 2024 is the first year of our updated strategy. And in 2024, we returned to growth while we continue to improve profitability and continue to invest in future growth. So with a solid Q1 performance, we made a first step towards delivering these updated goals. And with that, let's now turn to the highlights of the first quarter on Page 2.

In Q1, we delivered GMV growth of 1.3% following on from 3 quarters of muted growth. And with that, we returned to growth in the first year of our ecosystem strategy. On profitability, we continued our path of margin expansion. We increased gross margin and reduced OpEx.

In B2C, we continue to elevate and expand our multi-brand platform. The partner business continued to outperform our own retail business that were putting us on track to reach our partner business target share of 40% to 50% of B2C GMV by 2028. And with our multi-proposition approach, we follow and cater to the very diverse needs of our customers across different aspects of the lifestyle. So this quarter, our beauty, sports, kids and family as well as our Lounge by Zalando proposition delivered the strongest GMV growth.

In B2B, we bring more and more volume into our logistics network through sales fulfillment. And as a result, we see continued strong growth of 13% in our B2B segment that were outperforming the group revenue growth rate. On multichannel fulfillment, we increased the number of merchants by 5%, bringing the total number now to [ 27% ], and our sales pipeline continues to grow. We also added tumor markets, Poland and Spain. So looking forward, we are on track to meet our full year targets, and we confirm our 2024 guidance.

So let's now turn to our Q1 performance in a bit more detail. Starting with the group figures on Page 3. In Q1, we returned to GMV growth. GMV grew by 1.3% to close to EUR 3.3 billion. Revenue came in broadly stable at EUR 2.2 billion. The revenue growth rate of minus 0.6% is below the GMV growth rate as a result of the growing partner business share. Our focus on margin expansion is reflected in the increase of adjusted EBIT. Adjusted EBIT came in at EUR 28 million representing a year-over-year improvement of EUR 29 million or plus 1.3 percentage points in margin. This was largely the result of a reduction in fulfillment costs, supported by an increase in gross margin. And with this set of results, we continue on our journey to deliver growth and increase profitability in 2024.

So let's turn to Page 4, our B2C segment performance. And as a reminder, the business-to-consumer segment includes our previous segment fashion store, off-price and also TMS, which we previously reported in all others. So starting with top line growth. We saw GMV grow by 1.3%, while revenues were down 1.9%.

The slow end of the four winter season sale in January was followed by a timely start into the spring/summer season which resulted in growth for the quarter. The partner business continues to outgrow our retail business and is increasing its share. And as mentioned before, we saw strongest GMV growth in line with our strategy further expand into Life style in beauty, sports, kids and family and Lounge by Zalando. There was a notable improvement in profitability with an increase of 1.4 percentage points resulting in a profit margin of 1.1%. We saw a reduction in fulfillment costs as well as an improvement in gross margin. And here, it's important to note that the B2C gross margin benefited from an improvement in the retail gross margin as well as the higher partner business share.

Let's turn to the corresponding B2C customer metrics on Page 5. Starting on the left. At the end of 2023, we had 49.6 million customers compared to now EUR 49.5 million in Q1. The active customer base developed broadly flat. On a last 12-month basis, this is roughly 3% less customers compared to the first quarter last year.

Moving over to the right. Here, all customer KPIs show similar trends as in the previous quarter. And this highlights our focus on differentiating now through quality. So while order frequency decreased by 3% from 5.1% to 4.9%, the average basket size increased by 5.4% to EUR 6.40 and as a result of higher average item value, and this is mainly the result of a change in assortment mix. GMV per active customer increased by 2.2% to EUR 297.

Let's now turn to Page 6 and talk about our B2B segment performance. And before we dive into the numbers, a brief recap of our B2B segment, which includes sales fulfillment. So [indiscernible] and multi-can fulfillment, our software business Tradebyte and Highsnobiety. So with sales, our goal is to solve the complexities of Europe and fashion and lifestyle for our brand and retail partners. With ETF, we have already solved these complexities for partners that sell on Zalando. And with multichannel fulfillment, we will now do so for partners of Zalando. Tradebyte is a leading channel integrator in the industry, which we acquired in 2016. This Software-as-a-Service business helps partners to map their products to sales channels like Zalando.

In Highsnobiety is an influential fashion and lifestyle media brand, altering our inspiration storytelling and assortment creation capabilities. We acquired a majority stake in Highsnobiety in 2022.

So now to the numbers. In Q1, B2B continues to show strong growth of 13.4%, and this growth was predominantly driven by sets. And with a profit margin of 2.5%, our B2B segment delivers profitability while we ramp up investment into our B2B strategy.

So now let's move on to Page 7. Here, you can see our group P&L. Our group gross margin improved year-over-year by 0.3 percentage points. This was driven by an increase in our B2C gross margin with better sell-through rates and improved inventory management in our retail business as well as a higher partner business share. The positive development was partly offset by the scaling of our B2B business, which comes with a lower gross margin. Moving on to fulfillment costs. has decreased by 1.8 percentage points. And with the growing sales for Finland business in the B2B segment, a larger share of actual fulfillment costs are now reported in cost of sales. So in Q1, the shift in costs drove roughly half of the reduction in fulfillment costs. The other half came from improved order economics.

Marketing costs, they increased by 0.9 percentage points. Here, we stepped up our investments in performance and brand marketing to leverage the timely start of the spring summer season for both demand generation as well as brand building. Admin and other expenses developed flat in the quarter. So summarizing the group P&L, we stepped up our profitability year-over-year as a result of an improved gross margin and a reduction in OpEx.

Turning to Slide 8 for net working capital. Net working capital was negative in Q1. Looking at the year-over-year development, we see a cash inflow of more than EUR 300 million, primarily from a lower inventory level. At the end of Q1, we had inventory of EUR 1.6 billion, so a year-over-year reduction of 23% and as a result of the improved inventory management. And compared to the end of Q4, inventories increased by 10%. And while this development reflects our continued prudent approach on buying for our retail business, we make sure that we have the relevant assortment as we see demand improvement.

So let's move on to Slide 9. Our cash and cash equivalents remain strong at about EUR 2.3 billion, and this is more than EUR 500 million better than last year coming from higher operating cash flow, largely as a result of improved net working capital. Compared to Q4 2023, we recorded a decrease of around EUR 230 million in cash and cash equivalents and this is primarily due to the seasonal net working capital increase of over EUR 100 million as we inbounded inventory for the spring/summer season. Cash CapEx amounted to around EUR 60 million as we continue to invest in key capabilities like logistics and technology.

So this now concludes the financial update for Q1. Let's move on to the outlook on Page 10. So here we confirm the guidance for the financial year 2024, which we provided to you in March. In what we said, in 2024, we returned to growth while we continue to improve profitability and continue to invest in future growth. So before we now jump into Q&A, let me just wrap up with the key takeaways of today. Our ecosystem strategy is off to a good start. In Q1, we delivered a return to growth and continued margin expansion. We accelerated our B2C growth by elevating and expanding our multi-brand platform and we delivered double-digit growth in B2B, driven by increased adoption of sales fulfillment. And with that, we confirm our full year guidance for 2024. So let's now open up for Q&A.

[Operator]

Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] And our first question today comes from Monique Pollard from Citi.

[Monique Pollard, analyst]

I've got sorry, if I can. The first one is just whether you could please give an update on current trading and what you've seen particularly through April. The second question is one around margin expansion. If I look at your guidance for the full year, the EBIT guidance, even at the top end of the range suggests at most 1 percentage point of adjusted EBIT margin expansion. And you've done 1.3 percentage points already this quarter. So just trying to understand sort of when during the year you expect less margin expansion as presumably you're expecting sort of top line to accelerate through the year or that had been the previous guidance. And then final question for me is just on the marketing expense. So obviously, that stepped up a bit sort of just wanting to understand -- are you still targeting the customer payback period of 1.5 years. Are you seeing good returns on that spend? And if you can give any color on the mix of brand marketing within there versus pure customer acquisition.

[Sandra Dembeck, executive]

Okay. Thanks, Monique. So on current trading, starting off with that one. So we're very pleased with the development that we have seen for the spring/summer season. And quarter-to-date, we have seen on top line, a modest acceleration compared to Q1. In regards to margin guidance, yes, you're right, basically, at the upper end, this is a 1 percentage point improvement on the EBIT margin. we are slightly ahead of that in Q1, but it's never linear. So there is a bit of quarter-by-quarter variance that we will see. We expect the second half to be slightly less on the margin progression than the first half. Remember that our Q4 result was extreme -- like last year was extremely strong on profitability.

And on the marketing expense, yes, we're still hearing to the 1.5 years return on invest. The mix is between brand and performance is still as it has been before 30-70, so 30% on brand and 70% on the performance marketing. What you see here is that as demand in the spring -- at the start of the spring/summer season had picked up, we kind of like accelerated a little bit on the marketing spend, but both in brand marketing as well as in performance marketing.

[Operator]

Our next question is from Adam Cochrane from Deutsche.

[Adam Cochrane, analyst]

In terms of -- two questions, Firstly, on the inventory, it's nice to see the reduction there. How is the quality of that inventory looking like now within that the number at the end of the first quarter, has all of the clearance been done? How much have we still got left to do on that, I suppose, is what I'm looking for. And then second, when you are talking about the timely start to the spring summer. If I recall last year, it was a deceleration that we had in April. So would you say that this is a good performance versus last year. Obviously, a really good start to the spring/summer in general.

[Sandra Dembeck, executive]

Thanks, Adam. So I would say it's a general comment around spring/summer. So we are happy with the spring/summer season. As always, in that period, you have ups and downs on the weather, yes, we had some snow in April, if you remember. But so therefore, we are happy with the way that the spring/summer season has developed. And quarter-to-date, we have seen this modest acceleration versus Q1, yes. So I think the other comment then around that relates actually then already to the inventory. So on the inventory, we are happy with the quality of the inventory. So the sell-through rates that we see and that we currently see also with the spring/summer assortment are a step up from where we had been.

And on the inventory level, that therefore, of course, also the DIO has significantly reduced. You asked then about the pockets of that inventory. Yes, we are happy with the quantity of the inventory that we have across the various categories. We talked to you last year about young fashion being the area where we had kind of like still more overstock than we wished for and where we had to continuously still clear the overstock. So those inventory levels now have normalized.

[Operator]

Our next question comes from Jurgen Kolb from Kaplan.

[Jurgen Kolb, analyst]

Very good. Two questions. First of all, I was wondering if you could maybe talk a little bit about the pricing environment that you're seeing maybe broken down into the two traditional or former markets, Europe and rest of Europe? That's the first one. The second one is the collections switch. Would you say that -- I mean, you talked about quarter-to-date. Obviously, situation is improving at least moderately. Would you say that the actual switch, the collections, which has already happened in March? Or do you still expect the bigger push coming in April, given that the weather conditions are, let's say, a little bit choppy.

[Sandra Dembeck, executive]

So talking about the second question first. So the collection switch this year was really timely with February, March. So this is when we brought in the spring/summer collection and since then, basically, we have observed the improvement that we performed, especially also on our wholesale business, in improved sell-through rates. So therefore, not only the strong performance on the partner business, but also strong performance in our spring/summer wholesale or retail business. There is still then the question around the summer period, yes. So basically, when will the summer collection really hit, yes? And this is then a question now of May. But yes, so the main season start was on time in February, March. And with that, off to a good start into this year.

On the pricing environment, well, I think what we have to say is the times of price -- like price inflation on the recommended retail prices are over. We see hardly any inflation there. This is all normalizing. We are improving the sell-through rates on our stock. And I would say the discount environment is roughly stable. So we haven't seen -- so I think it also has to do with the quarter because, of course, you have an end-of-season sale period January in there, which is heavily discounted whereas, I would say the current environment is more of a stable environment. And that doesn't really change because you also asked about [indiscernible] versus rest of Europe. The pricing isn't really a differentiator between the two regions. We don't see a massive difference between the two.

[Operator]

The next question comes from Georgina Johanan from JPMorgan.

[Georgina Johanan, analyst]

Can you hear me?

[Sandra Dembeck, executive]

Yes.

[Georgina Johanan, analyst]

Two from me, please. Just the first one, if you could give an indication of how MS growth is trending at the moment? And if you're sort of seeing any recovery in the trajectory there, please? And then second, you called out Kids and Sports being particularly good in the quarter. I'm just trying to understand if that was market driven or if that was more related to your kind of own early initiatives in those areas, please?

[Sandra Dembeck, executive]

So on [indiscernible], we have seen a more challenging performance in Q1, so that followed on from Q4. We see still the marketing budgets being slightly constrained, but there is -- we see now -- as we look into Q2, we see this pivoting, and we expect [indiscernible] to be back in growth latest in the second half. We are taking quite a few initiatives here because Retail Media is a large and sustainable growth environment. And so the opportunity is big for us there. We are working with the commercially more savvy brands on really sponsored products and branded collections. And we are working also with the high brand equity brands on really the mid-funnel activation, positioning the brand. So there is a lot that we have been doing on [indiscernible], and this will be visible in the numbers now as of Q2 and especially in the second half.

On the Kids & Sports, I'd like to talk about more of our internal KPIs, maybe rather than how has the market been where we measure the success of those two propositions is basically on active customers and GMV per active customer that we drive off that. And so we have seen especially on kids growth in active customers, which translated also in a strong growth in GMV per active customers. And in sports, it's really interesting to see that, especially now towards the end of the quarter how the active customer number has accelerated.

And with that, also the GMV per active customer has accelerated. And I think if you ask me about like the efforts we are putting behind this on kits, we are working really strong on the assortment, yes. We have brought on more brands, and we have also created a bit of a designer space for kids. And on sports, here on sports, I would say the bigger moments are still ahead of us now with the Olympics and with the European Championship. So that will be more something now for Q2 and Q3 to talk about.

[Operator]

The next question comes from Anubhav Malhotra.

[Anubhav Malhotra, analyst]

I have a couple of questions. Firstly, coming back to the marketing investment, just on your expectations for the rest of the year, given the significant investment increase you made in the first quarter? And then the second one on ASOS. You've mentioned one [indiscernible], which has taken a comprehensive package of services in the press release this morning, but could you break down for me out of the 27 clients? How many use just the fulfillment? How many are into the more comprehensive part of the services.

[Sandra Dembeck, executive]

So on sales, maybe we go back to the strategy update. We said basically, the focus of sales in the coming years is really on the fulfillment, and we will be adding further like services and software in the outer years of the strategy. So the 27 clients are primarily using the fulfillment services, yes, so what we call now the multichannel fulfillment where they very helpful for them to support their business, whether it's own com or whether it is their business on other marketplaces. And on the marketing spend, so we will -- you saw that we had a 0.9 percentage point higher spend in the first quarter, and we expect to have a similar dynamic also for Q2. So there'll be a kind of an elevated marketing spend year-over-year also in Q2.

[Operator]

Then we'll go to the next question, which is from Yashraj Rajani from UBS.

[Yashraj Rajani, analyst]

I have two, please. The first one is on active customers. So can you give us some color on what percentage of customers at this point are unprofitable on a unit economic basis. And again, given that you've lapped some of the profitability measures that you've undertaken, how should we think about active customers and orders going into the rest of the year? So that's the first question. The second question is on gross margin and fulfillment. I think you briefly touched upon this earlier. But can you remind us for Q1, how much cost has been reallocated from fulfillment to gross margin, i.e., what's the underlying improvement in gross margin and fulfillment on a like-for-like basis? And again, can you remind us on a full year basis how we should think about this.

[Sandra Dembeck, executive]

Okay. So on your first question around active customer, we don't disclose profitability on the active customer cohorts. But we have, over the last 18 months, really worked heavily on improving the profitability of our active customer base. Remember the introduction of the MLB, for example, but also other things. And it's also part of the reason our effort like the focus on profitable growth is part of the reason why we saw that degree the churn in our active customer base. So the profitability of our active customer base has significantly improved, but we don't disclose more details on this one.

On your question around gross margin and fulfillment costs. So in Q1, the benefit that we saw year-over-year on fulfillment costs, half of that benefit is because fulfillment costs got reallocated into cost of sales. And the other half is basically order economics. You asked about the dynamics going forward for the full year base. So we will continue to see fulfillment costs improved year-over-year, but to a lesser degree.

[Operator]

The next question comes from Paul Rolintan from HSBC. .

[Paul Rossington, analyst]

Just one question from me, please. On the retail gross margin, is it possible to kind of quantify how much -- what the benefit there has been? Just trying to think about how much kind of gross margin there is still to recover from reduced promotional activity. So any kind of color on that retail gross margin will be brilliant.

[Sandra Dembeck, executive]

Yes. Happy to do that. So basically in March, we said the B2C gross margin is 41%. And in the midterm, we want to get it to 45%. And one of the drivers was to improve the retail gross margin versus then the partner business share versus the contribution from [indiscernible] and that retail gross margin is the one that in this quarter now we really saw improved, and it had in March when we announced it, we said like there were various drivers. One was inventory management, which is something you're already on. And this is what you exactly see now in the improvement. So we had better sell-through rates because of the better inventory management and the relevance of the assortment the adjusted by, and that is what is driving the gross margin improvement.

We haven't yet seen the benefits from a less promotional environment or lower less discounting. These benefits we expect to come through only towards, I would say, the -- yes, the upcoming quarters and years, yes. So at the moment, you see benefits coming primarily from inventory management. To quantify it, so the B2C gross margin 2/3 of the improvement this quarter came from improving the retail gross margin coming from the better STR and only one that came from the improvement in the partner business.

Maybe just to add because I know the disclosures in the Q1 are lighter. The intention for us is really to use the half year and the full year, so Q2 and Q4 to provide you with the full set of platform KPIs, including also, of course, the gross margin.

[Operator]

Then we have our last question for today, which comes from Benjamin Kohnke from Stifel.

[Benjamin Kohnke, analyst]

If I may. The first one on channel shift. So I'm just wondering if the numbers that we're seeing for the offline fashion market in Germany are just broadly right. It seems like off-line continues to win market share or the talking about it the other way around Zalando continues to lose market share against offline. And Yes. Just wondering if you could give a sort of high-level comment how you see that and if you see that turning in the course of the year? And then the second one, really, if you could share maybe some more details around the investments you've done in storytelling, inspirational shopping and so on during the first quarter, and if you already see the benefits coming through in terms of maybe higher engagement rates on your platform.

[Sandra Dembeck, executive]

So on the channel shift, what we have seen is a stabilization of the online penetration, and we do expect actually to -- for online to go back into growth. Indicatively, the data had flat like half a percentage point of growth this year. And then I think we showed it at the strategy update it is forecast for the next -- the CAGR for the next 5 years to be at 5%, yes. So online penetration will increase and online, therefore, grow again. When we look at the market data, we see ourselves outperformed the online segment in Germany as we speak.

On the offline channel, I have to say, like my understanding of the market was that it was flat. So not sure about the different data sources that we are using here. But with that, for us, we are gaining market share, whether that is in online or in the total fashion market. On inspiration, yes, we are very busy with that one. So in Q1, what we have done is we further worked on the Zalando Fashion system. So that's the Open AI search where you can basically include your search and you the natural way that you would ask for it. Here, we introduced a voice version. So now you can basically talk to the fashion assistant. The fashion assistant doesn't talk back to you, it's right back to you, but you can talk to it. We also worked more with influencers. We had a British-Japanese singer and actress, as a brand ambassador for our refinance segment. And we did some capital collections with our space for the designer segment. So we are busy on all that. I would say at the moment, it's all about, as you rightly call it, engagement KPIs.

So we see positive signals, but I would say, give us please some time to further like to have that more at scale in order to start reporting on that, yes. For us, this is more indicative for the time being as we are launching various formats. Another format that we did that fell also into like the sports category was like life shopping. We did it with the famous soccer player. And all of these things are just now adding to the kind of customer engagement and inspiration that we want to create. But it's still -- this is early days. This is not yet at scale, and hence, we are not yet reporting any KPIs on that.

[Operator]

This concludes the Q&A session, and I would like to hand back to Patrick Kofler for closing comments.

[Patrick Kofler, executive]

Thanks, everyone, for joining today's session. That was a rather short Q1 update that we had a more extensive update back in March. So if there are any further questions, do not hesitate to contact us otherwise wishing you a wonderful day in May. Thanks, everyone, for joining.

[Operator]

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone.

Thank you very much for joining, and have a pleasant day. Goodbye.