H & M Hennes & Mauritz AB (publ) (HMB) Earnings Call Transcript & Summary

Welcome to the H&M conference call 9 months report for 2022. [Operator Instructions] Please be advised that today's conference is being recorded. Today, I am pleased to present Nils Vinge, Head of Investor Relations. I will now hand you over to our speakers. Please begin.

Thank you. Hi, everyone, and thank you all for joining us today. Welcome to this telephone conference about the H&M Group's 9 Months Results 2022. With me today is our CEO, Helena Helmersson; and our CFO, Adam Karlsson. We will now start with a short summary of the third quarter, and after that, we will be happy to answer your questions. You'll find the 9-month report on hmgroup.com Investor Relations. Now, I'll hand it over to you, Helena.

Thank you, Nils. Sales and profitability in the third quarter was largely impacted by the effects of our decisions to pause sales and then wind down the business in Russia. This explains half of the decrease in profits compared with the third quarter last year. In common with the rest of the industry, sales were weak in many of our major markets at the start of the period, but picked up gradually despite a heat wave in several European countries and some remaining delays in the supply chain. The quarter was also impacted by several other external headwinds such as increased raw materials and freight prices as well as stronger U.S. dollar. This resulted in substantial cost increases for purchases of goods. We have chosen not to fully compensate for these costs, which is reflected in the gross margin. Overall, the external factors had a substantial negative impact on profit for the quarter. With our long-term approach, we are continuously developing all parts of the company with a focus on meeting customers' ever-increasing expectations of affordable and sustainable fashion. It's now more important than ever to continue offering customers the best value for money. Customers should always feel confident that all the group's brands provide the best combination of fashion, price, quality and sustainability. We are continuing the integration of our sales channels to offer customers a smooth and inspiring experience in all our touch points. At the same time, we continue with the investments in tech and the digitalization of the supply chain. Efficiency, speed and flexibility have never been more important. In parallel, a program to reduce costs and further improve efficiency is being initiated. From the second half of 2023 onwards, this is expected to free up SEK 2 billion per year. With loyal customers all over the world, engaged colleagues and sound finances, in combination with a long-term perspective, we see good opportunities to strengthen our position despite the situation in the world around us. The autumn collections have been well received, and sales from 1st to the 27th of September are up, with 7% compared to last year. This is an important proof that we can grow also when customers' purchasing power is decreasing. Thank you very much for listening, and we're now happy to take your questions.

[Operator Instructions] The first question comes from Fredrik Ivarsson of ABG Sundal Collier.

Excellent. Two questions, first one on the cost savings program. Can you give some information about it? What is it? How much will it cost, et cetera, et cetera? That's my first question. And the second one on the gross margin. It was 50.4%, if adjusting for the Russian one-off. Price obviously did not fully offset the external headwinds, and when we look into the coming quarters, should we expect the price effect to be more positive or similar to what we saw in Q3?

Okay. I'll start with the cost program, then. It's a wide program that's directed to the overhead costs, and there are a number of components into it. It's everything from how we purchase services to how we set up our business when it comes to offices and travel, but of course, also to ensure that we have an efficient organization setup. So we write in the comments here, we believe that we will start to see the effect second half of next year, and there may be some costs connected to the program throughout the spring.

And when it comes to pricing, it's always the long-term approach from a customer perspective and of course, always balancing the best offering in profitability. That's all I can say.

Okay. Can you say anything about the price effect in Q3, then? What you saw in Q3.

No, obviously, we have -- as we discussed before, we have raised prices, but obviously not fully to compensate for the severe headwinds in sourcing.

I can complement a little bit also because, of course, it's different with different segments in the collections and in the assortments. So again, we have adjusted prices a little bit differently in different markets and different segments within our assortment, but always with a thought to improve our long-term kind of position and make sure that we have the best customer offer.

The next question is from Nicolas Katsapas of BNP Paribas Exane.

I have a couple of questions on Russia. I wanted to know how much the liquidation of inventory in Russia continued into September, and how that affected the current trading figure? And then do you -- linked to that, do you expect any further cost to exit Russia coming through in Q4? Because I see you called out total cost of SEK 2.5 billion, but only one-off costs of SEK 2.1 billion related to the exit.

Yes. So, the SEK 2.1 billion is the currency adjusted level that we communicated in mid-July. Then as the Russian ruble has appreciated, we now estimate the cost to go up from -- or SEK 2 billion to SEK 2.1 billion. So the local currency amounts are still the same. When it comes to the other sort of SEK 400 million, that's connected to the net effect of us having a profitable third quarter in Russia last year and not as profitable this year, as we only traded for less than a month.

And the liquidation continued into Q4, was that --?

Sorry, yes. It will, and it will gradually decrease now as we have started to permanently close some stores. So it will continue, but we are now starting to see some of the permanent closures coming through.

The next question is from Niklas Ekman of Carnegie.

Yes, can I follow up on that question? Just the impact from Russia here in September. Is there any tangible impact from this in the 7% growth that you're reporting here? Is that boosted by Russian liquidation at all?

It depends on how you see it. Year-on-year, we sell less in Russia. So excluding both years, it's actually -- sort of the average selling is above the reported figure. But of course, the fact that we opened Russia now gives us some kind of support in the 7% figure, so it depends on how you see it. If you exclude it totally both years, it is dragging down the results. The 7%, we should have been higher excluding Russia, both years. But of course, the current selling in Russia contributes to the turnover right now.

That's clear. And then can you give any indication how far you are from exiting Russia entirely? How many weeks or months away could that be?

Well, as we have communicated before, we have gradually opened up the stores, and that goes also for the closures. So now, we have closed a bit more than 30 stores as of now, and this will continue then the coming months. So in the near future, but we don't have an end date to communicate at this point in time. We will try to sell off a majority of the stock.

Okay. Fair enough. Another question is just on cost inflation, which you're warning you are continuing in coming quarters. Are you expecting cost inflation to be sequentially worse in Q4 than in Q3? And do you expect a severe impact also in H1, given what we know now about cost inflation?

If you decompose it into 2 parts, we see that the currency effect on cost of goods is worsening sequentially as we've had an appreciation of the U.S. dollars all through the summer here and into the autumn. So that we sequentially see worse. And then we also, of course, have uncertainties when it comes to the energy cost and prices going forward. So these are 2 things that we feel are uncertain going forward. But right now, in a negative trajectory when it comes to the currency.

The next question is from Daniel Schmidt of Danske Bank.

Helena, Adam and Nils. A couple of questions from me then. Just coming back to the savings program that you initiated, and Adam, you said that you'll see some effects gradually on this as of H2 next year, and there may be some costs for this program. It does sound that it -- is it sort of more organically driven? Or is it sort of you're not bringing forward the big axe, this is going to happen gradually was my interpretation of what you're saying. But doesn't that mean that you will see some savings at least at the start of '23?

Absolutely, and some of the components are more immediate. But as there are also some organizational components to it, that has a more gradual impact. So that's what I meant. There are some immediate savings on sort of purchases of services and all, but the organization transformation that we are in and focusing even more on has more of a gradual effect.

And is it reasonable to assume that we will see some of that already in Q1 next year then?

Parts of it. But as I said, that will be a more or long-term effect. So we estimate that we write in the report, that the majority of the impact will come second half year next year.

Okay. And just coming back to another question that we talked about last time, and it's been a topic on some other of your peers, sort of introducing a return fee. And I think you said that you were looking into that. Has anything happened on that front?

We are about to test return fees in a few of the markets to see the response from the customers. So let's see how they receive that.

And do you feel any need to sort of fast track that development, given what's happening in general on the sort of the need to cut costs? Has that been sort of [ dealt with? ]

Yes, it all depends on the -- how it's received by the customer. So that's why we do a test to see if that is something to fast track. But of course, that's only one initiative to improve the situation. There's many other things to do as well.

How quick could that happen? How long time do you need to evaluate that?

Well, the valuation doesn't have to take long time. Then of course, if we're about to roll it out, it will take some time. We don't have an exact time limit on it. But again, let's see when we see the evaluation of the tests, whether this is the most impactful thing to do or not.

Okay. And then just a last question on sort of not compensating fully in terms of price increases. You are seeing quite good growth at least for September, and even better if you adjust for Russia. Isn't that giving you any confidence that you could be a bit more aggressive on sort of passing along input cost inflation?

Yes, we do see good sales figures in September. Of course, to some extent, that can also be -- we saw a weather effect in August, where big parts of Europe had a heat wave. And in September, we got colder weather. So we're trying to assess that type of effect, of course, as well. But overall, we think and we see that it's very important now to stay flexible within certain areas. And pricing is, of course, one of them. To gradually follow the customer sentiment, and also look into the different segments in the assortment where we see that some segments are less price sensitive than others. So we try to work with this in a very kind of flexible way and always with the thought that we will also, at the same time, strengthen our position more long term, which means that customers have to trust us to give the best combination then of price, fashion, quality and sustainability.

The next question is from Richard Chamberlain of RBC.

A couple from me, please. So back on the cost savings program, could you just say a bit more color on why that's taking until second half of next year to see most of the benefits of that? That's my first question.

It is about the nature of the program that changed in the organization to ensure that we set this up efficiently. Isn't a quick fix, we need to do it with speed and efficiency. But still, we need to make sure that it's a long-term step up that we're going into. So we're looking into organizational structures to ensure that we have quick decision-making, that we remove layers and that we have a robust foundation to grow from. And we estimate that will take 6 to 9 months.

Okay. And second one is on the cash flow, it sounds like you're still getting a financial benefit to changes you've made to the invoice management and payment processes. Are you expecting more benefit in the second half -- sorry, from -- in Q4, sorry, from that program?

The program is fully implemented, with the exception of that we're also looking into non-commercial goods just to -- but that is, of course, a smaller portion of our purchases. So now, the effects will sort of fluctuate with the purchase volumes. So I think now the effect in this quarter was more related to that. We -- into the autumn, as we did now, build up stock, and that we now plan to sell out throughout the autumn. So for Q4, not a big -- we were not predicting it to have a major positive effect.

The next question is from Simon Irwin of Credit Suisse.

So firstly, can I just tell -- just a few thoughts around input costs for spring summer next year. Obviously, we know about currency. How are you seeing dollar input costs, for example, through raw materials for next year, labor cost inflation? And also, just how is your freight situation looking? Are you still seeing an increase in your average freight rates into next year?

As we also discussed during the Q2 report, we have seen that the input costs have peaked, and we believe that they are more on an elevated but stable level. What has not peaked or at least we're in a negative trajectory is the currency effect. So that is the big change of headwind now[indiscernible]. On the freight side, we can see that the volume pressure is coming down. But here as well, we have not seen a substantial positive effect in the short term here, but we foresee that more into the later part of the spring.

Okay. And just given the outlook, both kind of economic and in terms of your business, are you having any thoughts at the moment around capital allocation, particularly around either the buyback or in terms of new stores?

We have gradually adjusted our CapEx for the year. So sort of the current estimates are now in the range of SEK 6 billion to SEK 7 billion. So that is one of the adjustments we do to the capital allocation.

Okay. But the others, for now, your store program and stuff are largely unchanged?

Yes, that's unchanged.

Next question is from Adam Cochrane of Deutsche Bank.

The first question I've got is relating to markdown. You saw a markdown up in the third quarter and you're talking about markdown up again in the fourth quarter. Is the fact that markdown is increasing informing your pricing decisions and the decision not to fully pass it through to the consumer? Or is the markdown going up because you're passing through price increases that the consumer is not accepting?

There are many factors affecting the markdown. One is, of course, the current selling situation, but then also there is also a positive way of looking at markdown as activation. So I think you can look at it in 2 ways, and we believe we have an opportunity to activate customers and to really show that we have attractive prices throughout the autumn now. That's why we sort of indicate them in a slightly elevated level also through Q4.

In terms of customer behavior, the strong September and weaker parts of the summer, do you think -- can you draw any conclusions on consumer behavior? Or as you say, is it still -- it could be weather, it could be other factors that are at play at the moment. You're not seeing any trading down or up or anything within your own brands or your own ranges?

Yes. Following customer sentiments, of course, it's not very easy to understand what is what. But when looking into customer insights, it's, of course, clear. And only looking at how we have started the autumn selling, it's truly clear that affordable and sustainable fashion is -- there's high demand, which comes with an opportunity for us. Then again, we saw the heat wave, especially during summer or in August, that we saw affected to some extent and that the cold weather came more in September. So really hard to say what is what, but the fact that the customers really appreciate an offer that is based on both good prices, value for money and sustainability is very, very clear.

Final question. Others may be clear on this, but I'm struggling to work out the trajectory into Q4, Q1 of next year, Q2, Q3 of effects, freight. What is the scope of these headwinds? I kind of sort of got different views on hedging policies on rates, and just -- is the picture for gross margin looking to get worse over the next few quarters or better? I just -- a feeling of direction, really.

We can only -- we can only repeat what we've said. I mean, the world around us is very challenging at the moment. We've had pandemic, we have war, we have geopolitical challenges, and we try to navigate as well as possible through this. The visibility is very, very low even for us, so that's why flexibility, speed, efficiency is more important than ever as we write in the report. . But I think we have good chances in this environment to succeed and improve our positioning. And I think the -- even though it's early in the season and with -- of course, we've been helped by weather and in Russia partly in the September numbers. We think, as Helena said, the customers clearly show that they appreciate value for money more than ever. And then, of course, we don't give forecast, as you know. So it's up to you as an analyst to make your own bet.

Yes. With things like hedging of freight, utilities, FX, without sort of knowing some of the hedging pieces, it's quite hard for us to do forecasts. And that's why I suppose I was looking for a bit of directional input, really.

[Operator Instructions] The next question is from Ashley Wallace of Bank of America.

I have 2 follow-up questions, actually. One is just on the September revenue. Are you able to share with us which regions drove the acceleration in September? And then a follow-up question, sorry, on the gross margin and the direction of travel. In the release, you mentioned that the headwinds from external factors will grow in the fourth quarter versus last year. I was wondering if the headwind will also be bigger than the headwinds that you've just seen in Q3, which you called out at SEK 1.5 billion or 260 basis points of gross margin pressure?

Looking at September, I will also talk a little bit about the third quarter because it's connected. In the third quarter, we saw great progress in regions such as Americas, especially Latin America, Southeast Asia, to mention a few examples. And we saw less good progress in some parts of Europe, Central East and Northern Europe. During September, that picked up. So the markets that had low progress during the third quarter in the whole industry, I would say, has picked up during September.

And the question on gross margin, yes?

Yes. Could you say it again please, because it was a long question? Sorry.

Yes, sure. So in the release, you talk about the external factors which will grow in the fourth quarter versus last year. I was wondering if the external factors will also be bigger than the headwind of Q3, which I think you called out in the release as SEK 1.5 billion of headwind or 260 basis points of gross margin pressure?

As I mentioned previously, the negative trend we see right now is within the currency. So that is sort of our assessment right now, that we don't see that the U.S. dollar to euro has started to shift in a positive direction from our point of view. So that is a sort of increased headwind coming from currency.

But I guess, in aggregate, the increased pressure coming from U.S. dollar offset, I guess, slightly from the fact that you said that freight and some of the other pressures have started to ease, but the net impact is therefore still a bigger one in the fourth quarter? Or it's less severe than what you had in Q3, taking all the pieces together?

And to be clear, it's a timing effect here. We can see that sort of spot rates are coming down. But of course, that doesn't sort of give an immediate effect on the gross margin in the current quarter. So I think the biggest parameter to look out for is the strengthening of the U.S. dollar.

Okay. And can I have a follow-up question just on -- sorry, on the product that you're liquidating in Russia right now. Considering you've already taken the one-off impact of closing down Russia, how do those revenues drop through to the bottom line? Are they taking an extremely high margin, incremental margin drop-through as a result of the costs already incurred in Q3 to write down the Russian business?

The cost that we -- sort of the write-in costs are connected to specific closure costs. So the selling and profit is as of last year when it comes to the stores that still operate, so to say. So that's no different when it comes to how we consolidate the current operations.

Okay. So the incremental margin drop-through of the product, your liquidity in Russia today, is not going to be significantly higher than your Russia profitability in Q3 last -- or in Q4 last year?

Right, right.

[Operator Instructions] The next question comes from Rebecca McClellan of Santander.

I was actually -- most of my questions have been answered. I was just curious about whether you could give any more sort of detail on region-specific North America to the main markets in Europe? Anything that's going on in China possibly?

Sure. We've had good progress in North America, where we have also, of course, done certain investments since -- with progress. And those investments are well, mainly, they are linked to tech and supply chain. Now, of course, with the strong U.S. dollar, that is also of course affecting the results in the third quarter. But overall, we've seen a good progress when it comes to both the customer offer and the customer experience and how that is received. When it comes to Europe, again, going back to the third quarter, we had -- I would say that the whole industry went down a bit in the central parts and in markets that are big for us. That has picked up during September. Again, we need to follow this very, very closely. We've seen that when we, for example, have put even more effort into showing our great prices, something that we think we could have done even more during the third quarter. So when we have changed those things, we also see better progress in those markets. Looking at China, we keep on working with improving our customer offer, so that it's also very locally relevant and same with the whole customer experience. We do see slow progress. We're still in dialogue, of course, with different stakeholders. We're still in a challenging and complex situation, but we do believe in the market moving forward.

And when you say showing good prices in Europe, what do you mean? Does that mean promotional activity, or does it mean that...

Yes. So obviously, when customers have less money to spend, it's super important in our commercial plant, both in physical stores and online, to really highlight the great prices, great value for money that we have. We saw that we could have done that even more especially in the beginning of the third quarter, which we have amended with very good results.

The next question is from Andreas Lundberg of SEB.

I'll follow up on the last one there, with highlighting the good prices you have talked about Europe. Could you be more concrete? What does that mean?

Well, that actually means that when we see that it's high demand on a particular product, and of course, we have super competitive prices, to simply highlight more. So when you enter a store with a price signs with how you actually guide the customers to see the great offers that we have and the amazing value for money that we can offer. Same in the digital store. So if you would enter h&m.com, if you would do that now, I think you would see amazing fashion, and I would think you would also recognize several of the big prices that we highlight. So it's those type of very commercial activities. It's in our backbone, but we see that we could have done it even more during the third quarter also because we see that customer sentiments are also obviously changing a little bit since -- due to the inflation.

Good. Then a follow-up on China. Could you say sales were up or down year-on-year in the third quarter?

Slightly up.

Slightly up. Cool. And lastly, on buybacks, when do you expect the current program to be completed? And how do you view buybacks once that is completed?

The plan remains, and as communicated, it is to end the program by last November. And looking ahead, it's -- we will need to come back to that. So the current program is still in effect and planned time by November.

[Operator Instructions] Ms. Helmersson, at this time, there are no questions registered.

Thank you, everyone, so much for participating then. Thank you for all your questions. I wish you all a very nice day.