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

Hello, and welcome to the H&M Conference Call for 6-month report of 2023. Please be advised that today's conference is being recorded. For the first part of this call, all participants will be in a listen-only mode during the speaker presentation. And afterwards, there will be a Q&A session. [Operator Instructions]. Today, I'm pleased to present Nils Vinge, Head of Investor Relations. I will now hand you over to our speakers. Please begin when you are ready.

Thank you, and hello, and welcome, everyone. Today, we are presenting our 6-month report 2023. With me in the room is our CEO, Helena Helmersson; and our CFO, Adam Karlsson. After the presentation, we will answer your questions. So I leave over to you, Helena.

Thank you so much, Nils, and a warm welcome to you all. Now that the second quarter is behind us, we can conclude that we have taken a number of further important steps towards our goals. We increased sales in many markets despite a reduced purchasing power. With June almost over, we can see that the summer collections have been well received, despite unfavorable weather conditions that resulted in a late start of the season compared with last year in many markets. The external factors that influence purchasing costs continue to improve. At the same time, work on the cost and efficiency program is proceeding at full speed. Many of the changes that we have made in recent years are starting to pay off. We are also continuing our initiatives with even greater focus on the customer offering, and at the same time, we want to give our customers an even better experience with more inspiration and improved convenience in our physical stores and digital channels. We can clearly see that the physical store is important to our customers and in-store sales have increased in the year-to-date despite 300 fewer stores. At the same time, online sales continued to develop well. Around 30% of sales are online, which is at the same level as last year. This once again shows the strength of having both physical and digital sales channels, which strengthen and complement each other. We are, therefore, continuing our efforts to integrate the channels further to create a customer experience that is as smooth and inspiring as possible. At the same time, we are optimizing our store portfolio further to ensure that we have the right number of stores in the right locations at the right terms and with the right space. We have a well-positioned customer offering and are fully focused on meeting customers' ever-increasing expectations of affordable and sustainable fashion. Though the situation in the world around us remains tough, things are moving in the right direction in many of our areas. To reach our long-term goals for 2030, we have 3 main growth areas: H&M, portfolio brands and new growth and ventures. First and foremost, there is H&M, which is one of the world's biggest fashion destinations with several billion visits a year globally in store and online. We are continuing our intensive efforts within H&M to further elevate the customer experience in-store and online in order to meet customers that were increasing expectations. We are improving the assortment and broadening the offering with more products as well as services for added convenience when customers shop with us. We are deepening our customer relationships and striving to give customers unbeatable value in the form of fashion products that are both affordable and more sustainable. One example of this is that we are gradually increasing the proportion of sustainable and recycled materials in our products. In 2022, 84% of all materials were either recycled or made in a more sustainable way. This figure includes a 23% share of recycled materials, taking the company closer to its goal of 30% recycled materials by 2025. The third quarter has started well with increased sales in June in the period of first to 27th of June, sales increased by 10% in local currencies compared with last year. One of the main drivers was women's wear at H&M. The latest summer collections from H&M women's wear in our stores right now offers dresses and caftans as well as summer blazers in light neutral shades. Linen is still big and can be seen in most types of garments with the summer look further enhanced by high summer needs. In May, we were once again able to offer our customers a new and inspiring designer collaboration. And this time, it was together with the house of [ Mugler ]. The collection showcased well-priced exceptional fashion garments and accessories for both women and men and was extremely well received. Over the past year, we have made several investments in H&M's lifestyle brands. For example, we have continued to develop H&M Beauty, which offers a wide range of own and external brands and is developing strongly both in stores and online. Among other things, we have developed a new store concept and an updated range in the premium segment. The first flagship store that opened in Oslo recently received a fantastic reception. Our expansion is taking place with a focus on increasing sales in all our channels. For a number of years, we've been making major long-term investments with an emphasis on the digital. The physical stores are still incredibly important, customers appreciate having stores available where they can try on clothes and be inspired. The role of the physical stores has also been developed to become an important part of the supply chain, particularly as part of a last mile solutions. Our second growth area portfolio brands, which is COS, ARKET, Weekday, Monki and another stores increased sales by 17% in Swedish krona and 12% in local currencies in the second quarter. During the quarter, we saw, for example, continued strong sales development for COS and ARKET. COS has carried out an extensive upgrade of its assortment and strengthened its position in the premium segment. Our third business area, new growth and ventures covers new business models and investments in startups. We are continuing to invest in companies and to support these companies, for example, with knowledge and capital. Through a range of exciting and innovative partnerships and start working with entrepreneurs to create further value. Among other things, we are continuing to invest in startups that enable a more circular fashion industry that is in line with our focus on leading our industry towards a more sustainable future. We currently have holdings, and we recently led an investment round in Kintra Fibers, which has developed a bio-based polyester that is compostable and has the potential to be biodegradable, too. Kintra Fibers is designed to address the environmental impact of traditional polyester at every stage from production to end of life. The H&M Group's ambition is to lead the change towards achieving a circular fashion industry. We use our size and knowledge to drive positive change. In addition to investments in our own business, we, therefore, provide financial support to projects that contribute to reducing emissions throughout the value chain. This is the greenhouse gas emissions by 2030. As part of this, we are working to purchase 100% renewable energy in our own operations to reduce the use of fossil fuels and instead increase the use of renewable energy among our partners. We recently invested in 2 solar facilities in Sweden and the U.K. that take us one step closer to reaching our ambitious climate goals. Looking ahead, we can state in conclusion that despite the tough situation in the world around us, the H&M Group stands strong with a robust financial position, stable cash flow and a well-balanced inventory. Though the world around us remains challenging, we are seeing several areas where developments are going in the right direction, combined with our investor requisites for continued growth and improved profitability. Our goal of achieving an operating margin of 10% in 2024 remains in place. Thank you so much everyone for listening, and we will now be happy to take your questions.

[Operator Instructions]. Comes from Fredrik Ivarsson of ABG Sundal Collier. Fredrik, please go ahead.

One short question from me just on cash flow. So you're reducing the stock in trade very impressively, obviously, the working capital total is still roughly at the same level as last year or end of last year. So could you maybe provide any guidance on this matter for the full year?

Adam here. I think it's clear to see that the inventory levels are going down, but both, of course, from selling more productive stock, but also buying less. So I think the cash flow for Q2 and the first half year shows that we are getting more productive in our stock, but also buying less. So I think that is an indication also for the potential going forward that we have started to improve the stock-to-sales ratio and that will continue throughout the year without giving the cash flow for the year. But we see good progress, particularly connected to the stock levels.

Okay. But we shouldn't expect any in terms of total net working capital release? Is that sort of how we should read it?

We think that it's going to be a net positive effect of the quantification of it. It's too early to say as it's also affecting then, of course, the operating liabilities that works against the reduced stock level, so to say.

Our next question comes from William Woods of Bernstein.

I've got 2, if I may. The first one is on pricing into H2. How are you thinking about pricing going into the second half? What can we see that contributing? And then could you comment on the weakness in Q2. And how you're seeing that trend in Q3? It looks like markdown in the U.S. is going up quite heavily in terms of discounts. Any comments there?

When it comes to pricing, we've discussed that a lot the past quarters, we worked in a very dynamic way continuously with pricing where market on each product types to secure that we are the ones to offer the best value for money. And that means that we will continue to do so, of course, also in the coming quarters. So of course, potential to do certain changes in pricing to make sure that we are competitive. But this is always a balancing act because as you also know, we're very focused on also reaching the profitability target that we've set for end 2024. And that's kind of the balancing act that we will have to manage also continuously.

On the U.S., we have seen a customer sentiment weakening throughout the quarter, and I think that's a general industry trend, then it's difficult to say how that will evolve. We are confident that our offer is competitive even though the weaker trading in the market as something from many of our competitors. So it's a fiercely competitive market right now with a slightly weaker overall customer sentiment that we're, of course, closely monitoring to ensure that we keep our position and stay relevant to the customer.

But our cautious comment about markdowns in the quarter is not about America as such. It's more about the late start of the spring season. So we give us as an opportunity to activate more if needed.

Thank you. Our next question comes from Adam Cochrane of Deutsche Bank.

Two questions, if I may, I'll do one at a time. First one is on the cost performance and which of the SEK 2 billion identified cost saving program was actually achieved in this quarter. I know we originally were thinking of the second half of the year. Can you just sort of explain how much of that came into the second quarter? And on the cost control above and beyond that, can you just give us some of the measures roughly that you are taking to deliver that cost performance?

If we start with the cost program, I think you need to see the first half year as a whole as there are some fluctuations between the quarter, but we can see a net effect of around SEK 100 million in the first half year attributed them to as an early delivery. Although it is still on time and on schedule and on size level, as we have previously indicated, it's just a timing question in a positive direction amounting to roughly SEK 100 million for the first half year. Then you will see to the best of our estimates and a gradual positive impact throughout the autumn with Q3 trending in the same direction and hopefully getting the full effect towards end of Q4 and into Q1 of 2024. And overall then, when it comes to cost control, I think it's all linked to how we manage our planning, our resource planning, both in stores and in warehouses and also still repeat landlords throughout the last couple of years. And a big driver of that efficiency in stores and warehouses comes from the improved stock to sales rate effective stock that is more efficient to handle, which helps us to although we have headwinds when it comes to salary increases, maintain operational efficiency.

That's great. The second one is on price deflation, as you can see your raw material input costs, et cetera, coming down significantly, do you think it's possible that you'll be able to see a period of price deflation rate in 2024, but still see gross margin expansion given the fact that your input costs and freight costs are so much lower than they were?

Yes, that's possible. So back to what we discussed before. This is truly about balancing the fact that we take steps towards our profitability target, but also closely monitoring the competitive landscape and purchasing power to really secure that can come to us to get the best value for money. So we're monitoring this continuously and balancing that we've taken steps towards our profitability target for end 2024.

That's great. Finally, just to say goodbye to Nils, and thank him for all his help and time over the last few years.

Thank you, Adam. It's been a pleasure.

Our next question comes from Warwick Okines of BNP Paribas.

I'd echo that as well. Two questions for me, please. The first is on inventory and markdown. With constant currency inventory down 20% at the end of Q2, why are you expecting a slightly increased cost of markdowns in Q3? That's the first question. And the second is that you've talked about elevating the H&M brand. Could you just give us a sense of where you think you are with this, for example, how active is your store environment renovation at the moment?

Starting with the inventory and markdown. There are 2 parts to it. Even though we are pleased with the direction of the destock development, we have had a slightly postponed start of the spring selling, see May and June together. So that's why we guide for a slightly higher activation activity now in the beginning of the quarter. And then secondly, our market and the cost for the markdowns are also dependent on sort of the gross margin and the in prices, which means that we [ progressed ] a bit of the garments that were bought and had worse margins, which then affects technically the cost for the markdown for the quarter. So 2 effects, slightly sort of prolonged spring delayed summer and then the second one is more on the technical level, where we see that the cost will increase with the higher purchase costs that we've had in the old stock, so to say.

And when it comes to elevating the H&M brand, we are focusing on further improving the customer offer, customer experience and also bringing a lot of work linked to supply chain. If we look at ample improvements within H&M ladies, where we can now offer a broader assortment to our customers. When it comes to the customer experience, we develop both digitally but also do a lot of activities when it comes to developing the physical stores that -- store network. And with that comes, of course, certain closures still when it comes to mature developing the pure format, to make sure we have the relevant format and relevant assortment wherever we have a lot of activities going on there, making sure we have relevant stores across the globe. And then when it comes to the supply chain that has to do, of course, with assortment and precision to make sure we have the right product at the right place.

Our next question comes from Richard Chamberlain of RBC. Richard, please go ahead.

I just got one question on the assuring FX exposures on gross margin and the buying margin.

Hi, Richard. As we did give any percentage, but the direction is clear. We are increasing exposure in new markets, but this is a -- it's more the direction than the exact -- it's part of the -- what Helena talked about before, and we see we buy more in season. It's all connected, and we also see it in the inventory development.

Is that concentrated in any particular area like H&M women's fashion? I mean, I know already [ Cole's ] gets quite a lot of response market. So is it particularly H&M women's fashion that you're shifting some of that more to mutual sourcing markets?

It's a broader initiative than that touching more or less all the different business units within H&M. But looking at where we see the greatest progress right now, we can highlight H&M ladies, but that is not only because of that, but also a lot of doing and investing in.

Our next question comes from Sreedhar Mahamkali from UBS.

If I can, please. If I can just follow up on the North America pointed from earlier on, and you talked about slowing down throughout the quarter. Was the exit rate still positive? Or had it turned negative by the end of the quarter? And how should we think about the second half in terms of market and what you're seeing there. That's the first question, and...

Could you please -- we'll take one question at a time, please. Let's start with that one. Adam...

The -- we came out of a very, very strong quarter 1 for North America. And then we see that the overall sort of the industry is having a slightly weaker Q2 than Q1. And I think we are trending as the industry as a whole and see now when summer has arrived, we also see that the response from the customers going in the right direction. So a strong Q2 for a number of reasons, but a strong response for the customer throughout the summer.

Got you. In the current trading commentary that you also rebound in North America [indiscernible].

There's many parts that we have the rebound. I think looking at the comps from last year, we had a weaker June in many of the Central European markets. I would say that the European markets and Central Europe, that is a slightly bigger share of the country rebound.

Okay. Second question was just in terms of broadly pleasing, what is the underlying inflation that you're seeing? I know you referred to wage pressure a little earlier but OpEx actually declined in Q2, 2% in local currencies versus a 3% increase in Q1. Clearly, you've had some good contribution from the topline savings program. Was anything else going on within the P&L trends?

I think potentially slightly relating to the answer to then from operational efficiency improvements, being able to mitigate it slightly more than the wage pressure, so to say. So we were pleased with that, and that is based on a number of initiatives, but the primary driver is then the efficiency when it comes to the stock and the productivity of the stock. It's the product at the end of the day, that drives profitable selling. It's very different between [indiscernible] inflation looks. So it's not a one size fits all answer to it. But as a general answer, then our operational efficiency, wage inflation and a bit more than...

Nowicki of TextilWirtschaft.

First question would be one of the biggest margin [indiscernible] in fashion online retailing is the return rate. What is the average return rate at H&M and how did the introduction of consumer behavior and return rates in these markets?

So when it comes to your figure, we know that we are on a good level if comparing with competition. We do many different kind of reduce the level of returns from the beginning, such as, for example, guidance when it comes to sizing so that customers hopefully wouldn't want to return once they have ordered. And that's kind of the most important part of -- we have also started to roll out a fee for sending in returns. We have covered a rather big part of Europe when it comes to nonmembers and then also when it comes to H&M members. We are out to more countries, first of all, within Europe. So I would say that, that is going rather well, but put even more emphasis on trying with other means to decrease the rate of returns. That's where the focus is.

Next question would be, you mentioned the strong performance of the portfolio brands. On the other hand, to me, that means that your main brand H&M is not growing, taking order to grow again.

Well, looking into the quarter and rightly so that the portfolio of brands have done well, looking into the quarter, looking into H&M, we also see that rather a delay of the summer season start due to the weather. So that has hit the season on big markets, can capture parts of that then in June once the warmer weather has arrived. But that has been a rather big market within Central Europe and also North America. And North America, of course, as Adam said earlier, we've also reduced purchasing power with our customer group. So mainly it's related to these countries and regions.

Okay. Okay. My last question would be, how is H&M doing in your biggest market in Germany, right now or in the first 2 quarters and the beginning of the third?

We're doing well. Thank you. It's, as you said, the most important market for us together with U.S. And as Helena and Adam said, it was a slightly delayed start of the summer season, but have picked up well in June.

Are there any further questions?

[Operator Instructions]. Our next question for today comes from Nick Coulter of Citi Group.

I'll stick to 2 and go one at a time, if I may. Firstly to come back on the program that you have in place. The [indiscernible] point, there does look to be a step change in your underlying SG&A profile in the second quarter. Is it possible just to flesh out what's changed between the first and second quarters and how we should think about that going forward? Do you use Q2 as a base in terms of your SG&A efficiency? That's the first one.

What will remain is the efficiency potential that comes then from a higher productivity in our assortment and our stock, and that will remain. And I think that is the clearest distinction that we can see throughout the spring. But it's not that end of Q1 was bad, and then all of a sudden, start of Q1 was good. So it's a gradual improvement that we have been planning for and now executing on. So I think it's wise to see it as a half year in totality, but with a strong direction that we step-by-step take the steps needed to reach the long-term targets.

Those efficiencies outside of the SEK 2 billion program should continue to improve for the balance of the year, there's a trajectory of improvement excluding the SEK 2 billion?

Yes. The SEK 2 billion are more related even though it's not only visible in the administration role, so to say, in the income statement. There are also potentials throughout the cost structure. And the majority of them are then based on having a strong assortment with high productivity in our stock. And right now, we have a good trajectory ensuring that the quality of the inventory is good and that over in an effective and efficient way then. Then, of course, as I mentioned before, that we will have and continue to have some wage inflation headwind that we continuously, of course, work to mitigate as well as we can without compromising the customer experience.

And then secondly, if I may, just on the Nordics, it looks to be quite a strong underlying performance if you're able to pull out why that might have been a positive outlier, please?

Happy doing well, what is exceptionally well in this quarter, particularly for the Nordics and Sweden is the growth of Sellpy. So that is one sort of distinct difference that we see where Sellpy has become a big part of the Swedish retail and a strong leader when it comes to retail.

But are you doing anything different with respect to your merchandising or how you're looking at the store ambience? Is there anything that you're introducing in the Nordics first?

No, generally not. They have come far when it comes to implementation of the whole omni operational model and so forth. But it's not something distinctly different. It's just that they have -- as well as Central Europe have been part of our development for a long time, and we can see positive effects of it.

Our next question for today comes from Simon Irwin of Credit Suisse.

Question. Can you just talk a bit about the lease interest charge? I know it's not an enormous number, but it's gone up from being [ sub-SEK 200 ] a quarter to kind of [ SEK 300 and now SEK 400 ] a quarter. What's going on there in terms of the kind of way that your [indiscernible] is going because presumably your overall kind of lease liabilities aren't increasing? So can you just talk us through what we should expect on that front?

But you're right. I mean there is an interest component to the lease liabilities. And of course, with interest rates changing that affect the income statement. And I -- difficult to say how much the interest rates will continue to shift. But right now, it feels that we have reached some kind of peak of the increase, so to say, or at least a decline of the interest rate increase. So we hope that this will vision of the interest rate cost connected to IFRS going forward.

Right. And can you just talk a little bit, particularly around the admin expense line, in particular, which was looked very elevated in 1Q and then look to remarkably low in 2Q when historically, it's been around [ 2.5 ]. Is there a big shift in terms of some of the numbers within that expense line between the 2 quarters?

There are always sort of timing and phasing effects, and it's whether we sort of have some of the big invoicing done before the end of the fiscal year if it's taken beginning of the next, so to say. So that affected Q1. So I think the best sort of indicator of the direction is to see the 2 quarters as a whole then, but with, of course, still being committed to the overall size and timing of the efficiency program. And as I mentioned before, it will gradually become more visible throughout the autumn.

The SEK 2 billion, will that be kind of over-indexed within that line? Because it's obviously SEK 2 billion within the admin line, it's quite a large number.

Exactly. So it will be a split. So as we have this sort of function-based income statement. It will not only be visible in the admin role. It will be like a 30%, 30%, 40% split then with around [ 40% of admin ] cost and sales.

Our next question comes from Georgina Johanan from JPMorgan.

I've got 3, please. I'll ask them one at a time. Just on the first one, appreciate on pricing from here. But just to understand directionally in the second half of the year, should there still be some year-on-year benefit to gross margin as price increases either land or annualized, please. That was my first question.

Okay. So looking into the external factors on purchasing prices, as we've discussed before, we see that it's gradually being improved. And of course, that means the opportunity also to look into pricing, continuously to really make sure that we are the ones who have the best customer offer value for important product type. So we're reviewing that product type or product type on each of the different markets and again, I would like to put, of course, there is a potential to then reduce some of the prices to make sure that we're really competitive, but also, we're always keeping track on us also taking steps towards the very important profitability target that we have for 2024.

And then my second question was just following on from Simon's question on the interest expense. I note that a portion of the lease charge or rather the lease portion of the D&A charge has also moved up materially in the half quite about -- so which seems a large increase in the context of reducing store base. Is that purely accounting as well? Or is there something else going on there, please, in terms of the rent charges?

No, there's not something else going on. It's connected to interest rates increasing and currency translation.

Great. And then finally, just a quick question. Because I think for the last couple of quarters, you've called out the drag. Are you able to sort of quantify the impact in this quarter, please? And indeed, was it still a year-on-year drag in Q2?

Yes, it was a year-on-year drag, but we've seen that the sort of ease and come down. So it's not a majority share of the cost difference in this quarter as it's been over the last 2 quarters previously. So still a drag, but not as severe as previous half year.

Our next question comes from Dana Telsey from Telsey Advisory Group.

Good afternoon, everyone. As you think about the physical real estate -- could you think about the physical reality about size of stores, number of doors. Is it different by geography and are lease negotiations more favorable than another? And just one other thing on that, how is omnichannel advancing within your physical footprint? And Nils, you'll be missed. Thank you.

Thank you, Dana.

Okay. Looking into optimizing the store portfolio. First of all, we see that the physical stores are very, very important still for our customer. It's accessible. It's a way for our customers to get inspiration to -- but more importantly, it's kind of the combination that we always talk about on digital channels and physical channels and how those can strengthen each other. We're working on optimizing the store portfolio in many different ways. Of course, as digital has expanded when it comes to shopping behavior, we have, as you know, also reduced the number of stores in certain mature markets. Looking at the pace of that decline, of course, more and more work coming into more optimal levels. And we also see the opportunity to increase number [ throughout ] world as well. Looking into how to differentiate the stores, that is a very important topic and also investments moving forward because it's all about having the right store format and thereby also the right size at the right place -- the customer group around each and every store. We are also profiling the stores in different ways with having the relevant assortment for that customer group and also looking into space and interior and doing that according to the different store formats that we have developed. So that is a very important part of that as well. You had one question in the end of that omni. Not sure if I answered that. Could you please ask again?

Of course, as you think about omnichannel and the advancements that you're doing within the physical store footprint, what are you adapting in? Did you put something that you changed? Is there advancement there?

Well, it's part of the different store formats. That's also to think about omni, so how to make it seamless between digital and physical channels. So for example, if you want to hit something online and pick it up in store and how to further advance that, we, of course, do self-service checkout continuously. We do a lot of work on helping customers to navigate better in our stores. So there's a lot of different activities that is kind of experience more omni and more convenience. So that is a very important part of integrating the channels.

Thank you. Our next question comes from Anne Critchlow of Societe Generale.

Just thinking about the gross margin, is it fair to say that FX could still be a negative impact in the third quarter? And then more neutral in the fourth quarter, but not really past year?

As we said, we don't guide on the gross margin, but we do help you with the external factors that are important first. And as we said in the report, they are now reversing and becoming from having been very negative and gradually improving and now they're pivoting and becoming positive sometime in the third quarter, probably. So we're guiding for a neutral more or less for the quarter on the impact than the gross margin could be something else, of course. But for the fourth quarter, it's very much a tailwind for the input costs.

Paul Rossington of HSBC.

It's probably a somewhat boring question, to be honest. A significant amount of undrawn credit facility other than the maturity profile of those credit facilities, is there any other reason why you now lead them? And also just to say thank you very much to Nils for all of your hope. Thank you.

Thank you, Paul.

No, but we make sure strong liquidity and help the sort of access to cash. And we believe that given the last couple of years, we are right now and that gives us the sort of opportunity to look forward and build for the future to say, given a robust financial situation.

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

Big, big thank you to Nils Vinge since this is your last report with H&M Group, you, appreciated leader and colleague within H&M Group and have been a key person both in the current position, of course, but also in many other. Thank you to you and best of luck.

Thank you, Helena, and also thank you to the audience. It's been a pleasure working with you. And best of luck to all of you.

Then our new Head of Investor Relations, which is [indiscernible], a very warm welcome to you and from the next quarter, you will be the one that will lead the Investor Relations.

Thank you. I'm very excited about the opportunity and look for you all and continue the very strong collaboration has had with all of you.

Okay. So by that, a big thank you to all of you who's been participating. Have a lovely summer and a very good day. Thank you.

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