Industria de Diseño Textil, S.A. (ITX) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. A warm welcome to the presentation of Inditex results for full year 2019 results. My name is Jake, and I'm the operator on today's call. I'd now like to hand over to Marcos López, Capital Markets Director.

Good morning, ladies and gentlemen. A warm welcome to the presentation of Inditex's results for 2019. I'm Marcos López, Capital Markets Director. The presentation will be chaired by Inditex's Executive Chairman, Pablo Isla; here today with us are also our CEO, Carlos Crespo; and CFO, Ignacio Fernández. As usual, the presentation will be followed by a Q&A session, starting with the questions received on the telephone and then those received through the webcast platform. Before we start, we will take the disclaimer as read. I will now hand over to Pablo.

Good morning to everybody, and welcome to Inditex 2019 results presentation. First and foremost, our thoughts are with all those affected by the COVID-19 pandemic. Our #1 priority is the health and safety of local communities and our employees. We would like to give our thanks to our teams whose contribution in this difficult time has been truly inspiring. All of you know as well, but I would like to start my presentation highlighting the strength of Inditex fundamentals. 2019 has been a year of very strong operating performance. The sales growth, healthy margins and strong cash flows prove the health of the business model. The start of 2020 is affected by severe but temporary external factors, and we are managing the situation in very close detail. Let me tell you that we have total confidence in our business model and the long-term potential of the group. We continue developing the key lines of our long-term strategy to expand our fully integrated store and online platform. Inditex is in a robust financial condition. We generate strong free cash flow, enjoy the flexibility provided by a net cash position and require lower capital intensity going forward. We continue to see significant opportunities for global growth. 2019 has been very much about the continued rollout of our long-term strategic initiatives with a very clear goal, to provide a unique customer experience. These initiatives fuel the increasing differentiation of our model. Let me give you some numbers to illustrate the facts. Sales in 2019 were very satisfactory at plus 8%. Like-for-like sales grew 6.5%. Online sales increased 23% to EUR 3.9 billion or 14% of group sales. Gross profit reached EUR 15.8 billion and includes an inventory provision of EUR 287 million. Excluding this provision, net income would have grown 12%. We have also seen accelerating free cash flow generation reflected in the EUR 8.1 billion net cash position. The strength of the business model is reflected in the consistency of our like-for-like sales performance. Last year, like-for-likes reached 6.5% on a demanding comparable. Additionally, like-for-like sales were positive in-store and online and in all geographical areas. In 2019, we have been very active with our space portfolio. We have reinforced the differentiation of our key global flagships with the opening of very visible stores. In 2019, gross new space in prime locations grew 5%. We continue the optimization program, and the result was 2.5% net space growth. In 2019, Inditex has achieved sector-leading online sales of EUR 3.9 billion, an increase of 23%. Online sales account for 14% of group sales. In 2019, online launches have taken place for Zara in Brazil, Egypt, Indonesia, Israel, Lebanon, Morocco, Serbia, South Africa, Kuwait, United Arab Emirates, Qatar, Colombia, Philippines and Ukraine. The Board of Directors of Inditex, following the proposal of the Audit and Compliance Committee, in view of the current uncertain situation due to the COVID-19 pandemic, considers that it is not the right moment to take a decision on the dividend to be proposed relating to full year 2019. Consequently, the net income generated will be allocated to reserves with a view to submitting a final proposal on dividends at a later Board meeting prior to the AGM, which will take place in July. Initial collections for the Spring/Summer season have been well received by our customers. The COVID-19 pandemic is having a very significant impact. The online business continues to develop as normal in all markets. Our supply chain continues to operate normally due to the flexibility of the business model. Due to COVID-19, store and online sales in local currencies decreased 4.9% for 1st February to 16 March 2020. Store and online sales in local currencies decreased 24.1% and from 1st March to 16 March 2020. As of today, 3,785 stores are temporarily closed in 39 markets. All stores in China are open with the exception of 11 stores. While it is too early to quantify future impact, we are following events closely, and we have total confidence in our business model and the long-term potential of the group. Let me now hand you over to Ignacio for the financial section.

Thank you, Pablo. As a reminder, fiscal 2019 accounts have been prepared under IFRS 16. The standard has no impact either on the cash flows or the business itself. As already pointed out, we had a very strong performance in 2019. Net sales grew 8% to EUR 28.3 billion. Gross profit increased 7% to EUR 15.8 billion, and net income increased 6% to EUR 3.6 billion. As explained, we have booked an inventory provision of EUR 287 million to account for the impact that the COVID-19 pandemic might have in the net realizable value of the Spring/Summer inventory position at 31st January 2020. Excluding this provision, the reported net income would have grown 12% over fiscal year 2018. The impact on net income of leases under the IFRS 16 rules was EUR 88 million. The evolution of sales was very satisfactory with net sales growth of 8% driven by a very good performance of the integrated business model. Strong execution in 2019 is well illustrated in the like-for-likes growth at 6.5%. Inditex continues expanding its global sales platform. Like-for-like sales growth has been positive in all geographic areas. Gross profit reached EUR 15.8 billion, 7% higher than in fiscal year 2018. The gross margin reached 55.9%, minus 79 basis points. Based on current information, in accordance with the IAS 2 and IAS 10, Inditex has booked an inventory provision of EUR 287 million to account for the impact that the COVID pandemic might have in the net realizable value of the Spring/Summer inventory position at 31st January 2020. Excluding this provision, the gross margin will have increased 22 basis points to 56.9%, and gross margin profit by 9% to EUR 15.1 billion. Once again, efficiency gains have allowed us to try to control operating expenses in the period. Operating expense growth, excluding the impact of leases under IFRS 16 rules in the period, would have been plus 7.5%. The financial results line on the income statement includes an impact of leases under IFRS 16 rules of EUR 156 million. Now let me hand you over to Marcos.

Thank you, Ignacio. The flexibility of the business model we run can be seen clearly in the healthy working capital evolution. This operating performance was facilitated by the integration of the stores and the online operations as well as the ongoing space optimization taking place. This helped to drive the growth in the net cash position of 20% to EUR 8.1 billion as of the 31st of January 2020. Inventory, excluding the EUR 287 million provision, fell 6%, demonstrating our ability to run our business more efficiently and with less inventory. To summarize the cash flow evolution in the year 2019, let me tell you that funds from operations, including lease payments, grew 11% to EUR 4.9 billion. The strong operating performance, the working capital inflow and lower net capital expenditure resulted in a free cash flow of EUR 4 billion, up 54% from last year. Let me now hand you back to Pablo.

Thank you, Marcos. A few final comments on the outlook. The performance of Inditex in 2019 highlights the strength of the business model. The start of 2020 is significantly impacted by the COVID-19 pandemic. We believe an underlying level of like-for-like sales growth of 4% to 6% is sustainable going forward. However, given the current situation, we believe it is too early to give guidance for full year 2020 at this stage. Inditex is in a robust financial condition. We generate strong free cash flows, enjoy the financial flexibility provided by our net cash position and require lower capital intensity going forward. We have total confidence in our business model and the long-term potential of the group. We will continue developing our long-term strategy. We continue to see very significant global growth opportunities. And that concludes our presentation today. We'll be happy to answer any questions you may have.

[Operator Instructions] The first question today comes from Aneesha Sherman of Bernstein.

My question is about the online business. First, you said that online is now 14% of group sales. Can you give us the rough split of your store versus online distribution cost? I'm trying to understand to what extent the closures of stores will proportionately bring down distribution cost? And the second piece is, do you see your online margin structure deteriorating as customers are unable to return or pick up in stores, which is a big part of your online and stores channel structure?

Well, thank you for your question. As you have seen during last year, our online business has developed very strongly. We have reached EUR 3.9 billion of sales. Sales growth has been 23% for our online business. And as we have said before, the online business is nondilutive. We believe very much in this fully integrated approach going forward. Currently, of course, we are facing a very, I would say, a very extraordinary, a very unexpected situation. So I think it doesn't make a lot of sense to elaborate very much about this or that point, in particular, regarding this very unexpected and unusual situation that we are facing with so many stores closed temporarily in the different markets. We continue believing very much in this fully integrated approach regarding stores and online, this is one of the key elements of our global strategy. And of course, once things come back to normality, we will come back to this approach. What is very important for us is that in the different markets in which our stores are closed, we continue offering our customers the possibility of buying our products online. And this is what we are focused on, to continue developing our business as far as possible in the different markets.

The next question comes from Richard Chamberlain of RBC.

Actually, I had a question on the inventory provision, please. I know it's very difficult, but can you just give a little bit more color on the assumptions that you've made to come up with that inventory provision? And then my other point was on the manufacturing and logistics in Spain and the impact from the COVID-19 virus. How are you minimizing the risk from having fairly centralized setup in Spain? It doesn't sound like it's been very disruptive so far, but how are you thinking about minimizing the risk going forward?

Well, thank you for your question. What we can say, first of all, your question about manufacturing and logistics. Well, regarding manufacturing, what we are saying in the note and in the presentation is that, as you know, we have a very flexible business model. And from that point of view, at least until now, we are not having any significant impact. And about logistics, we are -- what we will try is to continue running our business as much as possible, having in mind all the stores that we have now closed in many different markets around the world, I repeat, on a temporarily basis. This is something which is very important to have in mind. About the inventory, what I would say is that, and later on, I will pass to Marcos to elaborate a little bit more, but what is very, very remarkable is that having in mind what has been our strategy during the last years and particularly during this year, 2019. Our inventory without the provisions or before the provision was minus 6%. So we were able to have 8% sales growth with minus 6% inventory levels at the end of the period. Then because of the situation and the potential impact of the -- on the inventory that we have at the end of the year, we have decided and we have thought that what was appropriate was to make this provision that, Marcos, you can elaborate a little bit more.

Yes. Richard, very much the assumption is based on the current information and in accordance with IAS 2 and IAS 10. We have booked the inventory provision of EUR 287 million to account for the impact that the COVID-19 pandemic might have in the net realizable value of the Spring/Summer inventory position at 31st January 2020. And this is as far as we would like to go right now. But I think what is very, very important, and Pablo mentioned it, the way that we were managing the inventory in a very, very tight way. And as we have mentioned, last year, without any provision, the gross margin would have increased 22 basis points to 56.9%, and at the same time, inventory would have fallen 6%. So the fundamentals of the business model remain very, very strong. I think the impact of the working capital is absolutely evident in the cash flow summary that we have presented to you. So the fundamentals of the company remain very, very strong.

The next question comes from Anne Critchlow of Societe Generale.

Firstly, please, could you give us a space guidance number, so the increase in physical space that you're planning for the year in percentage terms? And then secondly, please, could you give us some insight into what happened in China during the store closures to your online business? Did you see online sales actually accelerate there? If you could give a bit of color around that, that would be great.

Well, regarding your first question, what I would say is that we believe, as you can imagine, all our different plans for this year, we are reviewing them because of this situation that we are facing. So I think it is too early to think about any guidance for the 2020 year in terms of space growth, in terms of like-for-like sales growth. We hope that we will be able to give this guidance in the first quarter results presentation in the month of June. But we think it is too early to give any type of guidance at this stage. And regarding China, what I would say -- well, first of all, that during all the period, during the whole month of February, our online business continued working in the Chinese market. I think I don't want to elaborate very much if in this particular short period of time, online was growing or not or above or below what could be the average. What I think is relevant is that we continue developing our online business during the whole period. And what is also very relevant to mention is that today, mid-March, all our stores, with the exception of 11, are already opened, and our online business continues developing in a very normalized way. And we'll continue with this fully integrated approach as we are implementing in all the markets. I think that is what is relevant to mention right now. And regarding guidance, I repeat what I was saying, we hope we will be able to give you guidance in June in the first quarter results presentation conference call.

The next question comes from Rebecca McClellan of Santander.

A couple of questions, please. Firstly, Inditex is a big corporate in Spain, would it be able to enjoy the ERTE proposed by the government? And secondly, if you are in any sort of rent relief conversations, how amenable are you seeing the landlords in terms of trying to meet in the middle or not?

I prefer -- sorry, Rebecca, and thank you for your question. But we prefer not to elaborate very much on any specific market at this stage. As you can imagine, this situation is quite new in all the different European markets. And of course, as you can imagine, we are analyzing the situation on a country per country basis, and we will take all the appropriate decision. Decisions having in mind all the elements, our employees, cost structure, our long-term relations with our landlords, with our different suppliers. So we will take always balanced decisions and having in mind all the different stakeholders involved in the decisions.

The next question comes from Mariana Horn of UBS.

So my question is around OpEx. I was wondering if you could provide some color as to how much flexibility you have in terms of your cost base. So for example, if you could provide an indication of what percentage of your cost base is fixed and what percentage is variable? And relating to this, if you could tell us whether in the stores that are closed, you're still paying the employees that work in those stores? And also in terms of the current trading figure, which you provided for the month of March, is it possible for you to provide some color on how much of that came from online versus brick-and-mortar?

Starting with your second question about the split between stores and online, we believe that at this stage, it's not the right time to talk about that. As Pablo mentioned, we run a fully integrated model, and we believe it's not -- we don't want to enter in that type of discussion. Regarding the OpEx, it is true that Inditex has a significantly flexible OpEx structure. If you look at the numbers in the fiscal 2019 accounts, you will see that, that's the case. We have a very significant variable component in our sales, but at this stage, we would prefer not to enter into a discussion for the year.

Thank you very much. We are now finished with the telephone Q&A session to address the questions received through the webcast platform.

We've had a number of questions. I think most of them have actually been covered already. There is probably one remaining on inventory. I know you covered this Pablo and Marcos. How much further can you lower your inventory going forward, would you think?

Well, what I could say is that -- well, first of all, and we were saying during the presentation, we believe very much in the long-term prospects of our group. I think this is the most important thing to say. And we believe very much in the strategy that we have been developing in the last few years. That is why much more than to focus on a short-term impact and how much are we going to compensate related with costs. I think what we -- what is very important is to have the long-term view and we believe very much in these long-term prospects of our group. And the inventory position at the end of the year, even before the provision, it was minus 6%. It shows the flexibility of our business model, it shows how healthy are we running our company. So I think this is the essential point. This is very -- the most important element we wanted to transmit to you in this conference call. And now we are having this temporary impact, which is very significant, as we are saying in the presentation, many of our stores are closed on a -- for a -- we hope a short period of time in the different markets. But we continue believing very much on our long-term prospects and our long-term strategy. This is what I wanted to transmit to you today.

Thank you very much. That largely concludes the webcast questions now.

Well, and thank you, everybody. And thank you for participating in this presentation. And once more, as I was saying at the beginning, our main concern now is the health, of course, of our employees and the local communities in which we operate. And of course, for any additional questions you may have, we can continue in touch during the day through our capital markets department. Thank you. Thank you very much.