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

Good morning, ladies and gentlemen. A warm welcome to the presentation of Inditex's results for the interim half year 2020. I am 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 from the telephone and then those received through the webcast platform. Before we start, we will take the disclaimer as read. I'll now hand you over to Pablo.

Thank you, Marcos. Good morning to everybody, and welcome to Inditex results presentation. Let me tell you that we have total confidence in our unique business model. We continue developing the key lines of our long-term strategy to extend our fully integrated store and online platform, to complete the digitalization of the group and to push forward the goal of increasing our level of sustainability. I would like to start the presentation with an overview of fiscal 2020 year-to-date. Let me point out that we have seen a rapid recovery in operations over the course of the year. Our Autumn/Winter season collections have been very well received by our customers. As of today, 98% of our stores are open, and the store sales have been recovering progressively. At the same time, it's certainly worth noting that online sales continue to experience outstanding growth in all markets. As a result, store and online sales in local currencies from the 1st of August to the 6th of September were 11% below the demanding comparable of the previous year, marked by an increase of 8% from the 1st of August to the 8th of September 2019. I would like to highlight that the second quarter has marked a turning point in performance in 2020. Over the Spring/Summer season, COVID-19 has had a material impact on operations due to temporary stores closures and restrictions. Throughout this period, we saw outstanding progress in online sales. Our supply chain has continued to operate normally due to the flexibility of the business model. Key features of our operations like the inventory integration have proven to be crucial during the season. We have been driving efficiencies through the active management of operating expenses. The marked decrease in operating expenses in the period is a reflection of the efforts of everybody here at Inditex. The second quarter of 2020 saw the recovery turning point, laying the foundations for a progressive return to normal trading conditions going into the second half. At the beginning of the Autumn/Winter season, practically, all stores were open. We are seeing a continued improvement in in-store trading, all the while online sales continue growing at a remarkable pace. As you can see from this chart, a significant turning point was reached in the second quarter as the majority of stores reopened. During the second quarter 2020, the group's performance saw an inflection point, laying the foundation for a return to normal trading conditions. The chart shows the monthly sales performance in the period versus last year. Going into the second half of the fiscal year, sales trends have started to improve as stores have reopened. The strong trajectory of online sales has, of course, continued. In the first half 2020, global online sales made outstanding progress. This remarkable performance was greatly helped by our fully integrated business model, our single inventory position and the attractiveness of the product offer. Online sales grew 74% in the first half of 2020. It is because of these features that today, Inditex online operations enjoy sector-leading growth rates and profitability. The strong growth in online sales has continued going into the Autumn/Winter season. We have been seeing a progressive recovery in sales in the markets that have reopened the stores. The different performance by geography depends mainly on the timing of the reopenings. Online sales continue to grow across the globe. I'll hand you over to Ignacio now for the financial section.

Thank you, Pablo. As mentioned, the COVID-19 pandemic has had a material impact on our first half 2020 operations. Sales reached EUR 8 billion in the period. To minimize the impact, we have been actively managing our supply chain and inventory. The flexibility of our business model and the single inventory position was pivotal in this process. As a result, gross profit reached EUR 4.5 billion in the first half of 2020. Over the period, we moved quickly to drive efficiencies by managing operating expenses in response to adjustments in sales volumes. Cost control has been crucial in the first half with many initiatives now in place. Consequently, EBITDA in the first half 2020 is EUR 1.5 billion. As a reminder, we charged EUR 308 million to depreciation in the first quarter to complete the space optimization process. Excluding this charge, both PBT and net income for the first half would have been EUR 45 million and EUR 39 million, respectively. The second quarter of 2020 proved to be a turning point in the fiscal year, after which we saw a clear start to the recovery. The active management of our supply chain and the single inventory position have been instrumental in this process. We have also [ helped rapidly ] our operating expenses to attain efficiencies and adjust for sales volumes. The focus on cost control has been very important. As a result, EBITDA reached EUR 1 billion in the second quarter alone. The sales performance has been marked by the timing of the temporary store closes and restrictions. Online sales growth in the period has been very strong at plus 74%. Gross profit reached EUR 4.5 billion in the first half of 2020. The gross margin was 56.2%. The gross margin evolution over the period is strongly linked to high levels of flexibility enjoyed by our unique supply chain. This is clearly restating the inventory, which was 19% lower than the closing balance in the first half of 2019. Efficiency gains have allowed us to sustain high level of control over operating expenses in the period. You can see operating expenses decreased a remarkable 21%. All of the main components of operating expenses have shown good performance. Depreciation and amortization was EUR 1.7 billion. This includes the full charge for the completion of the store optimization program in 2020 and 2021 announced back in June. The financial results line of the income statement includes the interest on lease liabilities of EUR 65 million. The flexibility of the business model we run can be clearly seen in the evolution of working capital over this demanding period. Despite the very material impact of lockdowns on sales, we have been able to use the flexibility of our supply chain to adjust the volumes. The single inventory position was pivotal to achieving this performance. As a result, inventory fell 19% at the end of the first half 2020 and demonstrated the flexibility of our business model. The closing inventory is considered to be of high quality. These actions, in conjunction with the time management of operating expenses, helped to sustain the net cash position of EUR 6.5 billion, an increase of EUR 734 million over the end of the first quarter 2020. Let me hand you over to Marcos now.

Thank you. Over the first half, we have continued with our expansion. We opened stores in 14 different markets. Global online launches have continued rapidly, as you can see. The weight of the different concepts on group sales remains broadly unchanged. Evidently, operations have been materially impacted over the first half of the year, but as mentioned by Pablo earlier, we saw a clear turning point for the second quarter. We are seeing a progressive recovery across all concepts going into the Autumn/Winter season. The differences relate to each individual concept's geographic presence, location of stores and fashion profile. And now over to Pablo.

Thank you, Marcos. We continue to develop our global online business. Online sales have been profitable and non-dilutive from launch. We foresee very strong progress in the run-up to 2022. This progress has been and will continue to be underpinned by a very high level of integration between physical stores and online. The benefits of this integration have been especially evident over the first half of the year. Furthermore, we also expect to invest EUR 1 billion in online capital expenditure for the period 2020 to 2022. The ultimate aim is to accomplish full digitalization of stores across the globe. Online sales as a percentage of total sales are expected to continue rising over the long term. I'll now hand over to Carlos to comment on online and sustainability.

Thank you, Pablo. We continue furthering our global online reach with launches for Zara in Argentina, Uruguay, Paraguay, Peru, Bosnia-Herzegovina, Albania and Algeria over the first half of the year. In August, Zara launched online sales in Chile, Montenegro and North Macedonia. In September, Zara has launched online in Tunisia and Andorra and will launch in Costa Rica, Guatemala, Honduras and Nicaragua before the end of the month. As you know, sustainability has been a key part of our strategy for many years. Our commitment to a circular economy is best illustrated in these 5 main areas: the sustainability of the supply chain, the use of renewable energies, the commitment to sustainable fabrics, the conversion into eco-efficient stores and a zero waste and recycling policy. We're happy to tell you that we're making good progress on all these initiatives. Now I'll hand you back to Pablo.

Thank you. We continue to reinforce the differentiation of our stores by adding highly visible units. Our goal is to operate high-quality, digital, eco-efficient stores in conjunction with our global online platform in order to provide a unique customer experience. Through these initiatives, we are expecting increased profitability and lower capital intensity going forward. A good example is the enlargement of the Zara store in Paris at Pont Neuf, this project includes a total refurbishment of the interior around a visually appealing central stairway; the enlargement of the Zara store in Berlin at Tauentzienstrasse with an additional floor and new sustainable materials; the enlargement of the Zara store in Moscow at Kusnetsky Most, with double-fronted new interiors overlooking the pedestrian area. And a key project will be the relocation of the Zara store in Beijing at Wangfujing next month. This store will be the largest in Asia and one of the most technologically advanced stores in the whole group. In summary, we aim to further develop our unique business model by continuing with the global rollout of our fully integrated store and online platform. A good example of seamless store and online execution can be seen in the Zara Woman Autumn/Winter collection, the Zara Man Bauhaus capsule collection, Zara Kids Naturales collection, the new Zara fragrances created by Jo Malone CBE, Zara Home's Timeless Interiors collection, Massimo Dutti's Limited Edition collection, Bershka's NBA capsule, the Pull&Bear Teen Collection, the Stradivarius STR collection, Oysho's Comfortlux collection and the Uterqüe new official page on Instagram. And finally, the ordinary dividend for full year 2019 of EUR 0.35 per share will be paid on the 2nd of November 2020. Inditex's dividend policy of 60% ordinary payout and bonus dividends remains in place. As you all know, the remainder of the bonus dividend, EUR 0.78 per share, will be paid in calendar 2021 and 2022. Thank you for attending. That concludes our presentation for today, and we'll be happy to answer any questions you may have.

Please go ahead, operator.

[Operator Instructions] The first question today comes from Richard Chamberlain of RBC.

I just got a question on the online sales performance. Obviously, very strong in the first half and helping to offset store closures, but I wondered what kind of boost or positive effect to online sales you've seen from the lower product returns in the first half. Has that been a material [Audio Gap] the online sales growth rate?

Well, thank you. Well, the first thing I would like to tell you is that as you were saying and we were saying during the presentation that we are very satisfied with online sales growth during the first half. I think it shows the strength of our online proposition and the strength of our business model with this single inventory position between stores and online. But when we see that we have, globally, 74% online sales growth, and as you know, in Zara in general, but in Zara in particular, it's through our own webs and apps all across the world, you see how strong is our online proposition. So thinking about the future, thinking about the medium term, I think we can say that, of course, we are a world-leading online global retailer at the same time as we have this fully integrated approach between stores and online. And it's unbelievable, the effort made by our commercial teams. You cannot imagine, because, of course, there were a lot of restrictions about how could we -- well, first of all, thinking about the product, for sure. If you see the cover of the presentation with the sophisticated dresses, I mean the effort made by the commercial teams, and particularly, if we think about the online teams, it is exactly the same with all the limitations about the possibility of taking the pictures well and to be able to see this so significant rate of growth and in terms of customer service, in terms of the deliveries. Also, you must have in mind that during the period in which the stores were closed, something that for us is very important, which is in-store delivering, in-store returns was not possible. So the effort has been unbelievable. So what we can say is that we are very, very satisfied regarding all this effort from our commercial teams, first, regarding the product; second, regarding online; well, I would say, also regarding the stores. As soon as we were able to reopen the stores in the different markets, it is exactly the same. All our teams in the different countries, the way we have gone through this process of reopening and in terms of customer service and everything, it has been unbelievable. Well, now answering your question, I would say that there's nothing very relevant, different from the usual in what you are saying. So this online sales growth is a combination of existing customers and many new online customers, which we think is something very positive, thinking about the future. And in terms of the online patterns regarding returns, there's nothing very materially different to what is the usual pattern.

The next question comes from Anne Critchlow of Societe Generale.

What percentage of online orders at, say, Zara are now fulfilled from store inventory, please?

Well, this is -- this figure -- I would say, this idea of single inventory position, this idea of being able to use also the stores' inventory for the online orders is something that is very meaningful and very relevant for us. But to think about the figure here, it could be even confusing because it changes a lot depending on the moment in the season. What is key for us is to have this possibility, this possibility. And particularly, during the first half, it has been more relevant because we have seen a significant part of the first half in which the stores were closed. So that is why we have been able also to achieve this level of sales because we were able to use the inventory that we had in the stores. So what I would say is that this single inventory position is something very relevant, and it is becoming more and more relevant. But it is not really very meaningful to give a figure because it changes a lot depending on the different moments of the season. But what is very relevant for us is to have this possibility in order to have a better offer for our online customers.

The next question comes from Geoff Lowery of Redburn.

You achieved remarkable things in the first half around operating expenses and around inventory. If we turn to the future, and let's imagine that your sales recovered their 2019 level, would your OpEx base in your inventory be lower or higher than in 2019?

Well, in terms -- of course, it would have a lot to do with the global evolution of sales. In terms of inventory levels, as you know, of course, at this closing, we are minus 19% in terms of the global inventory. But if you think about the year 2019, we were also decreasing the inventory during the whole year. So thanks to this fully integrated approach, thanks to this single inventory position, we are able to run our business with even less inventory. And this is an effort that we are developing in the company. Well, we began in the Autumn/Winter season 2018, and we will continue with this effort, with this full integration, single inventory position. So this could be always a trend that inventory would always grow below sales if it grows. But I mean, it depends on how relevant is growth in sales. And in terms of costs, well, we can say that during this first half, also, we have made big efforts in terms of management of the different lines of costs. Of course, rental expenses, personnel expenses, other operating expenses, structural costs, every line of the -- of costs, you know that we have a significant part of our costs which are variable. Around 50% of our cost base is variable. And then we will always continue managing costs in a very strict way. This is a key element in the way we approach to the management of the company. But of course, it also has to do with the evolution of sales. But globally, we think we can be in normal conditions year-after-year. We can be able to run the company with less inventory as a proportion of sales and with the cost efficiencies, also thinking about costs as a proportion of sales.

The next question comes from Rebecca McClellan of Santander.

Yes. Can you hear me?

Yes.

Yes. And just on the online acceleration that we saw in the second quarter, does that make you review in your mind the store optimization program that you set out with the first quarter results?