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 9 months 2020. I am Marcos Lopez, 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'll take the disclaimer as read. I'll now hand you over to Pablo.

Thank you, Marcos. Good morning to everybody, and welcome to Inditex's results presentation. As you have seen in our release, Inditex operations showed a strong recovery in the third quarter 2020. We have had a remarkable execution in a challenging operating environment. Our Autumn/Winter season collections were very well received by customers. Practically, all of our stores were open, but many with significant restrictions. Online sales continued to experience outstanding growth in all markets. The result was a strong cash flow and a robust financial condition. We continued 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. Let me tell you that we have total confidence in our unique business model. Let me add some details on the performance over the third quarter. In this chart, you can see the strong progression of sales in the quarter, still marked by restrictions in stores and very strong online growth. To put the strength of the sales performance into context, 88% of stores still had restrictions on the space, opening hours or capacity over the third quarter. 5% of stores remained closed. In a somewhat more normalized environment, sales recovered strongly. As an example of the recovery, Inditex's sales in constant currency between the 1st and the 18th of October 2020 had already reached the historic highs of the same period in 2019. From the 19th of October onwards, our number of markets entered a new phase of closures and restrictions until the first week of December. This chart shows the number of stores with sales on a weekly basis and the timing of the restrictions. In the third quarter, store traffic and conversion rates improved. We operate a premium highly balanced store base. The broad geographical diversification of our stores with a balanced split between street and shopping centers in premium locations has helped to restore traffic rapidly. City center stores in capital cities account for less than 8% of group sales. The quality of our store base has also been a key factor, with 95% of stores having been optimized since 2012 into our integrated eco-efficient digital platform. The strong trajectory of online sales has, of course, continued. In the third quarter, global online sales made outstanding progress of plus 76%. The online sales in constant currency grew 75% in the first 9 months of 2020. Online visits have increased 44% over the same period last year to 3.4 billion visits. 97% of online growth in the 9 months 2020 was organic. The strong growth has continued into the fourth quarter. This remarkable performance is greatly helped by our fully integrated business model, our single inventory position and the attractiveness of the product offer. It is because of these features that our online operations enjoy sector-leading growth rates and profitability. Inditex online business is non-dilutive to margins and requires lower capital intensity going forward. In the third quarter, we achieved a strong operating performance. We continue to require less inventory to manage our operations. This is a result of the single inventory position, a key part of our business model, and has been further enhanced by the use of technology, such as RFID and Sint that allows in-store inventory to be used to fulfill online orders. The store optimization also improves inventory allocation and higher product availability, resulting in a stronger full price sales. This all helped to drive the strong cash generation seen over the period. Let me tell you that we have total confidence in our unique business model that fully integrates stores and online. A good example of seamless store and online execution can be seen in the Zara Women Autumn/Winter collection, the Zara Man monochrome layers, Zara Kids the Wanderers, Zara Home Interiors with a soul, Massimo Dutti Interlude editorial, Bershka Winter call, the Pull&Bear Art For Everyone, the Stradivarius Magical Allure collection, Oysho's Join Life Meditation collection, and the Uterqüe autumn/winter collection. I will hand you over to Ignacio now for the financial section.

Thank you, Pablo. As you have seen in our release Inditex's operation saw a strong recovery in the third quarter 2020. We have executed remarkably in what has been a challenging operating environment. As a sample of the recovery in retail sales in constant currency between the 1st and 18th of October 2020, has already reached the historic highs for the same period in 2019. The quarterly performance we reported in constant currencies illustrated a strong recovery. We have managed the supply chain very closely, and this has driven a healthy gross margin evolution. Operating expenses have been tightly managed. The quarter includes COVID-19 related extraordinary expenses of EUR 135 million. As mentioned, the health crisis has had a material impact on our sales over the 9 months period, sales recovery in the third quarter to reach EUR 14 billion over the 9 months. The sales performance has been marked by the timing of temporary store closures and restrictions. Online sales growth in constant currency has been very strong at 75%. The gross margin was 58%. And constant currency grew 110 basis points to 59.3% in the 9 months. The gross margin evolution over the period is strongly linked to the high levels of flexibility, enjoyed by our unique supply chain. This has clearly strengthening the inventory. It was 11% lower than the closing balance in the first 9 months of 2019. Efficiency gains has allowed us to assess a high level of control over operating expenses in the period. As you can see, operating expenses decreased by a remarkable 17%. There has been very efficient management of operating expenses across all departments and business areas. This has demonstrated our ability to react and adapt continuously to the changing trading environment. The main components of operating expenses have shown a very good performance. Depreciation, amortization was EUR 2.4 billion. This includes the charge for the completion of the store optimization plan in 2020 and 2021, as announced back in June of this year. The financial results line on the income statement include interest on lease liabilities of EUR 94 million. The flexibility of the business model we ran can be clearly seen in the evolution of working capital over this demanding period. Despite the very material impact of lockdowns on sales and be able to use the flexibility for our supply chain to adjust balance. A single inventory position was pivotal to achieving this performance. As a result, inventory fell 11% at the end of the third quarter. The closed inventories considered to be of high quality. As mentioned, the various initiatives in place allow us to generate working capital efficiencies even in the most challenging of environments. This chart shows the decrease in inventory requirements in our operation over recent years. This has us in conjunction with the strong flow to the net cash position to EUR 8.3 billion that is very high. The net cash position has increased by EUR 1.8 billion since the end of the first half of 2020. Let me hand you over to Marcos now.

Thank you. Over the first 9 months, we have continued with our expansion, we opened stores in 25 different markets, global online launches have continued rapidly, as you can see. The weight of the different concepts on group sales remains broadly unchanged. We are seeing a progressive recovery across all concepts going into the Autumn/Winter season. The differences relate to each individual concepts, geographic presence, location of stores and fashion profile. Store sales are improving. Online sales continued to grow remarkably. Oysho and Zara Home ranges had a strong performance in the first 9 months. We continue with the store optimization activities across all concepts. And now over to Carlos to comment on sustainability and online launches.

Thank you, Marcos. 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 are on target or exceeding all sustainability targets set for 2020. We continue expanding our online presence. In the third quarter, we further launched online sales in Costa Rica, Guatemala, Honduras and Nicaragua, amongst others. And now back to Pablo.

Thank you, Carlos. We continue to develop our global online business. Online sales have been profitable and nondilutive 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. They've had the benefits of this integration have been especially evident over the period. 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. 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 key project was the new Zara Store in Beijing at Wangfujing. This store is the largest in Asia and one of the most technologically advanced stores in the whole group. The store has had a very strong reception. We would also like to highlight the significant enlargement of the Zara Store at Bluewater Shopping Center in the outskirts of London, where we have doubled the size of the store to 3,400 square meters. This chart shows the evolution of our store operations over the fourth quarter. In November, 21% of the group stores were temporarily closed. A majority of these stores started to reopen in the first week of December with an improvement in store sales. Currently, 8% of the stores are closed with an additional 10% closed on weekends. Additionally, a significant number of stores have restrictions in capacity, space and opening hours. Online continues to grow at the remarkable rates of the first 9 months of this year. The chart shows the evolution of sales in the quarter marked by stores reopening. As a reminder, the ordinary dividend for full year 2019 of EUR 0.35 per share was paid on the 2nd of November 2020. Inditex's dividend policy of 60% ordinary payout and bonus dividend remains in place. As you all know, the remainder of the bonus dividend, EUR 0.78 per share, will be paid in fiscal 2021 and 2022. As normal, dividend payments will take place biannually in May and November. Thank you for attending. That concludes our presentation for today. We'd be happy to answer any questions you may have. Please go ahead, operator.

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

Inventory, please. Obviously, the inventory is down again at the end of the quarter year-on-year. And I wondered if you can explain or give some color on how much of that inventory reduction is to do with [indiscernible]. Or are you seeing shorter sourcing times or more flexible sourcing, and that's enabling Inditex to carry less inventory in the business? And then, I guess, a follow-up on inventories. How do you feel about the current inventory position given likely further restrictions in markets like Germany and the Netherlands and so on and those that are likely to come in, in the next few weeks?

Thank you. Well, what I would like to come back to one of the slides in the presentation in which we explained this inventory evolution over a long period of time. And it clearly shows the strategy of the company about the inventory and particular -- what I would say, first of all, that we have always managed our company with a low level of inventory. But then, thanks mainly to the stock integration, to the RFID, and to the store optimization plan, we have been able even to run the company with less inventory. And this began to be evident in the year 2018. It was particularly evident during the year 2019, in which we were having very strong like-for-likes and at the same time inventory was not growing or even decreasing at every quarter closure. And then this year, it is being extremely helpful in order to navigate through very -- this challenging environment that we are facing this year. So it's clearly the strategy of the company. So it has to do with the business model in the sense that we have always been running the company with low level of inventories. But now it's even much more because of this fully integrated approach between stores and online, because of the stock integration, because of the RFID implementation and because of the store optimization plan. And about the inventory at the end of the quarter, as we were saying, we think it's very healthy, and we have no concern at all from that point of view. And going forward, thinking about a much more normalized situation in the year 2021, 2022, what we can tell you is that we will continue running the company with less inventory as a percentage of our sales in the coming years. And it is a key element of our strategy, and it allows us to have higher full price sales to serve better our customers, which is something extremely relevant from every point of view. And as we were showing during the presentation, it is not something happening only this year. It is something -- it's a clear part of our strategy that began to be very evident in the year 2018.

The next question comes from Anne Critchlow of Societe Generale.

I appreciate visibility is pretty low at the moment. So please, could you tell us how you see the company going forward into 2021?

Well, thank you. What I would say is that I see the company in very strong condition. When I see to what has been going on during this year, particularly if we have in mind, for example, third quarter results, the evolution of sales with all the restrictions, with 5% of the store closed during the period, then online sales growth, the strength of this fully integrated approach, keeping gross margins stable in this very, very challenging environment. Then also the way we are managing costs -- cash flow generation during the period, during these 9 months and particularly during the last quarter. So I see the company in very strong condition. Also, what for me is very, very relevant is talking about our people. And what I can tell you, as we are showing during this year, is that we have a very, very solid team and that the execution of this team during the year 2020 is being remarkable, adapting constantly to the changing situation. So combining all these elements, I think we can say that we have a lot of confidence in the future. You are asking about the year 2021, for sure, but then also 2022 and the coming years. So we see the company in very strong condition, very strong position to think about the future in the coming years.

Our next question comes from Rebecca McClellan of Santander.

If you were to sort of adjust the inventory position for store absorptions, going forward, are you expecting to see further improvements in inventory to sales or would you expect it to normalize out from these levels?

Well, what I can tell you, Rebecca, is that this is an ongoing process. And our assumption, of course, in 1 particular quarter, it could be this or that. But as a global trend, what we are saying is that inventory, if it grows, we'll grow below sales growth. So we will increase the efficiency of our inventory position in the coming years. And this has a lot to do with all the elements I was mentioning, and you were referring to the store optimization plan, and it is also a very, very relevant part of this possibility of running the company with lower inventories as a percentage of sales. We think it's a key feature of the company today and, for sure, going forward.

The next question comes from Warwick Okines of Exane BNP.

I've got a question about gross margins. Could you maybe just describe the level of promotional activity in Q3 compared with last year? And perhaps you could just tell us if you would reiterate your gross margin guidance for the second half. I think last quarter, you said you were still thinking gross margins could be positive in the second half.

Well, thank you. Well, about the -- well, you see that the gross margin in the third quarter -- well, first of all, as we always say, when we talk about the gross margin, we always prefer at least to talk about a season, to talk about the 6 months period. But answering your question, you were asking about the gross margin in the third quarter. And we can say that we are very satisfied with the gross margin evolution during the third quarter. As we were saying in the presentation in constant currencies, we have a significantly positive gross margin in the third quarter. And so this is the combination of the way we are managing our sales, the way we are managing our inventories. Asking particularly about -- answering particularly your question in terms of promotional activity, there is nothing relevant in the third quarter to mention from this point of view. We continue applying our strategy, and we are satisfied with the evolution of gross margin during the third quarter. And at this stage, we continue seeing positive gross margin in the second half and the stable gross margin for the full year as we anticipated to you in September.

Next question comes from Geoff Lowery of Redburn.

Just 1 question really around online. You've helpfully given us the increase in the number of visits. And could you tell us what has happened to your customer count online? And then just on the integration between online and stores pre-virus, you used to talk about levels of returns and pickup that went to store. I'm interested if you've got any data you can share with us about what's happened during the COVID period to the online and stores integration?

Well, yes -- well, first of all, I will tell you that in the full year results, we will update more about online with, I would say, more details about our online sales growth during the year. Well, the first thing I would like to remark, as we were saying during the presentation, is that online sales growth, as it has always been the case, is 97% organic. So -- and this is applicable to the previous year. So it is online sales growth in the markets in which we already had online presence with the different brands. We think that this is very remarkable, and it has always been the case. If we analyze our online business since the year 2015. For example, every year, 97%, 98% of online growth is totally organic. And of course, with every year, we gain new online customers. But this year, it has been more significant than any other year. It's very much correlated with the number of visits growth that we were mentioning. But in any case, we will update you and we will give more details about our online business at the full year results presentation in March. This year has been very atypical, answering the second part of your question in terms of in-store deliveries, in-store returns, particularly in the markets and during the months in which stores have been closed or with a lot of restrictions. So it's very difficult to read what is going to be the trend from the situation this year. What we see in general terms is that regarding all the different online parameters when we -- when the stores are reopened in any particular market and begin to operate normally, all this integration in terms of in-store deliveries, in-store returns, et cetera, tends to come back to a much more normalized situation. But as I was saying, we will update you in more details in the full year results presentation in the month of March.

The next question comes from Aneesha Sherman of Bernstein.

My question is about the trading in the month of November. You said that 21% of stores were closed in November. Roughly what percent of sales did those stores represent? Or was it considerably higher or lower than the 21%? I'm just trying to think about how to view the minus 19% sales performance, and how much of that was driven by the stores decline versus the offset by transfer of trade online?

Basically, Aneesha, we have given you a very detailed evolution of sales and stores open. Obviously, the situation is very, very fluid. But what we can see is, regarding this quarter and practically the 9 months, is that the moment that the stores we open, even with significant restrictions as we have mentioned, we see a very strong increase in store traffic, and this has been happening also over the last few days of December. Obviously, we are following things very, very carefully. But what we can tell you is that we see strong growth in traffic when stores reopen, that people are willing to go back to the stores and the way customers behave is very, very normal and then obviously, extraordinary and remarkable growth of online. I think a key difference in our case is the fully integrated platform that provides the level of sales and the level of execution that you have seen recently.

The next question comes from Anne Critchlow of Societe Generale.

I was wondering what opportunities for store expansion you see in markets where perhaps competitors are now closing stores? Or do you see perhaps the market share opportunity being more online in the future?

No, the opportunity is integrated, but with the strategic lines that we have presented to you over many years. One very important part is to optimize the stores is to have the type of stores that we had in the presentation. We have referred in one case to our relocation, the store in Wangfujing, in Beijing. A tremendous store -- I mean, the reception has been unbelievable. And second, keep -- for example, the second part, the expansion of the Bluewater Store in the outskirts of London, we've double the size of the store, and you should see the queues in the coming days. So basically, is expanding this in conjunction with a very strong online proposition. As Pablo mentioned, 97% of online growth is organic is in the existing markets. Clearly, the proposition works very, very well, 67% of growth in Q3, 75% in the 9 months, and those rates continue. So clearly, the acceptance of the business model in this period has been very, very good. We've always said that the model, the Inditex model, the integrated one, is very good for the good times, but it's even better on the difficult times. Why? Because the flexibility and the way our teams work is very much trying to adjust to demand. And this is a quarter in which you see the advantages of the integrated model.

Our next question comes from Georgina Johanan of JPMorgan.

Just a question on OpEx, please. I think even adjusted for currency, it looks like it's running sort of better, i.e., down more than the variable portion that you called out previously is around 50%. So I was just wondering if there's any underlying savings that you've identified there that we should perhaps be expecting to continue into future years.

Well, as you were mentioning, we are acting during the whole year in a very significant way regarding our cost base. Part of our costs are variable at around 50%. So this evolves in line with sales. But then, of course, we are finding additional efficiencies in all the different lines of costs, and it has to do with the way we operate our stores, it has to do with rental renegotiations with our landlords, always thinking about a balanced approach and always thinking about a long-term relationship with them. But of course, this year is very exceptional from this point of view. And also all the different operations and the way to run them in a very, very efficient way. This has been the case during the whole year. And of course, this is also evident in the third quarter results. And our idea, as always, is to continue running our costs in a very efficient way. I really think it's very remarkable. And I come back to what I was saying before. It shows the strength of our teams all around the world, our commercial teams, when we think about the gross margin evolution, when we think about the evolution of sales in a social challenging environment. Our online teams with this incredible rate of growth, and then with all the operations, the technology behind it, all the operations that we need to manage, logistics, deliveries with this so significant growth. And then finally, our teams in all the countries in the way of operating the stores when we reopen in terms also of running our operations in a very efficient way. What I think it shows is the strength of the teams that we have all over the company.

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 few questions on the webcast platform, the first of which is, can you comment on the cash generation in the quarter and the net cash position, please?

Well, what I would say is that we are very satisfied with the cash generation during the quarter. I think we have been saying before that our company, thanks to online sales growth, thanks to this fully integrated approach between stores and online, is becoming less capital intensive. And we are able to generate cash in a very relevant way as we are seeing during this third quarter. And of course, also the operating performance of the company, and the fact of running the company with less inventory. So globally, we feel satisfied with the evolution or with the cash generation during the quarter. And as we were saying during our presentation, we keep our dividend policy with this 60% payout ratio. And then the idea of distributing the extraordinary dividend between the years 2021 and 2022 and having this biannual payments in the months of May and November. But I think the way we are running our company is very healthy, very healthy from the point of view of the inventories, from the point of view of sales and also very healthy in the sense of a cash flow generation.

The following question relates to online. How as online developed in the different concepts, please?

Well, before talking about our answering this question, about online, I would like to reinforce what Marcos was saying also because we believe very much in this fully integrated approach between stores and online with a very balanced store portfolio, as we were saying during the presentation, with high penetration. So very low market share, but at the same time, very balanced store portfolio between high street locations, shopping malls, big capitals, medium sized cities. So very, very balanced store portfolio. And what we are seeing also is that once we reopen stores and even with restrictions, store traffic begins always to increase. And our customers, we think that -- like very much this fully integrated approach between stores and online. So sometimes buying online, sometimes buying in the stores, buying online, but asking for in-store delivery or seeing the product online but then buying in the stores. So this fully integrated approach, we think, is very appreciated by our customers. You were asking me about the different brands, and I would say that this strong online growth has been across all concepts and across all geographies. So when you have a so, so significant rate of growth, we are talking in constant currencies, 75% in the 9 months, 76% in the third quarter. When you are thinking about a so strong level of online growth, it is applicable to the whole company, to all the different concepts and to all the different markets.

That concludes the webcast questions. .

Well, thank you for joining us in this conference call. And of course, through our Capital Markets department, we'll continue, ready to answer additional questions you may have. Thank you very much, and I take advantage of this opportunity to wish you a merry Christmas and all the best for the next year. Thank you very much.