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 2021. 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 on the telephone and then those received through the webcast platform. Before we start, we will take the disclaimer as read. And now over to Pablo.

Thank you, Marcos. Good morning to all of you, and welcome to our first half results presentation. I would like to highlight some key messages before we go into an analysis of the period. Inditex's differentiation and strategic transformation towards a fully integrated, digital and sustainable business model is accelerating. First of all, I want to recognize the effort made by our teams. Their dedication during the period has been outstanding. The strong individual commitment of all our people and our unique corporate culture totally focused on the customer continues increasing the differentiation of Inditex's business model. Our operating performance continues to go from strength to strength. Sales, EBITDA and net income in the second quarter 2021 have reached historic highs, surpassing pre-pandemic levels. Constant currency sales growth accelerated over the second quarter to 7% versus the second quarter of 2019. The Spring/Summer collections were very well received by our customers. Almost all our stores are now open. Online sales continued their high rate of growth. Our operating performance continues to generate strong cash flows and reinforces the robust financial position of the group. We also continue to make progress with respect to the sustainable development of our business model. At the AGM recently, we presented a set of new highly demanding targets. Regarding digitalization, the migration to the Inditex Open Platform is now 95% complete. As you have seen in our release, we have had a strong start to the Autumn/Winter season. The store and online sales in constant currency between the 1st of August and the 9th of September 2021 increased by 22% versus the same period in 2020 and 9% versus the same period in 2019. Let me add some details on the performance so far this year. This remarkable performance in the first half of 2021 was greatly helped by our fully integrated business model, our single inventory position and the attractiveness of the product offer. Inditex's competitive differentiation is bigger than ever. The impact of the store absorption program announced in June 2020 has already been fully recovered in store and online sales. As of today, 99% of the stores are open. The strong trajectory of online sales that we saw last year has, of course, continued well into 2021. Online sales in constant currency in the first half of the year have progressed very nicely indeed at plus 36%. This compares to plus 137% versus the first half of 2019. Online sales are expected to be more than 25% of total sales in 2021, 1 year before our initial target. It is because of these features that our operations enjoy sector-leading growth rates and profitability. Inditex's online business is non-dilutive to margins and requires lower capital intensity going forward. Let me tell you that we have total confidence in our unique business model that fully integrates stores and online. I'll hand you over to Ignacio now for the financial section.

Thank you, Pablo. As you have seen in our release, Inditex's operations showed a strong recovery in the first half of 2021. We executed very well in what turned out to be a challenging operating environment. We managed the supply chain very closely, and this drove the exceptional gross margin performance. Operating expenses have, of course, been tightly managed. As mentioned already, sales, EBITDA and income in the second quarter 2021 reached historic highs, exceeding pre-pandemic levels. This is the result of the very active management of the supply chain, with a healthy gross margin evolution and tight management of the operating expenses. The first half has seen a strong recovery in sales of 49%. Sales in constant currency grew 53%. Sales trends in the first half 2021 continually improved as the stores reopened, and online sustained its strong performance. Online sales in constant currency grew 36% or 137% versus the first half of 2019. During the second quarter 2021, sales growth in constant currency continued accelerating. Sales in the quarter were 51% higher than in the second quarter 2020 and 7% higher than in the second quarter of 2019, which was itself a historic high. Over the first half 2021, the currency impact on sales was minus 4.5%. At current exchange rates, the currency impact on sales is expected to be around plus 0.5% versus the second half 2020 and minus 5.5% versus second half 2019. The gross margin reached 57.9%. It was 170 basis points higher than in the same period in 2020. The gross margin evolution over the period is strongly linked to the high levels of flexibility enjoyed by our unique supply chain. Based on current information, Inditex expects a gross margin of around 57.5% plus/minus 50 basis points for the full year 2021. There has been very efficient management of operating expenses across all departments and business areas. This has demonstrated our ability to react and adapt to the changing trading environment. The main components of operating expenses have shown a very good performance. Efficiency gains have allowed us to exercise a high level of control over operating expenses in the period. As you can see, operating expenses over the first half of 2021 increased 25%, well below sales growth. Operating expenses were below the same period in 2019 despite the fact that practically all stores are open. Depreciation and amortization came to EUR 1.4 billion, 16% lower. The difference reflects the provision for the store optimization program for 2020 and 2021 charged to the first quarter 2020 accounts. Excluding the provision, this line would have increased 3%. The flexibility of the business model we run can be clearly seen in the evolution of working capital over this period. As you can see in this table, working capital has returned to the more normal levels seen prior to the pandemic. As a result, inventory at the end of the first half of 2021 was below the levels seen in the first half of 2019. The closing inventory is considered to be of high quality. These actions, in conjunction with the strong cash flow, took the net cash position to EUR 8 billion. And now over to Marcos.

Thank you. Over the first half of 2021, we have continued expanding our operations. This can be seen in the 27 different markets in which we have opened stores over the period. The weight of the different concepts on group sales remains practically unchanged. We are seeing a progressive recovery across all concepts going into the Autumn/Winter season. The differences relate to the geographic presence, location of stores and fashion profile of each individual concept. Store sales are improving, and online sales continue to grow. Stradivarius and Oysho had a strong performance in the first half of 2021. We continue with optimization activities across all concepts. As part of Inditex's strategy, Uterqüe will be fully integrated into Massimo Dutti over the next year. Uterqüe's entire product range will be available only on Massimo Dutti's website and selected stores. And now over to Carlos to focus on sustainability.

Thank you, Marcos. Inditex's lead in sustainability is reflected in the achievement of all the targets set for 2020 and, in some cases, even exceeding some of these demanding milestones. Inditex continues to make good progress in its sustainable development, having approved the following demanding targets at its last AGM: Join Life more than 50% by 2022; 100% renewable energy by 2022 from 80% previously in 2025; 100% more sustainable cotton by 2023, previously 2025; water consumption, minus 25% in our supply chain by 2025; net zero emissions by 2040, previously 2050; elimination of single-use plastics in customer packaging by 2023; 100% recycled or sustainable polyester/linen by 2025; and 100% sustainable cellulosic fibers by 2023. This is in addition to the existing targets already in place for 2023 and beyond such as in the use of renewable energy to reduce carbon emissions. And now back to you, Pablo.

Thank you, Carlos. Let me now talk about the outlook for 2021 and very especially about the features that make Inditex unique. Let's start with our fashion collections and the integrated store and online execution. A great place to start is with the Zara Woman 2021 Fall/Winter Collection or Zara Woman 2021 Après-vacances. On 30 September, Zara Man will launch the sport collection Zara Athleticz, available online and in selected stores. The Zara Kids back-to-school collections; Zara Home Portraits of a home campaign marked by sustainable interiors; Massimo Dutti Relaxed City editorial; Bershka Natural Tones collection; Pull&Bear Pacific Republic collection; the Stradivarius Autumn/Winter collection; Oysho's Working Leisure collections; and last but not least, the Uterqüe Fall/Winter collection. A very significant project for the beginning of October will be the opening of a new store for Zara in Paris La Défense with 5,000 square meters of surface on a single level. This will be one of the largest Zara stores of this type in the world. In November, we will open a very unique Zara store at Chengdu Taikoo Li, a center inspired by Chinese vernacular architecture. And a recent outstanding opening for Bershka with 2,700 square meters has taken place at Madrid Preciados. The strategic initiatives to strengthen our global, fully integrated store and online model are accelerating. We plan to continue developing these key long-term priorities in order to maximize organic growth. The goal is to continue increasing the differentiation of our business model so as to provide a unique customer experience. We will have invested EUR 1 billion in digital capital expenditure between 2020 and 2022. A key focus is on high-quality stores, with the aim that they be fully integrated, digital and eco-efficient. Total capital expenditure over this same period will be around EUR 900 million annually, helping to drive lower capital intensity and increasing profitability. Let us not forget that we aim to achieve all of this with sustainability remaining very much a central part of the strategy. We expect to deliver higher returns and lower capital intensity. As a reminder, the final dividend for full year 2020 of EUR 0.35 will be paid on the 2nd of November. Thank you for attending. That concludes our presentation for today. Now we would be very happy to answer any questions you may have.

Please, operator, go ahead.

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

Just a question for me, please, on the Zara brand. I wonder if you can give us an idea of the basket size for Zara online and also in store and whether the gap there is changing at all. I'm just wondering if that presumably higher basket online is helping to lift up the gross margin and also the operating expenses, along with obviously strong full-price sales.

Well, thank you, Richard. Answering your question, the first thing I would like to say is that what is really helping the evolution of the gross margin and the operating expenses and the efficiencies inside our company is what we call this fully integrated approach. I think that what is remarkable, if you see what has happened during the second -- the first half of the year or the start of the Autumn/Winter season, but thinking about the first half with the gross margin evolution, this has a lot to do, as we were saying during the presentation, with the single inventory position, with the fully integrated approach. You see that, for example, if we think about the start of the season, the trading update, sales growth between August 1 and September 9 is growing 22% compared to 2020, but even 9% compared to 2019. And inventories are minus 4% compared to 2019 level at the end of July. So what is really remarkable is this fully integrated approach between stores and online. And what I would also say about this trading update is that, well, this 9% is including, as we were saying during the presentation, the full absorption of the impact of the 800 stores that we have absorbed during the period. So it's really -- and having in mind, because you all know that there is some COVID impact in the Asian countries in the month of August. So even with all that, sales growth are 22% compared to 2020 and 9% growth compared to 2019. So what is very remarkable is the collections that we have, the execution of the business model, the work that our commercial teams are doing, the work that our teams at the country level are doing. And this is what is driving the evolution of the company, which we think is a very unique business model and a very unique approach to the business.

The next question comes from Rebecca McClellan of Santander.

Yes. Just a small one, please. Previously, you sort of talked about hourly trading restrictions. How is that in sort of like the second quarter in the current trading?

Well, yes, as we were saying -- but you perfectly know, and when you think about the second quarter and this is something also to have in mind if you think about OpEx during the second quarter, that if you remember, in the first quarter, on average, 25% of our stores were closed. Or we were having 25% less commercial hours in our stores. So in the second quarter, you see the impact of all these reopenings that we had. What we said in the first quarter results presentation is that during that period -- well, I can answer you for the whole quarter. For the whole quarter, it has been 6% in the second quarter, 6% of non-available hours coming from COVID and now at this moment is less than 2%. So now we are nearly operating fully our stores. As I was saying, there is some COVID impact in some different countries. But globally, even with that, we are having 9% sales growth compared to 2019 and 22% sales growth compared to 2020.

The next question comes from Warwick Okines of Exane BNP.

Yes. I've got a question about costs into the second half. Last year in H2, you booked a EUR 394 million COVID-related extraordinary expense. Do you expect to face more extraordinary costs this year? Or should we think about that cost just dropping out of the P&L?

Well, as Pablo was mentioning, we believe that the key driver both in sales, gross margin and OpEx will be this reopening. And you see that sales are accelerating in a very nice way despite the fact that we are assuming some costs from the reopening in terms of stores, and there is some lag in the sales in the stores. But this is happening, and you see in the trading update with 22% growth over last year. So COVID, hopefully, we will not have anything this year. And I think that the evolution of cost has been very, very nice, as Pablo has mentioned, very much in line with the performance of the company. The 2 key factors, as we discussed in the -- to analyze that, are probably this reopening, and we don't expect anything additional at this stage.

The next question comes from Simon Irwin of Crédit Suisse.

Can you just talk a little bit about what you're seeing in terms of air freight trends?

I didn't understand, and Marcos was clarifying to me, air freight trends. Well, when we talk about the -- globally, the gross margin or the cost structure of the company, we always say the same. Of course, there are elements that, let us say it this way, that are happening in the markets, but there are many elements involved. There are a lot of things that we can do related with that, of course. This is -- air freight costs are increasing, but this is one element of the many that you have when you run a company. I think the key for us with a huge difference -- well, having said that, the first thing I would say is that we are giving guidance for the gross margin, so we are expecting to have a very healthy gross margin in the second half of the year. And as Marcos was saying, of course, we will continue managing actively our costs all across the company. And we believe we will also have a healthy performance regarding costs. And what we can say is that, what for us is key -- of course, every results presentation, you could have this or that, this element that is increasing, decreasing this. But what is key is the essence, is the execution of the business model. We announced in June last year this absorption of a very significant number of stores. We have absorbed 800 stores, and we are saying trading update plus 9% compared to 2019, a strong execution of the business model, very healthy gross margin in the first half. And we believe it's going to be the case in the second half because of this fully integrated approach. So we always -- you know us perfectly, and we always prefer to talk much more about the essence, about the medium/long-term trends of the business in the way we operate the business, that about any this or that impact in one particular moment. So to answer your question, nothing as relevant as to have a very significant impact on our whole performance, our global performance.

The next question comes from Anne Critchlow of Societe Generale.

My question is on Uterqüe. I just wondered if you could give us a bit more color behind your decision to merge Uterqüe and Massimo Dutti. I mean, was it because Uterqüe wasn't quite as promising as you'd hoped? Or are you looking for cost efficiencies? Also, are you going to close all of the Uterqüe stores?

Well, yes, our -- the reason behind this integration of Uterqüe into Massimo Dutti is that we believe that integrating the Uterqüe collection into Massimo Dutti is going to give Uterqüe more visibility in many different markets. Uterqüe currently is present in very, very few markets. And we have thought that this was a better approach to integrate into Massimo Dutti, to not to have separated Uterqüe stores and then to have this collection integrated into the Massimo Dutti collection, of course, online globally and in some Massimo Dutti selected stores. We think -- well, we have the experience when we integrated Zara Home into Zara. In this case, we decide that -- we decided also to keep the Zara Home stores. But at the same time, we are also introducing Zara Home stores into Zara stores. For example, we were mentioning in the presentation this big stores that we are opening in La Défense. This Zara will have a Zara Home inside the Zara stores, the Zara store. And we are offering Zara Home product in the Zara web progressively in most of the countries in which -- in the world, in most of the relevant countries in the world with very, I would say, positive performance. So we think it is the right movement. It is a way to give to Uterqüe more visibility in different markets in which today it is not present. And we think it is the right approach and the right strategy going forward.

The next question comes from Olivia Townsend of UBS.

My question is just about the lockdowns in Asia that you mentioned earlier in the Q&A segment. So that's impacting demand at the moment. I was just wondering if you were able to quantify the impact of those lockdowns in Asia on sales during the latest period.

Well, we prefer not to elaborate very much on trading update. It's, I mean, from August 1 to September 9, very healthy trading update, even having in mind this impact in the Asia market. So you can think that it was very, very healthy without those markets. But we prefer not to elaborate very much in a trading update about that. I think what for us is key is how strongly -- well, first of all, because, of course, everything comes, first of all, with the product, with the collections. And you will see many, many things in the coming weeks about collections, capsules. From tomorrow onwards, you will also see -- we were talking about in the Zara Man, this Zara Athleticz, which we think is quite relevant. But you will also see from tomorrow in the Zara web, what we call origins collection in the Zara Man section, which is also very strong. And then in the Zara Woman section, you will see many capsules, the campaign, many different things during the season. So this is talking about Zara, but we could talk also about the other brands. So what for us is relevant is the global performance of the company, within this 9% trading update is very healthy. And well, the Autumn/Winter collections, as we were saying, have been very well received by our customers in the different markets. And what we will do is to continue working to have the best possible product, very sustainable and managing the company in a very efficient way.

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

Good morning. We've had a few questions on the webcast platform. The first of which is, has online click and collect and returns to store returned to normal, please?

Well, thank you. Yes, I think it is all progressively coming back to normal. Of course, this is something that when the stores are closed or with many restrictions, this particularly online deliveries or online returns in the stores are not at the normal level. Once the stores come back to normality, then, of course, for us, this is a key feature of our fully integrated approach between stores and online, having a significant part of online deliveries in our stores and 2/3 of our online returns taking place in the stores. And this is something that we see coming back to normal progressively in the different markets.

Perhaps you could talk a little bit about the 3 openings you mentioned in the presentation, please.

I was mentioning before in a previous question about La Défense, I think La Défense and also Preciados in Madrid are a good example, a very good example when we talk about this store optimization plan. Because in La Défense, in Paris, we used to have 2 small Zara stores for what Zara is today, 1 small Zara Home store and 1 small Pull&Bear store. And with this reorganization that we are doing, we are having a huge Zara in the best location inside the mall with a Zara Home inside the Zara store. And then we are also enlarging and relocating the Pull&Bear store in a very significant way. And 1 of the 2 previous Zara stores is becoming a new Bershka store in La Défense, which for Bershka is the perfect size. It was small for what Zara is today, but it's perfect for Bershka. So we used to have 4 stores in La Défense. Now we are going to have 3, but it has nothing to do, our presence, our approach to, I mean, the customer experience in our stores, the level of sales, the surface, the operation of the stores. So it's a perfect example of this store optimization plan. And Preciados, I was mentioning that also because we used to have -- well, in Preciados, we have Zara. We have Pull&Bear, a very beautiful store. We have Stradivarius. And we used to have a Bershka store close to the Zara store. And then 2 years ago, we enlarged and refurbished the Zara store, and we took the Bershka store that was very small for what Bershka is today. And then 2 weeks ago, we have opened a very, very relevant flagship for Bershka in Preciados Street. So this is -- these are 2 very good examples of this store optimization plan that we are developing in the different markets and which is a key part of our strategy, as you perfectly know.

The final question is, can you talk a little bit about the new Zara Man Athleticz collection?

Well, I think we have mentioned during the presentation and during the Q&A session, Zara Athleticz is something that we are launching on September 30 in some selected stores and, of course, online. Progressively, we will introduce in many other stores. Well, and you will see -- you have seen now in the presentation a small -- well, one slide about the image, but you will see fully very soon about the whole approach. And the idea is simplicity, comfort, functionality and, of course, style because it is Zara, and it always has to be style, but very, very high quality from a technical point of view. And we think this is something that is going to become progressively relevant inside the Zara Man section. So we think it's a very, very good initiative and with high potential going forward.

That concludes the webcast questions.

Well, thank you very much to all of you and Marcos.

Thank you very much. This concludes the Q&A session. We are open to have your questions. And now let me hand over to Pablo for the closing remarks, if there is nothing else.

No, nothing more. Thank you. Thank you, and we -- you keep in touch through the Capital Markets Department. Thank you.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect.