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

Good morning, ladies and gentlemen. Welcome to the presentation of Inditex's results for the interim 9 months 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, Oscar Garcia Maceiras; 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 9 months 2021 results presentation. I would like to highlight some key messages before we go into an analysis of the period. Inditex 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. Our operating performance continues to go from strength to strength. Sales, profit before tax and net income in the third quarter have reached historic highs, surpassing prepandemic levels. Constant currency sales growth accelerated further over the third quarter 2021 to 21% versus 2020 and 10% versus 2019. Our collections have been very well received by our customers. Almost all of our stores are now open. Online sales continued a high rate of growth. We continue to generate strong cash flow and to reinforce the robust financial position of the group. We are also making good progress with respect to the sustainable development of our business model. Regarding digitalization, the migration to the Inditex Open Platform is now 97% complete. As you have seen in our release, we have had a strong start to the fourth quarter. The store and online sales in constant currency between the 1st of November and the 10th of December 2021 increased by 33% versus the same period in 2020 and 10% versus the same period in 2019. Based on current information, Inditex expects a gross margin of around 57.5% plus/minus 50 basis points for full year 2021. Let me add some detail on the year so far and our strong differentiation. The remarkable performance in the 9 months of 2021 was greatly helped by our fully integrated business model, our single inventory position and the attractiveness of the product offer. The store optimization program has been a resounding success. The impact of the store absorption program announced in June 2020 has been fully recovered in the store and online sales already. In the third quarter 2021, we have reached another milestone. In-store sales in constant currencies have increased compared to 2019 with 11% less stores in operation. We are using technology to accelerate the strategic projects like RFID, SINT and IOP. The strong trajectory of online sales that we saw last year has, of course, continued in 2021. Inditex's competitive differentiation is bigger than ever. As of today, all of our stores are open. With sales in stores getting close to normality, online sales in constant currency in the 9 months have progressed very nicely indeed at plus 28%. This compares to plus 124% versus the first 9 months of 2019. Online sales are expected to be more than 25% of total sales in 2021, one year before our initial target. It is because of these features that our operations enjoy sector-leading growth rates and profitability. Inditex 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. The Board of Directors of Inditex at my initiative and at the initiative of the founder Amancio Ortega and following the proposal of the Nomination Committee has approved the appointment of Marta Pérez as Chair of the Board of Directors effective as from the 1 of April 2022. Oscar Garcia Maceiras, up to now General Counsel and Secretary of the Board, has been appointed Chief Executive Officer of Inditex effective 29th of November. With this, the Board of Directors completes the generational handover process initiated in 2011 with the replacement of Amancio Ortega as Chairman of Inditex. The appointments will be presented for ratification at the next Annual General Meeting. I'll hand you over to Oscar now for some introductory comments.

Good morning. I'm honored to join you today in my capacity as CEO, and I'm looking forward to meeting you all in person. My first message to you is one of continuity in the strategic pillars of Inditex. We enjoy a unique business model that fully integrates stores and online. This unique feature will remain one of the key pillars of Inditex. Let me tell you that we are in early stage in the development of all of this potential. The talent of the teams and individuals at Inditex is comparable to their commitment and entrepreneurial spirit. Our people are, by far, our main competitive advantage. What you have seen over the recent months, the way the group has managed some very difficult market conditions and the fact that we are already above prepandemic levels says it all. Sustainability and digitalization remain also at the core of our strategy. For those of you who have been following us for many years, our main priority is to invest in key initiatives for the future profitable growth of the group with financial discipline, and we will continue with a predictable and attractive remuneration policy. Now I'll hand you over to Ignacio for the financial section.

Thank you, Oscar. As you have seen in our release, Inditex operations saw a strong progression in the first 9 months 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 strong gross margin performance. Operating expenses have, of course, been tightly managed. As mentioned already, sales, PBT and net income in the third quarter 2021 is historic highs, seeing prepandemic levels. It 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. Under IFRS 16, occupancy costs are allocated to operating expenses, amortization and financial expenses. We consider occupancy costs to the operating expenses that was operating leverage. You can see this because compared to the third quarter 2019, PBT grew 7% above both sales and gross profit growth of 6%. This is mainly due to the tight control of operating expenses and our ability to find efficiencies in our operations. Part of this is also driven by the negotiation of rents. Sales strength in the 9 months 2021 have continued to improve as store sales return to normal. Online has sustained its strong performance. The 9 months have seen a strong recovery in sales of 37% over 2020. Sales in constant currency grew by 39%. During the third quarter of 2021, sales growth in constant currency continued accelerating. Sales in local currency in the quarter were 21% higher than 2020 and 10% higher than 2019, which was itself a historic high. Online sales progressed very nicely and online sales in constant currency in the 9 months were up 28% versus the same period last year up 124% versus 2019. The gross margin reached 59%. It was 101 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 or 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 some very good performance. Efficiency gains have allowed us to exercise a high level of control over operating expenses in the period. Depreciation and amortization came to EUR 2.1 billion, 10% 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 will 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 9 months 2021 was 6% above the level seen at the end of the 9 months 2019. The cost of inventory is considered to be of high quality. This assumes, in conjunction with the strong cash flow to the net cash position to EUR 9.6 billion. And now over to Marcos.

Thank you. Over the first 9 months of 2021, we have continued expanding our operations. This can be seen in the 39 different markets in which we have opened stores over the period. The weight of the different concepts on group sales remains practically unchanged. The younger concepts grouped together continue developing their operations satisfactory. I would like to highlight the strong sales of the group in the interim 9 months 2021. We are seeing a progressive recovery across all concepts. 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 9 months of 2021. We continue with optimization activities across all concepts. Let us talk about the outlook for 2021 and very especially about the features that make Inditex unique. We can start with our fashion collections and the integrated store and online execution. A good place to start is with Zara Atelier, a limited collection of patterned coats. Also, our AZ collection, which combines a physical collection with a metaverse one. Zara has launched the AZ collection online and in selected stores. It will have an extension on the virtual world, thanks to his presence in ZEPETO through a small metaverse in which Zara app users will be able to purchase virtual cloths and make-up for the avatar in the Ader Error for Zara store. The Zara Man Outwear editorial, the Zara Kids Party collection for the festive season, the Zara Home Christmas at home collection, Massimo Dutti Join Life ranges, Bershka Red western collection, Pull&Bear 19.91 Colours collection. Stradivarius Retro vibes, their first digitally created campaign with 3D animated background, Oysho Ski collection designed with both snow sports and upper ski in mind; and last but not least, Uterque autumn-winter collection. We continue to make our stores even more differentiated than ever. A good example is the recent opening in London at One New Change by St. Paul's Cathedral, the enlargement of our flagship store in Milan at Corso Buenos Aires and of course, the refurbishment of our Zara store in one of the streets with the strongest levels of customer traffic in Europe at Schildergasse in Cologne. Let me now hand you back over to Pablo.

Thank you, Marcos. 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 increase the differentiation of our business model so as to provide a unique customer experience. Our key focus is on high-quality stores with the aim that they be fully integrated digital and efficient. Let's not forget that we aim to achieve all of this with sustainability remaining very much a central part of this strategy. We expect to deliver higher returns and lower capital intensity. Inditex dividend policy of 60% ordinary payout and bonus dividends remains in place. The remainder of the bonus dividend, EUR 0.30 per share will be paid in calendar year 2022. As a reminder, the 2021 full year results will be released on the 16th of March 2022. Thank you for attending. That concludes our presentation for today, and we'll be happy to answer any questions you may have.

[Operator Instructions] Our first question comes from Richard Chamberlain from RBC.

So my question, please, is on the gross margin guidance, 57.5% for the year, which implies obviously a very big weighting and skew towards the fourth quarter. Now I understand that, obviously, because of the inventory provision at the start of the pandemic and a much softer comparable. But is there anything else to say on the timing of gross margin development in the second half, why the weighting is so skewed to Q4 versus Q3?

Well, thank you for your question. The first thing I would like to say is that we are extremely happy with the gross margin performance. And as you were saying, this will be fully visible when we publish the full year results. In any case, you must have in mind that the gross margin of the third quarter is the highest in the last 7 years. So this is something that you must have in mind. And in a season in which everybody is talking about all these disruptions in the supply chain, cost of transport, this is -- what we think is that this shows the strength of the business model, the fully integrated approach, the SINT that we are applying all across the world, and what we can tell you is that we are extremely happy with the evolution of the gross margin. We continue thinking that -- I mean, as we were saying that the gross margin for the full year will be 57.5% plus/minus always 50 basis points. We always say this but very, very strong gross margin performance. And you must have in mind what I was saying that we are talking about the highest gross margin in the third quarter in the last 7 years. So very strong performance of the business, very healthy evolution of sales. In constant currencies, we are talking about 10% versus 2019. In-store sales in constant currencies above 2019 levels with 11% less stores and online continue growing in a significant way. So yes, very, very satisfied with the evolution of the gross margin. And as we were saying, this will be fully visible in the full year results.

Our next question is from Rebecca McClellan from Santander.

This is Rebecca for Santander. Can you talk about pricing, please and in particular, how the Zara average selling price over autumn/winter 2021 compares to that of autumn/winter 2019, please?

Well, a stable pricing policy, Rebecca. What we are applying is a stable pricing policy, and our focus is totally on full price sales, thanks to the fully integrated approach and not having promotions or nearly not having any type of promotion during the season. And we are applying this policy of a stable pricing policy globally.

The next question is from Anne Critchlow from Societe Generale.

My question is about physical space. Just wondering what you think will happen to that in square meters terms next year, so whether it's likely to be up or down?

Well, Anne as you know, our plans regarding space are very, very clear. We have presented a plan to absorb stores and finalize our store optimization program. On the other hand, we always targeted 2.5% gross margin -- sorry, sorry, gross space growth. And what we would like to highlight this year is clearly the productivity of the stores. We are right now on the third quarter with in-store sales which exceed those achieved in the year 2019 with 11% less stores. Clearly, this is a resounding success, as Pablo mentioned during the conference call, but we're talking about a completely different store type to that of the competition in the sense that we have stores which are fully digitalized, which have RFID, which have SINT, which remember that in the year 2020, we were able to deploy EUR 1.2 billion of sales from the stores into online. And this is why I would say both we have now in this third quarter, the store sales in positive territory, and online, it's growing at 28%. I think this is very, very remarkable. So clearly, the productivity of the stores is increasing, and this is what you should expect looking forward.

The next question is from Simon Irwin from Credit Suisse.

Maybe could you just talk a little bit more about gross margins and particularly the disruption you saw to supply chain? What additional costs you saw during 3Q? And how you view the outlook for supply chain and gross margins into next year?

Well, we're still into this fiscal year. Clearly, there has been some, but it's very much where the advantage of the business model shows up. You have to bear in mind that 2/3 of our sourcing is in proximity, right? And 60% of our sales are in Europe. This means that we are clearly less exposed due to the model, due to the flexibility of the model, due to the proximity sourcing to the vagaries of these supply chain issues that have been affecting the sector. Obviously, we have absorbed all these factors. And -- but to an extent, you see that the impact has been relatively limited because our business model is completely different. And if we execute according to what you're seeing, you should expect something similar, not saying that we're not affected. But clearly, our model has a very, very strong advantage due to its integrated, flexible and based on proximity sourcing platform.

The next question is from Georgina Johanan from JPMorgan.

It was just on the stock position, please. I think on my math, your stock at the end of the quarter was a few percentage points higher than 2019 levels, which is a somewhat different trend to what we saw in H1. So I was just wondering if you could share any comment on that or the reasons for that, please.

Thank you. The first thing we can say is that it is significantly below sales growth both compared to 2019 and compared to 2020. So that is the key message to have in mind, that the trading update is plus 10% compared to 2019, plus 33% compared to 2020, and the store is growing plus 6% compared to 2019 and plus 19% compared to 2020. Very healthy, no concern at all, very strong trading update. And it has to do with what we always have been saying that, looking to the future, it should grow below sales growth, so a very healthy inventory position and no concern at all from that point of view.

The next question is from Warwick Okines from Exane BNP.

My question is on cash. How do you determine the right amount of net cash to hold on your balance sheet?

Well, you know that the company is strongly cash generative. As you mentioned, just over the previous quarter, the cash position has increased by EUR 1.5 billion. The cash flow is how you should look at a retailer is the way that our retail operates. The priorities regarding cash has always been the same. The first one is to invest in the future growth of the company, trying to differentiate ourselves as much as we can and obviously, with a predictive and attractive remuneration policy. The policy in place, 60% ordinary payout plus multiyear bonus dividends approved by the Board will result in a EUR 0.30 bonus dividend to be paid in relation to the fiscal 2021 results over calendar year 2022. And I'm sure, given the strong cash generation of the company, the Board in March will decide on how to update this policy for the coming years.

The next question is from Rebecca McClellan at Santander.

Just another small one from me. Turkey, I think it's about 10% of your sourcing at present. Is it right that it's euro-invoiced? And if that's the case, is there any chance of a tailwind into 2022?

Not really. I mean our proximity sourcing model is a key differentiating factor for Inditex. Spain, Portugal, North and Morocco, Turkey, play a very significant role, places in which we cannot take product very, very quickly. And in terms of logistics, once the product is finished, basically, we can move product from Spain, Portugal in 24 hours; Morocco, 48 hours; Turkey, 72 hours. And we have it in all central distribution platforms. You know that, in Turkey, while we buy in euros the components of the products, well, the fabric is mainly in dollars, the labor is in local currency but we definitely can adjust that. So we're not -- we remain extremely competitive, and we can tell you that our Turkey suppliers are working as normal as before.

From here, we will now move on to the webcast questions.

We've had a number of webcast questions today. The first of which relates to productivity, which we partially covered. I'll read it out as is. You mentioned in your presentation that your in-store sales have exceeded in-store sales in 3Q 2019. My back-of-the-envelope calculation, I estimate that you have absorbed around 7% of your net space, which implies to me that your stores are selling at least 8% more in constant currency per square meter in 3Q 2021 versus 3Q 2019. Can you comment, please?

Well, James, I think we have covered this during the call. It is very, very remarkable. The evolution of store sales and this fact of having growth with 11% less stores and what you are saying -- what the question is saying is the case that the productivity has increased in a very significant way. This is something that we were anticipating when we announced the combination of the store optimization plan. And what is happening is very much in-line with what we expected, and it has a lot to do with this fully integrated approach between stores and online that gives a huge potential to the company looking forward.

Thank you. The next question relates to online. In online, you're on track to reach more than 25% by 2025. Can you get -- by the end of the year, can you give us some color on how you expect to develop online over the next 3 years, please?

Well, we see online continue to grow strongly in the coming years. We believe very much in our fully integrated business model that provides a better retail experience within a store or online, fully integrated and digital. So a strong growth from our point of view.

And finally, can you please comment on the trading update, your sales performance in November to the first week of December, please?

Well, very strong trading update. This is what I would say 10% growth versus the same period in 2019, 33% versus the same period in 2020. So what we can say is a very healthy evolution of the business globally, very healthy evolution of in-store sales, very healthy evolution of online sales. So I would say a very strong season with very good execution of the business model.

Thank you very much. That concludes the webcast questions.

Well, thank you very much for joining us today in this conference call. And as always, through our Capital Markets Department, we would be ready to answer any additional questions you may have. Thank you, and I wish you all a happy Christmas. Thank you.

This concludes today's call. Thank you all very much for joining. You may now disconnect your lines.