Zara's Shrinking Profit Margins Expose a Fashion Behemoth -- Update

By Jeannette NeumannFeaturesDow Jones Newswires

Shrinking profit margins at the parent company of Zara have exposed a weakness in the armor of a fashion behemoth that has largely resisted the headwinds battering the industry.

Inditex SA, the Spanish company that owns Zara and brands such as Massimo Dutti and Bershka, reported Wednesday a net profit of EUR2.34 billion ($2.75 billion) for the nine months that ended Oct. 31, a 6% increase from a year earlier. Sales at Inditex climbed 10% to EUR17.96 billion for the period. Like-for-like sales accelerated in the run-up to the holiday season.

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However, Inditex's gross profit margin declined 0.3 percentage points to 59.4% in the fiscal third quarter from a year earlier.

The full-year gross profit margin at Inditex, whose full name is Industria de Diseño Textil SA, has continued to fall from its fiscal year 2013 peak of 59.8%.

While Inditex's profits outstrip those of competitors such as Hennes & Mauritz, analysts and investors have questioned whether the slide at Inditex is due to short-term factors such as currency movements or reflects long-term challenges to its model.

The company, which is the world's largest fashion retailer by sales, sources and produces the bulk of its garments close to home, which allows it to design and deliver new items to stores in as little as two weeks. That rapid-fire turnaround has transformed Zara's parent company into one of the world's most profitable retailers.

But Zara, and Inditex's seven other brands, including Pull&Bear and Stradivarius, haven't proved immune to the ills affecting American clothing companies such as Gap Inc, and J. Crew Group Inc., which have been hammered by consumers shifting to online shopping.

Most analysts attribute the shrinking margins to adverse currency moves that they expect to abate in 2018. Analysts at Macquarie Group estimate Inditex's gross margin will begin to rise next fiscal year to 57% and maintain roughly that level thereafter.

"If there is one company which has proven its ability to outperform even in a hostile market environment, this is Inditex," said Macquarie analyst Andreas Inderst.

Exact profitability comparisons between Inditex and rivals are difficult because companies have different reporting periods, but Zara's parent company has consistently reported higher gross margin figures than many.

Inditex's gross margin from Aug. 1 to Oct. 31 was 59.4%, while Mr. Inderst estimates that H&M will post a figure of 56.1% when it reports earnings on Friday for the Sept. 1 to Nov. 30 period.

Investor concerns about profitability have pushed Inditex's shares down 5% year-to-date through Dec. 12. While that decline is less than many of its peers, "investors appear to mistake FX dilution with fundamental pressures to the model," analysts at Jefferies said in a note.

On Wednesday, Inditex shares were up around 3% in Madrid trading, erasing some of those losses.

Zara's parent company generates more than half its sales in more than five dozen non-euro currencies, but makes most of its products in Spain. So the weakening of those currencies in comparison to the euro has chipped away at reported revenue in euros.

Inditex executives said Wednesday that without the negative currency impact, the gross margin would have increased in the fiscal third quarter, but they didn't say by how much.

Some analysts, however, think price cuts aimed at buoying sales have hurt Inditex's margin. They also believe sales at stores open at least a year are no longer offsetting the cost of increasing online sales. Online sales, they say, are less profitable than those at brick-and-mortar stores because of the added cost of delivery.

"While we retain our admiration for Inditex's business model, our confidence in the sustainability of exceptional revenue growth is declining as competition mounts," Berenberg Bank analysts wrote in a research report.

Inditex executives say the company is constantly adjusting prices but says it doesn't have a strategy of slashing prices of its cheapest garments. "Our pricing policy is very much stable in all the different geographies," Inditex Chief Executive Pablo Isla told analysts Wednesday.

Société Générale conducted an extensive study on Zara's prices in 10 countries and found the retail giant had in fact cut its lowest prices in 2017 compared with 2016, but that Inditex was also raising its top-end prices to widen its appeal and boost sales.

Write to Jeannette Neumann at

(END) Dow Jones Newswires

December 13, 2017 10:44 ET (15:44 GMT)