March 31 (Bloomberg) -- Hennes & Mauritz AB, the world’s second-largest clothing retailer, reported first-quarter profit that fell more than analysts anticipated as the company decided against passing on higher costs to customers.
Net income dropped 30 percent to 2.62 billion kronor ($420 million) in the quarter ended Feb. 28 from 3.74 billion kronor from the year-earlier period, the Stockholm-based company said in a statement today. The average estimate of 13 analysts surveyed by Bloomberg was for profit of 2.77 billion kronor.
The shares fell as much as 4.4 percent. H&M’s sales dropped 1 percent in the period while larger rival Inditex SA posted a 10 percent jump in its fourth quarter ended Jan. 31. H&M, which buys its products from about 700 suppliers, has reduced prices for some items even as the price of cotton has traded near a record while some competitors have raised or maintained them.
“H&M is making a massive bet on market-share gains,” Simon Irwin, an analyst at Liberum Capital in London, said by phone today. “They’re cutting prices in an environment where their costs are rising and competition is increasing.”
H&M shares fell as much as 9.5 kronor to 207.10 kronor and traded at 208.40 kronor as of 12:01 p.m. The stock has dropped 6.9 percent this year, compared with larger rival Inditex’s 0.7 percent advance. Inditex runs Zara stores.
The Swedish retailer’s strategy to not pass on increased sourcing costs has served it well and the strategy is “good in the longer term,” H&M Chief Executive Officer Karl-Johan Persson said at a press conference today.
H&M sells a trench coat on its U.K. Website for 34.99 pounds ($56.44), while Zara offers one for 79.99 pounds. Inditex, which also runs Massimo Dutti and Bershka stores, gets about 65 percent of its revenue from Zara.
H&M sources two-thirds of its product from Asia. Inditex gets about 35 percent of its products from there and only half of that amount comes from China, where input costs are rising the fastest, said London-based Societe Generale analyst Anne Critchlow in an e-mail.
“H&M has chosen to reduce its prices in the current environment, which further hurts the gross margin,” said Critchlow, who has a sell rating on the stock. “Inditex says its prices are maintained.”
H&M’s gross margin in the first quarter was 57.8 percent, compared with 61.9 percent a year earlier. Sales in February rose by 9 percent in local currencies from the same month last year and advanced 3 percent between March 1 and March 29.
“Inditex is much better-placed” than H&M, said Irwin. “Its top-line has been more robust, and given its mid-market positioning and proximity sourcing base it is less exposed to rising input prices.”
H&M also said today that the three months was “characterized by continued restrained consumption, a discount-driven market with many price activities and unfavourable weather conditions,” in December when it closed some stores temporarily amid heavy snowstorms.
“Sales have remained sluggish, which we think will raise concerns that H&M is confusing customers and pricing too close to discounters,” said Bank of America Merrill Lynch analyst Richard Chamberlain in a note today.
Inditex also plans to expand at about twice the pace of H&M, with a target of 500 new stores this year while H&M aims for 250. Inditex said on March 23 that it opened 160 stores in Asia last year, of which 75 were in China’s main and smaller cities. The Spanish retailer plans to add a further 120 Chinese stores across its eight brands in 2011.
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