Potential Pullback

Asos's Foreign Flair Can't Mask British Bother

No room for slipups if British shoppers pull back.
At Closing, May 25th
6632.00 GBp

If you thought band T-shirts, blouses and bikinis didn't have much to do with Brexit, think again.

The link is Asos Plc, the online seller of all things fashion to hip twentysomethings.

As the retailer generated 62 percent of its retail sales outside of the U.K. in the first half of its financial year to the end of February, it has been a big beneficiary of the post-referendum slump in sterling. Indeed, international sales rose 54 percent in the first half, compared with an 18 percent increase in the U.K.

Streets Ahead

Asos's forward p/e ratio is at a premium to its primarily store based rivals

Source: Bloomberg

Asos has been nicely protected from Brexit, but if the British shopper starts to cut back, some of the heady advantage it's enjoyed may start to fizzle out.

On Tuesday the company upgraded its full-year sales growth forecast from between 25 percent and 30 percent to between 30 percent and 35 percent. The company has decided to reinvest the windfall from surging revenues into even lower prices and better products. Chief Executive Officer Nick Beighton said that "as and when" sterling strengthens, Asos can benefit from having built a more powerful international presence.

That all looks smart. But the trouble is, price cuts and investment in a U.K. loyalty plan have taken their toll: the gross margin fell 0.6 percentage point in the first half. Asos said company was still broadly in line to achieve the mean consensus for full-year pre-tax profit of 80.6 million pounds ($100.4 million). 

Investing to Grow

Cutting prices and improving products in Asos's international arm took its toll on its gross margin

Source: Bloomberg

And life is about to get tougher -- particularly in its home market.

Asos pays for about 75 percent of the products it buys in sterling. It's hedged its currency exposure, and has also increased its natural defense -- the sales it generates in dollars and euros. Even so, Asos is unlikely to be able to escape the full effect of a weaker pound on its sourcing costs.

At the same time, its core U.K. customers are likely to see their real incomes squeezed by faster inflation. Britain still accounts for about 40 percent of retail sales, and remains an extremely promotional market, particularly for womenswear. 

It also has nimble rivals to contend with -- smaller upstart boohoo.com Plc is snapping at its heels. Stretched consumers, and aggressive competitors, mean Asos won't be able to raise prices in its domestic market, and it has pledged to do all it can to avoid hikes.

Catching Up

Smaller rival Boohoo.com is growing faster than Asos

Source: Bloomberg

2017: Boohoo and Asos are company forecasts. Zalando is Bloomberg forecast

The shares fell as much as 7.4 percent in early trading. Investors are right to be concerned. Asos isn’t the only high-sales-growth, margin-pressure story out there. Even Inditex SA, whose sales growth has left most rivals in the shade, saw its gross margin shrink to the lowest level in almost eight years in 2016.

Asos deserves some premium over bricks and mortar retailers. It is on a forward price earnings ratio of 62 times, compared with Inditex's 27, and 20 times for the Bloomberg Intelligence European specialty apparel index. But on such an outsized multiple, it can't afford any slip ups. 

Asos has been a great Brexit winner. The U.K. may be a shrinking share of its business as international sales continue to power ahead, but the humble British shopper still has the potential to throw it off course.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Andrea Felsted in London at afelsted@bloomberg.net

    To contact the editor responsible for this story:
    Jennifer Ryan at jryan13@bloomberg.net

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