ASOMF - ASOS: Improving Outlook Initiate At Buy

2023-08-02 18:07:56 ET

Summary

• ASOS has faced challenges in the past year, but there are signs of a turnaround with improved cash generation and execution on track.
• The company has returned to profitability, with EBIT of £20 million and improved profit per order in Q3 2023.
• ASOS has successfully refinanced its debt and has no significant debt obligations until 2026, providing financial stability and strengthening its liquidity position.
• At 0.4x forward EV/ Sales, ASOS appears cheap compared to its peers and provides a significant margin of safety. Initiate at Buy.

Investment Thesis

ASOS Plc ( ASOMY ) has had a tumultuous ride in the last few years just like other pandemic darlings (Boohoo ( BHOOY ) of the UK and Zalando ( ZLNDY ) of Germany) as the onset of the pandemic fueled a frenzy leading to shoppers staying home to purchase online. However, with physical shops reopening, the pandemic reset along with tougher macro backdrop and inflationary headwinds led to a rout in the stock prices.

Post the meteoric rise and the bust including the 65% decline in stock value in the last 1 year, we see a favorable risk reward given the fund raising in the rear view mirror, execution on track as demonstrated by Q3 results and visible signs of a turnaround through its Driving Change agenda with improved cash generation ability.

Execution on Track

ASOS reported a steep £291 mn in loss in H1 2023 which led to the shares nosediving by more than a fifth of their value. This was quickly followed by a much awaited fundraising announcement as it raised £350 mn in cash and stock mix with £275 mn raised as debt, albeit at higher interest rate of 11%, from hedge fund Elliott Advisors backed Bantry Bay and £75 mn in equity raises from two of its largest investors along with a potential £5 mn from other public shareholders. The fundraising provides the company a significant headroom to weather the current storm, strengthen liquidity and help reinvest within the company to improve shopper experience and gain market share.

It reported Q3 results largely in line with market expectations, further strengthening the visibility to commit to its 2H23 guidance. Key factors demonstrating the return to execution are:

1) Return to Profitability

ASOS' focus on profitability vs growth has managed to help them to return to profitability with EBIT of £20 mn, expanding 250 bps YoY despite a 14% decline in revenue. Profit per order improved 30% for the year as gross margins expanded 350 bps YoY, with a decline in lower rung customers with low order value and higher returns.

2) Consistent Improvement in Inventory Levels

Inventory levels doubled in 2022 as the company took some strategic missteps and the pandemic fueled shopping spree which led ASOS to double inventory fizzled, leaving them with a burgeoning older inventory which is a huge liability, especially in the world of fast fashion. However, the company's proactive measures have led them to consistently reduce inventory over the past few quarters, though it still remains elevated.

About 86% of the inventory is less than 12 months old which still marks a significant improvement from the position they were a year ago.

3) No Debt Maturities in Near Term

ASOS has been able to successfully refinance its existing £350 mn RCF facility with its maturity extended up to 2026 (from 2024) providing a huge breather to the cash strapped online retailer. Also, the convertible bonds worth £500 mn also have a maturity date of 2026 which means that the company has no meaningful debt obligations until 2026. This enables the company to catapult its cash preservation measures through its Driving Change agenda and improve its cash generation ability during the turbulent times.

4) Comfortable Valuation

ASOS trades at a significant discount with EV/ Sales of 0.36x compared to 0.70x of the peer set. We believe consistent improvement in operational performance driving cash generation would lead it to catch up with the rest of its peer set and drive meaningful share performance. We initiate at Buy with a favorable risk reward.

Risks to Rating

1) Failure to bring down inventory meaningfully, which still remains elevated, would lead them to significantly mark down prices to clear older inventory which would in turn put significant pressure on the gross margins.

2) Further deterioration in macro outlook would impair ASOS' ability to improve its profitability amidst declining sales and it may have to resort to higher promotions due to dwindling sales.

3) Competitive pressures from other European online retailers, such as Zalando, as well as brands and other retailers which have now significantly invested in their own omni channel offerings, which could further squeeze sales.

Conclusion

ASOS has had quite a volatile performance in the past few years as it first grappled with a shopping frenzy like never seen before which soon fizzled out as shoppers started returning to physical stores post COVID. It embarked on a series of strategic missteps in the past with burgeoning inventory, declining sales and waning customers. However, with the new executive team focused on profitability and improving cash generation measures, we believe the company is on the right path. Through its Driving Change agenda (reducing inventory, improving profitability per order and flexible balance sheet), it is already on track to achieving its stated 2023 goals of reducing inventory and cost savings (having delivered £200 mn of cost savings already YTD) and we believe the continued improvement in operational performance and valuation comfort provides a favorable risk reward. Initiate at Buy.

For further details see: