BOSSY - Hugo Boss: Will The Turnaround Be Successful Under A New Boss?

2023-03-21 05:18:49 ET

Summary

• Hugo Boss is undergoing a turnaround effort under new leadership, but the heavy exposure to Europe, which accounts for 63% of sales in FY22, may hinder its success.
• Gross margin may recover given 2 out of 3 factors impacted 4Q22 were macro factors that should cycle down to becoming a tailwind.
• Inventory levels continue to be high which increases the risk of inventory markdown.

Summary

Under the leadership of Hugo Boss' ( BOSSY ) new CEO, the business is undergoing its first innings of turnaround. While I applaud management renewed emphasis on driving growth and expanding market share, I can't help but notice its heavy exposure to Europe, which accounts for 63% of sales in FY22. Given the likelihood of a more challenging environment and cost of living headwinds for European consumers, this is not an ideal setting for BOSSY's turnaround effort. Until management provides convincing evidence of the success of turnaround efforts and the macroenvironment recovers in investors' favor, I advise holding off on buying BOSSY.

4Q22 results and quarter-to-date trends

Since Hugo Boss had already disclosed FY22's essential financials, the updates focused primarily on gross and EBIT margin, with the former showing softer growth than expected. Nonetheless, I think the main emphasis was on forward looking guidance as BOSSY is in the midst of its turnaround. The guidance given was generally in line with what was expected. Revenue is projected to increase by the low to mid single digits to €3.8-€3.9 billion, and EBIT is projected to be €350-€375 million. If we do the math, we get an EBIT margin of 9.2% to 9.8%, which implies a modest improvement from last year. Importantly, management stressed that there have been no signs of a slowdown in consumer spending across all regions so far this year. This is due in large part to China's robust start to the year, with year-to-date growth in the double digits, and the subsequent boost to neighboring Asian regions as a result of China's reopening. Quantitatively, management guidance embeds China to grow mid-teens in FY23.

Using this information, we can also infer management cautious tone with regards to the mid-single-digits overall revenue growth for FY23. Meaning to say, management is embedding the uncertain macro-environment and a slowdown from the strong start of the date. Which means, there could be room for surprise if macro turns for the better in 2H23. However, on the flipside, the guide could also mean a very bad FY23 in terms of volume. Supposed we assume BOSSY to increase pricing by mid-single-digits (not hard to imagine given the inflationary environment, and with the strong start of the year, this would mean that management is anticipating volume to decline strongly throughout FY23. As such, I would advise to be more cautious when digesting the strong start to the year commentary from management.

Margin targets

Management gave an implicit reference for achieving an EBIT margin of 9.5% in the middle range, and affirmed their dedication to achieving the previously declared goal of 12% by FY25. In the following discussion, I will elaborate on the gross margin, which I believe is a crucial factor in determining the recovery of the EBIT margin.

BOSSY achieved a gross margin of 61.8% in the year 2022, however in 4Q22, gross margin decreased by 1.5 percentage points as a result of increased freight costs, negative foreign exchange impact, and sales mix between channels and region. Looking ahead, I would think it is possible for gross margin to recover given 2 out of 3 factors impacted 4Q22 were macro factors that should cycle down to becoming a tailwind. Freight cost should eventually comedown and FX is going to flip into a tailwind as BOSSY does not hedge their FX. Moreover, I expect BOSSY to raise prices organically which would help with gross margin expansion as well. Now, the problem is forecasting the path of gross margin recovering. This is a tough one given nobody has an exact idea when will FX and freight turn for the better. I expect management to stay on point when communicating quarterly cadence moving forward, especially when we inch nearer towards 2H23. That aside, one thing to note is also whether BOSSY will face any potential markdown of inventory during this recovery phase, which will become a headwind for gross margin.

Inventory management

Inventory levels continue to be high, with a growth of 370 million, which is more than 50% compared to the previous year. Management stated that this was a deliberate measure to minimize supply chain risks and ensure that the products are readily available. Given the current state of the supply chain, I believe this is the correct course of action, especially since management has noted that shipping transportation times doubled in 2022 and that they experienced numerous instances of sold-out core merchandise. The immediate issue is how BOSSY will rotate through this large stockpile and if there will be any inventory markdowns. There is no danger here, according to management, because most of the stock is new or soon-to-be-released collections and staple items that can be sold throughout the year. Management expects stock levels to stabilize over the course of 2023, with the effects beginning to show in 2H23. However, I am very skeptical on any high inventory levels as the outcome has been similar for many retailers in that they need to write down inventories.

Stores

A 5% rise in available retail space and a 29% rise in store sales productivity contributed to brick and mortar retail's 29% growth in 2022. I bring this up because I think it is indicative of the success of BOSSY's recent initiatives to update and improve its store concept offerings. Positively, management has indicated a more optimistic outlook on the BOSSY store portfolio due to rising sales densities. Examining the data also confirms that management's statements are consistent with reality. Despite management's projections of only 400 stores by 2025, BOSSY ended 2022 with 471. Importantly, management has indicated that they may maintain a constant number of stores, which bodes well for the eventual realization of improved unit economic in the P&L as stores mature. Another important to note is that B&M fixed costs as a percentage of group sales are also expected to decrease from 26% in 2019 to 19% in 2025, a reduction of 700 basis points, and the company is currently halfway toward this goal despite the increased number of stores.

Conclusion

While BOSSY is making progress under the leadership of its new CEO, the heavy exposure to Europe, which accounts for 63% of sales in FY22, may be a headwind for its turnaround effort. Until management provides convincing evidence of the success of turnaround efforts and the macroenvironment recovers in investors' favor, it is advisable to hold off on buying BOSSY. Importantly, BOSSY's recovery of its EBIT margin will depend on the recovery of its gross margin, which could be impacted by macro factors such as freight costs and FX, as well as potential markdowns of inventory.

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