ZLDSF - Zalando: Guidance Is Encouraging But Timing Is A Concern

2023-03-09 07:55:32 ET

Summary

• ZLDSF's 4Q22 update is pretty much consistent with consensus expectations.
• I have concerns exist around the significant miss in gross margin and confusion in management messaging about double-digit growth targets for GMV.
• Management's goal of reaching double-digit EBIT margins by 2025 is encouraging.

Thesis

Overall, I find the 4Q22 update from Zalando ( ZLDSF ) to be fairly consistent with my expectations, albeit with some questions raised. Both the top line and EBIT for Q4 were in line with projections for 2023, and projections for EBIT margin in the high end of the 3-6% range for 2025 are sound. One thing I did notice is a significant miss in gross margin for 4Q22. While lower OPEX helped the EBIT line, my concern is that gross margin will take longer than expected to hit trough levels. In addition, I believe there is some confusion in management messaging about the double digit growth target in GMV. While the target has been set, it is not yet known when it will be achieved (would it be achieved in FY24 or FY25?). While these issues are concerning, I believe the stock will benefit from the company's results and outlook for the future. The double-digit GMV growth guide and margin target should start to be reflected in some consensus estimates (i.e., pulling ahead their estimates), which would be helpful for the stock. Given the uncertainty of the outlook, my recommendation may be to take a small speculative position in order to gain from the short-term optimism brought on by upward revisions in estimates.

More thoughts on 4Q22

Like I said before, I believe that 4Q22 results are generally in line with expectations. GMV increased by 5.5% year-over-year, revenues increased by 2.2%, and operating income was €146 million. As was already mentioned, the drop in gross margin of 4.4 percentage points was unexpected and 100 percentage points worse than was expected by consensus. ZLDSF has recently reset their inventory balance, and management has stated that this drop in gross margin was caused by the clearance of overstock (I am giving management the benefit of doubt). However, operating cost performance below the gross profit line was good. Timing is the issue, but I believe the gross margin situation would resolve itself as ZLDSF continues to destock. That said, in the near future (Q1/Q2), I would continue to see the overstock as a problem which will have a negative impact on gross margin. Since the new cost base is inherently lower, and if the gross margin problem was indeed an anomaly, we could see a rapid increase in EBIT in the coming quarters as ZLDSF's top-line grows. Improving the fulfilment cost ratio is a major contributor to the lower cost base (better unit economics due to higher basket value).

Guidance

ZLDSF has guided to an increase in GMV of 1% to 7% for FY23, which is in line with expectations. The guided EBIT ranges from €280 million to €350 million, which is 3% higher than consensus at the mid-point.

Regarding GMV projections, I think it would set the stage for a good growth acceleration story if ZLDSF could increase GMV growth rates to double digits in FY24. Specifically, ZLDSF has not released any updated absolute targets for FY25, which I think is not a big issue as I think all investors have realized that the company's previous GMV target of €30 billion is now unrealistic. Now, management has stated that it anticipates GMV growth rates in the double digits in the mid-term. This could refer to fiscal year 24 (FY24), but I'm not sure and the lack of clarity raises some questions (and probably gives management some leeway in timing). To put it another way, if they were to achieve double-digit growth in FY24, investors would be very pleased because this result would "beat" expectations (some consensus would think it is FY25). On the other hand, my guess is that investors are still on the side of caution, so even if it doesn't hit the target in FY24, the stock won't take much of a beating.

As for the EBIT margin, management stated that they anticipate reaching the upper end of their 3-6% adjusted EBIT margin goal by 2025, and ultimately achieving double-digit margins. This is promising because it matches consensus estimates. Management has also stated that they are actively working to increase profits, streamlining operations, and making strategic investments.

Conclusion

The 4Q22 update from ZLDSF is generally consistent with expectations, with some concerns around gross margin and management messaging about GMV growth targets. However, the company's results and outlook for the future should benefit the stock, especially if consensus estimates are revised upward. Importantly, management's goal of reaching double-digit EBIT margins by 2025 is in line with consensus estimates, and their efforts to increase profits and streamline operations are encouraging. While there is some uncertainty in the outlook, taking a small speculative position could provide short-term gains.

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