ZLDSF - Zalando: I Am Not Convinced That The Turnaround Story Is Successful Yet

2023-09-07 20:27:09 ET

Summary

• Zalando's 2Q23 results show a decrease in GMV and revenue, but operating profit exceeds projections.
• Management anticipates double-digit GMV growth in the medium term, fueled by increased marketing spending.
• While there are positive signs, sustainability of GMV growth and decrease in active customer numbers raise concerns.

Summary

In this post, I will share my thoughts on Zalando ( ZLDSF ) business and stock after the 2Q23 results. I believe ZLDSF is a stock that deserves to be in the monitoring zone of a watchlist. The July execution is positive. However, there are still many things to do and milestones to hit before I turn more positive about the business. Until then, I remain neutral and recommend readers continue monitoring the quarterly performance.

Investment thesis

For 2Q23 , Zalando's gross merchandise value [GMV] of EUR3.7 billion and revenue of EUR2.56 billion both decreased year over year. However, operating profit (EBIT) exceeded projections. Of Zalando's EUR144.8 million adj EBIT in 2Q23, EUR110.6 million came from the Fashion Store and EUR25.4 million came from the Offprice segment (note that Offprice revenue grew 16%, the fastest among all the subsegment). The number of orders placed fell 6.8% to 63.2 million, but the average value of those orders rose 3.9% to EUR58.1.

The bull case here is that management has stated that they anticipate GMV growth in the double digits sometime in the medium term. Since they have eased their requirements for marketing expenditures' return on investment, an increase in marketing spending will fuel the GMV expansion. As of the end of July, the company had returned to positive GMV growth, which the bulls would interpret as a sign that the aforementioned inflection point has begun to materialize. This is a very important point, as the equity story of Zalando has been dragged down the mud with the horrible GMV performance over the past few quarters. Remember, this is a business that has been growing GMV at a rate of 20++% but has now gone into the negative zone. Hence, the turnaround in July is strong evidence that the marketing strategy is working.

While active customer numbers have decreased over the past two quarters (from 51.2 million to 50.5 million), this still represents a 1.6x ratio compared to FY19, lending credence to the bull case that overall number of buyers is still on the uptrend. The optimistic view holds that Zalando is merely prioritizing its most lucrative customers and that the company's attention should be redirected from the sheer volume of its clientele to its customers' average spending habits. A strong indicator, especially considering the widespread discounting in the market, is the rise in the average basket size in the second quarter. Increases in average basket size are expected to continue in the future thanks to the premium segment's strong momentum, which is being driven by higher income demographics with growing spending power.

The case is certainly attractive and plausible. However, I am still not 100% convinced by this turnaround story. There are two factors I am paying attention to: first, whether this GMV turnaround is sustainable. Looking at the chart above, the same trend happened in 2Q22 and 3Q22, where it went from negative to positive only to dip back down to negative terrain again. Second, the number of active customers must eventually increase, and the negative trend today is something I am not comfortable with (there is only a reasonable limit to how much one customer can spend). I'm also hesitant to extrapolate July's improvement because cold weather in some markets likely boosted sales of fall clothing in early July. Zalando's falling gross margin and Offprice's continued success are further indicators that the current market climate is still heavily promotional. For Zalando, the longer this discount-heavy environment lasts, the harder it will be to suddenly stop offering discounts to customers because they will have become accustomed to them. Lastly, concerning the topic of active customers, I anticipate that the ease of online shopping has faced obstacles due to the implementation of Minimum Order Values (MOVs), bundling of orders, reduced product variety, and, in certain instances, charges for returns. Consequently, I expect that the pace at which online shopping becomes more prevalent is likely to decelerate from this point onward. This slowdown is expected to lessen the strength of the long-term positive impact on the industry.

When it comes to H2, we -- in the second half of the year, we will already increase our marketing spend. We will increase our -- we will decrease the expectations on the -- on our performance market spend because we already have, I think, some evidence with regards to how we see the -- like the autumn/winter merchandise being performed. And we as well just had as well a little bit more data to understand like how our customers are performing. That's why we are -- yeah, we're looking like to a better top line in the second half of the year. 2Q23 earnings results call

Conclusion

ZLDSF presents a mixed picture following the 2Q23 results. While there are positive signs in the July performance, I remain cautiously neutral about the company's turnaround story. The optimistic scenario revolves around Zalando's potential for double-digit GMV growth in the medium term, driven by increased marketing spending. The company's return to positive GMV growth in July is seen as a promising development, but sustainability is a concern, given previous fluctuations. However, the decrease in active customer numbers raises questions about the long-term strategy. The current promotional market environment and challenges in increasing active customers contribute to my hesitation. While Zalando's turnaround efforts are notable, I'm awaiting more evidence of sustained growth before turning more bullish on the stock. Monitoring quarterly performance is advisable for now.

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