2023-06-20 11:41:26 ET
Summary
- German online fashion retailer Zalando has seen a significant price drop YTD, improving its P/E. Its forward P/E is particularly encouraging, at near the historical median levels.
- Its Q1 2023 financials also show improvement in terms of both revenue growth and reduction of losses.
- However, weak revenue forecasts and macro risks from the DACH market may impact Zalando's financial recovery, leading to a Hold rating for now.
I had given the German fast fashion online retailer Zalando (ZLNDY) a Sell rating in my last article on it, titled " Unbelievably Pricey ". It has fallen by 36% since. That is no surprise, of course, considering a decline was indicated by the mismatch between the company's fundamentals and its price levels.
However, it has been five months since. And after falling pretty much for the entire time, Zalando has gained almost 11% in the last week at the time of writing This calls for another look to assess if there is reason to change the rating.
P/E is still high
First things first, its trailing twelve months [TTM] GAAP price-to-earnings (P/E) ratio has subsided significantly from the unacceptably high 2,852x to 185x, owing to the dramatic price decline and an earnings improvement in the interim. But let's be clear, it is still an exceptionally high number. For context, the corresponding figure for the consumer discretionary sector is 16.7x.
This alone signifies that more correction is likely, even though Zalando is now trading near all-time lows. But let's not jump the gun, but instead consider its fundamentals to get a more holistic perspective on it.
Slightly improved financials
Its latest financials are somewhat encouraging. Its revenue growth for the first quarter of 2023 ending March 31 (Q1 2023) is nowhere near the compounded annual growth rate [CAGR] of 24.5% seen over the last 10 years, but at 2.3% year-on-year (YoY), it's a definite improvement over the 1.5% fall seen in Q1 2022 and even flat sales seen for the full year 2022.
The company's net loss has also shrunk to EUR 38.5 million from EUR 61.3 million in Q1 2022. That its latest adjusted EBIT figure is also very close to breaking even is also a positive in the current circumstances, especially as it was a big negative figure of EUR 51.8 million in Q1 2022. Zalando says this is due to lower fulfilment costs, the biggest contributor to operating expenses, which are down by a significant 8.6% YoY.
The lower fulfilment costs are attributed to "Better order economics, primarily bigger basket sizes…". Interestingly, though, a look at the average basket size over the past 12 months reveals, that it has improved by less than 2% YoY. It is possible that the number improved significantly during Q1 2023, for which we don't have the details. But even otherwise, the company's cost control is notable, possibly on some softening in inflation. Its cost of goods sold, for example, is also down by 7.1%.
Improved EBIT outlook
The improvements, however, are unlikely to translate into significantly better financials over the course of the year going by Zalando's own outlook . It expects revenue growth to range between -1% and 4% in 2023. On the downside, this suggests that revenue can decline again, after showing a marginal 0.1% fall in 2022. The numbers for Q1 2023 show a pickup, so there is some hope that the performance will be positive, though.
In contrast to the muted revenue outlook, its adjusted EBIT forecast is rather positive, however. It expects the number to come in between EUR 280 to EUR 350 million. If it comes at the midpoint of this range, that's a huge 76% increase over the 2022 figure. Even at the lowest end, it is still an improvement over 2022's number. This is also a potentially positive sign for its net income. Analysts also expect notable growth of 87.2% YoY in EPS this year.
Alternative market multiples
As a result, Zalando's forward GAAP P/E is at 51.8x and the adjusted counterpart is at 35x. These are vast improvements over the TTM figure. The forward numbers are still higher than the figures for the consumer discretionary sector but are definitely lower than the median P/E for the company at 114.3x over the past 10 years and the forward GAAP P/E is close to the lowest the P/E levels have been at 48.2x. It's not an exact comparison, of course, since the historical figures are TTM, but it is indicative. The upshot here really is that ZLNDY always looks overvalued, so its valuations need to be seen in context.
There's more. Its price-to-sales (P/S) is at 0.67x, which is actually less than 0.87x for the consumer discretionary sector. Ditto for its forward P/S at 0.65x, compared to 0.88x for the sector.
The DACH market risk
Based on these, I am tempted to upgrade Zalando to a Buy rating. However, that would overlook the macro risk from its important DACH market, which constitutes Germany, Austria and Switzerland. While Germany has avoided a technical recession so far, with "the decline in private consumption is expected to have been contained" as per the European Commission , it's quite clear that a slowdown is here. It might even be at risk of the slightest recession, with the IMF predicting a -0.1% change in its GDP during the year. Austria and Switzerland too are expected to slow down considerably from 2022. This could tell on its sales.
What next?
There is no doubt that some positives are visible in Q1 2023, like the positive revenue growth. However, the company's forecast range does go into the negative growth territory, which can't be ruled out going by the slowdown expected in its important DACH market this year.
With controlled costs, though, it is still believable that the company can see better earnings this year. In fact, its forward P/E already looks relatively attractive going by the company's long-term average P/E levels. Its P/S is competitive too. These compensate for its still elevated TTM P/E, only partly though considering they are subject to change as we move through the year.
With its price at near all-time lows, now might look like a good time to buy Zalando. And maybe it is, for more bullish investors. But going by its still elevated P/E, weak revenue forecasts and macro risks to it, I think at this time it is best to err on the side of caution. I would wait for at least another quarter's numbers to feel assured of Zalando's financial recovery. I am going with a Hold for now. I do believe it might be due for another rating upgrade later this year, though.
For further details see:
Zalando: Recovery Possible But Risks Persist