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Introduction
Today I am delighted to have a guest post from Phil about INDUSTRIA DE DISEÑO TEXTIL, SA. Phil has proven his knowledge in the dividend Investing world by winning our very first dividend quiz on Dividend Talk. He also happens to be a fellow engineer. I am also excited because retail companies are not my strong point so I find this company review very interesting. Over to Phil and his Inditex company review.
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How is this company review structured?
How will this Inditex company review be structured? To set the scene, I will first start with some comments about the fashion industry. We will also have a close look at Inditex with typical questions like
- Who is Inditex
- What are their market position and revenue profile?
- What are their growth perspectives and financial stability?
- Last but not least, we will look at their dividend.
The Fashion Industry
Inditex belongs to the fashion industry, a sector that does not necessarily have a positive image. Over the last years, we have read a lot about bad working conditions, unacceptable quality clothes, and “fast fashion” social criticism. Who does not have items that were only worn a couple of times?
Furthermore, the industry has demonstrated itself to be an extremely competitive market and, if you cannot follow a trend, customers will not remember your name next year. The COVID19 crisis has uncovered several zombie companies and their weak balance sheets. This led to bankruptcies or a massive store reduction.
McKinsey offers yearly reports, “The State of Fashion 2020” and they’ve issued a special COVID19 mid-year update, “It’s time to rewire the fashion system: State of Fashion coronavirus update”. This could be a highly informative report for anyone not involved in the fashion industry.
To be attractive as an investment, a company in this industry needs a solid balance sheet, a proven track record to defend its market position, and an agile business model to follow trends.
https://www.buymeacoffee.com/dividendtalk
Inditex Company – Introduction
“Industria de Diseño Textil” or Inditex, with roots in the 60s, was founded in 1985 as the company that we know today. They started as a local Spanish company and expanded to international markets in 1988. As of today, Inditex runs over 7000 stores in 96 markets – next to their well-known brand Zara / Zara Home, they own brands like Pull&Bear, Stradivarius, Massimo Dutti and others.
The founder of Inditex, Amancio Ortega Gaona, is still the biggest shareholder (owning about 60% of all shares) and became one of the richest men on Earth. To be precise, he is number 6 on Forbes’ list “The World’s Billionaires” in 2020.
The business model of Inditex is affordable fashion and their business includes the complete value chain – from sourcing to sales.
“We want to create value through beautiful, ethical, quality products with a complete cycle of life. We act precisely and responsibly in every stage of the fashion process -from design and sourcing to manufacturing and quality control, logistics, and sales through stores and online- through a unique business model with three key pillars: flexibility, digital integration, and sustainability.
Quote from https://www.inditex.com/how-we-do-business/our-model
Following the McKinsey report, Inditex is one of the biggest players in their field. Their market capitalisation is currently in the range of ~80B€ and with that they are three times bigger than their competitor H&M (currently ~25…30B€).
Revenue Development and Stability of Margins
Inditex’s revenue development over the last ten years is impressive. Their FY2010 report stated that they generated 12.5B€ in revenue and in 2019 their revenue grew to 28.2B€. This is a top-line growth of ~9.5% CAGR! Their earnings have shown an impressive growth of ~8.4% over the last years as well.
With regards to margins, they had to accept some slight decline over the years. In 2010, their gross margin was at ~59% and currently, it is about ~55%. Same for the operating margin that had a slight decline from ~18% in 2010 to ~16% in 2019.
| 2011-01 | 2015-01 | 2020-01 | |
| Revenue EUR Mil | 12,527 | 18,117 | 28,285 |
| Gross Margin % | 59.3 | 58.3 | 55.9 |
| Operating Margin % | 18.3 | 17.6 | 16.7 |
| Earnings Per Share EUR | 0.56 | 0.8 | 1.16 |
This year Inditex has been heavily impacted by global store closures – in April nearly 6000 out of their 7000 stores were closed. For 1H 2020, they had a net loss of -195M€ vs. +1,549M€ in 1H 2019. In September they reported to be back in positive numbers and a strong online growth, see “Inditex returns to profitability and generates €734 million net cash in the second quarter” (source Inditex.com).
Inditex was heavily expanding in physical store presence worldwide but, moving forward, the focus is shifting to online shopping. Online availability is provided in 66 markets which makes 14% of their sales revenue. By 2022 they target 25% in revenue from online stores – with COVID19 accelerated process this plan seems realistic.
Way of Working and Innovation
Fashion is a very subjective topic, so let’s focus on the mechanics of the company. Inditex is said to be in the “fast fashion” segment – what does that mean? This means that there is no real Spring/Summer or Autumn/Winter selection. From trend identification to physical delivery in a store, cycle times are reduced to a couple of weeks. With that, Inditex’s brands can gradually replace their items in their stores and always have something new to offer. That is a big challenge for the supply chain and Inditex solves this by having close manufacturing sites in Spain and Northern Africa for their biggest market in Europe.
The mix of physical stores and increasing online shopping requires a seamless integration in their global supply chain. Investing in digitalisation and RFID traceability makes it possible to have an exact picture of local demand and inventory. This is what Inditex calls “Single inventory position” and it enables the physical store’s inventory to be used for online orders. In the 1H earnings call the CEO highlighted it to become more and more relevant over time (transcript on inditex.com).
In my option, Inditex has done a great job bringing innovation to the supply chain. It came to be as a surprise that with Inditex you buy a smoothly running machine rather than a fashion empire.
(source Inditex.com)
Financial Strength
I am truly no financial expert. Luckily, Engineer My Freedom and European DGI have recently covered how to read a balance sheet in their Dividend Talk (link on youtube.com) and I took it as guidance to look into some aspects of the annual report.
All data are based on the 2019 Financial Report (source on inditex.com):
- Debt-to-Equity Ratio: 0.9 (increase versus the last years because lease liabilities are part of the newly adopted IFRS16 standard last year)
- Goodwill: Less than 1% of the balance sheet
- Current Ratio: 1.56
- Cash or Cash Equivalents: 4.7B€ (1H 2020 update: Still 4B€) / Net financial cash: 6.4B€
The cash position is very impressive if you compare it with their current liabilities of 7.3B€.
After all, the balance sheet looks robust, doesn’t it?
Dividend
Dividends are an important fact for me as an investor and I appreciate a steadily snowballing dividend.
Here is Inditex’s dividend policy. They pay an interim ordinary dividend and a final ordinary dividend. The former one is paid beginning of May, the latter one is paid end of October. The target payout ratio of the ordinary dividend was increased from 50% to 60% in 2019 (source on inditex.com).
To make things a bit more complex, Inditex also pays a bonus dividend. In 2019, it was announced to have 1€ bonus dividend per share, distributed over the next three years (2019, 2020, 2021).
Pre-COVID19, Inditex’s dividend performance was as impressive as its revenue growth. In the last years the dividend was strongly growing at a rate of 14% (CAGR 2014-2018). At this point, I must admit that I could not find a clear answer to the dividend history and Inditex’s first payment. Earliest record that I was able to find was in ~2002…2003.
How did COVID19 impact the dividend payment? For FY19, Inditex only paid 0.35€ per share compared to the total FY18 dividend of 0.88€ per share. The bonus dividend payment was delayed:
“Inditex maintains its dividend policy that combines a 60% ordinary payout and bonus dividends. The remainder of the bonus dividend for calendar 2020 and 2021 (78 cents per share) will be paid in calendar 2021 and 2022.” (source 3M Update on Inditex.com).
Given the financial stability of Inditex, I was hoping for a higher dividend. However, I can understand that their management wanted to be on the safe side as Spain was hit hard by COVID19. I could also imagine some political pressure similar to what we have seen with French companies.
Summary and Conclusion
Doing my research over the last years, I came to the conclusion that there is a lot of headwind in this industry. Still, clothing is a necessity and will not disappear in the next 10 years. In order to avoid sleepless nights, I had to find a successful and resilient company that showed a financially stable balance sheet, as well as a flexible and innovative business model.
Inditex checked most tick boxes in this perspective. It was very impressive to see their efficient and innovative supply chain, and their track record in both, geographical and online expansion.
From a valuation perspective, it is not easy for me to name a clear price tag. Since Inditex had a strong growth performance in the past, their historical dividend yield was often in the range of 1.5% … 2.5%. If we assume that they can continue with dividends on pre-COVID19 levels next year, in the range of ~0.80€, and see Inditex being priced at 20€…24€, there is a chance of getting them with a hypothetical forward yield of 3.3% … 4%. Projecting a more conservative dividend growth rate of 10% CAGR (vs. 14% CAGR that they achieved), Inditex could be generating a dividend yield on cost of 8.5% … 10.4% in a decade from now.
Yahoo Finance chart from 1/1/2010 till today (source finance.yahoo.com)
Disclosure
I am long Inditex and opened my first position in spring 2018. I added during the first COVID19 dip in spring 2020 and added another tranche beginning of November. It is a medium-size core holding and I am fully aware that it is a riskier one with higher volatility.
The first draft was written on November 7th. With the good vaccine news over the last couple of weeks, Inditex was surging 15% … 20% up.
About the Author
Hi, this is Phil, a 32-year-old electronics engineer from Germany currently living in Belgium. I am extremely interested in understanding business models from different companies and in understanding what makes them special. Feel free to contact me on twitter (@philsegler).
Big thanks to Derek for the opportunity to publish this company review on his blog (Engineering High Five!).
Big thanks to my girlfriend for her patience with proof reding and for some entertaining discussions about different expressions 😊
Thanks Phil, really nice to see you writing articles as well! Good job 👏
Given that the owner as you also mentioned is one of the richest people on earth, I think most people have at least heard about the Zara brand, so it is nice to see exactly which company is behind it all and how it operates.
Thank you for the article, very well researched and illustrated!