Since I first published my analysis on ASOS in April, the stock plunged from ~15 pounds to ~7 pounds. Or approximately 60%. My cost average is much lower than 15 pounds due to doubling down to around 8 pounds.
In this post, I'll try to answer these questions:
1. What caused the price drops?
2. What critical updates on ASOS since my deep dive?
3. Is the thesis still valid?
Why the price drop?
We can spot two significant price drops:
- June, from ~15 to ~8 (where I bought more)
- August, from ~10 to ~7 again
June saw the most recent financial report and the announcement of the new CEO.
August saw the former CFO-COO's departure, alongside lowered guidance.
Apart from these "point-in-time" events, we have the background deterioration of the UK and EU economies - the biggest ASOS markets. Inflation hits hard, and consumer behavior is affected. In turn, causing for a general downturn in the fashion market.
The fashion market struggles post-pandemic
Data points can tell the story better than I can ever write down. I measure growth or shrink in real terms, taking into account at least 10% total inflation since 2020.
- Sales Feb-2020: $2,047M. Feb-2022: $2,688M. Real growth.
- Inditex (Zara, Pull&Bear, Bershka) sales Feb-2020: $17,153M. Feb-2022: $17,730M. Real shrink.
- Primark sales Feb-2020: £3,710M. Feb-2022: £3,540M. Absolute shrink.
- H&M sales Feb-2020: $5,715M. Feb-2022: $5,189M. Absolute shrink.
- The GAP sales Feb-2020: $4,674M. Feb-2022: $4,525M. Absolute shrink.
- Boohoo posts first ever UK sales drop (June 2022)
- Shein - Massive growth, but useless as an indicator. They injected billions to scale up, losing massively on each sale. Also - not fashion, but clothing. It's as if I'd include Walmart clothing sales here. You can wear it, but it's not fashion.
ASOS grew since 2020 while big fashion shrank. But if we look at the disparity between growth rates, then ASOS slowed down more than the big fashion - in percentage points. Going from +20% to +3% in the ASOS case is maybe more painful than going from +6% to -4% in some of the big fashion cases.
Regardless, the entire market is pushed down. And that's sales - it's even worse on earning since the cost of labor, materials, and even electricity are ridiculous now. Everybody's margins are sad to look at. Primark just issued a profit warning, blaming electricity costs.
I reiterate last point that given returns are specifically linked to our [ Nordstrom ] -- specifically linked to any specific brand, products or payment type, we believe they are driven by the inflationary pressures on our consumer disposable income.
We also know that the sharp increase in return rates during the period happened at the same time that consumers started to feel the pinch. For example, in the U.K. we saw a sharp increase in return rates, consigning with increases in national insurance contributions and increased energy, food and fuel prices.
We have a short period of data available. At this moment, it's difficult to say whether this is just an initial knee-jerk reaction to changing conditions or whether it could last longer.
José Ramos Calamonte, CEO, 22'P3 earnings call
As fashion - not clothing in general, but fashion - is a non-essential purchase, it's being driven down in consumers' priority in times of inflation. That means lower demand while production costs are rising. Low demand, higher competition for existing demand, while having higher costs.
It's a vicious loop, not too dissimilar from many other industries in an inflationary environment. It means weaker sales and lower margins while inflation rises. That's why stocks fare worse in an inflationary environment in general.
I don't attempt to predict when or how this ends. Timing is not for me. I only ask whether the company can weather the storm. ASOS can. They are not burdened by debt that can take them down.
Should the macro economics be better sooner than later, so does the returns on equity in general and of ASOS in particular. When is a question no one can answer. If you believe we're headed to a 70s scenario - that may be 5+ years. It's a risk to be acknowledged.
The financial results in June were a mixed bag. The sales growth was pretty much what was expected:
As shown above, these results are bad in the context of ASOS history, but normal for the wider fashion market at these times.
One thing to highlight, though, is the strong growth performance in the US. The Nordstorm partnership is working out well, and it's a good sign of how the logistics issue to the US has been mostly resolved.
The EU is down due to raging inflation and Brexit hardship. The ROW (Rest Of World) segment is down due to high freight costs, making the ASOS temporarily uncompetitive in these places.
Gross margins shaved 3.1% down to 44%. Margins were already low compared to the market, as I wrote in the ASOS financial performance report.
Freight prices had a lot to do with it. As having materials shipped from China to the UK, to then be shipped back around the world isn't cheap. Alongside inflation, this is a painful double whammy.
At least the outlook on freight prices seems good, as prices got cut by almost 50% since May:
New CEO - José Antonio Ramos
New CEO appointments usually lead to a market drop regardless of the new CEO's fit or capabilities. Reading into a short-term movement is hard enough, trying to deduce anything about the new management from it is impossible.
Especially when professional-practitioner CEOs more often than not lead to a short-term drop. Lisa Su is an engineer first, just as José Antonio Ramos is a fashion guy first.
A practitioner is a long-term play for the stock price. He improves the business fundamentals and focuses on what's important to create a great product that eventually sells really well. But it can take some time. Sometimes, years - case in point, Lisa Su in AMD.
An MBA-sales type of manager typically extracts value for shareholders very quickly. This leads to stock rises in the short-to-mid-term. But it sometimes can cost the company long-term value. Think Boeing, Intel, etc.
José Antonio Ramos will have to face supply chain issues, global expansion, and inflation. These are all business issues - not fashion issues. So I get the market concern. The short-term drop is pricing in the risk for that, that's all.
August COO-CFO departure
Mat Dunn was the operations-financial management guy I alluded to above. He also had over 3 years of experience in ASOS, so he's not only talented but also deeply familiar with ASOS challenges.
Many, me included, as I wrote in the original deep dive, expected him to be elected new CEO. Since he wasn't - it's not that surprising that he left. That's how typically these things work, and I'm sure the politics and gossip stories behind this are amazing - but that's beyond the point.
His departure is another nail on the points I made regarding the CEO. It's one less talent in the management that can deal with supply chains, expansion, and inflation.
It's scary, and thus it was priced in with a drop.
Can ASOS manage then?
The price drops are justified, pricing in the risks in the fashion market alongside Wallstreet's lower confidence in the current management to handle them.
I invest looking forward 10 years. And in 10 years - it won't matter. ASOS will not go bankrupt because of the current issues as they have healthy enough sales and are not burdened by debt.
I also see indicators that most issues are easing now - freight costs are dropping - resolving the supply chain costs issues, and US growth is great - meaning the logistics issues are mostly resolved.
Can they lose more margins in the business in the next year, causing another 20%-30% price drop? Of course, that can happen. But it won't matter in the long term, and I don't try to time this.
Updated DCF valuation
My valuation in the original ASOS deep dive might have been too excessive.
So I made adjustments by massively dropping everything down:
- The owner's cash flow used for the calculation slammed down to $60M from $150M. Originally my calculation showed ~$200M, and I used $150M expecting some pull-forward of demand for 2021. Now I adjust to take into effect lower margins for the foreseeable future and maybe a much bigger pull-forward in 2021 than I expected. The entire breakdown can be found in the original deep dive.
- The Bear, Likely, and Bull cases' growth rates slammed down. I got it so low as to question whether this can actually be so low. Yes, ASOS faces issues now - that's why I got in as a value play. But they did achieve 20.5% CAGR growth 2015-2022. Or 20.3% CAGR 2013-2020, in case you want to filter out the pandemic boom. I assigned 3% growth in the bear case, but that seems crazy to me.
- Terminal measure, which is the owner's cash flow + the growth in each case, adjusted. So do the terminal multiples.
- The discount rate remains 15%. I don't like to lower the hurdle rate for such investments.