Hennes & Mauritz's (HNNMY) F2Q 2014 Results - Earnings Call

Jun.18.14 | About: Hennes & (HNNMY)

Hennes & Mauritz AB ADR (OTCPK:HNNMY) Q2 2014 Earnings Conference Call June 18, 2014 8:00 AM ET

Executives

Nils Vinge - IR

Jyrki Tervonen - CFO

Analysts

Rebecca McClellan - Santander GBM

Caroline Gulliver - Jefferies

Charlie Muir-Sands - Deutsche Bank Research

Simon Irwin - Credit Suisse

Chris Chaviaras - Barclays

Anne Critchlow - Societe Generale

Jamie Merriman - Sanford Bernstein

Dana Telsey - Telsey Advisory Group

Geoff Lowery - Redburn Partners

Andrew Hughes - UBS

Fraser Ramzan - Nomura

Rebecca McClellan - Santander GBM

Paul Rossington - HSBC

Operator

Good afternoon ladies and gentlemen and welcome to the six month’s results 2014 conference call. (Operator Instructions). I would now like to turn it over to the Chairperson Mr. Nils Vinge. Please go ahead sir. And I will be standing by.

Nils Vinge

Thank you and welcome to this telephone conference on the occasion of H&M's six month results of 2014. Jyrki Tervonen, our CFO, is with me today again and we will be happy to answer your questions after the presentation. You will find the presentation slides to this telephone conference on hm.com. Please look at the slide second quarter 2014.

Our collections have been well received and we continue to gain market share in the second quarter. H&M Group sales were strong increasing 16% in local currencies. Converted into SEK the increase was 20% as a result of the weakened Swedish Kronor against in-house sales markets currency.

All Group brands contributed to the positive sales development. H&M COS & Other Stories, Monki, Weekday, Cheap Monday as well as H&M Home. We’re also very pleased that our new H&M Sport which we’re developing further continued taking market share in the sports segment.

And before we move on just to comment on current trading. Sales in June have started well, although there will be a negative calendar effect of 3 to 4 percentage points on the month as a whole. In May we had a positive calendar effect of 3 to 4 percentage points which will be reversed in June.

Gross profit in the second quarter increased 19% to 23 billion corresponding to a gross margin of 60.8% compared to 61.1% a year ago. Markdowns in relation to sales decreased marginally compared to Q2, 2013. The overall market situation and external factors such as cotton prices, the U.S. dollar and cost to inflation was slightly negative for sourcing to the Q2 compared to a year earlier mainly as a result of wage increases in the sourcing markets. Looking at the sourcing period to the third quarter of 2014, the market situation for the external factors is also considered to be slightly negative.

Cost control in the H&M group remains very good. In the second quarter cost in comparable stores were unchanged compared to the same quarter last year in absolute terms and decreased as a share of sale.

SG&A increased 16% to 15.4 billion, in local currencies the increase was 13%. The increase is mainly related to our expansion and our long term investments in IT and online but also in the broadening of the product range and the establishment of the new fashion brand & Other Stories.

Please turn to the slide long term investments. We see these investments as very important for H&M’s future success. They cost a lot now but will be very important for H&M for many years to come. The long term investments are aimed at further strengthening H&M’s market position and securing future expansion. Some of them are starting to generate revenue like Other Stories and H&M’s online store in the U.S. and France. Following H&M’s online launch in the U.S. last autumn we launched online shopping in France in the middle of March in this year and customer response has been very good.

Long term investments increased in the second quarter compared to the second quarter last year. In absolute terms the cost increased in the second quarter was similar to the increase in the first quarter this year but it did not have as big percentage impact on results as in Q1. This is because Q2 is a much larger quarter both in terms of sales and in terms of results.

In the second quarter the cost increase for the long term investments equaled around 50 basis points, half of which affected cost of goods sold and half affected operating costs. The long term investments will continue. In 2014 the cost will be at a higher level than in 2013. During the year cost may be dividend unequally between the quarters.

Let’s look at profitability in the quarter, please return to the slide second quarter 2014. Operating profits increased by 26% and the operating margin was 20% compared to 19% in the second quarter last year. Profit after financial items increased by 25% or SEK1.5 billion to SEK7.6 billion in the quarter.

After a tax rate of 24% net profit increased to 5.8 billion equaling earnings per share of SEK3.51 up from SEK2.81.

And now for some other key figures please turn to the slide key data. Stocking trade as of 31st of May amounted to 14.9 billion, an increase of 18% in Swedish Kronor and 16% in local currencies. The increase is mainly explained by the expansion in stores and online. The level and composition of the stocking trade is considered good. Cash flow from current operations was SEK11.9 billion compared to SEK11.2 billion a year ago. The main explanation is the strong results.

Investments in terms of CapEx totaled 3.9 billion, this reflects our store expansion but also continued investments in IT and logistics. The financial position of the group remain strong. Liquids funds amounted to 9.6 billion and return on equity was 50.5% involving 12 months compared to 45 last year.

And now some words on our expansion. Please turn to the slide expansion. Our offering is reaching more and more customers both through our stores and through e-commerce. In the second quarter we opened 93 new stores net and as of 31st of May we have 3285 stores in 54 markets. One of our most exciting happenings in the quarter was the opening of the first H&M store in Australia. A flagship store in the best location in Melbourne, the landmark General Post Office Building. You realize that there would be great interest in H&M in Australia but we were still surprised at the enormous attention that the opening attracted.

More than 3000 customers queued for several hours and many had even spent the night outside the store to be sure of getting in first. We’re looking forward to our continued expansion in Australia. And looking ahead for global expansion of the H&M Group continues.

For 2014 we maintain our plan to open around 375 stores net within our expansion target of increasing the number of stores by 10% to 15% per year. China and U.S. are expected to remain the largest expansion markets. In just a few years China has grown to become one of our largest markets with over 240 stores to-date compared to 150 stores just a year ago.

We also see room for continued expansion in other existing markets as well as in new markets. Three new countries will be added in total this year following the opening in Australia, the Philippines and India will become new markets for H&M in the second half of the year. And next year we will expand to Peru and South Africa.

Please turn to the next slide. Expansion continues also for the newer brands of the group, COS & Other Stories, Monki, Weekday, Cheap Monday as well as H&M Home.

Please turn to the slide H&M Online. In order to carrying through our multi-channel strategy we will continue our long term investments with expansion of H&M’s Online store to more countries. We’re currently preparing to open H&M’s Online store in Spain and Italy early this autumn and later this year we will launch H&M Shop Online in China.

So in total we’re adding online shopping in four large H&M markets this year and looking ahead the global roll-out will continue next year. In 2015 we plan to add between 8 and 10 new H&M online markets. We’re also continuing to broaden our offering within H&M.

Please turn to the next slide. Already this autumn H&M will launch an extended and improved shoe range for women, men, teenagers and children. The extended collection will be available on selective stores in nine markets including China, U.S., UK and Sweden as well as online at hm.com. The new shoe concept will offer a variety of styles in different price categories but as always at H&M prices.

This new extended shoe offering is part of our long term investments. We also have a very interesting designer collaboration coming up at H&M this autumn. With the U.S. designer Alexander Wang. Alexander Wang is based in New York where he started his fashion label in 2007 and today he is one of the most important voices in fashion. Wang is the first American Designer who teams up with H&M. He's tailoring is fashion forward, with a sporty look. The collection Alexander Wang and H&M will feature apparel and accessories for women and men. It will be available from the 6th of November in around 280 [ph] H&M stores around the world and online at hm.com.

And with that we’re now happy to take your questions. Please remember to only ask one question at a time.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Rebecca McClellan. Please go ahead.

Rebecca McClellan - Santander GBM

Just a couple of questions. Firstly, can you confirm your CapEx budget for the full year, please?

Jyrki Tervonen

Yes. At this moment, the best estimate still remains that it will end up being SEK9 billion to SEK9.5 billion for the whole year.

Rebecca McClellan - Santander GBM

And my second question, the incremental longer-term investment cost is still going to be between SEK600 million and SEK800 million. Is that right?

Jyrki Tervonen

That’s right.

Operator

Thank you. Next question comes from Caroline Gulliver. Please go ahead.

Caroline Gulliver - Jefferies

First question was just on why have markdowns only decreased marginally when the sales were so strong. I just wondered if there had been any change in the promotional strategy over the quarter. And then secondly, can you talk about any improvement which you're making to your delivery offer online, and in particular any plans to introduce click and collect?

Jyrki Tervonen

The first question markdown levels there, I think when we’re talking about the markdown levels we also always not to have always a correlation -- good turnover doesn’t have to mean always that the markdown levels going down because it's always on different markets question of salesmanship. We’re always reacting on what’s happening on the market and we’re pretty happy with the markdown levels, we have them and I think also the most important thing is that we have a good customer offering and then we work with the markdown so it's also a tactical tool on each market. So and this quarter we ended up that they were more or less 20 basis points having 20 basis points less negative impact on gross margin compared to last year.

Nils Vinge

Regarding your second question I think it was about free delivery and click and collect et cetera is that right?

Caroline Gulliver - Jefferies

That’s right, yes.

Nils Vinge

Right. Again when it comes e-commerce, we think it's important to talk about the total offering, so it's about the fashion, quality, price and of course lead times et cetera and I mean we do offer free delivery sometimes in campaign as such but it's not a standard thing and also I think it's important to say that free delivery, someone has to pay for it either it's the customer in terms of you’re putting the price, so it's a higher price or it's the investor who at the end of the day perhaps don’t get any returns on his investments but so I think it's in many cases we charge for small delivery and that’s straightforward but again it's the total offering that’s important. When it comes to click and collect and lot other features of course we’re looking to that but at the moment we don’t offer click and collect.

Operator

Thank you. Our next question comes from Charlie Muir-Sands. Please go ahead.

Charlie Muir-Sands - Deutsche Bank Research

I wanted to ask about China. As you say, it's your most important expansion market. Sales there are growing very strongly but not as strongly as the store count. Can you confirm firstly that the like for like stores are still growing sales and secondly can you talk about the dynamics as to why the total revenue base is not growing as quickly as the store count? Is it square meters and not as fast as store numbers or is it you’re going into less productive space in perhaps cheaper locations? Thanks.

Jyrki Tervonen

Yes. We have touched upon this question many times before and first of all we expand very quickly as we can’t just look at the numbers because a lot of the stores that you see -- have just opened and there is still not so much revenues in the numbers and secondly of course we started initially in the larger cities like Hong Kong and Shanghai and then we have step by step moved into second tiers, third tiers, four tiers et cetera. So it's a combination of many factors but sales are strong and developing very well.

Nils Vinge

And to your question about the like to like development, so we’re happy with the like to like development in China, it's developing in a good way.

Charlie Muir-Sands - Deutsche Bank Research

And if I can attempt some insight on your Group level like for likes. I appreciate you don't disclose those in absolute terms anymore, but has the contribution from new space and new online stores accelerated versus the first quarter, or can we interpret your constant FX acceleration in Q2 as being mainly about like for like?

Nils Vinge

The store contribution, space contribution is more or less on the same level as last year.

Operator

Thank you. Our next question comes from Simon Irwin. Please go ahead.

Simon Irwin - Credit Suisse

Could you just talk a bit about the shoe collection? You already offer shoes across the range, so what's different about this re-launched category?

Jyrki Tervonen

It's a big investment, not as big as the sports but it's about broadening the range and lot of product development. So for example in comfort and materials, et cetera and there is a greater variety of product with many different types of models.

Simon Irwin - Credit Suisse

And would we expect then that there will be a broader price range on these shoes to accompany the --?

Jyrki Tervonen

That’s right.

Simon Irwin - Credit Suisse

And is this similar to what you've been doing in other parts of the offer, of kind of generally broadening the offer and obviously in some cases increasing price points along with0, say, the premium lines?

Jyrki Tervonen

Yes but this is specifically on shoes and we’re as you said, we will have a wider price range and a lot wider collection so to speak. Initially as I said before it's going to be selected in nine countries in around 30 selected stores and they would be displayed in clear areas in men’s wear, and ladies wear, children et cetera.

Nils Vinge

And also that even though we’re spreading the price range it's still very good value for money.

Simon Irwin - Credit Suisse

Sure. And just in terms of the China launch. I know you've given us a considerable degree of disclosure about one-off or development costs through the course of this year, but is China in itself with the e-comm launch going to be a significantly lumpy element that we'd actually see in the P&L, or is it just part and parcel?

Jyrki Tervonen

It's part of the parcel I would say.

Simon Irwin - Credit Suisse

And it's all being done in house, or are you going to be using any third parties in terms of distributional websites, or anything like that?

Jyrki Tervonen

When it comes to distribution, we would work with third parties but the rest of it could be in-house.

Operator

(Operator Instructions). Our next question comes from Chris Chaviaras. Please go ahead.

Chris Chaviaras - Barclays

So two questions from me, one at a time. So first question on your online launches. It seems that you accelerate now the amount of countries that you are launching in. Do you leverage existing infrastructure or is there some incremental investments associated with these launches that are worth mentioning?

Jyrki Tervonen

Of course we’re capitalizing on the existing infrastructure and the IT systems et cetera but for each country there is lot of additional work to be done and after that lot of different payment system, cards et cetera and also logistics but we’re ramping up the number of new countries but in terms of sales we already cover maybe 60% - 70% of the group revenues.

Chris Chaviaras - Barclays

And the other question on a big pickup in the admin expenses. I know it's not a big part of your costs, but they did grow more than double what your stores grew. Any color there that you could give?

Jyrki Tervonen

And mostly related to the long term investments or cost and as we said it's more or less in the same range, the amount as in Q1 and half of it is on cost of goods sold on the remaining parties in the operating expenses and also most of them maybe in the admin expenses. So that's the main reason to the bump up in admin.

Chris Chaviaras - Barclays

And if I may, on your core stores, because you've mentioned that you will open more stores this year than last year, but you've just opened nine stores till now. Should we expect an acceleration of store openings for COS [ph] in the second half?

Jyrki Tervonen

We tend to open more in the second half and first half for COS.

Operator

Thank you. Our next question comes from Anne Critchlow. Please go ahead.

Anne Critchlow - Societe Generale

My first question is about & Other Stories. You say in the statement that's now generating revenue, but I guess it's been generating revenue for some time ever since you opened the doors of the first store. Did you mean EBIT, so making a contribution to profit?

Jyrki Tervonen

No it was more, of course we’re generating nice revenues increase.

Anne Critchlow - Societe Generale

Okay. And is it making a positive contribution to profit now?

Jyrki Tervonen

We don’t comment on profitability concept but we’re happy with the development. Absolutely.

Anne Critchlow - Societe Generale

And then the second question concerns your southern hemisphere sales. You've got quite a few areas now, so I'm wondering if your experience of what sells there is helping inform you of trends that might sell in Europe six months later.

Jyrki Tervonen

I don’t think it's that simple but of course having both online and sales in the Southern Hemisphere helps us to get a better picture of how fashion moves and changes absolutely.

Operator

Thank you. Our next question comes from the line of Jamie Merriman. Please go ahead.

Jamie Merriman - Sanford Bernstein

My question is about the sustainability initiative that you've been working on and some of your comments about rising manufacturing wages that you're seeing in Asia. Can you give us some indication about the level at which you're experiencing that increase? And also just philosophically is your view that customers are understanding of that and willing to pay a bit more for a product that's more sustainable. Thanks.

Jyrki Tervonen

Yes, I’m glad you noticed that product sustainability is very, very important and we take this very seriously. When it comes salaries, one example is of course Bangladesh where minimum salaries were up 78% as of 1st of December and of course this is reflected to the cost, that’s what we say with increased salary, cost inflation among the suppliers. And of course that’s part of we have to pay that but we also see positive things coming out of this. We see that in the long term at least to better stability and better quality and less unrest, so it's a very good thing and first of all sustainability is good for the people and the environment. So that was the salary. What was your second question please?

Jamie Merriman - Sanford Bernstein

It was just about are you seeing indications from customers that they understand your work on sustainability and are willing to absorb some of that cost.

Jyrki Tervonen

Yes we see definitely that is not as short term, this is something that’s becoming more and more important and we see that more and more customers are asking for it. We also see that our -- when we look for employees they want to work for the good companies so it's very important, it helps us in that perspective as well and also for us to work within the company. I mean we want to be proud of what we do and I’m very proud of what my colleagues and the company does.

I would just add one more thing, when it comes to the increased cost from the suppliers we decide not to pass it on to the consumers, that’s the reflection in the gross margin.

Operator

Thank you. Our next question comes from Dana Telsey. Please go ahead.

Dana Telsey - Telsey Advisory Group

Can you please comment on the H&M sport collection, how well it's been received, and how many stores it's being expanded into? And then any updates on raw material prices, cost inflation and currency, and the outlook for their impact on the gross margin. Thank you.

Jyrki Tervonen

First question sports, it's been very well received and I’m very happy and so far we have extended range in around 50 stores and we have number of stores with the sport in generally and number of stores around 2000 stores with ladies sports et cetera and we have now decided to expand this going further as a result of the very good reception. And your second question was about trying to quantify the increased cost in -- its very difficult for us to quantify it so that’s why we say it's increasing but it's difficult to quantify.

Dana Telsey - Telsey Advisory Group

When you mention the long-term incremental investments for this year, should we expect that going forward also?

Jyrki Tervonen

For this year we have quantified it to around 600 million to 800 million. Next year they will continue but we will have to come back about at the level -- whether it's going to be increasing further or decreased but let’s come back to that later on.

Operator

Thank you. Our next question comes from Geoff Lowery. Please go ahead.

Geoff Lowery - Redburn Partners

A question on online, please. In your big existing online markets, what proportion of the overall H&M range is actually available online to markets like UK, U.S., Germany? And how quickly do you expect to close that gap, as it were?

Jyrki Tervonen

We’re in many countries, we offer most products both online and offline, but I don’t think the target is to be a 100. Some products will be available only online and some products only offline. So this is a case by case but it's -- you could say that most products now are available in both channels.

Geoff Lowery - Redburn Partners

And the second, a very anoraky one. How big is the store in Melbourne?

Jyrki Tervonen

It's around 5000 square meters.

Operator

Thank you. Our next question comes from Andrew Hughes. Please go ahead.

Andrew Hughes - UBS

Just going back to your comments on supply chain and sustainability and minimum wage increases, just looking at it from the customers' perspective, what do your surveys show about whether people actually care about it and whether they're changing their shopping habits? I'm just trying to gauge whether we're right at the start of you getting benefit from it, or you're already seeing that come through in shopping habits.

Jyrki Tervonen

Yes more and more people are asking for it and it's becoming more and more important and of course we want to be proactive.

Andrew Hughes - UBS

And that's showing up in all your survey work?

Jyrki Tervonen

Absolutely.

Andrew Hughes - UBS

And a second question on footwear. Again, what's the opportunity there? Footwear presumably as a percentage of sales currently is miniscule. Would that be the right word?

Jyrki Tervonen

We wouldn’t invest in shoes if we didn’t see a very interesting potential.

Andrew Hughes - UBS

So as a percentage of sales currently, are we talking about just 1% or 2%?

Jyrki Tervonen

I will let you guys do that kind of guessing. We don’t disclose different part. Sorry.

Andrew Hughes - UBS

Okay. That would be a guess if I had to try. And perhaps just one last one. I know that following on from Anne's question about & Other Stories, you said that all the other non-H&M brands contributed. What did you mean by that? Did you mean that all together, those non-H&M brands saw profit growth?

Jyrki Tervonen

No I said when we talk about revenue increase and they all contributed to the revenue increase.

Andrew Hughes - UBS

I should hope so on that. But no comment on non-H&M profitability just all combined?

Jyrki Tervonen

I’m terribly sorry, no.

Operator

Thank you. (Operator Instructions). Our next question comes from Fraser Ramzan. Please go ahead.

Fraser Ramzan - Nomura

Actually, it was just a point of clarification. I think I have a very bad phone line and therefore missed something. Did you indicate you had 16% to 17% of revenue online in answer to Chris' question?

Jyrki Tervonen

No we don’t disclose how much we sell online. There must have been confusion somewhere. What was the question I answered?

Fraser Ramzan - Nomura

Okay. So you gave no indication. And you also indicated you had to absorb a minimum wage increase in Bangladesh. What was the number?

Jyrki Tervonen

The minimum salary increase was 78% in Bangladesh.

Fraser Ramzan - Nomura

78%. Thank you very much. Sorry, two geeky questions, but thank you very much.

Operator

Thank you. Our next question comes from Rebecca McClellan. Please go ahead.

Rebecca McClellan - Santander GBM

If you adjust the gross margin in the second quarter for the mark-down and for the longer-term investment, it looks like the external factor contribution was down 25 bps. Is that what you're thinking for the third quarter as well?

Jyrki Tervonen

What the gross margin becomes is, of course, at the end of the day, our -- what we do with the offering with the mark up and then the fabrics and whatever, there is lot of different factors that affect the gross margin but we say that the external factors are more or less at the same level for as we see it for Q3 as Q2.

Rebecca McClellan - Santander GBM

Okay. And just another question in fact. Has there been any change in the average selling price over the spring/summer versus the previous season?

Jyrki Tervonen

When it comes to pricing, we -- for competitive reasons, we choose not to comment on our pricing. Sorry.

Operator

Thank you. Our next question comes from Paul Rossington. Please go ahead.

Paul Rossington - HSBC

I was just wondering if you could put a little bit of color on your performance or experience of the U.S. market recently. There's been a lot of discussion about how valid these propositions are taking share at the expense of some of the incumbent brands in that space. Are you able to give us a few lines of how you're finding that market right now?

Jyrki Tervonen

Well the U.S. is as always highly competitive as we’re doing well and we increased sales 22% in the quarter and of course we’re very happy especially with our online launch.

Paul Rossington - HSBC

And are you seeing -- I presume by default, because of the rate of growth you're achieving, you're taking share, albeit off a relatively low base within the market. Is there anything to suggest that there is a structural shift in spending habits in that market at all?

Nils Vinge

I think it's very difficult for us to see that but as I have said we are still very small player in the U.S. market, even though we are now nationwide and we have 313 stores and we're expanding quickly. And we continue to take market share and we continue to see a great potential for H&M. I think the U.S. shoppers have taken H&M to their hearts and they appreciate fashion quality at the best price.

Operator

Thank you. Our next question comes from Chris Chaviaras. Please go ahead.

Chris Chaviaras - Barclays

One more question for you. You mentioned that costs will be higher in 2014. I wanted to clarify is that mainly because of stores or did you mean there is incremental cost investment beyond previous guidance of the SEK600 million to SEK800 million; just to clarify that.

Jyrki Tervonen

Sorry what cost?

Chris Chaviaras - Barclays

You mentioned in the beginning of the call that the costs in 2014 will be higher than in 2013. Now that's natural to assume given that you have store growth, but I wanted to clarify if you meant that cost investments will be higher in 2014 rather than 2013.

Jyrki Tervonen

They are not long term investments, it will be approximately SEK600 million to SEK800 billion, higher 2014 to 2013

Nils Vinge

Exactly the same message as in Q1.

Operator

Thank you. We have a follow-up question from Charlie Muir-Sands. Please go ahead.

Charlie Muir-Sands - Deutsche Bank Research

Yes, sorry. I wanted to ask about your thoughts on the external factors for the gross margin in the fourth quarter. I know it's a little bit further off, but given the recent decline in the cotton price, I wondered whether you see any lagged effects perhaps trickling through from then on or whether the wage pressures will continue to result in a net negative.

Jyrki Tervonen

Well we definitely see that the wage pressure will continue as you said. I mean there is lot of different factors and we’re still buying for Q4 but all in all I would say pretty much the same picture as for Q3 which is negative.

Operator

Thank you. We appear to have no further questions at this time. I will now hand back to you.

Nils Vinge

Okay. Thank you all very much for participating in this conference call. We wish you all a great summer and for those of you in the Southern Hemisphere, we wish you a great winter. And we will come back for the nine months results on September 26.

Operator

Thank you. Ladies and gentlemen thank you for your participation. This concludes today’s conference. You may now all disconnect your lines and once again thank you.

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