H & M Hennes & Mauritz: A Company That Aspires To Make Sustainable Fashion Available To All
Summary
- A look at fast fashion behemoth’s sustainability credentials and latest financials.
- Although the nature of business is essentially unchanged, H&M is attempting to incite the industry toward sustainability through its clout and scale.
- The Group is in a financially precarious state at the moment but there are reasons to be hopeful.
Fast fashion is not exactly a darling of sustainability advocates. Its business model of churning out new collections of low-cost apparel at speed has been reviled for fuelling rampant consumerism and creating colossal environmental waste. A lot of the bad press is justified but credible numbers to back the claims are too few and far between — which gives fast-fashion retailers plenty of leeway for greenwashing their damaging practices.
Though one company appears to be genuinely embracing sustainability. H & M Hennes & Mauritz AB (OTCPK:HNNMY) (OTCPK:HMRZF) is on a mission “to make great design available to everyone in a sustainable way”, while its brands endeavor “to offer customers the best combination of fashion, quality, price and sustainability”.
Source: hmgroup.com
With the new chief at the helm, the company is accelerating its transformation along the lines of digitalization and sustainability — the two trends the pandemic has decisively fast-tracked. The Group is investing heavily in technologies to enable innovation to meet changing customer expectations around material sourcing and supply chain transparency. H&M is effectively scaling what smaller responsible fashion brands do, hence proving that sustainable fashion can be commercially viable.
The business has been hit hard over the past year but there are signs that the company's nuanced approach to sustainability — offering sustainable creations aimed at value-conscious shoppers — is working. The recovery is certain but it may take longer than initially expected due to H&M's recent misfortunes in the Chinese market.
Sustainability
H&M Group has been formally reporting on sustainability since 2002 and generally has been talking about it more than any other fast-fashion brand. But sustainability has assumed an ever-greater role starting from 2020 which saw the former sustainability chief Helena Helmersson appointed the CEO, the first outside the founding family and the first female.
A big theme driving the latest initiatives is circularity. This is reflected, first and foremost, in material choices: over 60% of all materials now come from recycled or “more sustainable” sources; cotton specifically is 100% organic, recycled, or “sourced in a more sustainable way”. The near-term innovation target is for recycled material to contribute 30% by 2025. The Group has already launched its first collection made of recycled mixed-fibre textile and first products made from Renewcell’s Circulose®. The company is also introducing new business models in the way of platforms such as Sellpy, COS Resell, and Arket Rental which encourage conscious consumer choices in the secondhand fashion market.
Another major subject H&M Group is positioning itself around is supply chain management which is primarily about enhancing transparency and ensuring fair jobs. One of the first fashion companies in the world to publish a full list of suppliers and detailed product information, H&M is now offering to share its expertise with other companies for a fee through a service called Treadler. The demand for it comes mostly from mid-size fashion brands that find tackling supply chain’s inherently fragmented structure — from product development to sourcing, production, and logistics — difficult and expensive. H&M itself continues to improve the sustainability credentials of inputs and suppliers with the help of new technologies such as blockchain and AI.
H&M Group was among the few brands that stood by its purchasing agreements in 2020 undeterred by impending losses. It was also a year in which its 2013 Fair Living Wage Strategy got updated.
Note: In local currencies converted to USD.
Source: Sustainability Report 2020
Sustainability as a growth driver
It is well-recognized that today’s consumer understands the need to make conscious decisions about what they buy and where it was made. Increasingly, consumers say they want brands and governments alike to ensure respect for human rights and the environment along supply chains. They demand greater transparency about every stage of the manufacturing and selling process. In response to these trends, more and more brands are rolling out sustainable products, certain categories of which are exhibiting higher growth rates compared to traditional counterparts.
Source: Survey by Fashion Revolution, December 2020
Yet responsible products are not always easily accessible or affordable. In fact, the typically higher price tag that sustainable fashion comes with is the biggest factor deterring consumers with positive attitudes toward sustainable products from following through with their wallets.
H&M Group is solving this issue by making sustainable choices available to the masses. In addition to transparency, the emphasis is increasingly on creating products that are made to last and developing services (such as clothes rental, garment repair, second-hand commerce, recycling) in support of circular fashion. With the health crisis underscoring the consumer emphasis on social and environmental commitments of fashion companies, H&M’s consistent promotion of sustainability is bound to produce lasting gains.
Source: Survey by McKinsey, April 2020
Financials
The first quarter of the new financial year (which for H&M Group was a period from December 2020 to end-February 2021) brought yet another dose of disappointing results. Net sales in local currencies declined 21% (-10% in Q4’20 and -18% for full FY2020) to SEK40.1b (USD4.7b) as the second wave of COVID-19 restrictions resulted in a fresh round of store closures.
Source: H&M Group
In some positive news, the Group managed to reach decent sales levels in markets where there were fewer or no restrictions, evidenced by a recovery in the third quarter of 2020 as well as an overall increase in the number of loyalty program members. Sales also picked up in the month of March, +55% year-on-year.
Online sales are faring well although there is a wide divergence between various markets. Overall, digital sales increased by 57% in the first quarter (+50% in Q4’20 and +38% for full FY2020). Digitalization is continuing at a swift pace; portfolio brands currently trade online in over 50 markets out of 72, offering integrated omnichannel customer experiences. New online sales platforms have recently been launched in Australia, South Korea, Qatar, and several Southeast Asian countries.
Gross margin was a high 47.6%; but given a higher need for markdowns, it was still lower than last year’s corresponding 51%. Net profit moved into the red (from a barely positive EPS of SEK0.75 reported for FY2020 in November), mainly because of negative operating leverage. Greater savings from strategic cost optimization may lift margins in 2021.
The Group’s balance sheet position is sturdy, with debt well-covered by operating cash flow. In February, H&M issued a €500m sustainability-linked bond, which was 7.6 times oversubscribed, to finance the transition toward recycled materials as part of a larger drive to accelerate the pace of sustainability transformation post-pandemic.
Key metrics: Despite a difficult global backdrop, H&M Group maintains high earnings quality.
| Industry Median | 2020 | 2019 | 2018 | 2017 | 2016 | |
No. of stores | NA | 5,018 | 5,076 | 4,968 | 4,739 | 4,351 |
Profitability: | ||||||
Gross Margin | 49.7% | 50.0% | 52.6% | 52.7% | 54.0% | 55.2% |
EBITDA Margin | 13.7% | 15.5% | 12.2% | 12.0% | 14.5% | 16.5% |
Net Margin | 2.3% | 0.7% | 5.8% | 5.8% | 8.1% | 9.7% |
ROE | 7.8% | 2.2% | 23.3% | 20.7% | 26.8% | 31.2% |
ROIC | NA | 1.3% | 18.3% | 17.4% | 24.4% | 28.7% |
| Liquidity: Current Ratio | 1.2 | 1.2 | 1.3 | 1.4 | 1.4 | 1.6 |
| Leverage: Debt/Equity | 1.1 | 0.3 | 0.3 | 0.3 | 0.2 | 0.0 |
| Operating: Inventory Turnover | 3.1 | 2.5 | 2.9 | 2.8 | 2.8 | 3.0 |
Source: Refinitiv
The outlook is laced with both expectation and uncertainty. The traditional sales channel will be back in the game soon but not in full force. If 2020 saw a net decrease of 58 stores, the plan for 2021 is to bring the total down by 250 more stores. New stores will be located in growth markets which, together with deepening online penetration, may help boost sales. Although higher markdowns will need to be applied to sell off earlier collections, the Group targets to increase sales by 10-15% per year in the long term. Analysts expect the company to return to profitability by the end of the financial year.
Risks
Aside from the uncertainty around recovery from the pandemic, H&M's business may suffer protracted losses in China where it has been hit by a consumer backlash following the resurfacing of its months-old statement on Xinjiang, China’s main cotton-producing region. The statement dating back to September 2020 was a response to credible allegations of forced labour practices in factories neighboring internment camps for Uighurs, a Muslim ethnic minority. H&M Group and a number of other brands had decided to express their concern by purging their supply chains of cotton from Xinjiang. At the time, it did not evoke much of a response, and this recent focus is a result of a wider government campaign to push back against sanctions from the US and allies.
H&M, lacking the brand power and differentiation of some other affected companies like Nike (NKE) and Adidas (OTCQX:ADDYY), was the hardest-hit: its products were pulled out from Chinese e-commerce apps and 20 stores are in the process of being permanently closed (possibly due to landlord evictions). This means that the company will have to bear a considerable loss in the coming quarter and full 2021. As of the latest Q1’21, China accounted for the third-largest chunk of sales with 14.4% behind the US and Germany; but a more accurate figure is about 5% which China would normally contribute on an annual basis outside of the pandemic.
Top 10 markets by sales
2019 | 2018 | 2017 | 2016 | 2015 | |
1. Germany | 14.0% | 15% | 15% | 15% | 16% |
2. USA | 13.0% | 12% | 13% | 13% | 13% |
3. United Kingdom | 6.4% | 6.50% | 6.30% | 6.30% | 6.80% |
4. France | 5.2% | 5.40% | 5.70% | 5.70% | 5.90% |
5. China | 5.2% | 5.10% | 4.70% | 4.70% | 4.90% |
6. Sweden | 3.9% | 4.00% | 4.10% | 4.10% | 4.20% |
7. Italy | 3.6% | 3.60% | 3.80% | 3.80% | 3.90% |
8. Spain | 3.4% | 3.50% | 3.40% | 3.40% | 3.40% |
9. Netherlands | 2.9% | 3.10% | 3.10% | 3.10% | 3.40% |
10. Russia | 2.9% | 2.70% | 2.50% | 2.50% | 1.90% |
Note: Full annual report for FY2020 with geographic segment information is scheduled to be published on 6 April 2021.
Source: Refinitiv
While China is a significant market for obvious economic reasons, H&M Group would do well to stick to its sustainability principles, social justice included. The company generates over 75% of total sales from western countries (Europe 55%, US 13%, UK 6%, Canada 2%) where the consumer sentiment on sustainability is especially heightened and regulations around both environmental protection and human rights are becoming increasingly tight. A number of European jurisdictions have started embedding human rights due diligence standards into law, thus making it mandatory for companies to take action to protect human rights in their own activities and within the supply chain. Transparency and reporting requirements are being upped and extended across the board.
Thus far, H&M Group has kept a neutral stance, neither retracting its position on Xinjiang cotton nor affirming it. The company may be hoping that the storm eventually blows over, as it would in the past in somewhat similar cases. (In an apparent attempt to mollify the Communist Party and shift consumer attitudes, H&M has readily agreed to fix its other ‘mistake’ over territorial mapping.) But given the growing polarization between China and the West — and the improbability of the Chinese government admitting to any wrongdoing in Xinjiang — companies like H&M still risk getting caught in the middle.
Valuation
Difficult quarters and situation in China notwithstanding, the stock listed on Nasdaq Stockholm has not dipped by all that much. As of 5 April 2021, it is down 3.5% over the past month but up 14.4% in the 3-month period and 55.1% in the past year.
The company is currently unprofitable, so the basic P/E multiple is unusable. P/B and P/CF ratios indicate that the stock is trading at a slight discount to historical averages. Enterprise value multiples point in the same direction and also reveal that H&M Group is cheaper than peers in the same industry on aggregate.
Trailing 12 months | OM:HM B | OM:HM B 5Y Avg. | Specialty Retailers Avg. |
EV / Sales | 1.8 | 1.7 | 1.5 |
EV / EBITDA | 10.7 | 12.0 | 7.2 |
Price / Book | 5.3 | 5.7 | 4.7 |
Price / Cash Flow | 11.4 | 13.2 | 12.3 |
Source: Refinitiv as of 5 April 2021
With forward P/S of 1.3, the stock is close to fair value at the price of SEK195.42 per share, against the Street target of SEK200.81.
Conclusion
Admittedly, H&M is an arguable sustainability play. However, its dogged efforts are likely to pay off through improved performance down the road. I am positive about the company but do not see much upside in the stock at this point.
This article was written by
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