H&M is a Swedish company founded in 1947. It is a family owned company controlled by Stefan Persson and family. H&M act in the fashion industry and are one of the really big global players with 2078 stores in more than 30 countries. In 2009 they launched H&M Home which sells interior textiles through internet. Recently H&M have launched several new store concepts. Other than the H&M stores there are now also Weekday, Monki, COS and Cheap Monday stores. H&M’s new concept stores and their success will probably play a greater role in the future if H&M wish to continue their fantastic growth figures.
There are also uncertainties of H&M’s future since they are in the middle of a shift of expansion focus from the European and North American markets to China, Japan and Russia. H&M’s first years on these new markets seem to have been good and these markets will grow ever more important in the future. Another very important aspect for H&M is the future direction the global economy will take. Since H&M is based in Sweden but they do a lot of their trading in foreign currency the exchange rates has a very big impact on the profit.
The economic development in China and other markets where H&M has a lot of their fabrication will also have an impact on the future profit margins. All in all H&M have been and still are a great achieving company but the future poses great new challenges that H&M has to conquer in order to live up to their great history. H&M’s environment and business Business areas H&M’s business concept is: to offer fashion and quality at the best price. H&M offers a wide range for women, men, teens and children. H&M also sell cosmetics and home textiles. H&M has since their launch in 1947 stayed very true to their core concept.
They have competed through maintaining a cost leadership strategy. Since 2004 they have started to branch out and create new concepts in order to expand further in markets where they are very well expanded and to maintain an edge over competitors with a similar competitive strategy. In 2004 they began with designer collaborations and in 2007 they launched COS, a new store concept which is also meant to offer quality at the best price but targets a higher price segment. In 2008 they acquired FaBric Scandinavien AB and the brands Cheap Monday, Weekday and Monki which are aimed at a younger clientele.
The latest addition is H&M home which was launched in 2009. While the H&M concept is still the core of the company accounting for over 95% of the stores the other concepts are growing rapidly and will probably have a big impact on the future success of H&M. Geography H&M have stores in 35 markets. They are well established in Western Europe which is by far the largest market for H&M, with Germany accounting for 25% of the total sales. USA is another big market with sales of more than 7 billion SEK (including VAT) in 2009. H&M have recently opened franchise stores in the Middle East but so far these account for less than 1% of the total sales.
The most important new markets are Russia, Japan and China. These markets currently account for 2,5% of the total sales but this is a number that will probably grow rapidly in the future. Another important geographical aspect is the manufacturing locations. 40% of H&M’s manufacturing is located in Europe while the remaining 60% is located in Asia. The future economic development in emerging Asian markets will probably play a great impact on future manufacturing costs and profit margins. Currencies As one can discern when looking at the geography section the US dollar and the euro are both important currencies to H&M.
Since the parent company is based in Sweden the exchange rate of the Swedish krona compared to these currencies is very important for H&M’s result. The Chinese, Japanese and Russian currencies will also come to play a bigger role in the future when H&M expand further on these markets. To protect against some of the currency risk when purchasing goods in euro and US dollar H&M hedge 100% of the flow of goods. Translation effects also have an impact on the result since profits are reported in SEK. The result will increase or decrease compared to local currencies depending on if the SEK have weakened or strengthened.
No exchange rate hedging is carried out against this risk. Competitors There are a wide range of competitors for H&M since they focus on a lot of segments in the clothing industry. The different concepts such as COS which is aimed at higher price segments will also face different competition. Six of the major competitors which can be said to compete with H&M in its core business and challenges H&M’s price leadership strategy are Zara, Uniqlo, Forever 21, Urban Outfitters, Target and Top Shop. In Sweden the main competitors are Lindex, KappAhl and JC.
All competitors sell pretty homogenous products which can easily be replaced. To stay ahead of the competition it is important to work hard on brand and image. The company that can offer the market the “best” fashion for the lowest possible price will be the one staying in front. Strategies H&M seem to have a very clear and easy to understand business concept. H&M seem to be very good at following their concept and this might be a reason for their success over the past six decades. When you open the annual report the business concept is the first thing you see.
This is the case for a lot of companies but one thing that separates H&M’s concept is the fact that it is easy to understand and not to abstract. H&M’s business concept is to offer fashion and quality at the best price. They have a growth target to increase the number of stores by 10-15% per year, but also to increase sale in comparable units. The growth, which is fully self-financed, will proceed with an emphasis on quality and continued high profitability. H&M’s establishment strategy means every store is to be in the best business location. They do not own any stores instead they rent the premises.
H&M does not own any factories but instead work with independent suppliers in Asia and Europe. Products are to be made under good working conditions and with the least possible impact on the environment. H&M is driven by strong values such as simplicity, continuous improvement, team spirit, cost-consciousness and entrepreneurship. H&M’s own designers interpret fashion trends and create a fashion that is accessible to everyone. The stores are renewed daily with new products. SWOT analysis Strengths H&M produce clothes of a good quality but still manage to maintain a low price compared to a lot of other clothing retailers.
H&M can do this through large economies of scale, by buying large quantities at once. They also try to keep very few middlemen when producing and shipping which also helps to keep costs down. H&M is an old company with well established distribution channels this also helps in keeping costs down. Thanks to good distribution channels they can also deliver clothes from design to stores in an average of 12 weeks only Zara have a shorter delivery time. The average for the industry is somewhere around 6 months which means H&M can respond to fashion trends quicker.
H&M have been working hard at keeping their brand fresh and trendy through designer collaborations which have been very popular with the consumers. They also work a lot with the consumers when they are designing new clothing. The new brands in H&M also help in keeping it innovative. H&M’s long story off success have also made it an organization with a lot of experience and knowledge of how to create profitability. They have experience in expansion outside Scandinavia since 1976 and these 34 years of experience creates competition advantages against other companies.
Being a family owned company have also helped H&M to withstand a lot of the short-term focus on earnings that characterizes a lot of shareholders. A high solidity with hardly any debt in the company means H&M has a very strong financial position with a triple A rating. Weaknesses The large volumes H&M buy from their manufacturers is also a weakness. If they buy in large quantities there is always the risk that the clothes will not sell. There is a lot of different markets the clothes has to be accepted in and there is no guarantee everything will be well received.
In order to make room for the next collection they can be forced to sell at discount prices. H&M also tries to satisfy a large portion of the market. They have to keep up with trends for different age groups and for women as well as men. H&M’s wide focus forces them to compete with more specialized companies and their clothes might not always be considered the most fashionable compared to other brands. Looking at H&M’s history they have on a yearly basis performed very well and in such a high performance company it is hard to discern any real weaknesses. There are a lot of threats on the horizon though.
Opportunities Managed correctly the new brands and store concepts is an opportunity to outperform a lot of the competitors in certain segments. Further acquisitions of brands that might fit into the H&M family are also interesting and can create competitive advantages. Internet is an important sales channel nowadays and further development of the online stores in more countries is another opportunity. The recession in the global economy may also prove an opportunity for H&M. First of all, the low price strategy will be a good strategy during a recession when a lot of consumers get more price aware.
Second, a lot of companies with high debt might have suffered a lot in the recession when interest rates have fluctuated a lot and even though interest rates are low at the moment the global economy is not as stable as it were a few years back. H&M’s strategy of financing growth without debt might prove a winning strategy in years to come. The largest opportunities might however be the up and coming economies. China, Japan and Russia will become ever more important globally and successful growth in these markets will be key if H&M wish to maintain great results. Threats There are several threats facing H&M in the future.
One of the most obvious is the fact that H&M is well established in both Europe and North America which forces them to look to new markets if they want to keep growing at 10-15% new stores per year. The launch in Asia and Russia seem to have gone well but if all goes well it will not be long before they have to look for new markets. Growing with 15% yearly is also a much bigger feat now than 5 years ago since the actual number of stores will be a lot higher. Establishing costs seem to have risen over the last years and this might continue due to the fact that they are expanding into markets that are different from the Western markets.
To try to ensure future growth H&M have tried to branch out and launch new concepts stores. While this might prove great if managed successfully it might also make H&M lose sight of their core values. There is no guarantee that the launch of these stores will be a success worldwide even though they have been well accepted in Scandinavia. If the concept stores provide lower margins it will affect the total margins if they invest heavy in these stores. It is very important to make sure the concept stores have as good profitability as the H&M stores. The uncertain global economic environment is of course also a risk.
The SEK have strengthened a lot against most other currencies which has had an impact on 2010’s profits and if this continues it might be a problem for Swedish companies. An economic slowdown is also a threat even though H&M might be better situated for it than a lot of other companies. Emerging markets such as China where H&M produces a lot might become more expensive to produce in as the markets develop. Valuation model assumptions H&M is a true success story. Since being founded in 1947 H&M have managed to achieve fantastic results in terms of both growth and profitability.
When evaluating H&M it is important to take a realistic and somewhat pessimistic approach to H&M’s future possibilities. Otherwise it is easy to be overly influenced by the fantastic historical numbers. H&M is and has been a high performing company but there are several challenges to overcome to keep performing at the same high levels. H&M’s great history has made their shareholders very demanding and profits and growth rates that would be spectacular in other companies might even be disappointing in comparison with H&M’s past.
All of this calls for a slightly pessimistic view because there is a greater risk of overvaluing H&M as opposed to undervaluing it. Revenue growth rate H&M have a fantastic historical revenue growth rate. Between 2005 and 2009 they have an average growth rate of 13,6%. After a dip during the recession in 2008 they have recovered and in 2009 they presented a growth in revenues of 14,5%. However, the revenue growth rate figures are influenced a lot by the strength of the SEK. In 2009 when the SEK was very weak compared to the euro and the dollar this resulted in a large positive effect on the result.
The revenue growth in local currencies for 2009 was no more than 4%. This 12,5% difference in revenue growth if you compare local currencies to SEK is not normal. The unstable environment since the financial crisis has had a great impact on H&M’s revenue growth rate. In normal years the difference in growth in local currencies and SEK is between 1-2%. In august 2010 H&M had a revenue growth rate of 7,3% compared to 17,9% in 2009. It is difficult to speculate on the yearly revenue growth rate for 2010 but we are quite certain it will not come close to 2009’s figure of 14,5%.
If you look at the growth rate in local currencies the picture is different. So far in 2010 revenues have grown with 14% in local currencies but the SEK which is very strong compared to most currencies now instead have a negative impact on the result. H&M has a growth target of increasing the number of stores by 10 to 15%. The expansion plan for 2010 was to open around 240 new stores. That number was reduced to 220 stores in the latest quarterly report. Studying the 9-month report and comparing it to the 2009 9-month report give several indicators that H&M might have problems maintaining their high revenue growth rate.
Between 2005 and 2009 H&M has primarily grown on the European and North American market where there have been an abundance of countries to grow in. They still grow in these markets but not nearly with an as high growth rate as before. Since 2007 H&M has had to shift focus to Russia, China and Japan in order to maintain their high growth rate. H&M has managed to successfully establish themselves in these markets but not enough to offset their declining growth in their more developed markets.
Establishing in these markets might also prove more expensive than in the more homogenous Western markets. In the future we assume that the SEK will stabilize compared to the other currencies which will make exchange rates have less of an impact on the result. The revenue growth will instead depend more on the local currency growth rate. We believe it will be harder and harder for H&M to grow. As H&M are nearing maturity in the European and North American markets new growth opportunities will be harder to find and there are no guarantees that the new concept stores will be as profitable.
Furthermore if you compare the revenue growth over the last five year period with the growth over the coming five years a stable growth in percentage will demand higher and higher growth in revenues in terms of absolute value. Over the next 5 year period we assume that H&M will have an average growth rate of 10% which will decline to 8% over the next five year period. EBIT/Revenue H&M have been able to generate great margins with an average EBIT/Revenue of 22,3% over the last 5 year period. This high margin might be hard to maintain in the future.
Establishing costs will rise as H&M find fewer quality locations. Establishing in economies as Russia and China might also cost more since they are very different from the Western markets H&M are used to. With a lot of the fabricators in Asia the development of the Asian economies might also increase cost of goods which will lower the EBIT margin. A stronger focus on H&M’s new concept stores will also demand more capital. To ensure the stores are profitable money will have to be spent on strengthening the brands worldwide.
On markets were H&M is fully established they will have to focus on design and other innovations to stay ahead of competitors and this might also strain the margins. The latest quarterly report show H&M still maintain their margin of 22% but over the next five year period we think H&M will have to struggle to maintain this high margin. An average margin of 20% seems more realistic which will decline to 14% over the next 5 year period. Fixed assets/Revenue & Operating working capital/Revenue Fixed assets through revenue have increased over the last 2 years. This is due to more acquisitions of equipment during these years.
This is probably depending on more capital needed for running the new concepts such as H&M home, COS, FaBric brands and the internet services. These costs might well be startup costs but we calculate with a permanent increase in these costs in the future to 15% which is closer to the past 3 year average than the 5 year average. During the recession the structure of the operating working capital changed. The financial uncertainty made H&M hold more cash and shorter than 3 month investments. The 4-12 month investments declined to 0 in 2008. This has made the operating working capital through revenue abnormally low between 2007 and 2009.
In the latest 2010 quarterly report H&M still have few investments longer than 3 months but this number should rise as we put the recession further behind us. We predict an average over the next 10 year period of 11%. Other assumptions From the end of our forecast period until H&M reach a steady state we think they will spend another 5 years in stage 1. The tax rate of 26% is taken from H&M’s current prediction of 2010’s taxes. During the year a share split took place and the number of shares and dividends were adjusted. The risk free rate is an average for 2010 adjusted up by 0. 2% since the rate have increased recently. The Beta of 0. 6 is taken from Avanza. Sensitivity analysis A 1% increase in revenue growth rate raises the share value by 25. 1 SEK or 9,2%. A decrease of 1% lowers the value by 22. 7 SEK or 8,3%. A 1% increase in EBIT-margin raises the share value by 19. 9 SEK or 7,3%. A decrease of 1% also lowers the value by 19. 2 SEK or 7,3%. The other value drivers that have a big impact are changes to number of years in stage 1 and the risk free rate. The risk free rate has a huge impact since 99% of H&M’s total value is made up of value of equity because of their low debt.
Due to small dependence on fixed assets and change in working capital changes in these value drivers have a very low impact. Other valuation models and key ratios H&M had a P/E ratio of about 21 at the end of 2009. The P/E ratio was slightly lower at the latest quarterly report. The P/E ratios before the recession was as high as 24 and indicates that H&M is probably not overvalued at the current P/E ratio. According to Reuters the average industry P/E ratio is 10. H&M also have an impressive ROE of 52% while the industry average is 6% and an equally impressive ROI of 49% against the industry average of 5%.
Asset ratios have been of no interest in H&M’s case since their low dependence on fixed assets in their business model. The EV/EBIT equals 19. 4 while the EV/Sales equals 4. 14. All these numbers help showing that H&M are very good at generating value from every row in the profit sheet. Using Gordons growth formula to value H&M we get a figure of 292 SEK. To calculate this we have used a dividend of 8, WACC of 5,97% and a dividend growth of 3,23%. History of the share In 2010 H&M did a 2:1 share split to bring the total number of shares to 1 655 072 000.
The H&M share has a high correlation with the Stockholm OMX index they generally follow each other up and down. H&M has over the last 10 year period been well above index a gap that has increased since the financial crisis. The last 5 years the H&M stock has increased yearly except during the financial crisis. The stock has now recovered and surpassed the price before the crisis. The dividends per share have increased over the last five years although not as much between 2008 and 2009 as before. H&M have delivered increasing EPS over the last 5 years but as the dividends the increase has not been as large the last year.
Recommendation H&M have been a high performing company for a very long time. There are several obstacles for H&M to overcome in the future if they wish to continue their success. When doing our DCF valuation we have come up with an equity value per share that at the 13th of October stands at 274 SEK. The price of the share today stands at 238,50 SEK. We have tried to use caution when forecasting the future and feel assured that H&M will live up to our expectations. As a result of our valuation of 274 SEK our recommendation is to buy.
