Fashionable Investments — friend or foe?
By Ashley Gardyne, Senior Portfolio Manager — International Shares
05 October, 2017
Ecommerce is causing tectonic shifts in the retail sector — squeezing the profitability of traditional retailers, while driving growth for others. Before our recent trip to Europe we spent a lot of time researching successful European retailers like H&M and Inditex (owner of Zara) and leading online players like Zalando and ASOS (who now do free delivery and returns in New Zealand). On our trip we met a number of online and offline retailers, gaining some new perspectives and getting a better understanding of who the winners and losers may be.
Only a few years ago retailers argued that clothes shopping was an experience people enjoyed; so much so that the need to try clothes on and get the right fit would provide protection from online competition. We now know this isn’t true. First, free delivery and now more enticingly free returns, means your home can become the fitting room. This has driven the rapid growth of European online retailers like Zalando and ASOS. If online retailers can take care of delivery and returns for less than it costs to operate a store infrastructure (leases, store fitout, staff costs etc), then it is profitable for them and more convenient for customers. Fashion chain H&M already makes more than 25% of its sales from ecommerce in some of its mature markets. People will increasingly buy apparel online and retailers need to adapt.
Our portfolio company adidas is doing well, with on-trend product that is highly desired by consumers and a rapidly growing ecommerce platform. If you have product customers want, you can choose where you sell it — potentially keeping your best product to sell on your own website, and selling the rest to department stores. This creates a challenge for traditional department store chains who essentially retail products made by others. As most of this product is now available on websites like ASOS, Zalando or Amazon, the margin for simply being a retailer is under pressure.
Even in this changing world, clothing retailers can do well if they are nimble and embrace technology. Zara is a great example of this. Unlike traditional retailers that design and manufacture most of their merchandise at the start of the season, Zara make a fraction of what they expect to sell. They wait to see what is selling well in store, what competitors are selling, and what is popular on social media platforms. Zara then designs, manufactures and ships this product to store within six weeks. This speed and responsiveness to trends results in much less discounting of unsold stock at the end of season and a higher margin on each garment. Being fast and flexible is becoming a requirement for many apparel retailers.
As consumers increasingly look online to shop for clothes, it is the online malls like Zalando, ASOS and Amazon that are attracting the most eyeballs. Consumers value the ability to access multiple brands in one place, with a wide range, fast delivery and free returns.
While the world of retail is changing, there can still be attractive investment opportunities among companies that embrace this new environment. Portfolio company adidas is well positioned, with a strong product line-up and a rapidly growing ecommerce business. Amazon is the largest online apparel retailer in the US, and we are increasingly seeing brands turn to them to expand their online reach. While not currently in the portfolio, we also see both H&M and Zara as potential investment candidates in the physical retail world.