The Swedish company Hennes & Mauritz AB is the second largest clothing retailer in the world, just behind Spain-based Inditex (parent company of ZARA).
The H&M Group’s business consists mainly of sales of clothing, accessories, footwear, cosmetics and home textiles to consumers. In addition to H&M Home, the group also owns several brands, as shown here, which make the company well-known for its fast-fashion clothing offerings for women, men, teenagers and children. H&M was established in Vasteras, Sweden in 1947 by Erling Persson.
In 1974, H&M got its initial public offering (IPO) in Stockholm exchange. It remained a domestic brand until in 1990 domestic market sales were outnumbered by foreign sales. H&M’s principle for expansion is that every store shall have the best commercial location. The company entered U. S and Asian markets in 2000 and 2007 respectively. Now, the company had over 3,000 stores in 53 countries with its primary markets in Germany, the US, France and the UK. Strategy During the first 30 years of its existence, the company had a low-end image, and price was the most important element of marketing-mix.
The positioning has been changed in 1980’s, when the company started to focus more on improving quality, bringing new designs, advertising and reducing operational costs. Today the company successfully realizes its business concept, which is “to offer fashion and quality at the best price”. This strategy has been adopted since then, and switching their business concept from offering “low price” to “best price” is reflected on their image and their cost structure, as it will be illustrated in the following sections of this presentation.
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It essentially means that H&M is quite design-driven innovative while maintains its quality, sustainability and high profitability. This business concept is facilitated by having few middlemen, having a broad, in-depth knowledge of design, fashion and textiles, buying the right products from the right markets and being cost-conscious at every stage. H&M does not own any factories; it chooses to have its production outsourced to independent suppliers, primarily in Asia and Europe. And it doesn’t own any of its stores, either.
Instead, H&M rents store space from international and local landlords. SWOT analysis of H&M shows that the strengths of H&M are strong brand images and low costs, and its weaknesses are slow distribution system and low quality. Opportunities of it are possible new suppliers markets in Asia; the economic crisis can increase the interest for relatively cheap clothes and its handy online markets. Growth and Expansion H&M remains positive towards future expansion and the Group’s business opportunities.
HM’s growth target remains to increase the number of stores by 10-15 percent per year while maintaining high profitability and to increase sales within comparable units. Expansion includes H&M as well as COS, Monki, Weekday, Cheap Monday, & Other Stories and H&M Home. In 2012 the H&M Group stepped up the rate of expansion and opened 304 new stores net compared to the originally planned 275. The strong pace of expansion continues into 2013 with a planned 350 new stores net. The highest rate of expansion will be in China and the US.
There is also great potential for expansion in other markets such as Russia, Germany, the UK, Italy, Poland and France. Competitors H&M faces the fierce competition of the fashion industry: while Inditex(Zara), Uniqlo, GAP, and Mango are H&M’s key international competitors, local competition may also represent a threat and vary from market to market (for example, Forever 21 and TopShop in the Asian market).
In order to conduct this business analysis, GAP has been selected as the benchmarking target, since both are successful apparel companies and have a
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huge popularity in the same industry. However, it must be noted that they adopt different business strategies, which ultimately also affect their performances significantly as it will be demonstrated more in depth in the following sections of this presentation. In short, currently H&M has a continuous sales growth, even though its pace has been slowing down. The two main initiatives mentioned previously (internet store and new brand launch) are expected to accelerate the growth rate to the same level of the past years. Cash Flow Analysis H&M Cash Flow Analysis
Major source: CFO, CFI: change in financial investments, 3-12 months Major use: CFI: investments in fixed assets CFF: dividend GAPCash Flow Analysis: Major source:CFO is declining in line with net income. Major use: CFF for Repurchases of common stock, which caused manipulation of EPS. The growth rate of net income is smaller than that of EPS. Earning Quality Analysis Revenue Management Detection Net Sales and Account Receivables for H&M and Gap ($ in million) 2006 2007 2008 2009 2010 2011 H&M Net Sales 9,876 11,312 12,783 14,639 15,663 15,882
% of growth (YOY) 14. 54% 13. 00% 14. 53% 6. 99% 1. 40% Account receivables 125 162 287 287 326 337 % of growth (YOY) 29. 71% 77. 45% -0. 05% 13. 47% 3. 50% AR Turnover 41 37 21 27 24 23 Days receivable turnover 9 10 17 14 15 16 GAP Net sales 15,923 15,763 14,526 14,197 14,664 14,549 % of growth (YOY) -1. 00% -7. 85% -2. 26% 3. 29% -0. 78% Account receivable — — — — — — Source: H&M Annual Report, GAP 10K report H&M has continuously growing net sales. For H&M over the past 6 years, net sales have grown 60. 82%, while GAP’s net sales have decreased by 8. 63%.
H&M’s net sales have surpassed GAP since 2009 and maintained high growth rate even during and after financial crisis due to 1) successful expansion to Asia and US 2)The sales in Western European Countries have maintained the same level or recovered very fast during and after financial crisis, according to Morgan Stanley’s report. Compared to GAP, H&M had small amount of Account Receivables as 1~2% of net sales. However, it should not be an issue since Days receivable turnover was 17 days at most, which was almost equivalent to cash sales. Volatility of Earnings Detection
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($ in million) Standard Deviation 2006 2007 2008 2009 2010 2011 H&M Operating Income 454 2,211 2,656 2,910 3,128 3,563 2,945 CFO 468 1,742 2,223 2,596 2,597 3,156 2,517 Ratio 96. 89% ? ? ? ? ? ? GAP Operating Income 289 1,225 1,315 1,548 1,815 1,968 1,438 CFO 337 1,250 2,081 1,412 1,928 1,744 1,363 Ratio 85. 79% The operating income and CFO were not manipulated. CFO should roughly mirror the If the ratio (Standard Deviation of Operation Income to Standard Deviation of CFO) equals 1, it means that the CFO roughly mirror the operating income, are neither manipulated.
Compared to GAP’s ratio, H&M’s ratio is more close to 1, implying that the volatility of operating income and CFO is roughly the same. Profitability and Risk Analysis Operating performance of H&M The total amount of sales has been increasing from the year 2006, but the growth rate of sales fails to boast the same trend. Sales growth rate was stable at around 14% per year from 2007 to 2009, and began decreasing sharply from the year of 2009 and the downward trend was still intense last year making the increase of total sales barely noticeable in the year 2010 and the year 2011.
As H&M is an international corporation, its sales are spread all over the globe. So it may be beneficial to perceive into its segmented markets and see what is happening there. Germany is the hugest market of H&M which accounts for about one third of the total sales, and other major markets are France, Sweden, the United States, and the United Kingdom. The other markets which are not mentioned here together account for nearly half of the total sales. By delving into specific markets of the company, we can see that the growth rates of sales were in different trends and were fluctuating all the time years other than 2010, and they
simultaneously went downward in the year of 2010 and 2011. Moreover, in some markets, say in Germany, the decrease was so early as appeared in 2009, and the result is so awful as is already negative in 2011. This analysis tells us that the company owes its downturn in sales growth to nearly all its segmented markets instead of some specific markets, but the reasons of the downturn to a large extend have nothing to do with any specific markets, which means the reasons of the downturn must either exist within the H&M company as a whole or come from the global business environment.
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One major reason is the appreciation of Swedish krona, and this has a significant negative effect when converting sales from local currencies into the company’s reporting currency. Consequently, sales in local markets grow faster than the statistics listed above. However, as the sales growth rate is also declining in Sweden where the currency exchange risk doesn’t exist, there is definitely some other reason accounting for the overall downturn, which is to be analyzed in the following part of the report.
The sales do grow slowly, but whether or not the negative trend of growth rate of sales is a problem depends on its interaction with other financial results. If the COGS and other expenses decrease no slower than the sales rate, the phenomenon mentioned above isn’t worth worrying so much, for the profit is still increasing only may be at a relatively slow speed. However, if the COGS and other expenses growth rate decrease slower or even increase at this time, the problem is serious, for the profit growth rate is much lower than before and may even be negative to indicating that the company is undergoing a loss.
As is seen in the figure, the growth rates of COGS and expenses decreased faster than total sales in the year 2007, 2008, and 2009, making the growth rates of gross margin and operating margin relatively stable and gross margin and operating margin slightly increasing in those years. This means that the company cut down its expenditures to make the price lower in these years, and the strategy worked well by attracting more clients, thus resulting in favorable profit growth rates. However, in 2010 and 2011 while the sales growth rate was still decreasing, the growth rate of expenses began to increase, giving rise to the consequence that the
growth rates of profit margins suffered a sharp decrease to negative numbers, and profit margins decreased. This is a serious problem which needs to be analyzed in depth and handled effectively. One major reason of the increased expenditure is the fierce competition in the bad times of economy. In order to gain market share, H&M took intensified multiple price activities and markdowns which increased the expenditures and decreased the profits of the company. Another major reason is the cost inflation in the sourcing markets; especially the increase of the cotton prices that led to increased purchasing costs.
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The two factors are mainly responsible for H&M’s increase in costs and expenses. The effect doesn’t affect H&M only, and we can perceive decreased profit growth rates in all the three major companies in the fast-fashion retailing industry. All three companies enjoyed operating profit margin increase in the year 2009. However, in 2010 and 2011, H&M and GAP suffered decrease in operating profit margin while Inditex managed to keep its operating profit margin constant. This can be quite reasonable, for the factors increase the cost and expense are industry-wide and all the practitioners in the fast-fashion industry suffered.
Asset utilization The total asset turnover and inventory turnover of H&M are quite stable all these years with slight fluctuations around the average level of 3. 69 and 1. 84 respectively. So this indicates that even in the times of downturn (2010 and 2011), the company manage well in the view of inventory utilization and total asset utilization. The situation is different for receivable turnover, the average level of receivable turnover of H&M is normal and within half a month the receivables will be collected which poses hardly any threats to the company.
On average, the receivable turnover of H&M is nearly the same with that of Inditex, but the point is the two companies share quite different pattern of the changes underwent by the two companies. As for H&M, the receivable turnover fluctuated but decreased to a lower level; as for Inditex the receivable turnover is increasing over the time and the number nearly tripled during the past 5 years. This means the two companies are imposing quite different sales strategies with Inditex giving its credits to fast repay customers and H&M place less emphasis on this point in order to expand its brands in the following years.
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The decline of the H&M receivable turnover won’t last long as H&M maintains as a fast-fashion winner, if its expansion plan works, the receivable turnover may rebound as its products may be fast sold, its market power grows and cash can be collected in short time. In a word, H&M is experiencing declining effectiveness of its firm’s credit policies right now and the level of investment in receivables needed to maintain its sales level increased. Overall Profitability Generally speaking, the overall profitability of H&M’s total assets are great, higher than its main competitors.
This means H&M is utilizing its assets effectively to generate income. However, as the profits of H&M in the year 2011 decreased, the ROA decreased accordingly. The same rationale works for Inditex and GAP. The future ROA depends on the future of profits of H&M and the possible changes in total assets. Business Risk Fashion The risk of fashion is embedded in the industry property. Fashion has a limited shelf-life, and there is always a risk that some part of the collections will not be well received by customers.
Within each concept it is important to have the right volumes and achieve the right balance in the mix fashion basics and the latest trends. To optimize fashion precision, the Group buys items on an ongoing basis throughout the season. Weather Products of H&M are purchased in order to be sold on basis of normal weather patterns. Deviations from normal weather conditions may affect sales, this is particularly true at the transition between two seasons. Negative Macroeconomic Changes
There is a risk that negative macroeconomic changes in one or more countries will result in an economic downturn, which is likely to change consumer purchasing behavior. It is therefore important to be aware of such changes which may affect the Group’s business and to have a flexible buying model that can be adjusted to different market conditions. External Factors in Production Countries Uncertainties also exist concerning how external factors such as raw materials prices, transport costs and suppliers’ capacity will affect buying costs for the Group’s products.
The Group therefore needs to monitor such changes closely and have strategies in place to deal with fluctuations in external factors as advantageously as possible for both the company and its customers. Trade Intervention Buying may be affected by decisions at a national level on export/import subsidies, customs duties, etc. These effects primarily impact specific markets rather than the global company itself. Foreign Currencies Most of the Group’s sales are made in euro and the most significant currencies in which the Group’s purchasing takes place are the US dollar and the euro.
Fluctuation in US dollar or euro exchange rate is the single largest transaction exposure for the Group, which is dealt with hedging under forward contracts. Besides transaction exposure, translation effect also impacts the underlying profit or loss, and net assets of the Group. And the company takes no equity hedging for this risk. Financial Risk Liquidity With its super ability to generate cash, H&M’s liquidity is a little bit more than sufficient. It’s entirely self-funded, which means total immunization from risk related to debt or interest payments.
The cash conversion cycle and working capitals are showing positive results for the company. The cash conversion cycle is usually shorter than 3 months, the quite ratio is around 3, and CFO can cover the current liabilities well. Besides, capital expenditure ratio of H&M for past 7 years has been always above 2, and was on top of the industry in 2011. As the company is having more cash and cash equivalents than what is needed, it sets out to reduce the amount for better uses, and this results in the decrease in working capital ratios the increase of cash conversion cycle.
As besides some surplus of liquidity was reduced in the form of distribution of dividends in 2011. Solvency H&M is a company with small proportions of debt. As can be seen from the debt to equity ratio these years, debt is only around 30 percent of the equity and long-term debt can be omitted. And the company is always generating enough operations cash flow to cover all its principals’ repayment requirements, with its CFO to debt ration always above 1. This means that the company barely has any long-term risk. Earnings Forecast General Market Performance in 2011
Although H&M divides its business into three segment markets, in order to better analyze the future trends, we subdivide the markets into 6: North Europe (Nordic region), West Europe,Middle Europe, East and South Europe, North America and Asia. According to 2011 statistics, West Europe and Middle Europe markets were severely suffering from the economy downturn. Sales growth in West Europe slowed down but was still positive. For the rest of the markets, though the growth rate was not sopleasing as before, the growth kept rapid. Major Countries Performance in 2011
On the country level, H&M’s major markets can generally fall into three groups based on the sales in 2011. The three groups accounted for 92 percent of H&M’s total sales A. First group (Sales>80 billion SEK): There are 5 countries in this group: Germany, USA, France, UK and Sweden. Germany was still the largest market of H&M, with its sales amounted to 23 percent of the global sales. Among this group, USA, France and UK managed to have positive sales growth in 2011, while sales in Germany and Sweden slightly decreased. The sales of this group accounted for 51. 4 percent of sales in worldwide.
