M
ASTER
T
HESIS IN
F
INANCIAL
A
NALYSIS
F
INANCIAL
A
NALYSIS AND
V
ALUATION OF
INDITEX
C
EYHUN
N
ECATI
P
EHLIVAN
2
E
XECUTIVE
S
UMMARY
In this study, we are interested in determining
the value of the Spanish clothing giant
I
NDITEX
Group, now the world's largest
clothing retailer. Its flagship chain store is
well-known Zara. The Group also owns
brands such as Massimo Dutti, Pull and Bear,
Oysho, Uterqüe, Stradivarius and Bershka.
In spite of volatile raw material costs, unstable
world economy, financial crisis, currency risk
exposure and fierce competition in the market,
the growth of I
NDITEX
is unstoppable.
The Spanish Group now runs more than 5000
stores in 78 countries with a remarkable
expansion
into higher-growth emerging
markets.
I
NDITEX
's cheap-and-chic line has changed the
face of the industry. Thanks to its "fast-
fashion" strategy and highly flexible supply
chain, new designs can be created as the
season moves along and hence rapidly adjust
its supply to meet the customer's demand.
I
NDITEX
's balance sheet analysis shows a net
negative working capital that can be explained
by its business model. Profitability analysis
such as EBITDA margin and ROIC, based on
the NOPLAT calculations through income
statement, demonstrates that its closest
competitor H&M is slightly above I
NDITEX
.
Finally, cash flow analysis confirms the
financial health of I
NDITEX
and demonstrates
that it is not facing any liquidity or insolvency
problem.
According to the DCF valuation, the target
price is estimated at EUR 81, 38% higher than
the current share price. A comparison with the
market multiples valuation indicates a soaring
target price. This difference leads us to
conduct a scenario analysis focused on the
best and the worst cases.
UC3M Student Research
The material in this report has been prepared and
published for educational and discussion purposes
only.
Recommendation: BUY
Source: I
NDITEX
Annual Reports, Bloomberg.
Key data
Company
Inditex
RIC
ITX.MC
Bloomberg
ITX:SM
Market cap (USDm)
50,099
Market cap (local currency m)
EUR36,676
Shares outstanding (m)
623,33
Target price
EUR81
Share price
EUR59
Potential return (%)
38%
12 September 2011
Ceyhun Necati Pehlivan
Master in Financial Analysis
Universidad Carlos III de Madrid
Disclaimer & Disclosures
This report must be read with the disclosures and
disclaimer at the end of the document, which forms
part of it.
3
T
ABLE OF
C
ONTENTS
E
XECUTIVE
S
UMMARY
... 2
1. I
NTRODUCTION
... 6
2. C
ORPORATE
I
NFORMATION
... 8
a) History
...
8
b) Brand
portfolio
...
8
c)
Shareholding structure and corporate governance ... 10
3. I
NDUSTRY
A
NALYSIS
... 13
a) Manufacturing
costs
...
13
b) Macroeconomic
factors
...
14
c) Currency
Risk
...
14
d) Market
competition
...
15
4. G
EOGRAPHY
A
NALYSIS
... 18
a) Suppliers
...
18
b) Buyers
...
19
5. S
TRATEGY
A
NALYSIS
... 23
a) Cheap-and-chic
...
23
b) "Fast"
fashion
...
23
c) Technology
...
24
d) Continuous
growth
...
24
e) Centralised and vertically integrated model ... 25
6. F
INANCIAL
A
NALYSIS
... 27
a) Reorganising financial statements ... 27
i. Accounting
rules...
27
ii. Reorganising the balance sheet ... 27
iii.
Reorganising the income statement ... 30
b) Profitability
analysis
...
31
i. EBITDA
margin
...
31
ii. Return on invested capital (ROIC) ... 32
c)
Decomposition of the profitability ratio ROIC ... 33
d) Sales and stores ... 35
e) Cash
flow
analysis
...
37
7. V
ALUATION
... 42
a) Introduction
...
42
b) Assumptions
...
42
i.
Sales and stores ... 42
ii. EBITDA
margin
...
43
4
iii.
NOPLAT margin ... 44
iv. Working
capital
...
44
v. Invested
capital
...
45
c) DCF
Valuation
...
45
i. WACC
...
46
ii. CAPM
...
46
iii.
Risk-free rate ... 47
iv.
Beta ()... 47
v. Risk
premium
...
49
vi. WACC
conclusion
...
50
vii. DCF
valuation
conclusion
...
50
d) Multiples
Valuation
...
51
i. Price/Earnings
ratio
...
52
ii. EV/EBITDA
...
53
iii. Multiples
conclusion
...
54
e) Scenario
analysis
...
55
i.
Best-case scenario vs. Worst case scenario ... 55
ii. Comparison of results ... 56
8. C
ONCLUSION
... 59
B
IBLIOGRAPHY
(
ONLY CITED
) ... 62
A
NNEXES
... 67
D
ISCLAIMER
&
D
ISCLOSURES
... 89
6
1. Introduction
In this study we are interested in determining the value of the Spanish fashion apparel
giant I
NDITEX
Group (hereinafter "I
NDITEX
"
or "Group"),
which owns brands such as
well known Zara and some other developing brands. Now present in 5 continents, the
world's largest fashion group has been cited several times as a unique success story, and
its business strategy has been taught at the top Business Schools around the world
1
.
Hence, we are going to update these studies, and analyse whether this success and
continuous growth is still unchanged and possible in the current global economic
recession and financial crisis as well as in the future.
In order to answer to this question, we are going to conduct several analyses. First of
all, we will take a closer look at the general information of the company such as its
history, brand portfolio, shareholding structure and corporate governance. Then, we are
going to analyse the fashion and apparel retailer industry wherein the Group operates
and see the challenges that it is currently facing. After that, we will see the
geographical market position of I
NDITEX
and the regions wherein it runs some
thousands of stores. Subsequently, we are going to analyse the business strategy of
I
NDITEX
, which is the key to its worldwide success. Later, we will move on the
financial analysis of I
NDITEX
and explore its financial performance and profitability.
Finally, we are going to conduct a stock valuation in order to estimate the I
NDITEX
's
economic value per share and determine the intrinsic value of the shares. On the basis
of our analyses and valuation, we will be able to predict its probable price evolution and
give a recommendation to the investor to buy, hold or sell the shares.
1
"ZARA: Fast Fashion", G
HEMAWAT
/N
UENO
, Harvard Business School, 2006; "ZARA: Fashion
Follower, Industry Leader", C
RAIG
/J
ONES
/N
IETO
,
The Wharton School
-
Philadelphia University, 2004.
8
2. Corporate Information
a) History
2
Industria de Diseño Textil, S.A. (Textile Design Industry), more commonly known as
I
NDITEX
, is founded in 1985 as the holding company of the group of businesses
operating at the time. However, its origins as a fashion distribution group started ten
years earlier when Amancio Ortega Gaona
3
opened his first Zara store in A Coruña, in
north-western Spain, the city which is still home to its headquarters
4
. After extending
its network to major Spanish cities, the I
NDITEX
Group moved to the international
markets with its first store in Portugal in 1988. In the 90's, I
NDITEX
began creating or
acquiring subsidiaries to manage different brands such as Bershka, Pull and Bear,
Massimo Dutti, and Stradivarius. In the 2000s, the Group turned into the world's
largest clothing retailer with more than 5000 stores in 78 countries. Today I
NDITEX
's
brand stores can be seen in the most important fashion capitals such as New York,
London, Paris and Milan.
b) Brand portfolio
I
NDITEX
currently runs 5154 stores segmented into eight branded chains: its flagship
brand Zara
5
, Pull & Bear, Massimo Dutti, Bershka, Stradivarius, Oysho, Zara Home and
Uterqüe. The distribution of stores per brand is as follows:
Figure 1: I
NDITEX
's stores distribution per brand in 2011 (04/30/2011)
Source: Own construction, http://inditex.com/en/who_we_are/stores
33%
12%
13%
14%
9%
6%
11%
2%
Zara
Bershka
Pull & Bear
Stradivarius
Massimo Dutti
Oysho
Zara Home
Uterqüe
2
http://inditex.com/en/who_we_are/timeline
3
http://inditex.com/en/who_we_are/board_members/amancio_ortega
4
http://inditex.com/en/who_we_are/our_group
5
In this study, we consider that the brand "Zara kids" with 205 stores is related to Zara, rather than an
independent brand.
9
With 1745 stores, Zara is the largest and the best known fashion brand of I
NDITEX
. Zara
is known for its stylish designs similar to the famous Italian fashion houses but with
modest prices.
After Zara come the lesser brands. Bershka, created in 1998, is the second important
brand of the Group. It is aimed at a young target market with 734 stores in 51 countries.
Pull & Bear focuses on casual clothing for young people with an independent, urban
style at accessible prices in 47 countries. Stradivarius presents its apparel for young
women in 46 different countries. The 542 Massimo Dutti stores offer an elegant and
classic style. With 443 stores in 27 countries, Oysho focuses on women's lingerie. Zara
Home specialises in home decor and linens. Finally, launched in 2008, Uterqüe is the
newest retailer
of the I
NDITEX
Group, sells accessories and fashion extras.
When we look at the sales proportions below, the previous distribution differs.
Figure 2: I
NDITEX
's sales distribution per brand in 2010
Source: Own construction,
Annual Report 2010, p. 21.
7%
2%
6%
7%
10%
65%
2% 0,5%
Zara
Bershka
Pull & Bear
Stradivarius
Massimo Dutti
Oysho
Zara Hom e
Uterqüe
For instance, Zara realises approximately 65% of all sales with only 34% of the stores
in 2010. This almost gives a double sales-to-stores ratio. Therefore, Zara is extremely
successful compared to the other brands of the Group in terms of sales-to-stores ratio.
10
Table 1: I
NDITEX
's sales-to-stores ratio per brand in 2010
Source: Own construction,
Annual Report 2010, p. 21.
Brand
Sales-to-Stores
ratio
Zara
1,9
Bershka
0,7
Pull & Bear
0,5
Stradivarius
0,5
Massimo Dutti
0,7
Oysho
0,3
Zara Home
0,4
Uterqüe
0,3
Bershka and Massimo Dutti are occupying the second position. On the other hand,
young brands such as Oysho and Uterqüe represent the weakest brands with the lowest
sales-to-stores ratio.
In conclusion, I
NDITEX
brands are aimed at all target markets. The Group continuously
grows with new stores and new brands as well as strengthens its principal brand Zara.
This multi-brand strategy offers higher growth potential whilst diversifying risk. It is
therefore the key strategy of the Group that we are going to take a closer look at
afterwards.
c) Shareholding structure and corporate governance
I
NDITEX
has been entirely owned by the founder Amancio Ortega Gaona (74) and his
relatives until May 2001 when he decided to proceed to an IPO and to sell 26% of his
shares to public investors. The IPO has been valued at EUR8.9bn ranking Amancio
Ortega Gaona as the Spain's richest individual and world's 7
th
wealthiest person with an
estimated net worth of USD31bn
6
. However, he is known for his very low profile and
reclusive personality away from paparazzi.
Since, I
NDITEX
is listed on the Spanish stock exchange Ibex 35 and is also part of
international indexes FTSE Eurotop 100, Eurostoxx 600 and sustainability indexes such
as FTSE4Good and Dow Jones Sustainability
7
.
As of January, 31 2011, parent company share capital amounted to EUR93,499,560 and
is represented by 623,330,400 registered shares of EUR0.15 par value each, subscribed
and fully paid. All shares belong to a single class and series, have the same voting and
profit-sharing rights and are represented by book entries
8
.
6
http://www.forbes.com/global/2001/0528/024.html
7
I
NDITEX
Annual Report 2010, p. 8.
8
I
NDITEX
Annual Report 2010, p. 169.
11
Table 2: Shareholders
of I
NDITEX
Source: Own construction,
http://inditex.com/en/shareholders_and_investors/investor_relations/principal_shareholders
Shareholders
Shares
%
Individuals
24.060.555
3,86%
Institutions
229.669.782
36,85%
Partler 2006, S.L.
57.872.465
9,28%
Gartler, S.L.
311.727.598
50,01%
Total
623.330.400
100%
With regard to the figures above, we note that Amancio Ortega Gaona is the indirect
holder of the shares held by two significant shareholders: Gartler, S.L. and Partler 2006,
S.L.
9
. Therefore, Amancio Ortega holds the majority of the shares and he has the
controlling voting rights of the company. In other words, regardless of the public
trading of I
NDITEX
, Amancio Ortega keeps control over his self-made empire. In terms
of corporate governance, this may lead us to ask the potential principal-agent problem
which arises under conditions such as asymmetric information, moral hazard and
conflict of interest to the detriment of minority shareholders. Nevertheless, we note that
Amancio Ortega recently stepped down as chairman of Inditex in favour of his
successor, Pablo Isla (47) who is the current Chairman and CEO of I
NDITEX
10
.
9
I
NDITEX
Annual Report 2010, p. 208.
10
http://www.inditex.es/en/press/press_releases/extend/00000823
;
http://www.independent.co.uk/life-
style/fashion/news/end-of-the-line-for-zara-tsar-who-built-a-83649bn-empire-2183197.html
13
3. Industry Analysis
a) Manufacturing costs
First of all, the textile and apparel industry went through a tough year struggling with
the surging and fluctuating prices of raw materials. It is important to note that the latter
account for c50% of input costs. Not only gasoline is very expensive, but also cotton
prices skyrocketed and reached historic highs by more than 100% in last March
11
.
According to the International Cotton Advisory Committee, cotton was the most
volatile of all the 53 exchange-traded commodities in 2010. As a consequence, soaring
cotton prices have pushed clothing prices up since the beginning of 2011, a trend likely
to continue until the end of the year
12
. Although cotton prices are currently reduced by
half since this peak, the future seems uncertain and the volatility of cotton prices
threatens the industry.
Figure 3: Monthly cotton prices over past five years
Source: Bloomberg
In addition, weather constitutes a risk factor for the cotton production. The second
largest cotton producer behind China, India suffered of low rainfall which was 80%
below normal in June, threatening cotton crop
13
. Similarly, the USA, the third largest
producer of cotton, had losses because of the poor harvest due to the extreme weather
14
.
As shown above, we should also take into consideration the whims of the nature, which
may have a negative effect on the global cotton production, so prices and the industry.
11
http://online.wsj.com/article/SB10001424053111903554904576458270983393048.html
12
http://online.wsj.com/article/SB10001424053111903454504576488072671999428.html
13
http://online.wsj.com/article/SB10001424052702304803104576425531824396852.html
14
http://online.wsj.com/article/SB10001424052702303657404576361103883263890.html
14
Secondly, with regard to the labour cost, minimum wages have been raised by average
c15% by the Chinese government in 2010
15
, and by c20% in China's biggest export
province, Guangdong. However, we do not expect higher wages and social charges in
other third world countries such as India, Bangladesh, Cambodia, Pakistan and Vietnam
which offer the lowest labour costs in the textile industry. This strong competitiveness
across Asian countries is likely to even further reduce the prices in the industry.
b) Macroeconomic factors
The consumer climate in the most important export markets such the USA and Europe
is highly uncertain
16
. Consumers are affected by the slumping housing market and high
unemployment rates in the US. Stock-market is also turbulent partly due to the
Standard & Poor's recent downgrade of the American debt. In Europe, sovereign debt
crisis also hit consumers. Hence, slowdown in consumer spending across Europe fused
with rising raw materials and supply chain costs. Therefore, consumers are currently
more price-sensitive. On the other hand, this may represent a growth opportunity for
brands with relatively accessible prices such as I
NDITEX
.
In addition, the world's largest cotton producer and consumer China is facing a growth
slowdown. A sharp slowdown in China's economy could reduce its demand for
commodities exported from other countries. A slowdown could also crimp the appetite
of China's 1.3 billion people for products from the United States and Japan, affecting
their economies.
However, in general, we expect an improvement in 2012 compared to 2011, with a
return to GDP growth in most countries.
To conclude, the textile and apparel industry is currently facing a very unstable world
economy that is hit by a severe recession and financial crisis.
c) Currency Risk
Raw materials are typically paid for in USD. Therefore, a strong USD against EUR
would put additional pressure on the companies that outsource predominantly in USD
out of the Far East but receive the vast majority of revenues in Euro or similar
currencies (e.g. SEK).
15
R
OSSINGTON
,
p. 29.
16
http://online.wsj.com/article/SB10001424053111903918104576503991750500336.html
15
Figure 4: Exchange rate: 1 EUR in USD
Source: Reuters
I
NDITEX
sources 65% of its cost of goods sold (CoGS) from Spain and neighbouring
countries (Portugal and Northern Africa), other Eastern European territories such as
Turkey. The remaining 35% is sourced from the Far East.
This low exposure to Far
East sourcing allows I
NDITEX
to better handle input costs pressures. This is not the case
of Hennes & Mauritz (H&M) that sources 65% of CoGS from the Far East in USD, and
receive an important part of its revenues from the European markets in EUR or SEK.
The geographical exposure will be further discussed in the geography analysis.
d) Market competition
Finally, we can mention the fierce competition as a challenge that market players face in
the industry. Present in 78 countries, I
NDITEX
faces competition with local retailers in
all of these markets. However, in general terms, we can compare the Spanish Group to
large international apparel retailers such as H&M, GAP, Esprit and Benetton.
High Price
Low Price
Massimo Dutti
Gap
Benetton
Stradivarius
Bershka
H&M
Figure 5: I
NDITEX
brands and
peers' market positioning map
Source: G
HEMAWAT
/N
UENO
,
p. 23
and own construction
Uterqüe
Esprit
Low
Fashion/Trendy
Zara
Pull & Bear
Burberry
High
Fashion/Trendy
16
In the Figure 5 above, we can see the peers' market positioning in terms of price and
fashion/trend
17
. Abovementioned competitors have different positions and targets
within the market. Indeed, while GAP, Benetton and Esprit are positioned within the
low fashion with middle price segment, most of the I
NDITEX
brands are within the high
fashion with low cost segment of the market
18
. According to the same figure, H&M
seems like the I
NDITEX
's closest competitor operating in the same segment of the
market.
I
NDITEX
and H&M are by far the world's largest apparel retailers with market
capitalisations of EUR36bn and EUR34bn, respectively. GAP is the American
competitor with a market capitalisation of EUR6bn. In our analysis, we will especially
consider these three companies.
17
Fashion is a subjective notion and mostly depends on individuals' taste. To be as objective as possible,
the Figure 5 has been prepared on the basis of several personal interviews with people in charge of retail
stores.
18
Zara Home and Oysho specialised respectively in home décor and women's lingerie have not been
included in the Figure 5.
18
4. Geography Analysis
a) Suppliers
We discussed above the low exposure of CoGS to Far East suppliers of I
NDITEX
and we
saw that this allows the Group to reduce the currency risk and better handle input cost
pressures compared to its closest competitor H&M. Moreover, this gives I
NDITEX
a
high degree of production flexibility, which will be also discussed in the strategy
analysis.
We see in the Figure 6 below that Asian suppliers are increased by 6% compared to the
last year, while number of suppliers from the European Union dropped. The Asian
supply price competitiveness explains it all.
Figure 6: I
NDITEX
suppliers' distribution per geographical area
19
Source: Own construction,
Annual Report 2010, p. 65.
I
NDITEX
adopted an internal Compliance Programme of Code of Conduct (Tested to
Wear) and the International Framework Agreement signed with the International Textile
Garment and Leather Workers Federation (ITGLWF). The objective is to "strengthen
the relationship in the long term with its suppliers"
20
. An environmental strategy has
also been implemented, and it involves suppliers, who must include this variable in their
working processes.
Recently, a supplier in Brazil has been accused of slave labour by authorities facing
fines and possible functions
21
. To avoid this kind of incidents and damage of the
company image, further control and monitoring of the supply chain have to be
improved.
19
Suppliers producing more than 20,000 units a year.
20
I
NDITEX
Annual Report 2010, p. 8.
21
http://uk.reuters.com/article/2011/08/17/zara-brazil-idUKN1E77G18N20110817
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