Inditex Retail Space Turnaround: adapting to omnichannel

According to RBC Capital Markets Insights, European General Retail Apparel space reductions easing. We perceive early signs of space reductions in the sector easing off, as rentals reduce and stores remain an integral part of retailers’ omnichannel offers. RBC thinks this could be helpful for valuation multiples in the sector. Retailers continue to improve the level of convenience for customers and their strong cashflow generation should allow for higher dividends in H2.

The way we shop has changed and retail spaces have evolved in terms of selling area, inventory levels and also location. Furthermore, fashion retail assortment is changing due to casual shopping trends. Retail selling layout, visual merchandising and assortment are enhanced by technological solutions such as virtual reality, demand forecasting, location intelligence and mapping, analytics, amongst others. Store efficiency is enhanced by renovation, relocation and flexibility, adding new shopping formats such as pop ups and dark stores.

Covid-19 is redefining many shopping districts across the globe. High street shopping relies on tourism and based on current trends, UNWTO expects international tourist arrivals to be down about 85% in the first quarter of 2021 over the same period of 2019. So, not surprising to walk around these areas and see stores empty. High streets are declining and different shopping areas or districts could emerge in a post-covid world.

Space reductions easing. For the omnichannel retailers lower rentals are making the economics of running stores more attractive, which remains supportive for online sales. For instance Inditex closed 9% of its stores last year, or more importantly 5% of its space. RBC expects a flat to small positive contribution from space in the year ended January 2023. Similarly, H&M has stated it will close up to 5% of its stores this year (less in space terms) and we expect this to ease off next year. Primark has continued with its space expansion during the pandemic, and we expect a further 4-5% contribution over the next year.

% Space growth for ABF (Primark), H&M and Inditex from 2018 to 2021+

Digital enhancements and effect on margins. Retailers are improving their apps and online offers to give more information about which garments are available in which stores, with a slight bias in favour of stores to allow better showcasing of product. RFID is almost a commodity amongst mass-market retailers that see the back end and front end benefits of implementing radio-frequency identification. Retailers are trying to balance offline ROI redefining their location strategy (fewer, but more efficient stores and operational omnichannel ecosytem: click & collect, ship from store, return in store, order in store, etc), but a digital shift will put upwards pressure on both gross margins and opex in the sector.

Associated British Food (ABF – Primark) is not following top leading fashion retailers space growth trend but their business model and strategy is different as well. Primark didn’t develop e-commerce and omnichannel capabilities.

What are Inditex forecasts according to RBC? (source: European General Retail – Aug 02, 2021)

For Inditex we have nudged up our earnings forecasts by 1-3%, mainly owing to a slightly firmer expected gross margin trend. We think margins are being helped by good execution of Inditex’s business model, generally good full price sales in the sector. In recent quarters we think gross margin may have also been helped by a shift to digital, given Inditex’s higher basket size online, albeit this will also inflate operating costs.

We expect Inditex’s sales to trend in line to slightly above 2019 levels, although we are mindful of some renewed store closures in Asia , with H&M last week stating that c.3% (150) of its stores are closed, compared to 130 two weeks ago. Impacted markets include Malaysia, Indonesia and India.

We do not think Inditex has significantly changed its sourcing profile in recent years, although at the margin we have seen some shift from China to Turkey for several retailers, which is known for quality, quick response product. Also important to consider the surge on shipping costs from Asia that could increase nearshoring. Transporting a 40-foot steel container of cargo by sea from Shanghai to Rotterdam now costs a record $10,522, a whopping 547% higher than the seasonal average over the last five years, according to Drewry Shipping.

Financial Times – George Steer and Valentina Romei in London (Jan, 2021)

Inditex continues to improve its online offer eg it is rolling out an “in store mode” on the Zara app which will show the sizes available of garments in store. H&M has this capability too. Zara often has a slight time delay in favour of stores driven by its distribution algorithm, which allows for better showcasing of the product.

Searching size/store availability of “DRESS WITH LINEN” in London at Zara.com

As we stated on the front page, we expect Inditex’s space reductions to ease off next year. It expects to open as many as 450 flagships in 2020-22 so we think space contribution next year should be at least flat or potentially a small positive contribution to sales.

Inditex continues to be one of the leaders in the sector on ESG. It has set a 2023 target for 100% more sustainable cotton (previously 2025), across the product range, and is on track to achieve this. Unlike some other retailers (H&M Supply Chain transparency), Inditex does not yet publish a list of its suppliers to aid transparency but we expect it to do so in the next few years.

Inditex Quarterly Estimates – July 2021. Royal Bank of Canada

Source and collaborations:

RBC Capital Markets. July 2021. Richard Chamberlain, Sherri Malek, Piral Dadhania, Wassachon Udomsilpa and Manjari Dhar.


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