While H&M could not escape economic instability in some key European markets, the company’s geographically diversified base allowed it to deliver reasonable fourth-quarter and full-year results. With more than 17% of store locations spread across France, Spain, Italy, Greece, and Portugal, we think the quarter could have been materially worse than what was reported.
The quality merchandise at fair prices across multiple concepts kept H&M’s products in favor with its audience, and we anticipate this will remain the case going forward, as the company continues to launch locations in new countries and through new channels (online in new countries and new brands). We are updating our model after today’s conference call and will likely raise our fair value estimate modestly to account for H&M’s opportunities in years ahead. In the fourth quarter, H&M reported total sales growth of 5%, to SEK 32 billion (excluding VAT).
Twelve percent location growth (to 2,776 units) drove the increase, offset by flat sales in comparable units and significant currency headwinds. Gross margins contracted 28 basis points year over year, to 61.6%, as cotton prices, cost inflation, and currency effects weighed on results (the company does a fair amount of purchasing in U.S. dollars). On a positive note, management indicated that markdowns relative to sales were at the same level versus the fourth quarter last year.
The selling, general, and administrative expense ratio rose 115 basis points as the cost base grew because of location expansion, IT investments, increased spending for online sales, and the introduction of the & Other Stories brand. Inventories grew 10%, spurred by the aforementioned location expansion in the quarter. H&M’s financial position remained strong at the end of the fiscal year, with SEK 14.1 billion in cash at the end of the year and no long-term debt on the balance sheet.
The company is positioned to remain a compelling growth story. Management anticipates location growth again this year of 10%-15%, which would give H&M more than 3,000 locations by year-end across all of its brands. While selling, general, and administrative expenses will likely remain inflated again this year, we cannot penalize management for investing in the growth of its business, and anticipate that kronor spent today on ascertaining the proper infrastructure will pay handsomely into profitability down the line. H&M has approximately 325 stores opening in the 2013 year, with a significant proportion opening in some of its stronger performing markets recently–specifically, the United States and China.
In addition, the brands are penetrating five new countries this year (Chile, Estonia, Lithuania, Serbia, and Indonesia), indicating to us that management has no intention of slowing down anytime soon. With an upcoming presence in South America and soon-to-be online presence in the United States, we think the upside from new markets and more economically certain consumers across the globe will outweigh the temporary instability plaguing Southern Europe.
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