Zalando Earnings: Profitability Improves Starkly but May Be Coming at Cost of Growth; Shares Cheap

We are maintaining our fair value estimate for no-moat Zalando ZAL as the company reported still-sluggish sales but strong improvement in profitability in the second quarter. For the full year, management slightly increased its outlook for EBIT but expects to be toward the lower end of guidance on gross merchandise value and revenue, both of which are already similar to our forecasts. We continue to view the shares as materially undervalued, trading in 5-star territory with over 70% upside to our fair value estimate. We believe Zalando is well positioned to invest countercyclically and take market share in a more challenging demand environment.

For the second quarter, group GMV was down 1.8% and group revenue was down 2.5% (versus 2.8% and 2.3% increases in the first quarter). Despite the small revenue decline, adjusted EBIT was up 88% as operating margin increased from 3% to 5.7% in the quarter. Gross margin came under pressure from the promotional environment and business mix and was down 40 basis points. Most operating profit came from improvement in fulfillment costs on improved order economics, scaling of partner business, and marketing costs. We suspect that the industry’s higher focus on profitability with minimum-order introductions and less aggressive marketing, in addition to more adverse market conditions, is putting some pressure on growth rates. Active customer numbers increased 2.4% year on year with retention among customers attracted during the pandemic generally weaker. Average orders per customer declined 3%. Overall, the off-price segment drove growth with a 16% quarterly increase. Inventory decreased 1.6%, approximately in line with revenue trends, as the company tries to conservatively manage its stock position to avoid overstocks.