Group 9

Executive summary
● Financing: Inditex favours equity financing of activities and investments, and consequently has very low amount of long term
debt obligations. Hence, their tax expense is also somewhat high.

● Markets and brands: All brands has seen growth in sales since 2015. Zara + Zara Home remains the company’s most important
brand, representing Uterqüe has the highest compound annual growth rate in the period, while Zara + Zara Home has second
highest. The company continues to capture market share in especially America and Asia & RoW markets. Latest strategy focus
and investments are due to consolidation of their global presence, to deliver both online and physical shopping alternatives to
consumers across the world.

● Operations: Inditex’s capital structure remains stable throughout the company’s expansion. This indicates a company who
knows how they want to run their business, and has shown an ability to maintain relevant operational items at a desired level
(scalability). Their negative Net Working Capital (NWC) has further decreased in the period, and the company’s cash conversion
cycle are close to negative 37 days. Although, this is common in the retail fashion industry, the company maintains a strong
operational capability and bargaining power with suppliers and customers.

● Profitability: Cash flows to equity remains positive throughout the period, and most of the group’s organic growth, investments
and CapEx needs have been substantially financed by profits from the business. However, some decrease in margins, as well as
its low debt financing, has led to slightly lower ROE and ROCE. Company profitability ratios are still above industry average
and to be considered satisfactory, but the development should be monitored with caution.
 Sector analysis and company situation
Sector analysis: Company situation:
● The fashion retail industry is regarded as a defensive sector ● Inditex is today one of the world’s largest fashion retailers with
due to its low cyclicality. eight distinctive brands (Inditex 2019).

● Market characterized by “Retail apocalypse”, an ongoing shift ● The company has had a strong, equity-financed expansion
in consumer behavior toward more online shopping and “death period, but facing slowing growth in the last years.
of physical stores”.
● Strategy that focuses on integrating physical and online stores
● Opex-intensive industry with high raw materials and SG&A has resulted in investments in software and technology.
costs.
● Named the most sustainable company in the retail industry by
● Capex such as expenditure on PP&E is relatively low. the Dow Jones Sustainability Index for the third year in a row

● Consumers’ environmental awareness creates new market ● Low executive management turnover with founding partners
segments and requirements. still member of board.

● Highly competitive market with benefits from economies of ● Need to continue adapting to consumer demands regarding
scale. Competitors with similar concepts are e.g. H&M and sustainability and affordability.
GAP.
Revenues see declining growth and margins shrinks slightly in the period. Online sales increases its contribution to
net sales.
● Sales & growth: Declining sales growth. Although, Inditex has had a compound
annual growth rate (CAGR) of 9,35% in the period (last 5 years), they had only
3,19% the last year.

In FY2018, online sales grew 27% (accounted for 12% of net sales). The company
has invested heavily in integrated software systems to further consolidate its
position in the online fashion market.

The company has maintained its focus on organic growth, keeping M&A at a
minimum. In 2018, 91,9% of company sales came from their own-managed stores
and online.

● Gross margins and EBIT margin: for the group has decreased steadily from
2014 (59,3%) through 2018 (56,7%). This is mainly due to:
○ Higher raw material and consumables costs due to climate changes.
○ Operating leases has increased slightly due to increased new store openings
and more premium locations.
○ Depreciation expense and PP&E, Personnel, SG&A and other expenses have
remained at a stable level in the period.

● Tax and FX: Total tax contribution for 2018 was 6,166 Bn € with direct taxes being
2,764 Bn €. Income tax expense amounted to 980M €. Net foreign exchange
gains were 3M €.
Zara remains the flagship brand, while Spain is
still the most important single country. America-
region and Uterqüe brand are markets to watch in
the future.

● Brands:
Zara + Zara Home (the flagship brand) generated 68,9% of the
group’s total revenues in 2018 and has the second-largest CAGR
(10,38%) of the brands in the period. Thus, this brand is still the
most important for the group.

However, their smallest brand, Uterqüe, has had the highest

CAGR (10,4%) in the period and might become a strong
contributor in the future. This shows that the company has a strong
ability to innovate and establish new brands and business units.

● Geography:
Spain is still the most important, single-country contributor to total
revenues (16,2%), while “Rest of Europe” represents 45,1% of
sales. However, America has the largest CAGR in the period
(14,9%) and thus a market to watch in the future.
Cost lines has remained at a stable level, but higher raw materials cost drive gross and
EBIT-margins lower.

● General: Cost lines has remained at a steady level compared to

sales throughout. This is in an indication of sustainable expansion
and a well-organised business model. However, gross margin has
decreased throughout the period, mainly due to increased raw
materials and consumables costs.

● Cost of Sales (~43% of sales): Raw materials and consumables

represent almost exclusively the full amount of CoS. Has increased
from 40,7% to 43,3% of revenues in the period.

● Operating Expenses (~35,4% of sales): Personnel expenses

(~44,3%) and operating leases (25,6%) are the main drivers of
OpEx. However, Employees/Sales-ratio has declined over the
period, which indicates a more efficient use of staff.

● Capital expenditures: PP&E amounted to 38,5% of Total Assets

(primarily Fixtures, furniture and machinery, or land/buildings). Key take away: Higher raw material costs are the
Capex accounts for approximately 7% of revenues annually. main reason why gross- and EBIT-margin has
declined over the period.
Inditex is an equity-based company where the majority
of debt is current liabilities. Moreover, they have shown
the ability to maintain their capital structure
throughout their expansion.

● Capital structure: Inditex is a robust and defensive equity-based

firm.

● Financing: Their long term debt obligations are close to non-existent

and their cash & eq.-holdings is 31,3% of total assets.

● Consequently, they have a negative net interest-bearing debt (after

deducting cash) and investments are primarily equity-financed.

● Net Operating Assets (NOA): amount to only 36,8% of total assets,

while Net PP&E amount to 38,5% of total assets.

Key take away: Inditex has shown an ability to maintain its capital
structure by keeping their operational items at a steady level throughout
its expansion.
Improved NWC from 2015-19 and Liquidity
situation remains robust in the period.
Evolution of NWC in the period:
As seen in the previous slide, Net Working Capital-items had a
rather stable development compared to Total Assets in the
period. As the relative analysis shows of NWC;
● Accounts Payables has increased.
● Accounts Receivables has decreased.
● Inventories have remained at a stable level.

Liquidity:
As a result, the company’s liquidity situation remains
robust throughout the period, and well above the general
benchmark of 1.0. The company retains a strong cash balance
and a sustainable free cash flow to equity.

Cash Conversion Cycle:

Inditex is well on way to return to its 2014 figures of negative
(-) 40 days. This indicates a healthy development of avg.
days to convert sales to cash, strong bargaining power and
interest-free financing of investments in operations from
suppliers.
Return On Capital Employed
Since 2017, ROCE has decreased due to:

● A decrease in the operating margin due to increasing expenses:

○ The cost of raw material increased throughout the period, due to
climate changes.
○ The rise of rental expenses has been driven by new store openings
and premium establishments located on the world's most
important shopping streets.
○ The company has started construction of new facilities devoted to
the new Zara.com studios and working areas with the latest audio-
visual technologies.

● Foreign currency effects, mostly due to the strong euro.

FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019
Inditex is especially affected by foreign exchange rates,
as its clothes are produced in Europe, but most of the
Operating Margin 18,53% 18,00% 17,91% 17,30% 16,66% 16,45% sales are outside the Euro-zone. However, this impact is
not very significant in total figures.
Capital Engaged Turnover 1,67 1,61 1,82 1,92 1,87 1,82 ● An increase of the Capital Engaged since 2014,
translates into a CE turnover decrease of 0.08 between
ROCE 30,99% 28,90% 32,59% 33,18% 31,09% 29,94%
2017 and 2019.
ROCE AFTER TAX 23,07% 21,74% 25,29% 25,08% 24,06% 22,87%
Slight decrease in profitability margins, but still at a
satisfactory level. After 3 years of stable evolution, ROE has decreased the last
year:

● The net income has increased less than the total

revenue, generating a decline in the profitability margin
(costs have increased more than sales).

Nevertheless, the average profit margin for the retail

clothing industry is within a range of 4%-13%. Hence,
Inditex is still considered profitable compared to its
competitors.
Reasons for the increase in overall expenses are raw
material prices, new store openings and investments in
technology.

● The increase in equity and low level of debt also has some
consequence for the decrease in ROE:
FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 Equity has from 2017-2019 increased proportionally more
than debt, evidently meaning that Inditex still favors
Net income margin 14,21% 13,80% 13,75% 13,54% 13,29% 13,17% equity to finance its activities.
Sales/Assets 1,30 1,32 1,36 1,34 1,29 1,29

Asset/Equity 1,39 1,32 1,35 1,37 1,45 1,38

ROE 25,71% 23,97% 25,19% 24,83% 24,95% 23,50%

Debt level remains low and bonus dividend
payments in year 2018-2020. Dividend policy:
Debt level: The dividend per share has increased since the beginning of the
period by more than 40%, and today’s dividend payout ratio
The leverage ratio of Inditex is decreasing steadily in spite of its amounts to about ~60%.
expansion, further cementing the company’s focus on equity
financing. The ordinary dividend should increase to represent a payout ratio of
Pros with today’s debt level: 60%. Inditex will also distribute a bonus dividend totalling €1 per
● Most of the investments are financed by the company’s share due to a change in dividend policy for years 2018-2020.
funds.
● The high interest coverage ratio shows the ability of Pros with today’s divindend policy:
Inditex to handle its outstanding debt, which means low ● Provide shareholders loyalty.
risk of bankruptcy.
Cons with today’s debt level: Cons with today’s dividend policy:
● Inditex may not be investing sufficiently in technologies ● The cash paid out to investors could have been used to
and products, to stay ahead of competition in the long reinvest in the business.
term.
● Using debt to finance its activities would allow for more
tax saving.
FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019

Debt 4 477,90 4 908,30 5 906,36 6 869,88 6 709,00 7 001,00

Equity 9 246,2 10 430,7 11 410,2 12 713,4 13 497,0 14 653,0

Leverage 0,48 0,47 0,52 0,54 0,50 0,48

Statement of cash flows Financial Year (trailing 12
months) FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019

Inditex managed to control NWC Cash from Operating Activities 2 827,4 3 247,5 4 499,5 4 131,4 3 961,0 4 029,0
and liquidity risk in operations
Inventory 1 676,9 1 859,5 2 195,0 2 549,2 2 685,0 2 716,0

OPERATING 815,2 861,8 668,8 861,0 778,0 820,0

● The majority of changes in operating cash flow come from the +Accounts receivable

changes in net income, cash paid in taxes and depreciation & -Accounts payable 3 332,5 3 507,9 4 514,3 5 095,1 4 906,0 5 099,0
amortization, which account for 85.03%, -25.98% and 24.31%,
respectively. All of these items witness a slight increase in the Net Working Capital −840,3 −786,6 −1650,4 −1684,9 −1443,0 −1563,0

period (last 5 years).

+ Net Income 2 377,1 2 500,5 2 874,6 3 157,0 3 368,0 3 444,0
● Net working capital (NWC) has decreased from -840.3 (2014)
to -1563.0 (2019), with some slight fluctuations (peaking at + Net Income （ % ） 84,07% 77,00% 63,89% 76,41% 85,03% 85,48%
-1684.9 in 2017). Inditex puts increasing monetary investments
into the current operations, with a high percentage being accounts + Depreciation & Amortization 855,1 904,9 1 021,7 1 062,7 963,0 1 100,0

payable, indicating a strong bargaining power to its suppliers.

+ Depreciation & Amortization
Meanwhile, inventory increases slightly but it remains stable （%） 30,24% 27,86% 22,71% 25,72% 24,31% 27,30%
compared to total assets and the company’s overall capital
structure Cash Paid For Taxes −895,7 −707,2 −977,3 −797,6 −1 029,0 −1 070,0

● Inditex is not exposed to significant liquidity risk as it

Cash Paid For Taxes(%) −31,68% −21,78% −21,72% −19,31% −25,98% −26,56%
maintains sufficient cash and cash equivalents to meet the
outflows from its operations. Change in Inventories −142,4 −243,9 −425,1 −388,8 −293,0 −70,0

Change in Inventories(%) −5,03% −7,51% −9,45% −9,41% −7,40% −1,74%

Statement of cash flows
Investing and Financing positions are in line with Inditex’s strategies
FINANCING
INVESTING
● Inditex creates value for its shareholders thanks to adequate balance
● Inditex has over the period (last 5 years) invested mainly in between re-investment in the business and the distribution of an attractive
acquisition of fixed assets (PP&E) and intangible assets, such as and predictable dividend.
design and intellectual property. The decreases in 2016 and 2017 ● The majority of financing cash flow goes to dividend paid for the last 5
result from cash outflow from other investing activities. years (97.30% in 2018). The high level of FCFF and FCFE with
● To ensure growth and enhance flexibility, the logistics expansion decreasing leverage ratio could be the main drivers to corporate dividend
plan includes investments in logistics centres and automating policy.
processes, consequently increasing cash outflow from fixed asset. ● The group operates in an international environment, accordingly, is
● Investment in intangible assets such as industrial design, software exposed to foreign currency risk on transaction. As reported in the notes of
and intellectual property plays an important role in maintaining financing cash flow, effect of exchange rates on cash is managed by the
Inditex’s leading role. arrangement of financial hedges.

Financial Year (trailing 12 Financial Year (trailing 12

months) FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 months) FY 2014 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019

+ Change in Fixed & Intang −1 250,4 −1 796,3 −1 517,9 −1 431,6 −1 391,0 −1 462,0 FCFF 1,718.9 1,625.7 3,155.2 2,878.8 2,379.7 2,649.7

+ Change in Fixed & Intang(%) 92,56% 97,25% 62,84% 59,74% 167,19% 77,97% FCFE 1,709.1 1,626.1 3,147.9 2,925.9 2,706.0 2,872.0

Leverage (D/E) 0,48 0,47 0,52 0,54 0,50 0,48

Cash from Investing Activities −1 350,9 −1 847,1 −2 415,7 −2 396,3 −832,0 −1 875,0
Conclusions and Recommendations
Conclusion:
In general, Inditex is considered a robust, equity-financed company with profound knowledge about their operations. The company underwent a
comprehensive, but sustainable expansion in the period, investing heavily in new software and technology to meet consumer demands. Its value-
stock characteristics with a firm dividend yield policy seemingly delivers a favourable choice for defensive investors as markets continues to
become more volatile and uncertain in a late cycle. However, the negative development (decrease in margins and profitability) should be closely
monitored, to ensure the company’s ability to remain viable in the future.

Recommendations:
1. Might want to take advantage of debt/bond financing to gain benefits from tax shield, as well as leverage its robust balance sheet and
trusted position in the market. As the company should be able to obtain favourable bond covenants and interest rates from creditors, one
could argue that there is a more optimal financing structure. Accordingly, adjust group’s dividend policy after the change of financial
structure.
2. Keep investing in integrated software systems to position Inditex’ business for changes in consumer behavior and future preferences.

Positive outlook: Outlook Negative outlook:

● Increase in Online Sales. ● Economic downturn/slowing economy and generally

● Potential market growth in especially America-region lower consumption and consumer spending.
and Uterqüe brand. ● Declining revenue growth and shrinking margins, due
● Robust liquidity ratios and cash holdings. to higher raw material costs, operational leases, and
● Ability to maintain a stable capital structure investments in stores and technology.
throughout expansion.
Source: Inditex Annual Report 2018 and Bloomberg data.