US Edition ASOS
£26.50-£2.10
Questor says SELL
ONLINE fashion retailer ASOS reported sales and profit figures for the Christmas period that would be the envy of most companies, yet shares in the Aim-listed company fell sharply on yesterday’s trading update.
The company may be growing rapidly but costs are also increasing and Questor sees no reason to change the contrarian advice to sell the shares.
Retail sales during the first three months ended December 31 increased by 38pc compared with the same period last year and this was ahead of market expectations for growth of 36pc. On the face of it an impressive result, but there was a more mixed story in the detail.
Retail sales in the UK increased by 37pc during the period and in Europe sales were up 69pc year-on-year. Combined, these regions contribute two thirds of group sales and both these results were ahead of market forecasts for first-quarter growth of 29pc and 59pc respectively.
Elsewhere the trading slightly disappointed, with US sales growth of 28pc, and expansion in the rest of the world of 19pc falling short of expectations for growth of 39pc and 28pc respectively.
ASOS shares have risen so quickly that any sign of a slowdown in the rapid growth raises questions about the heady price of the shares. They now trade on a price-earnings multiple of 100 times the forecast earnings per share of 64p. If profits and earnings per share continue to grow at more than 30pc for the next two years, taking sales to £1.6bn, and pre-tax profits of £117m, the shares will still be rated on 60 times August 2016 earnings per share of about 108p.
Questor isn’t saying that won’t happen. In fact, this British online success story will hopefully meet and exceed those targets. However, investing is all about risk, and ultimately investors shouldn’t be distracted by the siren call of sales growth – as alluring as it is – because many a fortune has been lost when sales don’t deliver profits.
Purely as an illustrative example, let’s say the growth in pre-tax profits were to slow to 20pc, and investors were willing to pay only 30 times the earnings for the shares. That would give forecast earnings per share of 60p for August 2014 and an indicative share price of £18.00, or a fall of nearly three quarters in the share price from current levels.
What this illustrates is not what will happen, but the risk to shareholders’ capital if anything should change. Capital preservation should always come first in investing and gains second.
So far everything is going well at ASOS. In fact the company said the retail gross profit margin had improved by another 90 basis points to about 52pc during the first quarter. There could be some bumps in the road though. The company is rapidly outgrowing its logistics capability and is planning a £110m investment during the next two years, with £25m to £30m going into its Barnsley site during the next eight months. That represents a 77pc increase in capital expenditure on last year.
ASOS has grown to become the largest single company listed on the Aim market with a market value of £5.4bn. It is also one of the biggest fashion retailers in the UK. But there were signs in the latest full-year results that it was working harder to deliver its impressive growth.
The marketing and advertising costs doubled from £21.2m to £40.9m last year. In terms of a ratio to sales, that is an increase to 5.3pc by the end of August 2013, and the costs are expected to increase further to 6pc of sales during the current year, or about £63m. None of these events in and of themselves is a cause for concern. However, taken together, they increase the risk to investors. Questor simply cannot get comfortable about a share price rated on 100 times earnings and to protect against any losses is more than happy to leave 10pc to 20pc on the table for somebody else. Sell.