Which would result in the better share price reaction: a sub-3% or 27% increase in sales?
On the face of it, conventional wisdom was seemingly turned on its head in last week’s tale of two retailers.
Tesco’s shares surged to the top of the FTSE 100 leaderboard after the supermarket giant reported a 2.8% rise in sales, while Asos sold off despite its sales jumping by 27% year-on-year.
Is this outcome testing the narrative in UK retail of ‘online good, bricks and mortar bad’ seen in recent years, and what question does it raise around one of the UK’s favourite investments?
Asos is perhaps – with the exception of Amazon – the quintessential online retail brand, and has long been a stock market darling after starting life as a penny stock, now trading at £61.64.
‘There can be no clearer demonstration of how stock markets work, and how confusing they can seem, than the share price moves at online retailer Asos and grocery giant Tesco,’ noted AJ Bell investment director Russ Mould.
The simple answer to this is, of course, that sentiment drives markets in the short term; investors’ expectations of Tesco have been so dampened by its rising competition and accounting scandals, that a barely 3% rise seemed liked a turnaround.
Mould said: ‘This is why a 2.8% increase in total sales and a meagre 0.4% increase in like-for-like sales at the group level were still seen as a good result for the grocer, especially as UK operations grew on a like-for-like basis for the ninth straight quarter.’
However, beyond short-term sentiment there are some real questions about AIM-listed Asos.
The dip in Asos’s share price was also a response to the company increasing its capital investment budget for the year, to between £230 million and £250 million, up from £200 million to £220 million.
‘You don’t often see a company’s shares fall 6% after delivering 25% sales growth, but Asos’s issue is that, while it’s nailing the revenue side of the profit equation, costs seem to have a life of their own,’ said Nicholas Hyett, equity analyst at Hargreaves Lansdown.
‘Any retailer growing at 20%+ a year will need to invest, but what’s disappointing about Asos is its tendency to underestimate capex requirements by some tens of millions a year. The rapid growth isn’t delivering any meaningful margin benefits, which only adds to the frustration.’
Mould agreed, pointing to the knock on effect on the company’s cash flow.
‘This means less cash flow and additional costs in the near term, even if Asos is responding to and generating rapid growth in its core business; it shows how investors, a little more nervous after the recent slide in the broader markets, are perhaps demanding more jam today and less jam tomorrow,’ he said.
Expectation versus reality
For Hawksmoor senior investment analyst Ian Woolley, it is this exuberant investor sentiment that is a real point of danger for Asos as an investment, specifically its high valuation.
‘Asos is trading on around 80 times earnings,’ he said. ‘There are an awful lot of growth expectations built into the share price, so there is not a lot of room for disappointment.’
Woolley noted that despite there being very strong growth levels in its most recent results, this still was not strong enough.
He added: ‘That has always been a major concern for Asos, the valuation levels and very high expectations.’
Asos, therefore, is somewhat trapped between showing investors it can maintain its current growth trajectory in the short term, while also continuing to invest for the future, ramping up both US and European sales.
‘Asos’s increased capital requirements implies that the narrative of “online good” and “bricks and mortar bad” is not quite as simple as it may seem,’ said Mould.
‘The holy grail for any investor is to find a truly scalable business, one that can grow but does not require additional investment to do so.’
In the past, online retailers had been seen by many as fitting the bill by avoiding the overheads and expenses of physical high street stores.
However, Mould thinks Asos is now showing it still needs warehouses to keep inventory on hand to ensure the rapid customer fulfilment its business model relies on.
‘This investment [warehouses] can soak up cash, reduce the scope for any possible future dividends and add costs to the business, so online retail, while a powerful model, still requires careful management.’
Hyett adds that the uptick in costs as it builds out its infrastructure should be short-lived and be reduced upon completion.
‘Once that’s out of the way, increased sales volumes should see margins heading in the right direction – we hope,’ he said.