Inditex Analysis 2011

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Financial Analysis


Executive Summary In this document we analyze Inditex, a major fashion retailer in the world, which is rapidly expanding into emerging markets. We argue that Inditex provides a strong and unique value proposition for fashion buyers, and that it holds a powerful position over its suppliers and among its competitors. In addition, neither their value proposition nor their industry position is currently threatened, and their strategic expansion in higher margin emerging markets is providing major opportunities for growth. From a financial perspective, the data show that the company’s profitability is among the best in the industry, only surpassed by one of its main competitors, H&M. In this comparison however, Inditex’s ROE and ROA figures are distorted by the large quantity of cash currently on their balance sheet. In addition, one of Inditex’s strategic advantages is that it is extremely efficient in its management of inventory and receivables, and can also exert tremendous pressure on its core suppliers through its vertically integrated model to obtain beneficial terms of credit. This results in a negative operating working capital situation, which provides the company with a strategic advantage in terms of financial flexibility and cash flow. Finally, we have analyzed plausible strategies that the company may follow in the short term and based on this information we consider Inditex to be a very safe and lucrative investment opportunity. 1. Overview Inditex is a Spanish corporation and the world's largest fashion group. It is made up of almost one hundred companies dealing with activities related to textile design, manufacturing, distribution and retail sales. Inditex currently runs over 5,000 stores worldwide and owns 8 concepts (brands). The group designs and manufactures almost everything sold in its stores, and has developed a logistics system focused on maintaining low inventories for distributing new fashions quickly and at low cost. Amancio Ortega, Spain's richest man, and the world's 7th richest m an, is the founder and was chairman of Inditex until 2011. He retains a 59.29% stake in Inditex, which provides him effective control of the company. 2. Industry Analysis Porter’s five forces framework was used in order to examine the competitive characteristics of the fashion retail industry in which Inditex operates. Buyer power: Although purchasing volumes in the fashion sector are usually small, buyers do have strong bargaining power since the costs of switching to another brand are insignificant and competitor products are readily available. In addition, price is an important decisive factor in the buying decision, thus creating a very price sensitive market. Cutting costs through outsourcing to low-income countries is therefore a commonly observed strategy among retailers. In the financial statements, this strategy would translate into lower fixed assets and COGS. Supplier Power: Fashion trends change rapidly, which increases pressure on retailers to turn over their inventories quickly. But individual suppliers do not hold significant bargaining power vis-avis the large retailers, such as Inditex, because the cost of switching to new suppliers is minimal. This allows retailers to exercise more bargaining power over suppliers and can be translated into lower COGS and/or lower payables turnover. In addition, Inditex has a substantial share of the equity in many of its suppliers, increasing its power over them. Threat of Substitutes: It is fair to say that there is no immediate threat of substitute products in the clothing industry as such. In a narrow sense, a threat of substitutes exists in terms of customers choosing less fashionable and cheaper products, but not in the wider sense of substituting clothing as a whole. Another potential threat regarding substitutes is not directly related to products, but rather to the sales channel utilized. Internet purchases may pose a limited substitute...
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