H&M: growth at a cost

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Poor old H&M. The Swedish clothes retailer is invariably compared with Inditex, its Spanish rival. And it does not come off too well. Inditex has more stores, is growing faster and boasts higher profit margins. H&M is doing its best to keep up – it opened 304 new stores in 2012, and has doubled its store count in the past six years. That enabled revenues to increase by a 10th last year, despite the dire economy in western Europe, where most of its shops are located.

But the growth has come at the cost of lower returns. Five years ago, H&M made operating margins of 23 per cent, and boasted a return on equity of 41 per cent. Both metrics have declined as the company has grown – margins are now 18 per cent, while return on equity is (an admittedly still decent) 38 per cent. The company’s opening programme will inevitably tail off at some stage, and like-for-like sales growth was just 1 per cent in 2012. So any profits growth will have to be based on chasing margins back up again.

Will H&M be able to pull it off? The answer lies not in comparing the company with Inditex, which is still growing, but in comparing it with Gap. The US retailer grew from 1,300 stores in 1992 to 3,000 a decade later, but since then its store count has been broadly flat and its revenues have gone nowhere. The good news is that Gap’s margin has recovered from the nadir of 2002; the bad news is that it is still not as high as it was in 1992, when the growth spurt was in its early stages.

So H&M may get those returns back eventually if it stops opening shops, but that prospect alone does not justify a rating of 21 times forecast earnings. Like Inditex, Gap, and other fashion retailers, H&M has to find the balance between investment in new stores, growth in existing stores and improvement in profitability. At the moment, the balance at H&M looks too skewed towards the first of those priorities.

Email the Lex team in confidence at lex@ft.com

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