Zara-owner Inditex ITX 1.00% has emerged as a rare winner in the retail industry’s shift to e-commerce, making it by far the world’s most valuable fashion retailer. But there is a flip side to its success that investors ignore at their peril.
Most chains design items based on high-fashion runway templates, send the blueprints to Asia for low-cost production, then market them to consumers through well-located stores. But now online sales are cannibalizing store sales, while social media bring consumers closer to fashion trends, meaning mass-produced designs look out of date before they hit stores. Profits at former sector darling Hennes & Mauritz , HMB 0.51% owner of H&M, have cratered.
Spain-based Inditex always had a different approach: Watch what sells and quickly make more of it. The company “treats clothing as a perishable good,” notes Andreas Inderst, an analyst at Macquarie.
This model has performed well in the digital age. Keeping close to trends protects Zara from the scourge of mass discounting. And a more differentiated product has given it pricing power to roll out key online services like home delivery and returns more profitably than others. Starting in 2015, Inditex’s valuation soared relative to H&M’s.
This year the gap has narrowed. A slowdown is one reason. Analysts expect Inditex to post constant-currency sales growth of 10% for the year through January this week—still far better than the 3% increase H&M reported for the year through November, but underwhelming after Inditex’s 15% growth the previous year.
But the rally in the euro, up 16% against the dollar over a year, is the bigger problem. While the company’s sales are global, with particular strength in emerging markets, operating costs are unusually concentrated in its home country, Spain.
This is deliberate: Inditex is only able to respond rapidly to market trends because it is so centralized. The company sources roughly two-thirds of its inventory from countries close to its headquarters and design hub, rather than from Asia. All its clothing passes through Spain before being sent out in a continuous stream of small batches across the globe.
More often than not over Inditex’s public history currency has been a headwind, says Anne Critchlow, an analyst at Société Générale. But the current financial year is looking particularly bad, with a sales hit of 3% if current rates hold.
The stock has fallen by more than a third since last May. Excluding its big net cash position, Inditex trades for 15 times expected operating profits, a six-year low. For those with a longer-term view, this could be a canny time to buy into a retailer that is holding its own against online specialists such as Zalando, Asos and Amazon’s Zappos.
But don’t be fooled by the kind of constant-currency growth rates used to evaluate most consumer companies. The one problem with Inditex’s centralized operating model is that currency does matter.
Write to Stephen Wilmot at stephen.wilmot@wsj.com