Francesco Lavecchia: Hello, and welcome to Morningstar. I'm Francesco Lavecchia, and today, with me is Jelena Sokolova, equity analyst at Morningstar. With Jelena today we are going to talk about a single stock, Zalando.
So, Jelena, as the German company recently released its 2022 full year results, I would like to start with your comments about these results. You said the results were mixed. On the negative side, revenues were flat, margins were down. But on the positive side, active customers continued to grow. So, can you give us more color about those results?
Jelena Sokolova: Yes. Hi, Francesco. Thanks for having me. So, as also its peers in online industry, Zalando experienced weakening demand trends in 2022. There were a few reasons behind that. First of all, of course, the lockdowns were canceled, and people could come back to in-store shopping. And the second, there was also a hit to consumer confidence due to inflation and also war in Ukraine.
So, for Zalando, of course, even though they tried to control the costs, but still the demand was so much weaker than they have anticipated at the start of the year. So, that of course pressured the margin. Also, 2020 and 2021 provided a very, very challenging comparison base for them as around 80% of competition, so the brick-and-mortar stores, were effectively very much curtailed. So, that benefited the online players like Zalando. So, some deceleration was to be expected and also was expected by us.
We think that longer term though, the trend towards shift to online channels is intact, driven by demographic trends, company investments and also flywheel effect. We think that the fact that active customer numbers still grew despite these more challenging conditions show the consumer interest in online channel and also in Zalando's offering.Lavecchia: In your last note, you said that as Zalando is increasing the number of its active customers, it is strengthening its position with brands and is enforcing the network effect. So, why we don't recognize an economic moat to Zalando, and what we want to see in order to assign them a moat?
Sokolova: Right. So, Zalando is very valuable, of course, for the branded partners because it provides them an access to around 10% of European population and active customers. Given that apparel industry is very, very fragmented, there are very few brands that can achieve this kind of reach on a standalone basis. However, for the end consumer, value of this offering is a little bit less obvious.
Even though the consumers might value the scope of choice that Zalando platform provides, they still might shift to lower-cost alternative if it presents itself. So, we are actually looking at the conversion rate to see if Zalando is getting better than peers at personalizing the offering for consumers as a result of their knowledge of consumer data and algorithm and as a result, making this consumer stickier. But so far, their conversion rates remain on par with the industry.
Lavecchia: Okay. After full year results, you confirmed your fair value estimate at €65 and a 5-Star rating. So, why, in your opinion, the market is discounting Zalando so heavily? And do you think there are other investment opportunities in the online fashion platform segment right now?
Sokolova: Yes. So, I think the main point of differentiation between us and the market is that we do expect that this trend of shift towards online buying of apparel in Europe is continuing despite even deceleration in this current year. So, we think that it is driven by this demographic shift, company investments and flywheel effect. And we also think that since the conditions for financing attraction got much more challenging in the industry that the strong players and strong scale players with good access to financing, like Zalando, should benefit by investing countercyclically and also gaining market share.
So, as a result of that, we do expect a faster revenue development for Zalando and also better scaling of costs and margin improvement compared to the market. And we actually also think that profitability improvement should come from faster growth and also cost control. There are also other opportunities in online fashion in Europe. ASOS, for instance, and Farfetch also look quite undervalued, also in 5-Star territory. However, Zalando is our preferred pick in this space with a combination of scale, financial resources and also valuation.
Lavecchia: Perfect. Thanks so much Jelena for your time and for your insights. For Morningstar, I'm Francesco Lavecchia. Thanks for watching.
