Description

We believe H&M is a melting ice cube in fast fashion retail with a poorly defined brand position that is over-earning with increasing competition from “ultra-fast fashion” companies SHEIN & Temu. H&M is trading near its all-time high pre-COVID forward P/E multiple despite likely continued share losses into the foreseeable future leading to sales growth below expectations & consensus estimates for margins in 2024-2025 that appear significantly too high. Freight headwinds are abating this year, but underlying promotional intensity & volume deleverage are likely to drive steady-state GM degradation. Lower volumes that H&M is unable to offset by pricing (management has largely said as much) with elevated promotional intensity will likely drive FY24-25 EPS 30%+ below consensus. Freight & FX headwinds abating will be a positive for margins this year, but are masking continued underlying deterioration that will become visible as 1) market share continues to fall due to ultra-fast fashion new entrants SHEIN & Temu, 2) industry volumes deteriorate faster than expected due to challenged consumer wallets as a result of tighter credit, or 3) we lap the freight & FX tailwinds into next year. We see 40%+ downside from current levels driven by roughly equal parts earnings misses and multiple compression.

SHEIN is becoming the go-to for consumers younger than 35, with survey data indicating SHEIN is the #2 most popular shopping destination following Amazon. SHEIN has a traffic advantage given its popularity on TikTok, it has a data advantage by tracking user interests across social media & competitors, and it has a supply advantage with a direct-shipping model allowing SHEIN to price at a ~50% discount to H&M and often up to a ~70% discount to Zara.

Since the beginning of 2019, SHEIN has gone from approximately ~10% the size of H&M (in the US) to nearly double the size, and it is still outgrowing H&M by ~4x. See chart below.

Approximately ~35% of H&M customers now shop at SHEIN, up from ~7% in December 2019.

While the above only references the US, we can see a similar story globally as illustrated by app & web traffic data for both SHEIN & newcomer SHEIN-copycat Temu (owned by Chinese e-commerce company PDD).

Temu launched in September of 2022 and has followed a similar trajectory to SHEIN. Temu is now the #1 most downloaded app in the Apple app store & Google Play Store in the US. SHEIN is #2 most downloaded shopping app after Temu, followed by Amazon at #3. Globally, SHEIN has ~11x the monthly downloads & users of H&M, and Temu already has ~4x the monthly downloads & 2x the monthly users of H&M. See charts below for global comparison of SHEIN, H&M and Temu downloads and active users.

Despite the meteoric rise of SHEIN in the last 36 months, fast fashion retailers have only recently begun to feel the pain last year. This is largely due to the significantly supply constrained environment fast fashion retailers enjoyed through 2021. 2021 began with industry inventory down ~20% vs. 2019 in the first several months, in conjunction with a demand spike that began at the end of March. However, due to industry lag time of ~8 months from consumer feedback at cash register to when orders down the supply chain are affected, we didn’t see imports move higher until October. For most of the year, margins expanded substantially given tight supply & resultant increasing mix of full price sales. In 2021 fast fashion retailers didn’t feel the pressure from SHEIN competition given the tight supply environment. However, in 2022 that as industry inventory levels were bloated, which led to misses across the sector. It's worth noting that virtually all of the weakness has been misattributed to 1x COVID related normalization issues rather than competitive.

Given the tight supply environment, H&M EBIT margins expanded ~600bps in 2021, the first time margins expanded since before 2013. Then as demand normalized post COVID, and due to incremental competition from ultra-fast fashion new entrants, in 2022 EBIT margins contracted -330bps. However, despite conntinued competitive pressures, consensus implies ~300bps of margin expansion through 2024.

In addition to increasing competition, our industry conversations suggest H&M is struggling to define its brand identity. It has flip flopped several times and over the last several years it has tried to brand itself as the “sustainable” / ESG fast fashion choice. However, because their practices don’t match their branding, the company has been subject to investigations, fines & widespread allegations of greenwashing.

Fast forward to today and H&M is trading ~50% off September lows and is up ~35% YTD. Recently in 1Q23, despite sales missing expectations, Gross Margins came in better than expected (though still declined -220bps y/y), which has squeezed the bears and lifted expectations for EBIT margins to not only inflect positively this year, but continue to expand through 2025. Consensus currently implies EBIT margins expand +100bps in 2023, +190bps in 2024 & +50bps in 2025. Given elevated competitive intensity & changing consumer behavior toward “ultra-fast fashion,” along with management’s history of mis-execution and missed targets, we believe that expectations for both sales and margins are too high. While H&M still has near-term Gross Margin tailwinds from improving freight & FX, our work suggests underlying margins continue to deteriorate and 2024-25 estimates are significantly too high.

The primary downside to what appears to be an attractive fundamental setup is that 1) H&B continues to be a consensus short (though short interest has moderated somewhat since 1Q23 margins came in better than feared), 2) in 2021 H&M instituted its first ever buyback of SEK 3bn & is planning to renew it this year at the AGM, and 3) the founding family has been aggressively buying stock. For reference the founding family bought roughly ~8mn shares per month from June-Dec of 2022 & then between ~5-9mn shares per month YTD. While it may be a coincidence, purchases by the family spiked around 4Q, which was when GMs were artificially depressed (which management did not disclose). There are a number of yellow-red flags in HMB’s earnings (changing answers, increasingly dodged questions & reduced disclosures).

The company buyback, founding family buying, coupled with YTD peak >20 days to cover, served as the fuel for a sharp re-rating when margins came in better than feared. H&M is now trading at ~24x forward P/E, near its pre-COVID high of ~26-27 (briefly touched in ’07 & ’15). LT pre-COVID average is ~18x w/ range of 12-27x. In prior periods with challenged global macro, HMB traded b/t ~12-16x.

We see downside of SEK 88, or approx. ~40% downside applying 16x P/E (higher end of its range during periods with challenged macro) to our estimates that are ~30% below consensus. Note that this does not assume a macro shock, in which case the multiple is likely to be pressured further, despite founding family buying & the buyback.

If you wanted to hedge out industry risk, we recommend being long ITX SM (Zara). ITX is a much better business (better mgmt, supply chain, brand position, ROIC, & structurally better margins) & is growing faster (for reference ITX QTD growth is +14% y/y vs. HMB +4% y/y). ITX is taking some short-term pain in wage investments which will catch up to HMB in either the form of increased talent competition and/or catch-up investment potentially next year. Historically ITX has traded at a premium to HMB given it’s a better business & a sizeable premium during periods where it outgrew HMB. However, right now ITX is trading at a -4x turn discount to HMB. On fundamentals & valuation, ITX is a compelling hedge against a scenario where industry growth significantly beats expectations.

Catalyst

Catalysts:

Sales & earnings misses (exiting 2023 into 2024), consumer macro (also a risk), and cessation of buyback next year under a more challenged macro scenario.

Risks

High short interest, potential for accelerated founding family buying or an upsized buyback, and potential for industry growth to exceed expectations off of better than expected macro.