Description

Recommendation

Yoox Net-a-Porter (YNAP) is a global online retailer of luxury goods with EUR 2Bn in sales and over 2.9MM active customers worldwide. The Company owns and operates a range of online luxury fashion stores, both full-price and discount, and also partners with several luxury brands to power the front and back end of their online stores. YNAP was formed ~2.5 years ago via the combination of Yoox Group (the #1 discount luxury retailer known for its best in class technology and logistics platform) and Net-a-Porter (#1 luxury online retail brand with most attractive customer base) and is now well positioned as the largest player in global digital luxury with 10% market share.

The luxury goods market trails the rest of the retail sector in terms of online penetration and just 7.1% of all luxury goods are sold online today (and just 3% of hard luxury). We expect that to increase to ~11% global penetration by 2021 and believe YNAP can grow revenues 20% annually through 2021E as it benefits from this secular trend. YNAP’s increased scale should drive significant operating leverage via reduced fulfillment costs per order and G&A leverage, driving adjusted EBITDA margins from ~8% today to ~14% in 2021. At 20x our 2021E EPS of EUR2.50 we are forecasting a target price of $50 at YE2020, 76% above today’s share price of EUR28 for a 20% annualized return.

Thesis

YNAP is the dominant presence in online luxury retail and we believe the global luxury goods market will continue to follow the rest of the retail sector and move online. We believe YNAP will maintain share as this market grows for a few reasons:

·    Online retail is hard and shoppers now demand robust customer service, same and next day delivery and free returns. This burden, combined with the need to fulfill orders globally from regional stock supplies, is often too difficult for luxury brands to do in-house (for perspective, YNAP fulfills one order every four seconds). Moreover, customers and brands both benefit from online wholesale retailers like YNAP (vs single brand channels). A customer does not have the wherewithal to individually search, let alone download the app, for its various favorite brands and styles. YNAP does this for them by curating their favorite selections along with the freshest inventory, driving customer loyalty and order frequency. Luxury brands then get access to a wider range of customers then they ever would on their own.

·    However, luxury brands are reticent to partner with other online retailers like Amazon because they are fiercely protective over their brand and their customers’ shopping experience. Amazon is largely price driven with limited customer trust in their curatorial power. In contrast, luxury brands speak very highly of YNAP properties like Net-A-Porter for their success in delivering a great customer experience and protecting the brands’ perception and pricing. Because of YNAP’s superior editorial context and trusted voice with their target customer they get preferential (often exclusive) merchandising from top brands (e.g. Chanel and Gucci) who know that YNAP has the greatest chance of turning the inventory fastest at the lowest average markdown out of all other online channels.  As a result of having the best and most comprehensive selection of merchandise they attract the best customers, creating a flywheel amongst an affluent and fiercely loyal customer base.  YNAP’s average customer orders an average of nearly $400 and 3 orders per year (and this skews much much higher for top cohorts).

·    On the discount side, brands are chiefly concerned with two things: how quickly they can liquidate inventory without it hurting their next season of wares, and the price at which that inventory is liquidated. Yoox therefore benefits from the same flywheel of having the most attractive customer set who orders the most frequently, allowing them to turn inventory more quickly and eliminate inventory risk for brands. By integrating these two functions via their merger, YNAP now has tremendous visibility into its ability to sell inventory through both full-price (“in season”) and discount (“off season”) channels, improving its ROIC.  No other online luxury retailer can match YNAP’s scale on both the full-price and discount side of the market

YNAP has a few very important levers to drive growth beyond the 15% annual growth in online luxury spending forecast by industry sources over the next 5 years.  Thanks to these factors and the superior competitive position outlined above, we forecast organic revenue growth of ~18.5% / yr through FY’21

1) Increased mobile penetration

a.     Mobile shoppers now drive 43% of sales and 62% of visits to YNAP properties (up from 17% and 20% in 2012) with mobile shoppers proving to be much more valuable than the traditional desktop customer:

2) Increasing customer base with over-indexed growth of high net worth individuals

a.     YNAP is a bit different than most ecommerce businesses as 2% of customers (EIPs) contribute 40% of net revenues

b.     EIPs  order 12x as often as non-EIPs with 3x the average order value driving average spend of EUR10K annually vs. the EUR650 company average

c.     YNAP global scale allows them to invest in regional footprints (like recent office openings in the Middle East and China) to cater to these customers both online and offline. This required high level of customer service reduces churn which drives >95% retention for this customer set.  While the EUR 10K annual spending seems high, considering the well above average wealth of this segment, YNAP’s wallet share amongst these shoppers remains <40% penetrated

d.     YNAP plans to drive growth in the Middle East by targeting this underrepresented customer base (EIPs represent 3x the population in the Middle East relative to other regions) with difficult, but solvable logistics challenges (sensitive marketing regulations, right-to-left Arabic writing, extensive cash pay, difficult addressing system and multiple currencies) that fall right into YNAP’s wheelhouse

3) Increased product set – primarily fine jewelry and watches

a.     Hard luxury is a EUR54Bn market with 3.4% online penetration

b.     YNAP can sell this on a consignment model (zero inventory) and branded jewelers like Tiffany and Zenith have made this a high priority

We believe YNAP can eventually earn margins higher than that of existing online retailers as the gross profit per order, or per unit of weight, of luxury retail is so much higher than that of every day consumables like diapers, groceries or even normal apparel and fulfillment costs represent a much lower share of revenues (see Exhibit below). Likewise because of this dynamic, YNAP’s scale disadvantages in fulfillment costs versus a much larger would be competitor like Amazon are less relevant.  Moreover, we believe YNAP will benefit from integration both Yoox and Net-a-Porter onto a single technology and logistics platform, reducing costs. We expect nearly 600 bps of adjusted EBITDA margin improvement from the following:

1) Gross margin improvement (200bps)

a.     Omni-stock program (single source inventory for in-season and off-season) enables lower average markdown and higher sell-through from multibrand.

b.     Improved buying terms across multibrand in-season and off-season upon volume increase

c.     Growing share of higher-margin private label and further pricing sophistication

2) Operating margin improvement (350 bps)

a.     Fulfilment costs as a share of net revenues down 200 bps via lower handling costs as a result of greater stock allocation in Italy. YNAP currently spend EUR22 per gross order (ie inclusive of returns) on fulfillment and we expect this to drop to EUR20 by 2021 further juiced by increased AOV

i. Net-a-Porter relied on geographic specific inventory held in different regions with threshold-based stock levels to guarantee same day and next day. This impacted efforts to optimize supply and demand

ii. The primary focus of Yoox’s integration efforts with NAP was to move the new Company onto its logistics platform which includes a more centralized globally available inventory (“omni stock program”) with just in time flows connecting hub and spoke (ie order flows optimized for speed and delivery costs)

iii. This global visibility and reach should help weather regional slowdowns and allow for lower inventory levels to support the same amount of revenue

iv. The capacity utilization across the Company’s warehouses remains <40% such that there should be a good deal of fixed cost leverage as the business continues to scale

b.     G&A savings of 1%-1.5% of revenues given operating leverage on fixed costs. We remain conservative in assuming G&A doubles over the next 5 years but is outpaced by continued topline growth

c.     We forecast flattish customer acquisition costs as efficiencies in personnel costs and vendor terms are reinvested into marketing spend to drive growth

This topline growth and margin improvement should drive attractive free cash flow growth further aided by capex and net working capital savings. YNAP is completing the majority of their technology and integration investments related to the merger in 2017 and expect modest growth on that line item moving forward dropping from 7% of sales today to 4-5% by FY’21. Moreover, net working capital should fall from roughly 7% of sales to 5-6% by 2020 as better sell through on the omni-stock program leads to a reduced inventory burden.

Valuation

From a valuation perspective, we have online penetration of luxury goods at ~11% in 2021, below that of where the US is today and YNAP’s share of overall luxury ecommerce at just 10.8%, implying significant growth runway that should arguably support a valuation multiple higher than 20x EPS.

At this multiple, with the company still growing topline 15-20% per year, we are forecasting a target price of $50, which works out to a 20% IRR from today’s share price.  If you were to also give credit for ~ €4 / share of expected excess cash on the balance sheet at YE 2020, the implied share price would be €54 and the IRR would increase to 23%.   At an EPS multiple of 30x, the share price would be €75, which works out to an IRR of 36%

Key Risks

·       Amazon or others can invest heavily in their own curatorial and brand building efforts to successfully court the EIPs that have made YNAP successful to date

·       Increased competition may also force the Company to reinvest more into their business which would limit their ability to meet the margin expansion targets outlined above

·       Integration hiccups leak into 2018, limiting margin improvement and sapping management focus on topline growth

·       Luxury retailers eventually scale enough on the internet that they in-source their ecommerce operations hurting YNAP’s monobrand business (~10% of total revenue today)

Exhibit – Superior Unit Economics of Luxury E-Commerce Retail

Catalyst

• Omni-stock program improves sell through accelerating topline growth

• Introduction of private label drives earlier than expected gross margin improvement

• Lapping of recent headwinds like shutting down subscale web properties, fx headwinds, and the most disruptive integration efforts reduces noise in financials and lead to an improving multiple going forward