Financial Position of Zara - Report Example

• Executive Summary

Zara is one of Inditex’s brands and currently the fastest growing fashion producer and retailer. The Inditex Group encompasses100 companies within the textile manufacturing, designing, and distribution sectors which produce over 84million garments annually. Although Zara faces stiff competition from companies such as H &M, the firm is strategically positioned to continue with its global expansion strategies strengthened by its unique business model. Currently, Zara controls the entire fashion production process and retail functions. The fast-changing fashion industry requires the company to adapt quickly, making it a pioneer in fast fashion. Traditionally, competitors often prioritize the production costs by outsourcing the manufacturing processes to China. Although the strategy is economical and safeguards a company’s finical health, it creates a long and dilatory supply chain. On the contrary, Zara sources the majorities of its factors of production from Spain and Portugal creating a short albeit more responsive supply chain. Despite, the higher overhead costs, Zara’s ability to react quickly has proven to be key in the fashion world, which is reflected in its strong and sound finical standings.

Executive Summary2

Introduction3

Financial Position4

Profitability4

Growth8

Liquidity10

Stock Performance12

Competitor Analysis13

Conclusion14

Reference List15

Appendices16

Appendix A: The formulae used in determining the growth ratios16

Appendix B: Zara’s Liquidity Ratios18

Appendix C: Zara’s Pest Analysis19

Appendix D: Zara’s Swot Analysis20

Appendix E: Stock performance21

Appendix F: Stock performance22

Appendix G: Completive Analysis23

• Introduction

In 1975, Zara opened its first store in Spain before its parent company, the Inditex group, was formed. Now, 42 years later, Zara is the world's leading apparel retailer managing over 20 clothing collections annually. Zara's recent flagship store in its hometown, La Coruña, Spain, exemplifies the company's growth strategy of maintaining its competitive position by focusing on building more brick-and-mortar stores, as well as, online expansion. Zara's new store opened in March 2017 with over 56,000 sq. ft replacing five smaller ones spread around the town. An analysis of Zara's financial reports indicates that the company has been a successful brand since its inception with consistent annual growth in both net sales and profits. For example, the total net sales were € 8,088 million in 2010 representing approximately 65 percent of Inditex's total sales revenues. Consequently, the 2010 Annual report indicates that Zara remains Inditex's leading brand in profitability, growth, liquidity, financial structure, and economic risks management. This report employs ratio analysis to present Zara's financial position. The report will discuss the relevant annual changes in Zara's financial position and their implication to stakeholders. Also, how the company's financial situation and performance can be improved have been appraised. Finally, the various aspects of financial performance and position that are of concern have been succinctly highlighted, and the necessary remedies suggested.

• Financial Position

The following sections will help appraise specific aspects of Zara’s financial position by analysing the respective financial ratios and company data and putting them into context: profitability, growth, liquidity, stock performance, and competitor analysis.

• • Profitability

Zara's strategic growth objective focuses on expanding "through the continuous establishment of new stores both domestically and abroad" (Eriksson & Jonsson, 2011, p. 1). Unlike the majorities of companies, Zara has managed to achieve its growth objectives while maintaining its profitability almost every year. Eriksson and Jonsson (2011, p. 1) note that this is remarkable since the profitability of most companies seeking to achieve aggressive growth often “suffer after extensively expanding into new markets" (Eriksson &Jonsson, 2011, p. 1). Therefore, the fundamental query identified in this paper is whether Zara's future profitability will be jeopardised by its continued growth.

Zara’s profit growth stagnated at € 1.41 billion in 2008, a strong performance considering the 2008/9 global financial crisis (Eriksson & Jonsson, 2011, p. 123). However, the company’s profit growth experienced a 10 percent increase to € 1.54 billion (Botter, 2017, p. 9). Since then, Zara’s profits have consistently risen through 2010, 2011, and 2012 fiscal years, in which its umbrella company, Inditex, posted a €3.9 billion (78 percent) profit growth over the five year period (4-traders, 2016, p. 4). Between fiscal years 2011 and 2012, Zara went from € 2.1 to €2.69 billion in profits, which translates into a 20 percent increase. On the contrary, the company’s primary competitor H&M’s experienced only 9 percent growth over the same period. Consequently, Zara appears to be financially sound and may continue generating over 60 percent of Inditex’s net profits since the company aims at aggressively seeking new markets (Eriksson & Jonsson, 2011, p. 34). Graph 1 shows Zara’s profitability ratios for fiscal years 2014, 2015, and 2016.

Graph 1. Zara’s profitability ratios for fiscal years 2014, 2015, and 2016

Source: (4-traders, 2016, p. 3)

Table 1 highlights Zara’s profitability values for fiscal years 2014, 2015, and 2016, which indicate that the company’s Gross Profit Ratio increased till 2015 before slowing down in 2016 (Market watch, 2017, p. 12). Two rationales help underscore the relevant changes in the company’s financial position and the implication to various stakeholders. First, the reduced selling price of products within the fashion industry due to increased competition does not correspond with the decrease in the cost of goods sold. Thirdly, the unfavourable mark-up and purchasing policies, especially in Europe, have significantly impacted Zara's profitability ratios. The primary stakeholders affected include suppliers and customers. The former is forced to supply goods by incurring higher expenses while the latter enjoy the reduced prices.

Table 1. Zara’s profitability values for fiscal years 2014, 2015, and 2016

Source: (Marketwatch, 2017, p. 3).

Zara's net profit ratio (ROE and ROI) continues to increase, suggesting the company is utilising its available resources efficiently to achieve its growth objectives. Although the ROA reduced in 2016, it was inconsequential. Additionally, Zara’s operating profit ratio is within the 75 to 80 percent range; thus, the company is doing well (Eriksson & Jonsson, 2011, p. 178). For Zara’s shareholders, increasing net profit ratios is a positive indicator of future growth and higher return on investments. The company’s current approach to mitigating increased competition is crucial in sustaining its growth without jeopardising its profitability. For example, in the 2017 fiscal year, Zara conducted market research to appraise customers’ demands and focus on delivering appropriate designs rather than using the catwalks to create demand for its new trends during the summer and winter seasons. The approach has been effective in sustaining both long-term growth and profitability making Zara the most profitable brand of Inditex.

• • Growth

The growth ratios provide Zara’s shareholders with crucial information necessary to develop an in-depth understanding of the company’s overall growth in the short and long-term. Three growth figures between 2014 and 2016 financial years have been taken into consideration: sales growth, assets growth, and debt growth (Table 2). Appendix A indicates the formulae used in determining the growth ratios. Table 1 indicates that the growth rations have been increasing in the past three years, which is great for all Zara’s stakeholders. It is imperative to note that the debt growth is negative since it reduces as Zara profitability increases.

Table 2. Zara’s growth rations

Source: (Marketwatch, 2017, p.12)

Zara’s positive growth ratios are directly correlated with its space growth, a measure of the space occupied by stores worldwide. The company’s space growth was 11.4, 13.7, and 17.2 percent in 2012, 2013, and 2014 respectively (Eriksson & Jonsson, 2011, p. 127). Overall, Inditex’s space growth reached 6,200 stores in 87 markets with Zara accounting for 10 percent of the growth (Table 3).

Table 3. Zara’s space growth in relation to other Inditex’s brands

Source: (Eriksson & Jonsson, 2011, p. 32)

Graph 2 puts the growth ratios into perspective. The positive growth is great news for potential investors and shareholders since the company’s capital can be reinvested with minimal risks. Also, assets growth may be expected to continue throughout the 2017 fiscal year while the debt reduces. Consequently, the increasing sales and assets ratios with the reducing debts indicates that the financial condition of Zara is good and is expected to experience further growth in future. Therefore, Zara’s future profitability will not be jeopardised by its continued growth.

Graph 2. Zara’s growth ratios

Sources: (Eriksson & Jonsson, 2011, p. 32)

• • Liquidity

Liquidity ratios encompass both current and quick ratios. The former indicates Zara’s ability to honour its debt obligations over its business cycle. Vincent, Kantor, and Geller (2016, p. 82) note that the ideal current ratio is 2:1, and the higher it goes, the more a company can pay its debts. On the contrary, Zara’s quick ratio highlights its short-term liquidity to potential investors, and it indicates the company’s ability to employ its quick assets to honour its current liabilities. According to Vincent, Kantor, and Geller (2016, p. 122), the ideal quick ratio should be 1:1, and a higher ratio suggests that the business can meet its current debt obligations using the available quick funds. On the contrary, a quick ratio lower than 1:1 shows that the company relies too much on inventory to pay its short-term debts.

In 2012, Inditex opened over 300 new stores underpinned by Zara’s growth. The expansion is expected to continue, as Zara “predicts the openings of 400 new stores by 2019” (Vincent, Kantor, & Geller, 2016, p. 34). However, these extensive growth objectives bring to the fore financial metrics such as the total debt/equity and current ratios. Zara’s current ratio is 1.92, which is significantly higher than the industry average of 1.27. Therefore, Zara has twice as much liquid assets as liabilities, which is a good indicator of financial stability as the company continues to grow. Stakeholders such as shareholders, lenders, and potential investors are confident since the high current ratio suggests that the company cannot undergo insolvency during periods of slow growth.

Total debt and equity helps appraise a company’s total liabilities against the stockholders' equity and indicates the proportion of debt and equity a company uses to finance its assets and growth. Between 2014 and 2016, Zara maintained a total debt/equity ratio of 0.1 percent suggesting almost all the company growth came from its profits rather than debts (Vincent, Kantor, & Geller, 2016, p. 174). Compared to the H & M’s 0.6 debt/equity ratio, Zara’s figures are surprisingly low for a fast-growing company. Therefore, Zara can afford to engage in the future expansion without risking accumulating excessive debts. Zara’s cash flow between 2014 and 2016 also indicate that the company is financially healthy. Unlike other liquidity measures, cash flows focus on evaluating cash inflows from operations, outside financing, and investments. However, cash outflows such as expenses are deducted from these inflows to determine the liquidities of business. Zara experienced positive cash flows between 2014 and 2016 (Table 4).

Table 4. Zara’s Liquidity Ratios

2014

2015

2016

Current Ratio

1.365 Times

1.71 Times

1.94 Times

Quick Ratio

0.923 Times

1.28 Times

1.49 Times

Cash Flow

1.6

1.8

2.1

Source: (Eriksson & Jonsson, 2011, p. 3)

The company’s cash flow ratio is 19.93, “well above the industry average of 2.1,” which is outstanding given Zara’s high growth experienced between 2014 and 2016 (Johnson, 2013, p. 156). Therefore, Zara’s primary stakeholders may consider the company as being financially sound with numerous opportunities for additional future investments (Appendix B).

• • Stock Performance

Zara’s stocks, the Inditex (IDEXY), have recorded positive growth between 2014 and 2016, but slow growth has been reported in the past six months due to a slight underperformance in gross margin in 2016 caused by the slowing European economy. However, Inditex’s primary competitor, H &M, experienced even slower growth during the same period (Johnson, 2013, p. 121). The IDEXY share prices fell albeit modestly after Zara reported impressive sales growth in 2015 notwithstanding the challenging environment for fashion retailers. Currently, Inditex remains the world's leading largest fashion retailer in market capitalisation and value. Between 2014 and 2016, the company experienced a net sales increase by 11 percent ($17.4 billion), which was underpinned by Zara’s robust expansion into new markets (Eriksson & Jonsson, 2011, p. 153). Nonetheless, Inditex share prices fell by 0.3 percent in Madrid to €32.9.

The company experienced third-quarter growth of 14 percent slightly ahead of its 13 percent estimates in 2015 (Appendix E and F). The one percent represents Zara’s pick up from the second-quarter growth of 14 percent in 2015. The company’s net profit between 2014 and 2016 came in at €1.3 billion. The growth momentum is due to Zara’s sustained investment in novel stores and logistic facilities. Also, the company’s ongoing development of an integrated offline-online e-commerce store has been crucial in supporting the growth in stock prices. According to Inditex’s CEO, Pablo Isla, the company’s online and in-store sales increased by 16 percent between 2014 and 2016 due to its offline and online store model. Inditex’s stock performance indicates that the company “is at the frontline of fast-fashion retailing, “since its novel business model allows emerging trends and designs to be in stores faster than its competitors (Eriksson & Jonsson, 2011, p. 173).

• • Competitor Analysis

In merchandise designs, strategy, and pricing among other aspects, H&M provides stiff competition to ZARA (Eriksson &Jonsson, 2011, p. 78). However, unlike Zara, H&M’s financial is not doing as well financially. For example, a comparative analysis on both companies ‘key ratios such as gross profit, net profit, current, and debt-equity ratios infers that H & M is incurring losses, unlike Zara’s high profitability. Table 5 shows H & M’s profitability ratios.

Table 5. H & M’s profitability ratios

YEAR

2014

2015

2016

Net Profit Ratio

13.7%

14.7%

12.2%

Gross Profit Ratio

54.3%

53.76%

51.3%

Current

Ratio

2.6 times

2.7 times

2.4 times

Debt Equity Ratio

0

0

0

Source: (Eriksson & Jonsson, 2011, p. 32)

Table 1 shows that H &M’s gross profit and net profit ratios did not increase as is the case with Zara’s ratios, instead they reduced significantly. It is imperative to note that the ideal current ratio is 2:1, but H & M’s ratio exceeds this suggesting the company can honour its debt obligations. Similarly, H & M’s debt/equity ratio between 2014 and 2016 has remained at zero since the company has nil debts. Consequently, Zara’s major competitor is not at risk of insolvency since it is not running in losses, but it is not enjoying high profits either (ITX.MC 2016, p. 2).

• Conclusion

Zara has experienced positive growth since it opened its first store in 1974 and is now the world's leading apparel retailer. The analysis on the company’s financial reports suggests the brand will continue experiencing positive growth in both net sales and profits. Consequently, Zara will remain Inditex’s leading brand in profitability, growth, liquidity, financial structure, and financial risks management. Between 2014 and 2016, the company opened over 500 new stores globally. Additionally, Zara experienced a 7 percent store growth, but the company’s operating expenses including the start-up costs for novel stores also grew by 14 percent. As a result, Zara’s ordinary capital expenditures reached $876 million due to the new stores. Additionally, Zara’s gross profit and net income margin increased between 2014 and 2016, as did the return on equity. Essentially, Zara has strong cash reserves with little debt; thus, the company can self-finance its expansion projects while increasing dividends paid to shareholders during the rapid growth period. In the 2017 fiscal year, Zara’s management announced that the company would continue expanding at a similar pace and will reach $1.63 billion in capital expenditures for new stores by 2018. The analysis conducted here indicates the company has a strong financial position and may continue self-financing its growth without necessarily increasing its current debts.

• Reference List

4-traders 2016, Inditex: Zara store owner sees solid profit growth in H1 | 4-Traders, www.4-traders.com [Online] Available from: <www.4-traders.com> [Accessed 9 November 2017].

Botter, L 2017, Inditex Stocks Slips After Zara Owner Reports Double-Digit Sales Growth, thestreet.com [Online] available from: <https://www.thestreet.com/story/13924986/1/inditex-stocks-slips-after-zara-owner-reports-double-digit-sales-growth.html> [Accessed 9 November 2017].

Eriksson, C, & Jonsson, S, 2011, Inditex-A company analysis with a focus on growth. [Online] Available from: <https://gupea.ub.gu.se/bitstream/2077/25661/1/gupea_2077_25661_1.pdf> [Accessed 9 November 2017].

ITX.MC 2016, Summary for Industria De Dise\O Textil, yahoo [Online] Available from: <https://finance.yahoo.com/quote/ITX.MC/> [Accessed 9 November 2017].

Johnson, M 2013, Zara bags profit growth for Inditex. ft.com [Online] Available from: <https://www.ft.com/content/b7d3640c-623f-11e3-99d1-00144feabdc0> [Accessed 9 November 2017].

Marketwatch 2017, Zara parent Inditex profit up, but margin falls. marketwatch [Online] Available from: <www.marketwatch.com> [Accessed 9 November 2017].

Vincent, J, Kantor, P and Geller, D 2016, Inditex Strategy Report. Bridges Consulting, [Online] Available from: <http://economics-files.pomona.edu/jlikens/SeniorSeminars/Likens2013/reports/inditex.pdf> [Accessed 9 November 2017].

• Appendices
  • Appendix A: The formulae used in determining the growth ratios

[value of present year – value of previous year]

Growth (%) = ---------------------------------------------------------- X 100

Value of previous year

Source: (Vincent, Kantor & Geller, 2016, p. 34)

• • Appendix B: Zara’s Liquidity Ratios

Source: (Vincent, Kantor & Geller, 2016, p. 34)

• • Appendix C: Zara’s Pest Analysis

Source: (Vincent, Kantor & Geller, 2016, p. 14)

• • Appendix D: Zara’s Swot Analysis

Source: (Vincent, Kantor & Geller, 2016, p. 12)

• • Appendix E: Stock performance

Source: (Botter, 2017, p. 12)

• • Appendix F: Stock performance

Source: (Botter, 2017, 9)

• • Appendix G: Completive Analysis

Source: (Vincent, Kantor & Geller, 2016, p. 18)