Industry Insight

Opening Up – Fashion retail in a post-COVID-19 world

By: Mark Nelson

In aggregate, the fashion retail sector has been one of the hardest hit by the effects of the COVID-19 pandemic. Most major fashion retailers have underperformed the MSCI World index since the mid-February market peak, with a not insignificant number being forced to file for bankruptcy.

This week, however, we have begun to see a recovery in shares across the sector as governments around the world detailed plans to reopen their respective economies. In the UK, Prime Minister Boris Johnson announced has that non-essential shops, which would include apparel and footwear retailers, will be able to reopen from 15 June, as long as they adhere to new guidelines to protect shoppers and workers.

We believe this represents a temporary reprieve for the sector, rather than the beginning of a new period of prosperity, with the industry continuing to face a number of challenges that were present before the crisis. First and foremost is the rise of ecommerce which, while a structural tailwind for some (in particular the digital native brands), has been a persistent thorn in the side of traditional bricks-and-mortar fashion companies and department stores. In addition, the idea that consumers, particularly in the developed world, have reached “peak stuff” has also been the subject of increased discussion over the last few years, and may receive greater attention should people readdress their priorities following the pandemic. Concerns over sustainability and the significant impact on the environment from fast fashion (and rampant consumerism in general) is a further challenge that the industry must overcome.

That said, reports of the demise of fashion retail and suggestions that the sector is in structural decline are overplayed, in our opinion. This is partly due to the so-called “frequency illusion”, where in this case a stream of negative headlines regarding underperforming (and often smaller) fashion retailers obscures the overall picture. It should be noted that a number of the largest listed names have produced strong returns in the years leading up to the pandemic, whether measured by total shareholder returns or returns on invested capital.


The State of Fashion 2020 report put together by McKinsey and The Business of Fashion estimates that 56% of companies within the fashion industry destroyed value in 2018, as measured by economic profit. Yet, several of the top 20 producers of economic profit in the fashion industry were retailers, including Zara owners Inditex; TJX; Fast Retailing, the owners of Uniqlo; and Next.

This bifurcation between the winners and the losers within retail supports our opinion that it is a very much a stock picker’s sector. There are a range of business models in operation, some of which have fared better than others over the last several years and indeed during the current crisis.

These business models can be split into three broad categories: in-store-only, online-only and omnichannel. Pure bricks-and-mortar retail businesses (in-store-only) are few and far between but Primark, which is a subsidiary of Associated British Foods, is one of them. The company offers a highly differentiated value proposition, selling its products at extremely low prices and, in 2019, it accounted for half of ABF’s revenues and almost 65% of operating profit.

Primark had continued to perform well over the last three years, growing both revenues and operating profits at over 9% annually. ABF’s shares have performed poorly, however, as some of its other businesses have offset increasing profits at Primark. Going forward, we continue to believe that the Primark proposition is like few others in the space, and its lack of online presence is understandable given that the low cost of its products makes it extremely difficult to get the ecommerce economics to work. However, we do have concerns about the relevance of the Primark offering in a post-COVID-19 world, in which sustainability may become an increasingly important factor for consumers.

The omnichannel space is where you will find most of the traditional bricks-and-mortar retailers that have at least partially transitioned online in response to the growth in ecommerce.

Next, for example, was one of the earliest among the major bricks-and-mortar retailers to build an online presence, leveraging its logistical capabilities developed through years of operating its catalogue service. Revenues from its online division surpassed those of its store network for the first time in the year ended January 2020, while online profits have been higher since 2016. Its online business, however, differs from some of its competitors in that it serves as a channel through which it sells Next products, but also as a platform for other brands. Sales through the platform, which Next refers to as its Label business, are split 44% and 56% between wholesale and commission-based, with Next looking to increase the commission share of Label revenues, as operating on this basis aligns its interests with those of its partner brands but also lowers the inventory risk for the company.

Inditex, meanwhile, the Spanish owner of Zara, also operates an omnichannel business model, but sells only its own brands. The company is amongst the highest quality names in the space, with an outstanding track record of revenue growth (averaging 14% annually over the last two decades) and value creation. It enjoys the highest gross margins of its peer group which are supported by a unique business model. The company has a high degree of vertical integration and is involved in each stage of the fashion process, while more than 50% of its production facilities are in proximity to its northern Spain headquarters. This, combined with its innovative and leading use of technology, allows it to shorten the time it takes to get its product to market and therefore it can rapidly respond to consumer preferences and trends. This has meant that its brands have remained more relevant and not experienced the in-store sales declines that others in the space have. The company is also arguably underpenetrated online, with ecommerce accounting for just 14% of net sales, but growing fast, up 23% during 2019.

Elsewhere, off-price is another business model which has proven highly successful in recent years. It has gained market share compared to other subsegments of fashion retail, with the State of Fashion 2020 report referenced earlier stating that in the three years to the end of 2018, the value segment delivered 14% of total returns to shareholders. This compares to premium’s 1% and mid-market’s -2%, while the luxury subsegment has also gained market share, producing total returns to shareholders of 22% over the same period.

The biggest player in off-price is TJX, whose model is to sell quality, fashionable, brand-name and designer merchandise at prices generally 20% to 60% below full-price retailers. The company’s first quarter results were heavily impacted by the COVID-19 pandemic as all its stores and its website were closed for half of the period.

However, the TJX reported “very strong” sales in stores that have recently reopened and we believe that the growth in off-price could accelerate post-crisis, with TJX’s flexible and opportunistic approach to procuring inventory making the company well placed to benefit from the difficulties that other retailers face.

Furthermore, we consider TJX to be a highly quality business, with a track record of value creation as measured by returns on invested capital, which should be supported going forward by the competitive advantages that the company enjoys. Its online penetration is relatively low but will grow over time, and we continue to believe that the value proposition offered by TJX will drive store-traffic post COVID-19, something that the strength of sales in stores that have recently reopened would support.

In the online only space, the three major European players are ASOS, Boohoo and Zalando and each have slightly different business models. ASOS sells its own-brand products but also those of other brands and aims to differentiate itself from its peers through the quality of its curation. It was the posterchild for online retail in the UK for a number of years, however, increased competition in the space has pressured margins more recently.

Boohoo, meanwhile, sells only its own-branded products and has experienced startling revenue growth, supported by the addition of new brands to the business and its geographic expansion. The company is amongst the most heavily criticised for the environmental impact of the fast fashion model, but its fashion-forward and low-priced products continue to experience strong demand amongst young consumers.

Finally, Zalando, in contrast to Boohoo, is focused on the sale of the products of other brands. The company originally operated a wholesale model but is in the early stages of a switch in strategy and is now increasingly focused on the development of its platform-based business. This asset-light model, in which it does not purchase inventory from partner brands, has a number of positives in our opinion. By providing a fashion ecosystem through which brands can reach millions of customers (as well as offering add-on services such as fulfilment and marketing), the company removes inventory risk for its business and offers potentially better scalability. As at the end of 2019, the company had just a 1.6% market share of the European fashion industry, suggesting it has room to expand, and while operating margins have recently been pressured by investments in technology, the shift towards commission-based revenue should be supportive of margins over the medium term in our opinion.

Shares of the digital native businesses have performed better since the COVID-19 pandemic began, with the crisis accelerating the growth in ecommerce. Going forward, however, we do not believe that this is evidence that online-only is the only way to go from an investment perspective. Ecommerce penetration will continue to grow and companies with a bricks-and-mortar presence will need to carefully manage their store networks in the years to come, perhaps reimagining how stores are presented, stocked, and utilised in a post-COVID-19 world. However, there remains a place for physical stores, particularly in models like off-price for which the outlook remains positive, in our opinion.

The intensely competitive nature of the fashion retail sector makes having a differentiated business model is essential, and as detailed above there are a variety of models at work in the space. That said, having a clear and focused strategy is no guarantee of success and some models will prove to be more relevant than others. We therefore believe that the bifurcation of returns seen in recent years will be an ongoing feature in this industry, making stock selection as important as it has ever been.

Should you have any questions about anything raised in this article, please don’t hesitate to contact us via email, or on 0207 337 0777.

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This note has been produced by Killik & Co on the basis of publicly available information, and all sources are believed to be reliable, but we have not independently verified such information and we do not give any warranty as to its accuracy. Some of the stocks mentioned in this note are covered by Killik & Co’s Equity Research team and others are not. The mentioning of the stocks does not represent a recommendation to buy or sell any securities, and the note is intended as a marketing communication rather than research. This note does not purport to be a complete description of the securities, markets or developments referred to in the material. All expressions of opinion are subject to change without notice. Nothing in this note should be construed as investment advice or as comment on the suitability of any investment or investment service.  Prospective investors should take advice from a professional adviser before making any investment decisions. There are risks with almost every investment that you may not get back the original capital invested. The value of your investments may fall as well as rise and the past performance of investments is not a guide to future performance.