H&M has warned of a "very negative" impact from higher purchasing costs

H&M has warned of a "very negative" impact from higher purchasing costs

H&M Hennes & Mauritz will likely suffer gross margin pressure in the near-term, analysts believe, as the negative impact from the strong US dollar is compounded by increased purchasing costs and increasing wages.

The Swedish apparel group yesterday (25 June) warned of a "very negative" impact from higher purchasing costs due to the strengthening of the US dollar for the remainder of the year.

Over the last 12 months, the dollar has appreciated in value, on average, by more than 20% against the world's other major currencies. As a consequence, it has been weighing on the earnings of US brands and retailers with large overseas operations.

In the case of H&M, the challenge it is facing is the conversion from its retail sales to the Swedish krona.

Challenging market conditions
Speaking on the firm's earnings call yesterday, CFO Jyrki Tervonen reiterated this point when he said June had "started well" compared to last year, but admitted that marketing conditions regarding sourcing, external factors, and purchasing in the third and fourth quarters, are "very negative".

Stifel analyst Richard Jaffe, believes this strengthening of the dollar against most currencies will put near-term gross margin pressure on H&M. Gross margin in the quarter narrowed to 59.4% from 60.8% a year earlier.

"The increasingly stronger US$ exchange rate will result in increased purchasing costs in the second half (more than we saw in 2Q) compounded by increasing wages. Despite the increased costs, we believe H&M is unlikely to pass the cost increases on to their customers in order to be the lower-cost provider and gain market share. We view this as the correct strategy for the company but acknowledge the near-term pressure on earnings."

Indeed, Tervonen told analysts that despite the pressure, H&M will "still make sure to have the best customer offering in each individual market".

Asked whether average selling prices for autumn/winter and spring/summer for 2015/2016 will alter in order to try and dampen the impact of the cost inflation, the finance chief answered: "This of course is the million dollar question. As you very much know, for us it's always about having the right balance of fashion, price and quality in a sustainable way, and we will never be the first one to raise prices, so it will be very interesting to see what is going to happen this autumn."

Bernadette Kissane, apparel and footwear analyst at Euromonitor International, believes that, despite the negative impact from the dollar, H&M produced an "impressive performance". Particularly, she said, given direct competitor Inditex reported a 28% increase in sales in its latest quarter.

"H&M’s continued success comes as a result of rapid store expansion and increasing demand for fast fashion as consumer become accustomed to trend-led products at low prices. The global apparel industry is going through a transitional period that is favouring designer labels and fast fashion brands, resulting in the mid-tier retailers squeezed, evidenced by the disappointing performance of brands such as Gap Inc and J Crew."

Expansion plans
In June last year, H&M revealed plans to expand the business, entering new markets such as the Philippines and India, and expanding its e-commerce business.

Speaking on their earnings call, Tervonen said H&M is continuing with those plans, and in 2015 will open a total of 400 stores. The largest expansion is taking place in existing markets with China and the US posting the largest number of new store openings.

China is expected to remain one of its largest expansion markets alongside the US. The retailer now operates over 290 stores in the country, and recorded sales growth of 59% to SEK5.15bn in the first six months of the year.

In the US, H&M operates 370 stores and saw sales grow 58% on last year to reach SEK11.79bn.

During the first half, the retailer added 128 new stores globally, ending the period with a total of 3,639 stores in 58 markets.

"We are adding five new markets this year. Taiwan, Peru and Macau have already opened and the customer response has been great. And now we're looking forward to opening new stores in India and South Africa, two incredible large markets where we see great potential. They will open towards the end of the year," Tervonen told analysts.

Positive outlook
He also commented on reports H&M is looking into new store concepts and may introduce an all-new brand that is very different to its flagship label.

In an interview with Bloomberg following the results, CEO Karl-Johan Persson said the upcoming concept could be launched in 2017 and "will be completely different from H&M" and different to the retailer's sister brands also.

Tervonen confirmed the comments during the call, adding: "Yes there are some concrete things that we are looking into. But I don't think [it will be] 2017." He declined to comment further.

Looking to the first half, the CFO said H&M will continue to increase its long-term investments, despite the pressure and headwinds. "These will enable us to be a natural part of our customer's increasingly digital world. This will strengthen our customer offering further."

Jaffe believes such long-term investments are likely to hold back EPS for the remainder of the year but views them as a positive move.

"In 2015, the spend on long-term investments (within IT, e-commerce and the broadening of the company’s product range) will increase an additional SEK400-600m on top of 2014’s SEK800m spend. Despite the drag on EPS (approximately SEK0.23), we view these investments as a positive for the long-term, as it strengthens the company’s market position and creates an interwoven online and store customer experience."