Bernstein expects Primark to grow sales at a 16% CAGR over the next four years

Bernstein expects Primark to grow sales at a 16% CAGR over the next four years

Value fashion giant Primark will use its low selling price to help sustain significant growth in 2015, increasing sales through further expansion into continental Europe and the Northeast US, analysts believe.

Bernstein Research, which launched joint coverage of the value fashion retailer's parent AB Foods last week with its European food and retail teams, has described Primark as an apparel retail disruptor.

“At its core, we believe Primark's value proposition has been to undercut incumbent value retail pricing (ie. H&M), by accepting a lower gross margin, in order to gain market share,” the analysts note.

This has worked to tremendous effect in the UK, they believe, given Primark is now the number one apparel retailer by volume and number three by value.

“In Primark, we see some similarities to global apparel retailers H&M and Inditex, and one major difference… selling price, which we believe will help it sustain significant growth going forward,” they add.

Strong growth 
Last month, the retailer revealed sales growth over the Christmas period, driven by increased selling space and high sales densities in stores opened during the last year. Sales rose by 15% at constant currency rates for the 16 weeks ended 3 January, and despite unseasonably warm weather throughout autumn, Christmas trading was strong.

Bernstein expects Primark to grow sales at a 16% compound annual growth rate (CAGR) over the next four years, by expanding further into continental Europe and into the Northeast of the US.

Since 2005, Primark has broken out from its UK/Ireland base, with its first European store opening in Spain in 2006. Currently, the retailer operates 77 stores across Iberia, Germany, Holland, France, Austria and Belgium, accounting for 28% of Primark’s 278 stores.

According to Bernstein, last year 19 of 21 new Primark stores were in Europe and the analysts believe there is much more opportunity for growth in Europe and the US where its first store will open this year.

In comparison, rivals Inditex and H&M are three times the size of Primark in sales, and four and seven times larger in terms of space, respectively. “By 2024 we assume Primark will operate from 32m sq ft...with 354 stores in Europe (excluding UK/Ireland) and 83 in the US,” the analysts predict.

Primark inked a deal with Sears Holdings to lease space in seven stores in the US in October. The retailer first revealed plans to enter the US in April last year, with a store opening planned in Boston towards the end of 2015. It expects to have up to ten stores in the Northeast of the US by the end of 2016.

Bernstein acknowledges, however, that this entry comes with risks, given UK retailers have a mixed-to-bad track record there. Nonetheless, there have been several encouraging examples of success with similar formats, such as Forever 21, among others.

“As we have seen in Europe, we believe US consumers are also increasingly valuing low prices as they attempt to participate in fast changing trends. With a market that is over 5x the size of the UK, if Primark does succeed, first in the Northeast, and later more broadly, this supports an even longer growth runway.”

Continental Europe, on the other hand, looks like a “slam dunk”, the analysts believe. They model 10% space growth CAGR in Europe over the next five years. In Spain, Primark has gained 1.3 percentage points of market share in seven years and become the 11th largest apparel retailer by value.

“We expect Primark could double its space in Iberia,” the analysts say. “In Germany and France, Primark is still in the early days of expansion, but we expect it to benefit from the same consumer trends that propelled H&M's market share in these countries as consumers continue to search for lower and lower prices in fast fashion.”

There are still number of countries within Europe, however, that Primark has yet to enter, and Bernstein expects Italy may be next on its agenda.

Margin pressure
But it is this focus on growth that will come at the expense of margins, as the retailer continues to use low price points to drive share gains, volume growth and operating leverage.

The analysts expect margins to fall in 2015 given tough comps and FX headwinds, but remain in the 12-13% range over the medium-term, which is in-line with management guidance.

“We believe the driving factor in Primark's success has been selling price, as it has undercut incumbent value retailers by circa 30% and the broader market by 50%. We do not expect margins to expand much beyond the 12-13% range as we believe Primark will use any gains from sourcing and cost improvement to lower prices, and drive volumes and market share gains.

"Rather, we expect this strategy and selling price may force other competitor margins down as they face lower prices and margins or lower market share.”

In the near term, the analysts expect some negative pressure on margin as Primark expands its warehouse capacity in Europe, causing operating deleverage, and as the retailer compares very low markdowns in 2013 with the weak autumn. This may be offset, somewhat, by lower materials costs, given the drop in cotton and polyester prices in 2014.