Stock Quality CheckOnline fashion retailer

Analysts see upside potential for Zalando

The online fashion retailer Zalando is still struggling with a notable decrease in consumer activity. Nevertheless, after a prolonged decline, analysts foresee substantial increases in the company's stock value in the future.

Analysts see upside potential for Zalando

The online fashion retail sector continues to struggle to find its footing after the pandemic-induced boom has ended. Consumers, wary of inflation, are still holding onto their money, opting to forgo constantly chasing new fashion trends from the comfort of their couches. Consequently, the industry in Germany had to endure a double-digit decline in revenue in the third quarter.

While the performance wasn't as bleak for the largest player in Europe, Zalando, which is headquartered in Berlin, only saw its revenue decrease modestly by just over 3% from July to September compared to the same period in the previous year. However, even in the capital, they are not immune to the structural challenges in the industry. "The market environment remained challenging in the third quarter and limited our ability to grow," said CFO Sandra Dembeck during the presentation of the financial results.

Competition from Chinese low-cost providers

From the management's point of view, there is now definitely no chance of growth for the year as a whole. The industry, plagued by sluggish demand and discount battles triggered by full warehouses, had already led to Zalando's first-ever stagnation in 2022. Additionally, new low-cost providers from China, such as Shein or Temu, are disrupting the market, diverting customers from the industry.

Since then, the company, like many competitors, has been trying to counteract these challenges through cost-cutting measures. In order processing, costs relative to revenue decreased by about two and a half percentage points in the first nine months. In marketing, the company is now more selective about where the money should go, reducing costs by 0.6 percentage points in relation to revenue during the same period. A previously announced staff reduction program, aiming to eliminate several hundred positions, has also been completed. Other measures include an increase in platform fees for business partners and a minimum order value for free shipping which was introduced in 2022. Nevertheless, Zalando continues to offer free returns.

These measures are already impacting the profitability. The earnings before interest and taxes (EBIT) after nine months were just under €42 million, compared to a loss of €14.5 million the previous year. Thus Zalando recently left its forecast for adjusted EBIT untouched. It is expected to be between €300 million and €350 million, up to 90% higher than the previous year.

Boss, Inditex, and H&M are growing

Despite these measures, skepticism prevails in the market. With a drop of about one-third, hardly any DAX stock has suffered as much as Zalando this year. A similar bleak picture can be seen with the Hamburg-based rival About You, whose shares have declined by about 28% in the same period. British online retailer Asos also experienced a decline by roughly 20%.

But that doesn't mean that people are completely abandoning shopping in times of inflation and geopolitical crises. Consumer sentiment still exists but is now increasingly being expressed in physical retail stores post-pandemic, as demonstrated by Hugo Boss, Inditex, and H&M. All three companies still generate the majority of their revenue in their brick and mortar stores, and they all have recently registered a significantly increased demand. Investors have seen gains of 10%, 36%, and even 44% in their stock values in the current year.

"Risk-reward profile has shifted to the upside"

According to analysts, the end of the decline may not have been reached with these values, but they see more significant potential for stock price increases again for online retailers like Zalando and About You. Analysts listed on Bloomberg estimate the average twelve-month target price for About You at €6.06, representing a 42% increase compared to the current price. Zalando's target price is currently even 57% above the current value.

"Since the shares are traded just above the 2014 IPO price, we believe that the risk-reward profile has shifted to the upside and maintain our buy recommendation," Deutsche Bank analyst Adam Cochrane wrote in early November. Twenty other analysts on Bloomberg share a similar view, while eight recommend holding the shares. Three analysts suggest to sell the stock.

Zalando's long-term goals are at any rate ambitious. In the European fashion market, which is estimated to be worth around €450 billion in the coming years, the Berlin-based company aims to capture more than 10%. Nevertheless, their current size already poses bureaucratic problems. In April, the EU Commission identified the company as one of 19 "very large online platforms" that must now meet special requirements under the Digital Services Act. Non-compliance could result in fines of up to 6% of annual revenue. Zalando filed a lawsuit against this classification at the end of June.