Rocket Star

Zalando Zips to the Top of the Heap

Photographic studio lights illuminate a mannequin during product photo shooting at the headquarters of online fashion retailer Zalando SE in Berlin, Germany, on Wednesday, Oct. 8, 2014. Revenue from online shopping in Germany is expected to grow 22 percent this year and 16 percent next year to $73.5 billion -- the fastest of the five biggest European Union countries, according to researcher eMarketer. Photographer: Krisztian Bocsi/Bloomberg
A product photo shoot at the headquarters of online fashion retailer Zalando.
  • Why it matters

    Why it matters

    Zalando, created as a startup by Rocket Internet in 2008, has supplanted Metro as Germany’s biggest online retailer. The company’s success stems in part from its successful use of digital solutions, such as apps for mobile devices.

  • Facts

    Facts

    • After declining from around €36 to less than €24, Zalando’s share price suddenly jumped to €37.25 last week.
    • Profits have increased from €23 million to almost €51 million.
    • The company’s base of active customers – those who placed at least one order within the last 12 months – has increased from 2.2 to 18.8 million.
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  • Audio

    Audio

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Olaf Koch, the head of German retail group Metro, has actually done everything right.

He has been rebuilding the company for years, has invested in startups and sold subsidiary Kaufhof for a surprisingly high price. The group will soon be split up, which should awaken further growth aspirations. Metro’s share price has increased by about 15 percent since the beginning of the year.

But despite all that, he was unable to stop a major shift in the retail business. As of this week, Metro has been replaced by Zalando as the most valuable retail group in Germany.

The triumph of online retailing is also reflected in the stock market. After a significant increase in its share price, Zalando’s market capitalization hovered around €9.3 billion ($10.5 billion) in Frankfurt. At the same time, Metro’s market capitalization was only about €9 billion.

What happened? In the first half of the year, it still looked as if investors were slowly losing patience with the company many had at first pinned their hopes on, a product of Berlin’s startup factory Rocket Internet. The Zalando share price had gradually crumbled from about €36 at the beginning of the year to less than €24. The consistent upward trend since the company’s IPO in October 2014 seemed to have been broken. Zalando’s catchy advertising slogan, “Shout for Joy,” had apparently lost its appeal.

But then, within the last week, the euphoria suddenly returned.

A strong interim financial report caused the share price to jump to its highest level of the year to date, €37.25. In the second quarter, the retailer achieved earnings before interest and taxes (EBIT) of about €81 million. This puts Zalando at the upper end of the range of €68-88 million the company had announced when it released its preliminary figures in July. EBIT was only at €30 million in the second quarter of last year.

 

The Zalando SE logo sits on a stack of cardboard boxes in the creative department at the headquarters of the online fashion retailer in Berlin, Germany, on Wednesday, Oct. 8, 2014. Revenue from online shopping in Germany is expected to grow 22 percent this year and 16 percent next year to $73.5 billion -- the fastest of the five biggest European Union countries, according to researcher eMarketer. Photographer: Krisztian Bocsi/Bloomberg
Zalando is going from strength to strength after a shaky few months. Source: Bloomberg

 

“We are extremely pleased,” board member Rubin Ritter said when the numbers were released last week. “Despite ongoing investments in our long-term growth strategy, Zalando has become stronger and more profitable.” On balance, profits increased from €23 million to just under €51 million.

But Zalando has a lot more going for it than just good quarterly results. Particularly noticeable, for example, is the large increase in the number of active customers, that is, customers who placed at least one order within the last 12 months. It increased from 2.2 to 18.8 million. Loyal customers are an important currency, especially for online retailers, because acquiring new customers triggers high marketing costs. Zalando’s success in holding onto its customers is reflected in its marketing budget ratio, which declined from 12 to 10.05 percent in the second quarter.

This directly affects the EBIT margin, which rose in Zalando’s German-speaking markets to 13.5 percent, a 2.9-percent increase over the same quarter of the previous year. Analyst Thomas Maul of DZ Bank was impressed. The increase showed that the online fashion retailer had underscored its ability to earn operating margins of more than 10 percent, and had strengthened both investor confidence in its business model and margin targets, Mr. Maul wrote in a study released early in the week.

The key point, however, is that Zalando’s business model is changing, from that of a pure online fashion retailer to a technology group in the online retail business. The company plans to increase its staff of developers from 1,300 to about 2,000 by the end of the year. In online retailing, companies that can offer the best digital solutions have a leg up, which Zalando clearly has, as evidenced by its promising use of apps for mobile devices. Smartphones or tablets are now used for 67.4 percent of all page impressions, compared to 56.6 percent in the second quarter of 2015.

Zalando has boosted its revenues by not only using these technical solutions for its own business, but also making them available to others. For instance, Zalando offers brand manufacturers the opportunity to use the platform for virtual flagship stores, and in doing so is becoming more and more of an online marketplace. The company launched the new strategy more than a year ago with 100 brand shops. That number has now increased to more than 2,000. Zalando board member Mr. Ritter also expects “that the business with brand shops will continue to grow.” Growth into areas other than the fashion segment is also conceivable.

Analysts have rewarded the company for its strategy. Carl Hazeley of U.S. investment bank Goldman Sachs, for example, has great expectations for Zalando. He lists the share on his “Conviction Buy List,” with a target price of €43. After meeting with Zalando management this week, he said he was convinced that the online fashion retailer could grow up to three times faster than the European fashion industry as a whole.

This makes him even a little more optimistic than Zalando management itself, which expects annual revenue growth of 20 to 25 percent for the coming years. Market researchers predict annual revenue growth of just under 10 percent for Internet retailing as a whole, while Bankhaus Lampe even expects to see 12 percent average annual growth in online retailing in Germany until 2020.

Since the interim results were released, a number of analysts have revised their target prices for the Zalando share upward. Peter Steiner of Bankhaus Lampe is confident that the share price could increase to €45, while Thomas Maul of DZ Bank has even raised the fair value to €46.

The company’s management itself has fueled these high expectations. It raised its forecast for the adjusted EBIT margin for the current year by one percentage point, to between 4.0 and 5.5 percent. But now Zalando needs to deliver, or else it could quickly lose the prestigious title of Germany’s most valuable retail group.

 

Florian Kolf heads the consumer goods, luxury and fashion desk for Handelsblatt.  To contact him: kolf@handelsblatt.com

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