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|  | MARCH 10, 2005
By Eric Wahlgren Fast, Fashionable -- and Profitable The performance of European "cheap chic" chains H&M and Inditex is making rival U.S. apparel chains look like wet rags Here's a fashion that American retailers might want to copy from abroad: making profits. Europe's big "cheap chic" clothing retailers Hennes & Mauritz (known as H&M) and rival Inditex, the name behind Zara, Massimo Dutti, and other brands, are cranking out profits that U.S. competitors like Gap (GPS ) and Abercrombie & Fitch (ANF ) can only dream about. Stockholm-based H&M posted 14% higher profits of $1.06 billion on 11% higher sales of $7.86 billion for the fiscal year ended Nov. 30, 2004. And Spain's Inditex, which expects to report full-year results on Mar. 31, saw its profits soar 39%, to $524 million, in the nine months that ended Oct. 31, on sales that increased 24%, to $5.23 billion. Contrast that performance with that of, say, Gap. In fiscal 2004, the San Francisco outfit, which runs the Banana Republic and Old Navy chains, reported 11% higher profit of $1.14 billion -- not shabby at all. But its net margins were only 7%, well below H&M's 13% and Inditex's 10%. And the U.S. retailer's single-digit revenue growth badly lags behind the Europeans' performance. NIMBLE PLAYERS. What are H&M and Inditex doing right? These retailers have a better fashion focus, argues Wendy Liebmann, founder of WSL Strategic Retail, a New York City consultancy. Using the haute couture runway for inspiration, their in-house designers key in on the broader trends that will appeal to the masses. They have plenty of room for expansion, too. H&M has a presence in only 20 markets around the world, notes Carl-Henric Enhorninj, H&M's head of investor relations, so "the prospects for future growth are very, very big." The European upstarts are also much nimbler than their U.S. counterparts when it comes to getting new styles on the market, Liebmann says. Zara can get clothes from the design studio onto the racks in as little as two weeks. Why? It has kept much of its production in Spain instead of outsourcing to Asia and other low-wage areas. H&M does get a lot of its products from low-wage areas, but its network of local production offices allows it to respond almost as quickly as Zara. By contrast, it can take Gap months to adopt new fashion innovations, analysts say. "Even if H&M and Zara don't have a hit, because of their speed to market, they can get in and out of an item very quickly and not have a dud sitting on the rack for a very long time," Liebmann adds. "RELATIVE IMMATURITY." Of the two, Inditex seems to be more in fashion among analysts at the moment. H&M is pricier, trading on the Stockholm exchange at around 27 times earnings, vs. about 24 for Inditex on several Spanish exchanges. Jose Ruiz, deputy head of research at Kepler Equities in Madrid, rates Inditex a buy, and his price target suggests the stock could appreciate an additional 11% from current levels. Inditex is also projected to continue growing faster. Rebecca McClellan, a retail analyst with Exane BNP Paribas in London, expects it to post 24.6% higher net income ($973 million) on 18.9% higher sales ($8.92 billion) in fiscal year 2005, ending in January, 2006. In contrast, she sees H&M increasing its net income 15.9% ($1.23 billion) on 13.6% higher sales ($8.93 billion) for its 2005 fiscal year, ending November, 2005. "We like Inditex better because of the strength of the brand and the relative immaturity of the business," says McClellan, who has assigned it an outperform rating, vs. an underperform for H&M. DIFFERENT U.S. STRATEGIES. One reason for optimism about Inditex: Sales at Zara stores open for at least one year -- a key retail performance measure -- rose 8% in the first half of its fiscal year, while H&M's same-store sales were essentially flat in fiscal 2004, if currency effects are included. Analysts expect Inditex to open new stores faster, too. At the end of Nov. 30, 2004, H&M had 1,068 stores worldwide with 145 to 155 more slated to open in 2005. Zara, Inditex' best known brand, only had 695 stores as of the end of October, 2004. But the Inditex group had a total of 2,163 outlets including Bershka stores, which are targeted at young women, and the menswear chain Massimo Dutti. Counting these brands, Inditex has the potential to add 300 to 350 stores overall a year, McClellan says. In the all-important U.S. market, the two European upstarts have vastly different strategies. H&M has charged in, opening 75 stores since arriving in the U.S. five years ago. Its U.S. operations turned profitable last year, in part because of heavy investments in logistics facilities to supply the stores, analysts say. WELL-TIMED INVENTORY. Zara, which has opened only 16 U.S. stores since entering the region in 1989, says it's concentrating on a few main markets in Europe, including Germany, France, Britain, and Italy. In the U.S., as elsewhere, it has no logistics facilities on the ground, with distribution, most design, and production handled from Spain. Zara's Spanish facilities air-ship clothes to U.S. stores as often as three times a week, Ruiz says. As a result, in some regions Zara clothing costs as much as 20% more than H&M's, Ruiz estimates. But Zara rotates clothes faster, giving it among the highest sales per square meter figures in the industry. "Their business model is not focused on cost but rather on having the right items at the right moment," he says. Both companies face challenges, of course. Currency swings could depress growth, for one. The strong euro may dent Inditex' sales in Latin America, where it derives about 10% to 15% of revenues, Ruiz says. For now, though, no signs indicate that Inditex or H&M is losing focus. Both have wealthy founders ready to do whatever it takes to keep their companies at the cutting edge. And both are pumping out profits. That's one trend that never goes out of style with investors.  Wahlgren is a correspondent for BusinessWeek Online in Paris Edited by Thane Peterson
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