A business creates value when is able to grow and deliver return on capital that exceeds its underlying cost – investors want to be compensated for the risks taken. The ability to create value is directly linked with businesses operational efficiency (reflected at operational margin level), investment required to achieve it (working capital and CAPEX) and long-term visibility (growth strategy and scalability).
The translation of the value creation concept to luxury fashion can be mainly decomposed by the ability to (i) manage inventory efficiently – the largest annual investment by far, which impacts both operational margins and working capital needs – and (ii) address the target market successfully.
Ultimately, enterprise value (EV) reflects the perception of value effectively created. According to public information (Graph 1 – EV/Sales Valuation Multiple), market leaders are expected to generate, on average, EV equivalent to 6,0x sales, while traditional retailers, based on Stockedge’s own estimations, are not expected to exceed 1,0x sales.
If we take into consideration that traditional retailers are delivering average net profit margins of 7% to 8%, negatively impacted by inventory (mis)management, and remain highly dependent to the representation of a restricted number of international brands (for a pre-determined period of time), it becomes very clear why the existence of such gap.
Some traditional retailers try to counterbalance these limitations through the adoption of aggressive and expensive online strategies, which end-delivering high sales growth but with no/negligible impact at bottom-line level or developing distinctive capabilities (i.e. create very limited additional value).
We believe net profit margins can be improved significantly (Graph 2 – Revised PL Decomposition).
Full-market transparency (optimal ordering and efficient monitoring) and intraday liquidity (global and real time inventory allocation at tight execution charges) are expected to generate up to ~20% sales incremental value.
On top of the improved net profit margins, transparency and intraday liquidity is also expected to give long-term visibility to traditional retailers – either through dynamic brand portfolio management (i.e. lower dependency and gain bargaining power) or a more efficient direct-to-consumer approach (i.e. understand better what end-consumers are really looking for).
Altogether, full-transparency and intraday liquidity are estimated to deliver long-term visibility and generate additional annual benefits equivalent up to 20% sales. Consequently, despite not changing business landscape, traditional retailers are able to capture a much higher recurrent value – EV can be revised upward from current 1,0x sales to about 3,0x sales.
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