Industria de Diseño Textil, also known as Inditex, is one of the world's largest fashion retailers and is primarily known for its flagship brand, Zara. The company is credited with pioneering the concept of "fast fashion," which has enabled it to transform from a small sewing workshop in A Coruña, Spain, into one of the most influential players in the global fashion retail industry within just a few decades. The question remains whether the company is still a good investment. This analysis will delve into that question.
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Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
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The Business
Industria de Diseño Textil, commonly known as Inditex, is one of the world's largest fashion retailers. Founded by Amancio Ortega in 1985, Inditex is headquartered in Arteixo, Galicia, Spain. The company engages in the retail and online distribution of clothing, footwear, accessories, and household products, operating under well-known brands such as Zara, Pull & Bear, Massimo Dutti, Bershka, Stradivarius, Oysho, and Zara Home. As of the end of January 2024, which marks the close of Inditex's fiscal year, the company had a total of 5.692 stores across all brands, with 4.589 of these stores being company-owned and 1.103 franchised. Franchised stores are managed by independent partners under a contractual agreement with Inditex, adhering strictly to the company's brand standards and operational guidelines. Inditex operates across four key segments: Europe ex Spain, which contributes 48,7% of sales; the Americas, contributing 19,6% of sales; Asia & Rest of the World, contributing 16,9% of sales; and Spain, contributing 14,8% of sales. The company is renowned for its fast fashion business model, which allows it to swiftly translate the latest fashion trends from the runway to its retail stores, significantly reducing the time from design to market. Inditex's competitive advantage in fast fashion is largely due to its substantial control over its supply chain, encompassing design, production, and distribution. This vertical integration enables the company to respond rapidly to changing fashion trends. Unlike many competitors that rely on third-party production, Inditex owns a significant number of its manufacturing facilities, particularly in regions close to its headquarters such as Spain, Portugal, and Morocco. This proximity not only reduces lead times but also allows for the quick restocking of popular items. I believe that Inditex's well-established brands and its competitive advantage in fast fashion provide the company with a strong moat.
Management
Óscar García Maceiras is the CEO of Inditex. He joined Inditex as General Counsel and Secretary of the Board of Directors in 2021 before assuming the role of CEO later that same year. Óscar García Maceiras holds a Bachelor's Degree in Law from Universidade de A Coruña and a PhD in Law from Universidad CEU San Pablo. Prior to joining Inditex, he served as a State Attorney in his hometown between 2001 and 2005. In 2005, he joined Banco Pastor, initially as the Chief Legal Officer and later as its General and Board Secretary. In 2012, he was named Deputy Secretary of the Board and Head of the Corporate Legal Department at Banco Popular. That same year, Mr. García was appointed Managing Director of Corporate Development and Legal Affairs at SAREB, Spain’s management company for assets arising from bank restructuring, as well as its General Counsel and Board Secretary. In 2016, he joined Banco Santander as Group General Counsel and Deputy Secretary of the Board of Directors. Óscar García Maceiras believes that three core values have guided Inditex's journey from a small clothing workshop to a global leader in the fashion market: humility, caution, and ambition. Humility involves maintaining a constant awareness of customer needs. Caution means being prepared for both the ups and downs of the business cycle, ready to adapt to new circumstances. Ambition drives continuous learning, understanding, and listening. Under his leadership, Inditex has achieved several years of record sales, consistently delivering impressive numbers and high free cash flow per share. His extensive experience across various industries, his commitment to these values, and his strong track record at Inditex make me confident in Óscar García Maceiras's ability to lead the company moving forward.
The Numbers
The first metric to investigate is the return on invested capital (ROIC). Our criterion requires a 10-year history with all figures exceeding 10% annually. For some reason, Finbox didn't have the numbers from 2015. However, in the nine years for which we do have data, Inditex has delivered a high ROIC in eight years. The low ROIC in 2021 was due to the pandemic. Inditex's fiscal year runs from February 1st to January 31st, meaning that fiscal year 2021 spanned from February 1st, 2020, to January 31st, 2021. Thus, it makes sense that ROIC was low that year, as the pandemic significantly impacted Inditex's business. Post-pandemic, ROIC has not quite reached the heights of the pre-pandemic period, but it's worth noting that the past three years have been affected by the tailwinds of the pandemic and macroeconomic headwinds. It is encouraging that Inditex has managed to increase ROIC every year over the past three years, and hopefully, this trend will continue moving forward. Overall, the numbers are very encouraging, as Inditex has managed to deliver a ROIC above 15% in eight out of the nine years for which we have data.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. I don't have the growth rate from 2013 as Finbox only provides data for the past ten years. Inditex has managed to grow its equity every year over the past nine years, with the exception of fiscal 2021, which was impacted by the pandemic. These numbers are very impressive, and I expect that Inditex will continue growing its equity annually moving forward.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising that Inditex has managed to deliver positive free cash flow every year over the past decade. There have been years where free cash flow has dropped, particularly in fiscal year 2021, which was impacted by the pandemic. Free cash flow also decreased slightly in fiscal year 2023 due to macroeconomic headwinds. However, Inditex managed to grow its free cash flow again in fiscal year 2024, delivering its highest free cash flow ever, which is very encouraging. While the levered free cash flow margin in fiscal year 2024 wasn't as high as it has been in previous years, it remains the third highest levered free cash flow margin in the past ten years, which is impressive, especially considering the ongoing macroeconomic headwinds in fiscal year 2024. The free cash flow yield isn't as high as it has been in the past, but it is still above the ten-year average, indicating that the shares are trading at a reasonable valuation—something we will revisit later in the analysis.
Debt
Another important aspect to consider is debt. It is crucial to assess whether a business has a manageable level of debt that can be repaid within a period of three years, which is determined by dividing the total long-term debt by earnings. Upon analyzing Inditex's financials, it is evident that the company has no debt. Therefore, debt is not a concern when considering an investment in Inditex.
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Risks
Based on my findings so far, I believe that Inditex is an intriguing company. However, no investment is without risk, and Inditex also faces its fair share of risks. One risk is macroeconomic factors. There are several macroeconomic factors that may affect Inditex. The company has mentioned that the costs of some goods and services in their value chain have not yet returned to pre-inflationary levels, while some markets have experienced pressure on labor costs due to inflation and employment misalignments. Additionally, the economic and geopolitical environment has generated instability and volatility in financial markets, leading to foreign exchange risks, particularly concentrated on the US dollar and Turkish lira. During 2023, fluctuations in non-euro currencies negatively impacted the company's sales growth. Moreover, in many of the markets where Inditex operates, the economic outlook shows some fragility, which creates considerable uncertainty regarding potential economic performance and its impact on consumer spending. Therefore, macroeconomic factors such as inflation and foreign exchange rates may directly affect the profitability of the company, while economic uncertainty could dampen consumer confidence, leading to reduced spending on Inditex products.
Competition is another significant risk for Inditex. The company operates primarily in the fast fashion segment, where it faces competition from global giants like H&M, Uniqlo, and rapidly growing online-only players such as Shein and Boohoo. These competitors often employ similar business models, focusing on speed to market, low prices, and frequent inventory turnover. Any of these competitors could potentially replicate or innovate upon Inditex's strategies, which could erode its competitive advantage. Additionally, Inditex faces growing competition from online-only retailers. The rise of digital-first brands like ASOS, Shein, and Zalando presents a unique challenge. These companies typically have lower overhead costs due to the absence of physical stores and can offer a wide range of products at competitive prices. They also benefit from advanced data analytics, targeted marketing, and a strong presence on social media platforms, enabling them to quickly adapt to consumer trends. This increasingly competitive landscape could pressure Inditex's market share and profitability.
Supply chain disruptions pose a significant risk to Inditex, given the company's reliance on a highly efficient and integrated supply chain to maintain its competitive edge in the fast fashion industry. Several factors beyond Inditex's control can disrupt its supply chain. Geopolitical tensions, such as political unrest, trade wars, or sanctions, could impede the flow of goods, impose tariffs, or result in higher production costs. Natural disasters, including earthquakes, floods, or hurricanes, can cause significant disruptions by damaging infrastructure, halting production, or impeding transportation networks. Additionally, raw material shortages pose a critical risk. Inditex's ability to maintain its fast fashion model depends on the consistent availability of raw materials like cotton, fabrics, and dyes. Disruptions in the supply of these materials, due to factors such as poor harvests, trade restrictions, or supply chain bottlenecks, could delay production and lead to higher costs, potentially affecting the company's ability to deliver new fashion trends quickly and at competitive prices.
Reasons to invest
There are numerous reasons to consider investing in Inditex. One is Inditex's strategic approach to its store network. Inditex continues to open new stores in key markets while optimizing its existing store network. This includes opening stores in high-traffic locations, refurbishing and enlarging existing stores, and closing underperforming ones. By focusing on quality rather than quantity, Inditex is positioning itself to maximize sales productivity and maintain a strong presence in both mature and emerging markets. The planned 5% annual gross space growth from 2024 to 2026 indicates a commitment to strategic expansion, which is expected to contribute positively to sales. Inditex emphasizes the strength of its integrated approach, where physical stores and online platforms work synergistically. This model allows the company to leverage the strengths of both channels, enhancing customer experience and driving growth. The ability to seamlessly blend in-store and online shopping is a significant competitive advantage, especially as consumers increasingly demand flexible shopping options. Inditex has reported strong growth in both physical store sales (8%) and online sales (16%), highlighting the success of its integrated model. The robust performance of physical stores, even as online sales grow, indicates that Inditex’s store network remains a vital component of its overall business model. The combination of store and online sales is a key driver of Inditex's business, underscoring the importance of maintaining and optimizing its physical presence.
Investing in logistics. According to management, the growth of the group is underpinned by improvements to its logistics platforms. Inditex is committing €900 million annually over 2024 and 2025 to enhance its logistics capabilities. This investment includes the construction of new distribution centers and the expansion of existing ones across key regions in Europe. These projects are designed to significantly increase Inditex’s capacity to manage inventory and distribute products efficiently on a global scale. The investments in logistics are closely tied to enhancing the customer experience. Inditex recognizes that today’s customers expect to receive their products quickly and conveniently, whether shopping online or in stores. By bolstering its logistics infrastructure, Inditex can ensure it delivers on these expectations, providing customers with what they want, when, where, and how they want it. This is particularly crucial in the fast fashion industry, where speed and availability are key competitive advantages. Thus, Inditex’s logistics expansion plan is a strategic move to enhance its operational capabilities and support future growth. By investing in state-of-the-art distribution centers and expanding its logistics network, Inditex is positioning itself to better serve its global customer base, improve delivery efficiency, and capitalize on emerging market opportunities, thereby increasing the company's competitive advantage.
Operates in a fragmented market. Inditex operates in 213 markets, indicating a vast global presence. However, despite this extensive reach, the company acknowledges that it holds a relatively low market share within these markets. This is significant because it suggests that even though Inditex is already a major player in the fashion industry, there is still substantial room for growth. The fashion retail sector is highly fragmented, with market share distributed across numerous brands and retailers, many of which are much smaller than Inditex. This fragmentation presents opportunities for Inditex to increase its market share through continued expansion, innovation, and consolidation. Inditex also has potential for growth in emerging markets and regions where its presence is currently smaller. These markets may feature growing middle classes and increasing demand for fashionable, affordable clothing, making them particularly well-suited to Inditex’s business model. Additionally, even in more developed markets, there may be untapped customer segments that Inditex can target through its diverse brand portfolio.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 1,73, which is from 2023. I have selected a projected future EPS growth rate of 9%. Finbox expects EPS to grow by 9,0% in the next five years. Additionally, I have selected a projected future P/E ratio of 18, which is twice the growth rate. This decision is based on Inditex's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be €18,22. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Inditex at a price of €9,11 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 8.667, and capital expenditures were 1.399. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 979 in our calculations. The tax provision was 1.475. We have 3.113 outstanding shares. Hence, the calculation will be as follows: (8.667 – 979 + 1.475) / 3.113 x 10 = €29,43 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Inditex's Free Cash Flow Per Share at €2,33 and a growth rate of 9%, if you want to recoup your investment in 8 years, the Payback Time price is €28,01.
Conclusion
I believe that Inditex is an intriguing company with strong management. The company has a moat through its well-established brands and a competitive advantage due to its vertical integration, which allows it to control a significant portion of its supply chain, from design to production to distribution. Inditex has consistently delivered a high return on invested capital (ROIC), except during the pandemic, and has recently achieved its highest free cash flow ever. Inditex faces some short-term risks, particularly from macroeconomic factors that can impact the company's performance, which is partly why its ROIC hasn't reached previous highs. However, macroeconomic conditions are expected to improve over time. Competition remains an ongoing risk for Inditex. The company not only competes with other fast-fashion giants like H&M and Uniqlo but also faces growing competition from online-only retailers such as ASOS and Zalando, as well as from emerging players like Shein, which combines fast fashion with an online-only retail model. The supply chain is crucial to Inditex's competitive advantage, and any disruptions could negatively affect its business. However, Inditex's store strategy should boost growth in the future. The company plans to open more stores, leading to an expected 5% annual gross space growth from 2024 to 2026, which should contribute positively to sales. Additionally, Inditex's ability to seamlessly integrate in-store and online shopping provides a significant competitive advantage. Inditex's investment in logistics is expected to enhance the customer experience by ensuring that products are available when, where, and how customers want them, which is particularly important in the fast fashion industry. This investment should further strengthen Inditex's competitive edge. Finally, Inditex operates in a fragmented market, giving it ample room to increase its market share through continued expansion, innovation, and consolidation. The company also has significant potential to expand in emerging markets and regions where it currently has a smaller presence. I already own shares in Inditex and would like to increase my position. I believe that buying shares below €40 would be a good long-term investment, as this price would offer a 30% discount on intrinsic value based on two out of three valuation methods.
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