Stock Analysis

An Online Retailer That’s Amazon-Proof?

This is the first post of many in the Stock Analysis section of this blog, where I break down stocks that I feel are undervalued. Some posts can be found on the Wappcap blog or Seeking Alpha as well.

Zalando is an online fashion retailer, based in Germany that may be beating Amazon at its own game. Usually when investors hear ‘online retailer’, they feel that it is a poor investment due to the ‘Amazon Effect’. This term refers to the disruption of retail, both online and in physical outlets, resulting from increased e-commerce sales from Amazon. We can see the impact in Wal-Mart and Macy’s. 5-year return for WMT is 33%, and M’s is -50% compared to Amazon, who’s seen a cool 404% return over the same timeframe.

This alone is enough to make investors portfolios have only one stock in their e-commerce sector, named Amazon. I’ll be frank, I own Amazon as well, but I also like diversification. When it comes to e-commerce, I also like geographical diversification, and also own Alibaba and MercadoLibre. While looking to invest into the European e-commerce market, I came across Zalando. Unlike many online retailers, it’s profitable, trades at a reasonable valuation, and is a very solid company that emphasizes customer experience. Furthermore, they seem to be oblivious to the so called ‘Amazon Effect’.

Europe’s E-Commerce Opportunity

Europe could prove to be a lucrative investment when looking at the e-commerce sector. “Online retail in Europe is growing exponentially, particularly in Southern Europe,” states a 2017 research report published by Ecommerce Europe. Central and Eastern European Countries saw large growth in 2016. In Romania sales increased by 38%, and the market in Slovakia and Estonia grew by 35%, Ukraine saw a growth of 31%. Poland and Bulgaria grew by 25%. This report also detailed the issues that consumers had with online e-commerce with the three main complaints being speed of delivery (17%), technical failures (13%) and damaged goods (9%).


Zalandos Business Model

Zalando SE is Europe’s leading online fashion platform and connects customers, brands and partners together. They focus on fashion; selling clothing shoes and accessories from almost 2000 brands in 15 countries. They sell from many sources, local artisans to international brands and have centrally located fulfillment centers that efficiently get the product to the consumer. These are supported by warehouses in Northern Italy, France and Sweden with a focus on local customer needs. “Zalando’s shops attract about 200 million visits per month. In the third quarter of 2017, 72 percent of traffic came from mobile devices, resulting in 22.2 million active customers by the end of the quarter,” states the company’s fact sheet.

The company stresses customer satisfaction, much like Amazon. Zalando recently launched a membership program in Germany (dubbed Zalando Zet) that will give shoppers access to perks like same-day shipping, advice from stylists, and early sale access. They intend to bring one day shipping to many major European cities, such as Stockholm in the coming year.

A Look At Financials

Investors will be surprised when they look under the hood of Zalando. The company is chugging along with pretty consistent, high growth from when it was founded in 2008. It went from nothing to a company with a market cap of almost $10 billion in under 10 years, and has nearly doubled since listing.

Looking at the Q3 report for 2017 will pleasantly surprise investors. The company continued the strong growth that it’s been experimenting with revenues up 28.7% to EUR 1,074.7 million, and adjusted EBIT at EUR 0.4 million (0.0% margin). From last quarter, active customers increased by one million; the company now has 22.2 million active customers. This is the highest growth the company has experienced since Q2 2015, and a growth of almost 16% year-over-year.

Breaking down the revenue; the DACH (German, Austria and Switzerland) region increased 22.3% year-on-year to EUR 497.7 million (Q3 2016: EUR 407.1 million, 9.7% growth). The rest of Europe grew by 30.9% (YoY) to EUR 489.7 million (Q3 2016: EUR 374.0 million). In the DACH region, growth increased 12.6% since last year which is strong.

Order frequency increased to a record average of 3.8 times per active customer in the last twelve months.

Co-CEO Rubin Ritter said: “The very strong revenue growth in the third quarter underlines our growth focus and shows that our investments already pay off. For the fourth quarter as well as the coming years, we continue to focus on growth with the goal to double our business by 2020 and remain willing to further invest to reach this ambition.”

Management expect revenue growth in the upper half of its guided range of 20-25%, despite a “weaker than expected October”.

Investments – “You have to spend money to make money”

Costs And Margins (Source)

Zalando Management is extremely focused in investing its profits back into the company, with emphasis on capacity expansion and infrastructure, explaining the high CapEx figures on Fuffilment Costs. “We see a very positive operating cash flow of 155 million, which is then sort of [eaten] up by the investments we are making primarily in CapEx, but also some M&A activity which leads then to a negative cash flow of EUR54 million in the first nine months,” stated Rubin Ritter – Co-CEO, in the Q3 earnings call.

Let’s take a look at where this cash is going. A large majority of it is going to software development, where they are focusing on three main things: Search, Browsing and Inspiration. They have created a new search engine that is being rolled out to all markets by the end of this year, which yields faster and more relevant results. This will result in a higher order frequency, and in turn higher revenue. They also create effective conversion mechanisms for user’s browsing a broad range of product. Zalando uses user data more intelligently, to display more relevant products and is using more social/interactive elements on the site.

Aside from software development, the company is very focused in investing and building infrastructure. They have broken ground on a new fulfillment center in the center of Poland (whose e-commerce market has grown by 25% last year) and expect to ship the first parcels in the fall of next year. In Sweden, the company opened a new center this past month. The fulfillment center, located Brunna, is idea “We expect to cut delivery time by one to two days for our customers across the Nordics markets, which we think will yield additional growth momentum in these markets that also in the past have been important drivers of our growth,” Stated Mr. Ritter in the earnings call.

They are also developing locations in both Northern Italy and Paris, with “more locations to come”.

The company has an extremely large cash balance of around $1 billion, which the company is “not afraid of using”. Co-CEO Rubin Ritter stated, “[It will be used for] investments into new categories like beauty or new markets [or] it also could be around M&A activity if we see targets that make us stronger. And this will really be the focus on the next three years to continue to invest and find a good use of our capital.”

These investments in user experience, conversion to sales and infrastructure are sure to be the driving factors of Zalando’s future growth. By being able to cut lead time down by as much as 50% in some locations, they will be able to solve Europe’s biggest grief with e-commerce – speed of delivery, while also tackling the issue of returns.  “One of the key drivers of Zalando’s success in the [German] region has been its ability and willingness to handle from a logistics perspective a relatively higher merchandise return rate (~50%),” stated Credit Suisse.

But Amazon Has Prime Wardrobe, And Operates In Europe


Both management and Morgan Stanley aren’t worried about the ‘Amazon Effect’. According to this SA News Report, “Morgan Stanley thinks Zalando has a ‘protected position’ in apparel even with Amazon’s introduction of Prime Wardrobe.” It continues to state that “The firm says Zalando’s strong relationship with brands and “best in class” logistics give it an edge. The online seller is also seen having a head start on how to use data for in-season fashion purchases.”

Mr. Ritter and Zalando’s management also remain optimistic when discussing Amazon.  “Amazon is trying to steal everybody’s lunch,” he told the Financial Times in an exclusive interview. But, he feels that Zalando is situated to become Europe’s go-to destination for online fashion products. “The Amazon model is — you can get everything, and get it cheaply and conveniently,” he said. “But it’s very transactional. It’s not the best proposition for fashion.” He also stated that there is only a 20-25 per cent overlap in the two companies’ assortment.

If we compare both Zalando’s and Amazon’s business models for fashion, there is a notable difference. Sellers on Amazon Marketplace compete by price, whereas on Zalando the price stays the same, regardless of whether it’s being sold by Zalando or by its brand partners. This makes sellers like Zalando more than Amazon, as their are higher margins on the less competitive platform. And, Amazon is at a clear disadvantage on the logistics side. They are unable to handle the returns that come with fashion products, due to their lower number of warehouses and fulfillment centers (Zalando has about 5-600,000 M2 of floor space). They also cannot support the one day shipping, and do not have the ‘hometown advantage’.


Zalando, due to a strong European footprint, rapid expansion/investment and great growth could prove to be a lucrative investment. Because they are a company that is focused on investing their profits back into themselves, they stand to benefit in the long term, and their stock price has shown this, up almost 150% in 3 years. If investors can get over the (rightful, but unnecessary in this case) fear of the ‘Amazon Effect’, and invest in the company for its extreme growth, they can stand to come out on top in the future.

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