#WeeklyInvestorReader | wk. 20

Note to readers: #WeeklyInvestorReader contains a few of the articles I read during the week. Visit my Twitter @HurriCap for any other articles that may not have been included. 

Bruce Greenwald: Channeling Graham and Dodd: Everyone thinks the market is expensive – Barrons, May 13, 2017 Everyone thinks the market is expensive. It isn’t, says Greenwald.

Why Amazon is Eating the World – Tech Crunch, May 14, 2017 | Amazon’s lead will only grow over the coming decade, and I don’t think there is much that any other retailer can do to stop it. The reason isn’t the bullet-point moats that are talked about in headlines, and it isn’t the culture of innovation or Bezos’s vision as CEO (though I do think Amazon’s culture is incredible and Bezos is the most impressive CEO out there). It’s the fact that each piece of Amazon is being built with a service-oriented architecture, and Amazon is using that architecture to successively turn every single piece of the company into a separate platform — and thus opening each piece to outside competition.

The Mac is Turning Into Apple’s Achilles Heel – Above Avalon, April 12, 2017 | Apple’s decision to change course and develop a new Mac Pro has received near-universal praise from the company’s pro community. While developing a new Mac Pro is the right decision for Apple to make given the current situation, it has become clear that the Mac is a major vulnerability in Apple’s broader product strategy. The product that helped save Apple from bankruptcy 20 years ago is now turning into a barrier that is preventing Apple from focusing on what comes next.

Full Transcript: Billionaire Investor Warren Buffett Speaks with CNBC’s Becky Quick on “Squawk Box” – CNBC, May 9, 2017 Following is the full unofficial transcript of a CNBC interview with Berkshire Hathaway Chairman & CEO Warren Buffett on CNBC’s “Squawk Box” (M-F, 6AM-9AM ET) today, Monday, May 8th. Video from the interview is available on CNBC.com.

Sorry, we’re closed: The decline of established American retailing threatens jobs – The Economist, May 13, 2017 | A love affair with shopping has gone online

Retail Ripe For And Resistant To Disruption – Greenwood Investors, May 14, 2017 | A favorite cocktail party question we had a few years ago was, “which business do you think will get amazoned next?” At the time it seemed slightly novel. Now, it seems like the norm. In fact, your GreenWood Researchers recently overheard two grandmothers from Long Island saying there was no need to be entrepreneurial anymore, “because Amazon is just going to destroy your business.” In some respects, this is equivalent to the taxi driver investing in tech stocks in the late 1990s, but in other respects, it’s a sign that retail disruption has gained critical mass.

EBITDA and Gross Profits: Learn to Move Up the Income Statement – Focused Compounding, May 10, 2017 I think both EBITDA and EPS are “bullshit earnings” when they are the only numbers reported to shareholders. Of course, EPS and EBITDA are literally never the only numbers reported to shareholders. There is an entire income statement full of figures shown to investors each year. Profit figures further down the income statement are always more complete – and therefore less “bullshit” – than profit figures further up the income statement.

Is EBITDA as Bad as Buffett Says? – Morningstar, May 18, 2017 | In Berkshire Hathaway’s annual report to shareholders, Warren Buffett expressed disdain for financial reporting practices that deliberately inflate earnings figures in an attempt to “make the numbers.”

Berkshire Hathaway: A Safe, High-Quality, Growing Company With 30% Upside Over the Next Year – Kase Capital, May 4, 2017 | Berkshire Has Everything I Look for in a Stock: It’s Safe, Cheap and Growing at a Healthy Rate

A Few Notes About the Spotify Stock Market Listing – Felix Salmon, May 14, 2017 Everybody’s writing about this idea that Spotify might go public not through a traditional IPO, but rather through a direct listing. Direct listings are rare beasts, and so in order to understand them, reporters phone up bankers who work in equity capital markets. But the problem is that bankers who work in equity capital markets hate direct listings, because they mean they get much lower fees. And so they start spreading misinformation. So let’s go through some of the assertions.

Amazon’s epic 20-year run as a public company, explained in five charts – Recode, May 15, 2017 Soaring revenue and cash flow, plus intentionally tiny profits

5 Media Stocks Worth Tuning In For – Morningstar, May 16, 2017 |What’s ailing these companies? Though many issues are company-specific, there are also general concerns contributing to media stocks’ malaise. Subscription revenue is one. In addition, advertising revenue continues to be an issue among many media players.

How the iPhone triumphed in business – Financial Times, May 17, 2017 Apple’s ubiquitous smartphone outdid rivals but can it hold out for another decade?

An ‘asset class du jour’ is emerging out of the retail apocalypse – Business Insider, May 17, 2017 | Industrial real estate is emerging as a winner out of the crisis in brick-and-mortar retail

Spotify revenues rise but losses widen – BBC, May 24, 2017 | Spotify saw revenues reach €1.95bn ($2.2bn; £1.5bn) over the past year, but the Swedish music streaming platform has still not made a profit.

Stock Buybacks: What corporations are not telling you Arne Alsin, Founder, Worm Capital – Worm Capital, May 8, 2017 Trillions of dollars of shareholder wealth have been spent on nonproductive buybacks since rules were liberalized in 1982—and much of it has bHen wasted. Just since 2010, over $3 trillion of shareholder cash has been withdrawn from corporate accounts and sent to the stock market for buybacks, generating zero tangible benefit for shareholders. We will establish in this report that stock buybacks are wildly excessive, and that investors are being harmed. Among those harmed include index fund investors, pensions, retirees, and unsophisticated investors. Among those that benefit from buybacks include corporate insiders—primarily executives and boards of directors.

An Industry in Disruption, AUTOS. Notes from a Capital Junkie. Tit-for-Tat Analysis – CSInvesting, May 19, 2017 An electric vehicle has drastically fewer moving parts than an internal combustion vehicle and is, by design, far more modular, meaning that barriers to new entrants are significantly lower.

Cognitive Bias Survival Guide Manage the Mind to Make Better Decisions – GeekWrapped, 2017 | You know the feeling: Every day you get flooded with new ideas and information. You barely have enough time to process it all. Sure, you’re a smart and rational person that puts a lot of thought into the decisions you make. But the brain still takes decision-making shortcuts all the time. It especially happens when you need to act quickly, there is too much information, or limited memory. Here’s the deal: Research suggests that there are a number of intellectual stumbling blocks which can get you entangled in wrong judgment without you even noticing. They are called Cognitive Biases. The result is errors and irrational decisions that can hold you back. To help all of us escape this mental quicksand we’ve put together this real-world Cognitive Bias Survival Guide. It’s designed to reduce wrong conclusions and bad choices, plus protect you from charlatans trying to exploit ignorance. Think of it as anti-virus software for the brain!

In Swedish

Magnus Dagel: Tre aktier som sticker ut på börsen – Di, 17 maj 2017 | Från börsens alla balansräkningar har vi plockat ut tre som är intressanta på olika sätt. En vars nettokassa gradvis har sjunkit, en som har stärkt balansräkningen rejält det senaste året och en där kapitalet går runt i ett kretslopp.

Magnus Dagel: Allt ljus på balansräkningen – Di, 16 maj 2017 | Har du undrat över vilka bolag som har börsens starkaste balansräkningar, vilka som är högst skuldsatta och vilka som har mest goodwill? Di har lämnat vinsterna ett tag och i stället gått igenom börsbolagens balansräkningar på längden och tvären.

“Därför tvingas Izettle samarbeta med Swish” – Di, 18 maj 2017 | Izettle var länge förknippat med sin lilla dosa för kortbetalningar. Avtalet med Swish visar att man klippt navelsträngen – och byter kortavgifter mot ambitionen att växa som ett bolag för digitala kassaregister, skriver Di Digitals Jonas Leijonhufvud.

#WeeklyInvestorReader | wk. 19

Note to readers: #WeeklyInvestorReader contains a few of the articles I read during the week. Visit my Twitter @HurriCap for any other articles that may not have been included. 

Omnicom Group Inc. (NYSE:OMC) $OMC – Singular Diligence, 2016 | Omnicom Group Inc. (NYSE:OMC) is one of the world’s largest “marketing services” companies. It is a publicly traded holding company that owns many different agencies. Omnicom breaks its revenue down into four categories: advertising (50% of revenue), customer relationship management (34%), public relations (9%), and specialty communications (7%).

The Local News Business Model – Stratechery, May 9, 2017 | It’s hardly controversial to note that the traditional business model for most publishers, particularly newspapers, is obsolete. Absent the geographic monopolies formerly imposed by owning distribution, newspapers have nothing to offer advertisers: the sort of advertising that was formerly done in newspapers, both classified and display, is better done online. And, contra this rather fanciful suggestion by New York Times media columnist Jim Rutenberg that advertisers prop up newspapers for the good of democracy, nothing is going to change that.

Investment Insights from Jim Chanos of Kynikos Associates – C4K Investor Series, March 1, 2017 | We had the rare opportunity to sit down with the world-renowned, President and Founder of Kynikos Associates, Jim Chanos. Read our full interview with him in the latest edition of the Capitalize for Kids Investor Series.

The Michael Milken Project – Institutional Investor, May 1, 2017 | How did a 70-year-old ex-con barred for life from Wall Street become one of its most respected men?

How Pixar’s Billions Mock Fear of IP, Theft, Robots, and Recessions – Real Clear Markets, May 11, 2017 | Many readers are familiar with Pixar Animation’s endless streak of #1, globally popular computer-animated films.  They include Toy Story, Toy Story 2, Monster’s Inc., The Incredibles, Inside Out, and many, many more.

How to Judge a Business’s Durability – Geoff Gannon, June 13, 2015 | Of course, for millions of years, people couldn’t look it up. They couldn’t read and they hadn’t invented writing yet, so there was nothing to look up.

The Big Difference Between “Moat” and “Durability” – Geoff Gannon, March 2, 2017 | Durability is about the product and the product economics of the industry. Moat is the ability of the specific company to sell more of the product and have better product economics than competitors.

Why Facebook Keeps Beating Every Rival: It’s the Network, of Course – The New York Times, April 19, 2017 | The tech world just witnessed a robbery. The heist was so brazen you kind of had to admire it, even if it was pulled off with all the grace of a gas station stickup.

What in the World Is Causing the Retail Meltdown of 2017? – The Atlantic, April 10, 2017 | The number of malls in the U.S. grew more than twice as fast as the population between 1970 and 2015, according to Cowen and Company’s research analysts. By one measure of consumerist plentitude—shopping center “gross leasable area”—the U.S. has 40 percent more shopping space per capita than Canada, five times more the the U.K., and 10 times more than Germany. So it’s no surprise that the Great Recession provided such a devastating blow: Mall visits declined 50 percent between 2010 and 2013, according to the real-estate research firm Cushman and Wakefield, and they’ve kept falling every year since.

In Swedish

H&M måste möta marknadens krav – Di, 9 maj 2017 | Det faktum att H&M:s aktie har tappat 40 procent av sitt värde de senaste två åren är ett ofantligt misstroendevotum från investerarna. Samtidigt köper storägaren Stefan Persson aktier. Det innebär rimligtvis att det finns ett informationsglapp mellan storägaren och resten av marknaden, som inte förstår hur värderingen ska kunna försvaras.

H&M:s tystnad upprör ägarna – Di, 9 maj 2017 | Klädjätten H&M är sämst bland börsens storbolag på investerarrelationer, tycker många stora fonder och institutioner. ”Vi tror att en ökad informationsgivning gagnar både bolaget och dess aktieägare”, säger Ramsay Brufer, ägaransvarig på Alecta.

Free Singular Diligence Issue: Omnicom (NYSE:OMC)

Want some good reading for the weekend? Check out this research report on the marketing services company Omnicom (NYSE: OMC) provided for free via Gannon on Investing.

Download this old issue from the Singular Diligence collection here.

For some background info, see here.

Disclosure: I am not receiving any compensation for any of the links provided. I have no business relationship with any company or individual mentioned in this article. I have no position in any stock mentioned.

New Mauboussin Report: The Incredible Shrinking Universe of Stocks – The Causes and Consequences of Fewer U.S. Equities

Credit Suisse’s Global Financial Strategies team has published a new report, “The Incredible Shrinking Universe of Stocks – The Causes and Consequences of Fewer U.S. Equities”

  • There has been a sharp fall in the number of listed stocks in the U.S. since 1996.
  • While listings fell by roughly 50 percent in the U.S. from 1996 through 2016, they rose about 50 percent in other developed countries. As a result, the U.S. now has a listing gap of more than 5,800 companies.
  • The propensity to list is now roughly one-half of what it was 20 years ago. The net benefit of listing has declined.
  • Mergers and acquisitions (M&A) are the leading reason for delisting, and initial public offerings (IPOs) are the primary source of new listings. In the last decade, M&A has flourished while IPOs have floundered.
  • Regulation has increased the cost of listing and facilitated meaningful M&A.
  • As a consequence of this trend, industries are more concentrated and the average company that has a listed stock is bigger, older, more profitable, and has a higher propensity to disburse cash to shareholders.
  • Exchange-traded funds have filled part of the list gap.

Click here to read the full report.

See here for a collection of links to other Mauboussin papers.

New Mauboussin Report: To Buy or Not To Buy – A Checklist for Assessing Mergers & Acquisitions

To Buy or Not To Buy: A Checklist for Assessing Mergers & Acquisitions

“Companies that act early in an M&A cycle tend to generate higher returns than those that act later. The first movers enjoy the benefits of a larger pool of targets and cheaper valuations than companies that buy later in the cycle. Cheap and accessible financing prompts action by buyers at the end of the cycle. So do bandwagon effects, or what Warren Buffett, chairman and chief executive officer of Berkshire Hathaway, calls the ‘institutional imperative.’”

Credit Suisse’s Global Financial Strategies team has published a new report, “To Buy or Not To Buy.”

  • Companies spend more on mergers and acquisitions (M&A) than any other alternative for capital allocation.
  • Empirical analysis shows that M&A creates value in the aggregate, but that the seller tends to realize most of that value.
  • While the market’s initial read of a deal is not perfect, there does not appear to be a bias.
  • Careful studies show that value creation is largely independent of EPS accretion or dilution.
  • Buyers see their stock rise when the present value of synergies exceeds the premium they pledge to the seller.
  • The form of financing and category can send signals about a deal’s merit.
  • We suggest answering four questions in order to assess mergers and acquisitions: How material is the deal? What is the market’s likely reaction? How did the buyer finance the deal? Which strategic category does it fall into?

Click here to read the full report.

See here for a collection of links to other Mauboussin papers.

#WeeklyInvestorReader | wk. 4

Note to readers: #WeeklyInvestorReader contains a few of the articles I read during the week. Visit my Twitter @HurriCap for any other articles that may not have been included. 

You can look it up – Seth Godin, January 21, 2017 | Of course, for millions of years, people couldn’t look it up. They couldn’t read and they hadn’t invented writing yet, so there was nothing to look up.

The end of active investing? – Financial Times, January 20, 2017 | Technology and low returns have delivered a killer blow to a once-dominant industry.

Buy. Squeeze. Repeat. – Fortune, January , 2017 | The Brazilian investors who control Kraft Heinz are applying their proven formula to construct a new global food colossus. What will they buy next?

Valuation and investment analysis – Bronte Capital, January 3, 2017 | I just had a chat with someone who wondered why I did not have a valuation for everything in my portfolio – a buy and a sell price. My reaction: such (false) precision was silly and ultimately counter-productive.

When do you average down? – Bronte Capital, January 4, 2017 | A decent stock note is 15 pages on the business, one page on the management, one paragraph or even one sentence on valuation. Valuation might normally be a set of questions along the lines of “what do I need to believe” to get/not get my money back. But I would prefer a simple modification to this process. This is a modification we have not done well at Bronte (at least formally) and we should do better. And that is the question of averaging down.

My Interview with Edward Thorp, from Tim Melvin – Daily Speculations, January 19, 2017 | Edward Thorp is one of the most well known figures on Wall Street. Throughout his venerable career he’s spent time as a mathematics professor, hedge fund manager, blackjack player, and author. “The father of the wearable computer,” recently released his sixth book, “A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market.” Marketfy’s Tim Melvin recently caught up with the Wall Street legend to discuss his career and outlook on investing. Below is their conversation, slightly edited for length and clarity.

Big-Bank Executives Have Sold $100 Million in Shares Since Election – Wall Street Journal, January 24, 2017 | The sales, coming as financial stocks soared, are more than in that same period in any year over the past decade.

Tax Reform Top of Mind for Wide-Moat U.S. Industrial Firms – Morningstar, January 23, 2017 | While management teams enthusiastically highlighted corporate tax reform, capital mobility, and infrastructure spending as potential near-term earnings tailwinds, all stopped short of explicitly incorporating these favorable outcomes into 2017 expectations. We agree that it’s too early to include Trump’s America in the base-case assumptions that fuel our discounted cash flow analyses. However, if President Donald Trump’s target corporate tax rates and modest top-line growth materialize, our bull-case scenarios look realistic.

Does Dow 20,000 Mean Stocks Are Overvalued? – Morningstar, January 25, 2017 | With the Dow crossing the hurdle of 20,000 this morning, many investors are wondering if this is a sign that the bull market is nearing its end or if stocks have become significantly overvalued. In short, Morningstar’s stock analysts see stocks, as a whole, trading at only slightly above their fair value estimate and that there are some values out there, even among Dow components. However, this is not to say that a correction or even a bear market is not in the cards. Current market valuations don’t tell us very much about where stocks are going in the near term; the market can stay overvalued for a long time, could become deeply undervalued or could bounce along at current levels. This unpredictability is one the reasons that trying to time the market around major news events, index milestones. and broad valuations is exceedingly difficult.

Renowned value investor Francis Chou is willing to wait on a bargain – Canadian Business, January 26, 2017 | He’s regarded as one of the savviest value investors in the world. The market is overpriced right now, he says, but it will come down—it always does.

Inside Pandora’s Quest to Take on Spotify, Apple Music & Amazon – Billboard, January 19, 2017 | As the lights of the strip ­glimmer below, Pandora co-founder/CEO Tim Westergren stands before two dozen advertising executives in a 61st floor suite in the Cosmopolitan of Las Vegas. It’s the first day of 2017’s Consumer Electronics Show (CES), and he’s pitching Pandora’s new direction. “In my opinion, the other music subscription products out there are unsatisfying,” he says, referring to the on-demand streaming services the new Pandora Premium will begin competing with later in 2017. “They give you millions of songs, a search box and ‘good f—ing luck.'”

Cash Cows Of The Dow – Meb Faber, January 14, 2017 | Long time readers know that I have been a shareholder yield advocate on the blog for almost a decade.  (We used to call it net payout yield back then, and we define it as the combination of dividends and net buyacks.) People are slow to change of course, but my hopes are that eventually you all come around to a little common sense.  Sometimes books and white papers are too much, and all that is needed is a simple chart or table that will change people’s minds. Remember the old Dogs of the Dow strategy where you just invest in the 10 highest yielding Dow stocks each year?  This strategy was popularized by O’Higgins, and historically beat the market.  But as you all know, a shareholder yield approach does even better historically.

How Well Does Running Vanguard Pay? – Bloomberg Businessweek, January 19, 2017 | The index fund pioneer is an important shareholder voice on executive pay, but its own compensation practices are kept private.

In German

Mit diesen Problemen kämpft H&M – Stern, December 13, 2016 | H&M hat eine ganze Generation mit günstiger Mode versorgt. Doch das schwedische Modehaus hat Probleme, denn die jungen Kunden kaufen bei der Konkurrenz – oder gleich im Netz. H&M braucht dringend neue Ideen.

H&M fehlt das Konzept für neue Gegner – Wirtschafts Woche, November 16, 2016 | Die Krise bei H&M ist symptomatisch für die Branche: zu viele Filialen, zu wenig Umsatz, kein Konzept gegen neue Angreifer. Eine Änderung der Strategie der einstigen Vorzeigekette ist nicht in Sicht.

In Swedish

“För oss har pengarna inte varit problemet” – Di,24 januari 2017 | Den som investerade 10.000 kronor i investmentbolaget Latour vid starten 1985 har sett kapitalet växa till 8 miljoner kronor. Di har besökt vd Jan Svensson och familjen Douglas börsnoterade överavkastningsfabrik i ett industriområde i södra Göteborg.

Historien om en bank som nästan gick omkull – Aktiefokus, 26 januari 2017 | Denna historia börjar 2002 med en bank. Det skulle egentligen kunna vara vilken bank som helst men det är en verklig nordisk bank som jag har valt för att illustrera några poänger för hur grov lönsamhet snabbt kan vända till att banken behöver räddas genom tillförsel av nytt eget kapital.

H&M- Sveriges största value trap? – Fundamentalanalysbloggen, 25 januari 2017 | Den som köpte H&M på toppen för två år sedan har idag bara 65 % kvar av sina pengar. Detta beror inte på något missförstånd på marknaden pga negativa skriverier, utan på verkligheten. En verklighet som borde ha sänkt aktien än mer vore det inte för att marknaden, inte minst när det gäller en gammal nationalklenod, är sen att agera när det börjar gå dåligt. Det känns också som om ingen riktigt vill skriva ner H&M i Sverige. Man får inte låta sig luras att tro att en fallande aktiekurs tyder på “rea på aktien”. Det beror oftast på att företaget har problem och i H&M:s fall väljer man istället för att lösa problemen att måla över rötan med expansion. Med andra ord mer av det gamla, det jättelika butiksnätet, som idag är ett problem. Lite som att kurera bakfylla med Bloody Mary.

H&M i marknaden – Lundaluppen, 22 januari 2017 | Sedan H&M släppte sina försäljningssiffror för december har dödsrunorna duggat tätt och att H&M är en besvikelse på aktiemarknaden de senaste åren är ett faktum. Jag tänkte titta lite mer på bolagets strategi, dess position i branschen och på klädmarknaden som helhet. Det är en marknad i förändring där den stora förflyttningen just nu går från fysisk butik till onlineförsäljning. Utöver denna mångåriga trend finns den vanliga utmaningen i modebranschen med skiftande moden och ständiga heta nykomlingar. I vissa fall förstärker dessa trender också varandra, men mer om det senare. I detta inlägg vill jag titta på bolaget H&M, inte så mycket på aktien H&M.

H&M: Stuck Between a Rock and a Hard Place?

All amounts in SEK. 

The story of H&M goes back to 1947 when Erling Persson – father to Stefan Persson (Chariman of the Board) and grandfather of current CEO Karl-Johan Persson – opened the first store. Since then, H&M has grown and expanded its business internationally. At the end of its latest full fiscal year in 2015 it operated a total of 3,924 stores in 61 different markets around the globe with total sales of 181 billion (fiscal year 2015). As of 31 August 2016 the group had 4,135 of which 176 were franchise stores.

The Persson family is the dominant major shareholder and controls 69.7% of voting rights and 37.7% of total shares outstanding (see table below). H&M is more of a publicly listed family company. This could be one of the reasons explaining H&M’s poor quality when it comes to financial reporting and the disclosures presented in the annual report.

This text focuses on H&M’s annual report for fiscal year 2015 (1 December 2014 to 30 November 2015).

Source: H&M Annual Report 2015

Expansion has been nothing but extraordinary with each year offering new store openings and growing total revenues. Focusing on revenues, H&M has delivered some pretty solid growth. But, the further down the profit and loss statement we go, the worse it gets. Profitability has not kept up with the growth in sales, putting pressure on profit margins.

During the last nine years, that is 2007 to 2015, H&M grew its revenues at a compounded annual growth rate (CAGR) of 8.7%, from 78,346 million in 2007 to 181,861 million in 2015. Gross profit and operating income during the same period grew at a CAGR of 8.0% and 3.9%, respectively. The lower CAGR in gross profit and operating income put pressure on profit margins, with gross profit margin going from 61.1% in 2007 to 57.0% in 2015, and operating margin from 23.5% to 14.9%.

The last decade has offered a solid mix of challenges for H&M; a financial crisis, currency movements, weather and fashion trends as well as growing competition from e-commerce and online retailers. The problem is not in the revenue growth itself, it is that profitability has significantly declined.

For most businesses growth comes at a cost. To maintain and grow its store count – from 1,522 in 2007 to 3,924 stores in 2015 – H&M spent a total of 56 billion in tangible capital expenditures. Then we also know most businesses have costs for growth SG&A and increasing working capital needs that comes with a certain amount of growth. H&M also spent an increasing amount of cash on its online sales business, either expensed directly through the income statement or capitalized on the balance sheet. Other operating expenses have increased from 8.9% of sales in 2007 to 10.8% in 2015. Intangible capital expenditures amounted to 5 billion, of which 4 billion was spent in 2012-2015.

The high level of investments together with declining profitability have resulted in a lower amount of cash, with cash and cash equivalents steadily declining from 20.9 billion in 2007 to 13.0 billion in 2015 (8.7 billion per Q3 2016). H&M is no longer able to found its yearly dividend from free cash flow, and the dividend has been maintained at about the same level in the latest five year period thanks to cash in the bank from prior years. Of course this could be solved to some extent by H&M if they decided to stop or reduce its growth capital expenditures (and other growth expenditures) or manage to increase profit margins and cash flows. The unpleasant part in this equation is that lowering capital expenditures would most likely result in a lower future growth rate (fewer store openings each year, even if compensated in the best case to some extent by rising online sales), or no future growth at all and in a worst case scenario with declining future total revenues.

Source: Morningstar

Average return on equity (excluding cash and cash equivalents) has averaged 88% in 2007-2015, from a high of 134% in 2007 to a low of 52% in 2015. Returns are still great, but it’s also obvious that what we’ve got here is a negative trend in the underlying profitability. The main question for investors today is what H&M’s future profitability will look like? With the retail industry, and especially the fast-fashion sector being one of heavy competition it’s not entirely obvious what the future has to offer. Historically, H&M has made its long-term shareholders very wealthy. The question going forward isn’t about whether H&M has been great or not in the past – we all know it has. The question is what future performance H&M will be able to offer? And the last 5, 7 and 10 year periods may all have made a reasonable answer to this make-or-break question a little gloomier. But, it may still be as great as its always been, or? Since we don’t know in which areas H&M deploys all its growth expenditures and the mix between the “old H&M” and the new growth initiatives and brand building that has been ongoing for some time.

As always, we know what’s been but not what will be. H&M is currently trading at 234 per share, a level first reached in 2010. In the middle of 2013 the market changed its view of H&M and the share price went from 230, reaching an all-time high of 368.50 in 2015. Since then the share price is down about 36%.

It’s been almost a decade of declining profit margins and profitability. With a great annual report at hand we would be able to search for potential answers and understand in a good enough way what goes into this negative trend in profitability. But I’m afraid we don’t have one, since H&M seems to be following more of a “non-disclosure” policy than the other way around– sad but true, at least for outside passive investors. Let’s take a look at a few different areas in the 2015 annual report to see what’s missing.

Source: Avanza.se

Quality of Financial Reporting

Reading H&M’s annual report for fiscal year 2015 provides some great insights into the business. Although there are a few things that an outside passive investor would probably very much like to know, about which H&M says nil.

When reading an annual report and thinking about a specific business, ask yourself; What financial and non-financial metrics would I want if I was the one running the business? A few things you probably would like to know about are:

  • Sales per region, per country, at the store level, as well as sales per square meter – for each major brand in the portfolio.
  • The profitability of the business – that is, profit margins and invested capital turnover, together making up the return on invested capital – and any changes occurring and the reasons explaining any significant changes in underlying trends – again for each major brand in the portfolio.
  • Tangible and intangible capital expenditures – both maintenance and growth – split between the major brands in the portfolio.
  • Revenue growth – probably on a quarterly basis, but at least year-over-year – per region, per country, and at the store level – and again you’d want to know this for each major brand.

Does management tell you the business facts that they themselves would want to know if their positions were reversed? Let’s find out, but as a primer – you might become a little concerned about the state of things if you keep on reading.

Same Store Sales Growth. H&M no longer discloses monthly same store sales data. That’s fine with me if we talk about monthly data, but I would very much like to know what same store sales, at least year-over-year, look like. Especially in a case like H&M were growth in new stores could mask the performance in the current and old store count. Too bad, H&M does not provide this data to outside investors. Of course the relative value of this metric declines as online sales makes up a greater part of total sales. But, since H&M does not break out its online sales, should outside passive minority investors interpret this as a fact that online sales makes up a non-material part of total sales? Because if online sales made up a material and significant part of total sales, shouldn’t this information be disclosed in the annual report?

Same store sales growth is a relevant metric as long as there are physical retail stores making up a material portion of total revenues. And with the current strategy of maintaining a high growth rate and expanding the total number of retail stores, it seems unreasonable to expect this to change for some time. Thus, same store sales data is a metric of interest to investors and should therefore be disclosed, at least on a yearly basis in the annual report.

Total square meters. What are the total square meters of all of H&M’s retail stores? Management knows, you don’t since this is a non-financial metric that is not disclosed. A highly relevant metric, one could argue, for a retailer to make it possible to track revenue, profit, and invested capital per square meter for its physical retail stores. This metric should also be disclosed (at least in the annual report).

Operating Segments. Below is note 3 Segment Reporting from the 2015 annual report. There is only one issue with this note; the way it is structured and presented. It doesn’t provide anything of real value to someone trying to understand, analyze and assess the underlying business fundamentals. Maybe that’s what management want? To make it as hard as possible for others to get a glimpse of how different regions are performing. I don’t know. All I know is that this disclosure from H&M about their operating segments is of no value to me when evaluating and valuing H&M as a going concern. Right now a great part of the total operating profit belongs to Group Functions which makes it a little less useful when it comes to analyzing and assessing the development for each operating segment.

One has to assume that this segment information is in line with the requirements in IFRS 8, but one also has to assume that management does not want to provide any real value to readers. If they had wanted to do so they would have designed it in a different way.

H&M should provide information about the different geographical segments (at a proper level), different brands and their sales and profit margins and invested capital. Regarding online sales, this should also be separated and reported on a stand-alone basis. More about this below.

Source: H&M Annual Report 2015

Share of Online Sales. How much of total revenues is generated from H&M’s online business? No one knows, except for management. You could look around and try to make an educated guess, and that might be good enough, but a disclosure about revenue from online sales is nowhere to be found in the annual report.

One could elaborate on the question regarding at what level of online sales in relation to total sales that would require H&M to disclose this key metric. If H&M’s online business accounts for as much as 10-12% of the total 2015 sales revenue, that is around 21 billion to 25 billion (Source: Bernstein via just-style), one could argue that this is material information to investors, and therefore should be disclosed in the annual report.

It will be interesting to follow how this develops and whether we’ll see any online sales figures in the upcoming annual report for fiscal year 2016.

Profitability of Online Sales. As much as we want to know how much sales the online business generates, we also would like to know any profitability of such sales. But, there’s no information about this in the annual report. I guess we could all agree on the importance of online sales for fashion retailers from now on. The question is what profitability looks like in this area? An educated guess is that it might not be the high-margin, high-profitability business that we’ve gotten used to in the past where most of the sales was generated via H&M’s physical retail stores.

E-commerce is no cash cow for fast-fashion retailers, whose thin profit margins from high volume sales are slashed by free shipping and returns. As the retail market as a whole is moving online, however, H&M—which was late to the game—is finally making the necessary investments to compete. “The penetration rate of online sales for apparel is just going to increase over the next five years, so if you don’t have an e-commerce website, your customers are likely to go elsewhere,” said Grant. (Source: Forbes)

Sales and profitability of different store brands. H&M discloses total revenues (hey, that’s great – ain’t it?), revenue per country and also revenue per region (in their segment reporting). What’s missing is a breakdown of revenue between the different brands, and also the split in revenue between physical retail stores and online sales. Further, no information is provided about operating income and invested capital for each brand.

Source: H&M 2015 Annual Report

CEO comments. The CEO comments is a great chance for a CEO to talk directly to all the shareholders and outside passive minority investors. Many CEO’s are either not good enough to express themselves and their business strategy in writing, or they just don’t want to make an effort great enough to do so in a proper way (at least seen from the perspective of an outside passive investor). CEO comments when it comes to H&M might be good, but I still think it could be improved a lot from here since much of the information provided doesn’t really offer any great insights into the business more than on a consolidated level.

Marketing and other operating expenses. H&M does not disclose its marketing expense and not any expenses related to IT. By putting together the different expense categories (rental, payroll etc.) disclosed in H&M’s annual report we can calculate how much of total operating expenses that is made up of other expenses – see table below.

Total operating expenses to sales increased from 76.5% in 2007 to 85.1% in 2015, mostly explained by higher COGS to sales (+2.3 pp), depreciation to sales (+1.1 pp), and other expenses to sales (+3.3 pp). Rental, labor, and amortization was almost unchanged. Other expenses made up 12.7% of total operating expenses in 2015 compared to 11.7% in 2007. It would be interesting to know what makes up these other operating expenses and how they have changed in composition during 2007-2015.

Calculations by Hurricane Capital. Source data from H&M.

Earnings Call Transcripts. This is not an issue that is specific to H&M, neither to the annual report itself. I bring this up just because I think all listed Swedish companies should be required to provide transcripts of earnings calls in their investor relations section. Fortunately, there are external parts providing transcripts. See here for some H&M earnings call transcripts provided via Seeking Alpha.

Nine-Month Report 2016

A quick look at the most recent nine months shows an increase in net sales of 5.6%, compared to an increase in total store of 12.5%. H&M opened 264 (206) stores and closed 53 (42) stores, i.e. a net increase of 211 (164) new stores. The group had 4,135 (3,675) stores as of 31 August 2016, of which 176 were franchise stores.

Revenue growth slowed significantly in the first nine months in 2016 compared to the same period in the prior year. The negative trend in both gross and operating profit continued to put pressure on margins and profitability. Earnings per share declined in Q3 2016 (-9.3%) as well as for the nine months 2016 (-17.2%).

Inventory increased with 23.9% year-over-year to 31.231 million at the end of Q3 2016. Total capital expenditures amounted to -9.288 million (tangible capital expenditures of -8.087 million and intangible capital expenditures of -1.201 million).

Also, H&M raised 3.724 million in short-term loans in the first nine months 2016. Without this short-term loan H&M’s cash and cash equivalents would have been 4.956 million instead of 8.680 million at the end of Q3 2016, compared to 10.963 million in Q3 2015.

Source: H&M Nine-Month Report 2016

Final words and valuation

To wrap this up, H&M is a good business and I have liked it earlier on and might come to do so again in the future depending on how it all plays out. What I don’t like is to invest in a business I think is a good one – especially when the historical track record has been great (which could have a significant impact on the quality of your own judgement) – just to realize later on that it wasn’t such a good business as I originally thought (and by then running the risk of a permanent loss of capital).

Calculation by Hurricane Capital. Source data from Börsdata.se.

Currently H&M is trading at a P/E (TTM) of 21.2 and EV/EBIT (TTM) of 16.1, in line with its 10-year average. If H&M is able to maintain or even turn around the negative trend in earnings and keep growing the business, the current share price probably would be considered a great entry point for investors in hindsight, most likely somewhat of a bargain. If this is not the case, that is, profitability will decline even further along with slowing revenue growth, the current share price is at a high level and you should look elsewhere for ways to invest your hard-earned money.

Personally, the last decade and the negative trend in profitability coupled with increased importance of having a presence in the online sales field and the tough competition in the retail business makes H&M a too uncertain investment case for me, at least at the current price level. There are many other great businesses out there with more favorable characteristics and less uncertainty. Let’s go try find some of these instead.

If you want to make your own assessment of the quality of H&M’s financial disclosures, click here to read H&M’s annual report for fiscal year 2015.

Disclosure: I have no position in the stock mentioned, and no plans to initiate any position within the next 24 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion, and should not be considered investment advice. Always do your own due diligence and contact a financial professional before executing any trades or investments.