ASOS: 0 or 100 Real Quick

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Note: All currency is in British Pounds

Overview

For this week’s writeup, I think it's best if I disclose the following information: most of these writeups are planned ahead of time. While this isn’t something that is usually relevant to readers, in the case of ASOS it is. In the last couple of weeks, my original thesis has largely blown up, making ASOS a very different situation from what I would normally own or writeup. The original thesis read something like this: “ASOS is going through temporary issues but it has a strong brand and competitive position. The company has grown revenue every year of its existence so simply repeating its peak revenue numbers as inflation comes down and margins revert to normal within the next few years seems pretty conservative. Oh, and they have finally found a new CEO to guide the company through its next stage of growth.” It hasn’t quite played out like this. Now ASOS is a “0 or 100” type of investment. The stock can easily get to multiples of where it is today if the company can simply survive without diluting shareholders. This is much more easily said than done, and there is a real chance that the company has to raise money or it may go to 0.

Business

ASOS is a fully digital fast fashion retailer that targets the “20-somethings” age group. The fast fashion industry, particularly the fully online segment, is built around speed. The strategy usually goes something like the following: pinpoint the most popular trend at a given time, load up on as much inventory around this trend, clear this inventory as fast as possible, look for the next trend and repeat. Whether you prefer Zara, Shein, Zalando, or ASOS, the concept is very popular amongst younger consumers and is only getting bigger as more of the world’s population is born into or joins the world of e-commerce. 

The market share figures are hard to determine as there are many ways to break the market down, numbers are unreliable, and some information just isn’t available.  That said, ASOS has a very strong position in the UK market with about 50% market share amongst fully online fast fashion retailers. ASOS is the clear leader in this market, with the strong brand and sales figures to back it up. While all of the fast fashion retailers have slightly different strategies, ASOS’ focus on providing the most fashionable products at a great value is very different from the typical model of simply competing on price. This emphasis on fashion and value, rather than strictly on price allows ASOS to cover a wider range of financial demographics while also making the brand less commoditized as customers are not just there to find the lowest price. What is important to note is that this makes ASOS “less commoditized,” which is a far cry from being de-commoditized. Though less than their UK competitors, ASOS’ top-line numbers are coming down (even if only temporarily), as they are being forced to clear out inventory by competition on price. Clearly, this is a commoditized offering. Still, as UK consumers come to terms with the cost of living crisis, ASOS’ strong position within the region should make it one of the biggest beneficiaries of increases in discretionary spending. 

Background

From its inception in 2000, ASOS spent its first fifteen years led by co-founder, and then CEO, Nick Robertson. Though managing an online retailer through the tech bust, Great Financial Crisis, and European Debt Crisis seems far from ideal, Nick’s time as CEO was a massive success. Nick stepped down in 2015, and another Nick, Nick Beighton, was hired as CEO. Beighton’s time at the helm of the company was not quite as smooth. This era brought with it a few negative marks of note including allegations of poor working conditions (which were quickly refuted) and taking away the company’s free return policy. Despite these hurdles, the spending boom that came with the end of lockdowns brought record results for ASOS. Beighton left in October 2021 with a warning about the effect of supply chain pressures on the company. From there, Matthew Dunn, then both CFO and COO, stepped in to run the day-to-day of the business. After about a year, the company appointed José Antonio Ramos Calamonte, former Chief Commercial Officer, as CEO, with Dunn subsequently leaving. While it was disappointing to see Dunn go, obviously this new guy must be pretty good if the company would just let Dunn walk, right? Well, last week ASOS put out its first earnings release with its new leader, and to say it was abysmal is an understatement. The numbers were about what was expected (which wasn’t good), but to say the call was awful would not do it any justice. Though I am typically hesitant to be this (publicly) critical of a CEO, this is well worth the exception. It was as if he knew literally nothing about the company he was running. Again this is not something I would lean on, but for reference, at the start of the call the stock was down less than 5% and by the end was down more than 25%- all without any changes in the projected numbers. It was pretty stunning to listen to, and quite frankly I was embarrassed for him.

Cash Burn, Balance Sheet, and Valuation

It’s never a good start when your “Valuation” section is coupled with “Cash Burn,” but in the case of ASOS these are the cards we’ve been dealt. As of its last earnings release, dated February 28, ASOS had $309M in cash and $731M in debt- far from an ideal setup. It is first worth noting, that of the $731M, $100M is from an undrawn revolving credit facility. This $100M is not something the company will need to pay off unless it is used. Even better, they can draw on this cash as a source of funding, if needed of course. What is really important here though is that despite the large debt load, the company has no maturities until the $250M already drawn from the credit facility is due in November of 2024. If you believe the company can return to being cash flow positive in the back half of 2023, it should have plenty of time to generate cash to pay off that maturity. Now to the cash burn. Over the first half of the fiscal year, ASOS blew through $241M in cash. While I would take what they say with a grain of salt, management did say this period should be the most painful in terms of cash burn. To be slightly more conservative than management, let’s assume that ASOS doesn’t turn cash flow positive for another half a year and the cash burn doesn’t decrease at all. In this scenario, ASOS would still be left with about $70M in cash and should still be able to survive without raising capital. Though the situation is fragile, I believe the company will survive without the need to raise capital.

Now that we have concluded that we expect ASOS won’t go belly up, let's get to the valuation. With there being no going concern risk, the story changes from one of replacement value to one of economic value. Though it has not played out exactly as originally surmised, I’ll refer back to my original thesis in figuring out the company’s economic value. For those of you who forgot, the thesis went on the basis that the company could again generate its peak earnings figure. This result would give the company $1.26 in earnings. Historically, ASOS has traded at a multiple of at least 30 times earnings. I would very rarely, if ever, underwrite a company at this price. In addition, the company has pulled back on its international expansion and growth plans in general. Because of this, I believe a market multiple of 15x is more than fair. At $1.26, this would put the stock at $18.90- more than 4 times today’s price.

Summary

Often in investing people are fooled into believing the idea that taking more risk means the chance at a bigger reward. In most cases, the biggest rewards come with the least amount of risk, as buying something below its intrinsic value, or with the always popular margin of safety, provides a combination of downside protection with major upside potential as the stock marches towards its intrinsic value. ASOS is one of the cases where this rule is broken. The company is burning cash, the new CEO seems to be way in over his head, and the risk of default or a capital raise is real. Still, if you can get comfortable with the risks, ASOS brings the potential for immaculate gains in a relatively quick period of time.