Earnings call: Zalando focuses on ecosystem strategy for growth

In the recent Q1 2024 earnings call, Zalando’s CFO, Sandra Dembeck, outlined the company’s strategic shift towards becoming an ecosystem for fashion and lifestyle shopping. Zalando reported a Gross Merchandise Volume (GMV) growth of 1.3%, signaling a return to growth and improved profitability.

The company is on track with its full-year targets and maintains its 2024 guidance. The partner business has shown stronger performance than the retail business, and specific categories like beauty and sports have experienced notable GMV growth.

Zalando’s B2B sales fulfillment has also seen a robust increase of 13%. During the call, Dembeck addressed questions on current trading, margin expansion, and marketing efficiency, indicating a modest acceleration in top-line growth and good returns on marketing investments.

Key Takeaways

• Zalando aims to transition from a platform to an ecosystem, focusing on becoming a primary destination for fashion and lifestyle.
• The company has introduced new mid-term guidance up to 2028, emphasizing strong growth and expanding profit margins.
• Q1 results showed a GMV growth of 1.3% and an improvement in profitability, with the partner business outperforming the retail sector.
• Growth was particularly strong in the beauty, sports, kids, family, and Launch by Zalando categories.
• Zalando confirms it is on course to meet its full-year targets and 2024 guidance.

Company Outlook

• Zalando expects to continue its trajectory of growth and margin expansion, with a focus on becoming an ecosystem for fashion and lifestyle inspiration.
• Online market penetration in Germany has stabilized, with Zalando outperforming the segment and gaining market share.
• The company forecasts a compound annual growth rate (CAGR) of 5% for the online fashion market in Germany over the next five years.

Bearish Highlights

• Margin progression is anticipated to be slightly less in the second half of the year compared to the first half.

Bullish Highlights

• The company has seen strong GMV growth in specific categories and B2B sales fulfillment.
• Positive signals of customer engagement with investments in story-telling and inspirational shopping, although specific KPIs have not been reported.

Misses

• Despite improved profitability, details on the profitability of the active customer base were not disclosed.
• Benefits from a less promotional environment are expected in future quarters, not currently reflected in the Q1 performance.

Q&A highlights

• Dembeck is pleased with the company’s performance for the spring/summer 2024 season, with a modest top-line growth acceleration compared to Q1.
• The company has achieved an adjusted EBIT margin expansion of 1.3 percentage points in Q1, with expectations of lower margin expansion in the second half.
• Marketing investments are yielding good returns, with a strategic mix of brand and performance marketing.
• Improvement in retail gross margin is primarily due to better inventory management, and half of the Q1 benefit came from cost reallocation and order economics.

Zalando’s commitment to evolving into an ecosystem and maintaining a strong growth trajectory while expanding profit margins underscores the company’s strategic direction for the coming years. The CFO’s insights during the earnings call paint a picture of a company that is adapting to market trends and customer engagement strategies, positioning itself for continued success in the online fashion market.

With Zalando’s stock ticker (ZAL.DE) reflecting the company’s performance, investors and market watchers will be keeping a close eye on the company’s progress towards its stated goals.

Full transcript – Zalando (ZLNDY) Q1 2024:

Patrick Kofler: Thank you and good morning from my side as well and welcome to our Q1 2024 Earnings Call. Today I’m joined by our CFO, Sandra Dembeck. Sandra will briefly walk you through the financial developments of the quarter and is available for questions afterwards. As usual this call is being recorded. The live webcast as well as the replay of the call will be available on our Investor Relations website later today. Sandra, with that said, I will now hand it over to you. Please go ahead.

Sandra Dembeck: Thanks Patrick. Good morning everyone and hello also from my side. Thanks for joining this morning’s call. I’m very excited about our updated strategy that we presented to you in March and so before we jump into the Q1 results, let me do a brief recap. So, with our updated strategy, we are moving from platform to ecosystem and this is allowing us to cover a larger share of the fashion market. In our consumer business, we are evolving into the go-to destination for quality fashion and lifestyle shopping and inspiration. And in B2B, with sales, we are building the operating system to fashion and lifestyle e-commerce across Europe on and off Zalando. And with our updated strategy, we also presented to you our new mid-term guidance until 2028. It reflects our ambition to return to strong growth and to continue our margin expansion. So, 2024 is the first year of our updated strategy and in 2024, we returned to growth, while we continue to improve profitability and continue to invest in future growth. So, with a solid Q1 performance, we made a first step towards delivering these updated goals. And with that, let’s now turn to the highlights of the first quarter on Page 2. In Q1, we delivered GMV growth of 1.3% following on from three quarters of muted growth. And with that we return to growth in the first year of our ecosystem strategy. On profitability, we continued our path of margin expansion. We increased gross margin and reduced OpEx. In B2C, we continue to elevate and expand our multi-brand platform. The partner business continued to outperform our own retail business that we’re putting us on track to reach our partner business target share of 40% to 50% of B2C GMV by 2028. And with our multi-proposition approach, we follow and cater to the very diverse needs of our customers across different aspects of their lifestyle. So, this quarter, our beauty, sports, kids and family, as well as our Launch by Zalando propositions delivered the strongest GMV growth. In B2B, we bring more and more volume into our logistics network through sales fulfillment. And as a result, we see continued strong growth of 13% in our B2B segment, thereby outperforming the group revenue growth rate. On multi-channel fulfillment, we increased the number of merchants by five, bringing the total number now to 27 and our sales pipeline continues to grow. We also added two more markets, Poland and Spain. So, looking forward, we are on track to meet our full-year target and we confirm our 2024 guidance. So, let’s now turn to our Q1 performance in a bit more detail. Starting with the group figures on Page 3, in Q1, we return to GMV growth. GMV grew by 1.3% to close to EUR3.3 billion. Revenue came in broadly stable at €2.2 billion. Revenue growth rate of minus 0.6% is below that GMV growth rate as a result of the growing partner business share. Our focus on margin expansion is reflected in the increase of adjusted EBIT. Adjusted EBIT came in at €28 million, representing a year-over-year improvement of €29 million or plus 1.3 percentage points in margin. This was largely the result of a reduction in fulfillment costs supported by an increase in gross margin. And with this set of results, we continue on our journey to deliver growth and increased profitability in 2024. So, let’s turn to Page 4, our B2C segment performance. And as a reminder, the business-to-consumer segment includes our previous segments Fashion Store, Offprice, and also ZMS, which we previously reported in all other. So, starting with top line growth, we saw GMV grow by 1.3%, while revenues were down 1.9%. The slow end of the fall winter season sale in January was followed by a timely start into the spring/summer season, which resulted in growth for the quarter. The partner business continues to outgrow our retail business and it’s increasing its share. And as mentioned before, we saw strongest GMV growth in line with our strategy to further expand into Lifestyle and Beauty, Sports, Kids & Family and Lounge by Zalando. There was a notable improvement in profitability with an increase of 1.4 percentage points, resulting in a profit margin of 1.1%. We saw a reduction fulfillment costs as well as an improvement in gross margin. And here it’s important to note that our B2C gross margin benefited from an improvement in the retail gross margin as well as the higher partner business share. Let’s turn to the corresponding B2C customer metrics on page 5. Starting on the left, at the end of 2023, we had 49.6 million customers compared to now 49.5 million in Q1. So, active customer base developed broadly flat. On a last 12 months basis, this is roughly 3% less customers compared to the first quarter last year. Moving over to the right. Here all customer KPI show similar trends as in the previous quarter, and this highlights our focus on differentiating now through quality. While order frequency decreased by 3% from 5.1 to 4.9, the average basket size increased by 5.4% to €60.40 as a result of higher average item value. And this is mainly the result of a change in assortment mix. GMV per active customer increased by 2.2% to €297. Let’s now turn to page 6 and talk about our B2B segment performance. And before we dive into the numbers, a brief recap of our B2B segment, which includes sales fulfillment, so ZFS and multichannel fulfillment, our software business, Tradebyte and Highsnobiety. So with sales our goal is to solve the complexities of Europe and Fashion and Lifestyle for our brand and retail partners. The setup as we have already solved these complexities for partners that sell on Zalando, and with multichannel fulfillment, we will not do so for partners of Zalando. Tradebyte is a leading tenant integrator and industry, which we acquired in 2016. The software-as-a-service business hubs partners to map the product to face channels like Zalando. And Highsnobiety, Highsnobiety is an influential Fashion and Lifestyle media brand bolstering our inspiration storytelling and assortment creation capabilities. We acquired a majority stake in Highsnobiety in 2022. So now to the numbers in Q1, B2B continues to show strong growth of 13.4% and this growth was prominently driven by B2C, and with the profit margin of 2.5% our B2B segment delivers profitability while we ramp up investment into our B2B strategy. So now let’s move on to page 7. Here you can see our group P&L. Our group gross margin improved year-over-year by 0.3 percentage points. This was driven by an increase in our B2C gross margin with better sell-through rates and improved inventory management in our retail business, as well as a higher partner business share. The positive development was partly offset by the scaling of our B2B business, which comes with a lower gross margin. Moving on to fulfillment costs, that decreased by 1.8 percentage points and with the growing sales fulfillment business in the B2B segment, a larger share of actual fulfillment costs are now reported in cost of sales. So in Q1, the shift in cost drove roughly half of the reduction in fulfillment costs. The other half came from improved order economics. Marketing costs increased by 0.9 percentage points. Here we stepped up our investments in performance and M2M marketing to leverage the timely start of the spring summer season for both demand generation as well as brand building. Admin and other expenses developed flat in the quarter. So summarizing the group P&L, we stepped up our profitability year-over-year as a result of an improved gross margin and a reduction in OpEx. Turning to slide 8 for networking capital. Net working capital was negative in Q1. Looking at the year-over-year development. we see a cash inflow of more than €300 million, primarily from a lower inventory level. At the end of Q1, we had inventory of €1.6 billion, so year-over-year reduction of 23% as a result of the improved inventory management. And compared to the end of Q4, inventories increased by 10% and why this development reflects our continued prudent approach on buying for our retail business, we made sure that we have the relevant assortment as we see demand improving. So let’s move on to slide 9. Our cash and cash equivalents remained strong at about €2.3 billion and this is more than €500 million better than last year coming from higher operating cash flow largely as a result of improved net working capital. Compared to Q4 2023, we recorded a decrease of around €230 million in cash and cash equivalents and this is primarily due to the seasonal networking capital increase of €100 million as we inbounded inventory for the spring-summer season. Cash CapEx amounted to around €60 million as we continue to invest in key capabilities like logistics and technology. So this now concludes the financial update for Q1. Let’s move on to the outlook on page 10. So here we confirm the guidance for the financial year 2024, which we provided to you in March. In March, we said in 2024, we returned to growth while we continue to improve profitability and continue to invest in future growth. So before we now jump into Q&A, let me just wrap up with the key takeaways of today. Our ecosystem strategy is off to a good start. In Q1, we delivered a return to growth and continued margin expansion. We accelerated our B2C growth by elevating and expanding our multi-brand platform and we deliver double-digit growth in B2B driven by increased adoption of ZFS fulfillment. And with that, we confirm our full-year guidance for 2024. So let’s now open up for Q&A.

Operator: Ladies and gentlemen, at this time we will begin the question-and-answer session [Operator Instructions] And our first question today comes from Monique Pollard from Citi. Please go ahead with your question.

Q – Monique Pollard: Hi, morning, everyone. Thanks for taking my questions. I’ve got three, if I can. The first one is just maybe, you could please give an update on current trading and what you’ve seen particularly through April. The second question is one, around margin expansion. If I look at your guidance for the full year, the EBIT guidance even at the top of that range suggests at most one percentage point of adjusted EBIT margin expansion. And you’ve done 1.3 percentage points already this quarter. So just trying to understand, sort of when during the year you expect less margin expansion as presumably, you’re expecting sort of top line to accelerate through the yield or that had been the previous guidance. And then, final question for me is, just on the marketing expense. So obviously, sort of I just wanted to understand is through COGS in the customer payback period of 1.5 years, have you seen good returns on that span, and if you can give any color on the mix of brand marketing within that versus unit fuel cost of acquisition. Thanks very much.

Sandra Dembeck: Okay. Sure. Thanks, Monique. So on current trading, starting off with that on. So we’re very pleased with the developments that we have seen for the spring summer 2024 season. And from quarter-to-date, we have seen on top line a modest acceleration compared to Q1. In regards to margin guidance, yes, you’re right. Basically, at the upper end, this is a one percentage point improvement on the EBIT margin. We are slightly ahead of that in Q1, but it’s never linear. So there is a bit of a quarter-by-quarter variance that we will see we expect the second half to be slightly less, on the margin progression than the first half. Remember, that our Q4 results most extreme — like last year was extremely strong and profitability. And on the marketing expense, yes, referring to the 1.5 years return on invest. The mix is between brand and performance is still as it has been before 30/70, 30 on brand and 70 on the performance marketing. What you see here is that, extra demand in the springs — the start of the spring summer season had picked up — be kind of like an accelerated, a little bit on the on the marketing spend but both in brand marketing as well as in performance marketing.

Operator: Our next question is from Adam Cochrane from Deutsche Bank. Please go ahead.

Q – Adam Cochrane: Hi good morning, Sandra and Patrick. In terms of — two questions, firstly, on the inventory it’s nice to see the reduction there. How is the quality of inventory looking like now within that the number of the end of the first quarter. Had all of a clearance been done, how much should we still got left to do on that is what I’m looking for. And then secondly, when you are talking about the timely start to the spring summer, if I recall last year it was the deceleration that we had in, in April. So would you say that this is a good performance versus last year. which is really good start to the spring summer in general, thanks.

Sandra Dembeck: Thanks, Adam. So I would say, it’s a general comment around spring summer. So we are happy with the spring summer season. As always in that period you have ups and downs on the weather. We had some snow in April, if you remember. But so therefore, we are happy with the way that the spring summer season has developed. And quarter-to-date, we have seen this modest acceleration versus Q1 yes. So I think the other comment then around that relates actually then already to the inventory. So on the inventory, we are happy with the quality of the inventory, so the sell –through rate that we may see and that we currently see also that the spring summer assortments are a step-up from where we had been. And on the inventory level, the data of course, also the DIO has significantly reduced. You’ve asked then about the pockets of that inventory. Yes, we are happy with the quantity of the inventory that we have across the various categories. And we talked to you last year about young fashion being in the area, where we had kind of like so more overstocked than we wished for and where we had to continuously still clear the overstock. So those inventory levels now have normalized.

Operator: Our next question comes from Jürgen Kolb from Kepler. Please go ahead.

Jürgen Kolb: Very good, thank you very much. Two questions. First of all, I was wondering if you could maybe talk a little bit about the pricing environment that you’re seeing maybe broken down into the two traditional or former markets Europe and rest of Europe. That’s the first one. The second one is the collections, which would you say that – I mean you’ve talked about quarter-to-date. Obviously, the situation is improving at least moderately. Would you say that the actual switch the collections which have already happened in March or do you still expect the bigger push coming in April, given that the weather conditions are let’s say a little bit choppy? Thank you.

Sandra Dembeck: Thanks. So talking about the second question first, so the collection switch the symbols really timely with the February-March. So this is when we brought in the spring summer collection. And since then basically we have observed the improvements that we performed, especially of on our wholesale business and improved sell-through rates. And therefore not only good strong performance from the partner business but also strong performance in our spring summer wholesale and retail business. There is still then the question around the summer period yes. So basically, when will the summer collection really hit yes. And this is then a question now of May, but yes so the main season start both was on time in February, March. And with that off to a good start into this year. On the pricing environment well, I think what we have to say is the times of price like price inflation on the recommended retail prices are over. We see hardly any inflation there. This is all normalizing. We are improving the sell-through rates on our stock. And I would say the discounting environment is roughly stable. So we haven’t seen — so I think it’s — what else I have to do with the quarter because of course you have an end of season sale period January, which was heavily discounted various I would say the current environment is more stable environment. And that doesn’t really changed because you also asked about [indiscernible] rest of Europe. The pricing isn’t really a differentiator between the two regions. We don’t see a massive difference between the two.

Operator: The next question comes from Georgina Johanan from JPMorgan. Please go ahead.

Georgina Johanan: Hi. Can you hear me?

Sandra Dembeck: Yes.

Georgina Johanan: Hi great. Hi everyone. Thanks for taking my question. Two for me please. Just first the first one, if you could give an indication of how the domestic growth is trending at the moment and if your thoughts any recovery in that trajectory that leads? And then second, you called out kids in school been particularly good in the quarter. I’m just trying to understand, if that was market-driven or is that was more related to your kind of own early initiatives in those areas please? Thank you.

Sandra Dembeck: Morning, Georgina. So on sediments, we have seen a more challenging performance in Q1 yeah so that’s followed on from Q4. We see still the marketing budgets being slightly constrained. But there is a busy now. As we look into Q2, we see this pivoting and we expect customers to be back in growth latest in the second half. We are taking quite a few initiatives here because retail media is a large and sustainable growth environment. And so the opportunity is because there we are working with the commercially more savvy brands on release sponsored products and branded collections. And we are working also with the Hi brand equity brand on really the mid-funnel activation positioning the brand. So there is a lot that we have been in doing uncertain as and this will be visible in the numbers now as of Q2 and especially then also in the second half. On the kids and sports, I’d like to talk about what our internal KPIs maybe rather than how has the market been somewhat where we measure the success of those two propositions is basically on active customers and GMV per active customer that we drive of that. And so we have seen especially on kids growth in active customers which translated into strong growth in GMV per active customer. And in sports, it’s really interesting to see that especially now towards the end of the quarter how the active customer number has accelerated. And with that also the GMV per active customer has accelerated. And I think if you ask me about like the efforts we’re putting behind us on kids, we are working really strong on the assortment yeah. We have brought on more brands and we have also created a bit of a designer space for kids. And on sports, I would say the bigger moments are still ahead of us now with the Olympics and the European Championship. So that will be more something for Q2 and Q3 to talk about.

Operator: The next question comes from Anubhav Malhotra. Please go ahead.

Anubhav Malhotra: Hi. I have a couple of questions. Firstly, coming back to the marketing investment, just on your expectations for the rest of the year, given the significant investment increase you made in the first quarter? And then the second one on ZEOS. You’ve mentioned one client, which has taken a comprehensive package of services in the press release this morning, but could you break down for me, out of the 27 clients, how many use just the fulfillment? How many are into the more comprehensive part of the services? Thank you.

Sandra Dembeck: So on sales, maybe we go back to the strategy update. Where we said basically, the focus of sales in the coming years is really on the fulfillment, and we will be adding further like services and software in the outer years of the strategy. So the 27 clients are primarily using the fulfillment services, yes. So what we call now the multi-channel fulfillment where they — where it’s helpful for them to support their business, whether its own .com or whether it is their business on other marketplaces. And on the marketing spend, so we will — you saw that we had a 0.9 percentage point higher spend in the first quarter, and we expect to have a similar dynamic also for Q2. So there’ll be a kind of an elevated marketing spend year-over-year also in Q2.

Operator: Then we’ll go to the next question, which is from Yashraj Rajani from UBS. Please go ahead with your question.

Yashraj Rajani: Hi. Good morning. Thank you for taking my question. I have two, please. The first one is on active customers. So can you give us some color on what percentage of customers at this point are unprofitable on a unit economic basis. And again, given that you’ve lapped some of the profitability measures that you’ve undertaken, how should we think about active customers and orders going into the rest of the year? So that’s the first question. The second question is on gross margin and fulfillment. I think you briefly touched upon this earlier. But can you remind us for Q1, how much cost has been reallocated from fulfillment to gross margin i.e., what’s the underlying improvement in gross margin and fulfillment on a like-for-like basis? And again, can you remind us on a full year basis how we should think about this? Thank you.

Sandra Dembeck: Okay. So, on your first question around active customer. We don’t disclose profitability on the active customer cohorts. But we have, over the last 18 months really worked heavily on improving the profitability of our active customer base. Remember the introduction of the MOV, for example, but also other things. And it’s also part of the reason our effort — like the focus on profitable growth is part of the reason why we saw to a degree the churn in our active customer base. So the profitability of our active customer base has significantly improved, but we don’t disclose more details on this one. On your question around gross margin and fulfillment costs. So in Q1, the benefit that we saw year-over-year on fulfillment costs, half of that benefit is because fulfillment costs got reallocated into cost of sales. And the other half is basically order economics. You asked about the dynamics going forward for the full-year base. So we will look at the will continue to see fulfillment cost improve year over year but to a lesser degree.

Operator: The next question comes from Paul Rossington from HSBC. Please go ahead.

Paul Rossington: Good morning. Just one question from me please. On the retail gross margin, is it possible to kind of quantify how much — what the benefit there has been? Just trying to think about, how much kind of gross margin there is still to recover from reduced promotional activity? So any kind of color on that retail gross margin was a brilliant. Thanks very much.

Sandra Dembeck: Yeah. Happy to do that. So basically, in March we set them the B2C gross margins of 41%. And in the midterm, we want to get it to 45%. And one of the drivers was to improve from the retail gross margin versus the partner business share versus the contributions from settlements. And that retail gross margin is the one that in this quarter now we really saw improve and it had — in March we announced that we said like the various drivers. One was inventory management, which is something already on and this is what exactly see now in the improvement. So we had better sell-through rates because of the better inventory management and the relevance of the assortment the adjusted by. And that is what is driving the gross margin improvement. We haven’t yet seen the benefits from a less promotional environment or lower less discounting yeah. These benefits we expect to come through only to what I would say he upcoming quarters and years now. So at the moment, you see benefits coming primarily from inventory management to quantify it, so the B2C growth margin two-thirds of the improvement this quarter came from improving the retail gross margin sold coming from back to STR and only one that came from the improvement in the partner business. And maybe just to add because I know the disclosures in the Q1 are lighter the intention for us is really to use the half year and the full year, so Q2 and Q4 to provide you with the full set of platform KPIs including of course the gross margin.

Operator: So we have our last question for today which comes from Benjamin Kohnke from Stifel. Please go ahead.

Benjamin Kohnke: Good morning, Sandra. Good morning, Patrick. Thanks for taking my question two, if I may. The first one on the channel shift. So just wondering if the numbers that we’re seeing for the offline fashion market in Germany are just broadly right. It seem like offline continues to win market share or we are talking about it the other way round number continues to lose market share against offline. Yeah, just wondering if you could give a sort of high-level comment how you see that if you see that turning in the course of the year? And then the second one, really if you could share maybe some more details around the investments you’ve done and story-telling inspirational shopping and so on during the first quarter, and if you could already see the benefits coming through in terms of maybe being a higher engagement rates on your platform? Thank you.

Sandra Dembeck: Good morning, Benjamin. So on the channel shift, what we have seen is a stabilization of the online penetration. And we do expect actually for online to go back into growth. Indicatively, the data had 0.5 percentage point of growth this year. And then I think we showed it at the strategy update this forecast for the next — the CAGR for the next five years to be at 5%. So online penetration will increase and online therefore grow again. When we look at the market data, we see ourselves outperformed the online segment in Germany. As we speak on the offline channel, I have to say my understanding of the market was that it was flat. So I’m not sure about the different data sources that that we’re using here. But the fact for us we are gaining market share, whether that is an online or in the total fashion market. On Inspiration, yeah, we are very busy. So in Q1 what we have done is we further work on the Salon Fashion Assistance. So that’s the OpenAI search, where you can basically include your search in your the natural way that you would ask for it. Here we introduced a voice version, so now you can basically talk to the Fashion Assistance. The Fashion Assistance does contact to you right back to you. So you can to it. We also work more with influencers. We had a British, Japanese singer and actress as a brand ambassador for the Designer Segment. And we did some capital collections with US-based sales for the Designer Segments. So we are busy on all that. I would say, at the moment it’s all about, as you rightly call it engagement KPI. So we see positive signals. But I would say give us please some time to further like to pass that scale in order to start reporting on that. Yeah. For us this is more indicative for the time being, as we are launching various formats. Another format that with that fell also into like the Sports Category was like Life Shopping. We did it the famous soccer player. And all of these things are just not adding to the kind of customer engagement and inspiration that we want to create. But still this is early days. This is not yet at scale. And hence we are not yet reporting any KPIs on it.

Operator: This concludes the Q&A session. And I would like to hand back to Patrick Kofler for closing comments.

Patrick Kofler: Thanks everyone for joining today’s session. That was a rather short Q1 update, but we had a more extensive update back in March. So any further questions, do not hesitate to contact us, otherwise, wishing you a wonderful day in May. Thanks everyone for joining.

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