Zara escapes economic recession in Spain

Clothing giant Inditex sees its first-quarter profits rise by 30%.

(Photo: Bloomberg/Getty)

An already smarting Spanish stock market got more bad news in late July after Telefonica, the country’s largest telecom, announced that it was suspending its dividend and slashing revenue forecasts. It’s reports like these that have sent investors fleeing from European markets. If a giant like Telefonica is teetering, then everything else must be going to the dogs too.

The shareholders of Inditex, the Artexio, Spain–based company behind high-fashion, low-cost retailer Zara, know otherwise. On June 13, the company stunned investors and analysts when it revealed that its profit climbed 30% in the first quarter of this year and sales jumped 15% year over year.

What’s perhaps most intriguing is that while the company has stores around the world, 70% of its revenues come from Europe. It’s also in a cyclical sector and based in a country that’s seen its stock market fall by nearly 30% this year. Why is it doing so well while other eurozone firms have struggled? According to Don Huber, lead manager on the Franklin World Growth Fund, the answer lies in its unique business model.

The company does several things that other retailers don’t, he says. First, it stocks clothing in limited quantities. When a particular style runs out, it runs out. “They’ve trained consumers not to wait for it to go on sale,” he says. “It may not be there.” Second, its factories are based in Europe, so new designs can get into stores in about two weeks. Clothing lines shipped from China face a lag time more like two months.

Zara also prices clothes differently depending on the location. Jaime Katz, an analyst with Morningstar, says its wares are usually cheaper in Europe and more expensive in Asia and North America. That’s coming in handy now, she says, as Zara can make a little more money from countries that aren’t in the midst of a crisis. It’s this nimbleness, says Katz, that sets the chain apart, and it’s key in an environment where people have less to spend. “When you can move inventory through like they do, you can react very quickly to what buyers want,” she says.

Inditex is a growth business, says Huber, but it will also appeal to income investors. In most countries, it has less than a 1% market share, and in some cities it has only one store. Yet Zara is in 84 different countries. “They have one of the broadest footprints in clothing retail, but they still have tremendous opportunity to gain market share,” he says. Income investors will like its 3.5% dividend and minimal debt. Its return on equity is also about 28%. The company has also cut costs and spends far less on advertising than its competitors.

Some fund managers still aren’t sold. Bob Gorman, chief portfolio strategist with TD Waterhouse, recommends looking to northern Europe for opportunities. He says investors should buy global companies in defensive sectors that pay a dividend, over those in Spain where the macro economic situation is so difficult.

However, Huber reasons that “you can’t judge a company by where it’s headquartered” or even the market it’s in. It’s about the business model, the customers and the brand. If a company’s fundamentals are strong and its growth potential looks good, then there’s no reason not to buy it even if it is located in Spain. “We’re not scared off by a company that can grow in this market,” he says.