Monday 17 August 2015

Zalando (ZAL GY) ... H1 prompts further observations

Monday 17th August 2015

Zalando (ZAL GY), currently capitalized at €7.9 billion, last week reported its half year performance to 30th June 2015. This is a follow-up to a prior post on five observations

Here are some further observations ...

As I understand matters, in late 2014 the group decided to extend its practice of invoice billing. Zalando indicates that this is "... a popular payment method in several countries, e.g., DACH, Benelux and Nordics, driving customer satisfaction and check-out conversion."

The customer takes receipt of their package of clothing, shoes, onesie, etc, accompanied by a bill requesting that they settle payment due within a certain period. According to Zalando it is 14 days to pay in Germany; mail order's buy now - pay later.

Apparently, Zalando has an algorithm for weeding out worthy buy now - pay later invoice billing customer types, which historically has proven to be "... robust, successfully limiting risk."  Then - as already mentioned - in late 2014 it extended the invoice billing offer to capture new customers. Low and behold, this together with a rise in systemic fraud resulted in an increase in bad debt, which largely occurred in Q1 2015.

Trade receivables totaling €18.5 million were seemingly written off.

Zalando write down of trade receivables
Source: Zalando H1 2015 report
This would appear to have knocked c. 2.3 percentage points from the Zalando's adjusted EBIT margin.
Impact of receivables write down on group margin
Source: Zalanda H1 2015 report

Several points may wish to be considered:

1. The chickens are coming home to roost

One has to wonder what Zalando expected as a result of loosening whatever qualifying conditions were required in order to extend invoice billing. You hand over your goods on an IOU, you takes your chances.

2. Quality of sales is vital on wafer thin margins

While in the context of €1,377 million of H1 2015 sales an €18.5 million write down is relatively small, it is still c. 5.6% of the incremental €329.5 million increase in sales as compared to H1 2014 sales of €1,047 million. Further still, as profit margins are thin, it has a significant impact. Ex the receivables write down, EBIT would have been 36% higher in H1 2015.

3. Does the maths stack up?

I may well be wrong here but the numbers provided by Zalando in its presentation are somewhat unclear.

As highlighted in the receivables write-off above. €18.5 million was:

"... recorded as an expense in the second quarter of 2015 in line with IAS 8 as a change in estimates. Those changes in estimates relate predominantly to trade receivables originating from the first quarter of 2015."

The group then goes on to highlight that:

"In the second quarter of 2015, Zalando generated adjusted EBIT of EUR 30.2m (prior year: EUR 35.1m). This decrease of 2.3 percentage points in the adjusted EBIT margin from 6.4% in the second quarter 2014, to 4.1% in the second quarter 2015 is due to the afore-mentioned increase in payment costs offsetting the fundamentally strong operating performance of the business."   

So as I understand matters, €18.5 million was expensed in Q2 2015, and without this adjusted EBIT would have been €18.5 million higher at €48.7 million (€30.2 million + €18.5 million), so the adjusted margin would have been 2.3 percentage points higher at 6.4% as compared to the out-turn of 4.1%.

Q2 2015 sales were reported to be €733 million.

Adjusted EBIT of €30.2 million = an adjusted 4.1% EBIT margin, which tallies up as reported.

However, if adjusted EBIT was higher by €18.5 million (due to the impact of the receivables write down) and this was equivalent to an adjusted EBIT margin of 6.4%, then ...

An adjusted EBIT margin of 6.4% on adjusted EBIT of €48.7 million = implied sales of €761 million.

I.e. sales would have been €28 million higher.

I may indeed have my maths wrong on this or there may be rounding errors involved so any light on this would be welcomed.

4. What does this say for some of the businesses in Rocket's portfolio?

If Zalando is experiencing "unexpected systematic fraud" in those bastions of online shopping rectitude being Germany, Austria, Switzerland, Benelux and the Nordics, then what are the chances of systematic fraud for Rocket's Zalora operating in Thailand, Indonesia, Philippines, etc? Or Rocket's Dafiti operating in Brazil, Argentina, Chile, Colombia, and Mexico? Or Rocket's Lamoda operating in Russia, Kazakhstan, and Ukraine?

Rocket's Jumia/Zando business operating in Nigeria, Cameroon, Ghana, Uganda, Ivory Coast etc, is probably a safe bet. This is especially as the majority of its c. €62 million of 2014 sales would likely have been settled by cash on delivery in a market where according to Rocket itself "... approximately 80% of the population does not have a bank account to overcome fears of internet fraud."

And another thing ... 

The company is seemingly awash with cash and yet ...

Zalando reported €974 million in cash and cash equivalents to 30th June 2015. Cash and cash equivalents decreased in the period by €77.4 million, the main driver indicated to be due to investment of funds into term deposits.

Here is the group's condensed statement of cash flows and accompanying text.

Zalando H1 2015 condensed statement of cash flows
Source: Zalando H1 2015 report
Here is the group's fuller cash flow statement from H1 2015

Zalando H1 2015 cash flow statement
Source: Zalando H1 2015 report
And here is the group's discussion on the movement in its current liabilities.

Increase in liabilities
Source: Zalando H1 2015 report
A few items to note.

  1. In the accompanying text to the condensed statement of cash flows, Zalando points to positive cash flow from operating activities which had "... mainly been achieved through longer payment terms with suppliers."
  2. As per the cash flow statement, there was a €78.2 million cash inflow attributable to increased trade payables in H1 2015. As highlighted above, this was seemingly a principal driver of the €23.3 million in total operating cash inflow during the same period. 
  3. The cash flow statement shows that total cash outflow into "investments in term deposits" totaled €110 million in H1 2015.
  4. The group again highlights in its discussion on movements in current liabilities, that trade payables rose "... from deliveries of goods and was achieved through longer payment terms with suppliers."
  5. It also indicates that "Under reverse factoring agreements, selected suppliers transferred their receivables due from Zalando totalling €128.2m to a factor as of June 30, 2015 (prior year: €90.5m)."
I'd highlighted the group's use of reverse factoring agreements in my prior post and these arrangements would appear to be forming an increasing proportion of its trade payables and similar liabilities.

In fact, according to Zalando's accounts, its trade payables and similar liabilities have risen as follows:

  • 2013: €410 million
  • 2014: €492 million
  • H1 2015: €569 million

Meanwhile, the group's use of reverse factoring (included in its reported trade payables and similar liabilities) has risen as follows:

  • 2013: €38 million
  • 2014: €91 million
  • H1 2015: €128 million

Hence, reverse factoring liabilities as a percentage of trade payables and similar liabilities have risen as follows:

  • 2013: 9%
  • 2014: 18%
  • H1 2015: 23%   

One possible interpretation of what is occurring is that Zalando is using a third party financier to settle an increasing proportion of its trade payables. Presumably the third party financier is paying a supplier (or suppliers) to Zalando on the date due and Zalando pays the third party financier at a later date.

If this is the case, then it looks increasingly like this reverse factoring arrangement is akin to a loan, benefiting Zalando.

Assuming this interpretation to be correct, then one could be forgiven for thinking it slightly strange. Especially as Zalando would appear to be awash with cash, so much so that it is having to shove increasing amounts into term deposits.

Of course, the upshot of all this is that Zalando's operating cash and free cash flow is materially boosted, while investing cash flows out.

I am short Zalando.

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 


  1. Article only available in German (so far). What were they thinking?

    1. Hi Marko - do you have a link as the one you provided does not seem to work?

  2. The german article. I tried to post a google translation link....doesn't work.

    1. Astonishing. With that approach, no wonder they reckon they can get to 5-6% of online European clothing sales.
      Thanks for highlighting.

  3. I was looking at Zalando use of reverse factoring and from 2013 onwards they grew from 38M Euro to 450M Euro (1084.21% increase), which means that they are inflating operating and free cash flows for almost a decade fooling who invested in their company. Can be considered a fraud?