H & M Hennes & Mauritz AB (publ) (OTCPK:HNNMY) Q3 2022 Earnings Conference Call September 29, 2022 3:00 AM ET
Company Participants
Nils Vinge – Head, Investor Relations
Helena Helmersson – Chief Executive Officer
Adam Karlsson – Chief Financial Officer
Conference Call Participants
Fredrik Ivarsson – ABG Sundal Collier
Nicolas Katsapas – BNP Paribas Exane
Niklas Ekman – Carnegie
Daniel Schmidt – Danske Bank
Richard Chamberlain – RBC
Simon Irwin – Crédit Suisse
Adam Cochrane – Deutsche Bank
Ashley Wallace – Bank of America
Rebecca McClellan – Santander
Andreas Lundberg – SEB
Operator
Welcome to the H & M Conference Call Nine Months Report of 2022. For the first part of the call, all participants are in listen-only mode during the speaker’s presentation, and afterwards, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded.
Today, I am pleased to present Nils Vinge, Head of Investor Relations. I will now hand you over to our speakers. Please begin.
Nils Vinge
Thank you. Hi, everyone, and thank you all for joining us today. Welcome to the telephone conference about the H & M Group’s nine months results 2022. With me today is our CEO, Helena Helmersson; and our CFO, Adam Karlsson. We will now start with a short summary of the third quarter, and after that, we will be happy to answer your questions. You’ll find the nine-month report on hmgroup.com Investor Relations.
Now I’ll hand over to you, Helena.
Helena Helmersson
Thank you, Nils. Sales and profitability in the third quarter was largely impacted by the effects of our decision to post sales and then wind down the business in Russia. This explains half of the decrease in profits compared with the third quarter last year.
In common with the rest of the industry, sales were weak in many of our major markets at the start of the period, but picked up gradually despite a heat wave in several European countries and some remaining delays in the supply chain.
The quarter was also impacted by several other external headwinds such as increased raw materials and freight prices, as well as stronger U.S. dollar. This resulted in substantial cost increases for purchases of goods. We have chosen not to fully compensate for these costs, which is reflected in the gross margin. Overall, the external factors had a substantial negative impact on profit for the quarter.
With our long-term approach, we are continuously developing all parts of the company with a focus on meeting customers ever increasing expectations of affordable and sustainable fashion. It’s now more important than ever to continue offering customers the best value for money. Customers should always feel confident that all the Group’s brands provide the best combination of fashion, price, quality and sustainability.
We are continuing the integration of our sales channels to offer customers a smooth and inspiring experience in all our touch points. At the same time, we continue with the investments in tech and the digitalization of the supply chain.
Efficiency, speed and flexibility have never been more important. In parallel, a program to reduce costs and further improve efficiency is being initiated. From the second half of 2023 onwards, this is expected to free up SEK2 billion per year.
With loyal customers all over the world, engaged colleagues and sound finances in combination with the long-term perspective, we see good opportunities to strengthen our position despite the situation in the world around us.
The autumn collections have been well received and sales from the 1st to the 27th of September are upward 7% compared to last year. This is an important proof that we can grow also when customer’s purchasing power is decreasing.
Thank you very much for listening and we’re now happy to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] The first question comes from Fredrik Ivarsson of ABG Sundal Collier.
Fredrik Ivarsson
Thank you. Good morning, everybody. Can you hear me?
Helena Helmersson
Yes. Good morning.
Adam Karlsson
Yeah. Good morning.
Fredrik Ivarsson
Excellent. Two questions. First one on the cost savings program, can you give some information about it, what is it, how much will it cost, et cetera, et cetera? That’s my first question. And the second one on the gross margin, it was 50.4%, if adjusting for the Russian one-off. Price obviously did not fully offset the external headwinds and when we look into the coming quarters, should we expect the price effect to be more positive or similar to what we saw in Q3? Thank you.
Adam Karlsson
Okay. Thank you. I’ll start with the cost program and it’s a wide program that’s directed to the overhead cost and there are a number of components into it. It’s everything from how we expect the services, to how we set up our business when it comes to the offices and travel, but of course, also to ensure that we have an efficient organization set up.
So as you’re right in the comments here, we believe that we will start to see the effect in second half of next year and there maybe some costs elected to the program throughout the spring. And when it comes to pricing, it’s always the long-term approach from a customer perspective, and of course, for balance it will the best offering and profitability. That’s all I can say.
Fredrik Ivarsson
Okay. Thanks. Can you say anything about the price effect in Q3 than, that you saw in Q3?
Adam Karlsson
Well, obviously, we have — as we’ve discussed before, we have raised prices, but obviously, not only to compensate for the year headwinds and source.
Helena Helmersson
I can complement a little bit also, because of course, it’s different with different segments in the collections than in the assortment. So, again, we have adjusted prices a little bit differently in different markets and different segments within our assortment, but always with the thought to improve our long-term kind of position and make sure that we have the best customer offer.
Fredrik Ivarsson
Okay. Great. Thank you.
Operator
The next question is from Nicolas Katsapas of BNP Paribas Exane.
Nicolas Katsapas
Hi, there. Thank you for taking my questions. I have a couple of questions on Russia. I wanted to know how much the liquidation of inventory in Russia continued into September and how that affected the current trading figure. And then do you — link to that, do you expect any further cost to exit Russia coming through in Q4, because I see you called out total cost of SEK2.5 billion, but only one-off costs of SEK2.1 billion related to that exit? Thank you.
Adam Karlsson
Yeah. So the SEK2.1 billion is the currency adjusted level that we communicated in mid-July and as the Russian ruble has appreciated we now estimate the cost to go up from SEK2,000 or SEK2 billion to SEK2.1 billion. So the local currency amounts are still the same.
When it comes to the other sort of SEK400 million, that’s connected to the net effect of us having a profitable third quarter in Russia last year and not as that profit in this year as we only traded for less than a month.
Nicolas Katsapas
Thank you. And the liquidation continued into Q4, was that?
Adam Karlsson
Yeah. Sorry. Yeah.
Nicolas Katsapas
Okay.
Adam Karlsson
It will and it will gradually decrease now as we have started to permanently close some stores. So it will continue, but we are now starting to see some of the permanent closures coming through.
Nicolas Katsapas
Okay. Thank you.
Operator
The next question is Nik — is from Niklas Ekman of Carnegie.
Niklas Ekman
Thanks. Yes. Can I follow up on that question? Just the impact from Russia here in September, is there any tangible impact from this in the 7% growth that you’re reporting here? Is that boosted by Russian liquidation at all?
Adam Karlsson
Okay. It depends on how you see it. Year-on-year, we sell less in Russia. So excluding in both years, it’s actually sort of the average selling above the reported figure. But, of course, the fact that we opened Russia now, gives us some kind of support in the 7% figure. So it depends on how you see it. If you exclude it totally both years, it is dragging down the results, the 7%, we should have been higher excluding Russia both years. But, of course, the current spending in Russia contributed to the turnover right now.
Niklas Ekman
Thank you. That’s clear. And can you give any indication how far you are from exiting Russia entirely? How many weeks or months away should that be?
Helena Helmersson
Well, as we have communicated before, we have gradually opened up the stores and that goes also for the closures. So now we have closed a bit more than 30 stores as of now and this will continue then the coming months. So, in the near future, but we don’t have end date to communicate at this point in time. We will try to sell off a majority of the store.
Niklas Ekman
Okay. Thanks. Fair enough. Another question is just on cost inflation, which you’re warning of you continuing in coming quarters. Are you expecting cost inflation to be sequentially worse in Q4 than in Q3 and do you expect a severe impact also in H1 given what we know now about cost inflation?
Adam Karlsson
Yes. It will be composite into two parts. We see that the currency effect on cost of goods is worsening sequentially as we’ve had an appreciation of the U.S. dollars all through the summer here and into the autumn. So that we sequentially see worsen. And we also, of course, have uncertainties when it comes to the energy costs and prices going forward. So these are the two things that we feel are uncertain going forward. But right now, in a negative trajectory when it comes to the currency.
Niklas Ekman
Okay. And thank you so much for taking my questions.
Operator
The next question is from Daniel Schmidt of Danske Bank.
Daniel Schmidt
Yes. Good morning, Helena, Adam, and Nils. A couple of questions from me then. Just coming back to the savings program that you initiated, and Adam, you said that, you will see some effects gradually on this as of H2 next year and there may be some costs for this program. It does sound, like, is it sort of more organically train or is it sort of — you’re not bringing forward the big act. This is going to happen gradually was my interpretation of what you’re saying. But doesn’t that mean that you will see some savings at least at the start of 2023?
Adam Karlsson
Absolutely. And some of the components are more immediate. But as there are also some organizational components to it, that has a more gradual impact. That’s what I meant. There is an immediate savings on sort of purchases of services and all, but the organization transformation that we are in and focusing even more on has more of a gradual effect.
Daniel Schmidt
And is it reasonable to assume that we will see some of that already in Q1 next year then?
Adam Karlsson
Parts of it, but as I said, and that will be a more long-term effect, so we estimate that we rightly move forward that the majority of the impact will come second half year.
Daniel Schmidt
Okay. Just coming back to another question that we talked about last time and that’s been a topic on some other your peers sort of introducing a return fee and I think you said that you were looking into that. Has anything happened on that front?
Helena Helmersson
Yeah. We are about to test return fees in a few of the markets to see the response from the customers. So let’s see how they receive that.
Daniel Schmidt
And do you feel any need to sort of fast track that development given what’s happening in general on the sort of the need to cut costs, has that been sort of…
Helena Helmersson
Yeah.
Daniel Schmidt
Has that…
Helena Helmersson
Yeah.
Daniel Schmidt
Yeah.
Helena Helmersson
Sorry.
Daniel Schmidt
Go ahead.
Helena Helmersson
It all depends on the — how it’s received by the customer. So that’s why we do a test to see if that is something to fast track. But, of course, that’s only one initiative to improve the situation. There’s many other things to do as well.
Daniel Schmidt
How quick does that happen? How long time do you need to evaluate that?
Helena Helmersson
Well, the valuation doesn’t have to take long time. Then, of course, if we’re about to roll it out, it will take some time. We don’t have an exact time limit on it. But, again, let’s see when we see the evaluation of the test, whether this is the most impactful thing to do or not.
Daniel Schmidt
Okay. And then just a last question on sort of not compensating fully in terms of price increases, you are seeing quite good growth at least for September and even better if you adjust for Russia. Isn’t that giving you any confidence that you could be a bit more aggressive on sort of passing along input cost inflation?
Helena Helmersson
Yeah. We do see good sales figures in September. Of course, to some extent, that can also do — we saw weather effect in August where big parts of Europe had a heat wave, and in September, we got colder weather. So we’re trying to assess that type of effect, of course, as well. But, overall, we think and we see that it’s very important now to stay flexible within certain areas, and pricing is, of course, one of them.
To gradually follow the customer sentiment and also look into the different segments in the assortment where we see that some segments are less price sensitive than others. So we try to work with this in a very kind of flexible way and always with the thought that we will also, at the same time, strengthen our position more long-term, which means that customers have to trust us to give them best combination then of price fashion within vicinity [ph].
Daniel Schmidt
All right. Thank you, guys. That’s all for me.
Helena Helmersson
Thanks.
Adam Karlsson
Thanks.
Operator
The next question is from Richard Chamberlain of RBC.
Richard Chamberlain
Thank you, and good morning, everyone. A couple from me please. First, back on the cost savings program, could you just say a bit more color on why that’s taking until second half of next year to see most of the benefits of that? That’s the first question, please.
Adam Karlsson
It is about the nature of the program that changed in the organization to ensure that it set us up efficiently isn’t a quick fix. We need to do it with speed and efficiency. But still we need to make sure that it’s a long-term step-up that we’re going into.
So we’re looking into organizational structures to ensure that we have quick decision-making that we remove layers and that we have a robust foundation to grow from, and we estimate that, that will take six months to nine months.
Richard Chamberlain
Okay. Thank you. And second one is on the cash flow, it sounds like you’re still getting a financial benefit to changes you’ve made to the invoice management and premium processes. Are you expecting more benefit in the second half, or sorry, from — in Q4, sorry, from that program?
Adam Karlsson
The program is fully implemented with the exception of that we’re also looking into non-commercial goods just — but that is, of course, a smaller purchase — portion of our purchases. So now the effect will sort of fluctuate with the purchase volumes.
So I think now the effect in this quarter was more related to that we into the autumn as we did now build up stock and that we now plan to sell out throughout the autumn. So for Q4 not a big — we were not predicting it to have a major positive effect.
Richard Chamberlain
Okay. Thank you.
Operator
The next question is from Simon Irwin of Crédit Suisse.
Simon Irwin
Good morning, everyone. Can you hear me okay?
Helena Helmersson
Yes.
Simon Irwin
So, firstly, can you just help us a few thoughts around input costs for spring/summer next year? Obviously, we know about the — about currency. How are you seeing dollar input costs, for example, through raw materials to the next year, labor cost inflation? And also just how is your freight situation looking, are you still seeing an increase in your average freight rates into next year?
Adam Karlsson
As we also discussed during the Q2 report, we have seen that the input cost have peaked and we believe that they are more on an elevated but stable level. What has not peaked or at least we’re in a negative trajectory is the currency effect. So that is the big change of headwind now is coming [inaudible].
On the freight side, we can see that the volume pressure is coming down. But here as well, we have not seen a substantial positive effect in the short-term here, but we foresee that more into the later part of the spring.
Simon Irwin
Okay. And just given the outlook, both kind of economic and in terms of core business, are you having any thoughts at the moment around capital allocation, particularly around either the buyback or in terms of new stores?
Adam Karlsson
We have gradually adjusted our CapEx for the year. So the current estimates are now in the range of SEK6 billion to SEK7 billion. So that is one of the adjustments we do to the capital allocation.
Simon Irwin
Okay. And the others for now your store program and stuff are largely unchanged?
Adam Karlsson
Yeah. That’s unchanged.
Simon Irwin
Great. Thank you very much.
Operator
The next question is from Adam Cochrane of Deutsche Bank.
Adam Cochrane
Hi. Good morning. The first question I’ve got is relating to the markdown. We saw a markdown up in the third quarter and you’re talking about markdown up again in the fourth quarter. Is the fact that markdown is increasing informing your pricing decisions and the decision not to fully pass it through to the consumer or is the markdown going up because you’re passing through price increases that the consumer is not accepting? Thanks.
Adam Karlsson
There are many factors affecting the markdown. One is, of course, the current selling situation. But then also there is also a positive way of looking at markdown is activation. So I think you can look at it in two ways. And we believe we have an opportunity to activate customers and to really show that we have attractive prices throughout the offer now. That’s why we indicate and a slightly elevated level also through Q4.
Adam Cochrane
In terms of customer behavior, the strong September and weaker parts of the summer, do you think — can you draw any conclusions on consumer behavior, or as you say, is it still — it could be weather, it could be other factors that are at play at the moment? Are you not seeing any trading down or up or anything with your own brands or your own ranges?
Helena Helmersson
Yeah. Following customer sentiment, of course, it’s not very easy to understand what is what. But when looking into customer insights, it’s, of course, clear and only looking at how we have started the autumn selling. It’s truly clear that affordable and sustainable fashion is there high demand, which comes with an opportunity for us.
Then, again, we saw the heat wave, especially during summer or in August that we saw affected to some extent and that the cold weather came more in September. So really hard to say what is what, but the fact that the customers really appreciate an offer that is based on both good prices, value for money and sustainability is very, very clear.
Adam Cochrane
Okay. Final question is, others may be clear on this, but I’m struggling to work out the trajectory into Q4, Q1 of next year, Q2, Q3 of FX freight. What is the scope of these headwinds? I sort of got different views on hedging policies, on rates and just — is the picture for gross margin looking to get worse over the next few quarters or better, just a feeling of direction really?
Adam Karlsson
We can only repeat what we’ve said. I mean the world around us is very challenging at the moment. We’ve had a pandemic. We have a war. We have geopolitical challenges. And we try to navigate, as well as possible through this. The visibility is very, very low even for us. That’s why flexibility feels efficiency is more important than ever as we write in the report.
But I think we have good chances in this environment to succeed and improve our position in. And I think the — even though it’s early in the season, and of course, even helped by weather and then — and Russia partly in the September numbers. We think, as Helena said, the customers clearly show that they appreciate value for money more than other.
Adam Cochrane
Okay. Thanks.
Adam Karlsson
And then, of course, we don’t give forecast, as you know it’s up to you to acknowledge, really make your own best.
Adam Cochrane
Yes. It seems like hedging of freight, utilities, FX, without sort of knowing some of the hedging piece, it’s quite hard for us to do forecast and that’s why I though you just looking for a bit of directional input really?
Adam Karlsson
Of course.
Operator
[Operator Instructions] The next question is from Ashley Wallace of Bank of America.
Ashley Wallace
Oh! Hi. Good morning. I am — I have two follow-up questions, actually. One is just on the September revenue. Are you able to share with us which regions drove the acceleration in September? And then a follow-up question, sorry, on the gross margin and the direction of travel. In the release, you mentioned that the headwinds from external factors will grow in the fourth quarter versus last year. I was wondering if the headwinds will also be bigger than the headwinds that you’ve just seen in Q3, which you called out at SEK1.5 billion or 260 basis points of gross margin pressure.
Helena Helmersson
Looking at September, I will also talk a little bit about the third quarter, because it’s connected. In the third quarter, we saw great progress in regions such as Americas, especially Latin America, Southeast Asia to mention a few examples.
And we saw less good progress in some parts of Europe, Central East and Northern Europe. During September that picked up, so the markets that had low progressed during the third quarter in the whole industry, I would say, has picked up during September.
Ashley Wallace
And the question on gross margin, yeah.
Adam Karlsson
Yeah. Could you say again, please because it was a whole question, sorry?
Ashley Wallace
Sure. Yeah. Sure. So, in the release, you talk about the external factors, which will grow in the fourth quarter versus last year. I was wondering if the external factors will also be bigger than the headwind of Q3, which I think you called out in the raise SEK1.5 billion of headwinds or 260 basis points of gross margin pressure?
Adam Karlsson
As I mentioned previously, the negative trend we see right now is within the currency. So that is sort of our assessment right now that, we don’t see that the U.S. dollar to euro has started to shift in a positive direction from our point of view. So that is a sort of increased headwind coming from currency.
Ashley Wallace
But, I guess, in aggregate, the increased pressure coming from U.S. dollar offset, I guess, slightly from the fact that you said that freight and some of these other pressures have started to ease, but the net impact is therefore still a bigger one in the fourth quarter or it’s less severe than what you had in Q3 taking all the pieces together?
Adam Karlsson
No. The — and to be clear, it’s a timing effect here. We can see that that our spot rates are coming down. But of course, that doesn’t sort of give an immediate effect on the gross margin in the current quarter. So I think the biggest permit to look out for is the strengthening of the U.S. dollar.
Ashley Wallace
Okay. And can I ask a follow-up question just on, sorry, on the — of course, you’re liquidating in Russia right now. Considering you’ve already taken the one-off impact of closing down Russia. How do those revenues drop through to the bottomline? Are they taken at extremely high margin — incremental margin drop through as a result of the costs already incurred in Q3 to write-down the Russian business?
Adam Karlsson
The cost that we — sort of the write-down costs are connected to specific closure costs. So the selling and profit is as of the last year when it comes to the stores that we operate, so to say. So that’s no difference when it comes to how we consolidate the current operations.
Ashley Wallace
Okay. So the incremental margin drop through of the product you’re liquidating in Russia is not going to be significantly higher than your Russia profitability in Q3 last year or in Q4 last year?
Adam Karlsson
Right. Right.
Ashley Wallace
Okay. Thanks. Thank you.
Operator
[Operator Instructions] The next question comes from Rebecca McClellan of Santander.
Rebecca McClellan
Yeah. Good morning. Can you hear me?
Helena Helmersson
Yes.
Adam Karlsson
Yeah.
Rebecca McClellan
Yeah. Good morning, everybody. I was actually — most of my questions have been answered, I was just curious about whether you could give any more detail on region specific, North America and to the main markets in Europe, anything that’s going on in China possibly?
Helena Helmersson
Sure. We’ve had good progress in North America, where we have also, of course, done certain investments since we’ve progressed. And those investments are, well, mainly they are linked to tech and supply chain. Now, of course, with the strong U.S. dollar, that is also, of course, affecting the results in the third quarter. But, overall, we’ve seen a good progress when it comes to both the customer offer and the customer experience and how that is received.
When it comes to Europe, again, going back to the third quarter, we had — I would say that the whole industry went down a bit in the Central part and in markets that are big for us that has picked up during September.
Again, we need to follow this very, very closely. We’ve seen that when we, for example, have put even more effort into showing our great prices, something that we think we could have done even more during the third quarter. So when we have changed those things, we also see better progress in those markets.
And looking at China, we keep on working with improving our customer offer, so that it’s also very locally relevant and staying with the whole customer experience. We do see slow progress. We’re still in dialogue, of course, with different stakeholders. We’re still in a challenging and complex situation that we do believe in the market moving forward.
Rebecca McClellan
And thank you. And when you say showing good prices in Europe, what do you mean, does that mean promotional activity or does it mean…
Helena Helmersson
Yeah.
Rebecca McClellan
…customer?
Helena Helmersson
Exactly. So, obviously, when customers have less money to spend this super importance in our commercial plant, both in physical stores and online to really highlight the great prices, great value for money that we have. We saw that we could have done that even more, especially in the beginning of the third quarter, which we have amended with very good results.
Rebecca McClellan
Okay. Thank you.
Operator
The next question is from Andreas Lundberg of SEB.
Andreas Lundberg
Thank you. Good morning. Can you hear me…
Adam Karlsson
Yeah.
Andreas Lundberg
I’ll follow up on the last one there, with highlighting the good prices you have talked about Europe. Can you be more concrete what does that mean?
Helena Helmersson
Well, that actually means that when we see that it’s high demand on a particular product, and of course, we have super competitive prices to simply highlight them more. So when you enter a store with a price signed with how you actually guide the customers to see the great offers that we have and the amazing value for money that we can offer.
Same in the digital stores, so if you would enter H&M.com, if you would do that now, I think you would see amazing fashion and I would think you would also recognize several of the big prices that we highlight. So it’s those types of very commercial activities.
It’s in our backbone, but we see that we could have done it even more during the third quarter also because we see that customer sentiment are also obviously changing a little bit since due to the inflation.
Andreas Lundberg
Good. Then a follow-up on, I am sorry, could you say sales were up or down year-on-year in the third quarter?
Helena Helmersson
Slightly up.
Andreas Lundberg
Slightly up. Cool. And lastly, on buybacks, when do you expect the current program to be completed and how do you view buybacks once that is completed? Thank you.
Adam Karlsson
The plan remains and as communicated that it is to end the program by last November. And looking ahead, we will need to come back to that. So the current program is still in effect and sometime last [inaudible]
Andreas Lundberg
Cool. Thank you so much.
Operator
[Operator Instructions] Ms. Helena, at this time, there are no questions registered.
Helena Helmersson
Thank you, everyone, so much for participating then. I thank you for all your questions. I wish you all a very nice day.
Operator
Ladies and gentlemen, thank you for joining. The conference is now over and you may disconnect your telephones.
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