March 27 (Bloomberg) -- Hennes & Mauritz AB, Europe’s second-biggest clothing retailer, said the cost of investing in online expansion weighed on first-quarter earnings as it seeks to keep up with the pace of change in the industry.
Operating profit rose 8.7 percent to 3.4 billion kronor ($526 million), though the increase would have been 14 percent without the cost of long-term investments, the Stockholm-based company said in a statement today. Net income rose 7.8 percent to 2.65 billion kronor, missing the 2.89 billion-kronor average of eight estimates compiled by Bloomberg. H&M shares fell as much as 4.9 percent.
“The operating cost grew more than everyone expected,” Anne Critchlow, an analyst at Societe Generale in London, said by phone. The increase was due to investment in online as well as H&M’s COS and & Other Stories store formats, she said.
The retailer, which sells jersey jumpsuits for $39.95, is ramping up its online business and introducing new store concepts to close the gap with bigger Zara-owner Inditex SA and combat increased competition from online retailers such as Asos Plc and budget chains including the U.K.’s Primark. Costs in 2014 will be higher level than last year, the company also said today.
The shares fell as much as 14.30 kronor to 275.60 kronor, the steepest intraday decline since September 2012. They were down 4.4 percent at 277.30 kronor as of 12:38 p.m. in Stockholm.
Costs for online, information technology and new concepts will weigh on this year’s results by an additional 600 million to 800 million kronor compared with a year earlier, Nils Vinge, head of investor relations, said today.
“It’s great that H&M is diversifying away from the price competition in the core concept, so there is no issue with that over the longer term, but those costs disproportionally hit the first quarter,” Critchlow said.
Profit growth in the quarter was also stinted by a narrower gross margin as discounts in relation to sales increased from a year earlier. The profitability gauge narrowed to 54.9 percent from 55.2 percent a year earlier.
Sales at constant rates of exchange have risen 12 percent so far this month, H&M said, matching the first-quarter pace. The March figure implies growth of about 2 percent on a like- for-like basis, according to Critchlow.
“Overall, these are a disappointing set of results,” Jamie Merriman, an analyst at Sanford C. Bernstein in London, said in a note. “While part of this miss can be attributed to long-term investments, we believe it is also indicative of weak like-for-like sales performance and price investment, as the company tries to compete in the fast-growing and increasingly populous value-apparel world.”
Primark, a unit of Associated British Foods Plc, is expanding across Europe and increased selling space by about 8 percent in its first quarter. H&M also faces mounting competition from TK Maxx owner TJX Cos., which said last month that it sees potential for 875 outlets in Europe, more than double its current number of stores in the region.
“It’s tougher today than a year ago and it will be tougher in a year than it is today,” H&M Chief Executive Officer Karl- Johan Persson said about competition in an interview today. “But we have strengthened our position and continue to take market share so we feel confident.”
H&M, which also operates brands including COS and Monki, plans to add 375 stores this financial year. Openings in countries like Australia and India are scheduled for 2014, with the fastest expansion being in China and the U.S.
The cheap-chic clothing retailer also announced today that online stores are set to open in China, Spain and Italy this year. H&M will also expand in the U.S. with an online store for its COS format and an & Other Stories store.
Inditex last week reported its slowest earnings growth in five years as it made investments in new retail space and distribution. The company encouraged investors with accelerating revenue growth in the first six weeks of the fiscal year.
Inditex, which gets about two-thirds of sales from its Zara concept, has almost twice as many stores as H&M. While H&M’s namesake brand makes up more than 90 percent of its store count, only about a third of Inditex total stores are Zara shops. H&M doesn’t break out sales per concept.
Quarterly sales, excluding value-added taxes, amounted to 32.1 billion kronor, H&M reported March 17.