Derek Zoolander learnt that “there’s a lot more to life than being really, really, ridiculously good looking”. Investors in Prada, a stock market darling since its debut three months ago, may soon come round to a similar way of thinking.
The basic growth strategy of the Italian fashion house is similar to that adopted by many luxury-goods companies in recent years: build out a network of directly operated stores (Dos), to reduce the share of revenues given over to wholesalers. The big difference is that Prada is currently more aggressive, looking to expand its Dos count by 75 per cent by 2014. There is evidence that the plan is bearing fruit; net revenues rose by about a fifth between the end of January and the end of July. But inventories rose by almost a third over that period. Non-current assets, mostly additions of land and buildings, also rose sharply. All that weighs on asset efficiency, or the sales Prada generates for every euro of assets. So-called “asset turns” were flat over the 12-month period, leaving the Milan-based company as one of the least impressive by that metric among peers.
According to the classic DuPont profit model, even if asset turnover remains sluggish, Prada’s middling returns on equity could be improved by margin enhancement or financial leverage. The latter seems unlikely for now: one of the primary aims of relieving investors of €206m in the June initial public offering was to allow Prada to reduce its short-term bank debt while improving its cash balance. As for margins, Prada’s falling royalties from licensing its brands suggest that it lacks the desirability of a Calvin Klein or Burberry, notes Berenberg, the private bank. Meanwhile, its relatively low level of spending on advertising looks unsustainable. However pretty those headline numbers, in short, the substance is somewhat lacking.