ASOS (LSE: ASC) rocketed 17% higher during the first hour of trading this morning, after the online fashion retailer said that sales growth accelerated to 22% during the second quarter, making it the firm’s best quarter for nine months.
UK sales rose by 30% during the three months to 28 February, while US sales were up by 24% and EU sales were 13% higher, on a constant currency basis.
Better still, ASOS reported that the number of active customers had risen to 9.3m, a 13% increase on the same time last year.
Watch the margins
Sales growth at ASOS may be impressive, but today’s update suggests to me that this growth is coming at a cost.
The retailer’s gross profit margin fell by 3.2% during the second quarter, compared to the same period last year. This accelerates the fall we saw during the first quarter of the current year, when gross margins were 1.7% lower than during the equivalent period last year.
As a result, gross margin has fallen by 2.7% over the last six months — more than the 2.1% decline reported for the whole of last year.
My calculations suggest that ASOS now has a gross profit margin of around 47%. By way of comparison, this is significantly lower than the 61% gross margin reported on Wednesday by online fashion peer Boohoo.com.
Cutting prices is the simplest and most reliable way to increase volume — but this gradual erosion of ASOS’s margins could be bad news for investors.
Profits on track
However, City analysts appear to have factored ASOS’s declining margins into their forecasts.
ASOS chief executive Nick Robertson said this morning that pre-tax profits for the full year are expected to be in-line with market expectations. Based on the latest consensus forecasts, that equates to normalised earnings per share of around 41.7p, giving a prospective P/E of 92…
Although the firm does have a strong balance sheet — net cash of £74m was reported at the end of August last year — I’m concerned that ASOS’s strong valuation leaves no room for error.
In particular, I suspect the firm is cutting prices in order to boost sales growth, at the expensive of profitability.
A brave buy
ASOS may yet become the Amazon of online fashion retail. This would make the shares cheap at today’s price, but personally, I’m not brave enough to take this risk.
In my view, it’s time for investors to take profits and look elsewhere for explosive new growth stocks.