Asos faces margin challenges and balance sheet risk, says Citi

The reaction of Asos investors to the US sales tax has been overdone, says Citigroup, but analysts at the bank cut their target price for the online clothes retailer due to lower growth assumptions.

The e-retailer's margin targets are "challenging" and its balance sheet position "creates risk", being free cash flow negative until at least 2020, with net cash of £40m and a £150m debt facility. "With only eight months capex requirement covered by this debt, the risk of emergency financing if Asos's sales growth is less than expected is heightened."

Given similar growth profiles, along with better cash-flow profiles and stronger balance sheets, Citi's analysts prefer Zalando and Boohoo in the European apparel e-commerce space.

Citi reduced its share price target for Asos to £70 from £77.50 as it cut its forecasts for earnings growth in 2019 and 2020.

Ahead of Asos's scheduled trading update for the four months to 30 June on 12 July, JP Morgan Cazenove also put out a note reiterating its £75 price target and forecasting retail sales growth of 24% on both a reported and constant currency basis, up from the second quarter rate of +20% with growth improving in all regions, with management expected to reiterate full year guidance for reported retail sales of 25-30%, along with unchanged margin and cash/ capex guidance.

"With a lesser focus on the US ahead of the new warehouse launch we expect growth in this market to have nudged only slightly ahead of [period-two] despite easing comparatives, although a still very solid performance at +25% on a constant currency basis," analysts wrote, noting that Asos has a natural cash dollar hedge, meaning that whilst USD weakness in 2018 is a top line drag, it is a tailwind to the margin.

Cazenove expects third-quarter retail gross margin to "remain strong", up 130bps in line with the first-half exit rate, supported, as it was in the first half, by forex rates and an improved buying margin.