Morgan Stanley downgrades Inditex as investment case goes from 'great' to 'good'

Shares in Zara and Massimo Dutti owner Inditex tumbled on Wednesday after Morgan Stanley said the investment case has gone from "great" to "good," downgrading its stance on the stock to 'underweight' from 'equalweight' and cutting the price target to €21 from €26.

The bank said Inditex is still a world class retailer, but the investment proposition has been weakening for some years and this is not yet properly reflected either in consensus estimates or the multiple the market is applying to them.

MS noted that since its IPO in 2001, Inditex - which also owns Bershka, Oysho, Pull and Bear and Stradivarius - has opened more than 6,000 new stores, expanded into 63 additional countries and grown its earnings per share by 15% compound annual growth rate.

While the shares have increased more than tenfold, issues have been building for some years now and MS said it was time to acknowledge that the investment proposition is not what it was.

"In a sector where most companies have been struggling for years, Inditex has consistently stood out and we have long been loath to turn bearish on it. Indeed, prior to today, Morgan Stanley has NEVER had an 'underweight' rating on the stock.

"However, cumulatively, we have now cut our earnings forecasts by 19% over the last three years and we no longer feel comfortable ignoring the growing pressures the company faces."

MS noted that gross margins have fallen in each of the last five years, partly due to FX, but also as competition intensifies and Inditex lowers prices.

"We also think it interesting to note that the company is relying increasingly on Asian suppliers - suggesting that it may be sacrificing speed to market in order to keep sourcing costs down. Whilst operating costs have remained well controlled, we do not believe Inditex to be immune to the cost pressures faced by most apparel retailers as a result of ongoing online channel shift."

At 1245 BST, the shares were down 6.3% to €26.51.