Why Investors Should Run From Fast Fashion Retailers Asos Plc And Primark Parent Associated British Foods Plc

Fast fashion has been the buzz phrase in the retail world since the late 1990s as youth-oriented brands raced ahead of traditional retailers by offering inexpensive clothes that went from the catwalk to closets in a matter of weeks. Social media has added to this process in recent years. But will these brands, such as Asos Plc (LSE:ASC) and Primark via its parent Associated British Foods Plc (LSE:ABF), be able to stay on top of trends long enough to provide long-term investors with appealing returns?

Last week’s trading update for Asos saw overall group revenue surging by 23% year-on-year after management refocused growth efforts on traditional markets in the UK and EU. Alongside continued double-digit growth year after year, the company holds no debt, funding all expansion through strong operating cash flow.

Despite City analysts rushing over themselves to recommend buying-into Asos, I find there are substantial reasons to doubt the feasibility of the company as a long-term investment. While management has been wisely focusing on revenue growth over profitability in the short term, the company has yet to prove it has the pricing power necessary to increase margins when the time comes. Unlike designer fashion houses and their double-digit margins, Asos’ operating margins for the past year were 4.1% and fell over the holiday period.

Furthermore, although Asos does have very good growth prospects, I personally find it doubtful that fast fashion will prove to have more staying power than other trends in the ever-changing fashion world. Without the brand name and pricing power of high-end fashion companies I don’t believe Asos presents an appealing purchase, particularly trading at 54 times expected 2016 earnings.

Ignoring online

Primark, a division of the Associated British Foods conglomerate, has taken a different path than social media-savvy Asos by deciding to not sell online and instead expanding via high street stores. While one would normally expect this route to provide lower margins than Asos enjoys, Primark in fact boasted 12.6% operating margins in the latest full year, although the strong US dollar dented this number.

Due to Primark’s lack of online sales revenue, growth is tightly correlated to increased retail space, which is expected to grow by roughly 13% this year. With sales for the latest quarter up 3% year-on-year, dividends should be set to increase for the fifth year running although the shares currently yield a meagre 1.2%.

Conglomerates may have fallen out of fashion in many investing circles, but shares in the family-controlled ABF have provided a 180% return over the past five years. With the shares now trading at 30 times forward earnings and revenue growth at Primark (which provides some 60% of group operating profits) constrained by the need for physical stores I don’t believe now is the time to buy into ABF. Despite impressive margins and a diversified business with large defensive divisions, ABF’s fate is increasingly becoming tied to Primark, which carries with it the same long-term risk of falling out of fashion as Asos.

The risk of not anticipating the next trend year after year and depending on fickle young shoppers may well prove to be the undoing of some fast fashion retailers. Luckily for long-term investors, the Motley Fool has made available its latest report analysing five companies that have proven for decades their ability to consistently reward shareholders.

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Ian Pierce has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.