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The ASOS share price is rising. Here’s what I’d do

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The ASOS (LSE: ASC) share price has risen by more than 50% over the last year. Does this mean that the online fashion retailer has made it through the difficult period of the last two years and is ready to return to growth?

I think it’s possible that the company is ready for the next leg of its expansion. But as I’ll explain, this situation isn’t without risk.

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Lockdown good news

ASOS’s July trading statement looked pretty strong to me. Revenue during the four months to 30 June rose by 10% to £1,014.2m. This strong growth was powered by a 17% increase in international sales, which included a 20% rise in EU sales.

Looking back over the 10 months to 30 June, ASOS’s revenue rose by 17% to £2,611m, with sales growth of between 11% and 22% in all markets.

The company says that despite the impact of COVID-19, pre-tax profits for the year to 31 August are expected to be “towards the top end of market expectations”. I’m impressed with such a consistent performance in difficult conditions.

UK sales could surge this summer

These look like pretty healthy figures to me. And the company’s commentary suggests that July and August could be better. According to management, sales in the EU benefited as those countries came out of lockdown.

Sales in the UK and US were said to have suffered a bigger hit than European sales over the last four months, as a result of coronavirus disruption. If that’s correct, then July and August could see a strong surge in sales in the UK, which accounts for about 35% of ASOS sales.

Can the ASOS share price keep climbing?

Chief executive Nick Beighton says that he expects to report an improvement in underlying profitability this year. Importantly, he also expects a return to positive cash generation. That’s something ASOS has been missing over the last few years as it’s invested heavily in new warehouse capacity.

The key thing for me is to see a return to consistent profit growth. ASOS’s operating profit margin fell from 4.2% in 2018 to just 1.3% in 2019. If the company can deliver improvements to profitability, I think the ASOS share price could make further gains from current levels.

ASOS shares aren’t cheap

I feel more optimistic than I have done for a while about the outlook for the firm’s shareholders. But I’d have to say that the shares already look pretty expensive to me.

Based on broker forecasts, ASOS stock trades on 118 times 2020 forecast earnings. This ratio is expected to fall to 53 times earnings for 2021, as profits return to more normal levels after Covid-19.

These valuation ratios are pretty high for a business with low profit margins. In my view, the market will want to see continued strong growth before pushing ASOS’s share price any higher.

As things stand, I’d rate ASOS as a hold, rather than a buy. I’d be looking for another market dip to provide a safer entry point for new buyers.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended ASOS. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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