H&M: We believe Q3 has been tough

We believe H&M’s demand has remained sluggish in Q3, while the company faces several headwinds on the gross margin. We expect these to result in H2 being weaker than we previously expected and have hence lowered our estimates for 2024-25. We maintain our Reduce recommendation and target price of SEK 170.

H2 set out to be softer than we previously expected

In conjunction with its Q2 report, H&M communicated that June sales are expected to be down 6 %. While this was against a tough comparison figure, June is the biggest month in Q3 (Jun-Aug). The company commented further that it aims for mid-single-digit growth in H2. We believe that the consumer sentiment has remained soft and hence we now think it unlikely that H&M would hit the target of mid-single-digit growth in H2. Our local currency growth expectations are now 1% for Q3 and 4% for Q4. The negative FX impact will turn reported growth negative in Q3, we estimate, and also weigh on it in Q4. While H&M enjoyed quite strong improvement in the margins during H1, driven by gross margin improvement, the situation looks different for H2. For Q3 specifically, there will be headwinds to gross margin from ”external factors” such as freight and raw material, as well as higher markdown and generally declining prices. These have all been communicated by H&M before, but the softer-than-expected demand could put some extra pressure on the margin, we believe. We foresee gross margin in Q3 to be only marginally ahead of last year at around 51%.  With the lower sales estimate, H&M will not see any operational leverage in Q3, which obviously has hit our EBIT estimates as we see limited opportunities to adjust opex in the short term. As a result, our earnings forecasts are down some 10% for 2024 and we see EBIT-% below 8%, falling clearly below the company’s target of 10%. We also lowered estimates for 2025, while 2026 remained unchanged.

10% EBIT margin ambition looks challenging even in 2025

H&M’s ambition has been to reach its 10 % EBIT margin target in 2024. For the past 12 months, H&M has delivered an EBIT margin of 7.6%, and we now see only little improvement during H2, with 2024 ending at around 8%. From this base and given the current sluggish demand, we do not believe the target will be reached in 2025 either. Nevertheless, we continue to see a positive margin trend and H&M reaching an EBIT margin of 9.0% in 2025 and around 9.5% in 2026. We believe the improvement requires clear top-line growth, which would give leverage to opex, and thus the margin improvement is dependent on demand improving.

Share looks fairly valued

H&M’s P/E for 2024 is 20x, which is at the high end of our acceptable multiples. For 2025, the expected margin improvement drives the P/E down to 16x. The multiples are below the closest peer Inditex, which trades at 28x for 2024. We believe some discount is fair given Inditex’s better sales development. We estimate that H&M’s free cash flow and dividend yields are around 4% in the coming years. After a larger earnings improvement in 2024-25, driven by the increasing margin, we expect a steady sales/earnings growth of 5% in the medium term. Our DCF value is in line with our target and close to the current share price. Therefore, overall, we see the share as quite fairly valued.