24730087

In one of the most diverse sectors in the MSCI, "stock-picking" key "pair-trades" abound
Luxury and high-end fashion will be dominated by mega-brands, making PPR an attractive investment; Gucci will play a key role, growing sales above industry average and building an eminently scalable business; other luxury brands have upside potential In mass-fashion, the market rates H&M and Inditex at similar levels; we prefer Inditex because of better top-line growth through its multiformat portfolio, advantaged product and logistics processes, and SG&A leverage potential through geographic focus In value retailing, market is optimistically discounting strong EPS growth at M&S; we see oneoff price reductions & favorable cyclicality in seniors spend as key drivers, and doubt mediumterm prospects; Next, conversely, has solid sales & RoCE, with growing market expectations Within this diverse sector, we prefer companies with stronger earnings growth potential than widely expected; we rate PPR outperform, M&S and H&M underperform, and Inditex and Next market-perform
SEE DISCLOSURE APPENDIX OF THIS REPORT FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS
EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS
European Apparel & Footwear Retail: It All Depends on the Models
NOVEMBER 2006
Portfolio Managers Summary

Apparel & Footwear retailing appears to us to be one of the most diverse and interesting sectors of the MSCI. As players have very different characteristics, strategies and competitive outlooks, stock-picking is crucial. The following is a snapshot of the current opportunities. We think PPR is an interesting investment opportunity in the luxury space. We are convinced that, going forward, luxury and fashion will be dominated by mega-brands. Gucci can play a key role here, growing sales and EBIT building an eminently scalable business. Non-Gucci brands are performing better than plan, adding to the positive wind behind the stock. The conglomerates retail interests more attractive after the Printemps divestiture should face positive market conditions and provide stronger performance in 2006. Should more divestitures materialize on the retail side, we would take this as icing on the cake. We rate PPR stock outperform, with a target price of 130. On the global mass-fashion retailers side, the market is valuing H&M and Inditex at the same level. We strongly prefer Inditex over H&M. We are convinced Inditex has a better top-line growth opportunity playing its multiformat portfolio, SG&A leverage from deepening international markets penetration and a more solid business model based on being a fast follower of fashion trends, capitalizing on the fashion detection abilities of its store managers and its swift faonneur-based fast-track sourcing mode. This should guarantee Inditex has lower fashion misses in the short term and significantly stronger brand resilience in the long term. H&M, conversely, will not have the tailwinds of gross-margin increase to push its EPS going forward, significantly slowing its EPS growth long term. Short term, the convergence of increasing overseas apparel import prices, unfavorable exchange rates and rising inventory could take a toll on the 2H:06 results, precipitating a stock de-rating. We rate Inditex market-perform, with a target price of 34. We would stay out of or short H&M stock short term, and wait to see more clarity on the new chain and like-for-like development before committing to it at lower price. We rate H&M underperform, with a target price of SEK245. On the value retailers side, the market has been captured by the M&S revival, pushing M&S stock above 600p. We are convinced most of the good news is already in the price. A strong downward price shift, a massive advertising boost and a favorable apparel spend cycle in the senior age group are pushing M&S results. Next, conversely, has best-in-class productivity and RoCE, and a proven growth engine from space increase, catalog development and online dominance. Add to this market expectations that are for stellar results to continue at M&S, while remaining relatively subdued at Next. Possibly as a pair-trade, we rate M&S underperform, with a target price of 450p; we rate Next market-perform, with a target price of 1,875p. Luca Solca James Andrew, CFA Nathan J. McGarry luca.solca@bernstein.com james.andrew@bernstein.com nathan.mcgarry@bernstein.com +44-207-170-5008 +44-207-170-5182 +44-207-170-5153 November 3, 2006
Table of Contents
Significant Research Conclusions Overview European Apparel & Footwear Demand European A&F Retailers: A Darwinian Perspective European A&F Retailers: Valuation H&M: Reducing Acceleration Inditex: Continuing to Run M&S: Fighting Structural Decline Next: Will Deliver the Goods PPR: Value-Creation Through Focus Appendix Company Models Index of Exhibits 5 14 21 45 60 78 95 121 142 157 177 185 197
Exhibit 1
Financial Overview
H&M HM.B-SE (SEK) U 308.0 254,881 319.5 250.0 14.1% 1.8 730 245.0 (20.5)% November 61,262 13,173 21.5% 11.17 12.40 13.97 15.81 17.38 19.29 27.6x 24.8 22.0 19.5 17.7 16.0 13.1% 11.5 11.5 Inditex ITX-ES (Euro) M 37.4 23,223 38.1 23.8 35.8% 23.4 621 34.0 (9.1)% January 6,741 1,094 16.2% 1.29 1.54 1.88 2.25 2.65 3.16 29.0x 24.3 19.9 16.7 14.1 11.8 16.3% 20.8 19.7 Next NXT-GB (/p) M 1,870.0 4,190 1,961.0 1,330.0 21.8% 9.5 224 1,875.0 (0.3)% January 3,106 471 15.2% 125.6 140.9 157.2 172.9 186.7 197.6 14.9x 13.3 11.9 10.8 10.0 9.5 8.7% 5.9 9.5 Marks & Spencer MKS-GB (/p) U 656.5 11,056 668.0 428.0 30.0% 17.7 1,684 450.0 (31.5)% March 7,798 856 11.0% 31.1 36.7 36.6 35.0 31.3 28.6 21.1x 17.9 18.0 18.8 21.0 23.0 2.8% 4.7 (1.7) PPR PP-FR (Euro) O 116.3 13,962 121.1 88.7 22.2% 9.9 120 130.0 11.8% December 16,929 1,054 6.2% 4.33 5.61 7.17 8.78 10.26 11.50 26.9x 20.7 16.2 13.2 11.3 10.1 6.5% 15.7 21.6 MSCI Europe 1,446.8 1,455.9 1,222.2 12.3%
Rating Share Price (11/3/06) Market Cap (local curr. mil.) 52-Week High 52-Week Low YTD Performance YTD Relative Performance Fully Diluted Shares (mil.) 12-Month Target Price Upside/(Downside) Financials Fiscal Year-End Sales Last Year (local curr. mil.) EBIT Last Year (local curr. mil.) EBIT Margin Last Year Underlying EPS FY 2005 FY 2006E FY 2007E FY 2008E FY 2009E FY 2010E P/E Ratio FY 2005 FY 2006E FY 2007E FY 2008E FY 2009E FY 2010E Long-Term Growth (CAGR 2006-10E) Sales Growth EBIT Growth EPS Growth
Source: Corporate reports and Bernstein estimates.
Significant Research Conclusions

Demand Outlook We expect the European Union Apparel & Footwear (A&F) market to grow at just 1.4-1.5% in 2006 and 2007 and reach a total retail value of 325 billion. This growth represents a significant slowdown versus the 3.3% in the second half of the 1990s, and a moderate increase over the 0.9% per annum of the first half of the decade. We see the worst outlook in the major economies: Italy (the No. 1 EU A&F market worth 20.9% of the total), Germany (19.2%), the United Kingdom (17.6%) and France (13.6%) will develop below the EU average; while Spain will continue to enjoy solid growth. Apparel & Footwear expenditure is cyclical and strongly influenced by GDP growth. Economic slowdown in the United Kingdom, prospects of further interest-rate increases in the United Kingdom and euro zone and subdued Continental macroeconomic indicators suggest moderation. A macro positive in this picture could be an Italian post-general election recovery, a common pattern following previous polls. All being considered, we see Italy growing at 0.8%, Germany 0.1%, the United Kingdom 1.1% and France 1.2%. In a subdued market, we expect consumer A&F demand to continue to be influenced by a few long-term developing trends, favoring novelty and value: A preference to spend less available income rather than more in A&F; A desire for novelty, up-to-date and wow as a catalyst for spending; A drive to spend more for appearance; and A cutback on classics and dj vu. Increasingly ubiquitous availability of fashion information, internationalization and globalization of fashion trends, developing consumer taste and style sophistication, and the social and economic development of women as A&Fs major consumers will compound the spend trends above and raise the bar for A&F retailers. Industry Structure Apparel & Footwear retailing is far from homogeneous. In fact, structurally different players share this competitive space, with highly different formats, capabilities and cost structures (see Exhibit 2). Other retailing segments like DIY and toys, for example have much lower diversity with single-breed category killers competing against hypermarkets. A&F retailing is also the most fragmented specialty retail sector, with new entrants continuing to access the market.
Exhibit 2
Value
Hypermarket 1960-70 Broad & Grocery Out-of-Town Overseas Basic Local, Price-Focused Carrefour, Wal-Mart
Evolution of Apparel Retailing Formats
Category Offer Location Sourcing Product Communication
Department Store 1900-50 Broad High Street National Classic -
Discounter 1990-2000 Apparel & Accessories Neighborhood/Mall Flexible Multisource Basic & Fashion Primark, Target
Example
Printemps, M&S
Differentiated
Mass Basic 1970-80 Apparel High Street/Mall National & Overseas Denim/Fleece Print, Brand-Focused Benetton, The Gap Victorias Secret Focused Specialist 1970-80 Apparel Subcategories High Street/Mall National & Overseas Subcategory-Focused Print, Brand-Focused Mass Fashion 1980-90 Apparel & Accessories High Street/Mall Flexible Multisource Basic & Fashion Zara, H&M
Category Offer Location Sourcing Product Communication
Example
Upscale
Category Offer Price Brand Communication Coco Chanel Christian Dior Armani Versace
Artisan Store 1700-1800 Accessories/Apparel Very High Monobrand Low Gucci Prada
Haute Couture Atelier 1950 Apparel Very High Monobrand Low
Designer Flagship Store 1970-80 Total Look High Monobrand Very High
Accessory Specialist Flagship Store 1980-90 Broad High Monobrand Very High
Tiered Diffusion Store 1980-90 Total Look Moderate Monobrand High AX, Emporio Armani D&G
Luxury Retrenched Store 1980-90 Broad Moderate Multibrand Low Printemps Selfridges
Example
Lobb Herms
Note: Time indicated represents significant introduction/development in Europe/United States.
Source: Bernstein analysis.
Two Major Dynamics Are Playing Out
A new breed of value competitor is building inroads into the A&F market. You find in this group both new-generation A&F discounter specialists as well as grocery retailers expanding in nonfood and apparel, leveraging the traffic synergies of their hypermarket formats. Both are attacking with extremely aggressive pricing, enjoying a structurally advantaged low cost base that couples international sourcing and minimal SG&A. The net result is twofold: Significant A&F price deflation and a diminishing available market for traditional players. Value players are boxing out an increasing portion of the market. The United Kingdom with the likes of Asda, Tesco and Primark has been first in this trend, but we expect the value dynamic to spill over and accelerate into other European markets in the near future. Mass-fashion retailers are satisfying the increasing sophistication of consumer demand, as it moves away from classic and requires increasingly up-to-date products. Mass-fashion retailers enjoy both a cost and a differentiation advantage versus traditional players like department stores and mass-basic players from: (a) their unique product development and merchandising capabilities; (b) their speed in getting from style trends and design ideas to actual product in the stores; and (c) their sophisticated international sourcing. Mass-fashion is rampant, both in the form of international and national players. In the United Kingdom, players like H&M, Top Shop and Zara are building market share with a trendy product and brand positioning, tuned to different age groups. Mass-fashion pricing is above value, but below that of traditional players. We look at our coverage through the lens of our structural understanding of the industry. To simplify things, we group apparel retailers in three major genera: (1) Value Retailers, including department stores, hypermarkets, mutated hypermarkets and discounters. Here we have M&S, given its history, and Next, given its continuing category expansion and increasingly middle-of-the-road style. (2) Differentiated Retailers, including mass-basic and mass-fashion retailers, as well as general independents. Here we have the inventors of mass-fashion: H&M and Inditex. (3) Upscale Players, including high-fashion and luxury-brand marketers, as well as upscale independents. In this space we count PPR. This is an arbitrary simplification: real-world players have genes from one or more pure retailer types. What we want to highlight with this, is that: (1) value retailers would primarily compete on price, leveraging an advantaged cost position, especially on SG&A; (2) differentiated retailers would primarily compete on range, offsetting a heavier cost structure by creating a superior product appeal (hence justifying a price premium over value retailers); and (3) upscale retailers would leverage superior brand investments and product quality to compete on significantly higher price points than value and differentiated players. Market observation confirms this is a practical and acceptable macro simplification. For example, analysis of European markets shows that department stores and hypermarkets compete for the same ground. An inverse correlation exists between the penetration of hypermarkets in a country and department store sales per head of population in that same market: the higher the hypermarket penetration, the lower the department store
Coverage Space
sales. Likewise, it looks as if there is only so much space for a differentiated offer: Selling space per head of apparel and accessories retailers (multiples and independents) in all major European countries varies little, despite great differences in multiple versus independent mix. As we see value, differentiated and upscale as three equally viable strategic positions in the industry, we expect that equally successful players in these positions would have approximately the same ROCE. Capitalizing on this logic, it is possible to create a quick & dirty format score card capturing actual retail economics and ROCE of each player (see Exhibit 3). This allows one to quickly grasp fundamental strengths and weaknesses of each players return equation as well as their unique hybrid blend of value and differentiation. From this quick & dirty ROCE analysis, it is possible to see that, for example, department stores like M&S are transitioning from a value to a differentiated position higher gross margin and higher unit price than Next while falling short on gross margin and sales effectiveness versus differentiated champions like Inditex and H&M.
Exhibit 3
Gross Margin (%) Pure Type Value Retailer Differentiated Actual Performance Next Inditex H&M M&S Primark Lower Higher 31.7% 56.2 59.1 50.0 40.0
Apparel & Footwear Retailers: Quick & Dirty Return Equation (Estimates Based on UK 2005 Numbers)
Unit Price () Lower Higher 11.1 12.1 7.8 12.5 4.7 Volume/m2 (no. of items per year) Higher Lower 630 330 329 290 890 SG&A/m2 ( per year) Lower Higher 900 1,100 950 1,550 750 EBIT/m2 ( per year) Par Par 1,317 1,144 567 263 923 Q&D ROCE Par Par 100 87 43 28 81
Source: TNS, corporate reports and Bernstein estimates and analysis.
The Shape of Things to Come
As competition increases and more and more is thrown at decelerating consumer demand, we expect to see the following key dynamics: (1) Continuing consolidation in the upscale segment. Expect megabrands like LV, Gucci, Prada and Armani to grow faster than average, as the bulk of demand growth in this space comes mainly from nouveaux riches who want well-known, top-of-mind iconic brands. (2) Converging pressure on middle-of-the-road value players. Expect traditional players with middle-of-the-road styles, costs and prices to suffer from the growth of discounters on the one side and mass-fashion retailers on the other, as they bring de-averaged propositions to consumers (discounters equal maximum price appeal and mass-fashion equals maximum product appeal). (3) Long run of mass-fashion players. Expect mass-fashion players to continue to grow, as they can both significantly increase penetration in their existing markets and successfully broaden their geographic presence. The innovative nature and intrinsic power of their selling proposition is securing increasing market success at home and abroad.
(4) Patchy discounter growth. Expect discounter growth to be a localized phenomenon in Europe, with the United Kingdom further ahead than other markets. In fact, apparel discounting requires high local critical mass in order to successfully combine lowest prices and appealing collection styles. Continental grocery retailers the natural candidates to develop a discounter offer have a strong grocery bias and mainly national presence (or national management focus). Before diving into each stock and considering its contingent price attractiveness, the long-term consequences for our coverage from the expected competitive dynamics and demand evolution are the following: Structurally, global mass-fashion players, such as Inditex and H&M are the most attractive players. They combine high-growth prospects with high geographic-risk diversification, given their increasingly global presence. Their specific skills and growing scale ensure that imitators are not a material threat on the horizon. Mega-brand fashion/luxury players are the next attractive group. Asian and worldwide fast GDP growth are creating new armies of consumers for them by the day, ensuring sustained faster-thanaverage growth. On top of this, they are expanding in established markets with accessible entry point prices and products. On the downside, this group is liable to short-term shocks that impact business travel, as we saw during recent high-profile terrorist attacks and epidemics. PPR is the premier stock in our coverage. We see value players like M&S and Next as the most difficult bets long term, given their almost exclusive exposure to the United Kingdom where we foresee further discounter and mass-fashion development and their middle-of-the-road position. Long term, recoveries like the one at M&S might appear as momentary bumps in an otherwise declining trend. Valuation Specialty retailers have one of the highest stock-performance standard deviations of all sectors. Investing in apparel & footwear retailers and in specialty retailers alike is a matter of stock-picking, not a sector call (see Exhibit 4). Long-term profitability growth expectations drive relative P/E performance. Consistent with our understanding of structural competitive dynamics, P/E ratios for incumbent traditional players indicate a constant downward trend, when observed over a 15-year time frame. The M&S relative P/E trend line, for example, moves from 1.3x at the beginning of 1990 to 0.9x at the end of 2005. Conversely, mass-fashion retailers relative P/Es have increased over time. In the case of H&M, for example, the relative P/E trend line moves from 0.6x at the beginning of 1990 to well above 2.0x at the end of 2005. Analysis of the current position against relative price-to-forward earnings (P/FE) long-term average indicates that the European discretionary retail sector is relatively expensive at +1 standard deviation. Dispersion of stocks in the sector is high. In the apparel retailing space, mass-fashion retailers H&M and Inditex are trading close to their long-term price-toforward earnings average; value retailers M&S and Next are at opposite ends, with M&S above and Next below their specific long-term price-toforward earnings average; PPR is also close to +1 standard deviation of its long-term average (see Exhibits 5 and 6).
10
Exhibit 4
Dispersion of Stock Price Performance Across MSCI Sectors (2001-05)

MSCI Europe Sector Consumer Discretionary Consumer Services Information Technology Technology HW & Equipment Consumer Discretionary Retailers Consumer Staples Beverage & Tobacco Industrial Transportation Materials Financial Real Estate Consumer Staples Household & Personal Products Industrial Capital Goods Consumer Discretionary Consumer Durables & Apparel Consumer Discretionary Automobiles & Components Health Healthcare Equipment & Services Health Pharmaceuticals & Biotechnology Energy Consumer Staples Retailing Financial Diversified Financial Services Information Technology Software & Services Financial Banks Utilities Industrial Commercial Services & Supplies Consumer Discretionary Media Telecommunications Financial Insurance Information Technology Semiconductors & Semi. Equipment Average Five-Year Price Change 82.7 (19.4) 20.8 68.7 67.9 48.1 111.6 34.2 0.9 (0.3) 27.4 67.0 15.1 18.2 (7.8) (0.2) (45.5) 10.4 6.7 (28.7) (38.5) (63.1) (53.0) (74.3) Standard Deviation 176.9 77.2 74.8 74.1 66.5 58.2 54.9 54.8 54.7 53.0 47.7 47.0 39.1 39.1 38.7 36.5 34.5 29.6 28.3 26.9 26.1 17.3 15.6 15.1
Note: The analysis includes the top eight companies for each sector by market capitalization; it does not consider the companies without a full five-year track history. Source: FactSet and Bernstein analysis.
Exhibit 5
European Discretionary Retailers: Relative Price-to-Forward Earnings (vs. MSCI Europe)

Relative Price-to-Forward Earnings (to MSCI Europe) 1.4x 1.3x 1.2x 1.1x 1.0x 0.9x 0.8x
Jan-88 Feb-89 Mar-90 Apr-91 May-92 Jun-93 Jul-94 Aug-95 Sep-96 Oct-97 Nov-98 Dec-99 Jan-01 Feb-02 Mar-03 Apr-04 May-05
Source: Bernstein Quantitative Strategy Group.
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
3.0x
3.5x
0.0x Jan-90
Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96
Exhibit 6
0.2x
0.4x
0.6x
0.8x
1.0x
1.2x
1.4x
1.6x
1.8x
2.0x
Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96
PPR
Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Jan-97 Jan-98 Mean Jan-99
Mean
Source: Bernstein Quantitative Strategy Group.
Hennes & Mauritz
0.0x
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
0.5x
1.0x
1.5x
2.0x
2.5x
3.0x
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Next
0.0x
0.2x
0.4x
0.6x
0.8x
1.0x
1.2x
1.4x
1.6x
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
Jan-98
Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Mean Jan-04 Jan-05 Jan-06
Jan-99
Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Jan-00
Jan-01 Mean
Jan-02
Jan-03
Jan-04
Jan-05
Relative Price-to-Forward Earnings vs. MSCI Europe
Inditex
Mean
Marks & Spencer
Jan-06
11
12
We primarily rely on our earnings view versus consensus to call stocks, as earnings surprises have time and again proven a powerful driver of stock-price movements. Our average earnings forecasts for the next two years are (see Exhibit 7): significantly above-consensus for PPR; moderately above-consensus for Inditex and Next; moderately below-consensus on H&M; and significantly below-consensus on Marks & Spencer.
Exhibit 7
26x Price-to-Forward Earnings 24x 22x 20x 18x 16x 14x 12x 10x 8x 0% 5%
Current Price-to-Forward Earnings vs. Bernstein and Consensus Earnings Growth Next Two Years
R = 28% y = 65.642x + 9.8026 MKS NXT NXT MKS H&M ITX PPR PPR
2
H&M
ITX
10%
15%
20%
25%
30%
Earnings Growth (Avg. 2007 vs. 2006; 2008 vs. 2007) Bernstein
Source: FactSet, Bloomberg L.P. and Bernstein estimates and analysis.
Linear (Consensus)
Short term, we believe neither Marks & Spencer nor H&M are going to significantly disappoint consensus: M&S earnings will benefit from actions aimed at increasing traffic in stores and reducing COGS; H&M will enjoy the tail end benefits of temporary quota elimination and continuing sales growth. Combining our strategic view on the business, our short-term and midterm view on the stocks, as well as their relative price-to-forward earnings position versus their long-term average, we come to the following conclusions: PPR: Outperform despite the recent stock price increase, we are convinced that the company has the ability to keep up earnings growth momentum and positively surprise consensus; Inditex: Market-perform beyond mid-term earnings growth in the next two years, we remain convinced Inditex has the best long-term earnings growth potential in our coverage; however, our estimates remain close to consensus in the short term, and we see few catalysts for the shares; H&M: Underperform gross-margin improvement will cease to be a key earnings growth driver, pseudo discount position limits price premium and margin enhancement, and shortcomings are bound to become apparent in the next 12-18 months; M&S: Underperform market honeymoon will continue as investors buy the recovery. Recovery is not structural though we ex-
13
pect problems down the road and will update our view as signs of weakness emerge. Enjoy the ride while it lasts; Next: Market-perform has been hammered as if there was an implication that as M&S goes up, Next comes down; it is in fact a solid and well-managed business, with potential of further growth in the United Kingdom. In retribution, we expect it will resurge as M&S will weaken. Risks Given the nature of the A&F retail sector, the bulk of investment risk is stock-specific rather than common to the whole space. On a sector level, apparel retailers stock prices like all other retailers are negatively influenced by interest-rate increases. This is of concern for both the UK and Continental European stocks in our space, given the prospect of further interest-rate increases. On a subsector level, lower overseas economic development in the United States and Asia would hurt PPRs luxury and upscale fashion business, which is more globally exposed and volatile. Mass-fashion retailers could also feel the impact, but on a lower scale. Besides, PPRs retail interests are heavily exposed to the French market, where a scenario of continuing social and political unrest would certainly involve slower trading. A falling dollar would negatively impact PPR luxury and fashion revenues, and favor mass-fashion and value retailers because of more favorable sourcing costs. This effect would be dampened for H&M, because of the increasing importance of U.S. retail sales. Finally, further downward evolution of UK consumer demand would damage M&Ss and Nexts economics alike, as they are almost totally dependent on the British market. Apparel retailing is a heterogeneous sector: dispersion of returns is high, given the widely differing positioning, earnings and growth prospects of the players in this space. Although we expect headwinds from the prospect of rising interest rates, we believe market pressure will increase the distance between winners and losers, offering the chance of stock-picking for discerning investors. We initiated coverage on the European Apparel Retailers earlier in the year: H&M, Inditex, Marks & Spencer, Next and PPR. Our valuations are built on a relative price-to-forward earnings framework, discriminating between the stocks in our coverage universe on the strength of forecast earnings growth, which we observe has been a useful driver of price-to-forward earnings. Our current recommendations are: PPR, outperform (price target 130); H&M, underperform (price target SEK245); Inditex, market-perform (price target 34); Marks & Spencer, underperform (price target 4.50); and Next, market-perform (price target 18.75).
Investment Conclusion
14
Overview
Differentiated Retailers: Why We Prefer Inditex Over H&M Few other retail companies are as well regarded as Inditex and H&M, which are credited with inventing a new A&F retail business model. Both are uniquely adapted to live in symbiosis with upscale fashion. They get inspiration in the form of style ideas, fabrics, color palettes, finishing process innovations, etc. and they perform a transmission belt function, helping upscale fashion to become increasingly relevant for an ever larger audience. Of the two, we are convinced Inditex has better investment potential for five major reasons: (1) Gross margin will stop being an earnings booster for H&M: H&M has improved gross margin by 8.5 percentage points in the five years between 2000 and 2005. We see current levels as the peak year for gross margin, expecting gross margin in 2006 and 2007 to be lower as quotas on imports from China to Europe are reintroduced. Gross margin improvement has been the single-mostimportant contributor to earnings growth for H&M in the time frame between 2000 and 2005, well above sales growth (see Exhibit 8). In comparison to H&M, Inditex has double the exposure to European sourcing and half the exposure to Chinese sourcing. Gross margin at H&M is 59.1%, while Inditex has 56.2%, with more room to grow.
Exhibit 8
12,000
H&M: Gross Margin Improvement

63% 3% (1)% (16)%
10,000 8,000 51% 6,000 4,000 2,000 0 2000 Earnings Sales Growth Gross Margin Operating Expenses Interest Tax 2005 Earnings SEK6,694 Million
SEK Million
(2) Inditex has superior product development and operations: H&M has a centralized buyer-driven product-development organization, where headquarters decides style, range, orders and deliveries to stores. Inditex has created a peer-to-peer organization where retail, design and operations work on equal footing. Store managers are responsible for sourcing decisions and activate pull product requests. We believe that this has important advantages for Inditex:
15
(1) more precise execution, as customer-facing personnel drive key product and assortment choices; (2) better time and cost to market, as operations have a chance to provide input on cost and lead times immediately; (3) risk-averaging across a large group of employees and minimization of catastrophic off-the-mark collections; and (4) better flexibility to adjust formats and stores to different international demand and competitive environments. Inditex has a faonneur-based sourcing mode that it uses to fast track fashion-intensive styles to stores, leveraging shorter lead times from local third-party manufacturers. This works hand-in-hand with Inditexs diffused and store-driven fashion culture. In fact, the ability to know better than competitors what is needed for the market turns the ability to source quickly and according to ad hoc specifications into a real advantage. In turn, the ability to source quickly according to ad hoc specifications allows the most delicate fashion-intensive assortment decisions to be postponed up until the very last moment. And this, in turn, improves the ability to precisely determine which products work for the market, as upscale fashion media campaigns and shows, as well as street-based trends, can be detected and interpreted. The hard economics advantage for Inditex is: (1) a higher proportion of full-price sales than traditional competitors, which more than offsets higher sourcing costs from local sources; and (2) lower volatility of sales growth, from lower risks of off-the-mark collections. (3) Inditexs multiple formats allow deeper market penetration: Inditex can cover a much broader portion of the Apparel & Footwear market both in terms of age groups, design styles and price points because of its retail formats portfolio. Multiple formats are proving to be a key driver of superior market penetration for Inditex: While Inditexs penetration of the Spanish market is very similar to H&Ms penetration of the Swedish market, the trajectory and speed at which this penetration is happening is far superior; half of this penetration is owed to non-Zara formats (see Exhibit 9). We believe that the ability to leverage multiple formats will result in Inditex growing its sales faster and longer term than H&M, both at home and abroad.
Exhibit 9
70
Inditex vs. H&M: Domestic Market Sales Penetration (1998-2005)

H&M CAGR: 2.6%
Domestic Market Sales Penetration ( per Head)
60 50 40 30 20 10 0 1998 Inditex CAGR: 17.3% Non-Zara Zara
1999
2000
2001
2002
2003
2004
2005
Source: Corporate reports and Bernstein analysis.
16
(4) Inditex has yet to reap the benefit of local critical mass: Inditex has been significantly more aggressive than H&M in entering foreign markets. While the Swedish retailer historically has chosen a paced approach, moving one market at a time and focusing on deepening penetration in the markets addressed, Inditex has maximized the width of its international front. As a result: (1) H&M has five to six times higher sales per country than Inditex; and (2) Inditexs SG&A has inflated following its international flag-planting spree. SG&A reduction is a P&L improvement opportunity that Inditex management has been concentrating on. Maximizing penetration in key European markets will be a key driver of SG&A leverage. (5) Inditex is cheaper than H&M: The market seems to increasingly perceive Inditex and H&M as one and the same thing. While correlation of H&Ms and Inditexs forward P/Es is virtually absent if data from the past three years are considered, a direct correlation between H&Ms and Inditexs forward P/Es emerges by focusing the observation on the most recent 12 months. The market is currently according H&M a premium, while we think that Inditex will provide better earnings growth in the short and medium term (see Exhibit 7 in the SRC). Value Retailers: Why We Prefer Next Over M&S Marks & Spencer and Next are two British institutions one with the prestige of tradition, the other with the allure of alternative appeal. The market is currently charmed by the M&S relaunch story and is overlooking Next, having significantly lower expectations for the latter than the former. No matter the magic spell of M&S relaunch, we prefer to invest in Next over M&S; here are our five major reasons: (1) Next has a younger and more-focused customer base: M&S is indeed the most admired UK retailer, but the difference of its consideration across age groups is striking: While women over 55 years old give M&S a 19.7% preference, women in the 35-55 age bracket indicate 10.6%. M&S is conspicuously absent from the Top 5 preferred-retailer list of women younger than 35 years old. Although Next has taken a converging mainstream positioning, maturing from its original alternative appeal, Next has the advantage of having a much more focused customer base and a younger one. M&S is struggling to be everything to everyone in a competitive arena where cost leaders have universal appeal and differentiated players must be focused, in order to fuel brand appeal and price premium. We dont think that the current universal M&S relaunch will work across age groups, no matter the money invested in changing the store layout and signage. (2) Next has a proven and profitable growth strategy: Next has a demonstrated growth strategy, based on: (1) space expansion in the United Kingdom; and (2) directory and multichannel sales development leveraging its customer base. Next has been growing its sales space at an annual rate of 12.4% in the past 13 years, through a mix of new stores, relocations and store extensions. Given the larger formats developed, the shopping center/out-of-town focus and current geographic penetration levels, we do not see material limitations to Next continuing to profitably expand its space. Next has leveraged its retail assets product capabilities, sourcing and operations, customer base into the directory channel. Next has become in
17
this way one of the few truly multichannel retailers in the United Kingdom. Directory sales have been growing at a slightly higher pace than retail sales, with a 16.6% CAGR between 1994 and 2005 contributing 20% of overall group growth. Continuing customer-base growth, strong Internet leadership and further category expansion will keep providing strong growth on this side. (3) Next has a more defensible base against discounter inroads: Mainstream A&F retailers will need to tackle further expansion of discounters coming to the High Street and grocers upgrading their products. We believe Next has a better ability to defend against this structural development as it enjoys a leaner cost base from: (1) more established international sourcing capabilities; (2) smaller and more productive stores; (3) lower real estate costs from a higher proportion of out-of-town versus High Street locations; and (4) more efficient operations and workforce management. Next is also better defended as it has a higher-involvement sales mix, selling more accessories and outerwear versus underwear and hosiery. Nexts A&F sales mix resembles that of mass-fashion retailers, while M&Ss is akin to that of discounters and grocers. (4) M&S will suffer from food dilution: In the past 10 years, M&S has increasingly become a food retailer. Food sales in the United Kingdom accounted for 50.8% of total UK net sales in the six months to October 1, 2005; they were a mere 41.8% in 1995. More than three-quarters of the sales increase M&S achieved between 1995 and 2005 was in food sales. Food has a structurally lower margin: we estimate that general merchandise is at least 50-60% more profitable than food for M&S. As M&S pushes ahead with food development, in our view, it will continue to lose ground in apparel, thereby diluting earnings. (5) Next is bound to positively surprise on easy expectations unlike M&S: The market has hugely different expectations on M&S and Next: the average operating profit and net income yearly growth expectations for FY 2006, FY 2007 and FY 2008 are around 5% in the case of Next, and approximately 15% in the case of M&S (see Exhibit 10). We are convinced that Next will be capable of performing at and beyond consensus expectations, and this may create upward pressure on the shares.
Exhibit 10
9% 8% 7% YoY Growth
Next vs. M&S: Median Consensus Expectations

Sales
22% 20% 18% 16% YoY Growth YoY Growth 14% 12% 10% 8% 6% 20% 15% 10% 5% 0% 2007E 2008E M&S 2009E 2007E 2008E 2009E Next 25%
Operating Profit
30%
Net Income
6% 5% 4% 3% 2% 1% 0% 2007E 2008E 2009E
4% 2% 0%
Note: FY 2006 = Next: year-end January 31, 2006; M&S: year-end March 31, 2006. M&Ss 2005 results are adjusted for divested activities. Source: FactSet, Bloomberg L.P. and Bernstein analysis.
18
Upscale: Why We Believe PPR Is Appealing
The market was enthusiastic about PPR a few years ago, and since then seems to have forgotten about it. (Barring 2005, when new interest awoke to changed leadership and management, new strategy and focus on organic growth, as well as, more recently, improving results.) Yet, we believe the PPR stock is nowhere near where it should be, based on its earnings potential and fundamental value. We are confident that, as new management, led by new CEO Francois Henri Pinault, continues to work on organic growth, more positive results will follow, fuelled by above-average growth at Gucci, stabilization of other luxury brands and improving consumer outlook for France-centered retail activities. The sale of Printemps, the department store division, is early evidence of promised focus in the business. (1) Continuing above-average development at Gucci: Gucci is a megabrand and it is more consistently top-of-mind than such revered luxury icons as Louis Vuitton or Armani (see Exhibit 11). To us, mega-brand status means consistently sustainable above-average sales growth with above-average profitability. In fact, we are convinced that in the world of luxury, winners will continue to win: On the demand side, luxury market growth comes mainly from new consumers entering the category be it nouveaux riches from emerging economies or aspiring consumers in developed countries, what these consumers want is the real thing; not some cool niche brand, but the high-profile, worldleading mega-brands. On the supply side, the increasing ante of competition is creating a virtuous cycle for mega-brands. Limited flagship store space and escalating lease costs require higher and higher space productivity (sales per square meter); space productivity is driven by top-of-mind status and ultimately by advertising budget sizes (the larger the better). The comparison of Guccis directly-operated stores network with Armanis and Louis Vuittons indicates significant growth space, and the opportunity to fill the top-of-mind versus sales gap (see Exhibit 11). Continuing sales growth and increase of sales in the Directly Operated Store (DOS) channel (which accounts for 61% of total Gucci sales in 2005) should ensure economies of scale and more than proportional profitability growth.
19
Exhibit 11
Top-of-Mind Fashion and Luxury Brands First Brand Mentioned (No Prompting)
Question: Which fashion or luxury brands for example, apparel brands, accessories brands, eyewear brands do you know or have you heard of? Italy Armani Valentino Versace Gucci D&G Prada Cavalli Benetton Spain Rayban Armani Dior Lacoste Levis Loewe El Corte Ingls Gucci 14% 6 4 3 3 3 3 2 22% 14 10 5 4 4 2 2 Dior Chanel Vuitton Lacoste YSL Rayban Gucci Cardin United States Rayban Gucci Levi's Calvin Klein Hugo Boss Armani Versace Prada France United Kingdom Gucci Rayban Versace D&G Armani Calvin Klein Next Nike China 6% Lacoste Valentino 4 2 Rayban 2 Gucci 2 Chanel 1 Cardin 1 Versace 1 Vuitton Germany 8% 8 6 6 4 3 3 2 3% 2 2 2 2 2 1 1 Hugo Boss Gucci Joop Armani Dior Chanel Lacoste Calvin Klein Japan Hugo Boss Gucci Versace Boss Prada Chanel Lacoste Calvin Klein 12% 10 10 6 4 3 2 2 12% 8 6 5 4 3 2 2
31% 21 8 5 4 4 2 2
Source: Abacus, December 2002, circa 1,000 respondents per country.
(2) Fixing non-Gucci luxury brands: Yves Saint Laurent (YSL) and the other fashion and luxury brands acquired between 1999 and 2001 have been the root cause of performance deterioration in the PPR luxury division. We are convinced there are good reasons for optimism on the return to profitability of the non-Gucci brands: (1) the new leadership is committed to a quick turnaround; (2) initial results are encouraging, as both Bottega Veneta and other minor brands have improved significantly in 2005 over 2004; (3) most minor fashion and luxury brands at PPR are focused on accessories (a key positive as accessories have structurally better economics than apparel); and (4) the residual concern is YSL, where significant restructuring is required and management growth targets are overoptimistic. On the other hand, we believe that a great deal of fixed cost at YSL can be eliminated in order to make the brand profitable sooner, or at least limit the losses. In fact, one of the key levers to consider is a possible right-sizing of the DOS network, whose development has significantly accelerated losses since the acquisition. (3) Improving retail economics: PPR retail business is indeed a group of diversified activities, with remarkably different characteristics: category focus, formats and geography. Category focus spans: (1) furniture and appliances of discount specialist Conforama; (2) hardware, software, consumer electronics and media of specialist FNAC; (3) apparel, personal and home accessories of catalogue specialist Redcats; and (4) pharmaceuticals, automotive and industrial parts of trading company CFAO. We see three major reasons why we expect the PPR retail business to profit from favorable tailwinds going forward: Conforama: favorable housing developments in the French market and expected post-general election recovery in Italy; FNAC: favorable consumer-electronics demand development, connected to major 2006 sports events; and
20
Cost-Reduction Opportunities: labor productivity across businesses, Far East sourcing for Conforama and cost efficiencies from paper-to-online switch at Redcats. (4) Earnings growth: PPR is undervalued versus consensus earnings growth estimates of 19.1% (average of 2006 versus 2005 and 2007 versus 2006). We foresee better-than-consensus earnings growth in the next two years, at over 30%. We anticipate that continuing earnings growth in 2006 and further above-expectations growth after 2006 should serve as catalysts for a re-rating of the stock and significant price appreciation.
21
European Apparel & Footwear Demand

Overview The weak retailing environment experienced over the last five years is drawing to a close. We expect the European Apparel & Footwear retail market to grow at 1.4-1.5% in 2006 and 2007 (if the relatively positive GDP forecasts for the euro remain intact), which represents a marginal increase versus the 0.9% of 2001-05. Within this headline outlook, we expect an increasing consumer demand of differentiated/up-to-date products and a move away from classic/traditional styles. This trend will be fuelled by: (1) the continuing internationalization of fashion trends; (2) the establishment of a stronger transmission chain between high fashion and the Street; (3) the increasing sophistication of consumers specifically women across European countries; and (4) the relative slowness of background consumer demand. Apparel & Footwear is one of the most important retail categories in Europe, second only to grocery. At 306.7 billion in 2001 (the latest year for which we have comparable data), Apparel & Footwear retail spend represented 16.1% of total retail spend, versus 17.0% in 1996 and 19.4% in 1991. Italy, Germany and the United Kingdom are the largest markets in absolute terms, with France a distant fourth (see Exhibit 12).
The European A&F Market: A Historical Perspective
Exhibit 12
European Union: Apparel & Footwear Market Absolute Retail Spend ( billion)
1991 55.7 57.2 31.7 37.6 24.0 9.1 7.2 5.7 7.2 5.9 3.9 2.9 2.8 1.3 0.5 252.7 1996 54.3 58.0 36.5 38.9 22.1 10.0 7.9 7.3 7.5 5.2 4.8 3.7 2.4 1.9 0.6 261.1 2001 63.9 62.2 56.0 41.7 25.4 11.2 8.5 8.4 7.7 6.0 5.5 4.3 2.7 2.6 0.6 306.7 1991-96 (0.5)% 0.3 2.9 0.7 (1.6) 1.9% 1.9 5.1 0.8 (2.5) 4.2% 5.0 (3.0) 7.9 3.7 0.7% CAGR 1996-2001 3.3% 1.4 8.9 1.4 2.8 2.3% 1.5 2.8 0.5 2.9 2.8% 3.1 2.4 6.5 0.0 3.3% 1991-2001 1.4% 0.8 5.9 1.0 0.6 2.1% 1.7 4.0 0.7 0.2 3.5% 4.0 (0.4) 7.2 1.8 2.0%
Italy Germany United Kingdom France Spain Netherlands Belgium Greece Austria Sweden Portugal Denmark Finland Ireland Luxembourg EU 15
Source: Verdict and Bernstein analysis.
The United Kingdom was the fastest-growing major market in the 19912001 decade, growing at 5.9% four to 10 times faster than the other four major European economies. The UK growth trend (in euros) was, however, boosted by a favorable euro/pound exchange rate, as the pound appreciated 13% versus the euro in the decade (see Exhibit 13).
22
Exhibit 13
1.70 1.60 1.50 / 1.40 1.30 1.20 1.10 1.00
Euro vs. Pound Sterling Exchange Rate (1990-2007E)
+13%
(14)%
+31%
2006E
Source: Verdict, EuroStat and Bernstein analysis.
But even eliminating the exchange-rate factor, A&F retail spend in the United Kingdom between 1991 and 2001 has grown by 4.6% per year, 3.3 times faster than in Italy (1.4%) and 8.1 times faster than in Spain (0.6%). The growth rate in the United Kingdom has been second only to Ireland among the EU 15. Italy leads all European nations in terms of per-capita Apparel & Footwear retail spend, with more than 1,100 per head. Germany and France have approximately two-thirds of Italys spend (even less, if adjusted by GDP per capita), while the United Kingdom and Austria are the only economies in Europe with a per-capita spend just 15% less than that of Italy. The United Kingdom has reduced its per-capita-spend gap with Italy by 2,800 basis points (bp) in 10 years, the largest reduction of all EU 15 countries (see Exhibits 14-16).
Exhibit 14
European Union: Clothing Market per Capita Retail Spending

1991 981 715 548 660 616 604 720 556 928 685 391 563 558 368 1,292 690 1996 955 708 621 670 560 644 778 682 942 588 477 703 468 522 1,448 700 2001 1,121 755 941 704 624 698 826 767 957 674 534 802 520 672 1,359 811 Gap to Italy > 25% 1991 100 73 56 67 63 62 73 57 95 70 40 57 57 37 132 70 Index vs. Italy 1996 100 74 65 70 59 67 81 71 99 62 50 74 49 55 152 73 2001 100 67 84 63 56 62 74 68 85 60 48 72 46 60 121 72 Delta 1991-2001 (549) 2,798 (443) (718) 71 35 1,177 (924) (962) 778 1,422 (1,050) 2,248 (1,048)
Italy Germany United Kingdom France Spain Netherlands Belgium Greece Austria Sweden Portugal Denmark Finland Ireland Luxembourg EU 15 Gap to Italy < 25%
Source: Verdict, Eurostat and Bernstein analysis.
2007E
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
23
Exhibit 15
1,600 1,400 A&F Retail Spend () 1,200 1,000 800 600 400 200 0 0 5,000
European Union: Clothing Market per Capita A&F Retail Spend vs. GDP per Capita
A&F / GDP per Head : 7.5% 5.0% Luxembourg Austria Belgium UK Denmark France Germany Greece Sweden Ireland Spain Netherlands Portugal Finland R = 36% 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000
2
3.5%
Italy
2.5%
GDP per Head ()

Note: GDP per head at 2001 prices and exchange rates; A&F per retail spend of 2001. Source: Verdict, OECD and Bernstein analysis.
Exhibit 16
European Union: Clothing Market per Capita A&F Retail Spend vs. GDP per Capita
(1.10)% Log (A&F Pct. GDP) (1.20)% (1.30)% (1.40)% (1.50)% (1.60)% (1.70)% 3.90
Greece Italy Portugal Spain EU 15 Austria UK Belgium France Netherlands Sweden Denmark Ireland Finland 500 4.30 Log (GDP/Capita) 4.40 700 4.50 Luxembourg 1100 900 4.60
Germany
Euro/Year 4.00 4.10 4.20
Note: GDP per head at 2001 prices and exchange rates; A&F per retail spend of 2001. Source: Verdict, OECD and Bernstein analysis.
Apparel & Footwear Growth Drivers
Apparel & Footwear is a cyclical category: retail spend is driven by GDP growth. Among the major EU economies, Italy, France and Germany have the highest historical correlation of Apparel & Footwear retail expenditure growth to GDP growth (see Exhibits 17-22).
24
Exhibit 17 Apparel & Footwear Year-Over-Year Expenditure Growth vs. GDP Growth: Italy
20% Year-Over-Year Growth
Exhibit 18 Apparel & Footwear Expenditure Growth vs. GDP Growth: Italy
16% Apparel & Footwear Expenditure Growth 14% 12% 10% 8% 6% 4% 2% 0% (4)% (2)% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%
20%
15% 10% 5% 0% (5)% 1Q:85 2Q:86 3Q:87 4Q:88 1Q:90 2Q:91 3Q:92 4Q:93 1Q:95 2Q:96 3Q:97 4Q:98 1Q:00 2Q:01 3Q:02 4Q:03 1Q:05
(10)%
R = 53%
Apparel & Footwear Expenditure Growth GDP Growth

Source: Haver. Source: Haver.
GDP Growth
Exhibit 19 Apparel & Footwear Year-Over-Year Expenditure Growth vs. GDP Growth: France
16% 14% 12% 10% 8% 6% 4% 2% 0% (2)% 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Year-Over-Year Growth
Exhibit 20 Apparel & Footwear Expenditure Growth vs. GDP Growth: France
12% 10% Apparel & Footwear Expenditure Growth 8% 6% 4% 2% 0% (2)% 0% 5% 10% GDP Growth
Source: Haver.
2
R = 51%
15%

Source: Haver.
25
Exhibit 21 Apparel & Footwear Year-Over-Year Expenditure Growth vs. GDP Growth: Germany
10% Year-Over-Year Growth 8% 6% 4% 2% 0% (2)% (4)% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Exhibit 22 Apparel & Footwear Expenditure Growth: Germany
10% Apparel & Footwear Expenditure Growth 8% 6% 4% 2% R = 25% 0% (2)% (4)%

2
0%
1%
2%
3%
4%
5%
6%
7%

Source: Haver. Source: Haver.
GDP Growth
The UK market stands out by itself. The correlation of Apparel & Footwear retail spend with GDP is the lowest among the major EU economies, with an R-squared of 11% (see Exhibit 23).
Exhibit 23
Apparel & Footwear Expenditure Growth vs. GDP Growth: United Kingdom
14% Apparel & Footwear Expenditure Growth 12% 10% 8% 6% 4% 2% 0% R = 11%
2
0%
10%
8%
2%
GDP Growth
Source: Haver.
What was the driver of such powerful growth in the United Kingdom? The answer lies in the development of value clothing and footwear. The UK Apparel & Footwear market has experienced the most extreme pricedeflation trend among the major EU economies in the past 10 years (see Exhibits 24-27). The most intense deflation has occurred in clothing (see Exhibits 28-31). Price deflation has been caused by a major mix shift, whereby the discount segment has come to dominate the A&F retail spend growth scene (see Exhibit 32). From 1996 to 2001, discount clothing generated 62% of the total apparel retail spend growth, i.e., 2,365 million out of a total of 3,789 million. In the same period, discount clothing grew at a
12%
14%
6%
4%
8%
26
16.6% CAGR, while nondiscount apparel was dismal in comparison, growing at a 1.2% CAGR.
Exhibit 24 Apparel & Footwear Inflation vs. CPI: United Kingdom

10% 8% 6% 4% 2% 0% (2)% (4)% (6)% (8)% (10)% (12)% Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05
Exhibit 25 Apparel & Footwear Inflation vs. CPI: Germany

10% 8% YoY Inflation 6% 4% 2% 0% (2)% (4)% (6)% Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-04 Jan-05 Jan-06 Jan-06
YoY inflation
Apparel & Footwear

Source: Haver and Bernstein analysis.
General CPI
Apparel & Footwear

General CPI
Exhibit 26 Apparel & Footwear Inflation vs. CPI: France

10% 8% YoY Inflation 6% 4% 2% 0% (2)% (4)% (6)% Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05
Exhibit 27 Apparel & Footwear Inflation vs. CPI: Italy

10% 8% YoY Inflation 6% 4% 2% 0% (2)% (4)% (6)% Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03
Apparel & Footwear

General CPI
Apparel & Footwear

General CPI
27
Exhibit 28 Apparel vs. Footwear Inflation: United Kingdom

4% 2% YoY inflation
Exhibit 29 Apparel vs. Footwear Inflation: Germany
4% 3% YoY Inflation 2% 1% 0% (1)% (2)% (3)% (4)% Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-05
0% (2)% (4)% (6)% (8)% (10)% (12)% Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Apparel
Footwear
Apparel
Footwear
Exhibit 30 Apparel vs. Footwear Inflation: France

4% 3%
Exhibit 31 Apparel vs. Footwear Inflation: Italy

6% 5% YoY Inflation 4% 3% 2% 1% 0% (1)% (2)% Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04
YoY Inflation
2% 1% 0% (1)% (2)% Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Apparel
Footwear
Apparel
Footwear
Jan-06
Jan-06
28
Exhibit 32
The Impact of Value Clothing on Clothing Retail Spend in the United Kingdom ( million)
1991 1996 2001 2004 Delta 1996 vs. 1991 Delta 2001 vs. 1996 Delta 2004 vs. 2001 Delta 2001 vs. 1991 CAGR 1996 vs.1991 CAGR 2001 vs. 1996 CAGR 2004 vs. 2001 CAGR 2001 vs. 1991 Delta CAGR 1996 vs. 1991 Delta CAGR 2001 vs. 1996 Delta CAGR 2004 vs. 2001 Delta CAGR 2001 vs. 1991 Value Clothing 0 0% 2,049 8 4,414 15 6,399 20 2,049 2,365 1,985 4,414 na 16.6% 13.2 na 1.8% 1.6 1.8 1.7 31% 62 55 42 Other Clothing 18,521 100% 23,113 92 24,537 85 26,153 80 4,592 1,424 1,616 6,016 4.5% 1.2 2.1 2.9 69% 38 45 58 Total Clothing 18,521 100% 25,162 100 28,951 100 32,552 100 6,641 3,789 3,601 10,430 6.3% 2.8 4.0 4.6 100% 100 100 100
Source: Verdict and Bernstein estimates and analysis.
In the 10 years between 1994 and 2004 discount clothing grew at a 14.7% CAGR, while nondiscount clothing managed only 2.2% (see Exhibit 33).
Exhibit 33
Apparel Retail Spend: United Kingdom (1994-2004)

Value Apparel CAGR: +14.7%
Nonvalue Apparel CAGR: +2.2%
30,000 25,000
Million
7,000 6,000 Million 5,000 4,000 3,000 2,000 1,000 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
20,000 15,000 10,000 5,000 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Without the discount boost, UK A&F market growth looks much more like that in other major EU markets: the contribution of discount clothing to total clothing spend growth has been 1.7% out of 4.6%, i.e., more than 40% (see Exhibit 34). The other major EU market that stands out is Italy, which has also been growing at an above-average EU rate (see Exhibit 35). In fact, taking the growth outliers the United Kingdom, Italy, Sweden, Denmark and Greece and the regression equation from Exhibit 34, it can be observed that the United Kingdom and Italy represent 48% and 41%, respectively, of the extra 18.5 billion growth versus the regression-based prediction.
29
Exhibit 34
Correlation of Apparel & Footwear Spend Growth to Nominal GDP Growth EU 14: 2001 vs. 1991
2001 vs. 1991
9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 0%
A&F Retail Spend Growth in Local Currency
Greece Ireland UK Denmark Sweden Belgium Germany 2% France Italy Spain Netherlands
Portugal Contribution of Value Clothing to U.K. A&F Retail Spend Growth y = 0.865x 0.019 8% 10% 12% R2 = 82% 14%
Finland Austria 4% 6%
Nominal GDP Growth
Source: OECD, Verdict and Bernstein analysis.
Exhibit 35
Apparel & Footwear Growth Outliers vs. 1991-2001 Regression

10.0 Delta A&F Retail Spend ( billion) 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 35.7 44.1 3.8 3.1 4.7
Regression Equation m = 0.87 q = -0.02 Nominal GDP A&F 1991-2001 Growth Growth Predicted Actual Delta United Kingdom 5.5% 2.8% 4.6% 1.8% Italy 5.1 2.5 3.8 1.3 Germany 10.6 7.2 8.4 1.2 Denmark 4.3 1.8 3.3 1.5 Sweden 4.0 1.5 2.4 0.8 Billion United Kingdom Italy Germany Denmark Sweden 1991 35.7 44.1 3.8 3.1 4.7 2001 Predicted 47.1 56.3 7.5 3.7 5.5 2001 Actual 56.0 63.9 8.4 4.3 6.0 Delta 8.9 7.6 0.9 0.6 0.5
Interestingly, the Italian A&F retail spend growth dynamic has been fuelled by price increases, rather than by a step-change in demand triggered by price deflation, similar to that in the United Kingdom (see Exhibit 36).
30
Exhibit 36
Apparel & Footwear Price vs. Volume Growth: United Kingdom vs. Italy
United Kingdom
Italy
Price Volume Index 180 160 140 120 100 80 60 1Q:98 4Q:98 3Q:99 2Q:00 1Q:01 4Q:01 3Q:02 2Q:03 1Q:04 4Q:04 29.1% Italy 3Q:05
Price Volume Index
180 160 140 120 100 80 60 1Q:98 4Q:98 3Q:99 2Q:00 1Q:01 4Q:01 3Q:02 2Q:03 1Q:04 4Q:04 3Q:05
Price
Volume
Price
Volume
The reason for this difference, in our view, lies in the shape of the retail industry in the United Kingdom and Italy: the former is at the forefront of consolidation and format innovation; the latter is one of the most traditional in Europe, still dominated by independent mom & pop specialist retailers (see Exhibit 37). On the grocery retailing side, the United Kingdom is also with France the major European economy where the retail industry is most concentrated (see Exhibit 38). Grocery retailers searching new avenues for growth associated with the acquisition of Asda by Wal-Mart, with its deep expertise in nonfood and apparel retailing in the United States, plus the development of stand-alone discounters (such as Matalan and Primark) have provided the catalyst for a British discount clothing boom.
Exhibit 37 Apparel Retailing Fragmentation EU 15 (2002)

1.6 Apparel Specialist Stores/Thousand Population 1.4
Exhibit 38 Top Five Players Share of the Grocery Retail Market

90% 80% Pct. Total Market Share 70% 60% 50% 40% 30% 20% 10% 49.4% 78.9% 78.5%
1.2 1.0 0.8 0.6 0.4 0.2 0.0 GR P LUX I NL IRL S E A DK F B SF D UK
0% France
Source: Europanel.
U.K. UK
Germany
Source: Verdict.
A broader look at the major European economies confirms that A&F price deflation is correlated to the A&F retail industry structure: the higher the level of concentration in the industry, the sharper the price deflation (see Exhibit 39).
31
Exhibit 39
Apparel & Footwear Retail Structure as a Driver of Price Deflation

Apparel & Footwear Price Deflation (1Q:01 vs. 3Q:05) 60 40 20 0 (20) (40) (60) 100 UK 125 150 175 200 225 France Germany Italy R = 84%
2
Apparel & Footwear Specialist Store Average Size (m2)

Note: 1Q:01 = 0. Source: Verdict, Haver and Bernstein analysis.
Value Clothing in Context
In our view, value clothing is the last cog of a transmission chain between the catwalk and the Street that is bringing A&F fashion closer and closer to the general public (see Exhibits 40 and 41).
Exhibit 40
The Transmission Chain Between the Catwalk and the Street

HC Prt Porter Diffusion
Best Denim/Cotton Basics
Denim/ Cotton Fashion
Better
Mass Fashion Good Value Clothing
Classic Content Focus

Fashion
32
Exhibit 41
The Transmission Chain Between the Catwalk and the Street : Layered Brand and Accessories Boom
HC
Layered Brand Concept Diffusion
Prt Porter Accessories Boom
Best Denim/Cotton Basics
Denim/ Cotton Fashion
Better
Mass Fashion Good Value Clothing
Classic Content Focus

Source: Bernstein estimates.
Fashion
1970-80: Italian Designers Invent the Layered Brand Concept
Italian designers were the first to try and quench growing fashion thirst in the widespread public by introducing the layered brand and collection concept. The idea was to translate the magic of couture design into cheaper and more-accessible designs and materials opening up the world of fashion through lower-priced collections sold under subbrands to an increasing number of consumers. While prt porter1 was still a French invention, the Italians first among them Giorgio Armani, Gianni Versace and Valentino Garavani created more and more collections and price points. The larger the brand, the higher the number of collections and the wider the price span it could support. Subbrands would serve both as identifiers of different price points and as safeguards for the higherpriced couture and prt porter collections. The retail price of the same item (e.g., a jacket or a dress) in different collections can differ by a factor of 10 to a factor of 100 and beyond, if couture and atelier garments are taken into account. The Armani brand is still deployed on five different collections today at increasing price points: Armani Exchange, Emporio Armani, Armani Jeans, Armani Collezioni and Giorgio Armani.
1 Haute couture is the creation of unique apparel pieces, designed ad personam for highly prominent clients (royalty, stars, high-net-worth individuals), who would wear these garments on special occasions. Prt porter is highly priced ready-made fashion for a wider public. While the most expensive haute couture piece can reach a 0.5-1.0 million price tag, prt porter would reach 50,000-100,000 maximum.
33
1980-90: The AccessoriesBased Brands Boom
As designer-based brands entered maturity and then consolidation mode, accessories became center stage. Two forces have determined the surge of accessories: Accessories brands can introduce lower-priced items without layered branding: they just need to develop collections with cheaper materials and/or create smaller-sized items. They can broaden their customer reach beyond the wealthy few with minimal or no brand-debasement risk. In fact, most accessories brands are still perceived to be something more i.e., luxury versus fashion while most of the items in their flagship store windows range between $500 and $1,000 (i.e., are affordable to a very wide public). Prada has been the champion of this trend, and its iconic small rucksack in black nylon has been the epitome of a mass product dressed up as a luxury one. It is no coincidence either that all major recent brand success stories in fashion have either come from a strong accessories heritage Gucci, Burberry or have been built on the development of a predominantly accessories business Dior. Consumers need brand markers to visibly anchor them to a certain group or lifestyle accessories have a structural advantage over apparel as markers: they have a rigid shape and they have the brand or logo on the outside. As a consequence, they are much easier to recognize and much harder to imitate by competing brands (accessories can be faked while an apparel cut can be immediately replicated with slight variations by all brands, if it proves to work).
1990 to Ongoing: Mass-Fashion A new chapter of the democratization of luxury is now being written by Retailing mass-fashion retailers. Different from a previous generation of apparel retailers who wanted to impose their own style i.e., Benetton, The Gap, etc. mass-fashion retailers recognize that the fashion system (i.e., the highfashion brands, the universally present fashion magazines, the pervasive fashion icons, etc.) is the source of creativity and see their mission as bringing the fashionable looks at the lowest possible price and in the fastest possible manner to the wide public. For us, Zara (part of the Inditex portfolio) is the clear champion of this new idea. Women Are Where the Action Is Apparel & Footwear is first and foremost a woman thing. To start with, womenswear as a market is worth twice that of menswear, and this gap is expected to grow. Taking the United Kingdom as an example, in 1994 womenswear was worth 11.0 billion while menswear accounted for 6.2 billion. Ten years later, in 2004, womenswear was worth 17.9 billion while menswear accounted for 8.6 billion (see Exhibits 42 and 43). Footwear is worth one-sixth of clothing 5 billion versus 30 billion and is slightly more balanced between womens and mens. Taking again the United Kingdom as an example, womens shoes were worth 38% more than mens shoes in 1994 at 2.1 billion. Ten years later, in 2004, womens shoes were worth 2.4 billion, or 35% more than mens shoes (see Exhibits 44 and 45).
34
Exhibit 42 Apparel Market: United Kingdom Absolute Spend

35,000 30,000 Spend ( million) 25,000 20,000 15,000 10,000 5,000 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 CAGR: +4.5% +3.0% +2.0%
Exhibit 43 Footwear Market: United Kingdom Absolute Spend

6,000 5,000 Spend ( million) 4,000 3,000 2,000 1,000 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2003 2004 2004 CAGR: +1.6% +1.8% +2.1%
Womenswear
Menswear
Childrenswear
Womens Shoes
Mens Shoes
Childrens Shoes
Note: Excluding other: Haberdashery, knitting wool, etc. Source: Verdict and Bernstein analysis. Source: Verdict and Bernstein analysis.
Exhibit 44
Apparel Market: United Kingdom Relative Spend

Womenswear Over Menswear Spend
Womenswear Over Childrenswear Spend
4.5 Relative Spend ( million) 4.0 3.5 3.0 2.5 2.0 1994 1995 1996 1997 1998 1999 2000 2001
2.50 Relative Spend ( billion) 2.25 2.00 1.75 1.50 1.25 1.00 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
2002
35
Exhibit 45
Footwear Market: United Kingdom Relative Spend ( billion)

Womens Shoes Over Mens Shoes Spend
Womens Shoes Over Childrens Shoes Spend
2.8 Relative Spend ( billion) 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Relative Spend ( billion)
2.50 2.25 2.00 1.75 1.50 1.25 1.00 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Womenswear is much more complex and articulated than menswear. While a limited number of relatively stable uniforms exist for men (i.e., the white shirt, the grey business suit, the khaki pants, etc.), womenswear relies on a structurally wider range of items, which in turn undergo a much higher and volatile set of style variations, and a much broader and swifter color palette evolution. For example, women can decide whether to wear trousers, a skirt, a dress, a suit; these will be cut very differently from season to season and will likely be of very different colors. When observed over time, our estimate is that womenswear is at least two orders of magnitude more complex than menswear, i.e., a 100 to 1 complexity gap. In high fashion, womenswear fashion shows are the event of the season; the menswear fashion week is a pale resemblance of them, with often perfunctory performances, fewer innovations and reduced audience expectations. When creativity does find a space on stage, the link between the catwalk and the real world is much more fragile for menswear than for womenswear. Womens fashion has a much deeper, broader and more immediate impact on what we see on the street every day. Socio-Demographics Are in Womens Favor The past 50 years have seen a huge change in the socio-demographic profile of women in Europe. Womens level of education, participation in the workforce and average salary to name a few defining parameters have all grown dramatically and much faster than mens across the European Union. Women are better educated. In the United Kingdom, womens participation in higher education has overtaken mens in the past 10 years. While in the early 1970s there were 205,000 women in higher education versus 416,000 men, in 2000 the number of women in higher education was 1.1 million versus 0.9 million men (see Exhibit 46). This trend is also seen across major EU economies. Female students represent today around 55-56% of tertiary students in the United Kingdom, France and Italy, the same level as the U.S. average in the past 10 years. In Spain female students stand at 53%, while in Germany they represent 49.5% of the total (see Exhibit 47).
36
Exhibit 46
United Kingdom: Numbers in Higher Education by Gender (1970-2000)

Population in Higher Education (000) 1,200 1,000 800 600 400 200 0 1970/71 1980/81 Male
Source: DFES.
1990/91 Female
2000/01
Exhibit 47
Female Percentage of Tertiary Students United Kingdom 60% 55% 50% 45% 40% 35% 30%
Female Percentage of Tertiary Students

Germany France Italy Spain
1989 1998 1999 2000 2001 2002 2003
1989 1998 1999 2000 2001 2002 2003
1989 1998 1999 2000 2001 2002 2003
1989 1998 1999 2000 2001 2002 2003
Source: Eurostat.
Women are working more. Female employment rates have increased significantly in Europe in the past decade: relative female employment rates in the three major European economies Germany, the United Kingdom and France are now around 83-84%, virtually the same level as in the United States. Italy and Spain are still behind at around 64-65%, but are growing fast (see Exhibits 48 and 49). Women are making more money. Women are filling the gender pay gap across the major European economies. Womens gross annual relative salary in industry and services has grown by around 500 bp in the United Kingdom and Germany in the past five to 10 years, where it was at 66% and 73%, respectively. Over the same period the increase in France has only been 150 bp, but the starting point there was already 80% (see Exhibit 50). A similar picture emerges by analyzing the hourly-wage gap. Here again relative pay differentials for women are reducing, with Italy and France showing a narrower gap 6% and 12%, respectively while Germany and the United Kingdom stand around 22-23% (see Exhibit 51).
1989 1998 1999 2000 2001 2002 2003
37
Exhibit 48
90% 85% 80% 75% 70% 65% 60% 55% 50% 45% 40% United Kingdom
Women vs. Men: Relative Employment Rate (1992-2004)

1992
1994
1996
1998
2000
2002
2004
1992
1994
1996
1998
2000
2002
2004
1992
1994
1996
1998
2000
2002
2004
1992
1994
1996
1998
2000
2002
2004
1992
1994
1996
1998
2000
2000
2002
2002
Source: Eurostat and Bernstein analysis.
Exhibit 49
United Kingdom
Women vs. Men: Relative 1992-2004 Employment Rate Gap vs. the United States
40% 35% 30% 25% 20% 15% 10% 5% 0% (5)%
1992
1994
1996
1998
2000
2002
2004
1992
1994
1996
1998
2000
2002
2004
1992
1994
1996
1998
2000
2002
2004
1992
1994
1996
1998
2000
2002
2004
1992
1994
1996
1998
Source: Eurostat and Bernstein analysis.
2004
2004
38
Exhibit 50 Relative Female Gross Annual Earnings in Industry and Services

Female Gross Annual Earnings as a Percentage of Male Gross Annual Earnings 83% 81% 79% 77% 75% 73% 71% 69% 67% 65% 1995 France
Source: Eurostat.
Exhibit 51 Womens Pay Differential (Unadjusted Form) as a Percentage of Male Earnings

Gender Pay Differential (Gap as a Percentage of Male Earnings) 30% 25% 20% 15% 10% 5%
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
1997
1999
2001
2003
Germany
United Kingdom
United Kingdom
Source: Eurostat.
Germany
France
Italy
Women Want More
The consequence for the apparel and accessories industry brand marketers and retailers alike is that their most important customers are getting more affluent, more sophisticated and more demanding. In effect, this means: Women want increasingly up-to-date product. They will not settle for classics, they will not settle for yesterdays fashions given a choice at an affordable price for their own purse, they will go for the latest fashion and the latest trends. Women want to actively manage the way they look. Gone are the days when they would rely on designers or retailers total look. Today it is mix and match of brands, styles and price points. As consumers want the right, up-to-date stuff, range becomes a paramount purchase and loyalty driver for apparel retailers. Taking again the United Kingdom as an example, range is by far the most important loyalty driver, and it is increasing (see Exhibit 52). Unsurprisingly, range is much more important for women than for men: 69.2% of female respondents identify range as a key loyalty driver versus 61.3% of males. Range is relatively more important for wealthier and younger consumers (see Exhibit 53). As consumers want more, price is very important. In the United Kingdom, consumers identify price as the second-most-important loyalty driver for apparel retailers after range. Quality more and more taken for granted scores a declining importance. Similarly, price is an important disloyalty driver, especially for value players like Asda, Primark and Matalan (see Exhibit 54).
New Shopping Patterns
2004
39
Exhibit 52
70% Percentage of Loyal Mani Users Identifying Loyalty Driver 60% 50% 40% 30% 20% 10% 0%
Source: Verdict.
Drivers of Apparel Store Loyalty (2001-05)

Range Price Quality Convenience Service
Exhibit 53
Proportion of Consumers Citing Range as a Driver for Loyalty
Range as a Driver of Apparel Store Loyalty by Gender, Age and Socioeconomic Group (2001-05)
72% 70% 68% 66% 64% 62% 60% 58% 56%
65+
AB
15-24
25-34
35-44
45-54
55-64
Male
Female
Age Group
Source: Verdict.
Socioeconomic Group
Exhibit 54
Price as a Disloyalty Driver in the United Kingdom (2005)

Sector Average Bhs Bonmarche Burton Debenhams Dorothy Perkins George/Asda Littlewoods M&S Matalan New Look Next Primark Range 52.3% 39.2 64.9 55.4 56.8 63.9 52.0 53.2 56.9 47.5 61.7 63.6 39.0 Price 30.9% 35.7 17.5 28.3 21.7 35.6 56.3 31.2 16.6 56.8 36.3 32.5 52.7 Convenience 11.1% 9.1 8.4 8.9 19.4 6.2 15.2 10.1 2.9 20.7 14.5 9.5 Quality 10.6% 5.0 8.8 16.1 4.8 3.5 8.0 15.4 12.0 6.4 7.8 14.1 Service 1.9% 2.7 0.6
3.1 2.2 4.7
Note: Items in bold are above the sector average. Source: Verdict.
DE
C1
C2
40
As consumers become more independent in their search for the right items at the right price, store loyalty becomes volatile. Taking again the United Kingdom, the percentage of consumers who declare loyalty to their main store is relatively stable, and even slightly on the way up (see Exhibit 55). But consumer allegiance to a specific store is a different matter: consumer preferences are fluid and can ebb and surge significantly, even in the very short term. This is true for both value players and differentiated mass-fashion players alike (see Exhibit 56).
Exhibit 55 Proportion of Clothing Shoppers That Are Loyal to Their Main Store: United Kingdom
90% 85% 80% 75% 70% 65% 60% 55% 50% 2001
Source: Verdict.
Exhibit 56 Change in Loyalty by Retailer: United Kingdom (2004-05)

Dorothy Perkins New Look Burton Debenhams Bhs M&S Next George/Asda Littlewoods Bonmarche Matalan Primark (15) (10) (5) 0 5 10 15
2002
2003
2004
2005
Source: Verdict.
Percentage Point Change in Loyalty Rates Since Previous Year
The Younger, the More Difficult
These trends are accentuated when observed by age group, with younger consumers proving the most difficult and demanding of all. In the United Kingdom, for example, consumers in the 15-24 year-old bracket are the ones shopping around the most (see Exhibit 57). They use an average of 4.0-4.5 stores versus 3.5 for consumers 35-54 years old and 2.0-2.5 for consumers 65+ years old.
Exhibit 57
15-24 Years
5.0 4.5 No. of Stores Used 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
Shopping Around Behavior: United Kingdom (2001-05)

35-54 Years 65+ Years
2001
2002
2003
2004
2005
2001
2002
2003
2004
2005
2001
2002
2003
2004
Source: Verdict.
2005
41
Younger consumers are also less loyal. Consumers in the 15-24 age group declare a loyalty to their main store of 72-73% versus 76% for 35-54 year-olds and 80-82% for 65+ year-old consumers (see Exhibits 58 and 59).
Exhibit 58
15-24 Years
86% 84% 82% 80% 78% 76% 74% 72% 70% 68% 66% 64% People in the Age Group Who Are Loyal to Their Main Store
Store Loyalty: United Kingdom (2001-05)

35-54 Years 65+ Years
2001
2002
2003
2004
2005
2001
2002
2003
2004
2005
2001
2002
2003
2004
Source: Verdict.
Exhibit 59
Loyalty Rates Detail: United Kingdom (2005)

84% 82% 80% 78% 76% 74% 72% 70% 68% 66% 64% 15-24 25-34 35-44 45-54 55-64 65+
Age Group
Source: Verdict.
Younger consumers are the ones placing the most emphasis on range, though range stays very important across all consumer groups. Price sensitivity is highest for consumers in the 15-24 and 35-54 brackets, with those 65+ considering price far less important. Senior consumers rank convenience and service relatively more important (see Exhibit 60).
2005
42
Exhibit 60
Loyalty Drivers: United Kingdom (2005)

15-24 Age Group Rating Index 70.2 106.8 41.3 104.3 10.1 71.1 23.9 98.8 4.2 55.3 3.2 133.3 3.0 100.0 3.1 67.4 35-54 Age Group Rating Index 65.3 99.4 42.7 107.8 15.1 106.3 107.9 26.1 6.2 81.6 2.0 83.3 2.6 86.7 5.2 113.0 65+ Age Group Rating Index 64.5 98.2 31.2 78.8 16.3 114.8 22.6 93.4 12.6 165.8 2.5 104.2 2.8 93.3 4.5 97.8
Range Price Convenience Quality Service Layout Facilities Ambience Note: Index on all shoppers. Source: Verdict
Clothing is most important in terms of percentage of overall spend for people in the 15-24 year-old group, where it accounts for 13.3% of total spend; older consumers also spend a significant percentage on clothing, at 12.9% of their total basket. In absolute terms, though, it is the 35-54 year-old group who are the highest spenders, with 623/year/head, given their higher level of overall retail spend (see Exhibit 61). The importance of clothing for the younger consumers is confirmed by the higher shopping participation of this group: more than 80% of individuals in the group shop for clothes, versus 75-80% among 35-54 year-olds and 65-70% among 65+ year-olds (see Exhibit 62).
Exhibit 61
Average and Total Clothing Spend: United Kingdom (2004)

Clothing Spend/ Head 536 623 425 549 Total Spend/ Head 4,038 6,160 3,306 Clothing Spend/ Total Spend 13.3% 10.1% 12.9%
Age Group 0-14 15-24 25-34 35-54 55-64 65+ Average/Total
Pop (000) 10,487 7,003 8,302 16,108 8,532 13,401 63,833
Clothing Spend Million Pct 3,754 10,035 5,695 35,044 10.7% 28.6 16.3 55.6%
Exhibit 62
100% 90% People in the Age Group Shopping for Clothing 80% 70% 60% 50% 40% 30% 20% 10% 0%
Shopping Levels: United Kingdom (2001-05)

15-24 Years 35-54 Years 65+ Years
2001
2002
2003
2004
2005
2001
2002
2003
2004
2005
2001
2002
2003
2004
Source: Verdict.
2005
43
Implications
The future is bringing an increasingly difficult and more sophisticated Apparel & Footwear consumer. New formats and consumer evolution are feeding on themselves: mass-fashion retailers are teaching consumers to become uncompromising in wanting range freshness and adequacy, value retailers are teaching them to want more and more competitive prices for a given, taken-for-granted, quality level. As brand and product offers multiply, consumers become increasingly less loyal: shopping around is up; mixing and matching has become the norm both of different brands and different price points. On the bright side, women who represent the bulk of the A&F market are becoming more and more sophisticated, educated, employed and, ultimately, wealthier. As the A&F retail industry evolves across Europe, value clothing is going to box out a portion of the overall A&F market. The speed of this trend and the size of this portion will depend on the ability of the players in each national market and the discount propensity of consumers in that market. As we have seen with grocery discount penetration in the late 1980s and early 1990s, European markets have different value propensity: ranging from Italy at around 10% to Germany at well over 20%. Mass-fashion as it is driven mainly by international players is going to happen much faster in the markets where this trend has been lagging. Among the major European economies, we see a huge opportunity for mass-fashion penetration in Italy, where key players have so far just a toehold. In quantitative terms based on past correlation to nominal GDP, expected GDP growth and exchange rates for countries outside the euro area we expect the A&F market to grow at 1.4-1.5% in 2006 and 2007 (see Exhibit 63).
Exhibit 63
1991 55.7 57.2 31.7 37.6 24.0 9.1 7.2 5.7 7.2 5.9 3.9 2.9 2.8 1.3 252.2
Apparel & Footwear Market: EU 14 Absolute Retail Spend ( billion)

Actual 1996 54.3 58.0 36.5 38.9 22.1 10.0 7.9 7.3 7.5 5.2 4.8 3.7 2.4 1.9 260.5 0.6% CAGR 2001 63.9 62.2 56.0 41.7 25.4 11.2 8.5 8.4 7.7 6.0 5.5 4.3 2.7 2.6 306.1 3.3% 2005E 66.3 60.7 55.8 43.0 30.1 11.4 8.9 10.2 8.0 6.3 5.7 4.5 2.8 3.2 316.9 0.9% 2006E 66.7 60.8 56.8 43.6 31.1 11.6 9.0 10.6 8.1 6.3 5.7 4.6 2.8 3.3 321.2 1.4% 2007E 67.7 61.1 57.3 44.3 32.4 11.8 9.2 11.0 8.2 6.4 5.8 4.7 2.9 3.5 326.1 1.5% 1991-2001 1.4% 0.8 5.9 1.0 0.6 2.1 1.7 4.0 0.7 0.2 3.5 4.0 (0.4) 7.2 2.0% 2004-07E 0.8% 0.1 1.1 1.2 4.0 1.2 1.4 3.9 1.4 0.3 0.8 2.1 1.4 4.9 1.3%
Italy Germany United Kingdom France Spain Netherlands Belgium Greece Austria Sweden Portugal Denmark Finland Ireland EU 14 Growth
Source: OECD, Verdict and Bernstein analysis and estimates.
Value clothing seems to have played out its above-average growth contribution in the UK market. In fact, growth in the United Kingdom was more significantly above the EU average at the start of the value trend in 1991-96 than in 1996-2001 (see Exhibits 64 and 65). Further value growth will be at the expense of other segments.
44
Exhibit 64 Correlation of Apparel & Footwear Retail Spend to Nominal Growth for the EU 14 1996 vs. 1991
14% A&F Retail Spend Growth in Local Currency 12% 10% 8%
UK Ireland
Exhibit 65 Correlation of Apparel & Footwear Retail Spend to Nominal GDP Growth for the EU 14 2001 vs. 1996
7% A&F Retail Spend Growth in Local Currency
Ireland Greece
Greece
6% 5%
Sweden
4% 3% 2%
Germany Denmark Italy
6% 4% 2% 0% (2)% 0%
Italy Denmark Spain
Portugal
Spain Portugal Netherlands Finland Belgium France y = 0.360x + 0.010 R2 = 66%
UK
Belgium Sweden Netherlands France Austria Finland Germany
R2 = 86%
1% 0%
Austria
5%
10%
15%
0%
5%
10%
15%
20%
Nominal GDP Growth

Nominal GDP Growth

Given the current price levels, we expect mass-fashion penetration in Italy will not project overall market growth above the European average, as volume increases will be balanced by price realignments across the board. We expect Spain, of the five major EU economies, to grow at the fastest rate, while Germany continues to be the most difficult major market. Last, but not least, Apparel & Footwear has one of the most fragmented customer bases in Europe. A&F is fragmented even in countries that have the most sophisticated and consolidated retail industry (see Exhibit 66).
Exhibit 66
Combined Main Users Share of Top Five Retailers: United Kingdom (2005)
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
Grocery
DIY
Personal Care
Clothing
Consumer Electronics
Source: Verdict.
This indicates structurally low barriers to entry. As a consequence, we expect new legions of specialized brands to keep entering the market and fight for coolest status recognition, hot on the heels of incumbent differentiated players.
Homewares
Footwear
Music & Video
45
European A&F Retailers: A Darwinian Perspective

Overview We see two major dynamics playing out in the Apparel & Footwear retail industry. First is that new breeds of value competitors are building inroads into the A&F market. This results in significant A&F price deflation and a diminishing available market for traditional players. Second, massfashion retailers appear to be satisfying the increasing sophistication of consumer demand as it moves away from classic to requiring more up-todate products. The net result is that traditional A&F retailers risk being caught in between value and mass-fashion competitors, with both a cost and price disadvantage, as well as a product and brand disadvantage. In our view, the European A&F retailing sector is in disequilibrium. Lack of industry concentration is the highest of all specialty retailing categories: 50% of that in consumer electronics and 30% of that in grocery or home improvement. There are legions of independent retailers. Structurally different players share the competitive space, with highly different formats, capabilities and cost structures other sectors have much lower competition diversity, with single-breed category killers competing against hypermarkets. New entrants continue to access the market both from known directions i.e., new differentiated specialists focusing on the next generation of consumers, and unknown directions such as new grocery retailers focusing on value. As primitive structural competition dynamics play out, Apparel & Footwear retailing will not be the territory of stock mean-reversion, in our view. Here, structural losers do not mean-revert they go out of business. The Sock Shop was the last focused specialist to go into Chapter 11 in the United Kingdom in January 2006. Conversely, structural winners surge. A sector bet makes little sense. Restructuring and relaunch bets need to be well thought through versus overwhelming structural competitive dynamics. Betting on the winners requires careful consideration of the extent and sustainability of their profitability growth momentum. Many very different players compete in the apparel retailing arena, with highly different formats, business models, cost structures and growth strategies. In fact, understanding the apparel retailing industry requires first and foremost comprehending the channel and format dynamics which operate within. Apparel retailing is very old, with several of its formats and players as old as a century or more, if independent specialist retailers are taken into account. As such, the current competitive landscape is the result of successive competitive stratifications (see Exhibits 67 and 68).
Many Very Different Animals
46
Exhibit 67
Department Store 1900-50 Category Offer Broad Location High Street Sourcing National Product Classic Communication Example Printemps, M&S
Evolution of Apparel Retailing Formats Mass

Hypermarket 1960-70 Broad & Grocery Out-of-Town Overseas Basic Local, Price-Focused Carrefour, Wal-Mart Mass Basic 1970-80 Apparel High Street/Mall National & Overseas Denim/Fleece Print, Brand-Focused Benetton, The Gap Focused Specialist 1970-80 Apparel Subcategories High Street/Mall National & Overseas Subcategory-Focused Print, Brand-Focused Victorias Secret Mass Fashion 1980-90 Apparel & Accessories High Street/Mall Flexible Multisource Basic & Fashion Zara, H&M Discounter 1990-2000 Apparel & Accessories Neighborhood/Mall Flexible Multisource Basic & Fashion Primark, Target
Note: Time indicated represents significant introduction/development in Europe/United States. Source: Bernstein analysis.
Exhibit 68
Artisan Store 1700-1800 Category Offer Accessories/Apparel Price Very High Brand Monobrand Communication Low Example Lobb, Hrmes
Evolution of Apparel Retailing Formats Upscale

Haute Couture Atelier 1950 Apparel Very High Monobrand Low Coco Chanel, Christian Dior Designer Flagship Store 1970-80 Total Look High Monobrand Very High Accessory Specialist Flagship Store 1980-90 Broad High Monobrand Very High Tiered Diffusion Store 1980-90 Total Look Moderate Monobrand High AX, Emporio Armani, D&G Luxury Retrenched Department Store 1980-90 Broad Moderate Multibrand Low Printemps, Selfridges
Armani, Versace Gucci, Prada
Note: Time indicated represents significant introduction/development in Europe/United States. Source: Bernstein analysis.
The first discontinuity versus specialist independent retailers was brought about by department stores. As much as the department store format looks traditional today, the first department stores were an innovation. Stores were advertised as the largest on earth and their owners were among the most visible personalities of their era. The next major innovation on the mass-retailing side was the hypermarket. The hypermarket is similar to a department store but migrated to modern times: (1) it includes grocery for one-stop-shopping convenience; and (2) it is structurally built to be reached by car. High shopping traffic from grocery and multiple-category cross-selling, as well as a low cost structure from an out-of-town location makes the hypermarket a formidable predator format to this day. The 1960s set the stage for the casual revolution. The winning retailers of that era realized the opportunity to innovate by: (1) introducing denim, fleece, jersey; (2) developing highly standardized styles and cuts; and (3) associating their offers with highly-advertised brands. Mass-basic retailers like Benetton and The Gap built great businesses, with flexible store formats adapted to suit both the High Street and the shopping mall. Their Achilles heel, in our view, is having a style of their own with two major drawbacks: (1) basic enough to be credibly imitated by me-too players, as well as hypermarkets and discounters (piling up competitive pressure and driving down prices); and (2) too basic to stay relevant (and, again, command high enough prices) in our current fashion-conscious competitive world. In our view, mass-basic retailers have today neither the product appeal to command premium prices, nor the low cost structures and traffic synergies to win on basics their evolutionary niche seems to be shrinking by the day.
47
Focused specialists have taken a different approach, and tried to build subcategory specialization. Several subcategories have been singled out at the height of this trend, with varying levels of success. The difficulty here is to succeed in fencing off and defending ones turf. While a few players have been remarkably successful at that (e.g., Victorias Secret), most have failed and slipped into a similar condition as mass-basic retailers: having neither the product appeal to command premium prices, nor the low cost structures and traffic synergies to win on basics only this time, on a subcategory rather than on a full-product offer level. Mass-fashion retailers are, in a way, the antithesis of mass-basic retailers: (1) they strive to bring the most up-to-date trends to the market; and (2) they have no ambition to create a style of their own, but aim to capture the best and hottest the fashion world has to offer. One could say that keeping abreast of whatever fashion there is, is their meta style. Until very recently, hypermarkets have focused their apparel offers on very basic designs and low profile subcategories: e.g., underwear, hosiery, nightwear, childrenswear and basic sportswear. More recently, the best players in the most advanced markets have introduced a significant fashion twist to their offerings: e.g., Target, Asda, Tesco, etc. This hypermarket mutation into fashion discounters, in our view, promises to be a formidable force shaping the industry going forward. It is interesting to note that a fashion-discounter niche exists per se in markets where traditional (food plus nonfood) hypermarket development has been slower i.e., the United Kingdom (see Exhibit 69). Primark (and many others) are a living example of this breed.
Exhibit 69
16 14 Hypermarkets/Population (no. of stores/mil. pop.) 12 10 8 6 4 2 0 France
Hypermarkets: Development in Key European Economies
Germany
Spain
Northern Italy
United Kingdom
Southern Italy
Note: Hypermarkets larger than 5,000 square meters. Source: Verdict, Eurostat, Planet Retail, FAID and Bernstein analysis.
Two Major Genera
To simplify things, apparel retailers could be grouped into two major genera: Value retailers, including department stores, hypermarkets, mutated hypermarkets and discounters. Differentiated retailers, including mass-basic and mass-fashion retailers, upscale formats and independents. Market observation seems to confirm that this is a practical and acceptable simplification. For example, analysis of European markets shows that
48
department stores and hypermarkets compete for the same ground. Department-store chains maintain a meaningful presence in just four European countries: the United Kingdom, Germany, France and Spain (see Exhibit 70).
Exhibit 70
Department Store Sales by Country: EU 25, 2004 (percentage of total)

Country United Kingdom Germany Spain France Finland Netherlands Ireland Italy Sweden Denmark Belgium Austria Greece Portugal EU 15 Total New 10 EU 25 Total Sales 34.8% 23.6 17.8 8.8 2.9% 2.6 2.4 1.7 1.0 0.8 0.5 0.3 0.3 0.2 97.9% 2.1 100.0% Cumulative 34.8% 58.5 76.3 85.2 88.1% 90.7 93.1 94.8 95.8 96.6 97.1 97.4 97.7 97.9 GDP 16.6% 21.4 8.1 15.9 1.4% 4.7 1.4 13.1 2.7 1.9 2.8 2.3 1.6 1.4 95.4% 4.6 100.0% Cumulative 16.6% 38.0 46.1 62.0 63.5% 68.2 69.6 82.7 85.4 87.3 90.1 92.4 94.0 95.4
100.0%
100.0%
We find an inverse correlation exists between the penetration of hypermarkets in a country and department store sales per head of population in that same market: the higher the hypermarket penetration, the lower the department store sales (see Exhibit 71). A similar relationship albeit to a lesser, but still highly significant degree exists between hypermarket penetration and department-store-chain profitability in a market (see Exhibit 72).
Exhibit 71
400
Department Store Sales/Head
Size of Department Store Business in the Key Countries ( billion)

United Kingdom
R2 = 98.7%
350 300 250 200 150 100 50 0 0 2 4 6 8 10 12 14 16 18 No. of Hypermarkets/Million Population Germany France Spain
Source: Verdict, Eurostat, Planet Retail, FAID and Bernstein analysis.
49
Exhibit 72
8%
Profitability of Department Store Players in the Key Countries

United Kingdom
7% Department Store Operating Margin 6% 5% 4% 3% 2% 1% 0% 0 2 4 6 8 10 12 No. of Hypermarkets/Million Population 14 Germany Spain
R2 = 74.0%
France
16
18
Note: United Kingdom = average of M&S, Deb, JL, HoF; France = average of Printemps, GL; Spain = El Corte Ingls; and Germany = Kaufhof. Source: Verdict, Eurostat, Planet Retail, FAID and Bernstein analysis.
Likewise, it looks as if there is only so much space for a differentiated offer. It is remarkable to notice that the selling space per head of apparel and accessories retailers (multiples and independents) in all major European countries varies little (see Exhibit 73). The little variation is explained to a great extent by the higher/lower expenditure level in a particular country (see Exhibit 74).
Exhibit 73
250
Specialty Apparel Retailers (Independents and Multiples): Space Development
Specialty Apparel Retailers 2 (m /thousand pop.)
200
150
100
50
0 Lux S A I B GR UK DK E IRL F NL P D SF
50
Exhibit 74
250 Apparel & Accessories Specialty Retailers Selling Space 2 (m /thousand pop.)
Specialty Apparel & Accessories Retailers (Independents and Multiples): Space Development
Lux
200
150 P SF 50 E
S IRL F NL GR D
B DK
A UK
100
R2 = 65%
0 400
500
600
700
800
900
1,000
1,100
1,200
1,300
1,400
Apparel & Accessories Expenditure/Head (/year)

The realization that formats can be grouped into two major genera, and that newer formats have an evolutionary premium (i.e., appear stronger and can win in direct competition against older formats) allows us to draw a first-level conclusion about European market attractiveness for mass-apparel retailers. In our opinion, some markets most notably Italy are less different in demand nature, although less developed in apparel retail formats. In apparel retailing terms, Italy looks like the Madagascar of Europe, where antiquated organisms evolved and still dominate: a major opportunity for newer and nimbler formats (see Exhibit 75). In our view, high per capita A&F spend, plus high supply fragmentation, makes Italy one of the most attractive markets for modern retailers to enter.
Exhibit 75
Market Attractiveness for Apparel and Accessories Multiples Specialty Retailers

GR Higher Lux
Supply = Fragmentation of Apparel & Accessories Specialty Retailers (no. of stores/thousand pop.)
1.5 1.3 P 1.1 IRL 0.9 S 0.7 SF 0.5 Lower 0.3 400 500 600 700 800 900 1,000 1,100 1,200 1,300 1,400 E DK F D B UK A NL I
Demand = Apparel & Accessories Expenditure/Head (/year)

Note: Circled areas are proportional to country population. Source: Verdict, Eurostat and Bernstein analysis.
51
Most Recent Evolutionary Adaptation
Mass-fashion retailers Inditex and H&M in our coverage deserve a section of their own, because of the novelty and the unique business model they bring to the market. Mass-fashion retailers are uniquely adapted to live in symbiosis with upscale fashion. They take R&D from upscale fashion in the form of style, fabrics, color palettes, finishing process innovations, etc. and they perform a transmission belt function, helping upscale fashion to become more and more relevant for a larger and larger audience. This symbiosis is possible for two main reasons: the idiosyncratic calendar and way that upscale fashion works; and the mass availability of information within the fashion world. The upscale fashion calendar (see Exhibit 76) is dictated by fashion show deadlines. Traditionally, there are only two fashion shows per year: spring/summer and fall/winter, which happen just short of one year before the goods hit the stores i.e., one sees spring/summer fashion shows in Milan in July (men) and September (women) of year N, for collections that will be sold in store during the spring/summer season of year N+1.
Upscale Fashion Calendar
Exhibit 76
Increasingly Homeostatic Equilibrium of the Upscale Fashion System

Increasingly Complex and Expensive Collections Decreasing Opportunity of Introducing More Than Two Collections per Year
Increasing Competitive Pressure Between Fashion Brands
Decreasing Opportunity of Switching Away from Order-Based Production
Long Lead Times
More and More Extreme Research for New Fabrics, Styles, etc.
In the fashion designers world, fashion shows are the point of arrival i.e., to get there, designer teams normally start to work on the spring/summer styles and collection as soon as the fall/winter shows are over (more precisely, as soon as their holidays after the fall/winter show fatigue are over, i.e., at best in January and February of year N). Given the way designer teams work, starting the design phase in January and February is already too late for markets that require early delivery and precollections. What is relevant here is the huge amount of time between the moment new styles become public knowledge and the time garments are actually sold to the public in stores. To understand why this is so, we need to get a bit deeper into how upscale fashion works.
52
Fashion shows serve a commercial function: they have the purpose of luring customers to town and getting them to visit the showrooms where extensive collections are on display for these same customers to place orders. What is not to be missed is that the upscale fashion industry manufactures garments based on these secured orders: there is virtually no risktaking in terms of which specific items will sell. In our experience, the ratio between items in a collection and items ordered and produced is upward of 10 to 1. As competition among designer brands has increased over time, this ratio has constantly increased: fashion brands include more and more styles in their collections in the hope that buyers will be dazzled and will pick some of them for their stores. This means higher and higher R&D costs, and for our purpose increasing public availability of information about new styles and looks. In turn, factories need enough time to produce the garments, after the orders are collected, credit-screened and confirmed. This would not take three to six months were it not for the fabric availability problem: new collections are largely developed on new ad hoc fabrics; fabric manufacturers do not produce and do not keep these new fabrics in stock, as they can have no assurance as to whether the garments with these fabrics will sell or not and less and less so, as collection complexity increases; brand marketers will order fabrics more or less at the same time, as fashion shows and showroom campaigns happen in parallel. The net result is that fabric delivery time in the industry can be anywhere between 30 and 120 days hence the three to six months. Increasing competitive pressure among fashion brands contributes to stabilize a long-lead-time calendar (see Exhibit 77).
Exhibit 77
Year N January 30/1 (1) (3) (3) (3) (3) (3) (3) (3) (3) (3) 10/9 (3) 10/9 (3) 25-30/9 (3) February March 15/3 (2&3) (2) (2) (2) (1) (1) April May June July August September October November December January Year N+1 February
Best-in-Class Spring/Summer Prt--Porter Womens Collection Calendar (From Collection Briefing to Store Delivery) Typical Upscale Italian Fashion Brand
March
15/6 (3) 25/6 (2) Fashion Show
10/6 (1) 30/9 (2) (1) 15/6 (3) 25/6 (2) 10/6 (1) 10/6 (1) 10/6 (1) 1-30/7 (2) 1-30/7 (2) 1-30/7 (2) 15/7 (1)
1-30/7 (2) 1-30/7 (2) 1-30/7 (2) 15/7 (1)
1-20/10 (3)1 1-20/10 (3)1 1-20/10 (3)1
30/11 (3) (2)
(2) (2)
15/1 (3) (2&3)
(3) 15/2 (2&3)
15/3 (3) 20/3 (3)
30/9 (2) 20/9 (1) 20/9 (1)
(1) (1)
30/11 (3) (2) (2)
(2) (2)
15/1 (3) 15/1 (3)
(3) (3)
15/3 (3) 15/3 (3)
15/6 (3) 25/6 (2)3 10/6 (1)2 10/6 (1)2
1-30/7 (2)3 1-30/7 (2)3 15/7 (1)
30/9 (2) (1)
30/11 (3) (2) 1-30/7 (2)4 1-30/7 (2)4
(2)
15/1 (2&3)
(3)
15/3 (3)
15/6 (3) 30/9 (2) 30/1 1(3) (2) (2&3) 15/2 (2&3) 20/3 (3)
Collection Briefing Sketches (1) (2) (3) Fabric Selection (1) (3) (3) Fabric Orders for Sample Collection (1) (3) (3) Prototypes - 1st Designer Approval (2) (3) (2) (2)/(3) Prototypes - 2nd Designer Approval Milan Fashion Show Europe Ordine Tipo 20/4 (1&2) Sample Collection (Excl. Factory) 15/5 (1) Collection Showroom Sales Campaign Wholesale Orders 20/5 (1) Flagship Stores Orders Order Confirmations Flagship Stores Deliveries Wholesale Deliveries United States Base Order Definition 20/4 (1&2) 15/5 (1) Sample Collection (Excl. Factory) Showroom Sales Campaign 20/5 (1) Wholesale Orders 20/5 (1) Flagship Stores Orders 20/5 (1) Order Confirmations Flagship Stores Deliveries Wholesale Deliveries Japan Base Order Definition 20/4 (1&2) 15/5 (1)2 Sample Collection (Excl. Factory) Showroom Sales Campaign 20/5 (1)2 20/5 (1)2 Wholesale Orders Order Confirmations Wholesale Deliveries Asia 20/4 (1&2) Base Order Definition Showroom Sales Campaign Wholesale Orders Order Confirmations Wholesale Deliveries Note: (1) = Cruise Collection, Women Sold in the United States, Japan and worldwide monobrand stores (2) = Pre-Collection, Women (3) = Fashion Show Collection, Women
1 = All worldwide clients in Milan 2 = Collection in Tokyo transferred from Milan; or Japanese distributor places orders in Milan 3 = Collection in Tokyo transferred from New York 4 = Asian clients in Milan.
53
54
Mass-Availability of Information Add to this the universal availability of information about the new collections, and the opportunity for mass-fashion retailers is staged. Not only is it fairly easy for anyone interested to attend fashion shows and visit showrooms, but specialized magazines and Internet services give all of the imaginable details one desires. Even nonprofessional general public sources provide an incredible wealth of information. Mass-fashion retailers recipe for success lies on three pillars, in our view: Focus the product team on picking up and adapting what is already available in the fashion world rather than create unique styles. Produce collections based on in-stock standard fabrics immediately available for delivery from manufacturers; get what is left of unsold new fabrics. Create a continuous stream of new products hitting the stores as new items become available, factoring in sales-results feedback. Despite the fact that mass-fashion retailers start to merchandise their collections after upscale fashion shows are over, their reliance on available fabrics and their choice to have continuous snippet collections, allows them to have plenty of time to hit the stores on time, and to learn what sells and what does not. The competitive advantage of this adaptation is enormous: Order-of-magnitude faster operations, even without downstream integration; Constant store freshness and appeal, from continuing new product arrivals; Activity smoothed-out across all departments, eliminating the peak/trough activity schedule typical of season-driven fashion; and Cost compression: design, product and collection development, peak/ trough manufacturing premiums, unsold obsolete stock, etc. Competitive Dynamics So far we have implicitly used a descriptive definition of formats, relying on where stores are located, and what can be found in them (see Exhibit 78).
Exhibit 78
Location
Descriptive Characteristics of Apparel & Footwear Retail Formats

High Street Broad/ Multi-Category Basic High Street & Out-of-Town Apparel/ Multi-Category Classic Out-of-Town Apparel/ Subcategory Fashion
Category
Product
Price
Discount Department Store
Average
Premium Fashion Discounter
55
Using a descriptive framework gets us just so far; current players are rarely pure species individuals but more often than not inbetween formats or hybrids which are in constant evolution. Next, for example, has moved most of its stores away from the High Street and into shopping centers, doubling their size and adding nonapparel categories. What format was it? What is it now? Marks & Spencer has long ago focused on a select number of categories does it make sense to still consider it a department store? What has it become? Primark is moving to the High Street and will open one of the largest stores on Oxford Street in central London, just opposite one of the M&S flagship stores. In order to move forward we need to investigate Apparel & Footwear retailers nature beyond pure description. Our observation of the UK competitive situation indicates two to three Apparel & Footwear retailing competitive arenas: A discount arena, where Apparel & Footwear discounters as well as grocery retailers compete here we find companies like Primark, Asda, Tesco and Matalan. A middle ground arena, where international and national mass-fashion retailers operate here we find companies like New Look, H&M and Bhs. A premium arena, where department stores as well as international and national mass-fashion retailers concentrate here we find companies like Next, Zara, Top Shop, M&S and Debenhams. One Can Find Winners and Losers in Each Arena A primary driver of success seems to be pricing, as lower-priced players in each arena seem to get better-than-average sales/square meter and sales/employee results (see Exhibits 79 and 80). So is the case, for example, in the premium segment, where Next has been constantly gaining share in the past 10 years, and where it enjoys significantly better-than-average sales/square meter. A similar observation works in general to the middle ground and discount arenas, where the most price-aggressive players Primark, Asda and Tesco outperform more moderately positioned players in sales/square meter and sales/employee. Interestingly, competitive pressure introduced by new winning value players like Asda, Primark, Tesco is not felt only on a systemic level through general price deflation, but most intensely by less apt directvalue competitors, as Matalans position (see Exhibit 79) and its disappointing results history and downward trajectory demonstrate. This is relatively good news for differentiated players, as it would seem to indicate that a self-contained discount competitive arena exists, whose boundaries are not expandable at will.
56
Exhibit 79
30 25 20 15 10 Primark Discount Tesco
Premium vs. Discount Position Staff

R2 = 43%
Asda Middle Ground H&M
Items/FTE/Year (000)
Premium
Zara New Look Matalan Bhs Debenhams Next M&S
K / FTE Top Shop 150 K 100 K 50 K 14
5 0 4 5 6 7 8 9 10 11 12 13 Average Price/Item ()
Note: Companies plotted represent approximately 40% of the UK Apparel & Footwear market. Source: TNS, Verdict and Bernstein estimates and analysis.
Exhibit 80
1,200 1,000 800 Items/m /Year 600 400 Matalan 200 0 (200) 4 5 6
Premium vs. Discount Position Revenue

Discount Asda Primark Tesco Middle Ground New Look H&M Bhs Zara M&S Debenhams Top Shop Premium
R2 = 89%
2
R2 = 53%
K/m Next
6 5 4 3 2
8 9 10 Average Price/Item ()
11
12
13
14
Note: Companies plotted represent approximately 40% of the UK Apparel & Footwear market. Circles are proportional to company sales. Source: TNS, Verdict and Bernstein estimates and analysis.
Analysis of players consumer profiles confirms that discounters appeal to a universal public, as they penetrate at equal levels across different age groups. Premium players seem to have a much more polarized consumer focus. On the one hand, players like Marks & Spencer and Bhs appeal to older-thanaverage consumers; on the other, mass-fashion retailers are disproportionately appealing to younger-than-average shoppers (see Exhibit 81). Discounters have an average main user between 40 and 45 years old, while M&S and Bhs users are 55 years old; New Look and Next are 30 and 35 years old, respectively.
57
Exhibit 81
190% Age Segment Polarization 170% 150% 130% 110% 90% 70% 50% 25 30 New Look
Consumer Base Profile for Key Players in the UK Apparel & Footwear Market
YoungerFocused Next Bhs SeniorFocused M&S
Universal Players Matalan Debenhams Asda 45 50 55

R2 = 76%
Primark
35
40
60
Average Age of Main Users
Note: Polarization = standard deviation (main users percentage by age group)/average (main users percentage by age group). Source: Verdict and Bernstein analysis.
Furthermore, discounters like Asda and Primark are continuing to maintain the same average age in their customer base when observed in 2005 versus 2001 (with Primark even moving upstream to a younger average consumer). Premium players like Next and Marks & Spencer are undergoing a significant age drift in their customer base, as if they were not capturing a large enough younger shopper population so as to rejuvenate their customer base (see Exhibit 82).
Exhibit 82
190% Age Segment Polarization 170% 150% 130% 110% 90% 70% 50% 25 30
Age Drift Effect 2005 vs. 2001

YoungerFocused Next SeniorFocused
M&S
Universal Players Primark
Asda 45 50 55
R2 = 76%
35
40
60
Average Age of Main Users

Note: Polarization = standard deviation (main users percentage by age group)/average (main users percentage by age group); diamond indicates 2005 position, line shows 2001 vs. 2005 gap. Source: TNS, Verdict and Bernstein analysis.
This age drift effect is consistent with our wider observation and experience of the Apparel & Footwear market, as well as with a variety of creativity-focused businesses. Designers and artists, in general, all have a
58
distinct style specific to themselves (a Missoni pullover is a Missoni pullover, a Sting song is a Sting song, a Woody Allen film is a Woody Allen film, etc.). Apparel brands capture at one point the Zeitgeist and surge to success. Their distinct style is both the origin of their success and the root cause of their later downfall, in our view: pushing the fast-forward button, what captures the Zeitgeist at one moment becomes irrelevant the next. If the only entry barrier to apparel retailing were design and product creativity, this would be an even more turbulent industry. In principle, we see entry barriers in Apparel & Footwear retailing being raised higher, as players in the industry have developed a whole set of new capabilities. Mass-fashion international retailers, for example, can: maintain a multipoint global sourcing/logistics organization, differentiating by product/cost/delivery lead time; propose meta style collections, avoiding the risk of having their own designer team drifting out of fashion; and open and maintain a vast number of stores per day in multiple locations across the globe. Organizationally, the A&F retailers have become more sophisticated, and as such are harder to imitate. This contrasts to the organizational structure of recent years, where a buying office in Hong Kong could have been seen as a key differentiator. Nevertheless, we see two reasons why entry barriers will stay relatively low, leaving an open space for new entrants to be the new cool. Apparel retailing is a lot about coming up with the cool product, as we found out in the first chapter. As a retailer, the premium you get in sales/square meter by having that cool far outweighs most cost, capability and scale disadvantages you might have. Retailer brands take on an identity of their own, and grow old with their customer base. As retailer brands are successful and grow, they become more middle-of-the-road and by definition they move from minority to majority. This alone takes away their contrarian appeal, opening new spaces for younger and less-established competitors. The more middle-of-the-road the format (in terms of product, cost structure, capabilities required, etc.), the more likely the competitive niche will be occupied internationally by either local incumbents or quicker international players the less likely the retailer will be able to profitably grow internationally. In fact ceteris paribus incumbents will always win over new entrants in this middle-of-the-road area, as they are more meaningful for the local consumer base. This has been extensively the case for the companies in our coverage: Marks & Spencer and Next have poor histories in direct international expansion, contrasting with H&M and Inditex, which have successful track records. Summing it all up, the most important feature in the A&F retailing competitive space is new entrants (see Exhibit 83).
59
Exhibit 83
Apparel & Footwear Retailing Market Schematic
Mass-Fashion Retailers
New Cool Brands
Price
Incumbents
Consumer Age
Discounters
As we have seen, Apparel & Footwear retailing is both one of the most competitively diverse and most fragmented sectors in specialty retailing. This will mean that structural competitive dynamics will more than likely continue to be one of the most turbulent in the retail industry. The interaction between incumbent players and competitively advantaged new entrants promises to be one of the most compelling competitive dramas in the larger consumer goods and retail industry.
Oblivion
60
European A&F Retailers: Valuation

Overview Investing in discretionary retailers requires a stock-picking exercise, not a sector call. It is one of the most heterogeneous sectors in the MSCI, with standard deviation of stock price performance at 74.8% for 2001-05, the third-highest of the MSCI sectors. Long-term earnings-growth expectations seem the key driver of price appreciation. Relative price-to-forward earnings ratio shows a high correlation to long-term earnings-growth expectations: 96% R-squared for 1996-2000, 70% R-squared for 2001-05. Short-term expectations and earnings revisions are of disproportionately higher importance for growth stocks like H&M and Inditex, where earnings misses and positive surprises show the highest impact. The market clearly identifies different animal species akin to those identified in the section European A&F Retailers: A Darwinian Perspective, in the discretionary retail space. Companies with competitively advantaged and disruptively innovative formats like Inditex and H&M have consistently enjoyed significantly higher multiples, as well as the most severe compression and expansion excursions. So too has PPR, but more in connection to its continuing metamorphosis into a high-fashion and luxuryfocused company. The market seems to seek a relaunch story from venerable players like Marks & Spencer, with multiples swinging significantly, following investor sentiment versus future prospects. Interest rates have been inversely correlated to retailers relative price performance in the past 10 years. The somewhat anomalous observation that the retail index has been performing strongly in a period of monetary tightening of late may suggest market anticipation that the tightening cycle is approaching its peak. A degree of caution to the sector seems nevertheless advisable, especially since apparel and footwear consumer spend is highly influenced by GDP growth. Specialty retailing is one of the least coherent sectors of all. The five Apparel & Footwear companies in our coverage have had a relative averagestock-price performance of +40% in the five years between 1995 and 2000, and +45% in the five years between 2001 and 2005. Standard deviation has been 129% and 72%, respectively (see Exhibit 84). Putting this into context, we note that the dispersion of relative stock price performance of apparel retailers is one of the highest of all MSCI sectors (see Exhibit 85). In fact, discretionary retailers (MSCI definition), are the third-most-dispersed sector, after consumer services and hardware technology and equipment. By comparison, grocery retailers (staples retailers in the MSCI definition) have approximately half the dispersion of specialty retailers.
A Disparate Sector
BERNSTEIN RESEARCH
61
Exhibit 84
300% 250% 200% 150% 100% 50% 0% (50)% (100)% (150)% H&M 122% 232%
Relative Stock Performance (vs. MSCI Europe)
172% 143% 113% 39%
(12)% (54)% (82)% Inditex Next 1995-2000 2001-05

2001-05 73% 72
PPR
M&S
Group Average Group Standard Deviation Source: FactSet and Bernstein analysis.
1995-2000 78% 129
Exhibit 85
Dispersion of Stock Price Performance Across MSCI Sectors (2001-05)

MSCI Europe Sector Consumer Discretionary Consumer Services Information Technology Technology HW & Equipment Consumer Discretionary Retailers Consumer Staples Beverage & Tobacco Industrial Transportation Materials Financial Real Estate Consumer Staples Household & Personal Products Industrial Capital Goods Consumer Discretionary Consumer Durables & Apparel Consumer Discretionary Automobiles & Components Health Healthcare Equipment & Services Health Pharmaceuticals & Biotechnology Energy Consumer Staples Retailing Financial Diversified Financial Services Information Technology Software & Services Financial Banks Utilities Industrial Commercial Services & Supplies Consumer Discretionary Media Telecommunications Financial Insurance Information Technology Semiconductors & Semi. Equip. Average Five-Year Price Change 82.7 (19.4) 20.8 68.7 67.9 48.1 111.6 34.2 0.9 (0.3) 27.4 67.0 15.1 18.2 (7.8) (0.2) (45.5) 10.4 6.7 (28.7) (38.5) (63.1) (53.0) (74.3) Standard Deviation 176.9 77.2 74.8 74.1 66.5 58.2 54.9 54.8 54.7 53.0 47.7 47.0 39.1 39.1 38.7 36.5 34.5 29.6 28.3 26.9 26.1 17.3 15.6 15.1
Note: The analysis includes the top eight companies for each sector by market capitalization; it does not consider the companies without a full five-year track history. Source: FactSet and Bernstein analysis.
62
Sector Valuation Drivers
Despite huge diversity within the sector, two basic drivers seem to consistently impact company valuations in the sector as a whole: change in interest rates; and growth expectations. Observations of interest rates and relative price performance over the 10year period between 1995 and 2005 indicate an inverse correlation between the level of interest rates and the relative price performance of European retailers (see Exhibit 86). Discretionary retailers show relative price behavior versus interest-rate movements similar to the Europe Retailing Index as a whole, although in periods of falling interest rates discretionary retailers have outperformed; in the short period of policy-tightening, discretionary retailers performed in line with the MSCI Europe Retail Index. We feel it is the relative performance of the wider sector compared to the interest-rate environment that is particularly helpful to view (see Exhibit 87). What we note from this chart is that the inverse relationship only really began at the start of the tightening cycle in mid-1999, which drove retailer underperformance yet further. As monetary tightening reached its peak, the recent sustained outperformance of the sector names began, as illustrated in Exhibit 84.
Driver 1 Change in Interest Rates
Exhibit 86 MSCI European Retailing Index vs. 1-Month Euribor (1995-2005)

Relative Price Performance 120% 110% 100% 90% 80% 70% 60% 50% Jun-95 Mar-96 Dec-96 Sep-97 Jun-98 Mar-99 Dec-99 Sep-00 Jun-01 Mar-02 Dec-02 Sep-03 Jun-04 Mar-05 Dec-05 7% 1-Month Euribor 6% 5% 4% 3% 2% 1% 0%
Exhibit 87 MSCI Europe Retailing Index Relative Performance vs. 1-Month Euribor (1995-2005)
1.2 Relative Closing Price 1.1 1.0 0.9 0.8 0.7 0.6 0.5 Jun-95 Mar-96 Dec-96 Sep-97 Jun-98 Mar-99 Dec-99 Sep-00 Jun-01 Mar-02 Dec-02 Sep-03 Jun-04 Mar-05 Dec-05 7% 6% 5% 4% 3% 2% 1% 0% 1-Month Euribor
MSCI European Retailing Index Discretionary Retailers 1-Month Euribor

Note: ECU rate from June 1995 to December 1998. Source: FactSet, Eurostat and Bernstein analysis.
MSCI Europe Retailing Relative 1-Month Euribor
Source: FactSet, Eurostat and Bernstein analysis.
63
We would also note that the outperformance from mid-2003 seems to have been driven by an expanding relative price-to-forward earnings, as shown in Exhibit 88.
Exhibit 88
Relative Price to Forward Earnings
Coverage Retailers: Relative NTM P/E vs. MSCI Index and 1-Month Euribor
7% 6% 5% 4% 1-Month Euribor
1.6x
1.4x
1.2x 3% 1.0x 2% 1% 0.8x Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 0%
Relative Price-to-Forward Earnings

Source: FactSet and Bernstein analysis.
1-Month Euribor
The perhaps anomalous observation is that the retail index has been putting in stronger performance and has been expanding the relative P/E in a period of monetary tightening (see Exhibits 87 and 88). For now we perceive this as anticipation by the market that the current tightening cycle is already approaching its peak, although we are keeping this move under observation. Driver 2 Earnings Expectations Observations of discretionary retailers P/E ratios over the past 15 years indicate a direct correlation with long-term growth expectations (see Exhibits 8991), where we have looked back historically at consensus medium-term EPS growth expectations1 as a driver of price-to-forward earnings. We believe the low correlation found in the early years (see Exhibit 89) is attributable to the thin consensus figures which are available in the data set. In addition, stockprice growth and EPS growth have been directly correlated in the past 10 years (see Exhibits 92 and 93).
1 We have taken historical consensus estimates back to 1991 for current fiscal year (FY1), and fiscal year two years after that (FY3). The medium-term growth rate is the compound annual growth rate between these two.
64
Exhibit 89 Discretionary Retailers: I/B/E/S Growth Forecast vs. Relative Price-to-Forward Earnings (1991-95)
Relative Price-to-Forward Earnings 250% 225% 200% 175% 150% 125% 100% 75% 50% 5% 7% 9% 11% 13% 15% 17% Next M&S PPR H&M R = 5%
2
Exhibit 90 Discretionary Retailers: I/B/E/S Growth Forecast vs. Relative Price-to-Forward Earnings (1996-2000)
Relative Price-to-Forward Earnings 250% 225% H&M 200% 175% 150% 125% 100% 75% 50% 5% 10% 15% I/B/E/S Growth
Source: FactSet, I/B/E/S and Bernstein analysis.
R = 96%
PPR M&S Next
20%
25%
I/B/E/S Growth
Exhibit 91
Discretionary Retailers: I/B/E/S Growth Forecast vs. Relative Price-to-Forward Earnings (2001-05)
Relative Price-to-Forward Earnings 250% 225% 200% 175% 150% 125% 100% 75% 50% 5% 10% 15% I/B/E/S Growth
R = 70%
H&M Inditex PPR M&S
Next
20%
25%
65
Exhibit 92 Apparel Retailers: EPS vs. Price Growth (1995-2000)

100% H&M 80% PPR
Price CAGR
Exhibit 93 Apparel Retailers: EPS vs. Price Growth (2001-05)

40% 30% 20% Price CAGR 10% 0% Inditex M&S H&M Next
R = 85%
60% 40% 20% Next 0% M&S (20)% (40)% (40)%
(10)% (20)% PPR (30)% R = 74%

0% 10% 20% 30% 40%
2
(20)%
0%
20%
EPS CAGR
40%
60%
80%
(40)%
(40)% (30)% (20)% (10)%
EPS CAGR
Source: Source: FactSet and Bernstein analysis.
It is long-term EPS growth expectations that seem to drive price-toforward earnings. While we have seen there is a strong relationship between the long-term EPS growth rate expected by consensus and the relative price-to-forward earnings ratio, the consensus growth rate for the current fiscal year does not provide as strong a link (see Exhibit 94). For the growth stocks in our coverage (i.e., Inditex and H&M, where over the last 10 years the historical short-term growth expectation is similar to the long-term consensus prospects) the strength of the relationship between earnings growth expectations and relative price-to-forward earnings is highest (see Exhibits 95 and 96). The rapid growth forecast for H&M and Inditex (following its flotation in May 2001), plus the strong growth at PPR through the latter half of the 1990s, have served to polarize our stock universe. In fact, H&Ms P/E of 45x and PPRs P/E of 30x in the 1995-2000 period, as well as H&Ms P/E of 30x and Inditexs P/E of 27.5x in the 2001-05 period, are high enough to significantly impact the weighted-average P/E ratio for the sector (see Exhibit 97).
66
Exhibit 94 Current-Year Consensus EPS Growth Rate vs. Price-to-Forward Earnings

24x H&M 22x Price-to-Forward Earnings 20x 18x 16x 14x Next 12x 10x 8x 0% 5% 10% 15% 20% 25% 30% Current-Year Consensus EPS Growth Rate
Note: Updated @ 5/20/2006. Source: FactSet, Bloomberg L.P. and Bernstein analysis and estimates.
Exhibit 95 Inditex: Historical Strength of Linkage Between Near-Term Earnings Growth and Relative Price-to-Forward Earnings
Relative Price-to-Forward Earnings
R = 38% Inditex
2.5x
R = 43%
2.0x
M&S
PPR
1.5x
Linear (Consensus)
1.0x
0.5x 0% 10% 20% 30% 40%
Current-Fiscal-Year Consensus Growth Rate
Source: FactSet, Bloomberg L.P. and Bernstein analysis.
Exhibit 96
Relative Price-to-Forward Earnings 3.5x 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x (20)%
H&M: Historical Strength of Linkage Between Near-Term Earnings Growth and Relative Price-to-Forward Earnings
R = 25%
2
(10)%
0%
10%
20%
30%
40%
50%
Current-Fiscal-Year Consensus Growth Rate

Source: FactSet, Bloomberg L.P. and Bernstein analysis.
Exhibit 97
Discretionary Retailers: Absolute P/Es (1991-2005)

1991-95 29.4x na 16.6 18.1x 19.1 P/E 1996-2000 44.6x na 29.7 19.3x 18.1 2001-05 30.5x 27.6 16.7 17.5x 14.8 Average 1991-2005 34.8x 27.6 21.0 18.3x 17.4 Standard Deviation 6.9x 7.1 6.1 0.7x 1.8
H&M Inditex PPR M&S Next
67
The majority of other discretionary retailers P/E ratios remain in the 15x to 20x band across the past 15 years. It remains a fact, though, that average relative P/E for the group has marginally contracted, if 2001-05 is compared against the 1996-2000 period (see Exhibit 98).
Exhibit 98
Coverage: Relative NTM P/E

H&M Inditex PPR M&S Next MSCI DRI 10-Year Average NTM P/E 1.55x 1.33 1.00 0.85 0.78 1.32x Standard Deviation 0.44x 0.35 0.29 0.22 0.22 0.31x 2005 NTM P/E 1.33x 1.15 0.78 0.72 0.72 1.20x
Valuation Framework Price-to-Forward Earnings
Based on our analysis, we have formed a price-to-forward earnings rationale with which to value the stocks in our coverage, and to arrive at target prices and relative recommendations. We take our long-term earnings estimates for the stocks; then, based on our estimated target earnings growth rate, we apply a multiple to the MSCI Europe Index price-to-forward earnings; and use this modified price-to-forward earnings multiple to value our forecast EPS and formulate our price targets. A summary of this valuation is presented below in Exhibit 99.
Exhibit 99
Prices at 11/3/06
Coverage Universe Split by Segment

Historical RP/FE (Min.) Mean (Max.) 60% 115 184 106% 153 232 61% 153 309 48% 101 257 67% 108 149
Stock MSCI PPR
Market 1,442.4 116.30
Price Target 110.00 Consensus 29.50 Consensus SEK180 Consensus 1,740p Consensus 425p Consensus
EPS Delta (5)% 2006 104.35 5.61 5.37 1.54 1.55 2007E 113.28 7.17 6.61 1.88 1.79 SEK14.0 14.4 146.5p 154.5 36.6p 42.0
P/FE 2006 2007E 13.8x 20.7x 21.7 24.3x 24.2 24.8x 24.3 13.3x 13.4 17.9x 17.2 12.7x 16.2x 17.6 19.9x 20.9 22.0x 21.3 12.8x 12.1 18.0x 15.6
P/E vs. MSDLE15 2006 2007E 150% 157 176% 175 180% 176 96% 97 129% 124 127% 138 156% 164 173% 168 100% 95 141% 123
Target EPS CAGR RP/06E 2000-05 2006E-10E Rating 150% (7)% 20% O
Inditex
37.40
(21)%
150%
25%
20%
H&M
SEK308
(41)% SEK12.4 12.7 (7)% 140.5p 139.7 36.7p 38.2
140%
29%
12%
Next
1,870p
100%
22%
7%
M&S
657p
(35)%
100%
13%
(5)%
Sources: Bloomberg L.P., I/B/E/S and Bernstein analysis.
As we are using our current-fiscal-year EPS in our target price calculations, our target prices actually represent the stocks current fair price, rather than the target price in 12 months. Below we summarize the rationale for each of the Apparel & Footwear retailers in our coverage.
68
The British Apparel Couple: The M&S Conundrum
The Marks & Spencer relative forward P/E has undergone a progressive downward trend in the past 15 years (see Exhibit 100).
Exhibit 100
1.6x 1.4x Relative Forward P/E 1.2x 1.0x 0.8x 0.6x 0.4x Jan-90 Jan-91 Jan-92 Jan-93
Marks & Spencer: Relative Forward P/E
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
30% 25% 20% 15% 10% 5% 0%
We are now right in the middle of a rerating, following a pattern similar to that which began in late 2000, albeit with the added complexity of the Philip Green bid impact in 2004 (see Exhibit 101).
Exhibit 101
1.6x 1.4x Relative Forward P/E 1.2x 1.0x 0.8x 0.6x 0.4x 0.2x 0.0x
Marks & Spencer: Near-Term Growth Expectations vs. Relative Forward P/E
Jan-90 Jul-90 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98
Relative Forward P/E

Then and again now, the market has bought a relaunch story. We all know how disappointing the developments after 2001 were. And we can see how sharply the market has stepped back from its previous enthusiasm thereafter. As much as we like what the current M&S management team is doing, we see no structural reason either in consumer demand or in the competitive environment why a new rerating should be sustainable this time round. We consider the current P/E level a temporary overcorrection, and we expect the P/E in time to resume the long-term downward trend.
Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06
Growth Expectations
Growth Expectations
Jan-06
69
The recovery which began in late 2000 led to near-term earnings growth expectations reaching over 20% that ultimately proved to be too high a target, as the company recovered from its earnings trough in the year to March 2001. We continue to view few fundamental reasons to support a relative P/E above the long-term average. In addition, we expect coming earnings announcements (over the next 12-18 months) to fall short of todays consensus expectations (which in our view remain high) and cause downward pressure on the price-to-forward earnings multiple. Our views on the relative prospects for M&S and Next are built from our in-depth analysis of these two companies and their relative position in the British Apparel & Footwear market. We are convinced that earningsgrowth potential at Next is superior to that at M&S, which seems to be a contrary view to the wider market. Our expectations of earnings progression at Next are in line with consensus, and we view the stock as fairly valued near its long-term average relative price-to-forward earnings of roughly1.0x (see Exhibit 102).
Exhibit 102
2.8x 2.6x 2.4x 2.2x 2.0x 1.8x 1.6x 1.4x 1.2x 1.0x 0.8x 0.6x 0.4x 0.2x 0.0x Jul-90 Jul-91 Jul-92 Jul-93
Next: Growth Expectations vs. Relative Forward P/E

18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Jul-94 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Growth Expectations
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05

Growth Expectations
The International Couple: Inditex or H&M?
Inditex and H&M have enjoyed the highest relative P/Es among European specialty retailers in the past 10 years (see Exhibits 103 and 104) quite understandably, given their profitability growth track record: take H&M as the example with the longest documented earnings history, given its less recent IPO (see Exhibit 105). Relative P/Es have declined to significantly lower levels in the past five years and more recently have taken a downward trend as earnings momentum and expectations have become more subdued. In our view, the market takes an overly pessimistic view as to what Inditex can achieve, noting that the rolling near-term earnings CAGR expectation has just about halved in the last 18 months to a level below that of H&M (see Exhibit 106). We actually believe Inditex has the potential to grow its earnings at a higher pace than H&M, and argue in our valuation for a higher price-to-forward earnings for Inditex than for H&M.
Jan-06
Jul-06
70
Exhibit 103
3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x
H&M: Relative Forward P/E vs. MSCI Discretionary Retailers
MSCI Europe
MSCI European Discretionary Retailers
May-98
Exhibit 104
3.0x 2.5x
Inditex: Relative Forward P/E vs. MSCI Discretionary Retailers
MSCI Europe 2.0x 1.5x 1.0x MSCI European Discretionary Retailers 0.5x 0.0x May-98 May-05 Growth Expectations Nov-01 Mar-97 Aug-96 Sep-00 Aug-03 Mar-04 Oct-97 Apr-01 Feb-00 Jun-95 Jan-96 Jun-02 Dec-98 Jan-03 Oct-04 35% 30% 25% 20% 15% 10% 5% 0% Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jul-90 Jul-91 Jul-92 Jul-93 Jul-94 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-99
Exhibit 105
3.5x Relative Forward P/E 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x
H&M: Near-Term Growth Expectations vs. Relative Forward P/E

Growth Expectations
May-05
Nov-01
Aug-96
Sep-00
Aug-03
Mar-97
Apr-01
Jul-99
Mar-04
Oct-97
Jun-95
Jan-96
Jun-02
Dec-98
Feb-00
Jan-03
Oct-04
71
Exhibit 106
4.5x 4.0x Relative Forward P/E 3.5x 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x Jul-90 Jul-91 Jul-92 Jul-93
Inditex: Near-Term Growth Expectations vs. Relative Forward P/E

25% 20% 15% 10% 5% 0% Jul-94 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Growth Expectations
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05

Growth Expectations
We note that for our growth stocks (illustrated here with H&M), priceto-forward earnings multiple compression and expansion appears linked to earnings revisions (see Exhibit 107). There has also been a relatively strong correlation (R-squared of 50%) between earnings revisions for the current year (on a three-month rolling basis) and the relative price-to-forward earnings multiple (see Exhibit 108). This makes short-term earnings performance particularly relevant for these stocks.
Exhibit 107
3.5x Relative Forward P/E 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x
H&M: Year-Over-Year Earnings Growth (Quarterly and Yearly) and Relative Forward P/E
3% 2% 1% 0% (1)% (2)% (3)% (4)% (5)% Current-Year Earnings Revision (Month-Over-Month) 4%
Jan-90 Jul-90 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94
Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Relative Forward P/E Current-Year Earnings Revision
Jan-06
Jul-06
72
Exhibit 108
H&M: Year-Over-Year Earnings Growth (Quarterly and Yearly) and Relative Forward P/E Correlation of Three-Month-Rolling Average Earnings Revisions and Relative Price-to-Forward Earnings
2.0x Price-to-Forward Earnings Relative to MSCI Europe 1.8x 1.6x 1.4x 1.2x 1.0x 0.8x (1.5)%
2
R = 51%
(1.0)%
(0.5)%
0.0%
0.5%
1.0%
1.5%
2.0%
Current-Year Earnings Revision

Despite its shorter public market history, Inditex has also exhibited a relatively strong correlation between earnings revisions and its relative price-to-forward earnings multiple (see Exhibits 109 and 110), with an Rsquared of 27%.
Exhibit 109
2.5x Relative Forward P/E 2.0x 1.5x 1.0x 0.5x 0.0x
Inditex: Three-Month-Rolling Average Earnings Revisions and Relative Forward P/E

6% 4% 2% 0% (2)% (4)% (6)% (8)% Current-Year Earnings Revision (Month-Over-Month) 8%
Jan-90 Jul-90 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Relative Forward P/E Current-Year Earnings Revision
73
Exhibit 110
Forward P/E Relative to MSCI Europe
2.0x 1.8x 1.6x 1.4x 1.2x 1.0x 0.8x (4)%
Inditex: Correlation of Three-Month-Rolling Average Earnings Revisions and Relative Forward P/E
R2 = 27%
(3)%
(2)%
(1)%
0%
1%
2%
3%
4%
Current-Year Earnings Revision

Interestingly, having initially perceived H&M and Inditex as one-andthe-same thing, it seems the market is increasingly discriminating between the two stocks. When Inditex came to the market, there followed a period from July 2001 to the end of 2004, where the stocks traded with a similar multiple (see Exhibit 111). During this period, the correlation between the two forward P/Es was relatively high, at 66% R-squared (see Exhibit 112). In the last year, however, this close relationship has broken down, and the market has placed a higher multiple on forward earnings at H&M, whereas the Inditex relative multiple has been largely range-bound near 1.3x. This breakdown has resulted in the correlation being reduced, which for the whole of 2005 had an R-squared of 19% (see Exhibit 113).
Exhibit 111
3.5x 3.0x Relative Forward P/E 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x Jan-90 Jan-91 Jan-92 Jan-93
H&M vs. Inditex: Relative Forward P/E
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
H&M
Inditex
Jan-06
74
Exhibit 112
2.5x Inditex Relative Forward P/E
H&M vs. Inditex: Relative Forward P/E (July 2001 Through December 2004)
2.0x
1.5x
R = 66%
2
1.0x
0.5x
0.0x 1.0x
1.2x
1.4x
1.6x 1.8x 2.0x H&M Relative Forward P/E
2.2x
2.4x
2.6x
Exhibit 113
1.6x Inditex Relative Forward P/E 1.5x
H&M vs. Inditex: Relative Forward P/E (January Through December 2005)
R = 23%
1.5x 1.4x 1.4x 1.3x 1.3x 1.0x
1.2x
1.4x
1.6x
1.8x
2.0x
2.2x
2.4x
2.6x
H&M Relative Forward P/E

Going forward, market consensus on H&Ms and Inditexs earnings potential seems to converge (see Exhibit 114); however, we would anticipate that the recent relative P/E trends outlined in Exhibit 111 actually continue, such that Inditex has a higher rating than H&M consistent with our thesis on the prospects for each business. The propensity for the relative P/E ratios to be driven by earnings revisions (see Exhibits 108 and 110) points to this trend being driven forward and catalyzed by an earnings miss from H&M and/or a positive earnings surprise from Inditex.
75
Exhibit 114
Inditex and H&M: Consensus Estimates

Inditex Median High Low H&M Median High Low January 2007 Earnings 1.55 1.61 1.49 November 2006 Earnings 12.68 13.17 12.00 January 2008 P/E 24.2x 23.3 25.1 P/E 24.8x 23.9 26.3 Earnings 1.79 1.89 1.72 November 2007 Earnings 14.44 16.11 13.24 P/E 20.9x 19.8 21.8 P/E 21.8x 19.6 23.8
We see both backward- and forward-looking reasons for our outlook on H&M and Inditex: First and foremost, H&Ms earnings-growth momentum has been supported by a massive gross-margin improvement (8.5 percentage points over 2001-05). We do not believe this is sustainable on the contrary, re-introduction of import quotas from China will more than likely invert the trend, at least in the short term. The reintroduction of import quotas from China is bound to have a more important impact on H&M than on Inditex, since Inditex relies more on European/North African third-party manufacturing than H&M. On the pricing side, H&M has a lower price point and simpler product mix than Zara, which in our view limits its possibility to increase margins through price increases/mix upgrades furthermore, H&M could be more severely impacted by increasing competitive pressure from discounters. Inditex seems to have a better feedback loop from stores and a tighter product development/sourcing and operations/retail organization we believe this should prove an important asset in the effort to maximize achieved margins. Inditex can leverage a variety of formats, which as much as it raises questions on the export quality of them, the overall complexity in the firm and management ability to stay on top of it should expose Inditex to lower brand fatigue as both Inditex and H&M grow larger and larger. Inditex has the opportunity to leverage its SG&A by growing deeper in the approximately 65 countries it has entered so far and moving forward in its reduce 3 program. Weaker like-for-like development and increasing complexity (more geographic markets, more product categories, new retail chain) create the risk of SG&A inflation at H&M. The Retail Conglomerate in Our Coverage: PPR In our view, PPR is undervalued versus consensus earnings growth estimates of roughly 17% (near-term earnings CAGR from Exhibit 115), since we anticipate that continuing fast growth at Gucci, a reduction in earnings erosion from underperforming (non-Gucci) luxury brands, a positive housing and consumer electronics cycle in France, and the recent divestment of the Printemps retail business will enhance group profitability. From these actions, and a benign consumer environment in France that should favor PPRs retail operations, we forecast earnings growth at a higher rate than consensus in the next two years, well above 20%. We anticipate that con-
76
tinuing earnings growth in 2006 and further above-expectations growth thereafter will serve as a catalyst for a rerating of the stock and significant price appreciation.
Exhibit 115
4.5x 4.0x
PPR: Near-Term Earnings Growth Expectations vs. Relative Forward P/E

35% 30% 25% 20% 15% 10% 5% 0% (5)% (10)% Jul-90 Jul-91 Jul-92 Jul-93 Jul-94 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05
Growth Expectations
3.5x 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jul-06

Growth Expectations
A Cross-Check to Our Logic With Alternative Valuation Methodologies
While we have a preference of looking at the valuation of stocks in our coverage with a relative price-to-forward earnings framework, we have also taken comfort from viewing our valuations on a cash flow basis, looking at EV/EBITDA, free-cash-flow yields, and finally with a discounted cash flow (DCF). In Exhibit 116, we outline a broader range of valuation multiples, based on our forecasts over the next three years. While we include the valuation summary above for completeness, it is not the primary driver of our target prices. Recognizing the range of metrics used in the market, we also include our DCF analysis on the stocks in our coverage in Exhibit 117. We present the outcome of this DCF analysis as our view on the proportion of the current share price that is supported by a discounted cash flow of the next 10 years. We have chosen not to use DCF to set our target prices, as we believe the target relative P/E method is a better option to assess and forecast medium-term stock price movements in this space. Nevertheless, we have checked that DCF analysis directionally supports our conclusions on the stocks and, expectedly, it does: PPR is recognized as an interesting investment opportunity, where a large portion of todays share price is supported by the discounted value of next 10 years cash flows. On the same metric, Next seems preferable to M&S. Likewise, Inditex seems preferable to H&M.
DCF Is the Final Analysis We Reference
77
Exhibit 116
Valuation Metrics
PPR 116.3 Dec. Euro 13,962 $17,777 20.7x 16.2 13.2 0.77x 0.72 0.68 0.95x 0.84 0.76 10.13x 8.51 7.25 4.6% 5.9 7.1 4.1% 5.9 7.3 Inditex 37.4 Jan. Euro 23,223 $29,615 24.3x 19.9 16.7 2.89x 2.47 2.13 2.76x 2.33 1.98 12.65x 10.28 8.41 2.5% 3.6 5.0 2.4% 3.5 4.7 Apparel Retailers H&M SEK308 Nov. SEK SEK254,881 $31,174 24.8x 22.0 19.5 3.66x 3.22 2.85 3.66x 3.22 2.85 15.62x 13.81 12.16 2.6% 3.3 3.8 2.7% 3.4 4.0 Next 1,870p Jan. /p 4,190 $7,964 13.3x 12.8 11.6 1.26x 1.16 1.05 1.37x 1.34 1.19 7.70x 7.72 6.98 5.6% 5.1 5.4 5.6% 5.1 5.4 M&S 657p Mar. /p 11,056 $21,014 17.9x 18.0 18.8 1.32x 1.26 1.23 1.50x 1.43 1.42 9.72x 9.49 9.71 4.2% 3.2 2.7 4.1% 2.9 2.3
Closing Price (11/3/06) Year-End Currency Market Capitalization (local curr. mil.) Market Capitalization (US$ mil.) P/E 2006E 2007E 2008E P/Sales 2006E 2007E 2008E EV/Sales 2006E 2007E 2008E EV/EBITDA 2006E 2007E 2008E FCF Yield 2006E 2007E 2008E FCFE Yield 2006E 2007E 2008E
Source: Bloomberg L.P., corporate reports and Bernstein estimates and analysis.
Exhibit 117
Discounted1 Cash Flow Summary

PPR 116.3 6.6% 9.4 11.6 122 9,834 81 70% Inditex 37.4 8.5% 19.6 25.0 126 10,377 17 45% Apparel Retailers H&M SEK308.0 8.2% 20.0 22.8 155 SEK84,002 SEK102 33% Next 1,870 7.4% 13.3 16.0 107 2,455 1,066p 57% M&S 657 7.6% 9.8 13.6 100 3,445 205p 31%
Closing Price (11/3/06) Key Assumptions WACC Year 10 EBIT Margin1 Year 10 EBITDA Margin1 Year 10 Capex/Depreciation1 NPV of Next 10 Years (million) NPV of Next 10 Years (per Share) Percent Current Share Price in Next-10-Year NPV
1 We model full cash flow for the 10 nearest years. Source: Bloomberg L.P., corporate reports and Bernstein estimates and analysis.
78
H&M: Reducing Acceleration

Overview H&M has a great track record: continued top-line growth, double-digit profitability increases and superior stock price performance. Nevertheless, we believe H&Ms multiple will come under pressure in the near future, as profitability growth will slow more significantly than is embodied in current consensus estimates. The most immediate reason for this is that, in our view, gross margin the key profitability driver of the past five years will stop being a performance booster, and risks becoming a negative contributor to the bottom line. Longer term, H&Ms quasi discount positioning, which has been at the root of its success, will come back to haunt it: (a) closer proximity to developing apparel discounters, as well as a younger consumer base, will limit pricing leverage; (b) decreasing sales productivity coupled with increasing business complexity will result in a heavier SG&A burden; and (c) centralized product development and range definition will be put to the test, the more so the larger and more geographically dispersed the business becomes. Sure, the company will continue to grow it has demonstrated it can penetrate markets deeply and still has plenty of markets to enter. Yet we think that the earnings momentum of the last five years will not be replicated going forward, and that, as a consequence, P/E multiples will continue to adjust downward. Over the past 14 years, H&M has been one of the most impressive success stories in the Apparel & Footwear retail industry worldwide. The H&M recipe for success has been simple: fashionable collections, accessible pricing, a young-customer focus and international reach through a rapidly growing store base. Since 1991, H&M has increased its sales 9.6x (CAGR of 16.4% per year) and earnings 23.6x (CAGR of 23.2% per year). Stores have grown from 260 in 1991 to 1,244 in the first half of 2006, spread over 22 countries. Stock results are equally impressive: H&M outperformed the MSCI Europe Index in 10 of the last 15 years (see Exhibit 118). Consistent with its outstanding top- and bottom-line growth, the market has accorded a significant P/E premium to H&M: H&M has outperformed the composite relative-to-MSCI price-to-forward earnings of the eight companies in our coverage by 42% in the years between 1991 and 2004. Outperformance has been most significant since 1996, when the relative price-to-forward earnings began to shoot up (see Exhibit 119). H&M is trading close to its 42% average price-to-forward earnings premium to the specialty retail group to this day.
A Most Impressive Track Record
79
Exhibit 118
H&M: Annual Relative Price Performance (to MSCI Europe)
Exhibit 119
H&M: Relative Price-to-Forward Earnings vs. Specialty Retailers Composite
150%
Relative (to MSCI) P/FE
3.5x 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x

May-94 Mar-92 Nov-00 Feb-91 Aug-97 Sep-98 Dec-01 Feb-04 Mar-05 Jun-95 Jan-90 Jan-03 Apr-93 Jul-96 Oct-99
Relative Price Performance
100% 50% 0% (50)% (100)% 1991 1993 1995 1997 1999 2001 2003 2005
Average 42%
Specialty Retailers Composite

H&M
Reducing Acceleration
Over the long run, H&M may continue to be an attractive investment. However, we are concerned for the short to medium term. In essence, our concern is that earnings growth momentum will significantly subside, as a number of concurrent negative threats materialize. This risks bringing further multiple deterioration, continuing the P/E compression trend currently in place. Subsequent negative earnings surprises could ignite a faster deterioration and de-rating. We believe the risk of such a development is real, and see five converging reasons that support this negative scenario: (1) Gross margin the major force of earnings growth at H&M in the past five years is bound to become a negative contributor to earnings momentum. We see 2005 as the peak of H&Ms gross margin performance for the foreseeable future, as the company benefited through most of 2005 from the elimination of quotas on Chinese apparel and textile imports into the European Union. We foresee that the subsequent reintroduction of safeguards against Chinese imports will not allow a comparable bought-in margin result in 2006 and 2007 (see Exhibit 120). This effect in isolation could have a short-term negative impact on gross margin of 1.1 percentage points (of net sales).
80
Exhibit 120
H&M: Gross Margin (percentage of sales)

60% 58% 56% 8.5 pp 54% 52% 50% 48% 46% 2006E 2007E
(16)% Tax
1997
1998
1999
2000
2001
2002
2003
2004
Source: Corporate reports and Bernstein estimates and analysis.
(a) Gross margin has been a big deal for H&M: H&M has improved gross margin by 8.5 percentage points in the five years between 2000 and 2005. We see 2005 as the peak year for gross margin, and expect gross margin in 2006 and 2007 to be lower. Gross margin improvement has been the single-most-important contributor to earnings growth between 2000 and 2005, well above sales growth in fact, of the extra SEK6,694 million in net earnings of 2005 over 2000 (see Exhibit 121): 63% has come from gross-margin improvement; 51% from sales growth; 3% from operating expense reductions; (1)% from increases in interest expense; (16)% from tax increases.
Exhibit 121
12,000
H&M: Drivers of Earnings Growth 2005 vs. 2000

63% 3% (1)%
10,000 8,000 51% 6,000 4,000 2,000 0 2000 Earnings

Source: Corporate reports.
SEK Million
Sales Growth
Gross Margin
Operating Expenses
Interest
2005
SEK6,694 Million
2005 Earnings
81
Equally, gross-margin increase has been the root cause of H&M ROCE improvement, as it has more than balanced a worsening sales/capital employed trend (see Exhibit 122).
Exhibit 122
15% 14% 13% NOPAT/Sales 12% 11% 10% 9% 8% 7% 6% 5% 2.40x 2.45x 2.50x
H&M: RoCE Rolling-Four-Quarter (1Q:98 to 2Q:06)

2005 2Q:06 2004 2002 1999 30% 2001 2000 1998 25% 20% 15% 2.55x 2.60x 2.65x 2.70x 2.75x 2.80x 2.85x 2.90x 35% RoCE 40%
Sales/Capital Employed
H&M has the highest gross margin among the largest apparel and footwear retailers in the world (see Exhibit 123). It is not simply the comparison with other retailers alone that makes us cautious on further grossmargin expansion; H&M is likely to face, at best, flat, if not rising cost of goods, and will have limited scope for increasing selling prices, which we explore next.
Exhibit 123
H&M: Gross Margin Comparison With Large Apparel Retailers (2005)

Company H&M Inditex M&S Limited The Gap Sales ( billion) 7.7 6.7 5.9 7.6 13.1 Gross Margin 59.1% 56.2 52.5 45.2 39.2
(b) Impact of quota elimination and reintroduction: The impact from the elimination of quotas from January 1, 2005, on apparel and textile has been massive. In the first four months of 2005 import volumes of core apparel categories from China into the EU (e.g., T-shirts, pullovers, blouses, stockings, socks, trousers, dresses, suits, bras, etc.) increased by almost 200%, unit prices fell by 20%, and net value increased by 136% (see Exhibit 124). This was the combined affect of Chinese companies fighting to increase their export business in the post-MFA (Multifiber Arrangement) world, and European Apparel & Footwear retailers buying into the opportunity of saving on their sourcing costs (see Exhibits 125 and 126).
82
Exhibit 124
EU Imports of Selected Apparel Categories from China Immediately Post MFA Expiration
1/1/04 to 4/30/04 Total Volume Volume ( million) (million) 190.0 84.1 78.1 13.2 119.2 30.7 39.9 10.1 7.2 40.0 54.5 5.8 42.5 3.8 93.9 38.6 65.9 7.4 94.4 38.4 65.5 3.2 851.1 275.4 Unit Price () 2.26 5.90 3.88 3.96 0.18 9.43 11.05 2.43 8.85 2.46 20.36 3.09 1/1/05 to 4/30/05 Total Unit Volume Volume Price ( million) (million) () 409.6 1.71 239.5 337.1 74.6 4.52 589.9 164.3 3.59 106.6 32.6 3.27 33.7 153.2 0.22 131.3 17.1 7.67 66.9 10.4 6.46 75.7 33.6 2.25 36.9 4.7 7.85 141.8 73.5 1.93 75.1 4.8 15.77 2,004.6 808.3 2.48 First Four Months: 2005 vs. 2004 Delta Value 116% 332 395 167 368 141 57 (19) (44) 50 15 136% Delta Volume 185% 463 435 224 283 196 169 (13) (37) 91 48 193% Delta Price (24)% (23) (7) (17) 22 (19) (42) (7) (11) (22) (23) (20)%
Code 4 5 6 7 12 15 26 28 29 31 83 Total
Category T-Shirts Pullovers Mens Trousers Blouses Stockings & Socks Womens Overcoats Dresses Trousers Womens Suits Brassieres Overcoats
Note: Categories highlighted in grey are those for which China has agreed on June 12, 2005, to a three-year transitional regime of export limitations. Source: European Commission.
Exhibit 125
EU Import Shares of Chinese Apparel Exporters

Overcoats Brassieres Women's Suits Trousers Dresses Women's Overcoats Stockings & Socks Blouses Men's Trousers Pullovers T-Shirts 0% 10% 20% 30% 40% 50%
1/1/04 to 4/30/04
Source: European Commission.
1/1/05 to 4/30/05
Exhibit 126
Winners and Losers of the Post-Quota Era: Textile Exports to Developed Markets
YoY Change in Textile Exports (1H:05 $ Value)
60% 40% 20% 0% (20)% (40)% (60)% Swaziland Egypt Moldova Kenya Macedonia Bangladesh Indonesia Madagascar South Africa Philippines Sri Lanka Cambodia Myanmar Turkey Jordan Morocco Albania Bulgaria Lesotho Mauritius Mongolia Thailand Pakistan Romania Tunisia Vietnam Mexico Nepal China India Peru Laos Tajikistan
Source: World Bank.
83
There was uncertainty in 2004 on the overall impact of import quota elimination retailers expected a general reduction of sourcing costs, but were not certain about other drivers pushing in the opposite direction: Chinese currency revaluation, Chinese export taxes, etc. Rolf Eriksen wrote in the 2004 H&M Annual Report: It is difficult to say exactly how this will affect H&M. Various factors come into play, including what happens to the Chinese currency. China has introduced an export tax which will partly counteract the positive effect of the removal of the quotas. As things stand at present, in early 2005, we do not expect any price deflation during the spring. In hindsight, the impact of quota elimination has brought a significant reduction of sourcing costs for both European and North American retailers. Chinese T-shirts, for example, fell in price by 20-60% to European and North American importers (see Exhibit 127).
Exhibit 127
40% YoY Unit Price Increase 20% 0% (20)% (40)% (60)% (80)% (100)% (400)%
China Exports of Cotton T-Shirts (January Through October 2005)
Morocco Myanmar Mongolia Macedonia Thailand Laos Tajikistan Bulgaria Turkey R = 82% (200)% 0% 200% 400% 600% 800% 1,000% 1,200% 1,400% 1,600%
2
Albania
YoY Volume Increase

Note: Circled area proportional to report value; total T-shirt export value = $4.5 billion. Source: Chinese Customs.
We reckon that H&M has significantly benefited from the effects of quota elimination, as it is more exposed to non-European and Chinese sourcing. A conservative estimate, not considering sourcing mix shifts, would indicate savings of approximately two percentage points of net sales (see Exhibit 128).
84
Exhibit 128
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% H&M Europe & North Africa 37% 30% 30%
H&M vs. Inditex: Sourcing

H&M vs. Inditex: Sourcing Markets 13.5% 13.5%
H&M vs. Inditex: End of MFA Impact Back of the Envelope COGS (% of Sales) Sourcing from China (% of Total Sourcing) Price Reduction (Overall Virtuous Effect of Quota Elimination) Sourced for 2005 (% of Total Chinese Sourcing at New Price) COGS Impact (% of Sales) H&M 42.8% 30.0% (20)% 75% (1.9)% Inditex 46.5% 13.5% (20)% 75% (0.9)%
69%
Inditex China Other Asia ROW
Source: Corporate reports and Bernstein interviews and estimates.
Reintroduction of quotas risks changing the picture. China and the EU signed a three-year transitional MOU on June 10, 2005, that came into effect on July 12, 2005, and will expire at the end of 2008. Under this agreement, China will limit the increase of its textile and clothing exports into the EU to 8.0-12.5% per year in 10 sensitive product categories, six of which are core product categories of mass-fashion retailers like H&M (see Exhibit 124). It is fair to assume that the safeguards introduced will dampen aggressive price behavior on the part of Chinese exporters. But, as quota fill rates are rising fast (as shown in Exhibit 129), it is fair to assume import price inflation during 2006. This development promises to curb gross margin of European apparel retailers in 2006 and beyond and of H&M specifically, as it is more exposed to Chinese sourcing than other players.
Exhibit 129
EU Apparel Imports from China (First Four Weeks of 2006)

1/25/06 Code 4 5 6 7 26 31 Category T-Shirts Pullovers Men's Trousers Blouses Dresses Brassieres 2006 Quota (million) 540 190 339 80 27 220 Quota Use 1.5% 1.1 1.1 2.0 1.9 2.8 Licensed Use 9.3% 4.8 7.4 8.1 7.8 9.2 Total Fill Rate 10.8% 6.0 8.5 10.2 9.8 11.9 Two-Year Price Change (67.7)% (49.8) (78.9) (58.9) (49.2) (8.3)
Source: Emerging Textiles.
Recent interviews that we have personally conducted in China with apparel manufacturers and sourcing agents confirm our expectation of no further price deflation and possible inflation, given the impact of export quota costs. (2) H&Ms quasi discount positioning represents a strategic liability versus Apparel & Footwear discounter growth. Market data indicate a quasi discount positioning for H&M. In the United Kingdom, for example, H&M has a product mix by price band which resembles more discount players like Asda, than differentiated players like Top Shop, Inditex or M&S (see Exhibit 130).
85
Exhibit 130
Apparel & Footwear Sales by Price Tag

Avg. Unit Price
Primark Matalan Tesco Asda H&M New Look Bhs JJB Next Zara M&S Top Shop Debenhams 0% 10% 20% 30% 40% 50% 1-3
UK Apparel & Footwear Market by Price Tag Market Size ( 000) Market Volume (000) Average Retail Price () Note: 52 weeks to 8/21/2005. Source: TNS, Verdict and Bernstein estimates and analysis. 1-3 3,214,743 883,375 3.6 4-6 6,632,708 916,332 7.2 7-8 7,029,472 614,212 11.4 9-10 13,318,680 643,439 20.7
4.7 5.8 6.1 6.1 7.8 8.0 9.4 11.1 11.1 12.1 12.5 12.9 13.0
60% 4-6 7-8
70% 9-10
80%
90%
100%
Total 30,195,603 3,057,358 9.9
Growth of Apparel & Footwear discounters in Europe and in the United States risks making H&Ms position increasingly delicate. In the United Kingdom, for example, H&M is sandwiched in the middle ground between grocery retailers and specialist discounters on the one side and differentiated players on the other. As a result, H&M has sales-per-squaremeter below both groups of retailers (see Valuation Section, Exhibit 96), and finds itself stuck in the middle ground. Proximity to discounters the same as for other packaged-goods categories raises the issue of relative value for money offered to consumers and sustainable brand premium. The delicate point here is that discounters seem to win the value-formoney comparison against H&M hands down.1 In fact, it can squeeze into each product more sourcing costs than H&M does, leveraging its lower SG&A and superior space productivity. Assuming H&Ms cost percentage equals 100, discounters offer (see Exhibit 131): a value M2 from 173 to 196 of H&M, assuming discounters have the same absolute contribution margin per square meter as H&M; a value from 154 to 168 of H&M, assuming discounters have the same percentage contribution margin as H&M; and a value from 104 to 118 of H&M, assuming discounters have twice the percentage contribution margin of H&M.
1 Assuming that H&M has an SG&A cost disadvantage of +33% over discounters (higher staffing levels, High Street location versus out-of-town, more expensive store fixtures), and leveraging the data of Exhibit 132.
86
Exhibit 131
H&M vs. Discounters: Value for Money Leadership

Sales/m2 () SG&A (/m2) SG&A H&M 2,570 1,028 40% Asda 6,000 771 13% Tesco 4,380 771 18% 514 12% 3,095 71% 177 876 20% 2,733 62% 156 1,752 40% 1,857 42% 106 Primark 4,185 771 18% 514 12% 2,900 69% 173 837 20% 2,577 62% 154 1,674 40% 1,740 42% 104
Hypothesis 1: H&M and Discounters Have Absolute Contribution Margin/M2 Contribution (/m2) 514 514 Contribution (%) 20% 9% COGS (/m2) 1,028 4,715 COGS (%) 40% 79% COGS Index 100 196 Hypothesis 2: H&M and Discounters Have Same Percentage Contribution Margin Contribution (/m2) 514 1,200 Contribution (%) 20% 20% COGS (/m2) 1,028 4,029 COGS (%) 40% 67% COGS Index 100 168 Hypothesis 2: Discounters Have Twice the Percentage Contribution Margin of H&M Contribution (/m2) 514 2,400 Contribution (%) 20% 40% COGS (/m2) 1,028 2,829 COGS (%) 40% 47% COGS Index 100 118 Source: TNS and Bernstein estimates and analysis.
In other words, in order to conceive that H&M delivers the same value for money that discounters do, one has to assume that: (a) either discounters make twice the money on sales than H&M, or (b) that discounters pay twice the amount of money for the same product than H&M. Both hypotheses are extreme and unlikely, which leaves us with H&M having to build customer appeal through range and brand over a structural value disadvantage versus discounters. The fact that H&M leverages its brand to command a significant premium in the market against discounters becomes apparent if one compares the sales subcategory mix of H&M and discounters (see Exhibit 132): H&M has 1.7 times its fair share of womens outerwear/sportswear, while discounters have between 0.77x and 0.95x Discounters have 1.45-2.26 times their fair share of underwear/nightwear and hosiery and 1.67-2.42 times of childrenswear Consumers recognize H&Ms relatively less favorable value equation and shop H&M disproportionately more for visible garment categories than for less fashion-intensive ones.
Exhibit 132
Sales Product Mix Womenswear: United Kingdom (52 Weeks to 8/21/05)

Womens Outerwear Womens Underwear Womens Accessories Menswear Childrenswear Womens Outerwear Womens Underwear Womens Accessories Menswear Childrenswear H&M 62% 4 3 13 19 170 54 24 42 127 Asda 28% 12 6 22 32 77 153 52 73 218 Tesco 28% 11 5 20 36 77 145 44 67 242 Primark 35% 18 4 19 25 95 226 37 63 167 Market 36% 8 11 30 15
Note: Female consumers disproportionately shop for high-involvement outerwear at H&M: they accept paying a premium for what can be seen, but shop for less visible products elsewhere. Source: TNS and Bernstein analysis.
87
The continuing growth of discounters and their increasing fashion sophistication (e.g., Tesco with its Cherokee brand now exported into all its European stores, Target with its Isaac Mizrahi product range and NYC fashion shows) promises to bring more pressure on H&M, and create a possible collision course with it. Should grocery retailers and mass discounters succeed in coupling high volumes, low cost and high-fashion appeal, that would create a formidable proposition and, in our view, could force H&M to confront by improving its value offer to consumers i.e., by reducing its best-in-class margins. (3) Compounding its quasi discount positioning, H&M is bound to have limited pricing upside potential because of its younger-thanaverage customer base. The H&M customer base is younger than that of other mass-fashion retailers, and certainly significantly younger than that of established apparel and footwear retailers. In the United Kingdom, for example, 75% of H&M customers are in the 12-34-year age band, versus 67% at Zara, 31% at Asda and 10% at M&S (see Exhibit 133).
Exhibit 133
UK Customer Base by Age Band: Womenswear (52 Weeks to 8/21/05)

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% H&M Zara 12-34
Source: TNS.
Next 35-54
Asda 55+
M&S
Having younger consumers is certainly a positive in many respects. But younger consumers are more price-sensitive and less loyal, limiting priceincrease potential for retailers more exposed to them, like H&M (see Exhibit 134).
Exhibit 134
Shopping Behavior of UK Apparel Shoppers Index vs. Average = 100 (2005)

Loyalty Driver Range Price Convenience Quality Service Shopping Around Loyalty Avg. Spend (/year) Source: Verdict. 15-25 106.8 104.3 71.1 98.8 55.3 131.1 71.4% 536 35-54 99.4 107.8 106.3 107.9 81.6 102.1 74.5% 623 65+ 98.2 78.8 114.8 93.4 165.8 65.8 82.3% 425
88
In the past, H&M seems to have enjoyed little pricing and mix upgrade. Unfortunately, official volume data are scarce, but with what is available, we can draw a comparison of H&M to Inditex (see Exhibit 135): A significantly lower average unit price A track record of very moderate unit price increases
Exhibit 135
H&M vs. Inditex: Unit Price Trend

H&M Net Sales ( mil.) Pieces (million) Price/Piece () CAGR Period (years) 1997 2,419 250 9.68 2005 6,783 685 9.90 0.3% 7 1999 2,035 90 22.61 Inditex 2001 3,250 130 25.00 5.1% 2
Source: Corporate reports and Supply Chain Forum.
(4) H&M has held SG&A costs virtually constant in the past 10-15 years short-term developments could increase inflationary pressure. H&M has held SG&A costs around 37-38% of sales since 1997, leveraging formidable sales growth: 16.5% CAGR in the 1997-2005 time frame and 17.5% in the 1991-2005 time frame (see Exhibit 136).
Exhibit 136
H&M: Sales and SG&A Development

Net Sales (SEK million) Sales CAGR SG&A (SEK million) SG&A CAGR SG&A as a Pct of Net Sales 1991 6,411 1997 18,011 18.8% 6,724 37.3% 2001 39,699 21.8% 15,021 22.3% 37.8 2005 61,262 11.5% 23,009 11.2% 37.6
The key for SG&A equilibrium has been to increase productivity in order to compensate decreased efficiency: Sales/FTE increased 2.2% per year between 1997 and 2005, while personnel costs/FTE increased 1.4% per year; and Sales/store increased 2.8% per year between 2000 and 2005, while rent/store increased 3.6% per year Personnel costs, in particular, brought 110 bp of bottom-line improvement over 1997-2005, enough to compensate store-cost increases plus other SG&A inflation and keep SG&A as a percentage of net sales broadly stable (see Exhibit 137). Productivity improvements, though, have been declining in recent years, both in terms of sales/FTE and in terms of sales per store (see Exhibit 138).
Exhibit 137
1997 Personnel Costs Sales/FTE (SEK 000) Cost/FTE (SEK 000) Personnel Costs as a Pct of Sales Store Costs Sales/Store (SEK 000) Rent/Store (SEK 000) Store Costs as a Pct of Sales Other SG&A Total SG&A as a Pct of Sales
H&M: SG&A Dynamics (1997-2005)

1998 1,599 263 16.5% 40,983 1999 1,580 261 16.5% 45,494 2000 1,473 248 16.9% 44,654 4,633 10.4% 11.0% 38.2 2001 1,730 282 16.3% 51,490 5,547 10.8% 10.8% 37.8 2002 1,773 287 16.2% 53,936 5,891 10.9% 9.9% 37.0 2003 1,698 279 16.4% 51,045 5,567 10.9% 9.7% 37.0 2004 1,694 274 16.2% 50,276 5,425 10.8% 10.4% 37.3 2005 1,770 287 16.2% 51,351 5,541 10.8% 10.6% 37.6 1,489 258 17.3% 36,757
37.3%
36.2%
36.4%
89
Exhibit 138
20% 15% YoY Change 10% 5% 0% (5)% (10)% 1998 1999 2000
H&M: Store and Personnel Productivity Trend

Sales/FTE Sales/Store
2001
2002
2003
2004
2005
2001
2002
2003
2004
2005
We calculate that H&M has been experiencing a declining sales effectiveness trend, both in overall terms and in its major markets. H&M as a whole had sales per store of (0.3)% in 2005 versus 2004, 1.4% in 2004 versus 2003, and (2.1)% in 2003 versus 2002 (see Exhibit 139).2
Exhibit 139
Sales/Store YoY Growth in Local Currency Group Weighted Average

Change in Sales/Store
16%
Sales/Store (YoY Change)
12% 8% 4% 0% (4)% (8)% (12)% (16)%
1Q:01
2Q:01
3Q:01
4Q:01
1Q:02
2Q:02
3Q:02
4Q:02
1Q:03
2Q:03
3Q:03
4Q:03
1Q:04
2Q:04
3Q:04
4Q:04
1Q:05
2Q:05
3Q:05
4Q:05
1Q:06
The only major market where the sales/store trend is positive is Sweden, where the most significant store substitution activity has happened (see Exhibit 145). Germany, United Kingdom and France all show negative sales/store values in the past three years (see Exhibits 141-144). Indeed, the key net revenue growth driver for H&M as a whole has increasingly been new store openings, rather than increased sales per store: while both drivers contributed in equal terms in the years 1997, 1998 and 1999, new stores have been the predominant net revenues growth factor since then (see Exhibit 140).
2 H&M has chosen not to publish retail space data. We have: (1) taken quarterly stores and local-currency sales data by country; (2) calculated sales per store by quarter; and (3) calculated quarterly sales-per-store trends year-over-year. We have done this both as a weighted average for the Group and for its top four markets: Germany (27.2% of gross sales), Sweden (8.6% of gross sales), the United Kingdom (8.5% of gross sales) and France (7.3% of gross sales). We assume for this calculation an average of 1,400 square meters per store.
2Q:06
2000
2001
2002
2003
2004
2005
90
Exhibit 140
200% 175% 150% 125% 100% 75% 50% 25% 0% (25)% (50)% (75)% (100)% 1997 1998
H&M: Drivers of Revenue Growth
1999
2000 Sales/Store
2001 New Stores
2002
2003
2004
2005
Exhibit 141
25%
YoY Change in Sales/Store
Sales/Store YoY Growth in Local Currency: Germany

Sales in Germany as Pct. of Total Sales 35% 30% 25% 20% 15% 10% 5% 0%
Exhibit 142
30%
Yoy Change in Sales/Store
Sales/Store YoY Growth in Local Currency: United Kingdom

Sales in UK as Pct. of Total Sales
20% 15% 10% 5% 0% (5)% (10)% (15)% 2000 2Q:01 4Q:01 1Q:02 3Q:02 2002 2Q:03 4Q:03 1Q:04 3Q:04 2004 2Q:05 4Q:05 1Q:06
25% 20% 15% 10% 5% 0% (5)% (10)% (15)%

2000 2Q:01 4Q:01 1Q:02 3Q:02 2002 2Q:03 4Q:03 1Q:04 3Q:04 2004 2Q:05 4Q:05 1Q:06
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
Pct of Total Group Sales
91
Exhibit 143
15% 10% 5% 0% (5)% (10)% (15)% (20)%
Sales/Store YoY Growth in Local Currency: Sweden

Sales in Sweden as Pct. of Total Sales 16% 14% 12% 10% 8% 6% 4% 2% 0%
Exhibit 144
30% YoY Change in Sales/Store 20% 10% 0% (10)% (20)% (30)% (40)% (50)%
Sales/Store YoY Growth in Local Currency: France

7% 6% 5% 4% 3% 2% 1% 0% Sales in France as Pct. of Total Sales 8%
YoY Change in Sales/Store
2000 2Q:01 4Q:01 1Q:02 3Q:02 2002 2Q:03 4Q:03 1Q:04 3Q:04 2004 2Q:05 4Q:05 1Q:06
Exhibit 145
H&M: Store Growth by Region Summary

No. of Stores in 1997 211 117 49 40 5 216 123 39 27 25 2 Stores Opened Number Pct 99 15% 32 5 28 4 20 3 19 3 355 157 34 21 26 5 64 40 5 3 55% 24 5 3 4 1 10 6 1 0 Stores Closed Number Pct (34) 52% (25) 38 (2) 3 (7) 11 (23) (11) (8) (4) 35% 17 12 6 Net New Stores Number Pct 65 11% 7 1 26 4 13 2 19 3 332 146 26 17 26 5 64 40 5 3 57% 25 4 3 4 1 11 7 1 1 No. of Stores in 2005 285 124 78 56 27 611 288 73 48 52 7 71 50 7 10 4 1 297 102 52 91 27 12 11 2 1,193
Nordic Countries Sweden Norway Denmark Finland Euro Zone Germany Netherlands Belgium Austria Luxembourg France Spain Portugal Italy Ireland Hungary Rest of World United Kingdom Switzerland United States Poland Czech Republic Canada Slovenia Total
63 21 42
190 72 13 75 15 7 6 2 644
30% 11 2 12 2 1 1 0.3 100%
490
The negative impact from reduced productivity improvements has been mitigated by recent marginally improving efficiency, both in terms of cost/FTE and rent per store: in 2005, cost/FTE was down to 95.4% of the 2002 peak and rent per store was down to 92.1% of the 2002 peak (see Exhibit 138). Marginally improved efficiency seems to be the net effect of shifting geographic mix: growth in low-cost countries balances cost inflation in established markets (see Exhibits 146 and 147), although we expect this im-
2000 2Q:01 4Q:01 1Q:02 3Q:02 2002 2Q:03 4Q:03 1Q:04 3Q:04 2004 2Q:05 4Q:05 1Q:06
(9) (1) (8)
14% 2 12
181 71 5 75 15 7 6 2 578
31% 12 1 13 3 1 1 0.3 100%
(66)
100%
92
pact to wane going forward as the company focuses its expansion effort towards higher-cost countries (see below).
Exhibit 146
H&M: 1997 Sales by Country Market Penetration vs. Personnel Cost
Exhibit 147
500 Personnel Cost (SEK000/FTE) 450 400 350 300 250 200 150 100 50 0 0.01 I
H&M: 2004 Sales by Country Market Penetration vs. Personnel Cost

S CH N
500 Personnel Cost (SEK000/FTE) 450 400 350 300 250 200 150 100 50 0 0.01 0.10 Average: x = 0.24, y = 258 1.00 10.00 UK SF NL D B CH S N A DK L
CDN
US P SLO
F E
D B UK
DK NL A SF
CZ PL Average: x = 0.14, y = 274 0.10 1.00 10.00
Market Penetration (No. Stores/100,000 Pop)

Note: Circle size proportional to sales in the country. Source: OECD, corporate reports and Bernstein analysis.
Market Penetration (No. Stores/100,000 Pop)

Note: Circle size proportional to sales in the country. Source: OECD, corporate reports and Bernstein analysis.
Going forward we see the following reasons to expect a potentially worsening SG&A scenario: Continuing decline of sales per store => declining productivity gains/increased SG&A percentage Reduced sales growth target (10-15% per year for the next five years) => declining scale economies on central cost masses Increased number of countries where present => increase in complexity and coordination costs Expansion focus on relatively higher cost markets: United States., Canada, United Kingdom, Germany, France and Spain => reduced balancing effect from low-cost countries Expansion focus on the United States and the United Kingdom => strongest discounter markets could further pressure productivity (5) More broadly, we see a potential brand fatigue risk implicit in H&M going forward. H&M is already the largest Apparel & Footwear retail brand in the world (see Exhibit 148).
Exhibit 148
Largest Apparel & Footwear Retail Brands

Brand H&M Gap Nordstrom Marks & Spencer Old Navy Next Zara Victorias Secret Banana Republic Group H&M The Gap Nordstrom Marks & Spencer The Gap Next Inditex Limited The Gap Sales ( million) 6,626 5,485 6,196 5,565 5,501 4,277 4,441 3,581 1,845 Period (Ended) 52 weeks (11/30/2005) 52 weeks (1/31/2006) 52 weeks (1/31/2006) 52 weeks (2/4/2006) 52 weeks (1/31/2006) 52 weeks (1/31/2006) 52 weeks (11/31/2006) 52 weeks to( 12/31/2005) 52 weeks (1/31/2006)
Note: M&S data are an estimate of apparel sales, excluding food and home. Source: Corporate reports.
93
Among fashion-focused international brands, H&Ms brand size is even more impressive when analyzed on a country-by-country basis the comparison to Zara, for example, indicates that the H&M brand is on average three to five times the size of the Spanish brand (see Exhibits 149 and 150).
Exhibit 149
400
Inditex vs. H&M: Sales/Country All Markets
Exhibit 150
400 Sales/Country ( million) 350 300 250 200 150 100 50 0 1991
Inditex vs. H&M: Sales/Country International Only
Sales/Country ( million)
350 300 250 200 150 100 50 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Inditex
H&M
Inditex Sweden
H&M Spain
Note: Inditex includes Zara and all other group brands. Source: Corporate reports and Bernstein analysis.
Note: Inditex includes Zara and all other group brands; International = except home country. Source: Corporate reports and Bernstein analysis.
We are concerned that larger relative size though excellent for local scale economies will push H&M to reinforce its quasi discount positioning, further reducing its price and mix upgrade potential all the more so as H&M is planning to grow sales to the tune of 10-15% per year in the next five years, keeping a focused-geographic approach. Compounding size, we are concerned that further brand commoditization pressure will come from managing what is becoming an increasingly international business (see Exhibit 151) through a fully centralized product design and development function. We fear this might push the brand to a minimum common denominator approach, risking its brand cool indispensable to remain attractive to its younger customer base. Furthermore, a fully centralized product design and product development function increases the risk of missing a collection/season and of potential designer hubris as major U.S. fashion retailers have experienced in the past few years.
2005
94
Exhibit 151
Domestic Market: Sales in Home Country as a Percentage of Total Sales

80% 70% 60% 50% 40% 30% 20% 10% 0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Inditex Spain
Note: H&M = Sweden; Inditex = Spain.
H&M Sweden
95
Inditex: Continuing to Run

Overview Inditex has a unique operating model, a broad format offer and a maturing geographic footprint which we believe give the stock significant earnings growth potential, especially relative to other mass-fashion and valueapparel retail stocks in our coverage. We believe Inditex has excellent organization and process capabilities that maximize gross margin and minimize the risk of collection miss. These come from the combination of: (1) a peer-to-peer retail, design, operations, product development and buying structure that cut sourcing lead times; (2) store-driven product and assortment input that optimize style and buying decisions; (c) faonneur-based sourcing, logistics and store-replenishment capabilities that open a lastminute fast-track sourcing option for the most fashion-intensive portions of the collection. While the stock appears richly valued versus its peers, we believe the current valuation can be justified based on what we believe will be continued strong EPS growth. Indeed, our main reservations on the stock at present are that we think near-term earnings prospects are well understood, and that coupled with prospects for rising interest rates is likely to make any near-term re-rating difficult to achieve, particularly from present levels. Additionally, we would like to get initial evidence of the SG&A impact of Reduce 3 and geographic focus, which would give us stronger conviction in our longer-term, above-consensus view. Inditex is the most junior phenomenon in the worldwide Apparel & Footwear heavyweight champion league: the first Zara shop opened in 1975, the company was floated in June 2001. Yet, Inditex has achieved unprecedented success: in the 10 years between 1994 and 2004, sales have grown 7.5 times (CAGR of 22.3%), earnings have increased 12.2 times (CAGR of 28.5%), stores have moved from 424 to 2,244. This is an outstanding achievement, even compared to the worldwide best: in the same time period H&M has grown its sales only 16.6% per year and net earnings 21.2% per year. In 2005, Inditex drew level with H&M in sales, while commanding a higher RoCE than most apparel and specialty retailers in Europe and the United States (see Exhibits 152 and 153). Stock results have been impressive, but less than one would expect: Inditex outperformed the MSCI Europe Index in 2001 (35%), 2002 (53%) and 2004 (22%). In 2005, Inditex stock moved in line with the market, while in 2003 it shed 40% versus the market (see Exhibit 154).
A Short But Impressive Track Record
96
Exhibit 152
Inditex vs. H&M: Sales
Exhibit 153
Apparel and Footwear Retailers: Operating Leases and Cash-Adjusted RoCE vs. Leading Retailers
H&M A&F
8,000 7,000 Sales ( million) 6,000 5,000 4,000 3,000 2,000 1,000 0 1991 1993 1995 1997 1999 2001 2003 2005 Inditex CAGR (1994-2005): 22.3% H&M CAGR (1991-2005): 17.5%
20%
Next Inditex The Gap Boots M&S Home Depot Matalan DSG PPR
Fcuk
10%
NOPAT/Sales
Limited Benetton GUS 9% Kingfisher
8% 7% 6% 5% 4% 3% 2%
Ann Taylor
40%
30%
20%
ROCE
0.7x 0.8x 0.9x 1.0x
5%
2.0x
3.0x
10%
4.0x 5.0x 6.0x 7.0x
15%
H&M
Inditex
Source: Corporate reports and Bernstein analysis and estimates.
Exhibit 154
Inditex: Annual Relative Price Performance (to MSCI Europe)

60% Relative Price Performance 40% 20% 0% (20)% (40)% (60)% 2001 2002 2003 2004 2005
Consistent with its outstanding top- and bottom-line growth, the market has accorded a significant P/E premium to Inditex: Inditex has outperformed the composite index of the companies in our coverage by 49% in the years between 2001 and 2005 (see Exhibit 155). Inditexs relative forward P/E has substantially reduced versus the composite average in the past year. We believe this reduction begins to open an opportunity to invest in the stock, as in our view Inditex retains the superior ability to increase its earnings in the medium term.
97
Exhibit 155
Inditex: Annual Relative Price Performance vs. Specialty Retailers Composite (to MSCI Europe)
250% 200% 150% 100% 50% 0% Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Average 49% Premium
Inditex Relative Forward P/E

Specialty Retailers Composite
Continuing to Grow Profitability We are convinced that Inditex has significant potential to continue its strong profit growth into the medium term (see Exhibit 156).
Exhibit 156
70% 60% YoY Earnings Growth 50% 40% 30% 20% 10% 0%
Inditex: Earnings Growth Trend
2006E
2007E
2008E
2009E
We see three major reasons for this: (1) Inditex has an organization and process advantage which equips it to play and win in a market where consumers are getting more sophisticated, fashion-conscious and demanding; (2) Inditex has major sales-growth potential both at home and abroad its growth momentum in Spain and internationally is unmatched and leveraging its beachheads to penetrate markets deeper and playing out its broad format portfolio will allow it to maintain the current pace; and (3) Inditex has significant latitude to improve its profitability by reducing its SG&A: (a) increasing penetration of international markets; (b) leveraging its geographically driven fixed costs; and (c) refocusing its expansion on Europe versus the United States.
2010E
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
98
(1) Superior Organization. We think that the key competitive advantage Inditex has over other apparel retailers is teamwork, not vertical integration. For starters, vertical integration at Inditex is widely misunderstood. Many think that Inditex manufactures garments directly in its factories. This is wrong. What Inditex does is to organize part of its production through a third-party faonneur network,1 and maintain the flexibility to source either in a finished-product or in a faonneurbased way (see Exhibit 157). But running a faonneur network per se is not particularly revolutionary or distinctive. In fact, most Italian fashion brands work this way. Whats different for Inditex then? Two things: (a) The peer-to-peer organization Inditex has created, where retail, design and operations functions work on an equal footing. The fact that designers work side-by-side with other functions and not on top of them is something unheard of in the fashion industry. In fashion, designers are king. Operations, wholesale and retail functions are at their service. In order to avoid designer hubris syndrome, apparel retailers have chosen in most cases to subjugate designers to the sales function. But this is less than ideal: (i) you end up with a sad bureaucracy a far cry from the cool design team you wanted in the first place; and (ii) you invariably have a rulerbased organization, only that the monarch now has a different name. Inditex has taken a different avenue. The rulers, at the extreme, are the store managers. Designers, sales and operations physically sit side-by-side and strive together to satisfy the requests coming from the stores. Designers are in (large) part compensated as a function of how well the products they create actually sell (see Exhibit 158). (b) The pull process through which store managers convey product requests and make sourcing decisions for their stores. Most apparel retailers follow a centralized model. A central product and buying office is responsible for creating the collections and defining the assortments for the stores. Store managers responsibility is to manage the store staff and sell the product they receive, but they have no say in defining the assortment. This is, for example, the way H&M works. Inditex has chosen a different approach. The store managers are center-stage: (i) they convey product requests to the central team; and (ii) they have discretion over which products to source for a large part of the store assortment. In particular, store managers have a key role in adapting the fashion portion of the assortment and fine-tuning the fashion-versus-basics mix. Store managers at Inditex are paid well above the average in the industry a successful store manager can make twice as much as the average colleague as a function of store performance (see Exhibit 159).
1 A faonneur network is an industry-specific way of describing subcontracted manufacture or assembly of garments.
Exhibit 157
"finished product" sourcing mode "faconneur based" sourcing mode
Apparel Sourcing Modes: Finished-Product vs. Faonneur-Based
Fabric Suppliers
Accessories Suppliers
Faconneurs
Sourcing Order
Sourcing Order
Sourcing Order Technical specs
Fabric Suppliers
Accessories Suppliers
Faconneurs
Garment Provider
Catalogue
Fabric & Accessories
Garments
Garments
Orders
Third Parties Inditex
Cut fabric + Accessories batches
Finished garments warehouse
Operations + Buying Team
Raw Materials warehouse
Finished garments warehouse
Operations + Buying Team
Design Specs Catalogue selections
Lay-out specs
Design Specs
Design Team
Fabric Cutting Shop
Design Team
Source: Inditex.
99
100
Exhibit 158
1 1 2 A B
Cost Sourcing Options Design Options Style Trends - Fashion Shows - Fashion Media - Street -
Inditex: Peer-to-Peer Teamwork
Sourcing Alternatives
"Faconneur based" - Faconneur A - Faconneur B - Faconneur C - - Faconneur N
C 3 D 4
"Finished Product" - Supplier A - Supplier B - Supplier C - - Supplier N Lead Time
Operations Team
Design Team
Product Decisions
Retail Team
Style Requests
Sales & Order Statistics
Product A Product B Product C Product N
Store A xyz
Store B
Store N
Source: Inditex.
101
Exhibit 159
Inditex: Store-Manager-Centered Assortment Definition
Integrated Central Team: Retail + Design + Operations
Product Orders
Style Requests
Product Availability
Store Manager StoreSpecific Deliveries Standard Assortment Deliveries
Source: Inditex and Bernstein analysis.
We believe that this integrated, peer-to-peer, store-driven organization model gives Inditex important competitive advantages over other apparel and footwear retailers: Precision of execution: The people facing the customer are entrusted with most of the all-important product-range decisions: they are the ones who can know best about what works and what doesnt in their stores, more than anybody sitting at headquarters. Risk-averaging: Commercial success depends on how wisely a large group of people decide, not on the fact that a single or very restricted central team gets collections and assortments right: risk of catastrophic failure is minimized. Flexibility: Product assortment is defined locally by design, hence we can expect Inditex formats that have better ability to travel across markets and adapt to local consumer tastes and competitive environments. As success depends in large part on the quality of the store manager group, and as store managers are protected against poaching as mentioned, they are paid above the industry average, they are given an entrepreneurial and fun job, they are the key part of a winning team Inditexs competitive advantage is defensible and hard to imitate. It is only at this point that having a faonneur-based sourcing model becomes an advantage. In fact, what a faonneur-based sourcing model allows you to do is to get ad hoc specified products quickly. What good is it
102
to have the ability to specify a product to your requirements and have it delivered to your stores in no time, if that product you specified is the wrong product? On the cost side, the faonneur-based sourcing model is disadvantaged versus the finished-product model, as it must rely on closerange third-party manufacturers: complexity and frequency of information and physical-goods exchanges would not allow for a far-flung faonneur network to work practically and economically. In the Inditex case, geographic location allows it to manage a faonneur network which spans Spain, Portugal and Northern Morocco, allowing lower costs than, for example, Italian faonneur networks would imply. Obviously, a faonneur-based sourcing model is also very useful when everybody knows what the right styles are: (1) it allows you to actually get the styles jumping the queue catalogue-based garment providers may be flooded with requests and not be in a position to satisfy all orders quickly; (2) it allows you to tweak the prevailing styles and create your own style one of the scourges of mass-basic and mail-order apparel retailers is product uniformity, as they all buy from the same large-scale Asian garment providers; (3) provided your faonneur network is quasi integrated and well managed, it allows you to protect your styles from being copied by competitors. Peer-to-peer, store-driven assortment definition and faonneur-based sourcing converge to produce a virtuous cycle for Inditex. First, the ability to perceive precisely what is needed for the market turns the ability to source quickly and according to ad hoc specifications into an advantage. Second, the ability to source quickly according to ad hoc specifications allows the most delicate fashion-intensive assortment decisions to be postponed up until the very last moment. This, in turn, improves the ability to precisely determine what products work for the market, as upscale fashion media campaigns and shows, as well as street-based trends can be detected and interpreted (see Exhibit 160).
Exhibit 160
Inditex: Virtuous Cycle
Ability to understand local fashion markets and trends precisely bottom up
Advantage from sourcing garments quickly according to ad hoc specifications
Opportunity to wait longer before deciding the fashionintensive portion of the assortment
The Inditex Way has immediate practical and economic advantages: (1) it allows maximization of full-price sales, as pre-season commitments are reduced to a minimum while stores are (re)supplied with new and bestselling items in-season (see Exhibit 161); (2) it allows minimization of the risks of missing the seasons hot themes, reducing sales variance from one season to the other and smoothing growth (see Exhibit 162).
103
Exhibit 161
The Inditex Way vs. the Traditional Retail Model and the High-Fashion Model
Commitment 6-12 Month Pre-Season 90-100% 45-60% 15-25% Start of Season 98-100% 80-100% 50-60% In-Season 0-2% 0-20% 40-50% Full-Price Sales 40-60% 60-70% 80%+
High Fashion Traditional Retail Inditex Way
Exhibit 162
Inditex vs. H&M: Sales Growth and Standard Deviation

35% 30% YoY Sales Growth 25% 20% 15% 10% 5% Standard Deviation = 8.0 0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Standard Deviation = 5.6
Inditex
H&M
The Inditex Way is more relevant to formats which are: (1) fashionintensive; and (2) rich enough to support European sourcing costs. This has implied so far that the Inditex Way has been used only for Zara, as other formats in the group are less fashion-focused or on a lower price point. Most obvious formats for extending the Inditex Way would be Massimo Dutti and Bershka (see Exhibit 163).
Exhibit 163
Higher
Inditex Way vs. Format Portfolio

Avantgarde Bershka
Fashion Fashion Content Active Lower Classic Lower Stradivarius Pull & Bear Kiddys Class
Zara
Massimo Dutti Higher Price Point
104
Consumers especially women are becoming more and more sophisticated and require less basic and classic products and more fashionoriented styles. Assortment and range are by far the most important purchase and loyalty drivers for apparel, and are both on the way up. We see Inditex having an advantaged capability set to face these consumer trends, which in our view will allow this company to grow and prosper long term more than less-equipped counterparts. (2) Superior Growth Opportunity Short- and Medium-Term. Sales growth has been the primary driver of earnings growth at Inditex, contributing 86% of earnings growth (see Exhibit 164). We expect Inditex to produce superior sales growth going forward, both in its domestic market and abroad sales growth will continue to be a source of superior earnings growth.
Exhibit 164
1,200
Inditex: Drivers of Earnings Growth 2005 vs. 1998

52%
1,000 800 600 400 200 0 1998 Earnings

81% (41)%
7%
Million
650 Million
Sales Growth
Gross Margin
Operating Expenses
Other
2005 Earnings
(a) Domestic market: Inditex is showing superior sales growth momentum. While Inditexs penetration of the Spanish market is very similar to H&Ms penetration of the Swedish market (although Inditex Group penetration in Spain overtook H&M penetration in Sweden during 2005), the trajectory and speed at which this penetration is happening is far superior. We expect Inditex to continue to penetrate the Spanish market at a sustained rate into the foreseeable future (see Exhibits 165 and 166). Inditex is known internationally for its Zara apparel stores, but onethird of its sales depend on seven other non-Zara formats. Inditex has diversified its format portfolio during the past 15 years, both through internally created concepts and acquisitions starting in 1991 with the creation of Pull & Bear and up to 2003 with the birth of Zara Home (see Exhibit 167). Inditex can cover a much broader portion of the Apparel & Footwear market both in terms of age groups, design styles and price points because of its retail formats portfolio (see Exhibits 168 and 169). Having a format portfolio also allows better space to maneuver in competitive confrontations: flanking, pricing, market defense, etc. It is clear for example that the Zara format is not a direct competitor of H&M, while Bershka is. The fact that H&M does not have a counter-format to Zara, while Inditex has one to H&M, creates competitive asymmetry that could be leveraged to the advantage of Inditex in a variety of situations.
105
Exhibit 165
Inditex vs. H&M: Domestic Market Penetration (2004)

Sales Inditex in Spain Zara Non-Zara H&M in Sweden Inditex vs. H&M Surface Area Inditex in Spain Zara Non-Zara H&M in Sweden Inditex vs. H&M Stores Inditex in Spain Zara Non-Zara H&M in Sweden Inditex vs. H&M 2004 Sales ( million) 2,891 1,381 1,510 571 Surface Area (m2) 601,342 292,375 308,967 173,600 No. of Stores 1,461 259 1,202 124 Population (million) 42.7 42.7 42.7 9.0 Population (million) 42.7 42.7 42.7 9.0 Population (million) 42.7 42.7 42.7 9.0 Sales/Population (/head) 67.7 32.4 35.4 63.4 1.1 Surface Area/Pop. (m2/000 pop) 14.1 6.8 7.2 19.3 0.7 Stores/Population (no. stores/mil. pop) 34.2 6.1 28.2 13.8 2.5
Note: H&M stores estimated to be 1,400 square meters; H&M in Sweden and Inditex in Spain. Source: OECD, corporate reports and Bernstein estimates and analysis.
Exhibit 166
Inditex vs. H&M: Domestic Market Sales Penetration (1998-2005)

70 Domestic Market Sales Penetration (/Head) 60 50 40 30 20 10 0 1998 1999 2000 2001 2002 2003 2004 2005
Note: H&M in Sweden and Inditex in Spain. Source: Corporate reports and Bernstein analysis.
H&M 1998-2005 CAGR: 2.6%
Inditex 1998-2005 CAGR: 17.3%
Zara
Non-Zara
106
Exhibit 167
Brand Zara Kiddys Class Origin 1975 (Created) 1990s (Created) 2001 (Split from Zara)
Inditex: Retail Brands and Format Portfolio

Offer W&M Apparel & Accessories; Childrenswear; Cosmetics; Sunglasses Childrenswear & Accessories; Cosmetics; Fragrances W&M Apparel & Accessories W&M Apparel & Accessories; Childrenswear; W Fragrance W&M Apparel & Accessories W Apparel & Accessories; Sunglasses W Lingerie/Hosiery, Swimwear, Homewear Home Textiles; Tableware & Glassware Consumer Focus > 25 Years Children < 12 Years Style Focus Fashion (Formal & Informal) Active (Informal)
Pull & Bear/Often 1991 (Created) Massimo Dutti Bershka Stradivarius Oysho Zara Home 1995 (Acquired) 1985 (Created) 1998 (Created) 1999 (Acquired) 2001 (Created) 2003 (Created)
Teens and < 25 Years Active (Informal) > 25 years Classic (Formal & Informal)
Teens and < 25 Years Avantgarde (Informal) Teens and < 25 Years Fashion (Informal) Teens and < 25 Years Avantgarde > 25 Years Fusion
Note: W = Women; M = Men. Source: Inditex Web site, store checks, corporate reports and Bernstein analysis.
Exhibit 168
Inditex: Retail Formats Brand Positioning
Exhibit 169
Inditex: Price Positioning by Brand Womens Apparel & Accessories (Spring/Summer 2005)
Stradivarius 14.90-24.90 29.90 19.90 29.90-36.00 Zara 16.90 16.90-39.90 29.90-69.00 39.90-79.00 24.90-59.90 24.90-49.90 11.90 4.90-7.90 24.90-99.00 19.90-59.00 14.90 Massimo Dutti 9.90-22.90 29.90-54.90 110-120 39.90-64.90 24.90-64.90 29.90-79.90 49.90-69.90 39.90
Avantgarde Offer Breadth/Design Style
Bershka Zara
Fashion
Stradivarius
Active Classic Product Specialist
Kiddy's Class
Pull & Bear/ Often Massimo Dutti Oysho Zara Home
T-Shirts Tops Dresses Blazers/Jackets Skirts Pants/Jeans Bras Underpants Handbags Shoes/Sandals Sunglasses
32.90-36.00 4.90-16.90
< 12 12-25 > 25 Consumer Age Group (years)

Note: Circled areas = 2005 sales. Source: Inditex Web site, store checks, corporate reports and Bernstein analysis. Note: Prices for Spain. Source: Inditex Web site and Bernstein analysis.
Non-Zara formats have provided a key contribution to Inditex sales growth in Spain, representing a second growth wave after Zara this wave is continuing (see Exhibits 171-176). While in international markets 80% of the 1998-2005 sales increase has been generated by Zara, in Spain this figure is only 37%; 63% of sales growth in Spain between 1998 and 2005 i.e., 1,068 million has been generated by non-Zara formats. This is remarkable, considering that Inditex sales in Spain for 1998 were 872 million, including Zara. Sales growth of non-Zara formats sales in Spain represents 25% of total group sales growth between 1998 and 2005 (almost 40% of total group sales growth, if non-Zara growth abroad between 1998 and 2005 is also considered). Remarkably, non-Zara stores developments are happening at comparable sales effectiveness and profitability levels as that of Zara stores (see Exhibit 170). Consequently, the growth of non-Zara formats has been a ma-
107
jor earnings growth driver for Inditex as a group in the period 1998-2005, and we expect it to continue to be so in the foreseeable future.
Exhibit 170
7,000 6,000 5,000 Sales/m2 4,000 3,000 2,000 1,000 0 Zara
Inditex: Sales Effectiveness by Format (2005)
Average
Kiddy's Class
Pull & Bear
Massimo Dutti
Bershka
Stradivarius
Oysho
Zara Home
Exhibit 171
Inditex: Stores by Format Spain Only

Number of Stores 1998 2005 CAGR 161 259 7% 43 130 17 143 275 10 110 211 10 32 212 31 205 na 93 na 76 na 489 1,461 17% Delta Stores Number Pct 98 10% 87 9 132 14 101 10 180 19 205 21 93 10 76 8 972
Exhibit 172
Inditex: Sales by Format Spain Only ( million)

1998 655 35 80 80 22 Sales 2005 1,381 134 297 290 374 282 73 60 2,891 CAGR 11% 21 21 20 50 na na na 19% Delta Sales Pct Million 726 36% 99 5 217 11 210 10 352 17 282 14 73 4 60 3 2,019
Zara Kiddys Class Pull & Bear/Often Massimo Dutti Bershka Stradivarius Oysho Zara Home Total
Zara Kiddy's Class Pull & Bear/Often Massimo Dutti Bershka Stradivarius Oysho Zara Home Total
872
Exhibit 173
Inditex: Stores by Format International Only

Number of Stores Delta Stores 1998 2005 CAGR Number Pct 149 593 22% 444 46% 2 19 38 17 2 55 152 16 97 10 46 158 19 112 12 7 156 56 149 15 58 na 58 6 61 na 61 6 34 na 34 3 259 1,231 25% 972
Exhibit 174
Inditex: Sales by Format International Only ( million)

1998 675 30 35 4 Sales 2005 3,060 22 148 243 265 59 34 18 3,849 CAGR 24% na 26 32 82 na na na 27% Delta Sales Million Pct 77.0% 2,385 22 0.7 118 3.8 208 6.7 261 8.4 59 1.9 34 1.1 18 0.6 3,105
744
108
Exhibit 175
Inditex: Stores by Format All Markets

Number of Stores Delta Stores 1998 2005 CAGR Number Pct 310 852 16% 542 28% 45 149 19 104 5 198 427 12 229 12 156 369 13 213 11 39 368 38 329 17 263 na 263 14 154 na 154 8 110 na 110 6 748 2,692 20% 1,944
Exhibit 176
Inditex: Sales by Format All Markets ( million)

1998 1,330 35 110 115 26 Sales 2005 4,441 155 445 534 639 341 107 78 6,741 Delta Sales CAGR Million Pct 3,111 19% 61% 24 120 2 22 335 7 25 419 8 58 613 12 na 341 7 na 107 2 na 78 2 23% 5,125
1,616
(b) International markets: We expect Inditex to enjoy superior growth momentum in international markets in the foreseeable future. To start with, Inditex has created an impressive number of international beachheads, entering approximately 60 different countries by the end of the FY 2005. Inditexs international performance is very satisfactory, both in terms of sales and store development. Inditex is now appropriately shifting gears in its international strategy focusing on the key European markets, buying out franchising and JV partners in strategic markets where practicable. The fact that Inditexs international sales are still a relatively small portion of its total sales, and international market penetration is still relatively low and geographically unbalanced should be understood as a major growth opportunity for Inditex. We are convinced this opportunity will materialize over the medium term. Inditex has been significantly more aggressive than H&M in entering foreign markets. While the Swedish retailer historically has chosen a paced approach, moving one market at a time and focusing on deepening penetration in the markets addressed, Inditex has maximized the width of its international front (see Exhibits 177 and 178).
Exhibit 177
70 65 60 55 50 45 40 35 30 25 20 15 10 5 0 1991 1992
Inditex vs. H&M: Number of Countries Where Present
Exhibit 178
400 Sales/Country ( million) 350 300 250 200 150 100 50 0 1991
Inditex vs. H&M: Sales per Country International Only
No. of Countries
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Inditex
H&M
Inditex
H&M
Note: Inditex includes Zara and other group banners. International includes all markets except home market. Source: Corporate reports and Bernstein analysis. Source: Corporate reports and Bernstein analysis.
2005
109
Possibly in part due to Inditexs international success, H&M has in recent years accelerated its foreign expansion, opening multiple international fronts in parallel and most recently deviating from its rule of 100% directly-managed operations with a franchising agreement for the Middle East (see Exhibit 179). Management at H&M also plans to run trials on different store formats (announced at the 1H:06 results), which in effect mimics the approach Inditex has adopted over the last 10 years to increase penetration in existing markets.
Exhibit 179
H&M: Geographic Development Expansion Waves
1 Scandinavia Sweden Norway Denmark 2 West Europe First Wave United Kingdom Switzerland Germany 1947 1964 1967
1976 1978 1980
3 European/Scandinavian Branch-Out Netherlands 1989 Belgium 1992 Austria 1994 Luxembourg 1996 Finland 1997 6 East Europe Inroad Poland 2003 Czech Rep. 2003 Slovenia 2004 Hungary 2005 4 West Europe Second Wave France Spain Portugal Italy Ireland 1998 2000 2003 2003 2005 5 North America Inroad United States 2000 Canada 2004
Inditex international strategy initially aimed to maximize the width of its expansion front. A flexible approach to directly managed involvement has been chosen to this end, leveraging franchising agreements in minor markets, and three joint ventures for the key markets of Japan, Germany and Italy.
110
More recently, Inditex has moved to gain a more direct involvement in larger international markets (see Exhibits 180 and 181): Acquired 100% of joint venture in Japan (December 14, 2005) Acquired 100% of franchising operations in Russia (January 31, 2006) Agreed 80% acquisition of franchising operations in Poland (April 15, 2005) Acquired 100% of Massimo Dutti franchise in Mexico (January 12, 2005)
Exhibit 180
Inditex: Directly-Operated Stores, by Geography

DirectlyOperated Stores 1,287 165 103 102 57 41 37 36 27 25 14 13 12 12 12 10 9 7 6 5 5 5 4 4 2 2 2 2 1 1 1 2,009 90% Population (million) 41.0 10.0 102.0 59.8 11.0 59.1 57.5 82.4 10.3 25.2 291.0 176.3 127.5 31.3 70.3 7.2 16.1 38.6 8.1 38.0 8.9 15.6 5.4 144.1 10.2 9.9 3.4 0.4 7.0 4.5 3.9 1,476 24% GDP ($ billion) $880 183 915 1,610 206 1,545 1,520 2,233 284 136 10,403 1,370 3,435 923 449 216 469 408 237 413 232 153 167 1,186 161 133 27 24 188 165 72 30,342 63% Stores/100 ($ billion) $146.3 90.3 11.3 6.3 27.7 2.7 2.4 1.6 9.5 18.4 0.1 0.9 0.3 1.3 2.7 4.6 1.9 1.7 2.5 1.2 2.2 3.3 2.4 0.3 1.2 1.5 7.5 8.2 0.5 0.6 1.4 $6.6
Exhibit 181
Inditex: Franchised Stores, by Geography

Franchised Population Stores (million) 41 10.0 34 41.0 26 23.5 25 6.3 16 2.9 12 10.3 11 2.4 10 0.8 8 3.9 7 3.6 5 5.3 5 0.4 4 0.6 3 24.0 3 5.2 3 4.2 3 0.7 3 0.1 2 22.4 2 30.1 2 2.0 1 16.1 1 5.4 1 8.6 1 3.5 1 6.4 1 0.4 1 2.3 1 3.1 1 1.3 1 0.3 235 247 10% 4% GDP ($ billion) $183 880 297 123 65 284 39 15 142 16 22 7 12 219 136 101 12 2 147 115 37 469 69 57 36 31 24 21 19 16 9 3,605 7% Stores/100 ($ billion) $22.4 3.9 8.7 20.3 24.6 4.2 28.2 68.1 5.6 44.6 22.4 70.9 33.6 1.4 2.2 3.0 25.0 157.9 1.4 1.7 5.4 0.2 1.4 1.8 2.8 3.2 4.1 4.7 5.2 6.3 11.2 $6.5
Country Spain1 Portugal1 Mexico France Greece United Kingdom Italy2 Germany3 Belgium1 Venezuela United States Brazil Japan Canada Turkey Switzerland Netherlands1 Poland Austria Argentina Sweden Chile Denmark Russian Federation Czech Republic Hungary Uruguay Luxembourg1 Hong Kong Norway Puerto Rico Total Pct of World Total
Country Portugal1 Spain1 Saudi Arabia Israel United Arab Emirates Belgium1 Kuwait Cyprus Ireland Lebanon Jordan Malta Qatar Malaysia Finland Singapore Bahrain Andorra Romania Morocco Slovenia Netherlands1 Slovakia Dominican Republic Lithuania El Salvador Luxembourg1 Latvia Panama Estonia Iceland Total Pct of World Total
1 Markets with both Direct and Franchising operations. 2 Italy is an 80% owned joint venture. 3 Germany is a 50% owned joint venture. Source: United Nations, Inditex Web site, corporate reports and Bernstein estimates and analysis.
1 Markets with both Direct and Franchising operations.
Source: United Nations, Inditex Web site, corporate reports and Bernstein estimates and analysis.
Franchising currently accounts for 10% of the stores and is concentrated on four brands: Massimo Dutti, Zara, Stradivarius and Pull & Bear (see Exhibit 182).
111
Exhibit 182
Inditex: Directly-Operated Stores and Franchised Stores, by Brand (2005)

DirectlyOperated Stores 770 149 380 275 351 208 149 100 2,382 Franchised Stores 82 0 47 94 17 55 5 10 310 Share DirectlyOperated Franchised Stores Stores 90% 10% 100 0 89 11 75 25 95 5 79 21 97 3 91 9 88 12%
Total 852 149 427 369 368 263 154 110 2,692
26% 0 15 30 5 18 2 3 100
Inditexs international expansion has been successful. International sales and international stores have been growing at a higher rate than sales and stores in Spain in the past seven years. In most markets, stores are growing between 10% and 20% per year (see Exhibits 183 and 184).
Exhibit 183
Inditex: Domestic vs. International Growth ( million)

Spain 1998 1999 2000 2001 2002 2003 2004 2005 CAGR Sales 872 1,058 1,239 1,495 1,828 2,120 2,115 2,905 18.8% Stores 489 603 692 769 918 1,130 1,321 1,461 16.9% International Sales Stores 259 743 977 319 1,376 388 1,755 515 2,146 640 2,479 792 3,555 923 3,835 1,225 26.4% 24.9%
Exhibit 184
New Stores/Year (1998-2004)1 150
New-Stores Growth, by Geography

+30% +20% +10% / Year Portugal UK Greece Belgium Mexico France
Spain Italy D
20 10 5 2 1 0.5 0.2
Russia
S Czech 2 Lux 5
Canada Venezuela J Brazil PL US Austria
10
20
50 100 Number of Stores (2004)
250
1,000
3,000
Directly-Operated Stores
1 Time frame is shorter where market was entered after 1998. Source: Corporate reports and Bernstein analysis.
Franchised Stores
112
We judge that the current overexposure Inditex has in its Spanish domestic market (see Exhibit 151) is not a function of weaker international ability, but of exceptional market-penetration skills leveraging a superior organization model and a strong-format portfolio. Likewise, we are not concerned about the overexposure in secondary markets coming from an initial tumultuous and opportunistic development phase, when width maximization of Inditexs international front seemed a priority (see Exhibits 185 and 186 and Appendix 1). Inditex today has a strong platform in place for significant international growth short term: establish market beachheads, direct operations in key markets and more recently a focused push program into Europe.
Exhibit 185
Inditex: Zara Stores by Market Cluster at January 31, 2005

Cluster 1 2 3 4 5 Portugal Spain Total Countries 6 14 28 17 110 1 1 177 GDP $ Billion Percent $20,746 42.9% 3,637 7.5 3,139 6.5 15,753 32.6 4,030 8.3 $183 880 $48,368 0.4% 1.8 100.0% Stores Number Percent 199 27.5% 60 8.3 89 12.3 61 8.4 32 4.4 40 242 723 5.5% 33.5 100.0% Index vs.: GDP Non-Zara 103 280 177 88 304 73 42 53 85 48
Note: Store data correct at end-2005. Source: United Nations, corporate reports and Bernstein analysis.
Exhibit 186
Inditex: Non-Zara Stores by Market Cluster at January 31, 2005

Cluster 1 2 3 4 5 Portugal Spain Total Countries 6 14 28 17 110 1 1 177 GDP $ Billion Percent $20,746 42.9% 3,637 7.5 3,139 6.5 15,753 32.6 4,030 8.3 183 880 $48,368 0.4% 1.8 100.0% Stores Number Percent 44 2.9% 42 2.8 75 4.9 71 4.7 41 2.7% 166 1,082 1,521 10.9% 71.1 100.0% Index vs.: GDP Zara 37 36 200 113 414 136 78 188 176 207
Note: Store data correct at end-2005. Source: United Nations, corporate reports and Bernstein analysis.
What is particularly relevant in the case of Inditex, we believe, is the vast space it has to fuel superior growth rates long term. For example, if we just take European countries where Inditex is currently present and imagine increasing penetration there to (a) 100% of current DOS penetration in Greece; (b) 50% of current DOS penetration in Portugal; and (c) 33% of current penetration in Spain, we obtain a potential for new stores equivalent to (1) 1.31 times the 2,009 DOS existing in 2004, or another 2,636 new stores; (2) 1.76 times, or another 3,545 new stores; and (3) 2.44 times, or another 4,911 new stores. And this does not include any further growth in Spain, Portugal, America and Asia (see Exhibit 187).
113
Exhibit 187
Inditex: Long-Term Potential for New Stores in Europe Three Scenarios

DirectlyOperated Population GDP Stores (million) ($ billion) 1,287 41.0 $880 165 10.0 183 57 11.0 206 27 10.3 284 2 0.4 24 102 59.8 1,610 10 7.2 216 41 59.1 1,545 6 8.1 237 37 57.5 1,520 4 5.4 167 5 8.9 232 9 16.1 469 7 38.6 408 36 82.4 2,233 2 9.9 133 2 10.2 161 1 4.5 165 4 144.1 1,186 103 102.0 915 25 25.2 136 14 291.0 10,403 13 176.3 1,370 12 127.5 3,435 12 31.3 923 12 70.3 449 5 38.0 413 5 15.6 153 2 3.4 27 1 7.0 188 1 3.9 72 2,009 1,476 $30,342 90% 24% 63% Stores/ 100 ($ bil.) $146.3 90.3 27.7 9.5 8.2 6.3 4.6 2.7 2.5 2.4 2.4 2.2 1.9 1.7 1.6 1.5 1.2 0.6 0.3 11.3 18.4 0.1 0.9 0.3 1.3 2.7 1.2 3 7.5 0.5 1.4 $6.6 New Stores Potential 100% 40% 33% Penetration Penetration Penetration in Greece in Portugal in Spain in 2004 in 2004 in 2004
Country Spain1 Portugal1 Greece Belgium1 Luxembourg1 France Switzerland United Kingdom Austria Italy2 Denmark Sweden Netherlands1 Poland Germany3 Hungary Czech Republic Norway Russian Federation Mexico Venezuela United States Brazil Japan Canada Turkey Argentina Chile Uruguay Hong Kong Puerto Rico Total Pct of World Total
0 52 5 344 50 387 60 384 42 59 121 106 582 35 43 45 324
17 76 7 479 68 517 79 512 56 79 160 140 770 46 56 58 424
43 111 10 683 95 713 109 704 77 108 219 192 1,053 63 76 79 574
2,636 131%
3,545 176%
4,911 244%
1 Markets with both Direct and Franchising operations. 2 Italy is an 80%-owned joint venture. 3 Germany is a 50%-owned joint venture. Source: United Nations, company Web site, corporate reports and Bernstein estimates and analysis.
H&M, more established in its European expansion, has demonstrated it is possible to increase international penetration over time to levels comparable to its domestic market (see Exhibit 188).
114
Exhibit 188
H&M: Market Penetration vs. Geographic Expansion Wave (2005)

7 6 USA Expansion Wave 5 4 3 2 1 0 0.01 UK I CDN P F E NL SF B A D CH S PL SLO CZ Average: x = 0.14
DK N
0.10 1.00 Market Penetration (No. of Stores per 100,000 Population)
10.00
Note: Circled areas = 2005 sales. Source: Corporate reports and Bernstein analysis.
The Scandinavian core (Sweden, Norway, Denmark) has reached between 1.0 and 1.5 stores/100,000 inhabitants. The larger and more-competitive German and UK markets where new stores are still being added (one-third of all new stores opened in 2004 were in Germany and the United Kingdom) have reached 0.33 and 0.15, respectively. Switzerland, part of the first European wave, is at 0.64 (and close to maturity); other smaller branch-out markets have also reached significant penetrations: Austria: 0.63, Belgium: 0.42, Netherlands: 0.41 and Finland: 0.46. The last waves have still important space for growth: Southern Europe is below 0.10 (France is at 0.11); Eastern Europe is below 0.10; and United States and Canada are at 0.02-0.03. (3) Scope for Performance Improvement (a) SG&A: We expect SG&A at Inditex to significantly improve going forward as Inditex focuses on increasing penetration in European markets and developing its beachheads into significant-sized businesses. When Inditex announced that the United States will not be a development priority for the moment, we viewed this as a signal of more positive SG&A dynamics in the future. SG&A at Inditex has significantly increased in the past seven years, moving from 33% in 1997 to 37.2% in 2004 (see Exhibit 189).
115
Exhibit 189
Inditex: SG&A Dynamics (1997-2005)

SG&A (Percentage of Sales) 30% 25% 20% 15% 10% 5% 0% 1997 1998 1999 2000 2001 2002 2003 2004 2005 Employee Expenses Depreciation & Amortization Operating Leases Other SG&A
Note: SG&A = Operating Expenses + Depreciation & Amortization. Source: Corporate reports and Bernstein analysis.
Depreciation and amortization have virtually remained constant in percentage terms over the years. Employee expenses have increased on a unit basis, and have edged higher as a percentage of sales in the most recent year, although remaining less than 15.5% in 2005 (see Exhibits 190 and 191).
Exhibit 190
20,000 19,000 18,000 17,000 16,000 15,000 14,000 13,000 12,000 11,000 10,000
Inditex: Personnel Costs/Average Employee
Exhibit 191
16.0%
Personnel Costs (Percentage of Sales)
15.5%
15.0%
14.5%
14.0%
13.5%
1997
1998
1999
2000
2001
2002
2003
2004
2005
1997
1998
1999
2000
2001
2002
2003
2004
What has increased significantly is other SG&A. In fact, it has almost doubled, moving from 8.9% in 1997 to 16.3% in 2004 (see Exhibit 192).
2005
116
Exhibit 192
Inditex: Increase in Other SG&A

Year 1997 1998 1999 2000 2001 2002 2003 2004 2005 Other SG&A (Pct of Net Sales) 8.9% 10.8 12.3 12.2 12.9 13.9 14.9 16.3 18.3 Other SG&A Index 100 121 139 137 145 157 168 184 206
A clear correlation emerges between the DOS installed base abroad and other SG&A expenses (see Exhibit 193). We believe that the surging other SG&A expenses are in large part an implicit cost of the wide front expansion strategy.
Exhibit 193
Inditex: Total DOS Abroad vs. Other SG&A

1,300 Other SG&A ( million) 1,100 900 700 500 300 1999 1998 300 500 2002 2001 2000 2003 2004 2005
R = 92% 700 900
100 100
Number of New DOS Abroad

First of all, a thin presence in many countries puts a retailer at a disadvantage in leveraging flagship store investments. When entering a new market, fashion-oriented retailers will establish their first few stores in the most visible and trendiest commercial locations, i.e., Fifth Avenue in New York City; Oxford Street in London; Champs Elyses in Paris; Corso Vittorio Emanuele II in Milan, etc. The idea is that being in the right locations can project a brand in consumers minds quickly, especially for those companies relying exclusively on word-of-mouth communication. This of course is not free of charge, as prime locations are significantly more expensive than the average (see Exhibits 194 and 195). The logic, though, is to expand deeper into the market, covering more and more locations and averaging-out flagship-store costs. No deeper market penetration equals no leverage of flagship-store costs. The key difference between H&M and Inditex at this stage of their international expansion is not so much that Inditex has a cheaper domestic market (see Exhibit 196), but that H&M is much more penetrated in the markets where present (see Exhibit 197).
117
Exhibit 194
9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0
Lease Cost: Top Retail Locations in France and the United Kingdom
Gap = 71% Gap = 64%
Exhibit 195
9,000 8,000 Lease (/m2/year) 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0
Lease Cost: Top Retail Locations in North America

Gap = 88%
Lease (/m2/year)
Oxford St
Covent Gdn
Blvd. Haussmann
Manchester
Glasgow
Lyon
Champs lyses
Fbg St Honor
Brompton Rd
Birmingham
Edinburgh
Bond St
Leeds
LA Rodeo Drive
Chicago N Mich. Ave.
NYC Madison Ave.
NYC Union Square
Note: Gap = (1 Lower-Cost Location)/Higher-Cost Location. Source: Jones La Salle and Cushman & Wakefield.
Note: Gap = (1 Lower-Cost Location)/Higher-Cost Location Source: Cushman & Wakefield.
Exhibit 196
Lease Cost: Prime Locations in Europe

5,000 4,500 Lease (/m2/Year) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500
Paris Dublin London Moscow Munich Milan Madrid Barcelona Copenhagen Amsterdam Luxembourg Prague Budapest Brussels Stockholm Helsinki Warsaw
Source: Jones La Salle and Cushman & Wakefield.
Exhibit 197
H&M vs. Inditex: Penetration of Cluster 1 and Cluster 2 (Stores/Market, 2004)

Cluster 1 Germany France United Kingdom United States Italy Cluster 1 Japan Cluster 1 Cluster 1 + 2 Note: See Appendix 1 for clusters definition; excluding domestic market. Source: Corporate reports and Bernstein analysis. H&M 269 64 91 75 3 502 502 Inditex 36 102 41 14 37 230 12 242 Ratio 7.5 0.6 2.2 5.4 0.1 2.2 2.5 Cluster 2 Norway Netherlands Belgium Switzerland Denmark Austria Canada Luxembourg Cluster 2 H&M 75 66 44 47 53 51 6 7 349 851 Inditex 1 9 27 10 4 6 12 2 71 301 Ratio 75.0 7.3 1.6 4.7 13.3 8.5 0.5 3.5 4.9 3.0
Boston Newbury St.
NYC 5th Ave.
NYC E 57th St.
Toronto Bloor St.
118
Taking into account only nondomestic Cluster 1 and Cluster 2 markets where both companies have directly-operated stores (i.e., the markets where we can expect significant rental costs as well as steep slopes between flagship store costs and average commercial costs), H&M is three times larger than Inditex in terms of average number of stores per market. Second, most obviously thin international presence translates also into limited scale economies on geographically-driven fixed costs: management and coordination, store location search, communication, etc. In this light, Inditex-scale disadvantage versus H&M in international markets is approximately one to five. Assuming H&M has 1% of net sales of geographically driven fixed costs and a slope of 75% on these costs all else being equal this would imply Inditex would have a cost disadvantage versus H&M of 0.95% of sales. Third, one disadvantage of the Inditex Way is that it does not travel well to the United States. As Inditex relies more on European sourcing, and as European textile imports into the United States are subject to import duties, Inditex is at a structural disadvantage versus retailers sourcing most of their production from Mexico or other international markets enjoying preferential import treatment into the United States (see Exhibit 198).
Exhibit 198
Impact of Sourcing Costs and Duties of Imported Apparel to the United States
EU Cotton T- Shirts Sourcing Duty COGS Gross Margin Retail Price Index 8 16.5% 9.32 0.5 18.64 166 Mexico 5.6 0 5.6 50% 11.2 100 19% 17 12 6 5 0% 0 Cotton Trousers Sourcing Duty COGS Gross Margin Retail Price Index EU 20 16.1% 23.22 0.5 46.44 194 Mexico 12 0 12 50% 24 100 9% 8 8 7 6 0% 0
Top Five Exporters to the U.S., 2005 ($ million) Honduras $643.9 Mexico 570.1 El Salvador 398.6 Dominican Republic 188.7 China 154.1 $3,424.2 Total Spain Italy $0.5 14.0
Top Five Exporters to the U.S., 2005 ($ million) Pakistan $21.4 Mexico 19.8 Honduras 17.9 China 16.4 El Salvador 13.6 $236.5 Total Spain Italy $0.01 0.44
Note: Retail price is theoretical ; EU importers would operate at lower margins. Source: U.S. International Trade Commission and Bernstein estimates and analysis.
Exhibit 199
Zara: Price Positioning in Major Markets (Spring/Summer 2005)

Spain France Portugal Mexico Germany United Kingdom Greece Italy United States Sweden Stores 241 83 40 34 33 33 33 23 14 2 Price Index 100 135 100 126 135 149 109 135 148 140
Note: Average list price of 106 garments/accessories. Source: Company Web sites and Bernstein analysis.
119
(b) Cost of Goods Sold: Inditex should be in a good position on the cost-of-goods-sold side, both short term and longer term. Short term, Inditex is less exposed to Chinese sourcing and should be suffering little negative impact from the reintroduction of import quotas. After 2008 and longer term, Inditex could have the opportunity to marginally increase its sourcing from China and/or create a smaller-sized version of its operations and product platform abroad (Mexico? China?) to reduce COGS and boost its international expansion outside of Europe. The impact from the elimination of quotas on apparel and textiles on January 1, 2005, has been massive. In the first four months of 2005 import volumes of core apparel categories from China into the EU (e.g., T-shirts, pullovers, blouses, stockings, socks, trousers, dresses, suits, bras, etc.) have increased by almost 200%, unit prices have gone down by 20%, net value has gone up by 136% (reference H&M section, Exhibit 124). This was the combined effect of Chinese companies fighting to increase their export business in the post-MFA (Multi-Fiber Arrangement) world, and European Apparel & Footwear retailers buying into the opportunity of saving on their sourcing costs (reference H&M section, Exhibits 125 and 126). The reintroduction of quotas risks changing the picture. China and the EU have signed a three-year transitional MOU on June 10, 2005, that came into effect on July 12, 2005, and will expire at the end of 2008. Under this agreement, China will limit the increase of its textile and clothing exports into the EU to 8.0-12.5% per year in 10 sensitive product categories, six of which are core product categories of mass-fashion retailers like H&M (reference H&M section). It is fair to assume that the safeguards introduced will dampen aggressive price behavior on the part of Chinese exporters. At the moment, it is too early to have conclusive evidence of steeper import prices, because of: (a) product seasonality (Spring/Summer versus Fall/Winter), (b) only four weeks of data; and (c) end-of-year Chinese holidays (reference H&M section, Exhibit 129). But, as quota fill rates are rising fast, it is fair to assume import price inflation during 2006. This development promises to curb gross margin of European apparel retailers in 2006 and beyond. On the other hand, we reckon that Inditex will be suffering little negative impact, as it is less exposed to non-European and Chinese sourcing than other international Apparel & Footwear retailers. In comparison to H&M, for example, Inditex has benefited significantly less in 2005 from quota elimination (reference H&M section, Exhibit 128). Forecast Sales growth at Inditex is more a function of how hard the company pushes on the new-stores lever, than anything else. We assume a growth rate ranging from 20.3% in 2005 (fiscal-year ended January 31, 2006) to 14.8% in 2010 (fiscal year ending January 31, 2011). This puts us slightly above-consensus average for turnover growth. Where we are more optimistic than consensus is on the operating-profit and net-earnings estimates, which are at the very high end of consensus for 2007 (fiscal year ending January 31, 2008) and above-consensus average for 2007 (fiscal year ending January 31, 2008). The reason is that we expect better SG&A cost leverage from sales growth focus in Europe and marginally better COGS results (see Exhibits 200 and 201).
120
Exhibit 200
12,000
Inditex: Sales Forecast Bernstein vs. Consensus
Exhibit 201
1,400 Net Earnings ( million) 1,200 1,000 800 600 400 200 0
Inditex: Earnings Forecast Bernstein vs. Consensus
10,000 Sales ( million) 8,000 6,000 4,000 2,000 0 Jan 2007 Bernstein Consensus High Jan 2008 Consensus Low
Jan 2007 Bernstein Consensus High
Jan 2008 Consensus Low
Source: Bloomberg L.P. and Bernstein analysis.
Source: Bloomberg L.P. and Bernstein analysis.
121
M&S: Fighting Structural Decline

Overview Marks & Spencer (M&S) remains a British institution, highly respected by the market and consumers alike. Market expectations for M&S, nevertheless, are unreasonable. Anticipation of a structural relaunch, capable of erasing 15 or 20 years of competitive and consumer history, is illusory. In our view, M&S will never again achieve the dominance of the UK retail market that it once enjoyed and must start to embrace the challenges that lie ahead. M&S will proportionately be increasingly a food retailer as its food business grows while it loses its grip on the apparel and accessories market. This will make M&S a structurally less-profitable business. The current relaunch, fuelled with short-term and one-off actions, will increase earnings in the short term, but will not be capable in our opinion of inverting M&Ss decline in its apparel and accessories business. As short-term actions fade, earnings growth will again become a problem, prompting a downward correction to the M&S share price. The whole notion of going back to normal earnings requires that, first, a business has been badly managed and can now be managed better, and second, that the market and competitive environment are relatively constant. While we wont take issue with how Stuart Rose and his team have performed versus their predecessors, we contend that the UK Apparel & Footwear retailing market is now very different from five years ago, let alone 10 years ago. In the past five years for example discounters have increased market share from 10% to 15% and represent an increasing force to be reckoned with. Primark for one has grown dramatically and is planning to open its largest store ever on Oxford Street in London, just across from the M&S flagship. In Apparel & Footwear retailing, the market does not stand still. We expect mass-fashion and discounter growth to continue and thus predict that going forward, M&S will find it increasingly hard to maintain its market share, especially within the younger population segments, let alone go back to where it was 10 years ago. We are impressed by the good work that Stuart Rose and the new Marks & Spencer management team have done in the past 18 months: cutting costs, renegotiating terms with suppliers, adjusting the apparel offer price mix and relaunching the brand. The buzz around M&S has not been so positive for quite a time. The price of the M&S stock has reflected this: at 6.58 (October 11, 2006) the stock is more than 90% higher than the failed Philip Green/Revival Acquisitions bid price and almost 106% higher than the 2005 bottom of 3.19 (see Exhibit 202).
There May Be Trouble Ahead
122
Exhibit 202
8 7 Stock Price 6 5 4 3 2 May-03
M&S: Stock Price vs. MSCI Europe
Philip Green Bid
May-04
May-05
May-06 2004
Nov-03
Nov-04
Nov-05
Sep-03
Mar-03
Sep-04
Jan-03
Mar-04
Sep-05
Jan-04
Jul-03
Jul-04
Mar-05
Jan-05
Mar-06
Jan-06
Jul-05
M&S
MSCI Europe
The market seems to have a need to believe in an M&S relaunch story. Maybe one explanation for this is in the opening sentence of the 2001 Chairmans Statement. Luc Vandevelde wrote: One of the most revealing things about my first full year at Marks & Spencer was that almost every action or announcement has received front page and prime television news coverage. This is a powerful reminder to me of how important Marks & Spencer is to the British people, how close to the nations heart we really are. As much as we need to believe, history tells a different story. Since February 1986, the cumulative return of the MSCI Europe Index has been 2.5 times higher than that of M&S stock. M&S stock has under-performed the market in nine of these 20 years (see Exhibit 203).
Exhibit 203
125 100 Delta Price Performance (percentage points) 75 50 25 0 (25) (50) (75) 1986 1987 1988 1989
M&S: Annual Relative Return vs. MSCI Europe
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Jul-06 2005
Note: From February 20, 1986. Source: FactSet and Bernstein analysis.
The last consistent period of outperformance was in the early 1990s, between 1989 and 1993. After 1993 excluding 1997, 2002 and 2004, when it performed in line or slightly better than the market M&S stock has con-
123
sistently underperformed 2001 and 2005 have been the two notable exceptions. Both peaks 2001 and the current one were generated by the market buying into M&S relaunch stories. Modestly, we think that the future speaks against believing, too. As much as we respect the M&S brand and the work that Stuart Rose and the new management team are doing, we are convinced that the current stock price surge is driven more by the need to believe in an M&S resurrection, than by a cold-blooded analysis of facts and likely future developments. In fact, we see trouble ahead in the shape of lower-than-consensus earnings growth (see Exhibit 204).
Exhibit 204
10,000 9,500 9,000 8,500 8,000 7,500 7,000 6,500 6,000 5,500 5,000 2006
M&S: Sales and Net Earnings Forecast

Sales
1,000 900 800 700 600 500 400 300 200 100 0 2006 2007 Bernstein Low 2008 High
Net Earnings
Million
2007 Bernstein Low
2008 High
Note: Consensus data at March 6, 2006. Source: I/B/E/S and Bernstein estimates and analysis.
But for Now, Theres Music and Moonlight, Love and Romance
Music, moonlight, love and romance are not going to last. The recent tactics and the execution of the M&S management team have been first class, but M&S is facing overwhelming structural changes in the market that work against it and its earnings prospects. We see four major reasons for pessimism: M&S is losing its grip in apparel against better and better competitors discounters, mass-fashion and runner-ups are all gaining share and consumer relevance; M&S is diluting its business by growing more and more in food: a structurally less-profitable business than apparel retailing. With the grocers hot on its heels, M&S has to run to stand still; M&S has an inherently higher cost structure and lower performing format than best-in-class mass-fashion and differentiated competitors this, if not corrected, will put it at a disadvantage in the competitive game; and M&Ss opportunity to grow both abroad and in the United Kingdom is limited: the middle-of-the-road niche virtually always already occupied abroad, late in the game in the overcrowded UK environment.
Million
124
(1) Losing Grip in Apparel: The UK Apparel & Footwear retailing market has structurally changed in the past five to 10 years, becoming significantly more difficult and competitive (see Exhibit 205). Next has established itself as a solid No. 2 player, building over time on its initial unconventional appeal to become the updated mainstream alternative to Marks & Spencer; Next was 3.8% of the market in 2001 and 5.6% in 2005, a growth of 180 basis points. Value retailing has taken the UK Apparel & Footwear market by storm, driven by a tough core of grocery retailers and specialist discounters grocers and discounters went from 10.5% to 15.5%, a growth of 500 bp. Multiple retailing has gone through significant renewal: mass-basic retailers have gone down, while mass-fashion players have increased their market share overall, clothing multiples and sports shops have gone from 29.0% to 28.8%, i.e., (20) bp (see Exhibit 206). Multicategory stores have suffered excluding M&S, department stores have gone from 8.8% to 8.0% while general stores have moved from 4.7% to 4.0%, in total a decline of 150 bp. Traditional channels have so far been hit the hardest: mail order, independents and other more established outlets like market stalls and traditional Cash & Carry have lost a significant part of the market the traditional channel has gone from 32.1% to 27.6%, i.e., negative 450 bp. In this context, Marks & Spencer has moved from 11.1% to 10.5%, already a remarkable achievement in our view as the market share percentage loss has been contained to less than half that of other multicategory stores.
Exhibit 205
UK Apparel & Footwear Retail Market 2001 vs. 2006

52 Weeks Ended: Delta 3/11/01 3/5/06 Basis Points 10.5% 16.8% 630 3.7 6.4 270 6.8 10.4 360 3.8 5.9 210 29.0 29.0 0 19.6 18.9 (70) 9.4 10.1 70 11.1 10.2 (90) 13.5 11.7 (180) 8.8 8.1 (70) 4.7 3.6 (110) 32.1 26.4 (570) 9.7 8.4 (130) 8.6 6.1 (250) 4.5 4.4 (10) 1.7 1.7 0 1.4 1.0 (40) 2.9 2.7 (20) 3.3 2.1 (120) 100.0% 100.0% 26.4 30.3 Pct 47.6% 73.0 52.9 55.3 0.0 (3.6) 7.4 (8.1) (13.3) (8.0) (23.4) (17.8) (13.4) (29.1) (2.2) 0.0 (28.6) (6.9) (36.4)
Exhibit 206
UK Apparel & Footwear Retail Multiples Winners and Losers

Market Share 52 Weeks 52 Weeks Ended Ended 3/11/01 3/06/06 1.1% 1.5% 1.5 1.5 1.5 1.5 1.1 3.2 1.8 1.0 1.1 0.8 3.7 2.2 Delta
Value Retailers Grocers Discounters Next Differentiated Retailers Clothing Multiples Sports Shops Marks & Spencer Multicategory Stores Department Stores General Stores Traditional Channels Clothing Independents Mail Order Footwear Multiples Footwear Independents Market Stalls Other Outlets Cash & Carry Total (%) Total ( billion)
River Island Top Shop H&M Zara Littlewoods Dorothy Perkins Burtons Debenhams New Look
0.4% 0.0 0.4% (0.5) (0.4) (0.3) 0.5 0.4
(0.3)
Source: TNS and Bernstein analysis.
Source: TNS and Bernstein estimates and analysis.
This momentous shift in channel shares and within the clothing multiples channel has not happened by chance or because incumbents have allowed themselves to get distracted and distanced from the market. Value retailers and mass-fashion retailers are growing because they have substantial and defensible competitive advantages. Value retailers have a superior cost structure, associated in the case of grocery retailers with traffic
125
synergies. Mass-fashion retailers have superior capabilities in designing, sourcing and bringing their product range to market. Neither of these qualities can be replicated overnight. We see these same competitive dynamics continuing to play out into the future. M&Ss opportunity for a revival in Apparel & Footwear is limited by the strength, ability and structural characteristics of its opponents. In this changing and new competitive context, we are convinced that a sustainable and profitable market-share regain for M&S is unlikely. M&Ss market share of the UK Apparel & Footwear market has been on a constant downward trend for the past 10 years (see Exhibit 207). M&Ss share loss has been most notable in lower-consumer-involvement categories where value retailers have grown the most childrenswear is a case in point (see Exhibit 208).
Exhibit 207
18% 16% Market Share 14% 12% 10% 8% 6% 1995
M&S: 10-Year UK Apparel & Footwear Retail Market Share Trend
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Source: DNS and corporate reports.
Exhibit 208
2000
12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
UK Childrenswear Market Shares: Top 10 Players 2000 vs. 2005

12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Next Asda Tesco Woolworths
2005
Mothercare
Woolworths
John Lewis
M&S
Asda
Next
JJB Sports
Bhs
Adams
Tesco
M&S
Mothercare
Source: Verdict.
Matalan
Adams
Primark
Bhs
126
M&Ss customer base is aging; M&S is becoming less relevant for younger and middle-aged consumers (see Exhibits 209 and 210). An older customer base in our book is the most critical fundamental issue facing M&S. Sometimes we hear the argument that having an older customer base is good, as populations grow older and older people will be a larger and larger market segment. This is a flawed argument. People get old with the brands they know and that they trust. It is hard to imagine that the 45year-old woman who grew up with Next will suddenly wake up one morning and turn to M&S as she turns 55 years old. Brands that have an aging customer base risk declining with it, unless they can attract a new generation of consumers to the business.
Exhibit 209
M&S Is Fading With Younger Consumers

Favorite Stores by Age: Female Under 35 Asda Tesco New Look Next Top Shop Favorite Stores by Age: Male Under 35 Asda JJB Sports HMV Next Game 35-55 7.5% 6.5 5.6 5.0 4.5 M&S Asda Tesco Debenhams Next 35-55 7.0% 6.3 6.1 2.8 2.7 Tesco Asda Next Debenhams Morrisons 7.8% 7.8 4.5 4.0 3.3 M&S Tesco Asda Morrisons John Lewis 10.6% 9.9 7.5 6.8 5.6 M&S Asda Tesco John Lewis Debenhams Over 55 11.9% 9.1 7.9 6.9 4.1 Over 55 19.7% 8.5 8.0 6.1 5.5
Source: Retail Week, May 27, 2005.
Exhibit 210
25% 20%
M&S: Womenswear Market Share by Age Group
Market Share
15% 10% 5% 0% 8/26/01 12/16/01 12-34 Yrs 8/25/02 35-54 Yrs 12/15/02 55+ Yrs 8/24/03 12/14/03 8/22/04 12/12/04 8/21/05 12/11/05
Linear (55+ Yrs)
Linear (12-34 Yrs)
Linear (35-54 Yrs)
Note: 26 weeks ending on date shown. Source: TNS and Bernstein analysis.
M&Ss category mix is skewed toward lower-involvement categories, more similar to a discounter than to a mass-fashion player (see Exhibits 211 and 212). This is not ideal: it is better to compete on style for higherinvolvement and higher-price product categories against higher-cost massfashion players, than to compete on price for lower-involvement and lowerprice product categories against lower-cost discounters. The evidence suggests that M&S is proportionally more in the latter situation, the younger its customer.
127
Exhibit 211
M&S: Womenswear Sales Mix (52 Weeks Ended 12/11/05)

Discounters Mass-Fashion
Womenswear Sales Mix
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Debenhams Sainsburys Top Shop/ Top Man New Look Marks & Spencer Asda Matalan Primark Hennes Tesco Zara 55+ Years Next Bhs
Sportswear & Outerwear

Footwear & Accessories
Underwear & Hosiery
Exhibit 212
100%
M&S vs. Next: Womenswear Sales Mix by Age (52 Weeks Ended 12/11/05)
Marks & Spencer Next
Womenswear Sales Mix
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 12-34 Years 35-54 Years 55+ Years 12-34 Years Footwear & Accessories 35-54 Years
Sportswear & Outerwear

Underwear & Hosiery
Market-share data indicate a clear downward trend in apparel that has been going on for more than two years. Most recent data show that the countermeasures introduced heavy advertising spend and price realignment have succeeded in stopping market-share loss for the moment (see Exhibit 213). Taking a closer look, all of the comeback is dependent on higher traffic numbers. In our experience, this kind of growth is volatile, as traffic volumes will be influenced by competitors catching up on advertising, and as traffic impact fades, if advertising push is not increased.
128
Exhibit 213
1.0 0.8 0.6 Delta Market Share (percentage points) 0.4 0.2 0.0 (0.2) (0.4) (0.6) (0.8) (1.0) 6/2/02
M&S: UK Apparel and Accessories Market Share
3/9/03
6/1/03
3/7/04
3/6/05
8/24/02
2/15/02
8/24/03
5/30/04
8/22/04
5/29/05
12/14/03
12/12/04
8/21/05
Note: 24 weeks ending Y(N) versus 24 weeks ending Y(N 1). Source: TNS and Bernstein analysis.
M&S is still trying to be everything for everyone in the UK apparel market. This for us is the key strategic liability in the M&S apparel revival attempt: in a market where competitors are standing for spikier and spikier product, style, price and brand propositions, a middle-of-the-road generalist runs against the course of history. Competitors are getting stronger and specializing more and more, improving their relative appeal versus M&S for the consumer segments of choice. The difficulty for M&S is to increase its appeal to a younger consumer, without alienating its older customer base a very difficult balancing act. (2) Food Dilution: In the past 10 years M&S has increasingly become a food retailer. Food sales in the United Kingdom accounted for 50.8% of total UK net sales in the six months to October 1, 2005; they were a mere 41.8% in 1995 (see Exhibit 214). More than three-quarters of the sales increase M&S achieved between 1995 and 2005 was in food sales (see Exhibit 215). While M&Ss UK sales have increased in 10 years by 1,339 million (+2.1% per year), more than 1,020 million of this delta was food (+3.6% per year) and 319 million was general merchandise, i.e., clothing and home (+0.9% per year).
12/11/05
3/6/06
129
Exhibit 214
65% 60% UK Net Sales 55% 50% 45% 40% 35% 1995 1996 1997 1998
M&S: UK Sales Mix
1999
2000
2001
2002
2003
2004
2005
1H:002001
1H:012002
1H:022003
1H:032004
1H:042005
General Merchandise
Food
Exhibit 215
M&S: UK Sales Growth

1995 Million 3,317 2,379 5,696 Pct 58% 42 2006 Million 3,638 3,637 7,275 Pct 50% 50 Delta Million 322 1,257 1,579 Pct 20% 80
General Merchandise Food Total
This means that current sales growth is diluting M&S earnings in percentage terms, as food is significantly less profitable for M&S than clothing and home sales. In terms of operating profit, we estimate that general merchandise was at least 50-60% more profitable than food in the six months ended October 1, 2005, i.e., 12-14% versus 6-8%. Compared to other grocery retailers, M&S operating profit in food is significantly higher (see Exhibit 216). This reflects M&Ss distinctly differentiated product offer and relatively protected High Street and neighborhood locations. Taking the 96 directly-managed Simply Food locations, for example, only 40% have a Tesco Metro or Tesco Express store within one mile and only 30% have a Sainsbury Local store within one mile (see Exhibit 217).
Exhibit 216
10% 8% Operating Profit 6% 4% 2% 0% (2)% M&S Tesco
M&S: Operating Profit vs. Leading Grocery Retailers (2005)
Casino
Carrefour
Metro
Ahold
Morrisons
1H:052006
Sainsbury
2006
130
Exhibit 217
M&S: Simply Food Stores Proximity to Convenience Stores and Supermarkets

vs. Convenience Stores vs. Supermarkets
M&S Simply Food Stores With at Least One Competitor Store Within One Mile
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Spar Londis
Sainsbury Local
Sainsbury
Any Convenience
Kwik Save
Safeway
Aldi
Lidl
Tesco M/Exp
Tesco (Extra)
Independent Independent
Independent
Costcutter
Asda SC
Morrisons
Source: Retail Locations and Bernstein analysis.
Similarly, of the 36 M&S Food Stores, only 36% have a Tesco Metro or Tesco Express store within one mile, and only 19% have a Sainsbury Local within one mile (see Exhibit 218).
Exhibit 218
M&S Food Stores With at Least One Competitor Store Within One Mile 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Costcutter Londis
M&S: Food Stores Proximity to Convenience Stores and Supermarkets

vs. Convenience Stores vs. Supermarkets
Sainsbury Local
Sainsbury
Any Convenience
Kwik Save
Independent
Asda SC
Tesco M/Exp
Tesco (Extra)
Morrisons
Safeway
Aldi
Spar
Lidl
Source: Retail Locations and Bernstein analysis.
Going forward, we foresee that M&Ss operating margin in food will come under increasing pressure. Two factors will drive this: (1) the continuing push of leading grocery retailers seeking growth in the neighborhood and convenience market; and (2) the increasing quality of grocery retailers product offer, seeking to meet consumer convenience demands (e.g., food preparations, fresh food, etc.). Tesco and Sainsbury have zeroed in on the convenience market as one of their major growth avenues: both companies have grown their share of this market fivefold in the past five years: Tesco has moved from 1.0% in 2000 to 5.4% in 2005 (Source: Verdict). Sainsbury from 0.2% in 2000 to 0.9% in 2005 (Source: Verdict).
Any Supermarket
Somerfield
Waitrose
Any Supermarket
Somerfield
131
The muscle the leading UK grocery retailers can flex is phenomenal, both in terms of size, capabilities and brand appeal (see Exhibit 219). An example of this can be seen in advertising: M&S is spending close to 0.5% of its total UK sales (both food and general merchandise), Tesco can spend little above 0.2% of sales and yet have a share of voice that is almost 60% higher than that of M&S (see Exhibit 220).
Exhibit 219
M&S: Scale Disadvantage vs. Tesco and Sainsbury

UK Sales ( billion) 27.1 14.9 3.4 Relative Scale 8.0 4.4 1.0 50% 0.13% 0.23 1.00 Cost Disadvantage in Case of a Cost Slope of: 65% 80% 90% 95% 0.27% 0.51% 0.73% 0.86% 0.40 0.62 0.80 0.90 1.00 1.00 1.00 1.00
Tesco Sainsbury M&S Food
Exhibit 220
70 60
M&S: Advertising Expenditure vs. Tesco and Sainsbury

Advertising Spend
0.6% 0.5%
Advertising Spend as a Pct. of Total UK Sales
50 Million 40 30 20 10 0 2000 2001 Tesco 2002 Sainsbury 2003 M&S 2004
0.4% 0.3% 0.2% 0.1% 0.0% 2000 2001 Tesco 2002 Sainsbury 2003 M&S 2004
Source: Verdict, corporate reports and Bernstein analysis.
(3) Viscous Cost Disadvantage: We foresee likely bad news on the SG&A cost side too, as historically, M&Ss SG&A as a percentage of sales has risen 350 bp (see Exhibit 221). Today, M&S is enjoying the benefit on the space cost side of: (a) one of the most significant freehold real estate portfolios in the retail industry; (b) historical lease contracts which have helped shield M&S from sharp leasecost inflation of the past decades. But this is a double-edged sword. New stores and new sale and lease-back operations threaten to expose the implicit M&S space-cost disadvantage from lower space productivity right up to the P&L. On the staff front, M&S seems to be struggling to become lean and mean. Despite the recurring extraordinary initiatives of the past 10 years, M&S seems to be heavier than it should, especially at the top. This inherently high cost structure becomes all the more crucial, and worrisome, as M&S finds itself facing a market where low-cost competitors are structurally gaining share and putting pressure on margins across the sector. The higher staff costs, however, represent an opportunity for further earnings growth, should a decisive headcount reduction be eventually implemented.
132
Exhibit 221
SG&A (Percentage of Group Sales) 30% 25%
M&S: SG&A Components as a Percentage of Group Sales (1995-2005)
Delta 1995-2005 (basis points)
20% 15% 10% 5% 0%
Other Depreciation Renewals Occupancy Staff
+78 +100 -15 +57 +134
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Staff
Occupancy
Renewals
Depreciation
Other
(a) Space costs: On space cost, M&S has an implicitly structurally higher cost base versus other apparel competitors as it trades from more expensive High Street locations and less productive larger stores. The disposal of freehold real estate assets associated with current market-price lease contracts would expose the P&L to this implicit cost disadvantage. In comparison to Next, for example, we calculate that M&S store locations are inherently more expensive, as they are more often on the High Street than out-of-town; 28% of M&Ss 275 general merchandise stores are located out-of-town (including retail parks, shopping malls and stand-alone locations) versus 57% in the case of Next (see Exhibit 222). The complement to 1 i.e., 72% of stores for M&S and 43% for Next is located on the High Street (we have classified High Streets in three bands, as a function of city size).
Exhibit 222
100% 90% 80% 70% Stores 60% 50% 40% 30% 20% 10% 0%
M&S vs. Next: Store Locations

M&S = 275 Stores Next = 424 Stores
M&S Shopping Center

Source: Retail Locations, corporate reports and Bernstein estimates and analysis.
2005
SG&A
+354
Next High Street
133
Next, in fact, moved decisively in the past 10 years and relocated a vast number of stores away from the High Street, leveraging the trend towards out-of-town retailing in the United Kingdom. Nexts sales-space profile is today completely transformed, as close to 100% of current trading surface was either relocated or opened in the past 10 years (see Exhibit 223). Next has been aggressive in penetrating out-of-town locations: its UK penetration leaves few obvious gaps (see Exhibit 224).
Exhibit 223
60 Total Retail Space (million m2) 50 40 30 20 10 8% 0 1995 1996 8% 62% 61% 21% 22%
UK Retail Space Trend by Location
24%
25%
26%
27%
28%
29%
30%
31%
32%
60%
59%
58%
57%
56%
55%
55%
54%
54%
8% 1997
8% 1998
8% 1999
8% 2000 High Street
8% 2001
8% 2002
8% 2003
8% 2004
8% 2005
Neighborhood
Source: Verdict.
Out-of-Town
Exhibit 224
M&S vs. Next: UK Penetration by Region

Stores/Million Population M&S Next Out-ofHigh Out-ofHigh Town Street Town Street 5.0 6.8 4.0 2.7 5.8 7.8 4.5 3.3 4.5 6.1 2.6 3.6 3.6 6.0 3.3 2.7 3.9 7.5 5.7 1.8 5.0 6.4 3.7 2.7 4.3 6.7 3.7 3.1 4.7 8.4 5.7 2.7 4.3 7.1 4.7 2.4 3.6 9.5 7.1 2.4 14.4 14.4 0.0 14.4 4.7 7.2 4.4 2.8 0.6 0.8 1.1 0.5
Region Greater London South East South West East Midlands West Midlands Wales North East North West Scotland Northern Ireland Islands Total
No. of Stores M&S Next 42 57 55 74 23 31 28 46 22 42 15 19 21 33 37 66 22 36 6 16 4 4 275 424
Population (000) 8,435 9,494 5,055 7,686 5,586 2,980 4,907 7,880 5,062 1,685 278 59,049
Standard Deviation (Excluding Islands & Northern Ireland)
Notes: 1 The darkest shading represents 10% of the mean for that format (i.e., the 5.0 for M&S in Greater London falls within 10% of the mean for total M&S of 4.7). The lightest shading is for > 110% of the mean (i.e., the 5.8 for M&S in the South East is more than 10% above the 4.7 national figure). The pale grey shading shows < 90% of the mean (i.e., the 3.6 for M&S in the East Midlands is < 0.9 times the 4.7, or > -10% below the national average. 2 The number of M&S stores excludes stand-alone Simply Food (the food-only stores). Source: Retail Locations, ONS, corporate reports and Bernstein estimates and analysis.
Another structural reason for implicit space-cost disadvantage of M&S versus Next is its lower space productivity and larger store formats (see Exhibit 225): M&S has net sales of 4.3 per thousand square meters in the United Kingdom versus 6.6 per thousand square meters in the case of Next.
134
Exhibit 225
170 160 150 Index
UK High Street Rental Growth

1994-2004
1999-2004 114 112 110 Index 108 106 104 102
140 130 120 110 100
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
100 1999
2000
2001
2002
2003
2004
Source: Cushman & Wakefield, Headley & Baker and Bernstein analysis.
Whilst M&S is (relatively speaking) property asset rich, we find it diffiWhat Would a Freehold Sale and Lease-Back Mean for M&S? cult to see that a property sale and lease-back would be compelling on commercial property terms, given the operating-margin impact this would have. The discussed extraordinary real estate operation would expose these three sources of space-cost disadvantage for M&S versus Next on the P&L: More-expensive High Street locations versus cheaper out-of-town stores. Current market price leases versus historical price leases (see Exhibit 226). Lower-productivity larger stores versus smaller more-productive formats.
Exhibit 226
M&S vs. Next: Estimated P&L Impact of Real Estate Sale and Lease-Back ( million)
Next Current Situation UK GM Retail Sales UK Other Sales UK Total Sales UK Total Space (m2) UK GM Space (m2) High Street Out-of-Town Current Operating Lease Cost (/m2) Out-of-Town Cost (HS = 100) Back of the Envelope Future Scenario Current Lease (/m2) Freehold Adjustment (/m2) Location Adjustment (/m2) Inflation Adjustment 5% (/m2) Lease-Back Hypothesis Yield Hypothesis Space Impacted Hypothesis as Pct of Total Lease of Impacted Space (/m2) Lease of Non-Impacted Space (/m2) New Average Lease (/m2) UK GM Retail Sales (/m2) Current Lease (/m2) Current Lease (%) New Average Lease (/m2) New Average Lease (%) New Marginal Space Cost (/m2) New Marginal Space Cost (%) 2,058 0.036 2,058 309,000 309,000 43% 57 131.8 65 427 448 M&S 3,638 3,637 7,275 1,310,000 944,000 72% 28 127.1 65 156 448 503 528 4,000 6% 38 528 156 261 3,854 156 4.1% 261 6.8% 528 13.7%
427 6,659 427 6.4% 448 6.7%
135
A rough-cut, back-of-the-envelope calculation (see Exhibit 227) shows that the P&L impact of the discussed sale and lease-back operation would be substantial, bringing average lease costs of M&S and Next virtually in line at approximately 6.5%. The key point here, though, is that M&S would suffer a staggering 600 bp space-cost disadvantage versus Next on new stores and relocations, unless it created dramatically more productive stores. Assuming all of the discussed real estate proceeds are used to repay debt and shareholders (maintaining the current Debt/(Debt + Equity) ratio) as well as to eliminate the pension fund deficit, virtually no accretive or diluting EPS effect would materialize.
Exhibit 227
P&L Impact of New Operating Leases Total Sales New Lease New Lease Former Lease Delta Tax Rate Net-Profit Impact
M&S: Estimated P&L, Balance Sheet and EPS Impact of Real Estate Sale and Lease-Back ( million)
7,275 390.1 5.4% 1.7 263 30.1% (183.9) P&L Impact of Net Debt Reduction Current Debt Current Interest Current Rate = Future Rate New Debt New Interest Delta Tax Rate Net-Profit Impact Assumed Return on Disposed Real Estate Sold Property Value Leases on Former Property Gross Yield for Acquiring Lessor 1,729 134.9 7.8% 407 31.7 103.2 30.1% 72.1 4,000 263 6.6%
Balance Sheet Impact of Real Estate Split and Share Buyback Total Assets Current Land & Building New Total Assets Current Equity Current Debt Current Debt/(Debt + Equity) New Equity New Debt New Debt/(Debt + Equity) Use of Real Estate Proceeds Real Estate Proceeds Share Price () Shares Outstanding (mil.) Debt Repayment [Debt/(Debt + Equity)] Pension Deficit Repayment (IAS 19) Share Buyback New Shares Outstanding (mil.) Source: Corporate reports and Bernstein estimates and analysis.
3,194 2,310 884 1,155 1,729 60% 272 407 60% 4,000 5.7 1,682 1,200 775 2,025 1,326
EPS Impact 2005 EPS Former Earnings New Earnings New EPS Delta EPS Delta EPS (%)
31.1p 523 411 31.0p (0.1) (0.3)%
(b) Staff costs: Another cost area where M&S is struggling to be at par with competition is in staff costs. M&S seems to have performed over time better than Next on staff costs (see Exhibit 228). M&S and Next are now on par at 14.2% of net sales, considering M&Ss 1H:05-2006 staff costs which include, again, staff performance bonuses.
136
Exhibit 228
15% Staff Costs (Percentage of Sales) 14% 13% 12% 11% 10% 9% 8%
M&S vs. Next: UK Employee Costs

M&S Next
1998
1999
2000
2001
2002
2003
2004
2005
1998
1999
2000
2001
2002
2003
2004
This picture, though, does not include exceptional items for restructuring, closure and relocation activities, which have been recurrent in the past eight years, consisting in large part of staff and termination costs (see Exhibits 229-231). Looking at M&S staff costs in context, there seems to be the opportunity for further realignment and possibly new extraordinary restructuring costs going forward: Adjusting for scale, M&Ss staff costs seem to be slightly above the ideal regression curve allowing for 1% potential efficiency on sales (see Exhibit 231).
Exhibit 229
% UK Sales 0.4%
M&S: UK Exceptional Items

1.0% 0.4% 0.0% 0.6% 0.6% 0.8%
Exhibit 230
1999 2000 2001 2003 2004 2005
M&S: Detail of Exceptional Items ( million)

64.0 24.5 63.3 8.7 16.5 10.0 36.3 7.6 22.5 19.6 38.6 29.3 8.8 8.4 6.3 364.4
70 Exceptional Items ( million) 60 50 40 30 20 10 0 1999 2000 2001 2002 2003 2004 2005 Restructuring HQ Relocation Closures
Provisions for Impairment Head Office Restructuring Program UK Retail Restructure Closures in France and Germany Closure of Direct Catalog Business Head Office Restructuring Program Restructuring of General Merchandise Logistics Ops Head Office Relocation Head Office Restructuring Program Head Office Relocation Defense Costs Closure of Lifestore Head Office Relocation Board Restructure Head Office Restructuring Program Total
Notes: Restructuring includes: Retail, GM logistics and HQ; Closures include: direct catalog business and Lifestore. Source: Corporate reports and Bernstein analysis. Source: Corporate reports and Bernstein analysis.
2005
137
Exhibit 231
Staff Costs (Percentage of Sales) (70)% (75)% (80)% (85)% (90)% (95)% (100)% (105)% (110)% 3.5 3.7 Next 1% of sales
Staff Costs for Leading European Apparel and Grocery Retailers

R = 77% H&M Inditex M&S Morrisons Sainsbury Casino Tesco
2
Metro Carrefour
3.9
4.1
4.3
4.5
4.7
4.9
Sales ( billion)
Looking at staff by business area, M&S seems to be still managementheavy, both at the headquarters level and in the field. Previous headquarters restructuring has concentrated on other roles, rather than on management (see Exhibits 232 and 233). This is indeed an area of opportunity, should a decisive headcount-reduction exercise be eventually implemented.
Exhibit 232
M&S: Average Number of Employees/Business Area UK Headquarters

UK HQ Management
UK + Overseas Sales/Employee
UK HQ Other
1,600 1,400 1,200 1,000 800 600 400 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 UK + Overseas Sales/Employee 3,200 3,000 2,800 2,600 2,400 2,200 2,000 1,800 Average No. of Employees 10,000
3,000 Average No. of Employees 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
138
Exhibit 233
5,500 Average No. of Employees 5,000 4,500 4,000 3,500 3,000 2,500 2,000
M&S: Average Number of Employees/Business Area UK Stores

UK Stores Management
1,800
UK Stores Other
60,000 Average No. of Employees 55,000 50,000 45,000 115 40,000 35,000 30,000 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 110 105 100 135 130 125 120 UK Sales/Employee
1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 UK Sales/Employee
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
(4) Limited Growth Potential: We remain skeptical on the growth potential of M&S in the UK Apparel & Footwear retail market. Longer term, we fail to see any white space opportunity or compelling strategic reasons which would suggest stronger-than-market growth for M&S in this category. Shorter term, keeping abreast of demand dynamics which we expect to be weak in the next two years, and tougher in the first half of 2006 than at Christmas 2005 is already going to be enough of a challenge, as competition continues to increase, putting pressure on market shares and prices. In this context, significant growth of like-for-like sales and space is unlikely. We see it as a significant success and as a badge of honor for its management team that M&S has stopped its steeper-thanmarket decline, although from here it will find itself against more difficult comparables (see Exhibits 234 and 235).
Exhibit 234
M&S Like-for-Like Quarterly Growth vs. UK A&F Retail Market Quarterly Growth
2005
Exhibit 235
M&S Like-for-Like Quarterly Growth vs. UK A&F Retail Market Quarterly Growth Delta Percentage Points
20% 15% Delta Percentage Points 3/10/02 8/25/02 8/24/03 8/22/04 8/21/05 3/9/03 3/7/04 3/6/05 6/3/06 YoY Change 10% 5% 0% (5)% (10)% (15)%
10 5 0 (5) (10) (15) 3/10/02 8/25/02 8/24/03 8/22/04 8/21/05 3/9/03 3/7/04 3/6/05 6/3/06
Market
M&S
Linear (M&S)
Note: 12 weeks ending at each date versus year-over-year; closest period quarterly like-for-like sales have been used for M&S. Source: TNS and corporate reports.
Note: 12 weeks ending at each date versus year-over-year; closest period quarterly like-for-like sales have been used for M&S. Source: TNS and corporate reports.
139
As retail space threatens to grow faster than demand, and retail factor costs continue to increase, space growth will go to players that are more productive (i.e., higher sales/m2), more efficient (i.e., higher-margin, lowercost) and more flexible (i.e., able to use a wider span of store sizes, to fill in the gaps of marginal store-development opportunities). Past data seem to suggest that more-established players have been penalized in this race, moreso recently as competition has continued to increase (see Exhibits 236 and 237).
Exhibit 236
United Kingdom: Space Growth of High Street Retailers vs. Space Productivity (1995-2000)
Exhibit 237
United Kingdom: Space Growth of High Street Retailers vs. Space Productivity (2000-05)
R2 = 94% Next
15% Space Growth (CAGR 1995-2000)

2
20%
R = 73%
Space Growth (CAGR 2000-05)
10%
Next JL Bhs Debenhams Woolworths M&S (Excl. Food)
15% 10%
Debenhams
5%
5%
Bhs Woolworths HoF M&S (Excl. Food) JL
0%
HoF
0% (5)% 1,000
(5)% 1,000
3,000
5,000
7,000
9,000
3,000
5,000
2
7,000
Sales/m2 in 2000
Source: Verdict, corporate reports and Bernstein estimates and analysis.
Sales/m in 2000
Source: Verdict, corporate reports and Bernstein estimates and analysis.
On the international front, M&Ss growth path is, we think, a living demonstration of our Darwinian industry model. As much as M&S failed in more sophisticated markets like France, Germany and North America as it introduced a format with no significant competitive advantage versus established incumbents M&S is now having good success through franchising in less-competitively-developed markets (see Exhibits 238 and 239) Please refer to the Appendix for cluster definitions.
Exhibit 238
M&S: Discontinued Businesses in North America and Western Europe

Sales ( million) 285.0 448.1 25.8 Exceptional Charges ( million) 471.0 225.9 45.4 25.0 767.3
Exhibit 239
M&S: International Franchising Stores by Market Cluster

Index vs. GDP Notes 0 25 + 749 115 105
Date Mar 2001 Nov 2001 Apr 1999 Mar 1996 Total
Business(es) M&S stores in Continental Europe Brooks Brothers M&S (38 stores) in Canada DAllairds (85 stores) in Canada
GDP Stores Cluster Countries PPP US$ Bil. Pct Number Pct 1 6 $20,746 42.9% 0 0.0% 2 15 4,517 9.3 4 2.3 3 29 3,322 6.9 88 51.5 4 17 15,753 32.6 64 37.4 5 110 4,030 8.3 15 8.8 177 $48,368 100.0% 171 100.0% Total
Note: Excluding overseas territories of the United Kingdom (i.e., Bermuda, Gibraltar = 2 stores). + 4 stores in the Canary Islands. Source: Press, corporate reports and Bernstein analysis. Source: United Nations, corporate reports and Bernstein analysis.
140
Among the directly-operated international businesses, two out of three Kings Supermarkets in the United States and M&S stores in Hong Kong are remnants of the recent restructuring wave. The 27 stores-strong Kings Supermarkets chain has been openly indicated as a nonstrategic activity and has gone through several failed divestiture attempts in the past after a decline it is now performing better, but well below the group average (see Exhibits 240 and 241). The nine M&S Hong Kong stores were at first indicated as candidates to be turned into franchising stores, but the deal did not materialize they are performing well, but a number of stores are being surrendered to the landlord for redevelopment. Direct operations in Ireland are gradually developing, with new space both in M&S general-merchandise stores and piloting of Simply Food stores. M&S was trading from a base of 12 stores in the Republic of Ireland at the beginning of 2005. As much as it has grown in the recent past boosted by franchising development, new space and favorable trading environments operating profit from international operations remains at 10%, a fraction of the total groups. We do not expect this picture to change materially moving forward.
Exhibit 240
Sales
$500
Kings Supermarkets
Operating Margin
$20 Operating Margin ($ million) $18 $16 $14 $12 $10 $8 $6 $4 $2 $0 2000 2001 2002 2003 2004 2005 2000 2001 2002 2003 2004 2005 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Operating Margin as a Percentage of Sales
$450 $400 $350 $ Million $300 $250 $200 $150 $100 $50 $0
Exhibit 241
70 60 50 40 30 20 10 0 2000
M&S: Operating Profit from International Operations

14% 12% 10% 8% 6% 4% 2% 0% 2001 2002 2003 2004 2005 M&S Operating Profit as a Percentage of Group Operating Profit Before Exceptional Items
Operating Profit ( million)
141
Forecast
We think that the current M&S relaunch is mostly based on one-off actions, namely terms renegotiations with suppliers and higher sales from increased advertising push. The problem we see is that there is only so much scope to improve primary margin through renegotiations with suppliers and international sourcing, while operating-cost inflation is projected to continue and even get worse, should a real estate deal actually go through and had M&S pay retail market prices for its space. Short term, these improved supplier terms will show in the bottom line, but going forward we take a more pessimistic view than consensus. As consensus expects steady progress, we foresee a decline after 2006, when we anticipate: (a) the impact of short-term measures to fade; (b) general-merchandise performance to continue to lag; and (c) further margin dilution from increasing food sales in the group mix.
142
Next: Will Deliver the Goods

Overview We are convinced that Next is a solid and well-managed company with a strong customer base, proven product capabilities, demonstrated growth strategy in both store-based retail and multichannel, with space for cost efficiencies and subsequent margin enhancement. Next has several cards to play, even in a soft market: (1) a strong customer platform, with fast-growing share in the 35-55 year-old segment; (2) a superior product capability, coupling mainstream and fashion appeal; (3) proven avenues for growth through new retail space, catalog and online customer-base growth and offer expansion; and (4) margin enhancement levers through gross-margin improvement and cost efficiencies. The bad news regarding Nexts performance is that it leaves little space for improvement with: (1) strong earnings growth; (2) best-in-class RoCE performance; and (3) consistently positive stock price growth. The good news is that the market has low expectations of Nexts performance going forward into the medium term. Nexts sales growth has been the driver of significant earnings growth sales increase has driven the largest portion of earnings expansion in the five years between 1999 and 2005. Sales growth has been driven approximately 80% from retail space growth and roughly 20% from directory sales growth (see Exhibits 242 and 243).
Performance Champion
Exhibit 242
Next: Drivers of Earnings Growth (1999-2005)

13% (17)% (7)%
Exhibit 243
Next: Drivers of Sales Growth (1999-2005)

24% 2%
400 350 300 Million 250 200 150 100 50 0 Sales Growth 98% 12%
3,500 3,000 2,500 Million 2,000 1,500 1,000 500 (14)% 87%
Operating Expenses
1999 Earnings
2005 Earnings
Sales/m 2
0 Interest Gross Margin Tax 1999 Sales
Directory
Space
Other
Nexts lease-adjusted RoCE is among the highest in the industry; nonlease-adjusted RoCE has been improving consistently over time and is currently around 50% (see Exhibits 244 and 245).
BERNSTEINRESEARCH
2005 Sales
143
Exhibit 244
20%
Next: Operating Lease-Adjusted RoCE vs. Leading Retailers (2004)

H&M
Exhibit 245
12.0%
Next: RoCE (1994-2005)
NOPAT/Sales
NOPAT/Sales
Next Inditex The Gap Limited 10% Benetton Kingfisher 9% Boots GUS M&S 8% Ann Taylor Matalan Home Depot 7% PPR DSG 6% 5% 4% 3%
Fcuk
A&F
11.5% 11.0% 10.5% 10.0% 9.5% 9.0% 8.5% 8.0%

5x 6x 7x
1996 1997 2005 2001 1995 1994 1998 2000 1999 20% 3.0
2004 2003
40% 30% 20% 15%
2002
ROCE: 1.0
30% 5.0 7.0
2% 0.7 0.8 0.9
ROCE
1x
5%
2x 3x
10%
4x
Nexts stock-price performance has been equally impressive. Next has underperformed the market only twice in the past 15 years in 1998 and in 2005 and has by far the most consistent positive track record among the companies in our coverage (see Exhibit 246).
Exhibit 246
250% 225% 200% 175% 150% 125% 100% 75% 50% 25% 0% (25)% (50)% (75)% 1991 1992 1993
Next: Annual Relative Price Performance (to MSCI Europe)
Relative Price Performance
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Such a strong track record would be daunting for any company. The refreshing news is that the market currently expects relatively little from Next, as it remains captured by the M&S turnaround story. The comparison of consensus expectations on Next and M&S is striking. While the market expects higher sales from Next, the average operating profit and net income yearly growth expectations for FY 2006, FY 2007 and FY 2008 are around 6.5% in the case of Next, and approximately 10% in the case of M&S (see Exhibit 247).
2005
144
Exhibit 247
9% 8%
Next vs. M&S: Median Consensus Expectations

Sales
25% 20% YoY Growth YoY Growth 15% 10% 5% 0% 2007E 2008E Next M&S 2009E
Operating Profit
30% 25% 20% 15% 10% 5% 0% 2007E
Net Income
7% YoY Growth 6% 5% 4% 3% 2% 1% 0% 2007E 2008E 2009E
2008E
2009E
Note: FY 2006 = Next: year-end 1/31/06; M&S: year-end 3/31/06. M&S 2005 results adjusted for divested activities. Source: FactSet, Bloomberg L.P. and Bernstein analysis.
Why Next Will Perform at Least in Line With Market Expectations
We are convinced that Next will be able to meet (and perhaps exceed) consensus expectations into the medium term. We see four major reasons for this: (1) Next has established a strong customer platform which is proving attached to the brand; (2) Next enjoys a superior product capability, from development to merchandising; (3) Next has a proven growth strategy, both in terms of retail space increase and directory and online development; and (4) Next has room to expand margins and weather a declining like-for-like environment. (1) Strong Customer Platform Next has been one of the great winners in the UK Apparel & Footwear retail market: its market share has increased by almost 50% in four years, rising from 3.8% in 2001 to 5.6% in 2005. Value retailers grocers and discounters are the only other players to have performed at this level (see Exhibit 205, in the previous chapter). Next initially made its name in the UK Apparel & Footwear retail market by appealing to younger customers and developing its own alternative image. Over time, the Next alternative appeal has become mainstream, as its customer base has grown and become more mature. Nexts younger origin is clearly apparent by looking at its market share by age group: In womenswear, for example, Next is strongest among the 12-34 and 35-54 year-old demographics, while its share of those over 55 years is approximately one-third of this. Brand recognition among age groups indicates a similar picture (see Exhibits 248 and 249). So far, Nexts growth has been most intense in the younger-consumer segments: 12-34 years old and 35-55 years old. Next has doubled its relative size versus the market-leader M&S in both the 12-34 and 35-55 year-old segments, while maintaining its relative size in the 55-and-over segment (see Exhibit 250). Absolute market share indicates that Next is expanding into a mainstream position and establishing itself with the core middleaged consumers: as share of 12-34 year-olds increases moderately in the past five years, share of 35-54 year-olds has grown faster and overtaken that of the 12-34 year-old group (see Exhibit 251).
145
Exhibit 248
Next vs. M&S: UK Womenswear Market Share by Age Group (2005)

25% 20% Market Share 15% 10% 5% 0% 55+ Yrs 12-34 Yrs 35-54 Yrs 12-34 Yrs M&S 2005 Next 2005 35-54 Yrs
35-55 7.5% 6.5 5.6 5.0 4.5 7.0% 6.3 6.1 2.8 2.7 M&S Asda Tesco Debenhams Next Tesco Asda Next Debenhams Morrisons 10.6% 9.9 7.5 6.8 5.6 7.8% 7.8 4.5 4.0 3.3 M&S Asda Tesco John Lewis Debenhams M&S Tesco Asda Morrisons John Lewis
Source: TNS and Bernstein analysis,
Exhibit 249
Next vs. M&S: Brand Recognition

Under 35 Favorite Stores by Age: Female Asda Tesco New Look Next Top Shop Favourite Stores by Age: Male Asda JJB Sports HMV Next Game Source: Retail Week, May 29, 2005. Over 55 19.7% 8.5 8.0 6.1 5.5 11.9% 9.1 7.9 6.9 4.1
Exhibit 250
Relative Market Share: Next vs. M&S 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x 8/26//01 12/16//01
Next vs. M&S: UK Womenswear Market Share by Age Group
8/25//02
12/15//02
8/24//03
12/14//03
8/22//04
12/12/04
55+ Yrs
8/21//05
12/11//05
12-34 Yrs
Note: 24 weeks ending on date shown. Source: TNS and Bernstein analysis.
35-54 Yrs
55+ Yrs
146
Exhibit 251
8% 7% Market Share
Next: UK Womenswear Market Share

12-34 Years
8% 7% Market Share 6% 5% 4% 3% 2% 1% 0% 8/26//01 8/25//02 8/24//03 8/22//04 12/16//01 12/15//02 12/14//03 8/21//05 12/11//05 12/12/04
2
35-55 Years
6% 5% 4% 3% 2% 1% 0% 8/26//01 8/25//02 8/24//03 8/22//04 12/16//01 12/15//02 12/14//03 8/21//05 12/11//05 12/12/04
This shift to a larger and more mature customer base is a sign of Nexts success in growing from a niche alternative role to a mainstream position. We expect these lifecycle dynamics to continue to play out in the future, when long term, Next could become what M&S is today: the average customer age difference between Next and M&S is approximately 20 years. For the moment, Next is enjoying the best of both worlds, maintaining a cool brand appeal in the market, but with the size and the stickiness of an established player. In fact, Next attracts a significantly larger share of visitors than its market share would imply (see Exhibits 252 and 253).
Exhibit 252
35% 30%
Visitors Share
UK Apparel & Footwear Retail Market: Visitors Share vs. Market Share (2005)
y = 2.7563x + 0.0486 M&S Next Debenhams Asda Bhs
25% 20% 15% 10% 5% 0% 0% 2% 4% Dorothy Perkins Burton
Matalan New Look Primark Littlewoods R = 95% 6%

Market Share
Bonmarch 8% 10%
12%
Source: Verdict, TNS and Bernstein analysis.
147
Exhibit 253
Delta Actual vs. Predicted Visitors Share (percentage points)
Delta Actual Visitors Share vs. Predicted Visitors Share (2005)
4 3 2 1 0 (1) (2) (3) Dorothy Perkins Littlewoods M&S Next Matalan New Look Burton Asda Bhs Debenhams Bonmarch Primark
Source: Verdict, TNS and Bernstein analysis.
At the same time, Nexts ability to turn visitors into main users is aligned to that of established players (see Exhibit 254). This ability is one of the drivers of Nexts superior space productivity, with all the positive P&L and growth opportunity consequences that this implies, as we will discuss later. The fresher and trendier nature of Nexts main users is clearly apparent when comparing their shopping behavior to that of more established and/or mainstream players: Nexts main users have one of the highest shopping around scores of all (see Exhibit 255). This means that the average Next shopper is more demanding, more curious and more physically mobile than the average Apparel & Footwear retail shopper. The positive in this is that Next must be good to satisfy such a consumer and thus cannot self-indulge or take its eye off the ball. The negative, of course, is that if Next did take its eye off the ball its customer base would likely be more volatile than others and thus quick to shift their spending elsewhere. (2) Superior Product Capability Nexts advantage in the crucial area of product and merchandising emerges from the observation of its relative strength in the more visible and fashion-prone sportswear, outerwear and accessories categories versus lower-involvement categories like nightwear, hosiery and underwear. Nexts womenswear category mix is dominated by high-involvement products, with underwear and hosiery counting less than 5%. This is a clear positive; in fact, the higher the consumer involvement with the product: (1) the lower the consumer price sensitivity; (2) the higher the margin opportunity for the retailer; (3) the safer the retailer from discount competition; and (4) the stronger the consumer bond with the brand. Nexts product-category mix is similar to other mass-fashion retailers like H&M, Top Shop, New Look and Zara. Interestingly, Nexts high-involvement categories appeal is equally strong across age groups, while M&S fashion appeal is skewed towards older consumers (see Exhibit 249).
148
Exhibit 254
UK Apparel & Footwear Retail Market: Main Users Share vs. Market Share (2005)
y = 1.3878x + 0.0043 M&S
Exhibit 255
Shopping Around by Retailer (2005)
16% 14% Main Users Share 12% 10% 8% 6%
Next Asda
Primark Debenhams 4% Burton Matalan New Look Bhs 2% 0% Dorothy Perkins 0% 2% 4% 6% 8%
R = 97% 10% 12%
New Look Dorothy Perkins Next Matalan Debenhams Asda Bonmarch Littlewoods M&S Bhs Primark Burton 0 1 2 3 4
Market Share
Source: Verdict, TNS and Bernstein analysis. Source: Verdict.
Number of Other Stores Used by Main Users
Product and merchandising capabilities are underpinned by a solid sourcing and operations platform. On a smaller scale, Nexts productdevelopment and sourcing organization resembles that of most advanced mass-fashion retailers like Inditex and H&M in that it is: (1) highly international to achieve lower cost of goods sold; (2) multicountry to allow costversus-lead-time tradeoff sourcing decisions, as well as best-in-class quality by product category (e.g., suits and denim in Turkey and Eastern Europe, dresses and tops in China, etc.); and (3) (very) limited downstream in terms of integration into production coordination and manufacturing to allow sourcing flexibility and speed (see Exhibits 256 and 257). This is a far cry and an order of magnitude more effective than the standard buying offices of traditional department stores.
Exhibit 256
Next: Design, Sourcing and Production Organization

Organization Staffing Next Separate Company Next Sourcing Design + Production Coordination Hong Kong, Turkey, Sri Lanka, Romania 1,000 FTE H&M Internal Departments Design Stockholm
500 FTE
Production Coordination 22 centers worldwide (10 Europe, 10 Asia, 1 North Africa, 1 Central America) 700 FTE 700 Third-Party Suppliers
Production
1 Own Factory in Sri Lanka 2,000 FTE + Third-Party Suppliers
149
Exhibit 257
Next: Design, Sourcing and Production Productivity

2004 Group Sales ( million) 2004 Nonretail Sales Staffing of Design & Production Coordination (FTE) Retail Sales/FTE ( 000) Next 4,216 9%1 1,000 383.7 1,200 490.6 H&M 5,887
1 Ventura and other businesses have been excluded. Source: Corporate reports and Bernstein analysis.
Logistics is another area where Next has consistently invested over time, with a scheduled program of new warehouses and upgrades. Next has recently confirmed that the two new warehouses in development have been introduced on budget, on time and with no glitch. Continued effective product development, sourcing and operations will allow Next to stay ahead of its competitors e.g., introducing new collections every six weeks (rather than every 12 weeks) starting with the Spring/Summer 2006 season. (3) Proven Growth Strategy Next has a demonstrated growth strategy, based on: (a) Space Expansion in the United Kingdom: Next has grown its sales space at 12.4% per year for the past 13 years, through a mix of new stores, relocations and store extensions (see Exhibits 258 and 259). New stores have been the dominant driver, representing approximately two-thirds of total net space growth between 1998 and 2005. Net new space additions per year have constantly accelerated over time, from around 10% in the late 1990s to close to 30% in 2005. This has gone hand-in-hand with the development of larger store formats: roughly speaking, as new average store size has trebled between 1998 and 2005, new space additions trebled too as a percentage of previous-year retail space (see Exhibit 260).
Exhibit 258
Next: Retail Space Growth (1992-2005)

Retail Space
Retail Space Growth
45% YoY Retail Space Growth 40% 35% 30% 25% 20% 15% 10% 5% 0% (5)% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
450 Retail Space (000 m2) 400 350 300 250 200 150 100 50 0 1992 1993 1994 1995 1996 CAGR (1992-2004): 12.4% 1997 1998 1999 2000 2001 2002 2003 2004 2005
2005
150
Exhibit 259
Next: New Space as a Percentage of Previous-Year Retail Space
Exhibit 260
Next: Net New Space Addition as a Function of Average New Store Size
30% 25% 20% 15% 10% 5% 0% (5)% (10)% (15)% 1998 1999 2000 2001 2002 2003 2004 2005 New Stores Relocations Closed Stores Extensions
Net New Space (Percentage of Previous Space)
35%
35% 30% 25% 20% 15% 10% 1999 5% 0% 400 R = 71% 900 1,400 1,900
2
2005 2001 2002 1998 2000 2003 2004
Average Size of New Stores (m2)

As a consequence of the increasing size of new stores, the average store in the Next chain has been moving from below 300 square meters to more than 900 square meters, with a growth rate of 9.3% per year between 1992 and 2005 (see Exhibit 261). An example of the increasingly large store formats Next has been developing is the new Manchester flagship store, the largest so far: opened in autumn 2005, it measures 7,620 square meters and is on track to deliver payback of net capital invested in 17 months.
Exhibit 261
1,000 900 Average Store Size (m2) 800 700 600 500 400 300 200 100 0 1992 1993 1994
Next: Average Store Size (square meters)

CAGR (1992-2004): 9.3%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Central to the store-size-expansion strategy has been a constant move away from the High Street and toward shopping center locations, where Next is proving capable of playing the anchor role (with the obvious spacecost advantage that this involves). Next at this point is significantly less exposed to High Street locations than the market leader Marks & Spencer: more than 60% of Next stores are in-out-of town locations, while less than 30% of M&S stores are (see Exhibit 262). Given the larger formats devel-
151
oped, the shopping center/out-of-town focus and current geographic penetration levels (see Exhibit 262), we do not see material limitations to Nexts continued profitable space expansion. The only limiting factor could be a continuing flow of planning permissions. We are erring on the side of caution by assuming space growth of +11.6% and +10.0% for the current and next fiscal year, respectively, slightly more than one-third the growth achieved in 2005.
Exhibit 262
Next: UK Stores and Penetration by Region

Pop. (000) 8,435 9,494 5,055 7,686 5,586 2,980 4,907 7,880 5,062 1,685 278 59,049 No. of Next Stores In: Shopping High Centers Street 34 23 43 31 13 18 25 21 32 10 11 8 18 15 45 21 24 12 12 4 0 4 257 167 Next Penetration (stores/million pop.) Shopping High Centers Street Total 4.0 2.7 6.8 4.5 3.3 7.8 2.6 3.6 6.1 3.3 2.7 6.0 5.7 1.8 7.5 3.7 2.7 6.4 3.7 3.1 6.7 5.7 2.7 8.4 4.7 2.4 7.1 7.1 2.4 9.5 0.0 14.4 14.4 4.4 2.8 7.2
Region Greater London South East South West East Midlands West Midlands Wales North East North West Scotland Nothern Ireland Islands Total
Total 57 74 31 46 42 19 33 66 36 16 4 424
Note: Retail Locations data may over-/understate total store count trend is more useful here. Source: Retail Locations, ONS, corporate reports and Bernstein estimates and analysis.
Space development is being carried out with stringent financial criteria. Payback of net capital invested has been 24 months in the past few years and recently has been reduced to 18 months. Key to achieving favorable economics has been the out-of-town move, whereby SG&A costs have been declining faster than space productivity. In fact, Next retains one of the highest space-productivity performances among apparel retailers in the United Kingdom, even after the setback suffered in 2005 owing to the amount of new space introduced and negative like-for-likes (see Exhibits 263-265). We are expecting sales productivity to remain an important benefit to Next going forward.
Exhibit 263
Next: Retail Sales/m2 vs. Store Size and Operating Lease Expense as a Percentage of Retail Sales
Sales/m2 vs. Store Size Operating Lease Expense as a Percentage of Retail Sales
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
8,000 7,500 7,000 Sales/m2 6,500 6,000 5,500 5,000 4,500 4,000 3,500 3,000 200 400 600 800 1000 1995 1994 2005 1999 1997 1996 1998 2000 2001 2002 2003 2004
Average Store Size (m2)

152
Exhibit 264
Next: SG&A as a Percentage of Net Sales
Exhibit 265
Apparel and Accessories Space Productivity in the UK (2004)
SG&A as a Percentage of Net Sales
20% 19% 18% 17% 16% 15% 14% 13% 12% 11% 10% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Sales/m2
7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Average M&S Asda H&M Zara Next 2004 Next 2005 New Look Matalan Tesco Top Shop Debenhams Primark Bhs
Source: TNS, Verdict and Bernstein estimates and analysis.
(b) Directory and Online Growth: Next has leveraged its retail assets product capabilities, sourcing and operations, customer base into the directory channel. As a consequence, Next has become one of the few truly multichannel retailers in the United Kingdom. Directory sales have been an important growth driver, contributing around 20% of the total turnover increase of the past five years. In fact, directory sales have been growing at a slightly higher pace than retail sales, with a 16.6% CAGR between 1994 and 2005 (see Exhibit 266).
Exhibit 266
2,500 2,000 Million 1,500 1,000 500 0 1994 1995 1996 1997 1998 1999
Next: Retail Sales vs. Directory Sales

Retail Sales
1,000 900 800 700 Million CAGR: 15.3% 600 500 400 300 200 100 0 2000 2001 2002 2003 2004 2005 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 CAGR: 16.6%
Directory Sales
The key drivers of directory sales growth have been the ongoing customer-base expansion and the broadening of the product offer (see Exhibits 267-270). After a hiccup at the end of the 1990s, directory sales growth is expected to be fast and steady, boosted by: (a) the ongoing expansion of the Next customer franchise; (b) the competitive demise of traditional catalog players; (c) the dominant role Next commands in the online channel; and
153
(d) plans to continue to extend the offer in further product categories (e.g., gold and precious jewelry, toiletries and consumer electronics).
Exhibit 267
Directory Sales as a Function of Active Customers
Exhibit 268
Directory Sales as a Function of Average Customer Transaction
800 Directory Sales ( mil.) Directory Sales ( mil.) 700 600 500 400 300 200 100 0 0 500 1,000 1,500 2,000 2,500
Active Customers (000)
800 2005 2004 2003 2002 2001 2000 1997 1999 1998 1996 1995 1994 700 600 500 400 300 200 100 R = 100%
2
2005 2004 2003 2001 2000 1995 1994 280 290 300 310 1999 1998 1996 2002 1997
R = 58% 320 330
0 270
Average Customer Transaction

Exhibit 269
Directory Sales as a Function of Total Directory Pages
Exhibit 270
Directory Sales as a Function of Sales per Directory Page
800 Directory Sales ( mil.) Directory Sales ( mil.) 700 600 500 400 2001 300 200 1,000 2000 R = 97% 2,000 2,500 3,000
2
800 2005 2004 2003 2002 700 600 2003 500 400 300 200 150 2002 2001 2000 R = 94% 170 190 210 230 250 270
2
2005 2004
1,500
Total Directory Pages (000)

Sales per Directory Page ( 000)

Fast and complete development of its online offer has made Next the leading Apparel & Footwear Internet retailer in the United Kingdom after eBay. Next launched its online Web site in July 2000, made its full Next directory offer available since 2001 and has been leading in service (e.g., nextday delivery, credit, etc.) and flexibility (e.g., home delivery, store delivery, phone order, etc.) ever since. Furthermore, Nexts growing Internet presence has been supported by its typically young customer base who have greater computer literacy and higher online penetration. A leading online position is allowing Next to capture a disproportionate share of the rapidly growing online Apparel & Footwear retail market. To put this in context, Next has almost doubled the online market share of M&S, while the reverse is true in store-based retail. The online Apparel &
154
Footwear retail market represents more than 2% of the total A&F market, and was still growing in 2005 at around 25% per annum. With online orders growing at close to 60% per year between 2001 and 2005 and representing 39% of directory sales in 2005, the Internet channel is and will continue to be a strategic asset in achieving continuing revenue growth (see Exhibits 271-273).
Exhibit 271
Which Retailers Do Online A&F Shoppers Buy From? (October 2005)

eBay Next M&S Additions Direct Littlewoods Debenhams River Island Arcadia Kays Boden Vert Baudet Asos Great Universal Choice Grattan Freemands Yoox Haburi 0%
Source: Verdict.
10% 20% 30% 40% 50% 60%
Exhibit 272
1,000 A&F Online Spending ( mil.) 900 800 700 600 500 400 300 200 100 0 1998 1999 2000 2001 2002 2003 2004
Apparel & Footwear Online Spending (1998-2005)

YoY A&F Online Spending Growth 450% 400% 350% 300% 250% 200% 150% 100% 50% 0% 1998 1999 2000 2001 2002 2003 2004 2005 A&F Online Spending as a Percentage of Total A&F Market 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 1998 1999 2000 2001 2002 2003 2004 2005
Source: Verdict.
Exhibit 273
Next: Online Business

Directory Orders Placed Over the Internet Value of Internet Orders ( million) CAGR of Internet Orders Total Directory Sales ( million) Source: Corporate reports. 2001 12.4% 45 362 2005 39.0% 267 81.1% 685
2005
(4) Room for Margin Expansion We believe it is conceivable and plausible that Next can leverage its cost base to offset adverse economics in a declining like-for-like scenario. The three most likely sources of efficiency are: (a) cost of sales; (b) distribution- and operations-related costs; and (c) overhead costs.
155
Next has been keeping cost of sales virtually constant in the past 10 years, oscillating in a narrow band between 68% and 70%. We have three reasons for being positive on this front: (1) short term, our direct experience of management in times of crisis and the latest example from the UK market leader indicate that, when push comes to shove, it is always possible to extract value from suppliers; (2) more structurally, Nexts internationally established and multipronged sourcing organization should be able to leverage increasing sourcing volumes and offset any negative development from quota reintroduction; and (3) longer term, we believe that Nexts development of Next clearance will allow better margin realization. An indirect confirmation of Next having room for margin expansion is the analysis of Nexts market share by price point. Nexts historical data do not indicate any drift toward higher prices. Rather, the opposite is true: in the last five years Next has virtually doubled its market share in the two lowest price bands, whereas its shares in the second-highest and highest price bands have increased by only 50% and 20%, respectively (see Exhibits 274-276).
Exhibit 274
70.5% 70.0% 69.5% Cost of Sales 69.0% 68.5% 68.0% 67.5% 67.0% 1994
Next: Cost of Sales
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Exhibit 275
Next: UK Apparel and Accessories Market Share by Price Point
Exhibit 276
Next vs. M&S: UK Apparel and Accessories Relative Market Share by Price Point
Price Tag 9-10 Price Tag 4-6 Price Tag 7-8 7.84 -> 7.00 12.12 -> 11.11 21.28 -> 20.46
Avg. Price Price Tag 1-3 10% 4.15 -> 3.55
Price Tag 7-8 Price Tag 9-10 Price Tag 4-6 7.84 -> 7.00 12.12 -> 11.11 21.28 -> 20.46
Avg. Price Price Tag 1-3 90% 4.15 -> 3.55
9% 8% Market Share 7% 6% 5% 4% 3% 2% 1% 0%
12/16/01 12/15/02 12/14/03 12/12/04 12/11/05
Relative Market Share
80% 70% 60% 50% 40% 30% 20% 10% 0% 12/16/2001 12/15/2002 12/14/2003 12/12/2004 12/11/2005 12/16/2001 12/15/2002 12/14/2003 12/12/2004 12/11/2005 12/16/2001 12/15/2002 12/14/2003 12/12/2004 12/11/2005 12/16/2001 12/15/2002 12/14/2003 12/12/2004 12/11/2005
Source: TNS and Bernstein analysis
Source: TNS and Bernstein analysis
156
On the operating-costs front, we expect further benefits from the recent introduction of two new warehouses, which began to show in the January 2006 results. Company guidance also points to a cost-saving opportunity connected to directory distribution and call-center operations. Continuing turnover growth should provide further impulse for cost reductions, as economies of scale kick in on the least variable cost elements. In recent years inflationary developments connected to occupancy costs and utilities, as well as slowing like-for-likes, have more than offset scale effects, but the long-term trend should resume longer term (see Exhibit 277).
Exhibit 277
Next: SG&A Growth vs. Sales Growth

19.8% SG&A as a Percentage of Sales 18.8% 18.0% 1994 17.2% 16.5% 15.8% 15.0% 14.5%
0.45 0.60 0.80 1.00 1.20 1.50 2.00 3.00 3.80
Slope: 95% 1998
1999
1995 1997 1996 2000 2001 2002 2005 2004 2003
Sales ( billion)
Source: Corporate reports and Bernstein analysis
Forecast
We anticipate that Next will perform toward the top end of consensus expectations for the next two years. As far as sales development is concerned, we are assuming like-for-likes of 4.5% to January 2007 and (2)% to January 2008. We foresee continuing strength in directory-sales development and a more subdued retail space increase, around 10% in 2006 and 9% in 2007. Our expectations on net earnings are at the high end of consensus for both years (see Exhibit 278).
Exhibit 278
Next: Bernstein vs. Consensus Forecast at a Glance ( million)

Bernstein 2006 2007 (Jan-07) (Jan-08) 3,329 3,607 324 337 Consensus 2006 (Jan-07) 2007 (Jan-08) High Low Median High Low Median 3,718 3,283 3,332 3,718 3,445 3,551 331 308 321 383 320 346
Sales Net Income
Source: FactSet and Bernstein analysis and estimates.
In the absence of guidance, we have not considered the effect of stock repurchases which are likely to continue in the coming years, either on the net financial position, interest expense or stock price. We will monitor the current run-rate and update our assumptions accordingly.
157
PPR: Value-Creation Through Focus

Overview PPR is a monument to courage and entrepreneurship, created by Henri Pinault through a string of high-profile acquisitions, building one of the most admired retail and luxury conglomerates out of a family inheritance of wood manufacturing and wholesale businesses. Despite a strong 2005 when interest was roused by management changes, a new strategy and a focus on organic growth, as well as, more recently, improving results, PPR has been largely forgotten by the market. However, we believe PPR stock is undervalued, based on its earnings potential and fundamental value. As new management, led by new CEO Francois Henri Pinault, concentrates on organic growth, we are confident that more positive results will follow, fuelled by above-average growth at Gucci, stabilization of other luxury brands and an improving consumer outlook for France. Consistently positive results will be a catalyst for continued rerating of the stock, currently undervalued versus other retailers in our coverage. The markets love affair with PPR during the late 1990s ended abruptly in 2000; between 2000 and 2004 the stock underperformed the MSCI Europe Index by more than 20% per year. Only in 2005 did PPR regain some of this lost ground, returning a relative 18% (see Exhibit 279). This de-rating caused the PPR relative forward P/E to reach a low of 0.6x in October 2002 (see Exhibit 280).
Background: The Purgatory
Exhibit 279
100% Relative Price Performance
PPR: Annual Relative Price Performance (to MSCI Europe)
Exhibit 280
4.5x 4.0x Relative Forward P/E 3.5x 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x
PPR: Long-Term Growth Expectations and Relative Forward P/E

35% 30% 25% 20% 15% 10% 5% 0% (5)% (10)% Growth Expectations
80% 60% 40% 20% 0% (20)% (40)% (60)% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
The reasons for such a severe de-rating were to be found in a relatively overambitious acquisition and divestiture spree. As the group spread from retail to banking, and from luxury goods to electrical materials, the market became confused as to what sectors PPR was actually focusing on (see Ex-
Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Rel. Fwd P/E Growth Expectations
158
hibit 281). Below-average and declining RoCE further exacerbated the situation (see Exhibit 282).
Exhibit 281
Currently Active 1991 Home & Furniture Retailing 1991 I/E, Trading, Distribution 1992 Apparel Retailing 1993 Specialty Retailing1 1994 Electronics & Media Retailing2 1994 Catalog Retailing 1998 Luxury Goods
PPR: Sectors of Activity

Sales 2005 = 17.8 Billion
17%
11%
Divested 1992 Grocery Retailing 1992 Wood & Furniture Manufacturing 2002 Office Supply Retailing 2002 Banking & Financial Services 2003 Wood & Building Materials Retailing 2004 Electrical Materials Retailing 2006 Printemps, Department Stores
72%
Retail
1 Mobile technology retailing, underwear retailing and gift cards. 2 Rexel, electrical materials retailing. Source: Press, corporate reports and Bernstein analysis.
Trading, Distribution
Luxury
Exhibit 282
PPR: RoCE (1996-2005)

8% 7% 6% NOPAT/Sales 5% 4% 3% 2% 1% 0% 0.0x 5% 2001 2000 1999 2002 2003 2005 2004 RoCE 20% 1998 1996 1997 15% 10%
1.0x 2.0x 3.0x Sales/Capital Employed
4.0x
Source: Press, corporate reports and Bernstein analysis.
We feel PPR is now at a turning point because: (a) the below-averageperforming Rexel was divested in 2004; (b) a clearer and sharper new PPR has been created, with just two businesses: luxury and retail (see Exhibit 283); (c) after many acquisitions, a new era of organic growth has been announced; and (d) management has been renewed, both at group level and within divisions. Positive results are starting to emerge, which has helped breathe new life into the stock over the last year. We expect more and more substantial good news going forward. Due to an increasing debt burden (built through acquisitive expansion, exacerbated by coincidental high operating losses through to 2001-03), the company refinanced with a 1,080 million convertible and 750 million bond placement through 2003. We fully factor in the dilution caused by the convertible (roughly 10% of the outstanding equity) into our EPS forecasts.
159
It is the reduction in this debt, and the consequent boost to earnings from the reduction in interest charges, that lead to a large portion of our forecast EPS growth.
Exhibit 283
New PPR Brand Portfolio

Million Retail Conforama Fnac Printemps Redcats CFAO Other Total Source: Corporate reports. 3,140.0 4381.9 751.8 4377.3 2034.3 74.7 14,760.0 Luxury Gucci YSL Beaut YSL Bottega Veneta Other Luxury Brands Total Million 1,807.1 613.2 162.0 159.7 294.2 3,036.2
The Value Creation Opportunity: Business Levers
We believe PPR has a credible and significant opportunity to improve its short-term earnings performance (see Exhibit 284). We see three converging reasons for this: Continuing above-average development at Gucci; Fixing non-Gucci luxury brands; and Improving retail economics.
Exhibit 284
21,000 20,500 20,000 Million 19,500 19,000 18,500 18,000 17,500 17,000 16,500 16,000 2005
PPR: Sales and Earnings Forecast Bernstein vs. Consensus

Sales
1,000 900 800 Million 700 600 500 400 300 200 100 0
2006E 2006 2007E 2007
Net Earnings
2005
Consensus High Consensus Low
2006E
2007E
Actual
Note: Consensus as of August 11, 2006. Source: Bloomberg L.P. and Bernstein analysis.
Bernstein
Continuing Above-Average Development at Gucci
Gucci is a mega-brand. A soon-to-be-published AC Nielsen report based on 21,000 interviews in 42 countries Giorgio Armani and Gucci, the Worlds Most Coveted Fashion Brands will put Gucci at the very top of the luxury and fashion brands hierarchy. This is consistent with research carried out three years ago in eight of the most important world economies, highlighting Gucci as one of the most globally top-of-mind luxury and fashion brands. Most notably, the December 2002 research indicates that Gucci is more consistently top-of-mind than such revered luxury icons as Louis Vuitton, or even Armani itself (see Exhibits 285 and 286).
160
Exhibit 285
Top-of-Mind Fashion and Luxury Brands First Brand Mentioned (No Prompting)
Question: Which fashion or luxury brands for example, apparel brands, accessories brands, eyewear brands do you know or have you heard of? Italy Armani Valentino Versace Gucci D&G Prada Cavalli Benetton Spain Rayban Armani Dior Lacoste Levis Loewe El Corte Ingls Gucci 14% 6 4 3 3 3 3 2 22% 14 10 5 4 4 2 2 Dior Chanel Vuitton Lacoste YSL Rayban Gucci Cardin United States Rayban Gucci Levis Calvin Klein Hugo Boss Armani Versace Prada France United Kingdom Gucci Rayban Versace D&G Armani Calvin Klein Next Nike China 6% Lacoste Valentino 4 2 Rayban 2 Gucci 2 Chanel 1 Cardin 1 Versace 1 Vuitton Germany 8% 8 6 6 4 3 3 2 3% 2 2 2 2 2 1 1 Hugo Boss Gucci Joop Armani Dior Chanel Lacoste Calvin Klein Japan Hugo Boss Gucci Versace Boss Prada Chanel Lacoste Calvin Klein 12% 10 10 6 4 3 2 2 12% 8 6 5 4 3 2 2
31% 21 8 5 4 4 2 2
Exhibit 286
Top-of-Mind Fashion and Luxury Brands All Brands Mentioned (No Prompting)
Question: Which fashion or luxury brands for example apparel brands, accessories brands, eyewear brands do you know or have you heard of? Italy Armani Valentino Versace D&G Gucci Prada Ferre Cavalli Spain Rayban Armani Dior Lacoste Burberry Chanel Levis Loewe 19% 11 9 8 7 6 6 6 37% 35 26 16 15 12 8 7 Dior Chanel YSL Vuitton Lacoste Gucci Hermes Armani United States Rayban Ralph Lauren Gucci Levis Hilfiger Oakley Calvin Klein Versace France 31% 21 16 15 10 6 5 3 6% 6 5 4 4 4 3 2 Gucci Versace Armani D&G Rayban Chanel Prada Dior China Gucci Valentino Lacoste Versace Chanel Rayban YSL Vuitton 5% 5 5 4 4 3 3 3 Hugo Boss Joop Gucci Armani Lagerfeld Dior Chanel Versace United Kingdom 20% 18 16 15 14 9 8 8 Hugo Boss Joop Gucci Armani Lagerfeld Dior Chanel Calvin Klein Japan 24% 16 15 14 11 10 8 7 Germany 24% 16 15 14 11 10 8 6
The importance of mega-brand status is that with it comes sustainable above-average sales growth with above-average profitability. In fact, we are convinced that in the world of luxury, winners will continue to win. There are two reasons for this: (a) On the demand side, luxury market growth comes mainly from new consumers entering the category be it the nouveaux riches from emerging economies or aspiring consumers in developed countries. Owning a luxury product for these consumers represents a point of arrival. What these people want is the real thing not some cool niche brand, but the high-profile, world-leading mega-brands. Winners continue to win (see Exhibit 287). (b) On the supply side, the increasing ante of competition is creating a virtuous cycle for mega-brands. Limited flagship store space and escalating lease costs require higher and higher space productivity (sales/square me-
161
ter). Space productivity is driven by top-of-mind status and ultimately by advertising budget sizes the larger the better. Besides, superior space productivity allows winning brands to favor directly-managed monobrand distribution against multibrand wholesale stores, hence allowing them better brand deployment and control over rivals. Here too, winners continue to win (see Exhibit 288).
Exhibit 287
Winners Continue to Win Luxury for the Masses

Luxury Market Development Available Wealth
High
Years as Luxury Consumer

High
Fascination With Mega-Brands

Low
Low
Low
High
Exhibit 288
Higher Advertising Spend
Winners Continue to Win Top-of-Mind Virtuous Cycle

Top-of-Mind Superior Brand Deployment
Superior Store Economics

Higher Retail Space Productivity
More Direct Monobrand Retail Sales
These trends will favor high-profile, global brands like Gucci. Louis Vuitton (LVMH.FP not covered) is sailing with the same wind: despite being significantly larger than Gucci, Louis Vuitton has achieved annual growth of 15% during the past seven years (see Exhibit 289). After the acquisition campaign of 1999-2001 had caused the previous Gucci leadership to be distracted, new management has led Gucci back to double-digit growth (see Exhibits 290 and 291). Going forward, we believe that Gucci will be able to sustain this consistently strong growth well above the average 10% that Robert Polet has indicated for the luxury division as a whole. Gucci is successfully turning the page after the departure two years ago of former chief designer Tom Ford, the driving force of the Gucci revival in the 1990s. In our view, any residual concern over the departure of Tom Ford is overstated. New management and new artistic direction at Gucci by Frida Giannini has ensured resumption of sales growth and a series of new hits (e.g., the Flora bag, la pelle Guccissima), despite a few nostalgic fashion connoisseurs missing the high profile and ostentatious style of the 1990s. Besides, higher-than-average sales growth at directly-operated stores is, in our experience, the best indicator of a brand in good health: in 2005 like-for-like DOS sales growth was 21%+.
162
Exhibit 289
Louis Vuitton: Sales Growth

4,000 3,500 3,000
Sales ( million)
CAGR 1998-2005: 15%
2,500 2,000 1,500 1,000 500 0 1998 1999 2000 2001 2002 2003 2004 2005
Source: Bernstein estimates and analysis.
Exhibit 290
PPR: Luxury Acquisitions

1999 1999 2000 2000 Sergio Rossi Yves Saint Laurent Alexander McQueen Bedat 2000 2000 2001 2001 Bottega Veneta Boucheron Balenciaga Stella McCartney
Exhibit 291
2,000 1,800 1,600
Sales ( million)
Gucci: Sales Growth

25% 20%
YoY Sales Growth
15% 10% 5% 0% (5)% (10)% 2001 2002 2003 2004 2005 4Q:05 JanFeb 2006
1,400 1,200 1,000 800 600 400 200 0 2000 2001 2002 2003 2004 2005
Actual Exchange Rate
Constant Exchange Rate
The comparison of Guccis directly-operated stores network with those at Armani and Louis Vuitton highlight significant growth opportunity (see Exhibit 292). Continuing sales growth and increase of sales in the DOS channel (61% of total Gucci sales in 2005) will ensure economies of scale and more-than-proportional profitability growth. In fact, it is apparent that luxury brands with a high proportion of DOS operations have a predominantly fixed-cost base specifically, advertising, store operating leases, personnel. Cost-of-goods-sold for these companies is, in our experience, be-
163
tween 10-20% of sales. A predominantly fixed cost base lends itself to high operating leverage (see Exhibit 293).
Exhibit 292
Total Stores 385 121 54 37 33 27 26 14 10 10 9 7 7 5 5 20 361 121 44 35 31 31 21 12 12 8 6 40 294 233 20 13 12 16 3 1,043
Monobrand Stores: Gucci vs. Louis Vuitton and Armani

Gucci Stores 98 41 14 7 9 4 10 3 3 0 2 0 0 1 0 4 74 27 9 7 4 7 5 2 4 2 1 6 42 33 4 2 0 3 1 215 Index 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 Louis Vuitton Stores Index 122 124 39 95 20 143 12 171 7 78 9 225 8 80 4 133 1 33 2 na 3 150 1 na 2 na 1 100 4 na 9 225 86 15 16 11 6 8 8 3 2 3 3 11 122 95 9 4 7 7 1 331 116 56 178 157 150 114 160 150 50 150 300 183 290 288 225 200 na 233 100 154 Armani Stores 165 41 20 18 17 14 8 7 6 8 4 6 5 3 1 7 201 79 19 17 21 16 8 7 6 3 2 23 130 105 7 7 5 6 1 497 Index 168 100 143 257 189 350 80 233 200 na 200 na na 300 na 175 272 293 211 243 525 229 160 350 150 150 200 383 310 318 175 350 na 200 100 231
Asia and Pacific Japan South Korea China Hong Kong Australia Taiwan Singapore Malaysia Saudi Arabia Thailand United Arab Emirates Turkey Philippines New Zealand Other Europe Italy France Germany Spain United Kingdom Switzerland Greece Russia Belgium Austria Other Americas United States Canada Brazil Mexico Other Rest of World Total
Note: Store count as of March 10, 2006; Index: Gucci = 100. Source: Company Web sites and Bernstein analysis.
Exhibit 293
Luxury Brands: Scale vs. Profitability

50% EBIT as a Percentage of Sales 45% 40% 35% 30% Hermes 25% 20% 15% 10% 500 Bulgari Burberry Gucci Cartier R = 93%
2
Louis Vuitton
1,000 1,500 2,000 2,500 3,000 3,500 Sales ( million)
164
Fixing Non-Gucci Luxury Brands
Yves Saint Laurent and the other fashion and luxury brands acquired between 1999 and 2001 (see Exhibit 281) have been the root cause of performance deterioration in the PPR luxury division. Operating margins at the PPR luxury division have fallen consistently over the last five years, going from 22% in 1999 to 9% in 2003, but bouncing back in 2004 for the first time to about 12% (see Exhibit 294). The acquired brands have: (a) added an increasing burden to results because of their negative or below-average EBIT, and (b) distracted management from Gucci, which lost almost 100 million of absolute EBIT between 2001 and 2003 (see Exhibit 295). YSL and minor brands have been the key culprits, contributing respectively 80 million and 40 million (excluding central costs) of negative EBIT in 2004. Yves Saint Laurent Beaut and Bottega Veneta, respectively, have been performing slightly above and close to breakeven.
Exhibit 294
PPR: RoNA by Division
Exhibit 295
600 500
PPR Luxury Brands: Historical EBIT Performance

YSL YSL Bottega Other 40% Beaut Veneta 30% 20% 10% 0% (10)% (20)% (30)% (40)% (50)% (60)% (70)% (80)%
2001 2002 2003 2004 2005 2002 2003 2004 2005 2001 2002 2003 2004 2005
2001 2002 2003 2004 2005
Sales/Net Assets
Note: Other includes: Sergio Rossi, Balenciaga, McQueen, Boucheon, central costs. Source: Corporate reports and Bernstein estimates and analysis.
Former Gucci CEO De Sole declared (BBC, November 16, 1999): We believe Yves Saint Laurent is one of the really great trademarks, and our goal is to achieve the same financial success with YSL that we have achieved with Gucci. Disappointing results on acquired brands have been one of the precipitating factors of the high-profile leadership change of April 2004, culminating with the appointment of new CEO Robert Polet and the departure of De Sole and Tom Ford. We are convinced there are good reasons for optimism on the return to profitability of the non-Gucci brands. For starters, the new leadership is committed to a quick turnaround: CEO Robert Polet has indicated that 2007 is the deadline by which all brands, bar YSL, must reach breakeven or face being divested. Initial results are encouraging, as both Bottega Veneta and other minor brands have improved significantly in 2005 over 2004 (see Exhibit 296).
2001 2002 2003 2004 2005
Luxury 24% 99 22% 20% 00 18% 16% 01 04 14% 05 12% 02 10% 03 8% 6% New 4% PPR 2% 0% 0.0x 1.0x
Gucci
400 300 200 100 0
Retail 01 99 0098 97 96 2.0x 3.0x 02 03 04 05
RoCE 20% 15% 10% 5%

4.0x
(100) (200)
YoY EBIT Growth (Lines, %)
EBIT (Columns, mil.)
EBIT/Sales
165
Exhibit 296
PPR Non-Gucci Brands: EBIT (2004 vs. 2005)

40
Recurring Operating Income ( million)
20 0 (20) (40) (60) (80) Bottega Veneta YSL YSL Beaut 2004 Other Corporate Brands Cost
2005
Bottega Veneta and most of the other minor brands are focused on accessories (see Exhibit 297). We see this as a key positive. In fact, accessories brands have intrinsically better economics than designer-centered apparel brands: Lower Development Costs: Accessories designer teams normally comprise highly skilled professionals with very few prima donnas among them, their cost is a fraction of what a high-profile fashion designer would command, both in terms of salary and expenses; Lower Presentation Costs: It is not commonly expected that accessories brands organize fashion shows, a static presentation of the collection in the showroom will do conversely, every fashion brand worth its salt must have at least four fashion shows per year (Spring/Summer + Fall/Winter, Womenswear + Menswear); Lower Cost for Sample Collections: Excluding shoes, accessories samples can be sold at full price, as they do not come in specific sizes prt-porter collection samples, as they are in size 40-42 and are adapted for models wearing them in the showrooms, are normally discounted 80-90%; and Lower Need for Large Flagship Stores: Accessories collections physically require less space to be displayed and merchandised than fashion space productivity is normally higher.
166
Exhibit 297
Apparel Designer Brands vs. Accessories Specialist Brands: Timing of Category Diversification
The structurally lower fixed costs of accessories brands mean that it is easier for them to play a niche strategy and be profitable even at a relatively small size. To this, it must be added that: Accessories demand has been higher than apparel demand for the past 10 years and is projected to stay so going forward accessories will feel less pressure from the mix-and-match trend, as they are normally highly visible in a womans outfit and play the brand marker role (see Exhibit 298). Accessories brands have longer staying power than designer brands, as their very essence and raison dtre is to stand for product excellence in a specific category the flip side of this is that they are slower to stretch to new product categories, as craftsmanship travels less easily across categories than designer appeal; when it does, though, it sticks (see Exhibits 299 and 300). The good news on this front for PPR is that most non-Gucci brands are accessories-focused, with YSL the notable exception (see Exhibit 298). Sergio Rossi is the only nonprofitable accessories-focused brand. But now that PPR controls 100% of the brand after the recent acquisition, we are confident that Sergio Rossi too can be right-sized for profitability. Balenciaga, Alexander McQueen and Stella McCartney pose little concern, as both their turnover and EBIT size are not material.
167
Exhibit 298
Apparel Designer Brands vs. Accessories Specialist Brands: Extent of Category Diversification
Exhibit 299
Luxury Market Growth (1994-2002)
Exhibit 300
PPR: Luxury Category Sales Mix (2005)

Other Other Jewelry RTW Shoes RTW Other RTW Shoes Jewelry
Category Growth (CAGR, 1994-2002)
16% Eyewear 14% 12% 10% 8% 6% 4% 2% 0% 0 5 10 15 20 25 Underwear Shoes Pens Silk Watches Womenswear Jewelry Leather Menswear
100% 90% 80% 70%
Sales
60% 50% 40% 30% 20% 10% 0% Gucci YSL Bottega Veneta Bags Bags Shoes Bags
Category Size ( billion, 2002)

Source: Altagamma and Bernstein analysis. Source: Corporate reports and Bernstein analysis.
The residual real concern is YSL. After the acquisition, PPR has chosen a brute force approach for YSL, based on a sharp increase of collection development expenditure, communication and directly-operated stores. Unfortunately there is no surefire mechanics for a luxury brands relaunch, and what worked once (with Gucci) will not necessarily work a second time with YSL. Given the amount invested, this was possibly the hardest point to back away from for the new leadership, so CEO Polet has not set a fixed date for YSL to break even. The party line remains that YSL needs to almost double its current 160 million sales to 300 million in order to turn a profit. We are convinced that they will be unable to achieve this in the near future. On the other hand, we believe that as much as apparel-focused brands have higher fixed costs than accessories brands a great deal of
168
fixed cost at YSL can be eliminated in order to make the brand profitable sooner, or at least limit the losses. In fact, one of the key levers to consider is a possible right-sizing of the DOS network. As we have indicated, directlyoperated stores are a double-edged sword: they can multiply margin, starting a virtuous cycle if a brand can command high enough sales/m2, but they can also multiply losses otherwise. YSL seemed to be a case of the latter up until 2004 (see Exhibit 301).
Exhibit 301
YSL: Number of Directly-Operated Stores vs. EBIT

(55) (60)
EBIT ( million)
R = 14% 2001 2005
(65) (70) (75) 2003 (80) (85) 35 40 45 50 55 2002
2004
60
65
Number of Directly-Operated Stores
Whether PPR management will bite the bullet on YSL costs and possible right-sizing is a different matter. Opportunities for more productive use of the YSL DOS network are not amiss: (a) on the one hand, Bottega Veneta is growing and performing well above expectations, and needing new stores to develop (PPR plans 13 new DOS for Bottega Veneta in 2006); (b) having a portfolio of accessories brands could lend itself to adding ad hoc corners within selected YSL stores, experimenting with new and more space-productive multibrand formats. We would not rule out positive surprises on the YSL front too, as Polets FMCG background would possibly make him an innovator in a sector obsessed with sacred cows, like the mausoleum monobrand store. Improving Retail Economics PPRs retail business is a group of diversified activities, with remarkably different characteristics: category focus, formats and geography. Category focus spans: (a) furniture and appliances of discount specialist Conforama; (b) hardware, software, consumer electronics and media of specialist FNAC; (c) apparel, personal and home accessories of catalog specialist Redcats; and (d) pharmaceuticals, automotive and industrial parts of trading company CFAO (see Exhibit 302). Approximately 60% of retail activities is concentrated in France, ranging from FNAC at 77% to Conforama at 67%, to Redcats at 47%. The United States, with 8% of sales (catalog), is the second market, followed by Italy at 5% (Conforama and FNAC), the United Kingdom at 4% (catalog), Iberia at 3% (FNAC) and Scandinavia at 3% (catalog). CFAO is almost entirely focused on Africa (see Exhibit 303).
169
Exhibit 302
PPR: Retail Category Mix (2005)

Games Leisure Home Furniture Leisure Other Personal Accessories Accessories Home Apparel Furniture PCs, SW E-Commerce Auto Pharmaceuticals
100% 90% 80% 70%

Sales
Other TV, Video, PCs, Hi-Fi Home White Goods
Audio Hi-Fi TV Video Photo Books Records
Beauty Care
Industry & Trading Pharma
60% 50% 40% 30% 20% 10% 0%
Conforama
FNAC
Printemps
Redcats
CFAO
Exhibit 303
Conforama 2,126 587
PPR: Retail Sales Mix by Geography (2005) ( million)

Total FNAC 3,348 105 574 427 3,140 21% 355 4,382 30% 752 5% 530 359 293 4,377 30% 1,953 2,034 14% Printemps 752 Redcats 2,066 1,129 CFAO 81 Million 8,373 1,129 692 530 574 359 3,028 14,685 100% Pct 57% 8 5 4 4 2 21 100%
France United States Italy United Kingdom Iberia Scandinavia Other Total ( million) Total (%)
A business portfolio matrix indicates that PPRs retail business is developing fast and, for the most part, has interesting profitability (see Exhibit 304). Supporting acquisitions have boosted growth at Conforama, Redcats and CFAO while FNAC growth has predominantly been organic (see Exhibit 305). We believe that PPRs retail business will profit from favorable tailwinds going forward for three major reasons: Conforama: Favorable housing developments in the French market and expected post-general-election recovery in Italy; FNAC: favorable consumer-electronics demand development, connected to major 2006 sports events; and Cost-reduction opportunities: labor productivity across businesses, Far East sourcing for Conforama and cost efficiencies from paperto-online switch at Redcats.
170
Exhibit 304
16%
Sales CAGR (1995-2005)
PPR: Retail Portfolio Matrix (2005)
Exhibit 305
PPR: Growth Support Acquisitions (1996-2004)

Catalog Trading and Distribution 1991, CFAO
14% 12% 10% 8% 6% 4% 2% 0% 12% Other CFAO Total Redcats
Retail 1991, Conforama Major 1992, Printemps Acquisitions 1994, FNAC
1992-94, La Redoute 1996, SCOA 1997, Ellos 1997, Bernard 1998, Brylane 1998, Eveil et Jeux
Growth Support Acquisitions
2000, Surcouf 2000, Emmezeta 2001, Madelios
2001, Afrima
10%
8%
6%
EBIT (2005)
4%
2%
0%
Note: Circle sizes proportional to 2005 sales. Source: Corporate reports and Bernstein analysis. Source: Press, corporate reports and Bernstein analysis.
(a) Both housing authorizations and housing starts statistics are up in France, and more buoyant housing development is expected for 2006. Both housing authorizations and housing starts correlate positively with space productivity at Conforama, respectively, with a six-month and a threemonth time delay (see Exhibits 306 and 307). Space productivity in France historically has been a key driver of EBIT performance at Conforama, as sales in France represent close to 70% of total Conforama sales (see Exhibit 308).
Exhibit 306
4% 3%
YoY Sales/m 2 Growth
France: House Authorization Growth vs. Conforama Sales/m2 Growth

2004 2001
2006E
Exhibit 307
4% 3%
France: House Starts Growth vs. Conforama Sales/m2 Growth

2004 2001 2005
2006E
1% 0% (1)% (2)% (3)% (4)% (5)% (6)% (5)% 0% 2002
YoY Sales/m2 Growth
2%
2% 1% 0% (1)% (2)% (3)% (4)% (5)% 2003 2000 2002 y = 0.2912x 0.0196 R = 55%
2
2005
2000 y = 0.2839x 0.0281 R = 59% 2003 5% 10% 15% 20%

2
(6)% (10)%
(5)%
0%
5%
10%
15%
20%
YoY House Authorizations Growth

Note: House starts growth with six months delay, 2006E based on five months data. Source: Corporate reports and Bernstein analysis.
YoY House Starts Growth

Note: House starts growth with three months delay, 2006E based on two months data. Source: Corporate reports and Bernstein analysis.
171
More good news should come from the remaining 30% of the business based in Italy. Weak Italian consumer spending has been the key driver of Conforamas 2.7% like-for-like international revenue decrease in 2005. We expect Italian consumer spending to resume in 2006, as the post-generalelection effect will likely take place: in three out of five relevant elections (excluding 2001, when the economy was impacted by the 9/11 events), Italian consumer spending has significantly picked up, once it stayed constant and only once has it declined (see Exhibit 309).
Exhibit 308
10.0% 9.5% 9.0% 8.5% 8.0%
EBIT
Conforama: EBIT vs. Sales/m2 in France

R = 73%
2
Exhibit 309
Italy: Impact of General Elections on Families Spend
2000 1999 2001 2002
Delta in Families Spending: 12 Months After vs. 12 Months Before General Elections (Quarterly Average)
2001 1996
7.5% 7.0% 6.5% 6.0% 5.5%
2003
2004 2004 IFRS
1994 1992
2005 IFRS
1987
4,400 4,500
5.0% 4,000
4,100
4,200
4,300
1983 (8)% (6)% (4)% (2)% 0% 2% 4%
Sales/m2
Source: Istat and Bernstein analysis.
(b) The growth acceleration in French consumer-electronics expenditure has been slowing over the last two years (see Exhibit 310). A similar pattern can be observed in terms of consumer electronics retail sales growth (see Exhibit 311).
Exhibit 310
Consumer Electronics Expenditures as a Percentage of Total Consumer Expenditure
Exhibit 311
France: Consumer Electronics Retail Sales
30%
YoY Consumer Spend Growth
25%
28%
15% 10% 5% 0% (5)% 1Q:86 4Q:87 3Q:89 2Q:91 1Q:93 4Q:94 3Q:96 2Q:98 1Q:00 4Q:01 3Q:03 2Q:05
YoY Sales Growth
20%
23%
18%
13%
(10)%
8%
Note: Four-quarter moving average. Source: Haver and Bernstein analysis. Source: Haver and Bernstein analysis.
Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06
172
Major sporting events seem to dictate consumer electronics cycles in France, with consumer electronics spending growth in Football World Cup years significantly higher than in the years leading up to the World Cup. A major spending acceleration happened in three out of five World Cup years, once a modest acceleration ensued, and once only a very modest deceleration took place (see Exhibit 312). We believe it very possible that 2006 will provide the turning point in terms of declining consumer electronics growth deceleration, with an expected positive impact on FNAC sales dynamics and space productivity (see Exhibit 313).
Exhibit 312
France: Impact of FIFA World Cup on Consumer Electronics Spend
Exhibit 313
21,000 20,000 19,000 18,000 17,000 16,000 15,000 0.5%
France: FNAC Sales/m2 vs. Consumer Electronics Spend

2005 2001 2002 2000 2003 2004
Delta in Consumer Electronics Spend as a Percentage of Total Expenditure: YoY Growth Year N/(N 1) vs. YoY Growth Year (N 1)/(N 2) Quarterly Average Average 1986 1990 1994 1998 2002 (2)% 0% 2% 4% 6% 8% 10% 12%
Sales/m2
1999 1998
R = 68%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
Consumer Electronics Spend as a Percentage of Total Consumer Spend
Note: Year-end = year of FIFA World Cup. Source: Haver and Bernstein analysis. Source: Haver and Bernstein analysis.
(c) We expect that the focus on organic growth will heighten managements attention to efficiency opportunities. The most immediate one, it would seem, is personnel productivity. Employee costs as a percentage of sales have increased in the past 10 years by more than 100 basis points (see Exhibit 314). More recently, personnel productivity between 2001 and 2005 has fallen in the luxury division, while moving up modestly in the retail area by 1.9%. Given the size of the workforce on the retail side seven times the size of luxury further gains in productivity are bound to have a material positive impact on the bottom line (see Exhibit 315). Opportunities seem to be higher at Conforama, Redcats and CFAO, while FNAC has been a productivity gainer (see Exhibit 316).
173
Exhibit 314
PPR: Group Payroll Expenses as a Percentage of Sales

15.0% 14.5% 14.0% 13.5% 13.0% 12.5% 12.0%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Exhibit 315
80,000
No. of Employees at Year-End
PPR: Sales per Employee Retail vs. Luxury

Retail Luxury
300 0.9%
Retail
Luxury
70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 2001 2005 2001 2005
Employee Productivity Sales/Head ( 000)
250
1.9%
200 150 100 50 0 2001 2005 2001 2005
Exhibit 316
Sales/Employee ( 000)
PPR: Retail Sales per Employee and Number of Employees

Delta Sales
(2)% 13% (11)% 0%
250 200 150 100 50 0
25,000
No. of Employees
2%
(9)% 16% 31% 8% 11%
(8)%
20,000 15,000 10,000 5,000 0
35% 38% (15)% (5)%
FNAC
Conforama
Printemps
Redcats
CFAO
FNAC
2001
2005
Conforama
2001
Printemps
2005
Redcats
CFAO
174
Forecast
Our forecast is at the high end of consensus for 2006, both in terms of sales and net income. We expect positive earnings dynamics to continue and to be sustainable in 2007, fuelled by: (a) continuing above-average growth at Gucci; (b) quicker-than-plan improvement of non-Gucci luxury brands; and (c) positive consumer environment and cost efficiencies in the retail division. Consensus seems to have a positive but more subdued view (see Exhibit 317).
Exhibit 317
PPR: Bernstein vs. Consensus Forecasts at a Glance ( million)

Consensus Bernstein 2006E 18,138 1,276 627 2007E 19,365 1,502 921 High 19,902 717 2006E Low 17,902 557 Median 18,223 657 High 20,128 929 2007E Low 19,483 770 Median 19,483 837
Sales Operating Profit Net Income
Source: FactSet, Bloomberg L.P. and Bernstein estimates and analysis.
Potential Recovery Upside
The distance between the value the new PPR could potentially express using sales multiples and what PPR is actually worth using earnings multiples is most remarkable (see Exhibit 318). From top to bottom line, an enormous amount of value leaks i.e., almost 20 billion of capitalization, or twice the current market value. We are not saying that PPR shares should trade at about 300, but point to the operating leverage of sub-peer-level operating profitability. The value gap is proportionately larger on the luxury side than on the retail side.
Exhibit 318
Sum-of-the-Parts Valuation vs. Market Capitalization ( million)

Sales EBIT Headquarters Costs Interest Expense EBT Tax rate Operating Assets Retail 14,358 797.5 (16.1) (134.2) 647.3 30% 5,067 Retail 14,358 0.96x 13,822 453 15.3x 6,917 2.0 Luxury 2,712 288.0 (3.0) (214.6) 70.3 30% 8,105 Sum-of-the-Parts Value Luxury 2,712 5.09x 13,816 49 28.6x 1,410 9.8 Group 17,070 1.62x 27,638 502 16.6x 8,326 3.3 New PPR 17,070 1,085.5 (19.1) (348.8) (348.8) 30% 13,172 Actual 17,070 0.68x 11,665 502 23.2x 11,665
Sales Multiple Price/Sales1 Value Net Income Multiple Price/Earnings Value Sales/Net Income Value
1 Retail multiple = average of M&S, GUS, Kingfisher, Signet, DSG; luxury multiple = average of LVMH, Richemont, Hermes, Coach, Hugo Boss. Source: FactSet, PPR market cap on June 3, 2006, corporate reports and Bernstein analysis.
Potentially, PPR is at the starting point of a value-creating escalator should it be able to improve its earnings performance going forward: see how PPR compares against the benchmark companies used for the sum-ofthe-parts valuation (see Exhibit 319). Clearly, the opportunity for PPR is proportionately larger for the luxury business than on the retail side, as luxury multiples are significantly higher than general retail ones: price-to-sales is 5.3x, price-to-earnings is 1.9x. In our illustration, average comparator prof-
175
itability for Luxury retailers is greater than 20% a way to go for New PPR, which is at around 9%. High leverage from recent acquisition campaigns is a value depressant, but interest cost alone is not sufficient to explain PPRs lower-than-average earnings and value handicap versus price-to-sales multiples (see Exhibits 320 and 321). The opportunity to increase PPR value by significantly improving its operating earnings performance is material.
Exhibit 319
10x 9x 8x
Price/Sales
Earnings Performance vs. Price/Sales

R = 94% Coach
2
Exhibit 320
9x 8x 7x
Debt Leverage vs. Price/Sales Value
Coach R = 72% Richemont Hermes

2 2
6x 5x 4x 3x 2x 1x 0x 0% PPR PPR LVMH
Hermes
Price/Sales
7x
Richemont
6x 5x 4x 3x 2x 1x
R = 0% Signet Group DSG 1.0x
LVMH Hugo Boss Gus M&S Kingfisher 2.0x 3.0x
Hugo Boss Gus M&S Signet Group DSG Kingfisher 5% 10% 15%
R = 55%
PPR
4.0x
20%
25%
0x 0.0x
Net Income/Sales Luxury Retail
Debt/EBITDA
Luxury Retail
Note: Richemont earnings without BAT participation. Source: FactSet, corporate reports and Bernstein analysis. Source: FactSet, corporate reports and Bernstein analysis.
Exhibit 321
-
Calculated Value Impact from the Elimination of Interest Costs

Current Net Earnings Tax-Effected Interest Saving Net Earnings @ Interest = 0 New Price/Earnings Value Current Market Cap Delta Delta (Pct of Market Cap) New Price/Earnings Value Price/Sales Value Delta Delta (Pct of New P/E Value) Retail 3.2% 0.7 3.8% 8,351 9,690 (1,339) (14)% 8,351 13,822 (5,471) (66)% Luxury 1.8% 5.5 7.4% 5,710 1,975 3,735 189% 5,710 13,816 (8,106) (142)% Group 2.9% 1.4 4.4% 12,374 11,665 2,396 21% 12,374 27,638 (15,264) (123)%
Source: FactSet, corporate reports and Bernstein analysis.
177
Appendix
179
International Market Clusters

We have used two criteria to group 177 countries in five clusters: (a) human development level, according to the United Nations Human Development Index: 1-20, 21-50, >50; (b) population size: > 50 million, < 50 million. We obtain in this fashion five clusters (see Exhibits 322 and 323): 4x rich large markets these are the G6 countries: United States, Japan, Germany, United Kingdom, France and Italy. They have a ratio of 4/1 of GDP to population (11.1% of global population and 42.9% of global GDP). 4x rich small markets 14 countries which include Scandinavia, Benelux, Austria, Switzerland, Australia, New Zealand, etc; same 4/1 ratio (2% of global population and 7.5% of global GDP). 2x rich small markets 28 countries which include Poland, Greece, South Korea, Chile, etc.; 2/1 ratio of GDP to population (3.6% of global population and 6.5% of global GDP). 0.5x rich large markets 17 countries which include China, India, Brazil, Mexico, Russia, etc.; they have a ratio of 1/2 of GDP to population (64.5% of global population and 32.6% of global GDP). 0.5x rich small markets 110 countries, same 1/2 GDP to population ratio (17.9% of global population and 8.3% of global GDP).
Exhibit 322
Five Market Clusters by Population Size and Development Level

Cluster 1 2 3 4 5 Portugal Spain Total Countries 6 14 28 17 110 1 1 177 Population Million Pct 677 11.1% 125 2.0 223 3.6 3,949 64.5 1,098 17.9 10 41 6,123 0.2% 0.7 1.0% GDP PPP US$ Bil. $20,746 3,637 3,139 15,753 4,030 $183 880 $48,368 Pct 42.9% 7.5 6.5 32.6 8.3 0.4% 1.8 1.0% GDP/Pop. Ratio 3.9 3.7 1.8 0.5 0.5 2.3 2.7 1.0
Source: United Nations and Bernstein analysis.
Exhibit 323
177 Countries, Clustered by Population Size and Development Level
UN Human Development Index
4 Population (million)
Source: United Nations and Bernstein analysis.
180
In rough terms: Competition is highest in cluster 1 and lowest in cluster 5 and intermediate clusters are at descending levels of competition; a perfectly global retail brand, would have a store mix similar to the GDP mix Please see Exhibit 324 for details of markets in each cluster.
181
Exhibit 324
Market Clusters
2002 Births/ Life Literacy 2001-02 2002 Total Total Population Woman Expectancy Rate School GDP/ GDP (million) (Pct of total) in 2002 (Pct of Enrollment Head ($ bil.) 1975 2002 2015E 1970-75 2000-05 (years) >15) (1a, 2a, 3a) (PPP US$) $165 4.0 4.5 4.7 2.2% 1.8% 78.9 99.5% 98 $36,600 232 8.2 8.9 9.0 1.9 1.6 80.0 99.5 114 26,050 551 13.9 19.5 21.7 2.5 1.7 79.1 99.5 113 28,260 923 23.1 31.3 34.1 2.0 1.5 79.3 99.5 95 29,480 469 13.7 16.1 16.8 2.1 1.7 78.3 99.5 99 29,100 284 9.8 10.3 10.5 1.9 1.7 78.7 99.5 111 27,570 9 0.2 0.3 0.3 2.8 2.0 79.7 99.5 90 29,750 10,403 220.2 291.0 329.7 2.0 2.1 77.0 99.5 92 35,750 3,435 111.5 127.5 127.2 2.1 1.3 81.5 99.5 84 26,940 142 3.2 3.9 4.4 3.8 1.9 76.9 99.5 90 36,360 216 6.3 7.2 7.0 1.8 1.4 79.1 99.5 88 30,010 1,545 55.4 59.1 61.3 2.0 1.6 78.1 99.5 113 26,150 136 4.7 5.2 5.3 1.6 1.7 77.9 99.5 106 26,190 237 7.6 8.1 8.1 2.0 1.3 78.5 99.5 91 29,220 24 0.4 0.4 0.5 2.0 1.7 78.3 99.5 75 61,190 1,610 52.7 59.8 62.8 2.3 1.9 78.9 99.5 91 26,920 167 5.1 5.4 5.4 2 1.8 76.6 99.5 96 30,940 83 3.1 3.8 4.2 2.8 2.0 78.2 99.5 101 21,740 2,233 78.7 82.4 82.5 1.6 1.4 78.2 99.5 88 27,100 880 35.6 41.0 41.2 2.9 1.2 79.2 97.7 92 21,460 1,520 55.4 57.5 55.5 2.3 1.2 78.7 98.5 82 26,430 123 3.4 6.3 7.8 3.8 2.7 79.1 95.3 92 19,530 188 4.4 7.0 7.9 2.9 1.0 79.9 93.5 72 26,910 206 9.0 11.0 10.9 2.3 1.3 78.2 97.3 86 18,720 101 2.3 4.2 4.7 2.6 1.4 78.0 92.5 87 24,040 183 9.1 10.0 10.0 2.7 1.5 76.1 92.5 93 18,280 37 1.7 2.0 1.9 2.2 1.1 76.2 99.7 90 18,540 803 35.3 47.4 49.7 4.3 1.4 75.4 97.9 92 16,950 5 0.2 0.3 0.3 2.7 1.5 77.1 99.7 88 15,290 15 0.6 0.8 0.9 2.5 1.9 78.2 96.8 74 18,360 7 0.3 0.4 0.4 2.1 1.8 78.3 92.6 77 17,640 161 10.0 10.2 10.1 2.2 1.2 75.3 78 15,780 6 0.2 0.3 0.5 5.4 2.5 76.2 93.9 73 19,210 413 26.0 38.0 43.4 3.1 2.4 74.1 97.0 94 10,880 2 0.1 0.1 0.1 72.7 91.9 85 18,232 16 1.4 1.3 1.2 2.2 1.2 71.6 99.8 96 12,260 408 34.0 38.6 38.2 2.3 1.3 73.8 99.7 90 10,560 133 10.5 9.9 9.3 2.1 1.2 71.7 99.3 86 13,400 0 0.01 70.0 97.8 97 12,420 12 0.3 0.7 0.9 5.9 2.7 73.9 88.5 79 17,170 36 3.3 3.5 3.2 2.3 1.3 72.5 99.6 90 10,320 69 4.7 5.4 5.4 2.5 1.3 73.6 99.7 74 12,840 153 10.3 15.6 18.0 3.6 2.4 76.0 95.7 79 9,820 39 1.0 2.4 3.4 6.9 2.7 76.5 82.9 76 16,240 36 2.1 4.1 5.0 4.3 2.3 78.0 95.8 69 8,840 27 2.8 3.4 3.7 3.0 2.3 75.2 97.7 85 7,830 12 0.2 0.6 0.7 6.8 3.2 72.0 84.2 82 19,844 45 4.3 4.4 4.3 2.0 1.7 74.1 98.1 73 10,240 65 0.5 2.9 3.6 6.4 2.8 74.6 77.3 68 22,420 21 2.5 2.3 2.1 2.0 1.1 70.9 99.7 87 9,210 5 0.2 0.3 0.4 3.4 2.3 67.1 95.5 74 17,280 59 9.3 11.3 11.5 3.5 1.6 76.7 96.9 78 5,259 915 59.1 102.0 119.6 6.5 2.5 73.3 90.5 74 8,970 12 1.0 1.3 1.3 3.5 1.6 71.4 98.5 64 9,430 1 0.1 0.1 0.1 73.9 85.8 69 10,920 57 8.7 8.0 7.2 2.2 1.1 70.9 98.6 76 7,130 1,186 134.2 144.1 133.4 2.0 1.1 66.7 99.6 88 8,230 41 2.4 5.4 6.9 7.6 3.0 72.6 81.7 97 7,570 219 12.3 24.0 29.6 5.2 2.9 73.0 88.7 70 9,120 13 1.7 2.0 2.2 3.0 1.9 73.5 96.0 70 6,470 19 1.7 3.1 3.8 4.9 2.7 74.6 92.3 73 6,170 55 9.4 9.9 9.4 2.3 1.2 69.9 99.7 88 5,520 1 0.1 0.1 0.1 5.5 3.7 68.4 98.8 82 6,850 13 0.9 1.2 1.3 3.2 1.9 71.9 84.3 69 10,810 15 2.4 3.1 3.4 4.7 2.3 73.6 98.7 69 4,830 24 3.7 4.1 4.3 2.6 1.3 74.0 94.6 64 5,970 3 0.4 0.4 0.5 5.3 2.5 71.0 94.0 74 6,590
HDI Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67
Country Norway Sweden Australia Canada Netherlands Belgium Iceland United States Japan Ireland Switzerland United Kingdom Finland Austria Luxembourg France Denmark New Zealand Germany Spain Italy Israel Hong Kong Greece Singapore Portugal Slovenia Korea, Republic of Barbados Cyprus Malta Czech Republic Brunei Darussalam Argentina Seychelles Estonia Poland Hungary Saint Kitts & Nevis Bahrain Lithuania Slovakia Chile Kuwait Costa Rica Uruguay Qatar Croatia United Arab Emirates Latvia Bahamas Cuba Mexico Trinidad & Tobago Antigua & Barbuda Bulgaria Russian Federation Libya Malaysia Macedonia Panama Belarus Tonga Mauritius Albania Bosnia & Herzegovina Suriname
2002 HDI Cluster 0.956 2 0.946 2 0.946 2 0.943 2 0.942 2 0.942 2 0.941 2 0.939 1 0.938 1 0.936 2 0.936 2 0.936 1 0.935 2 0.934 2 0.933 2 0.932 1 0.932 2 0.926 2 0.925 1 0.922 1 0.920 1 0.908 3 0.903 3 0.902 3 0.902 3 0.897 3 0.895 3 0.888 3 0.888 3 0.883 3 0.875 3 0.868 3 0.867 3 0.853 3 0.853 3 0.853 3 0.850 3 0.848 3 0.844 3 0.843 3 0.842 3 0.842 3 0.839 3 0.838 3 0.834 3 0.833 3 0.833 3 0.830 3 0.824 3 0.823 3 0.815 5 0.809 5 0.802 4 0.801 5 0.800 5 0.796 5 0.795 4 0.794 5 0.793 5 0.793 5 0.791 5 0.790 5 0.787 5 0.785 5 0.781 5 0.781 5 0.780 5
182
Exhibit 324
Market Clusters (contd)

2002 Births/ Life Literacy 2001-02 2002 Total Total Population Woman Expectancy Rate School GDP/ GDP (million) (Pct of Total) in 2002 (Pct of Enrollment Head ($ bil.) 1975 2002 2015E 1970-75 2000-05 (years) >15) (1a, 2a, 3a) (PPP US$) $136 12.7 25.2 31.2 4.9% 2.7% 73.6 93.1% 71 $5,380 147 21.2 22.4 21.6 2.6 1.3 70.5 97.3 68 6,560 238 49.0 48.9 44.4 2.2 1.2 69.5 99.6 84 4,870 1 0.1 0.1 0.2 5.7 2.3 72.4 94.8 74 5,300 1,370 108.1 176.3 202.0 4.7 2.2 68.0 86.4 92 7,770 277 25.4 43.5 52.2 5.0 2.6 72.1 92.1 68 6,370 37 0.9 2.8 3.9 7.2 5.0 72.3 74.4 63 13,340 1 0.2 0.2 0.2 5.7 4.1 69.8 98.7 69 5,600 436 41.3 62.2 69.6 5.0 1.9 69.1 92.6 73 7,010 297 7.3 23.5 32.7 7.3 4.5 72.1 77.9 57 12,650 91 14.1 15.5 15.3 3.5 2.0 66.2 99.4 81 5,870 10 2.0 2.6 3.0 5.0 2.4 75.6 87.6 75 3,980 16 2.8 3.6 4.2 4.9 2.2 73.5 86.5 78 4,360 4 0.6 0.8 0.9 4.2 2.9 69.6 92.9 73 5,440 10 2.8 3.1 3.0 3.0 1.2 72.3 99.4 72 3,120 328 42.0 78.6 96.3 6.0 3.2 69.8 92.6 81 4,170 1 0.1 0.3 0.4 7.0 5.3 67.2 97.2 78 4,798 134 15.2 26.8 32.0 6.0 2.9 69.7 85.0 88 5,010 21 2.5 4.8 5.8 6.2 2.7 66.9 98.8 81 4,300 1 0.1 0.1 0.1 5.5 2.2 74.0 83.1 64 5,460 449 41.0 70.3 82.1 5.2 2.4 70.4 86.5 68 6,390 26 2.7 5.7 7.7 5.7 3.8 70.7 91.6 72 4,610 22 1.9 5.3 7.0 7.8 3.6 70.9 90.9 77 4,220 27 5.7 8.3 9.5 4.3 2.1 72.1 97.0 69 3,210 66 5.7 9.7 11.1 6.2 2.0 72.7 73.2 75 6,760 1 0.1 0.1 0.1 65.3 94.4 65 7,280 5,931 927.8 1,294.9 1,402.3 4.9 1.8 70.9 90.9 68 4,580 1 0.1 0.1 0.1 73.1 76.4 74 5,640 67 13.5 18.9 20.6 4.1 2.0 72.5 92.1 65 3,570 12 4.9 5.2 4.7 2.6 1.4 73.5 100.0 69 2,260 57 5.0 8.6 10.1 5.6 2.7 66.7 84.4 77 6,640 2 0.1 0.3 0.3 6.3 3.2 71.5 76.9 71 6,080 46 6.9 12.8 15.2 6.0 2.8 70.7 91.0 72 3,580 456 33.4 68.1 81.4 6.4 2.3 70.1 77.1 69 6,690 12 1.3 3.4 5.3 7.7 5.6 72.3 90.2 79 3,620 31 4.1 6.4 7.6 6.1 2.9 70.6 79.7 66 4,890 3 0.7 0.8 0.8 4.9 2.3 63.2 96.5 75 4,260 3 0.3 0.5 0.6 7.0 3.3 70.0 75.7 73 5,000 63 7.5 17.4 23.0 7.5 3.3 71.7 82.9 59 3,620 43 14.0 25.7 30.7 6.3 2.4 69.5 99.3 76 1,670 180 16.0 31.3 38.1 7.4 2.8 69.5 68.9 70 5,760 15 0.2 0.5 0.7 5.7 5.9 49.1 84.2 58 30,130 8 3.3 5.1 5.9 4.7 2.6 68.4 97.0 81 1,620 701 134.4 217.1 250.4 5.2 2.4 66.6 87.9 65 3,230 185 48.0 80.3 94.7 6.7 2.3 69.0 90.3 64 2,300 6 3.8 4.3 4.2 2.6 1.4 68.8 99.0 62 1,470 21 4.8 8.6 10.8 6.5 3.8 63.7 86.7 86 2,460 18 3.0 6.8 8.8 7.1 3.7 68.8 80.0 62 2,600 6 3.4 6.2 7.3 6.8 3.1 68.6 99.5 73 980 4 1.4 2.6 3.1 7.3 2.4 63.7 97.8 70 1,710 13 2.5 5.3 7.0 6.8 3.7 69.4 76.7 65 2,470 451 25.8 44.8 44.3 5.4 2.6 48.8 86.0 77 10,070 269 39.3 70.5 90.0 5.7 3.3 68.6 55.6 76 3,810 49 6.0 12.0 16.2 6.5 4.4 65.7 69.9 56 4,080 9 0.6 1.3 1.6 5.3 4.0 56.6 71.0 74 6,590 0 0.1 0.2 0.2 5.4 4.0 69.7 83.1 62 1,317 1 0.2 0.5 0.6 7.2 4.4 69.0 76.6 50 1,590 115 17.3 30.1 36.5 6.9 2.7 68.5 50.7 57 3,810 12 0.9 2.0 2.2 6.6 4.6 45.3 83.3 71 6,210 2,802 620.7 1,049.5 1,246.4 5.4 3.0 63.7 61.3 55 2,670 15 0.8 1.8 1.7 6.7 3.7 41.4 78.9 70 8,170 1 0.1 0.2 0.3 6.1 4.1 68.6 34.0 59 2,890 28 7.1 13.8 18.4 5.5 4.8 57.4 69.4 59 2,060 44 9.9 20.5 26.4 6.9 4.1 57.8 73.8 46 2,130 50 30.2 48.9 55.8 5.8 2.9 57.2 85.3 48 1,027 13 2.9 5.6 7.2 6.1 4.1 57.4 64.6 41 2,270 4 1.2 2.2 3.0 5.9 5.0 63.0 47.0 1,969
HDI Rank 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134
Country Venezuela Romania Ukraine Saint Lucia Brazil Colombia Oman Samoa (Western) Thailand Saudi Arabia Kazakhstan Jamaica Lebanon Fiji Armenia Philippines Maldives Peru Turkmenistan St. Vincent & the Grenadines Turkey Paraguay Jordan Azerbaijan Tunisia Grenada China Dominica Sri Lanka Georgia Dominican Republic Belize Ecuador Iran Occupied Palestinian Territories El Salvador Guyana Cape Verde Islands Syria Uzbekistan Algeria Equatorial Guinea Kyrgyzstan Indonesia Vietnam Moldova Bolivia Honduras Tajikistan Mongolia Nicaragua South Africa Egypt Guatemala Gabon So Tom & Principe Solomon Islands Morocco Namibia India Botswana Vanuatu Cambodia Ghana Myanmar Papua New Guinea Bhutan
2002 HDI Cluster 0.778 5 0.778 5 0.777 5 0.777 5 0.775 4 0.773 5 0.770 5 0.769 5 0.768 4 0.768 5 0.766 5 0.764 5 0.758 5 0.758 5 0.754 5 0.753 4 0.752 5 0.752 5 0.752 5 0.751 5 0.751 4 0.751 5 0.750 5 0.746 5 0.745 5 0.745 5 0.745 4 0.743 5 0.740 5 0.739 5 0.738 5 0.737 5 0.735 5 0.732 4 0.726 5 0.720 5 0.719 5 0.717 5 0.710 5 0.709 5 0.704 5 0.703 5 0.701 5 0.692 4 0.691 4 0.681 5 0.681 5 0.672 5 0.671 5 0.668 5 0.667 5 0.666 5 0.653 4 0.649 5 0.648 5 0.645 5 0.624 5 0.620 5 0.607 5 0.595 4 0.589 5 0.570 5 0.568 5 0.568 5 0.551 5 0.542 5 0.536 5
183
Exhibit 324
Market Clusters (contd)

Total GDP ($ bil.) $9 1 5 244 60 34 31 291 7 4 4 35 31 32 17 13 104 6 13 1 2 4 16 1 11 18 7 21 25 9 7 28 8 33 4 54 19 1 4 12 14 9 2 2002 Births/ Life Literacy 2001-02 2002 Total Population Woman Expectancy Rate School GDP/ (million) (Pct of Total) in 2002 (Pct of Enrollment Head 1975 2002 2015E 1970-75 2000-05 (years) >15) (1a, 2a, 3a) (PPP US$) 3.0 5.5 7.3 6.2% 4.8% 54.3 66.4% 59% $1,720 0.3 0.7 1.0 7.1 4.9 60.6 56.2 45 1,690 0.5 1.1 1.1 6.9 4.5 35.7 80.9 61 4,550 75.2 143.8 181.4 6.2 3.5 61.1 41.1 54 1,700 16.7 32.9 41.4 6.7 4.4 55.5 59.9 36 1,820 13.4 24.6 32.0 5.8 4.3 59.6 44.0 61 1,370 7.6 15.7 18.9 6.3 4.6 46.8 67.9 56 2,000 70.3 149.9 204.5 6.3 5.1 60.8 41.5 37 1,940 2.3 4.8 6.4 7.1 5.3 49.9 59.6 67 1,480 1.5 3.6 5.2 6.3 6.3 48.3 82.8 48 980 1.1 1.8 1.7 5.7 3.8 36.3 81.4 65 2,420 10.8 25.0 39.3 7.1 7.1 45.7 68.9 71 1,390 6.1 12.8 13.0 7.6 3.9 33.9 90.0 58 2,400 13.6 31.5 36.9 8.1 4.0 45.2 84.3 53 1,020 6.9 19.3 30.7 8.4 7.0 59.8 49.0 53 870 7.9 16.9 24.0 6.6 5.7 53.4 67.3 45 740 54.9 120.9 161.7 6.9 5.4 51.6 66.8 45 860 1.4 2.8 4.0 6.5 5.8 52.3 41.2 44 2,220 4.9 8.2 9.7 5.8 4.0 49.4 51.9 52 1,610 0.2 0.7 0.8 7.2 5.7 45.8 65.5 24 1,990 0.6 1.4 1.9 6.5 4.7 53.9 37.8 45 1,690 2.1 4.0 5.9 6.5 5.4 52.7 56.7 33 890 4.8 9.9 13.2 7.0 5.0 52.7 39.3 38 1,580 0.7 0.7 1.1 6.2 3.8 49.3 58.6 75 1,270 4.4 8.3 10.6 8.3 5.7 38.9 69.2 53 1,270 4.1 8.4 11.2 7.0 5.8 48.9 41.0 29 2,100 3.0 6.6 9.1 7.1 5.7 50.7 39.8 52 1,070 16.2 36.3 45.9 6.8 5.1 43.5 77.1 31 580 6.8 16.4 19.8 7.4 4.7 41.2 49.7 42 1,520 5.1 10.7 12.7 7.8 5.6 32.7 79.9 45 840 5.2 11.9 15.2 7.4 6.1 37.8 61.8 74 580 6.2 13.2 19.3 6.6 7.2 40.1 42.0 30 2,130 4.1 8.3 12.1 6.7 6.7 44.7 45.8 35 1,020 23.9 51.2 74.2 6.5 6.7 41.4 62.7 27 650 2.1 3.8 4.6 5.7 4.9 39.8 48.6 31 1,170 33.1 69.0 93.8 6.8 6.1 45.5 41.5 34 780 10.6 18.5 22.5 6.6 5.6 38.5 46.5 41 1,050 0.7 1.4 2.1 7.1 7.1 45.2 39.6 37 710 3.7 6.6 9.8 6.8 6.8 40.8 50.4 33 630 6.3 12.6 19.0 7.1 7.0 48.5 19.0 26 930 6.1 12.6 18.6 7.8 6.7 45.8 12.8 22 1,100 4.8 11.5 18.3 8.1 8.0 46.0 17.1 19 800 2.9 4.8 6.4 6.5 6.5 34.3 36.0 45 520
HDI Rank 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 157 158 159 160 161 162 163 164 165 166 167 168 169 170 171 172 173 174 175 176 177
Country Laos Comoros Swaziland Bangladesh Sudan Nepal Cameroon Pakistan Togo Congo Lesotho Uganda Zimbabwe Kenya Yemen Madagascar Nigeria Mauritania Haiti Djibouti Gambia Eritrea Senegal Timor-Leste Rwanda Guinea Benin Tanzania Cte dIvoire Zambia Malawi Angola Chad Congo, Democratic Republic Central African Republic Ethiopia Mozambique Guinea-Bissau Burundi Mali Burkina Faso Niger Sierra Leone
2002 HDI Cluster 0.534 5 0.530 5 0.519 5 0.509 4 0.505 5 0.504 5 0.501 5 0.497 4 0.495 5 0.494 5 0.493 5 0.493 5 0.491 5 0.488 5 0.482 5 0.469 5 0.466 4 0.465 5 0.463 5 0.454 5 0.452 5 0.439 5 0.437 5 0.436 5 0.431 5 0.425 5 0.421 5 0.407 5 0.399 5 0.389 5 0.388 5 0.381 5 0.379 5 0.365 4 0.361 5 0.359 4 0.354 5 0.350 5 0.339 5 0.326 5 0.302 5 0.292 5 0.273 5
Source: United Nations.
185
Company Models
187
Exhibit 325
Net Sales Cost of Goods Sold Gross Profit Selling Expenses Administrative Expenses Operating Profit Net Interest Profit After Financial Items Taxes Net Earnings EPS Split-Adjusted (SEK) YoY Change 2000 Nov-00 30,454 15,057 15,397 10,963 668 3,766 237 4,003 1,449 2,554 3.08 (17.0)%
H&M: Annual Income Statement (SEK million)

2001 Nov-01 39,699 19,200 20,499 14,111 910 5,478 256 5,734 1,915 3,819 4.61 49.5% 48.4% 51.6 35.5 2.3 13.8 0.6 14.4 9.6% 30.4% 33.1 29.1 45.5 49.5 49.5 827.5 1.0 33.4% 771 89 13.0% 54.6 16.2% 2002 Nov-02 45,522 20,419 25,103 15,822 1,023 8,258 370 8,628 2,942 5,686 6.87 49.0% 44.9% 55.1 34.8 2.2 18.1 0.8 19.0 12.5% 14.7% 22.5 12.1 50.7 48.9 49.0 827.5 1.0 34.1% 844 73 9.5% 56.4 3.2% 2003 Nov-03 48,238 21,145 27,093 16,827 1,042 9,224 386 9,610 3,219 6,391 7.72 12.3% 43.8% 56.2 34.9 2.2 19.1 0.8 19.9 13.2% 6.0% 7.9 6.1 11.7 12.4 12.3 827.5 1.0 33.5% 945 101 12.0% 53.9 (4.3)% 2004 Nov-04 53,695 22,977 30,718 18,928 1,123 10,667 338 11,005 3,731 7,275 8.79 13.9% 42.8% 57.2 35.3 2.1 19.9 0.6 20.5 13.5% 11.3% 13.4 12.2 15.6 13.8 13.9 827.5 1.0 33.9% 1,068 123 13.0% 53.3 (1.1)% 2005 Nov-05 61,262 25,081 36,181 21,801 1,208 13,173 380 13,553 4,306 9,246 11.17 27.1% 40.9% 59.1 35.6 2.0 21.5 0.6 22.1 15.1% 14.1% 17.8 14.8 23.5 27.1 27.1 827.5 1.0 31.8% 1,193 125 11.7% 54.2 1.6% 2006E 2007E 2008E 2009E 2010E Nov-06E Nov-07E Nov-08E Nov-09E Nov-10E 69,720 79,219 89,567 100,763 113,358 28,794 32,638 36,633 41,414 46,590 40,926 46,581 52,934 59,349 66,768 25,017 28,662 32,676 37,066 42,047 1,348 1,502 1,667 1,842 2,036 14,561 16,416 18,591 20,441 22,686 480 538 591 651 716 15,041 16,954 19,183 21,091 23,401 4,783 5,391 6,100 6,707 7,442 10,258 11,563 13,083 14,384 15,960 12.40 13.97 15.81 17.38 19.29 10.9% 12.7% 13.1% 10.0% 11.0% 41.3% 58.7 35.9 1.9 20.9 0.7 21.6 14.7% 13.8% 13.1 14.6 10.5 10.9 10.9 827.5 1.0 31.8% 1,342 149 12.5% 55.0 1.5% 41.2% 58.8 36.2 1.9 20.7 0.7 21.4 14.6% 13.6% 13.8 14.4 12.7 12.7 12.7 827.5 1.0 31.8% 1,510 168 12.5% 55.6 1.0% 40.9% 59.1 36.5 1.9 20.8 0.7 21.4 14.6% 13.1% 13.6 13.9 13.2 13.1 13.1 827.5 1.0 31.8% 1,699 189 12.5% 55.8 0.5% 41.1% 58.9 36.8 1.8 20.3 0.6 20.9 14.3% 12.5% 12.1 13.3 9.9 10.0 10.0 827.5 1.0 31.8% 1,911 212 12.5% 55.8 0.0% 41.1% 58.9 37.1 1.8 20.0 0.6 20.6 14.1% 12.5% 12.5 13.3 11.0 11.0 11.0 827.5 1.0 31.8% 2,150 239 12.5% 55.8 0.0%
Margin Analysis (% of Net Revenues) Cost of Goods Sold 49.4% Gross Profit 50.6 Selling Expenses 36.0 Administrative Expenses 2.2 Operating Profit 12.4 Net Interest 0.8 Profit After Financial Items 13.1 8.4% Net Earnings Year-to-Year Growth Net Sales Gross Profit SG&A Operating Income Net Earnings EPS Memo: Shares Outstanding (million) Split Multiplier (x shares) Tax Rate Total Stores New Stores New Stores (YoY) Sales/Store (LFL-Adjusted) Sales/Store Growth 9.2% 4.5 14.5 (17.8) (16.9) (17.0) 827.5 1.0 36.2% 682 69 11.3% 47.0 (1.9)%
188
Exhibit 326
Profit After Financial Items Provisions for Pensions Depreciation Tax Paid Cash Flow from Operating Activities Change in Working Capital
H&M: Annual Cash Flow Statement (SEK million)

2000 Nov-00 4,003 0 629 (1,451) 3,182 (1,240.6) 2001 Nov-01 5,734 0 900 (1,329) 5,305 707.6 6,012.3 2002 Nov-02 8,629 0 1,051 (1,867) 7,813 280.7 8,093.3 2003 Nov-03 9,609 0 1,126 (3,564) 7,170 (964.8) 6,205.1 2004 Nov-04 11,005 6 1,232 (3,900) 8,344 224.8 8,568.3 2005 2006E 2007E 2008E 2009E 2010E Nov-05 Nov-06E Nov-07E Nov-08E Nov-09E Nov-10E 13,553 15,041 16,954 19,183 21,091 23,401 18 22 26 32 38 46 1,452 1,761 2,045 2,364 2,724 3,128 (3,796) (4,783) (5,391) (6,100) (6,707) (7,442) 11,227 12,041 13,634 15,479 17,146 19,133 (1,091.5) 10,135.0 (1,894.2) (1,274.2) (1,310.7) (1,401.1) (1,644.9) 10,146.7 12,360.1 14,168.1 15,745.2 17,488.6
Net Cash Flow from Operating Activities 1,941.2 Cash Flow from Investing Activities (2,525.0)
(2,035.7) (1,221.9) (1,274.0) (1,588.5) (2,453.0) (156.5) (188.6) 0.0 (3,250.0) (3,100.0)
(3,160.7) (3,555.8) (4,000.3) (5,153.6) (5,797.7) 0.0 0.0 0.0 0.0 0.0
Change in Financial Investments 36 Months 0.0 Change in Long-Term Receivables/ Liabilities 68.2 Net Dividend for the Year (1,117.2) (1,049.0) Cash Flow from Financial Activities Cash Flow for Period Liquid Funds Beginning of the Period (Incl. 3-6 Months) Cash Flow for the Period Change in Currency Rates Liquid Funds at End of the Period (Incl. 3-6 Months Invest.) Net Cash/(Debt) (1,632.8) 6,832.4 (1,632.8) 203.6 5,403.2 5,499.8
0.0 0.0 24.2 (27.5) 6.3 (1,117.2) (1,448.2) (4,965.2) (4,964.5) (6,619.4) (1,273.7) (1,636.8) (4,941.0) (8,242.0) (9,713.1) 2,702.9 5,403.2 2,702.9 424.8 8,530.9 8,948.1 5,234.6 (9.9) (1,262.2) (2,031.1)
0.0 0.0 0.0 0.0 0.0 (7,440.4) (8,387.0) (9,489.4) (10,433.6) (11,576.2) (7,440.4) (8,387.0) (9,489.4) (10,433.6) (11,576.2) (454.5) 417.3 678.5 10,458.7 678.5 0.0 11,137.2 17,695.7 158.1 11,137.2 158.1 0.0 11,295.2 17,853.7 114.6 11,295.2 114.6 0.0 11,409.9 17,968.4
8,530.9 13,479.6 13,193.5 11,801.3 10,495.9 10,041.4 5,234.6 (9.9) (1,262.2) (2,031.1) (454.5) 417.3 (285.9) (276.2) (130.0) 725.7 0.0 0.0 13,479.6 13,780.6 13,193.5 13,399.5 11,801.3 15,232.3 10,495.9 17,054.4 10,041.4 16,599.9 10,458.7 17,017.2
Exhibit 327
2000 Nov-00 10,645 3,033 7,612 104 4,854 97 12,667 777 207 1,674 7,456 2,553 11,890 12,667 22.4 76.3 97.5 8.0
H&M: Annual Balance Sheet (SEK million)

2001 Nov-01 13,726 4,038 9,688 87 6,180 417 16,372 941 207 2,269 9,140 3,816 15,432 16,372 19.0 64.4 90.5 7.2 2002 Nov-02 18,661 5,287 13,374 118 6,118 301 19,912 824 207 2,256 10,938 5,687 19,088 19,912 17.3 80.9 80.0 7.4 2003 Nov-03 19,320 4,704 14,616 112 6,124 206 21,058 961 207 2,411 11,093 6,386 20,097 21,058 19.9 73.9 78.4 8.0 2004 Nov-04 21,416 4,885 16,531 101 6,429 181 23,242 1,033 207 2,539 12,189 7,275 22,209 23,242 17.4 68.8 84.2 8.6 2005 Nov-05 25,106 6,485 18,621 250 7,619 209 26,699 775 207 1,885 14,586 9,247 25,924 26,699 19.0 76.6 86.4 8.9 2006E Nov-06E 26,739 6,678 20,061 298 8,971 209 29,538 797 207 1,885 23,832 2,817 28,741 29,538 19.0 76.9 111.8 9.4 2007E Nov-07E 28,631 6,879 21,752 336 10,443 209 32,740 823 207 1,885 26,650 3,176 31,917 32,740 19.0 76.9 111.8 8.8 2008E Nov-08E 30,828 7,087 23,742 378 12,037 209 36,365 855 207 1,885 29,825 3,593 35,510 36,365 19.0 70.6 111.8 8.6 2009E Nov-09E 32,637 7,336 25,301 424 14,421 209 40,354 893 207 1,885 33,419 3,951 39,461 40,354 19.0 64.7 111.8 8.4 2010E Nov-10E 34,666 7,606 27,060 478 17,037 209 44,784 939 207 1,885 37,369 4,383 43,844 44,784 19.0 59.6 111.8 7.9
Total Current Assets Total Current Liabilities Net Working Capital Renting Rights Tangible Assets Total Other Assets Total Capital Employed Total Long-Term Liabilities Share Capital Restricted Reserves Profit Brought Forward Profit for the Year Total Shareholders Equity Total Sources of Capital Debtor Days Creditor Days Inventory Days Fixed Asset Turn
Note: Total net cash/(debt) position includes 3-12 month deposits. Source: Corporate reports and Bernstein estimates.
189
Exhibit 328
Net Sales Cost of Goods Sold Gross Profit Operating Expenses EBITDA Amortization & Depreciation Share in Income of Participated Cos. EBIT Financial Income & Exceptionals Income Before Taxes Taxes Minority Interests Net Earnings EPS () YoY Change 2000 Jan-01 2,615 (1,277) 1,338 (817) 521 (141) 0 380 (11) 369 (107) (3) 259 0.42 26.6%
Inditex: Annual Income Statement ( million)

2001 Jan-02 3,250 (1,563) 1,687 (982) 704 (187) (2) 516 (21) 495 (150) (5) 340 0.55 31.3% (48.1)% 51.9 (30.2) 21.7 (5.8) (0.1) 15.9 (0.6) 15.2 (0.1) 10.5% 24.3% 26.1 22.1 35.7 31.3 31.3 623.3 30.3% 1,285 204 18.8% 2.7 5.3% 2002 Jan-03 3,974 (1,926) 2,048 (1,180) 868 (209) 0 659 (44) 615 (173) (4) 438 0.70 28.7% (48.5)% 51.5 (29.7) 21.8 (5.2) 0.0 16.6 (1.1) 15.5 (0.1) 11.0% 22.3% 21.4 18.7 27.9 28.7 28.7 623.3 28.1% 1,561 276 21.5% 2.8 1.7% 2003 Jan-04 4,599 (2,293) 2,306 (1,433) 873 (246) 0 627 (14) 613 (165) (2) 446 0.72 1.9% (49.9)% 50.1 (31.1) 19.0 (5.4) 0.0 13.6 (0.3) 13.3 0.0 9.7% 15.7% 12.6 20.9 (4.9) 1.9 1.9 623.3 26.9% 1,924 363 23.3% 2.6 (5.5)% 2004 Jan-05 5,670 (2,636) 3,034 (1,795) 1,240 (314) 0 925 (39) 886 (248) (10) 628 1.01 40.7% (46.5)% 53.5 (31.6) 21.9 (5.5) 0.0 16.3 (0.7) 15.6 (0.2) 11.1% 23.3% 31.6 25.6 47.5 40.7 40.7 623.3 28.0% 2,245 321 16.7% 2.7 3.0% 2005 Jan-06 6,741 (2,953) 3,788 (2,329) 1,459 (366) 0 1,094 8 1,102 (291) (8) 803 1.29 27.9% (43.8)% 56.2 (34.5) 21.6 (5.4) 0.0 16.2 0.1 16.3 (0.2) 11.9% 18.9% 24.8 27.7 18.2 27.9 27.9 623.3 26.4% 2,692 447 19.9% 2.7 0.4% 2006E Jan-07E 8,043 (3,544) 4,499 (2,748) 1,752 (436) 0 1,315 12 1,327 (358) (14) 954 1.54 19.3% (44.1)% 55.9 (34.2) 21.8 (5.4) 0.0 16.4 0.1 16.5 (0.2) 11.9% 19.3% 18.8 18.2 20.3 18.8 19.3 621.0 27.0% 3,131 439 16.3% 2.8 1.2% 2007E Jan-08E 9,404 (4,091) 5,313 (3,181) 2,133 (510) 0 1,622 24 1,646 (461) (17) 1,169 1.88 22.4% (43.5)% 56.5 (33.8) 22.7 (5.4) 0.0 17.3 0.3 17.5 (0.2) 12.4% 16.9% 18.1 15.9 23.3 22.4 22.4 621.4 28.0% 3,582 452 14.4% 2.8 1.4% 2008E Jan-09E 10,900 (4,687) 6,213 (3,653) 2,560 (591) 0 1,968 24 1,993 (578) (19) 1,395 2.25 19.4% (43.0)% 57.0 (33.5) 23.5 (5.4) 0.0 18.1 0.2 18.3 (0.2) 12.8% 15.9% 16.9 15.0 21.3 19.4 19.4 621.4 29.0% 4,052 469 13.1% 2.9 1.9% 2009E Jan-10E 12,534 (5,327) 7,207 (4,165) 3,042 (680) 0 2,362 25 2,387 (716) (22) 1,648 2.65 18.1% (42.5)% 57.5 (33.2) 24.3 (5.4) 0.0 18.8 0.2 19.0 (0.2) 13.2% 15.0% 16.0 14.1 20.0 18.1 18.1 621.4 30.0% 4,550 498 12.3% 2.9 2.1% 2010E Jan-11E 14,362 (6,032) 8,330 (4,734) 3,596 (779) 0 2,817 25 2,842 (853) (26) 1,964 3.16 19.1% (42.0)% 58.0 (33.0) 25.0 (5.4) 0.0 19.6 0.2 19.8 (0.2) 13.7% 14.6% 15.6 13.8 19.3 19.1 19.1 621.4 30.0% 5,078 528 11.6% 3.0 2.4%
Margin Analysis (% of Net Revenues) Cost of Goods Sold (48.8)% Gross Profit 51.2 Operating Expenses (31.2) EBITDA 19.9 Amortization & Depreciation (5.4) Share in Income of Participated Cos. 0.0 EBIT 14.5 Financial Income & Exceptionals (0.4) Income Before Taxes 14.1 Minority Interests (0.1) Net Earnings 9.9% Year-to-Year Growth Net Sales Gross Profit SG&A EBIT Net Earnings EPS Memo: Shares Outstanding (million) Tax Rate Total Stores New Stores New Stores (YoY) Sales/Store (LFL-Adjusted) Sales/Store Growth 28.5% 27.8 27.6 28.1 26.6 26.6 623.3 29.0% 1,081 158 17.1% 2.6 6.5%
190
Exhibit 329
Inditex: Annual Cash Flow Statement ( million)

2000 Jan-01 259 128 135 (7) 387 41 428 (341) (47) (9) (38) 40 164 40 0 204 2001 Jan-02 340 218 175 42 558 8 566 (431) (29) (6) (23) 105 204 105 0 309 2002 Jan-03 438 279 198 81 717 30 747 (467) (73) (72) (1) 207 309 207 0 516 2003 Jan-04 446 276 230 46 722 4 726 (628) (117) (89) (28) (19) 516 (19) 0 497 2004 Jan-05 628 387 289 98 1,015 213 1,228 (742) (198) (220) 22 289 496 289 (12) 773 2005 Jan-06 803 437 366 72 1,240 180 1,421 (812) (399) (302) (97) 210 772 210 7 989 2006E Jan-07E 954 436 436 0 1,391 100 1,491 (951) (477) (477) 0 63 989 63 0 1,052 2007E Jan-08E 1,169 510 510 0 1,679 96 1,775 (978) (584) (584) 0 212 1,052 212 0 1,264 2008E Jan-09E 1,395 591 591 0 1,987 98 2,085 (1,017) (698) (698) 0 370 1,264 370 0 1,634 2009E Jan-10E 1,648 680 680 0 2,328 98 2,427 (1,178) (824) (824) 0 425 1,634 425 0 2,059 2010E Jan-11E 1,964 779 779 0 2,743 93 2,836 (1,249) (982) (982) 0 605 2,059 605 0 2,664
Net Income Adjustments to Net Income Depreciation and Amortization Other Funds from Operations Change in Working Capital Net Cash from Operations Capital Expenditure Cash from Financing Activities Dividends Other Financing Activities Cash Flow for the Period Cash & Cash Equivalents at the Beginning of the Year Cash Flow for the Period Foreign Exchange Impact on Cash & Cash Equivalents Cash & Cash Equivalents at the End of the Year
Exhibit 330
Total Current Assets Total Current Liabilities Net Working Capital Fixed Assets Other Non-Current Assets Total Capital Employed Total Long-Term Liabilities Total Shareholders Equity Total Sources of Capital 2000 Jan-01 600 670 (70) 1,396 223 1,437 266 1,171 1,437
Inditex: Balance Sheet ( million)

2001 Jan-02 854 834 19 1,663 177 1,771 285 1,486 1,771 2002 Jan-03 1,146 1,013 133 1,791 153 2,001 240 1,761 2,001 2003 Jan-04 1,321 1,093 228 2,118 142 2,418 312 2,106 2,418 2004 Jan-05 1,582 1,369 213 2,507 240 2,840 338 2,503 2,840 2005 Jan-06 2,047 1,851 196 3,079 155 3,352 453 2,899 3,352 2006E Jan-07E 2,141 1,982 159 3,593 155 3,829 453 3,376 3,829 2007E Jan-08E 2,530 2,255 275 4,061 155 4,414 453 3,960 4,414 2008E Jan-09E 3,094 2,547 547 4,487 155 5,111 453 4,658 5,111 2009E Jan-10E 3,731 2,858 873 4,984 155 5,936 453 5,482 5,936 2010E Jan-11E 4,573 3,187 1,385 5,454 155 6,918 453 6,464 6,918
191
Exhibit 331
Group Sales Sales of Discontinued Operations Sales of Continuing Operations Cost of Sales Gross Profit SG&A Operating Profit of Continuing Operations Operating Profit of Discontinued Operations Group Operating Profit Release/Utilization of Provisions Profit Before Exceptional Items Exceptional Items EBIT Net Interest/Charge Profit Before Tax Tax Minority Interests Net Earnings EPS Fully Diluted (pence) YoY Change 1999 Mar-00 8,196 0 8,196 (5,403) 2,793 (2,250) 543 0 543 0 543 (140) 403 14 418 (158) (1) 259 9.0p (30.5)%
M&S: Annual Income Statement ( million)

2000 Mar-01 8,076 733 7,343 (4,823) 2,520 (2,039) 481 (14) 467 0 467 (335) 132 14 145 (150) (2) (6) (0.2)p na 2001 Mar-02 8,135 516 7,619 (4,889) 2,731 (2,102) 629 (28) 601 43 644 (326) 318 18 336 (183) 0 153 5.3p na 0.0% (64.2) 35.8 (27.6) 8.3 (0.4) 7.9 0.6 8.4 (4.3) 4.2 0.2 4.4 (2.4) 0.0 2002 Mar-03 8,019 0 8,019 (5,118) 2,901 (2,128) 773 0 773 0 773 (44) 729 (14) 716 (209) 0 507 21.8p 309.0% 0.0% (63.8) 36.2 (26.5) 9.6 0.0 9.6 0.0 9.6 (0.5) 9.1 (0.2) 8.9 (2.6) 0.0 2003 Mar-04 8,302 330 7,972 (5,154) 2,818 (2,008) 809 57 866 0 866 (23) 843 (61) 782 (229) 0 552 24.2p 10.8% 0.0% (64.7) 35.3 (25.2) 10.2 0.7 10.9 0.0 10.9 (0.3) 10.6 (0.8) 9.8 (2.9) 0.0 2004 Mar-05 7,942 232 7,710 (5,026) 2,684 (2,007) 677 32 709 0 709 127 836 (91) 745 (158) 0 587 29.0p 19.9% 0.0% (65.2) 34.8 (26.0) 8.8 0.4 9.2 0.0 9.2 1.6 10.8 (1.2) 9.7 (2.1) 0.0 7.6 0.0% (3.3) (4.7) (0.1) (0.8) 6.3 2005 2006E 2007E 2008E 2009E 2010E Mar-06 Mar-07E Mar-08E Mar-09E Mar-10E Mar-11E 7,798 8,386 8,783 8,980 9,121 9,207 0 7,798 (4,812) 2,986 (2,130) 856 3 858 0 8,386 (5,122) 3,263 (2,258) 1,005 0 1,005 0 8,783 (5,403) 3,380 (2,369) 1,011 0 1,011 0 8,980 (5,561) 3,419 (2,441) 978 0 978 0 978 0 978 (125) 853 (264) 0 588 35.0p (4.3)% 0.0% (61.9) 38.1 (27.2) 10.9 0.0 10.9 0.0 10.9 0.0 10.9 (1.4) 9.5 (2.9) 0.0 0 9,121 (5,689) 3,432 (2,540) 892 0 892 0 892 0 892 (130) 762 (236) 0 526 31.3p (10.7)% 0.0% (62.4) 37.6 (27.9) 9.8 0.0 9.8 0.0 9.8 0.0 9.8 (1.4) 8.4 (2.6) 0.0 5.8 0.0% 1.6 0.4 4.1 (8.8) (10.7) 0 9,207 (5,764) 3,443 (2,617) 827 0 827 0 827 0 827 (130) 697 (216) 0 481 28.6p (8.5)% (62.6)% 37.4 (28.4) 9.0 0.0 9.0 0.0 9.0 0.0 9.0 (1.4) 7.6 (2.3) 0.0 5.2 (1.7) 0.9% 0.3 3.0 (7.3) (8.5) (8.5)
0 0 0 858 1,005 1,011 (6) 0 0 853 1,005 1,011 (104) (110) (120) 748 895 891 (225) (278) (276) 0 0 0 523 618 615 31.1p 36.7p 36.6p 7.2% 18.1% (0.5)% 0.0% (61.7) 38.3 (27.3) 11.0 0.0 11.0 0.0 11.0 (0.1) 10.9 (1.3) 9.6 (2.9) 0.0 0.0% (61.1) 38.9 (26.9) 12.0 0.0 12.0 0.0 12.0 0.0 12.0 (1.3) 10.7 (3.3) 0.0 0.0% (61.5) 38.5 (27.0) 11.5 0.0 11.5 0.0 11.5 0.0 11.5 (1.4) 10.1 (3.1) 0.0
Margin Analysis (% of Sales of Continuing Operations) Cost of Sales 0.0% 0.0% Gross Profit (65.9) (65.7) SG&A 34.1 34.3 Operating Profit of Continuing Operations (27.5) (27.8) Operating Profit of Discontinued Operations 6.6 6.5 Group Operating Profit 0.0 (0.2) Release/Utilization of Provisions 6.6 6.4 Profit Before Exceptional Items 0.0 0.0 Exceptional Items 6.6 6.4 EBIT (1.7) (4.6) Net Interest/Charge 4.9 1.8 Profit Before Tax 0.2 0.2 Tax 5.1 2.0 Minority Interests (1.9) (2.0) Net Earnings 0.0 0.0 Five Years 2000-05/2005-10 Year-to-Year Growth Sales of Continuing Operations Gross Profit SG&A EBIT Net Earnings EPS Memo: Shares Outstanding Fully Diluted (million) Tax Rate (Ordinary) Tax Rate (Ordinary + Exceptional) Total UK Space (000 m2) 0.0% (0.3) 0.7 3.5 (22.2) (30.5) 0.0% (10.4) (9.8) (9.4) (67.4) na
0.0% 3.8 8.4 3.1 141.9 na
0.0% 5.2 6.2 1.2 129.1 231.6
0.0% (0.6) (2.9) (5.6) 15.6 8.9
0.0% 1.1 11.2 6.1 2.0 (10.9)
0.0% 7.5 9.3 6.0 17.9 18.1
0.0% 4.7 3.6 4.9 0.6 (0.5)
0.0% 2.2 1.1 3.1 (3.3) (4.3)
2,886 37.9% 37.9 1,140
2,882 100.5% 102.7 1,152
2,865 58.1% 54.3 1,133
2,323 30.4% 29.2 1,143
2,282 29.3% 29.3 1,189
2,024 23.7% 21.2 1,198
1,682 30.1% 30.1 1,215
1,682 31.0% 31.0 1,248
1,682 31.0% 31.0 1,275
1,682 31.0% 31.0 1,296
1,682 31.0% 31.0 1,317
1,682 31.0% 31.0 1,329
192
Exhibit 332
1999 Mar-00 543.0 6.2 261.6 0.0 0.0 (49.2) (206.2) 92.3 641.5 15.2 (145.7) (167.0) (21.1) (413.5) (90.6) (162.5) 260.3 7.2 337.2 261.6 92.3 691.1 (167.0) 524.1
M&S: Annual Cash Flow Statement ( million)

2000 Mar-01 467.0 154.3 275.9 0.0 26.5 (30.3) (117.8) 81.6 2001 Mar-02 643.8 253.3 249.6 0.0 0.0 (30.0) 33.7 196.6 2002 Mar-03 773.0 429.4 234.9 0.0 0.0 (19.3) 213.8 (33.7) 2003 Mar-04 809.4 (145.1) 238.9 (400.0) 0.0 (48.2) 64.2 2.2 2004 Mar-05 677.1 884.1 253.5 0.0 0.0 (87.3) 717.9 14.2 2005 2006E 2007E 2008E 2009E 2010E Mar-06 Mar-07E Mar-08E Mar-09E Mar-10E Mar-11E 855.8 1,005.2 1,011.1 977.7 891.8 826.7 298.0 274.0 0.0 0.0 (0.7) 24.7 43.7 290.0 290.0 0.0 0.0 0.0 0.0 94.5 310.0 310.0 0.0 0.0 0.0 0.0 (4.9) 135.0 335.0 (200.0) 0.0 0.0 0.0 (7.5) 145.0 345.0 (200.0) 0.0 0.0 0.0 (9.4) 350.0 350.0 0.0 0.0 0.0 0.0 5.6
Operating Profit Adjustments to Operating Profit Depreciation & Amortization Contribution to the Pension Fund Exceptional Operating Charges Exceptional Operating Cash Outflow Other Change in Working Capital Net Cash Inflow from Operating Activities Net Cash Outflow from Investments and Servicing of Finance Taxation Capex and Financial Investment Acquisitions and Disposals Equity Dividends Paid Cash Inflow Before Mgmt of Liquid Resources & Financing Mgmt of Liquid Resources Financing (Decrease)/Increase in Cash Free Cash Flow NOPAT Depreciation Change in Operating Working Capital Cash Flow from Operations Net Investing Free Cash Flow
702.9 1,093.7 1,168.7 12.6 (164.6) (258.2) 5.9 (258.6) 36.8 (179.4) 176.0 261.6 (256.7) (38.2) (216.9) (294.4) (38.8) (225.4) 355.0 (46.9) (712.3) (404.2) 547.5 234.9 (33.7) 748.7 (294.4) 454.3
666.5 1,575.4 1,197.5 1,389.6 1,316.2 1,105.2 1,027.5 1,182.3 (49.8) (220.4) (293.9) 51.3 (247.1) (101.6) (166.7) (113.6) 363.8 (236.9) 12.9 (101.5) (266.3) 0.0 (233.0) 609.6 0.0 (562.8) 131.5 600.1 274.0 43.7 917.8 (266.3) 651.5 (110.0) (277.5) (545.0) 0.0 (266.7) 190.4 0.0 0.0 190.4 693.6 290.0 94.5 1,078.0 (545.0) 533.0 (120.0) (276.2) (599.5) 0.0 (264.4) 56.0 0.0 0.0 56.0 697.7 310.0 (4.9) 1,002.7 (599.5) 403.2 (125.0) (264.3) (659.5) 0.0 (264.8) (208.3) 0.0 0.0 (208.3) 674.6 335.0 (7.5) 1,002.1 (659.5) 342.7 (130.0) (236.2) (527.6) 0.0 (265.5) (131.7) 0.0 0.0 (131.7) 615.4 345.0 (9.4) 951.0 (527.6) 423.4 (120.0) (219.1) (422.0) 0.0 (268.2) 153.0 0.0 0.0 153.0 570.4 350.0 5.6 926.0 (422.0) 504.0
40.0 1,132.0 263.7 (265.4) 38.3 (12.8) 275.9 81.6 344.7 (258.2) 86.5 (29.1) (730.2) 372.7 274.6 249.6 196.6 720.8 176.0 896.8
(93.4) 1,320.4 (89.0) 66.7 347.0 (1,507.5) 164.6 611.9 238.9 2.2 853.0 (293.9) 559.1 (120.4) 558.7 253.5 14.2 826.4 (113.6) 712.8
Exhibit 333
M&S: Annual Balance Sheet ( million)

1999 2000 2001 2002 2003 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 3,717.1 3,516.2 3,760.7 3,246.3 3,869.5 2,162.8 1,981.6 1,750.8 1,710.9 1,884.7 1,554.3 1,534.6 2,009.9 1,535.4 1,984.8 4,298.4 4,177.2 3,431.5 3,464.8 3,507.6 5,852.7 5,711.8 5,441.4 5,000.2 5,492.4 804.3 126.6 0.0 16.5 4,905.3 5,852.7 15.8 160.8 34.3 1.9 735.1 395.3 0.0 15.6 4,565.8 5,711.8 14.4 135.9 34.5 1.8 2,156.3 203.8 0.0 0.4 3,080.9 5,441.4 14.8 146.1 32.0 1.9 1,810.0 186.1 895.8 0.0 2,108.3 5,000.2 15.7 150.0 35.8 1.9 2004 2005 2006E 2007E 2008E 2009E 2010E Mar-05 Mar-06 Mar-07E Mar-08E Mar-09E Mar-10E Mar-11E 837.5 1,142.1 1,372.5 1,461.1 1,270.5 1,152.5 1,313.6 1,289.3 2,017.0 2,151.5 2,179.1 2,189.2 2,193.6 2,207.3 (451.8) (874.9) (778.9) (717.9) (918.8) (1,041.1) (893.7) 3,447.5 4,068.4 4,323.4 4,612.9 4,937.4 5,119.9 5,192.0 2,995.7 3,193.5 3,544.5 3,895.0 4,018.6 4,078.8 4,298.2 1,133.8 109.5 794.9 0.0 1,155.3 3,193.5 14.9 133.5 28.2 2.4 1,133.8 109.5 794.9 0.0 1,506.3 3,544.5 14.2 93.6 24.7 2.3 1,133.8 109.5 794.9 0.0 1,856.8 3,895.0 65.8 153.0 28.4 1.9 1,133.8 109.5 594.9 0.0 2,180.4 4,018.6 71.4 153.3 28.4 1.9 1,133.8 109.5 394.9 0.0 2,440.6 4,078.8 69.6 147.2 28.4 1.9 1,133.8 109.5 394.9 0.0 2,660.0 4,298.2 68.3 143.7 28.4 1.8
Current Assets Current Liabilities Net Working Capital Fixed Assets Total Capital Employed Creditors: Amounts Falling Due After More Than One Year Provisions for Liabilities and Charges Net Postretirement Liability Minority Interests Shareholders Funds Total Sources of Capital Memo: Debtor Days Creditor Days Inventory Days Fixed Asset Turn
2,519.6 1,919.7 49.3 469.5 0.0 2,454.0 5,492.4 14.9 130.7 24.3 2.4 80.4 474.2 0.0 521.4 2,995.7 14.4 122.0 25.8 2.3
193
Exhibit 334
Next: Annual Income Statement ( million)
2000 2001 2002 2003 2004 2005 2006E 2007E 2008E 2009E 2010E Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07E Jan-08E Jan-09E Jan-10E Jan-11E 1,588.5 1,871.7 2,202.6 2,516.0 2,858.5 3,106.2 3,329.1 3,607.0 3,985.2 4,358.5 4,715.2 Turnover Cost of Sales (1,110.3) (1,308.1) (1,548.1) (1,762.5) (1,962.0) (2,120.8) (2,257.2) (2,434.7) (2,690.0) (2,942.0) (3,182.8) 478.2 563.6 654.5 753.5 896.5 985.4 1,072.0 1,172.3 1,295.2 1,416.5 1,532.4 Gross Margin SG&A (266.8) (306.2) (355.7) (380.0) (457.6) (516.5) (574.4) (642.8) (724.5) (812.7) (906.7) 478.2 563.6 654.5 753.5 896.5 468.9 497.6 529.5 570.7 603.8 625.7 Operating Margin Non-Operating Income/(Cost) 2.4 1.2 2.7 2.0 2.2 1.8 0.0 0.0 0.0 0.0 0.0 480.6 564.8 657.2 755.5 898.7 470.7 497.6 529.5 570.7 603.8 625.7 EBIT Interest 4.6 7.2 (0.3) (17.3) (18.2) (22.7) (32.8) (10.9) (0.1) 12.3 26.4 485.2 572.0 656.9 738.2 880.5 448.0 464.7 518.6 570.6 616.1 652.1 Profit Before Taxes Taxes (60.8) (76.0) (90.7) (108.1) (121.9) (135.3) (140.4) (156.6) (172.3) (186.1) (196.9) 424.4 496.0 566.2 630.1 758.6 312.8 324.4 362.0 398.3 430.0 455.2 Net Earnings EPS Diluted (pence) 46.4p 57.3p 68.1p 93.0p 116.7p 125.6p 140.9p 157.2p 172.9p 186.7p 197.6p YoY Change 22.4% 23.4% 18.9% 36.5% 25.5% 7.6% 12.2% 11.6% 10.0% 8.0% 5.8% Margin Analysis (% of Sales) Cost of Sales Gross Margin SG&A Operating Margin Non-Operating Income/(Cost) EBIT Interest Profit Before Taxes Taxes Net Earnings Year-to-Year Growth Turnover Gross Margin SG&A Operating Margin EBIT Net Earnings EPS Diluted Memo Shares Outstanding Fully Diluted (million) Tax Rate Total UK Space (000 m2) YoY Change (69.9)% 30.1 (16.8) 30.1 0.2 30.3 0.3 30.5 (3.8)% 26.7 11.4% 5.4 (3.2) 5.4 3.9 2.1 22.4 (69.9)% 30.1 (16.4) 30.1 0.1 30.2 0.4 30.6 (4.1)% 26.5 17.8% 17.9 14.8 17.9 17.5 16.9 23.4 (70.3)% 29.7 (16.1) 29.7 0.1 29.8 0.0 29.8 (4.1)% 25.7 17.7% 16.1 16.2 16.1 16.4 14.2 18.9 (70.1)% 29.9 (15.1) 29.9 0.1 30.0 (0.7) 29.3 (4.3)% 25.0 14.2% 15.1 6.8 15.1 15.0 11.3 36.5 (68.6)% 31.4 (16.0) 31.4 0.1 31.4 (0.6) 30.8 (4.3)% 26.5 13.6% 19.0 20.4 19.0 19.0 20.4 25.5 (68.3)% 31.7 (16.6) 15.1 0.1 15.2 (0.7) 14.4 (4.4)% 10.1 8.7% 9.9 12.9 (47.7) (47.6) (58.8) 7.6 (67.8)% 32.2 (17.3) 14.9 0.0 14.9 (1.0) 14.0 (4.2)% 9.7 7.2% 8.8 11.2 6.1 5.7 3.7 12.2 (67.5)% 32.5 (17.8) 14.7 0.0 14.7 (0.3) 14.4 (4.3)% 10.0 8.3% 9.4 11.9 6.4 6.4 11.6 11.6 (67.5)% 32.5 (18.2) 14.3 0.0 14.3 0.0 14.3 (4.3)% 10.0 10.5% 10.5 12.7 7.8 7.8 10.0 10.0 (67.5)% 32.5 (18.6) 13.9 0.0 13.9 0.3 14.1 (4.3)% 9.9 9.4% 9.4 12.2 5.8 5.8 8.0 8.0 (67.5)% 32.5 (19.2) 13.3 0.0 13.3 0.6 13.8 (4.2)% 9.7 8.2% 8.2 11.6 3.6 3.6 5.8 5.8
339.4 27.8% 153 12.2%
331.3 28.6% 184 20.6%
308.9 30.1% 217 18.0%
268.9 30.2% 264 21.6%
257.9 28.8% 309 17.0%
249.1 30.2% 400 29.5%
230.3 30.2% 447 11.6%
230.3 30.2% 491 10.0%
230.3 30.2% 536 9.0%
230.3 30.2% 579 8.0%
230.3 30.2% 625 8.0%
194
Exhibit 335
Next: Annual Cash Flow Statement ( million)

2000 Jan-01 213.8 (1.3) 41.3 5.4 4.5 11.5 275.2 5.0 (62.7) (57.1) 66.5 (72.0) 154.9 15.0 (183.6) (13.7) 122.6 (28.3) 94.3 152.5 11.5 205.3 (57.1) 148.2 2001 Jan-02 258.6 0.0 54.4 6.5 8.9 36.8 365.2 6.3 (59.8) (69.8) 0.0 (81.9) 160.0 (75.1) 2002 Jan-03 301.5 0.0 60.7 0.1 3.0 (50.4) 314.9 (1.1) (90.2) (83.2) (25.8) (88.4) 26.2 152.8 2003 Jan-04 375.5 0.0 66.7 1.4 (2.2) (39.2) 402.2 (9.7) (96.3) (95.6) 0.0 (85.4) 115.2 4.3 2004 Jan-05 441.1 0.0 75.2 (0.9) 2.6 (11.5) 506.5 (19.0) (117.1) (136.3) (1.2) (94.2) 138.7 (2.0) 2005 Jan-06 470.7 0.0 81.2 (0.2) 9.4 (47.6) 511.4 (20.2) (113.2) (169.8) 0.0 (103.7) 104.5 0.0 2006E 2007E 2008E 2009E 2010E Jan-07E Jan-08E Jan-09E Jan-10E Jan-11E 500.3 529.5 570.7 603.8 625.7 0.0 90.9 0.0 8.1 (34.0) 565.2 (32.8) (141.2) (150.0) 0.0 (112.5) 128.7 0.0 0.0 0.0 98.2 0.0 8.1 (35.6) 600.2 (46.3) (156.6) (185.1) 0.0 (116.3) 106.6 0.0 0.0 106.6 0.0 108.3 0.0 8.1 (49.4) 637.6 (40.6) (172.3) (201.7) 0.0 (127.6) 107.6 0.0 0.0 107.6 0.0 118.2 0.0 8.1 (48.8) 681.2 (33.8) (186.1) (218.0) 0.0 (137.2) 120.1 0.0 0.0 120.1 15.0 141.2 (320.0) 230.3 (48.8) 490.8 (218.0) 272.8 0.0 127.6 0.0 8.1 (46.6) 714.8 (26.0) (196.9) (233.6) 0.0 (144.3) 129.8 0.0 0.0 129.8 156.2 153.7 (190.2) 230.3 (46.6) 517.7 (233.6) 284.1
Profit Before Interest Non-Operating Exceptional Items Depreciation/Amortization Write-Off (Profit)/Loss on Disposal of Fixed Assets Other Change in Working Capital Net Cash Inflow from Operating Activities Returns on Investments and Servicing of Finance Taxation Capital Expenditure and Financial Investment Acquisitions & Disposals Equity Dividends Paid Cash Inflow Before Mgmt of Liquid Resources & Financing Cash (Outflow)/Inflow from Mgmt of Liquid Resources Financing (Decrease)/Increase in Cash in the Year Net Debt at Start of Year Movement of Net Debt in the Period Net Debt at January (N) Free Cash Flow NOPAT Depreciation Change in Operating Working Capital Cash Flow from Operations Net Investing Free Cash Flow
(60.4) (199.0) 24.5 94.3 99.7 194.0 183.8 36.8 275.0 (69.8) 205.2 (20.0)
(82.5) (142.6) (116.5) 37.0 (5.9)
(12.0) (291.7)
194.0 (188.8) (306.9) (250.8) (362.6) (233.9) (111.2) (382.8) (118.1) 56.1 (111.8) 128.7 122.7 126.2 (188.8) (306.9) (250.8) (362.6) (654.3) (547.7) (440.1) 208.8 (50.4) 219.1 (83.2) 135.9 260.8 (39.2) 288.3 (95.6) 192.7 312.4 (11.5) 376.1 (136.3) 239.8 327.3 (47.6) 360.9 (169.8) 191.1 347.3 (34.0) 404.1 (150.0) 254.1 230.3 (35.6) 432.2 (185.1) 247.1 230.3 (49.4) 457.2 (201.7) 255.5
Exhibit 336
Next: Annual Balance Sheet ( million)

2000 Jan-01 547 347 201 327 528 19 9 0 0 500 528 28.5 113.9 57.2 4.8 2001 Jan-02 655 403 252 335 586 20 19 0 0 547 586 22.3 112.5 48.7 5.6 2002 Jan-03 595 665 (70) 402 331 37 19 0 0 275 331 25.5 156.8 57.5 5.8 2003 Jan-04 710 577 134 393 527 53 19 300 0 155 527 27.3 119.4 55.8 6.5 2004 Jan-05 810 620 190 456 645 49 23 300 0 273 645 29.2 115.4 56.1 6.8 2005 Jan-06 912 751 161 562 723 39 10 298 116 261 723 29.8 129.2 55.7 6.0 2006E 2007E 2008E 2009E Jan-07E Jan-08E Jan-09E Jan-10E 978 1,157 1,366 1,587 1,085 1,128 1,187 1,246 (107) 30 179 341 621 708 802 902 514 738 981 1,242 39 10 298 116 52 514 29.8 175.4 55.7 5.7 39 10 298 116 275 737 29.8 169.0 55.7 5.4 39 10 298 116 518 980 29.8 161.1 55.7 5.3 39 10 298 116 780 1,242 29.8 154.6 55.7 5.1 2010E Jan-11E 1,812 1,302 510 1,008 1,518 39 10 298 116 1,055 1,517 29.8 149.3 55.7 4.9
Current Assets Current Liabilities Net Working Capital Fixed Assets Total Capital Employed Payables: Amounts Due > One Year Provisions for Liabilities & Charges Corporate Bond Net Retirement Benefit Obligation Shareholders Funds Total Sources of Capital Memo: Debtor Days Creditor Days Inventory Days Fixed Asset Turn
195
Exhibit 337
PPR: Annual Income Statement ( million)

2002 27,375 (16,786) 10,590 (3,864) (4,899) 1,827 (415) 1,412 1,278 (706) 0 1,985 (6) (234) 0 1,745 (155) 1,589 12.58 102.6% (61.3)% 38.7 (14.1) (17.9) 6.7 (1.5) 5.2 4.7 (2.6) 0.0 7.2 0.0 (0.9) 6.4 (0.6) 5.8 (1.5)% (0.4) 1.3 (7.7) 111.1 102.6 2003 24,361 (15,179) 9,182 (3,504) (4,381) 1,297 (314) 983 (31) (143) 0 809 55 (119) 0 745 (100) 645 5.08 (59.6)% (62.3)% 37.7 (14.4) (18.0) 5.3 (1.3) 4.0 (0.1) (0.6) 0.0 3.3 0.2 (0.5) 3.1 (0.4) 2.6 (11.0)% (13.3) (10.0) (29.0) (59.4) (59.6) 2004 24,213 (14,782) 9,431 (3,417) (4,547) 1,467 (349) 1,118 418 (415) 0 1,121 14 (107) 0 1,029 (89) 941 7.15 40.6% (61.1)% 38.9 (14.1) (18.8) 6.1 (1.4) 4.6 1.7 (1.7) 0.0 4.6 0.1 (0.4) 4.3 (0.4) 3.9 (0.6)% 2.7 1.0 13.1 45.9 40.6 2005R 16,929 (9,599) 7,331 (2,470) (3,807) 1,054 (307) 747 3 (187) 0 563 3 0 (1) 565 (38) 527 4.39 4.33 (38.6)% (56.7)% 43.3 (14.6) (22.5) 6.2 (1.8) 4.4 0.0 (1.1) 0.0 3.3 0.0 0.0 3.3 (0.2) 3.1 (30.1)% (22.3) (21.2) (28.1) (44.0) (38.6) 2006E 18,138 (10,197) ,941 (2,587) (4,078) 1,276 (295) 981 0 (255) 0 726 4 0 (55) 675 (49) 627 5.16 5.61 17.5% (56.2)% 43.8 (14.3) (22.5) 7.0 (1.6) 5.4 0.0 (1.4) 0.0 4.0 0.0 0.0 3.7 (0.3) 3.5 7.1% 8.3 6.2 21.1 18.9 17.5 2007E 19,365 (10,898) 8, 466 (2,756) (4,209) 1,502 (175) 1,327 0 (345) 0 982 6 0 0 988 (67) 921 7.17 7.17 39.0% (56.3)% 43.7 (14.2) (21.7) 7.8 (0.9) 6.9 0.0 (1.8) 0.0 5.1 0.0 0.0 5.1 (0.3) 4.8 6.8% 6.6 4.5 17.7 46.9 39.0 2008E 20,677 (11,608) 9,069 (2,913) (4,419) 1,736 (111) 1,625 0 (422) 0 1,202 7 0 0 1,210 (82) 1,128 8.78 8.78 22.5% (56.1)% 43.9 (14.1) (21.4) 8.4 (0.5) 7.9 0.0 (2.0) 0.0 5.8 0.0 0.0 5.9 (0.4) 5.5 6.8% 7.1 5.3 15.6 22.5 22.5 2009E 21,884 (12,271) 9,613 (3,056) (4,609) 1,948 (50) 1,898 0 (493) 0 1,404 8 0 0 1,413 (96) 1,317 10.26 10.26 16.8% (56.1)% 43.9 (14.0) (21.1) 8.9 (0.2) 8.7 0.0 (2.3) 0.0 6.4 0.0 0.0 6.5 (0.4) 6.0 5.8% 6.0 4.5 12.2 16.8 16.8 2010E 23,213 (13,016) 10,197 (3,200) (4,811) 2,186 (60) 2,126 0 (553) 0 1,574 10 0 0 1,583 (107) 1,476 11.50 11.50 12.0% (56.1)% 43.9 (13.8) (20.7) 9.4 (0.3) 9.2 0.0 (2.4) 0.0 6.8 0.0 0.0 6.8 (0.5) 6.4 6.1% 6.1 4.5 12.3 12.0 12.0
2000 2001 24,761 27,799 Net Sales Cost of Sales (15,174) (17,171) 9,587 10,628 Gross Margin Payroll Expenses (3,351) (3,754) Other SG&A and Depreciation (4,349) (4,895) 1,887 1,978 Operating Income Net Financial Expenses (262) (418) Income from Ordinary Activities Before Taxes 1,625 1,561 Nonrecurring Items (27) (33) Income Taxes (359) (292) Employee Profit Sharing 0 0 Net Income of Consolidated 1,238 1,236 Companies Share in Earning of Equity Affiliates 6 7 Amortization of Goodwill (119) (149) Net Income from Discontinued Operations 0 0 1,093 Net Income Before Minority Interests 1,126 Minority Interests (359) (341) 767 753 Attributable Net Income EPS Fully Diluted () 6.37 6.21 EPS Fully Diluted, Continuing () YoY Change 20.3% (2.5)% Margin Analysis (% of Sales) Cost of Sales Gross Margin Payroll Expenses Other SG&A and Depreciation Operating Income Net Financial Expenses Income from Ordinary Activities Before Taxes Nonrecurring Items Income Taxes Employee Profit Sharing Net Income of Consolidated Companies Share in Earnings of Equity Affiliates Amortization of Goodwill Net Income Before Minority Interests Minority Interests Attributable Net Income Year-to-Year Growth Sales Gross Profit SG&A EBIT Net Earnings EPS Memo: Shares Outstanding Fully Diluted (million) Tax Rate (61.3)% 38.7 (13.5) (17.6) 7.6 (1.1) 6.6 (0.1) (1.5) 0.0 5.0 0.0 (0.5) 4.5 (1.5) 3.1 26.8% 29.5 29.9 27.6 22.0 20.3 (61.8)% 38.2 (13.5) (17.6) 7.1 (1.5) 5.6 (0.1) (1.0) 0.0 4.4 0.0 (0.5) 3.9 (1.2) 2.7 12.3% 10.9 12.3 4.8 (1.9) (2.5)
124.1 22.5%
125.4 19.1%
127.2 26.2%
131.1 15.0%
136.1 27.0%
122.0 25.2%
121.5 26.0%
128.4 26.0%
128.4 26.0%
128.4 26.0%
128.4 26.0%
196
Exhibit 338
Net Income of Consolidated Companies Depreciation and Amortization Other Non-Cash Movements Gross Cash from Operating Activities Other Movements Change in Working Capital Net Cash from Operating Activities Net Operating Capex Net Financial Investments Net Cash from Investing Activities Net Cash from Financing Activities
PPR: Annual Cash Flow Statement ( million)

2000 1,238 399 (145) 1,492 4 (478) 1,017 (650) (2,974) 2001 1,236 439 (233) 1,441 7 209 1,657 (585) (1,819) 2002 1,985 455 (1,157) 1,283 4 97 1,384 (672) 2,517 1,844 2003 809 456 (122) 1,144 5 (132) 1,017 (500) 167 (333) 2004 1,121 473 (341) 1,253 5 (183) 1,075 (428) 60 (369) 490 23 1,219 0 2005 947 0 0 947 282 72 1,301 (346) 67 (298) (3,302) 13 (2,286) 4,650 2006E 1,173 425 0 1,598 (255) (131) 1,212 85 0 85 (611) 0 686 3,264 2007E 1,435 408 0 1,843 (345) (87) 1,411 56 0 56 (488) 0 979 2,285 2008E 1,654 425 0 2,079 (422) (92) 1,565 (511) 0 (511) (473) 0 581 1,704 2009E 1,852 480 0 2,332 (493) (85) 1,754 (539) 0 (539) (474) 0 741 963 2010E 2,079 510 0 2,589 (553) (93) 1,943 (571) 0 (571) (537) 0 834 129
(3,624) (2,403) 2,624 264 282 0 1,060 176 490 0
(1,901) (4,552) (23) 1,304 0 (76) (3,944) 0
Effect of Exchange Rate Changes on Cash/ Equivalents Net Cash Flow Year-End Net Debt/(Cash) SCB
Exhibit 339
Current Assets Current Liabilities Net Working Capital Fixed Assets Total Capital Employed Long-Term Liabilities Borrowings Long-Term Other Minority Interests Shareholders Funds Total Sources of Capital 2000 19,146 15,884 3,262 12,563 15,826 8,446 7,607 840 3,022 4,358 15,826
PPR: Annual Balance Sheet ( million)

2001 19,840 17,213 2,627 15,140 17,766 9,206 8,602 605 2,868 5,692 17,766 2002 15,835 12,748 3,087 14,189 17,275 8,088 7,545 543 2,719 6,469 17,275 2003 11,075 10,204 870 13,565 14,435 5,804 5,247 558 1,732 6,899 14,435 2004 10,232 8,470 1,762 12,719 14,481 6,616 6,095 521 171 7,693 14,481 2005 7,432 8,095 (663) 15,572 14,909 6,775 4,399 2,376 149 7,985 14,909 2006E 8,253 8,095 158 15,062 15,220 6,075 3,699 2,376 149 8,997 15,220 2007E 9,319 8,095 1,224 14,598 15,822 6,075 3,699 2,376 149 9,599 15,823 2008E 9,992 8,095 1,897 14,683 16,580 6,075 3,699 2,376 149 10,357 16,581 2009E 10,817 8,095 2,722 14,743 17,465 6,075 3,699 2,376 149 11,242 17,466 2010E 11,745 8,095 3,650 14,804 18,454 6,075 3,699 2,376 149 12,231 18,455
197
Index of Exhibits
1 2 3 4 5 6 7 8 9 Financial Overview Evolution of Apparel Retailing Formats Apparel & Footwear Retailers: Quick & Dirty Return Equation (Estimates Based on UK 2005 Numbers) Dispersion of Stock Price Performance Across MSCI Sectors (2001-05) European Discretionary Retailers: Relative Price-to-Forward Earnings (vs. MSCI) Relative Price-to-Forward Earnings vs. MSCI Europe Current Price-to-Forward Earnings vs. Bernstein and Consensus Earnings Growth Next Two Years H&M: Gross Margin Improvement Inditex vs. H&M: Domestic Market Sales Penetration (1998-2005) 4 6 8 10 10 11 12 14 15 17 19 21 22 22 23 23 24 24 24 24 25 25 25 26 26
10 Next vs. M&S: Median Consensus Expectations 11 Top-of-Mind Fashion and Luxury Brands First Brand Mentioned (No Prompting) 12 European Union: Clothing Market Absolute Retail Spend 13 Euro vs. Pound Sterling Exchange Rate (1990-2007E) 14 European Union: Clothing Market per Capita Retail Spending 15 European Union: Clothing Market per Capita A&F Retail Spend vs. GDP per Capita 16 European Union: Clothing Market per Capita A&F Retail Spend vs. GDP per Capita 17 Apparel & Footwear Year-Over-Year Expenditure Growth vs. GDP Growth: Italy 18 Apparel & Footwear Expenditure Growth vs. GDP Growth: Italy 19 Apparel & Footwear Year-Over-Year Expenditure Growth vs. GDP Growth: France 20 Apparel & Footwear Expenditure Growth vs. GDP Growth: France 21 Apparel & Footwear Year-Over-Year Expenditure Growth vs. GDP Growth: Germany 22 Apparel & Footwear Expenditure Growth: Germany 23 Apparel & Footwear Expenditure Growth vs. GDP Growth: United Kingdom 24 Apparel & Footwear Inflation vs. CPI: United Kingdom 25 Apparel & Footwear Inflation vs. CPI: Germany
198
26 Apparel & Footwear Inflation vs. CPI: France 27 Apparel & Footwear Inflation vs. CPI: Italy 28 Apparel vs. Footwear Inflation: United Kingdom 29 Apparel vs. Footwear Inflation: Germany 30 Apparel vs. Footwear Inflation: France 31 Apparel vs. Footwear Inflation: Italy 32 The Impact of Value Clothing on Clothing Retail Spend in the United Kingdom 33 Apparel Retail Spend: United Kingdom (1994-2004) 34 Correlation of Apparel & Footwear Spend Growth to Nominal GDP Growth EU 14: 2001 vs. 1991 35 Apparel & Footwear Growth Outliers vs. 1991-2001 Regression 36 Apparel & Footwear Price vs. Volume Growth: United Kingdom vs. Italy 37 Apparel Retailing Fragmentation EU 15 (2002) 38 Top Five Players Share of the Grocery Retail Market 39 Apparel & Footwear Retail Structure as a Driver of Price Deflation 40 The Transmission Chain Between the Catwalk and the Street 41 The Transmission Chain Between the Catwalk and the Street: Layered Brand and Accessories Boom 42 Apparel Market: United Kingdom Absolute Spend 43 Footwear Market: United Kingdom Absolute Spend 44 Apparel Market: United Kingdom Relative Spend 45 Footwear Market: United Kingdom Relative SpendG 46 United Kingdom: Numbers in Higher Education by Gender (1970-2000) 47 Female Percentage of Tertiary Students 48 Women vs. Men: Relative Employment Rate (1992-2004) 49 Women vs. Men: Relative 1992-2004 Employment Rate Gap vs. the United States 50 Relative Female Gross Annual Earnings in Industry and Services 51 Womens Pay Differential (Unadjusted Form) as a Percentage of Male Earnings 52 Drivers of Apparel Store Loyalty (2001-05) 53 Range as a Driver of Apparel Store Loyalty by Gender, Age and Socioeconomic Group (2001-05) 54 Price as a Disloyalty Driver in the United Kingdom (2005) 55 Proportion of Clothing Shoppers That Are Loyal to Their Main Store: United Kingdom 56 Change in Loyalty by Retailer: United Kingdom (2004-05)
26 26 27 27 27 27 28 28 29 29 30 30 30 31 31 32 34 34 34 35 36 36 37 37 38 38 39 39 39 40 40
199
57 Shopping Around Behavior: United Kingdom (2001-05) 58 Store Loyalty: United Kingdom (2001-05) 59 Loyalty Rates Detail: United Kingdom (2005) 60 Loyalty Drivers: United Kingdom (2005) 61 Average and Total Clothing Spend: United Kingdom (2004) 62 Shopping Levels: United Kingdom (2001-05) 63 Apparel & Footwear Market: EU 14 Absolute Retail Spend 64 Correlation of Apparel & Footwear Retail Spend to Nominal Growth for the EU 14 1996 vs. 1991 65 Correlation of Apparel & Footwear Retail Spend to Nominal GDP Growth for the EU 14 2001 vs. 1996 66 Combined Main Users Share of Top Five Retailers: United Kingdom (2005) 67 Evolution of Apparel Retailing Formats Mass 68 Evolution of Apparel Retailing Formats Upscale 69 Hypermarkets: Development in Key European Economies 70 Department Store Sales by Country: EU 25, 2004 71 Size of Department Store Business in the Key Countries 72 Profitability of Department Store Players in the Key Countries 73 Specialty Apparel Retailers (Independents and Multiples): Space Development 74 Specialty Apparel & Accessories Retailers (Independents and Multiples): Space Development 75 Market Attractiveness for Apparel and Accessories Multiples Specialty Retailers 76 Increasingly Homeostatic Equilibrium of the Upscale Fashion System 77 Best-in-Class Spring/Summer Prt--Porter Womens Collection Calendar (From Collection Briefing to Store Delivery) Typical Upscale Italian Fashion Brand 78 Descriptive Characteristics of Apparel & Footwear Retail Formats 79 Premium vs. Discount Position Staff 80 Premium vs. Discount Position Revenue 81 Consumer Base Profile for Key Players in the UK Apparel & Footwear Market 82 Age Drift Effect 2005 vs. 2001 83 Apparel & Footwear Retailing Market Schematic 84 Relative Stock Performance (vs. MSCI Europe) 85 Dispersion of Stock Price Performance Across MSCI Sectors (2001-05)
40 41 41 42 42 42 43 44 44 44 46 46 47 48 48 49 49 50 50 51
53 54 56 56 57 57 59 61 61
200
86 MSCI European Retailing Index vs. 1-Month Euribor (1995-2005) 87 MSCI Europe Retailing Index Relative Performance vs. 1-Month Euribor (1995-2005) 88 Coverage Retailers: Relative NTM P/E vs. MSCI Index and 1-Month Euribor 89 Discretionary Retailers: I/B/E/S Growth Forecast vs. Relative Price-to-Forward Earnings (1991-95) 90 Discretionary Retailers: I/B/E/S Growth Forecast vs. Relative Price-to-Forward Earnings (1996-2000) 91 Discretionary Retailers: I/B/E/S Growth Forecast vs. Relative Price-to-Forward Earnings (2001-05) 92 Apparel Retailers: EPS vs. Price Growth (1995-2000) 93 Apparel Retailers: EPS vs. Price Growth (2001-05) 94 Current-Year Consensus EPS Growth Rate vs. Price-to-Forward Earnings 95 Inditex: Historical Strength of Linkage Between Near-Term Earnings Growth and Relative Price-to-Forward Earnings 96 H&M: Historical Strength of Linkage Between Near-Term Earnings Growth and Relative Price-to-Forward Earnings 97 Discretionary Retailers: Absolute P/Es (1991-2005) 98 Coverage: Relative NTM P/E 99 Coverage Universe Split by Segment 100 Marks & Spencer: Relative Forward P/E 101 Marks & Spencer: Near-Term Growth Expectations vs. Relative Forward P/E 102 Next: Growth Expectations vs. Relative Forward P/E 103 H&M: Relative Forward P/E vs. MSCI Discretionary Retailers 104 Inditex: Relative Forward P/E vs. MSCI Discretionary Retailers 105 H&M: Near-Term Growth Expectations vs. Relative Forward P/E 106 Inditex: Near-Term Growth Expectations vs. Relative Forward P/E 107 H&M: Year-Over-Year Earnings Growth (Quarterly and Yearly) and Relative Forward P/E 108 H&M: Year-Over-Year Earnings Growth (Quarterly and Yearly) and Relative Forward P/E Correlation of Three-Month-Rolling Average Earnings Revisions and Relative Price-to-Forward Earnings 109 Inditex: Three-Month-Rolling Average Earnings Revisions and Relative Forward P/E 110 Inditex: Correlation of Three-Month-Rolling Average Earnings Revisions and Relative Forward P/E 111 H&M vs. Inditex: Relative Forward P/E
62 62 63 64 64 64 65 65 66 66 66 66 67 67 68 68 69 70 70 70 71 71
72 72 73 73
201
112 H&M vs. Inditex: Relative Forward P/E (July 2001 Through December 2004) 113 H&M vs. Inditex: Relative Forward P/E (January Through December 2005) 114 Inditex and H&M: Consensus Estimates 115 PPR: Near-Term Earnings Growth Expectations vs. Relative Forward P/E 116 Valuation Metrics 117 Discounted Cash Flow Summary 118 H&M: Annual Relative Price Performance (to MSCI Europe) 119 H&M: Relative Price-to-Forward Earnings vs. Specialty Retailers Composite 120 H&M: Gross Margin 121 H&M: Drivers of Earnings Growth 2005 vs. 2000 122 H&M: RoCE Rolling-Four-Quarter (1Q:98 to 2Q:06) 123 H&M: Gross Margin Comparison With Large Apparel Retailers (2005) 124 EU Imports of Selected Apparel Categories from China Immediately Post MFA Expiration 125 EU Import Shares of Chinese Apparel Exporters 126 Winners and Losers of the Post-Quota Era: Textile Exports to Developed Markets 127 China Exports of Cotton T-Shirts (January Through October 2005) 128 H&M vs. Inditex: Sourcing 129 EU Apparel Imports from China (First Four Weeks of 2006) 130 Apparel & Footwear Sales by Price Tag 131 H&M vs. Discounters: Value for Money Leadership 132 Sales Product Mix Womenswear: United Kingdom (52 Weeks to 8/21/05) 133 UK Customer Base by Age Band: Womenswear (52 Weeks to 8/21/05) 134 Shopping Behavior of UK Apparel Shoppers Index vs. Average = 100 (2005) 135 H&M vs. Inditex: Unit Price Trend 136 H&M: Sales and SG&A Development 137 H&M: SG&A Dynamics (1997-2005) 138 H&M: Store and Personnel Productivity Trend 139 Sales/Store YoY Growth in Local Currency Group Weighted Average 140 H&M: Drivers of Revenue Growth
74 74 75 76 77 77 79 79 80 80 81 81 82 82 82 83 84 84 85 86 86 87 87 88 88 88 89 89 90
202
141 Sales/Store YoY Growth in Local Currency: Germany 142 Sales/Store YoY Growth in Local Currency: United Kingdom 143 Sales/Store YoY Growth in Local Currency: Sweden 144 Sales/Store YoY Growth in Local Currency: France 145 H&M: Store Growth by Region Summary 146 H&M: 1997 Sales by Country Market Penetration vs. Personnel Cost 147 H&M: 2004 Sales by Country Market Penetration vs. Personnel Cost 148 Largest Apparel & Footwear Retail Brands 149 Inditex vs. H&M: Sales/Country All Markets 150 Inditex vs. H&M: Sales/Country International Only 151 Domestic Market: Sales in Home Country as a Percentage of Total Sales 152 Inditex vs. H&M: Sales 153 Apparel & Footwear Retailers: Operating Leases and CashAdjusted RoCE vs. Leading Retailers 154 Inditex: Annual Relative Price Performance (to MSCI Europe) 155 Inditex: Annual Relative Price Performance vs. Specialty Retailers Composite (to MSCI Europe) 156 Inditex: Earnings Growth Trend 157 Apparel Sourcing Modes: Finished-Product vs. Faonneur-Based 158 Inditex: Peer-to-Peer Teamwork 159 Inditex: Store-Manager-Centered Assortment Definition 160 Inditex: Virtuous Cycle 161 The Inditex Way vs. the Traditional Retail Model and the High-Fashion Model 162 Inditex vs. H&M: Sales Growth and Standard Deviation 163 Inditex Way vs. Format Portfolio 164 Inditex: Drivers of Earnings Growth 2005 vs. 1998 165 Inditex vs. H&M: Domestic Market Penetration (2004) 166 Inditex vs. H&M: Domestic Market Sales Penetration (1998-2005) 167 Inditex: Retail Brands and Format Portfolio 168 Inditex: Retail Formats Brand Positioning 169 Inditex: Price Positioning by Brand Womens Apparel and Accessories (Spring/Summer 2005) 170 Inditex: Sales Effectiveness by Format (2005) 171 Inditex: Stores by Format Spain Only
90 90 91 91 91 92 92 92 93 93 94 96 96 96 97 97 99 100 101 102 103 103 103 104 105 105 106 106 106 107 107
203
172 Inditex: Sales by Format Spain Only 173 Inditex: Stores by Format International Only 174 Inditex: Sales by Format International Only 175 Inditex: Stores by Format All Markets 176 Inditex: Sales by Format All Markets 177 Inditex vs. H&M: Number of Countries Where Present 178 Inditex vs. H&M: Sales per Country International Only 179 H&M: Geographic Development Expansion Waves 180 Inditex: Directly-Operated Stores, by Geography 181 Inditex: Franchised Stores, by Geography 182 Inditex: Directly-Operated Stores and Franchised Stores, by Brand (2005) 183 Inditex: Domestic vs. International Growth 184 New-Stores Growth, by Geography 185 Inditex: Zara Stores by Market Cluster at January 31, 2005 186 Inditex: Non-Zara Stores by Market Cluster at January 31, 2005 187 Inditex: Long-Term Potential for New Stores in Europe Three Scenarios 188 H&M: Market Penetration vs. Geographic Expansion Wave (2004) 189 Inditex: SG&A Dynamics (1997-2005) 190 Inditex: Personnel Costs/Average Employee 191 Personnel Costs (Percentage of Sales) 192 Inditex: Increase in Other SG&A 193 Inditex: Total DOS Abroad vs. Other SG&A 194 Lease Cost: Top Retail Locations in France and the United Kingdom 195 Lease Cost: Top Retail Locations in North America 196 Lease Cost: Prime Locations in Europe 197 H&M vs. Inditex: Penetration of Cluster 1 and Cluster 2 (Stores/Market, 2004) 198 Impact of Sourcing Costs and Duties of Imported Apparel to the United States 199 Zara: Price Positioning in Major Markets (Spring/Summer 2005) 200 Inditex: Sales Forecast Bernstein vs. Consensus 201 Inditex: Earnings Forecast Bernstein vs. Consensus 202 M&S: Stock Price vs. MSCI Europe 203 M&S: Annual Relative Return vs. MSCI Europe
107 107 107 108 108 108 108 109 110 110 111 111 111 112 112 113 114 115 115 115 116 116 117 117 117 117 118 118 120 120 122 122
204
204 M&S: Sales and Net Earnings Forecast 205 UK Apparel & Footwear Retail Market 2001 vs. 2006 206 UK Apparel & Footwear Retail Multiples Winners and Losers 207 M&S: 10-Year UK Apparel & Footwear Retail Market Share Trend 208 UK Childrenswear Market Shares: Top 10 Players 2000 vs. 2005 209 M&S Is Fading With Younger Consumers 210 M&S: Womenswear Market Share by Age Group 211 M&S: Womenswear Sales Mix (52 Weeks Ended 12/11/05) 212 M&S vs. Next: Womenswear Sales Mix by Age (52 Weeks Ended 12/11/05) 213 M&S: UK Apparel and Accessories Market Share 214 M&S: UK Sales Mix 215 M&S: UK Sales Growth 216 M&S: Operating Profit vs. Leading Grocery Retailers 217 M&S: Simply Food Stores Proximity to Convenience Stores and Supermarkets 218 M&S: Food Stores Proximity to Convenience Stores and Supermarkets 219 M&S: Scale Disadvantage vs. Tesco and Sainsbury 220 M&S: Advertising Expenditure vs. Tesco and Sainsbury 221 M&S: SG&A Components as a Percentage of Group Sales (1995-2005) 222 M&S vs. Next: Store Locations 223 UK Retail Space Trend by Location 224 M&S vs. Next: UK Penetration by Region 225 UK High Street Rental Growth 226 M&S vs. Next: Estimated P&L Impact of Real Estate Sale and Lease-Back 227 M&S: Estimated P&L, Balance Sheet and EPS Impact of Real Estate Sale and Lease-Back 228 M&S vs. Next: UK Employee Costs 229 M&S: UK Exceptional Items 230 M&S: Detail of Exceptional Items 231 Staff Costs for Leading European Apparel and Grocery Retailers 232 M&S: Average Number of Employees/Business Area UK Headquarters 233 M&S: Average Number of Employees/Business Area UK Stores
123 124 124 125 125 126 126 127 127 128 129 129 129 130 130 131 131 132 132 133 133 134 134 135 136 136 136 137 137 138
205
234 M&S Like-for-Like Quarterly Growth vs. UK A&F Retail Market Quarterly Growth 235 M&S Like-for-Like Quarterly Growth vs. UK A&F Retail Market Quarterly Growth Delta Percentage Points 236 United Kingdom: Space Growth of High Street Retailers vs. Space Productivity (1995-2000) 237 United Kingdom: Space Growth of High Street Retailers vs. Space Productivity (2000-05) 238 M&S: Discontinued Businesses in North America and Western Europe 239 M&S: International Franchising Stores by Market Cluster 240 Kings Supermarkets 241 M&S: Operating Profit from International Operations 242 Next: Drivers of Earnings Growth (1999-2005) 243 Next: Drivers of Sales Growth (1999-2005) 244 Next: Operating Lease-Adjusted RoCE vs. Leading Retailers (2004) 245 Next: RoCE (1994-2005) 246 Next: Annual Relative Price Performance (to MSCI Europe) 247 Next vs. M&S: Median Consensus Expectations 248 Next vs. M&S: UK Womenswear Market Share by Age Group (2005) 249 Next vs. M&S: Brand Recognition 250 Next vs. M&S: UK Womenswear Market Share by Age Group 251 Next: UK Womenswear Market Share 252 UK Apparel & Footwear Retail Market: Visitors Share vs. Market Share (2005) 253 Delta Actual Visitors Share vs. Predicted Visitors Share (2005) 254 UK Apparel & Footwear Retail Market: Main Users Share vs. Market Share (2005) 255 Shopping Around by Retailer (2005) 256 Next: Design, Sourcing and Production Organization 257 Next: Design, Sourcing and Production Productivity 258 Next: Retail Space Growth (1992-2005) 259 Next: New Space as a Percentage of Previous-Year Retail Space 260 Next: Net New Space Addition as a Function of Average New Store Size 261 Next: Average Store Size 262 Next: UK Stores and Penetration by Region
138 138 139 139 139 139 140 140 142 142 143 143 143 144 145 145 145 146 146 147 148 148 148 149 149 150 150 150 151
206
263 Next: Retail Sales/m2 vs. Store Size and Operating Lease Expense as a Percentage of Retail Sales 264 Next: SG&A as Percentage of Net Sales 265 Apparel and Accessories Space Productivity in the UK (2004) 266 Next: Retail Sales vs. Directory Sales 267 Directory Sales as a Function of Active Customers 268 Directory Sales as a Function of Average Customer Transaction 269 Directory Sales as a Function of Total Directory Pages 270 Directory Sales as a Function of Sales per Directory Page 271 Which Retailers Do Online A&F Shoppers Buy From? (October 2005) 272 Apparel & Footwear Online Spending (1998-2005) 273 Next: Online Business 274 Next: Cost of Sales 275 Next: UK Apparel and Accessories Market Share by Price Point 276 Next vs. M&S: UK Apparel and Accessories Relative Market Share by Price Point 277 Next: SG&A Growth vs. Sales Growth 278 Next: Bernstein vs. Consensus Forecast at a Glance 279 PPR: Annual Relative Price Performance (to MSCI Europe) 280 PPR: Long-Term Growth Expectations and Relative Forward P/E 281 PPR: Sectors of Activity 282 PPR: RoCE (1996-2005) 283 New PPR Brand Portfolio 284 PPR: Sales and Earnings Forecast Bernstein vs. Consensus 285 Top-of-Mind Fashion and Luxury Brands First Brand Mentioned (No Prompting) 286 Top-of-Mind Fashion and Luxury Brands All Brands Mentioned (No Prompting) 287 Winners Continue to Win Luxury for the Masses 288 Winners Continue to Win Top-of-Mind Virtuous Cycle 289 Louis Vuitton: Sales Growth 290 PPR: Luxury Acquisitions 291 Gucci: Sales Growth 292 Monobrand Stores: Gucci vs. Louis Vuitton and Armani 293 Luxury Brands: Scale vs. Profitability 294 PPR: RoNA by Division
151 152 152 152 153 153 153 153 154 154 154 155 155 155 156 156 157 157 158 158 159 159 160 160 161 161 162 162 162 163 163 164
207
295 PPR Luxury Brands: Historical EBIT Performance 296 PPR Non-Gucci Brands: EBIT (2004 vs. 2005) 297 Apparel Designer Brands vs. Accessories Specialist Brands: Timing of Category Diversification 298 Apparel Designer Brands vs. Accessories Specialist Brands: Extent of Category Diversification 299 Luxury Market Growth (1994-2002) 300 PPR: Luxury Category Sales Mix (2005) 301 YSL: Number of Directly-Operated Stores vs. EBIT 302 PPR: Retail Category Mix (2005) 303 PPR: Retail Sales Mix by Geography (2005) 304 PPR: Retail Portfolio Matrix (2005) 305 PPR: Growth Support Acquisitions (1996-2004) 306 France: House Authorization Growth vs. Conforama Sales/m2 Growth 307 France: House Starts Growth vs. Conforama Sales/m Growth 308 Conforama: EBIT vs. Sales/m in France 309 Italy: Impact of General Elections on Families Spend 310 Consumer Electronics Expenditures as a Percentage of Total Consumer Expenditure 311 France: Consumer Electronics Retail Sales 312 France: Impact of FIFA World Cup on Consumer Electronics Spend 313 France: FNAC Sales/m2 vs. Consumer Electronics Spend 314 PPR: Group Payroll Expenses as a Percentage of Sales 315 PPR: Sales per Employee Retail vs. Luxury 316 PPR: Retail Sales per Employee and Number of Employees 317 PPR: Bernstein vs. Consensus Forecasts at a Glance 318 Sum-of-the-Parts Valuation vs. Market Capitalization 319 Earnings Performance vs. Price/Sales 320 Debt Leverage vs. Price/Sales Value 321 Calculated Value Impact from the Elimination of Interest Costs 322 Five Market Clusters by Population Size and Development Level 323 177 Countries, Clustered by Population Size and Development Level 324 Market Clusters 325 H&M: Annual Income Statement
2 2
164 165 166 167 167 167 168 169 169 170 170 170 170 171 171 171 171 172 172 173 173 173 174 174 175 175 175 179 179 181 187
208
326 H&M: Annual Cash Flow Statement 327 H&M: Annual Balance Sheet 328 Inditex: Annual Income Statement 329 Inditex: Annual Cash Flow Statement 330 Inditex: Balance Sheet 331 M&S: Annual Income Statement 332 M&S: Annual Cash Flow Statement 333 M&S: Annual Balance Sheet 334 Next: Annual Income Statement 335 Next: Annual Cash Flow Statement 336 Next: Annual Balance Sheet 337 PPR: Annual Income Statement 338 PPR: Annual Cash Flow Statement 339 PPR: Annual Balance Sheet
188 188 189 190 190 191 192 192 193 194 194 195 196 196
209
Disclosure Appendix SRO REQUIRED DISCLOSURES

References to Bernstein relate to Sanford C. Bernstein & Co., LLC and Sanford C. Bernstein Limited, collectively. Bernstein analysts are compensated based on aggregate contributions to the research franchise as measured by account penetration, productivity and proactivity of investment ideas. No analysts are compensated based on performance in, or contributions to, generating investment banking revenues. Bernstein rates stocks based on forecasts of relative performance for the next 6-12 months versus the S&P 500 for U.S. listed stocks and versus the MSCI Pan Europe Index for stocks listed on the European exchanges unless otherwise specified. We have three categories of ratings: Outperform: Stock will outpace the market index by more than 15 pp in the year ahead. Market-Perform: Stock will perform in line with the market index to within +/-15 pp in the year ahead. Underperform: Stock will trail the performance of the market index by more than 15 pp in the year ahead. As of 11/02/06, our ratings were distributed as follows: Outperform/Buy 37.7%; Market-Perform/Hold 50.3%; Underperform/Sell 12.0%. Accounts over which Sanford C. Bernstein & Co., LLC, Sanford C. Bernstein Limited, and/or their affiliates exercise investment discretion own more than 1% of the outstanding common stock of MKS.LN / Marks & Spencer Group PLC. The following companies are or during the past twelve (12) months were clients of Bernstein, which provided non-investment bankingsecurities related services and received compensation for such services MKS.LN / Marks & Spencer Group PLC. An affiliate of Bernstein received compensation for non-investment banking-securities related services from MKS.LN / Marks & Spencer Group PLC.
210
OTHER DISCLOSURES
To our readers in the United States: Sanford C. Bernstein & Co., LLC is distributing this report in the United States and accepts responsibility for its contents. Any U.S. person receiving this report and wishing to effect securities transactions in any security discussed herein should do so only through Sanford C. Bernstein & Co., LLC. To our readers in the United Kingdom: This report has been issued or approved for issue in the United Kingdom by Sanford C. Bernstein Limited, authorised and regulated by the Financial Services Authority and located at Devonshire House, 1 Mayfair Place, London W1J 8SB, +44 (0)20-7170-5000. To our readers in member states of the EEA: This report is being distributed in the EEA by Sanford C. Bernstein Limited, which is authorised and regulated in the United Kingdom by the Financial Services Authority and holds a passport under the Investment Services Directive. To our readers in Australia: Sanford C. Bernstein & Co., LLC and Sanford C. Bernstein Limited are exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 in respect of the provision of the following financial services to wholesale clients: providing financial product advice; dealing in a financial product; making a market for a financial product; and providing a custodial or depository service.
211
Sanford C. Bernstein & Co., LLC and Sanford C. Bernstein Limited are regulated by the Securities and Exchange Commission under U.S. laws and by the Financial Services Authority under U.K. laws, respectively, which differ from Australian laws. One or more of the officers, directors, or employees of Sanford C. Bernstein & Co., LLC, Sanford C. Bernstein Limited and/or its affiliates may at any time hold, increase or decrease positions in securities of any company mentioned herein. Sanford C. Bernstein & Co., LLC, Sanford C. Bernstein Limited, or its or their affiliates may provide investment management or other services to the pension or profit sharing plans, or employees of any company mentioned herein, and may give advice to others as to investments in such companies. These entities may effect transactions that are similar to or different from those recommended herein.
CERTIFICATIONS
I/(we), Luca Solca, Senior Analyst(s), certify that all of the views expressed in this report accurately reflect my/(our) personal views about any and all of the subject securities or issuers and that no part of my/(our) compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views in this report.
Approved By: JAG

Copyright 2006, Sanford C. Bernstein & Co., LLC, a subsidiary of AllianceBernstein L.P. ~ 1345 Avenue of the Americas ~ NY, NY 10105 ~ 212/756-4400. All rights reserved. This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of, or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Sanford C. Bernstein & Co., LLC, Sanford C. Bernstein Limited or any of their subsidiaries or affiliates to any registration or licensing requirement within such jurisdiction. This report is based upon public sources we believe to be reliable, but no representation is made by us that the report is accurate or complete. We do not undertake to advise you of any change in the reported information or in the opinions herein. This research was prepared and issued by Sanford C. Bernstein & Co., LLC and/or Sanford C. Bernstein Limited for distribution to market counterparties or intermediate or professional customers. This report is not an offer to buy or sell any security, and it does not constitute investment, legal or tax advice. The investments referred to herein may not be suitable for you. Investors must make their own investment decisions in consultation with their professional advisors in light of their specific circumstances. The value of investments may fluctuate, and investments that are denominated in foreign currencies may fluctuate in value as a result of exposure to exchange rate movements. Information about past performance of an investment is not necessarily a guide to, indicator of, or assurance of, future performance.

24730087

Transféré par

Informations du document

Description originale:

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

24730087

Transféré par

Droits d'auteur :

Formats disponibles

In one of the most diverse sectors in the MSCI, "stock-picking" key "pair-trades" abound

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

European Apparel & Footwear Retail: It All Depends on the Models

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Portfolio Managers Summary

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Source: Corporate reports and Bernstein estimates.

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Significant Research Conclusions

Evolution of Apparel Retailing Formats

Category Offer Location Sourcing Product Communication

Department Store 1900-50 Broad High Street National Classic -

Category Offer Location Sourcing Product Communication

Haute Couture Atelier 1950 Apparel Very High Monobrand Low

Note: Time indicated represents significant introduction/development in Europe/United States.

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Source: Bernstein analysis.

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Two Major Dynamics Are Playing Out

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Source: TNS, corporate reports and Bernstein estimates and analysis.

The Shape of Things to Come

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Dispersion of Stock Price Performance Across MSCI Sectors (2001-05)

European Discretionary Retailers: Relative Price-to-Forward Earnings (vs. MSCI Europe)

Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96

Jan-97 Jan-98 Mean Jan-99

Source: Bernstein Quantitative Strategy Group.

Hennes & Mauritz

Relative Price-to-Forward Earnings vs. MSCI Europe

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Marks & Spencer

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

H&M: Gross Margin Improvement

Source: Corporate reports and Bernstein estimates.

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Inditex vs. H&M: Domestic Market Sales Penetration (1998-2005)

Domestic Market Sales Penetration ( per Head)

60 50 40 30 20 10 0 1998 Inditex CAGR: 17.3% Non-Zara Zara

Source: Corporate reports and Bernstein analysis.

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Next vs. M&S: Median Consensus Expectations

6% 5% 4% 3% 2% 1% 0% 2007E 2008E 2009E

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Upscale: Why We Believe PPR Is Appealing

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Source: Abacus, December 2002, circa 1,000 respondents per country.

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

European Apparel & Footwear Demand

The European A&F Market: A Historical Perspective

Source: Verdict and Bernstein analysis.

EUROPEAN APPAREL & FOOTWEAR RETAIL: IT ALL DEPENDS ON THE MODELS

Euro vs. Pound Sterling Exchange Rate (1990-2007E)

Source: Verdict, EuroStat and Bernstein analysis.

European Union: Clothing Market per Capita Retail Spending

Source: Verdict, Eurostat and Bernstein analysis.