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Earnings season: ASOS shares surge on turnaround hopes. Time to buy?

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The ASOS (LSE: ASC) share price rose by 15% in early trading on Thursday after the company said its turnaround plans were on track, despite a fall in Christmas sales.

Shares in the online fashion retailer have fallen by 75% over the last 12 months, but the business is still expected to sell £4bn of clothing this year. A small improvement in profitability could lead to a big jump in profits.

I’m wondering whether ASOS could be an exciting recovery play.

Key facts

Despite this morning’s share price surge, Asos isn’t exactly fighting fit at the moment. The firm’s underlying sales fell by 3% to £1,336.5m during the final four months of 2022, compared to the same period last year.

A 3% drop might not seem like a big deal, but it’s worth remembering the impact of inflation on prices. In its results earlier this year, ASOS said it had increased prices on its own-brand products. If revenue is falling despite higher prices, this tells me that sales volumes are also falling.

To be fair, postage strikes may have played a role in this. UK customers may have held off ordering near Christmas if they didn’t expect to receive deliveries in time.

This view is reflected in the geographic split of today’s results. UK sales fell by 8% during the four months to December, but EU sales rose by 6% over the same period.

Outlook: improving

ASOS reported a loss of £32m last year, despite selling nearly £4bn of goods. It’s clear to me that improving the profitability of this business is a top priority.

Fortunately, there was some good news on this front. New chief executive José Antonio Ramos Calamonte said he expects to report “significantly improved profitability and cash generation” during the second half of the current financial year.

To achieve this, he’s targeting a 5% reduction in stock levels and £300m of cost savings. Lower stock levels should free up cash, helping to reduce debt. Further price increases are also planned to protect and improve profit margins in the face of inflation.

ASOS shares: time to buy?

I’m encouraged by the firm’s new focus on profitability and cash generation. This is long overdue, in my opinion.

However, I’m concerned that ASOS faces tough competition from Next and other conventional retailers in its home market.

ASOS’s marketplace offering (which sells a range of well-known brands) is similar to that offered by Next. Both companies now have similar levels of revenue, but Next is far more profitable, thanks to its finance business and store network for cheap returns.

On the other hand, ASOS’s international business is bigger than Next’s, so there could be a long-term growth opportunity overseas.

Are ASOS shares cheap enough to be an attractive recovery play? I estimate that today’s share price surge has left the stock trading on 13 times 2024 forecast earnings. Coincidentally, that’s the same valuation as Next.

For me, this isn’t cheap enough. I reckon ASOS looks fully priced for now, especially given the risk of a recession this year.

The post Earnings season: ASOS shares surge on turnaround hopes. Time to buy? appeared first on The Motley Fool UK.

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