2010.09.26 0118PM Sanford European Apparel Retail Gauging the Rutledge

8/8/2019 2010.09.26 0118PM Sanford European Apparel Retail Gauging the Rutledge

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Luca So lca (Senior Analyst) [email protected] +44-207-170-5008A n d re a R os s o [email protected] +44-207-170-0568Mat t Wing [email protected] +44-207-170-0578

See Disclosure Appendix of this publication for important disclosures and analyst certifications.

European Appare l Re t a i l : Gauging t he Im pac t o f a MoreDiff ic u l t Sourc ing Envi ronm ent

Ticker Rating CUR

16/09/2010Closing

PriceTargetPrice

TTMRel.Perf.

EPS P/E

2009A 2010E 2011E 2009A 2010E 2011E Yield

ITX.SM O EUR 57.03 60.00 35.6% 2.11 2.57 2.98 27.0 22.2 19.1 1.9%HMB.SS O SEK 254.10 275.00 22.6% 9.90 12.01 12.70 25.7 21.2 20.0 3.2%MKS.LN O GBp 376.10 410.00 -4.4% 32.70 32.05 34.92 11.5 11.7 10.8 4.4%NXT.LN M GBp 2170.00 2300.00 14.6% 185.57 207.59 228.52 11.7 10.5 9.5 3.7%MSDLE15 1125.11 69.48 94.50 109.85 16.2 11.9 10.2 4.0%

O Outperform, M Market-Perform, U Underperform, N Not Rated

H i g h l i g h t s

European and American Apparel Retailers are bound to experience a more difficult sourcingenvironment in Asia going forward. Chinese apparel manufacturers are continuing to experience upwardcost pressures, as we had pointed out in our recent research (please refer to the report: European Apparel

Retailers: Sourcing Costs to Rise in 2011 , published on 22-Mar-10).

Raw material prices have continued to rise in 2010 YTD in China, Cotton is now 25% up yoy and Synthetic fibers are 12% up on average. (a) Cotton prices in China are now at an all time high of 2.69$/kg. Heavy rains and floods in Pakistan have contributed to inflate prices, as production and transportwere negatively affected. In fact, the price of cotton in Pakistan has risen >60% in 2010 YTD. India'srecent decision to set an annual cap to its cotton exports is not helping either; (b) Wool prices inAustralia are now at 1,056 $ cents/kg (18.5 micron) and increase of c.20% from one year prior. (c)Synthetic fiber prices generally have also been experiencing inflation in 2010 YTD, with viscose up16% yoy, nylon down -3.7%, polyester up 16% and spandex up 22%;

Labor costs have continued to increase in Asia. Tight employment conditions in China(unemployment official figures as of 1Q10 were at 4.2%, down from peak levels of 4.3% in '08 and'09) are continuing to push wage inflation in apparel manufacturing. Chinese apparel manufacturers aretrying to move up the value chain in their product focus and attempting to offset higher prices withshorter lead times and smaller order lots. Other lower cost markets are also experiencing pressure. InBangladesh, the lowest cost producer, the government decided to bring the minimum wage in theapparel manufacturing industry from $25/month to $44/month;

Chinese apparel manufacturers are experiencing high capacity utilization. This is coming fromhigher domestic market demand as we had picked up during our discussions with apparelmanufacturers in China in spring 2010 and rebounding export volumes. Apparel imports to the U.S.from the world for which we have data covering all of the 1H10 for total apparel have risen c.16%yoy vs. 1H09 in volume terms. The rebound was particularly strong in 2Q10, when cotton T-shirts andwoven shirts were up over 30% (vs. c.13% in 1Q10). Textile exports from China are strongly up, witha particularly sharp rebound in May and June, at c. +33%. Fabric exports are rising in the 40s, withclothing exports recovering in the high 20s. Knitted is growing much faster than woven apparel.
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Currencies have moved against apparel retailers, especially in Europe. Currencies have movedagainst apparel retailers, especially in Europe. When we look at yoy exchange rates of apparelmanufacturing countries to the EUR in 2Q and 3Q 2010 which should be relevant for the SS11season we see the USD appreciating +7.1% in 2Q10 yoy and +10.8% in 3Q10 to date yoy to the

EUR, with the CNY appreciating +7.2% and +11.6% and the TRY appreciating +9.1% and +9.4% vs.EUR. When we look at the UK, we see the USD appreciating +3.8% in 2Q10 yoy and +6.3% in 3Q10to date yoy to the GBP, with the CNY appreciating +3.8% and +7.1% and the TRY appreciating+5.8% and +5.0% vs. GBP.

We expect apparel retailers will adjust to higher sourcing prices increases in China by shifting their geographic sourcing mix. Nevertheless, mix shifts are likely to have practical limitations short-term,given the material share of Chinese apparel imports to both the EU and the USA.

China's share of European Union woven and knitted apparel imports has grown to 48% and 41% at the end of 2009, up from 39% and 29% respectively 4 years ago. In the USA, the Chinese share of total apparel imports in volume and value has grown to 38% and 35% at the end of 1H10, up from30% and 27.5% respectively in 1H08.

Besides, import statistics are also not likely to show meaningful geographic mix shifts for a few months - as we expect sourcing price increases are only going to hit starting with the SS11 deliveries.These should come into Europe and the USA in 4Q10 and 1Q11;

We anticipate apparel retailers will react with higher retail prices.

Analysis of retail price inflation in Europe suggests we are now back for a few months in a benigninflationary environment for retailers. In the UK, apparel retail price inflation has moved to the

positive in Apr-09, has stayed at around 3.0% in 1H10, and has recently moved to 3.5% in Jul-10 suggesting disciplined end-of-season SS10 clearance behavior and GM% defense on the back of guarded sourcing volumes. In Europe, we see that apparel retail price inflation has been close to flat in1H10 at c.-0.5% in Italy, for example +0.3%, in Germany +0.7%, in France +0.4%.

Apparel retailers have already guided that they are planning to raise prices in the face of higher sourcing costs and higher taxes down the road. Next, for example, has anticipated they would be planning to increase prices c.8% next year. This comes on the expectation that the consumer demandenvironment in the UK is likely to stay stagnant, and that price and margin sacrifices would not beconducive to volume gains on the back of consumer price elasticity. H&M also suggested they may belikely to raise prices although they could consider moderating price increases if faced with theopportunity to gain share.

We expect a more difficult sourcing environment will further accelerate a secular transition in European apparel retailing.

This trend is particularly obvious in the UK, where we have one of the most advanced apparel retailing environment. A new generation of value leaders pure discounters like Primark and grocery

retailers like Asda and Tesco are progressively squeezing the middle ground while the fashionintensive portion of the market is standing firm at 1/3 of the total, albeit with high churn amongwinners and losers. Traditional retail channels, general stores, and department stores encumberedwith low productivity, lower scale, higher costs and weaker consumer appeal are losing ground;

We expect value players will take the opportunity to increase their price leader advantage, to flex their sourcing muscle and to push the middle ground harder. This is likely to be more relevant in theUK short-term, where value leaders are already well developed, but should just further increase themedium-term opportunity for material apparel discount development in continental Europe (please see


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our reports UK Retail: Supermarkets and Non-Food - Part 1: The Rising Role of Supermarkets in UK Apparel Retailing and European Apparel: The Opportunity for Apparel Discounting in Europe, Part 2 , published on 04-Jun-10 and 15-Jul-10, respectively). The onus on middle ground players to shape-up becomes even more urgent. We would welcome a move by M&S to accelerate its direct sourcing and

supply chain rationalization plans in this context;We also expect that leading mass fashion retailers such as ITX and H&M should be advantaged in

this situation. Inditex is less exposed to Asia and is not experiencing sourcing price inflation in its proximity locations this should mute the effect of higher prices in Asia alone. Both Inditex and H&Menjoy significant scale both globally, with sourcing operations worldwide and within each sourcingmarket they should therefore be best equipped and most proactive in managing the adverse sourcingenvironment: (a) shifting their geo sourcing mix, (b) flexing their higher bargaining power

It is also clear that further continuing GM% gains as we have seen from mass fashion players are not on the cards going forward.

Both ITX and HMB have managed to increase their GM% substantially in the past 12 years,achieving 800bps and 1,082bps GM% expansion respectively. Higher GM% and lower tax rates have

been the two most important drivers of ROIC improvement, as we have shown in our report European Apparel Retailing: History and Opportunities for Capital Efficiency , published on 30-Nov-09. GM%gains have been achieved in a competitive retail environment where other players were obviouslyexperiencing the same favorable FX and sourcing trends hence also depend on company-specificactions. But there is no doubt that a falling USD and expanding sourcing base in China have helped themass fashion players and the industry;

We expect sourcing opportunities to continue to expand, as apparel manufacturing remains a low tech / low capex industry with very low barrier to entry. Having said that, the current juncture is likelyto bring GM% headwinds, as subdued demand trends in developed markets combine with risingdemand in EMs and higher manufacturing costs in China. SG&A cost control and space growth arelikely to stand up as the key earnings growth drivers going forward, with GM% expansion providing

neutral or negative contribution;We rate ITX, HMB and MKS Outperform with target prices of 60, SEK 275 and 410p, respectively. Werate NXT Market-perform with a target price of 2,300p.
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I n v e s t m e n t Co n c l u s i o n

European and American Apparel Retailers are bound to experience a more difficult sourcing environment inAsia going forward. Chinese apparel manufacturers are continuing to experience upward cost pressures, aswe had pointed out in our recent research (please refer to the report: European Apparel Retailers: SourcingCosts to Rise in 2011 , published on 22-Mar-10).Raw material prices and labor costs have continued to rise in China, cotton is now +25% up yoy;synthetic fibers are up +12% on average in '10 YTD; tight employment conditions are continuing to pushwage inflation in apparel manufacturing. Chinese apparel manufacturers are also experiencing high capacityutilization from higher domestic market demand and rebounding export volumes. In addition, key sourcingcurrencies (USD, CNY, TRY) have moved against the EUR and GBP (hence against European apparelretailers) in 2Q and 3Q10 to-date, i.e. the sourcing period for the SS11 season.

We expect apparel retailers will adjust to higher sourcing prices increases in China (a) by shifting their geographic sourcing mix (though this is likely to have practical limitations short-term, given the materialshare of Chinese apparel imports to both the EU and the USA) and (b) with higher retail prices.

We expect a more difficult sourcing environment will further accelerate a secular transition in Europeanapparel retailing. We expect value players will take the opportunity to increase their price-leader advantage,to flex their sourcing muscle and to push the middle grounder harder. This is likely to be more relevant inthe UK short-term, where value leaders e.g. pure discounters like Primark and grocery retailers like Asdaand Tesco are already well developed, but should just further increase the MT opportunity for materialapparel discount development in continental Europe.

The onus on UK middle ground players (e.g. Next and M&S) to shape-up becomes even more urgent. Wewould welcome a move by M&S to accelerate its direct sourcing and supply chain rationalization plans inthis context.

We expect that leading mass fashion retailers should be advantaged in this situation as both Inditex andH&M enjoy significant scale, globally (with sourcing operations worldwide) and within each sourcingmarket. They should therefore be best equipped and most proactive in managing the adverse sourcingenvironment. Nonetheless, GM% gains such as we have seen from mass fashion players in the last 12 years(+800bps at Inditex; +1,082bps at H&M) do not seem to be on the cards going forward.

We rate ITX, HMB and MKS Outperform with target prices of 60, SEK 275 and 410p, respectively. Werate NXT Market-perform with a target price of 2,300p.


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Deta i l s

European and American Apparel Retailers are bound to experience a more difficult sourcingenvironment in Asia going forward. Chinese apparel manufacturers are continuing to experience upwardcost pressures, as we had pointed out in our recent research (please refer to the report: European Apparel

Retailers: Sourcing Costs to Rise in 2011 , published on 22-Mar-10).Raw material prices have continued to rise in 2010 YTD in China, Cotton is now 25% up yoy andSynthetic fibers are 12% up on average. (a) Cotton prices in China are now at an all time high of 2.69$/kg. Heavy rains and floods in Pakistan have contributed to inflate prices, as production and transport werenegatively affected. In fact, the price of cotton in Pakistan has risen >60% in 2010 YTD. India's recentdecision to set an annual cap to its cotton exports is not helping either; (b) Wool prices in Australia are nowat 1,056 $ cents/kg (18.5 micron) and increase of c.20% from one year prior. (c) Synthetic fiber pricesgenerally have also been experiencing inflation in 2010 YTD, with viscose up 16% yoy, nylon down -3.7%,

polyester up 16% and spandex up 22% ( Exhibit 1 and Exhibit 27 to Exhibit 33 in the Appendix).

Exhibit 1Raw material prices have continued to rise in 2010 YTD

Raw Material Prices (USD) - Yoy Growth (%) 2007 2008 2009 2010 YTD

Cotton Spot Price in China 2.4% 6.5% (0.3)% 25.3%Cotton Spot Price in Pakistan 10.8% 8.0% (11.8)% 63.7%Wool Prices in Nanjing* 46.3% 5.8% (21.4)% (11.0)%Wool Prices in Australia (18.5 micron)* 19.9%

Synthetic Fibers: Nylon Filament Prices in China 8.9% 3.5% (20.7)% (3.7)%Spandex Prices in China 60.8% (30.7)% (11.2)% 21.6%Viscose Filament Prices in China 16.0% 3.8% (1.5)% 15.5%Polyester in China 8.3% (9.4)% (2.5)% 16.3%

Source: Emerging Textiles, Bernstein AnalysisNote (1): Yoy growth calculated by comparing the average price over the respective period.Note (2): 2010 YTD through 15-Sep-10 for all materials except Wool (through 15-Mar-10).Note (3): 2010 YTD wool prices in Australia reflect 1-year change as of 15-Sep-10.Note (4): 2-Month change for wool prices in Australia has been an increase of 9.71%.

Labor costs have continued to increase in Asia. Tight employment conditions in China (unemploymentofficial figures as of 1Q10 were at 4.2%, down from peak levels of 4.3% in '08 and '09) are continuing to

push wage inflation in apparel manufacturing ( Exhibit 2 to Exhibit 4 ). Chinese apparel manufacturers aretrying to move up the value chain in their product focus and attempting to offset higher prices with shorter lead times and smaller order lots. Other lower cost markets are also experiencing pressure. In Bangladesh,the lowest cost producer, the government decided to bring the minimum wage in the apparel manufacturing

industry from $25/month to $44/month ( Exhibit 5 ).


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Exhibit 2Chinese urban unemployment rates have declined frompeak levels in '08 and '09

Exhibit 3China's textile industry PPI has turned sharply upwards

3.8%

3.9%

4.0%

4.1%

4.2%

4.3%

4.4%

4.5%

1 Q 0 4

3 Q 0 4

1 Q 0 5

3 Q 0 5

1 Q 0 6

3 Q 0 6

1 Q 0 7

3 Q 0 7

1 Q 0 8

3 Q 0 8

1 Q 0 9

3 Q 0 9

1 Q 1 0

C h i n a ,

U n e m p

l o y m e n

t -

U r b a n

R a t e

( % )

China: PPI: Textile Industry

(4)%(3)%(2)%(1)%

0%1%2%3%4%5%6%7%8%9%

J a n - 0

7

M a r -

0 7

M a y - 0

7

J u

l - 0 7

S e p - 0

7

N o v - 0

7

J a n - 0

8

M a r -

0 8

M a y - 0

8

J u

l - 0 8

S e p - 0

8

N o v - 0

8

J a n - 0

9

M a r -

0 9

M a y - 0

9

J u

l - 0 9

S e p - 0

9

N o v - 0

9

J a n - 1

0

J a n - 1

0

M a r -

1 0

C h a n g e

Y o

Y -

%

Source: Haver, China National Bureau of Statistics, Bernstein Analysis Source: Haver, China National Bureau of Statistics, Bernstein Analysis

Exhibit 4Labor shortages in China have begun to push up wage costs for Chinese apparel manufacturers

" I get calls from factories every day but I can't find workers for them. Companies and governments need to find a way out. Highwages can only solve the problem in the short term".

- Zhang Quanshou , NPC deputy and chairmanof Shenzhen Quanshun Human Resource Co.

(per China Daily, "Workers Call the Shots", 11-Mar-10)

90%

75%

0%

10%20%

30%

40%

50%

60%

70%

80%

90%

100%

% Increased Salaries to Keep or Attract Staff

% Lowered Criteria for NewRecruits

%

o f P o l

l e d C o m p a n i e s

Source: China Daily, "Workers Call the Shots" (11-Mar-10), Bernstein AnalysisNote: Poll reflects responses of 300 companies and was conducted by Taihe Consulting Company.


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Exhibit 5Bangladesh raised the minimum wage in the apparel manufacturing industry from $25/month to $44/month in Jul-10

14

25

44

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

Pre-'06 2006 Jul-10

T e x

t i l e M i n i m u m

W a g e - B a n g

l a d e s

h ( $ / m o n t

h )

Local (Taka) 950 1662.5 3000

Source: BBC, Oanda, Wikipedia, Bernstein Analysis

Chinese apparel manufacturers are experiencing high capacity utilization. This is coming from higher domestic market demand as we had picked up during our discussions with apparel manufacturers in Chinain spring 2010 and rebounding export volumes. Apparel imports to the U.S. from the world for whichwe have data covering all of the 1H10 for total apparel have risen c.16% yoy vs. 1H09 in volume terms see Exhibit 6 . The rebound was particularly strong in 2Q10, when cotton T-shirts and woven shirts were upover 30% (vs. c.13% in 1Q10). Textile exports from China are strongly up, with a particularly sharprebound in May and June, at c. +33%. Fabric exports are rising in the 40s, with clothing exports recoveringin the high 20s. Knitted is growing much faster than woven apparel ( Exhibit 7 ).

Exhibit 6Apparel imports to the U.S. has risen strongly in 1H10,particularly in 2Q10

Exhibit 7Apparel imports into the U.S. from China have outpacedimports from the worldwide market in aggregate

From WorldUS Imports 2009 1Q10 2Q10 1H10

ValueApparel (11.8)% 2.4% 14.8% 8.4%

Cotton (11.0)% 1.9% 14.4% 8.0%Wool (25.6)% 0.3% 3.6% 2.2%

VolumeApparel (6.1)% 11.4% 19.5% 15.5%

Cotton (8.1)% 11.2% 17.2% 14.2%

Wool (15.6)% 10.5% 5.8% 7.6%

From ChinaUS Imports 2009 1Q10 2Q10 1H10

ValueTotal Apparel 2.5% 14.9% 18.6% 16.8%Men Cotton T-Shirts 68.6% 31.8% 63.3% 47.7%Women Cotton T-Shirts 87.0% 100.9 % 34.7% 61.3%

VolumeTotal Apparel 10.7% 29.1% 24.2% 26.4%Men Cotton T-Shirts 157.5% 31.7% 51.1% 42.7%Women Cotton T-Shirts 204 .2% 147.2 % 4 8.1% 80.3%

Source: Emerging Textiles, Bernstein Analysis Source: Emerging Textiles, Bernstein Analysis


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Currencies have moved against apparel retailers, especially in Europe. Currencies have moved againstapparel retailers, especially in Europe ( Exhibit 8 ). When we look at yoy exchange rates of apparelmanufacturing countries to the EUR in 2Q and 3Q 2010 which should be relevant for the SS11 season we see the USD appreciating +7.1% in 2Q10 yoy and +10.8% in 3Q10 to date yoy to the EUR, with the

CNY appreciating +7.2% and +11.6% and the TRY appreciating +9.1% and +9.4% vs. EUR. When welook at the UK, we see the USD appreciating +3.8% in 2Q10 yoy and +6.3% in 3Q10 to date yoy to theGBP, with the CNY appreciating +3.8% and +7.1% and the TRY appreciating +5.8% and +5.0% vs. GBP.

Exhibit 8Key sourcing currencies have appreciated vs. the EUR and vs. the GBP in 2Q and 3Q 2010, which should be relevantfor the SS11 season

Sourcing CCY vs. EUR Sourcing CCY vs. GBPUSDEUR CNYEUR TRYEUR USDGBP CNYGBP TRYGBP

2Q09 0.7347 0.1076 0.4678 0.6464 0.0946 0.41152Q10 0.7870 0.1153 0.5106 0.6707 0.0983 0.4353

3Q09* 0.7031 0.1029 0.4680 0.6081 0.0890 0.40483Q10* 0.7787 0.1148 0.5121 0.6466 0.0953 0.4252

2Q, yoy% +7.1% +7.2% +9.1% +3.8% +3.8% +5.8%3Q, yoy% +10.8% +11.6% +9.4% +6.3% +7.1% +5.0%

Source: Factset, Bernstein AnalysisNote: Calendar quarters; * 3Q to-date, from 01-Jul to 15-Sept

We expect apparel retailers will adjust to higher sourcing prices increases in China by shifting theirgeographic sourcing mix. Nevertheless, mix shifts are likely to have practical limitations short-term, giventhe material share of Chinese apparel imports to both the EU and the USA.

China's share of European Union woven and knitted apparel imports has grown to 48% and 41% atthe end of 2009, up from 39% and 29% respectively 4 years ago ( Exhibit 9 and Exhibit 10 ). In theUSA, the Chinese share of total apparel imports in volume and value has grown to 38% and 35% at the endof 1H10, up from 30% and 27.5% respectively in 1H08 ( Exhibit 11 and Exhibit 12 ).

Exhibit 9China has gained woven clothing import share (value)vs. EU27 countries

Exhibit 10A similar trend can be observed in the import of knittedclothing for the EU27

Woven Clothing

39% 40%

44%46%

48%

20%

25%

30%

35%

40%

45%

50%

2005 2006 2007 2008 2009

V a l u e

S h a r e - %

Knitted Clothing

29%27%

31%

39%41%

20%

25%

30%

35%

40%

45%

50%

2005 2006 2007 2008 2009

V a l u e

S h a r e - %



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Exhibit 11China's volume share of total apparel imports into theU.S. has increased >800bps since 1H08

Exhibit 12The trend in China's value share (of U.S. apparelimports) tells a similar story

30.0%

38.1%

0%

5%

10%

15%

20%

25%

30%

35%

40%

1H08 1H10

V o

l u m e

S h a r e

( % )

27.5%

35.1%

0%

5%

10%

15%

20%

25%

30%

35%

40%

1H08 1H10

V a l u e

S h a r e

( % )


Besides, import statistics are also not likely to show meaningful geographic mix shifts for a fewmonths - as we expect sourcing price increases are only going to hit starting with the SS11 deliveries.These should come into Europe and the USA in 4Q10 and 1Q11.

We anticipate apparel retailers will react with higher retail prices.

Analysis of retail price inflation in Europe suggests we are now back for a few months in a benigninflationary environment for retailers. In the UK, apparel retail price inflation has moved to the positivein Apr-09, has stayed at around 3.0% in 1H10, and has recently moved to 3.5% in Jul-10 suggestingdisciplined end-of-season SS10 clearance behavior and GM% defense on the back of guarded sourcing

volumes ( Exhibit 13 ). In Europe, we see that apparel retail price inflation has been close to flat in 1H10 atc.-0.5% in Italy, for example +0.3%, in Germany +0.7%, in France +0.4% ( Exhibit 14 to Exhibit 17 ).

Exhibit 13UK apparel retail price inflation turned positive in Apr-09 and has been c.3% in 1H10, suggesting disciplined end-of-season SS10 clearance behavior and GM% defense on the back of guarded sourcing volumes

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

1 8 - 0

7 - 1

0

2 3 - 0

5 - 1

0

2 9 - 0

3 - 1

0

3 1 - 0

1 - 1

0

0 6 - 1

2 - 0

9

1 1 - 1

0 - 0

9

1 6 - 8 - 0

9

2 1 - 6 - 0

9

2 6 - 4 - 0

9

1 - 3 - 0

9

4 - 1 - 0

9

0 9 - 1

1 - 0

8

1 4 - 9 - 0

8

2 0 - 7 - 0

8

2 5 - 5 - 0

8

3 0 - 3 - 0

8

3 - 2 - 0

8

9 - 1

2 - 0

7

1 4 - 1

0 - 0

7

1 9 - 0

8 - 0

7

2 4 - 0

6 - 0

7

2 9 - 0

4 - 0

7

5 - 0

3 - 0

7

7 - 0

1 - 0

7

1 2 - 1

1 - 0

6

1 7 - 0

9 - 0

6

G r o w

t h ( y o y ,

% )

Source: Kantar (f.k.a. TNS), Bernstein Analysis


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Exhibit 14EU27 Consumer Prices Clothing (Yoy growth, NSA)

Exhibit 15Italy Consumer Prices Clothing (Yoy growth, NSA)

(2.0)%

(1.5)%

(1.0)%

(0.5)%

0.0%

0.5%

1 Q 0 6

2 Q 0 6

3 Q 0 6

4 Q 0 6

1 Q 0 7

2 Q 0 7

3 Q 0 7

4 Q 0 7

1 Q 0 8

2 Q 0 8

3 Q 0 8

4 Q 0 8

1 Q 0 9

2 Q 0 9

3 Q 0 9

4 Q 0 9

1 Q 1 0

2 Q 1 0

E U 2 7 C l o t h i n g

P r i c e s -

Y o y

G r o w

t h ( % )

(2.5)%

(2.0)%

(1.5)%

(1.0)%

(0.5)%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1 Q 0 6

2 Q 0 6

3 Q 0 6

4 Q 0 6

1 Q 0 7

2 Q 0 7

3 Q 0 7

4 Q 0 7

1 Q 0 8

2 Q 0 8

3 Q 0 8

4 Q 0 8

1 Q 0 9

2 Q 0 9

3 Q 0 9

4 Q 0 9

1 Q 1 0

2 Q 1 0

I t a l y C l o t h i n g

P r i c e s - Y o y

G r o w

t h ( % )

Source: Eurostat, Haver, Bernstein AnalysisNote: Reflects 'Harmonized Index of Co nsumer Prices'

Source: Eurostat, Haver, Bernstein AnalysisNote: Reflects 'Harmonized Index of Consumer Prices'

Exhibit 16Germany Consumer Prices Clothing (Yoy growth, NSA)

Exhibit 17France Consumer Prices Clothing (Yoy growth, NSA)

(2.5)%

(2.0)%

(1.5)%

(1.0)%

(0.5)%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1 Q 0 6

2 Q 0 6

3 Q 0 6

4 Q 0 6

1 Q 0 7

2 Q 0 7

3 Q 0 7

4 Q 0 7

1 Q 0 8

2 Q 0 8

3 Q 0 8

4 Q 0 8

1 Q 0 9

2 Q 0 9

3 Q 0 9

4 Q 0 9

1 Q 1 0

2 Q 1 0

U K C l o t h i n g

P r i c e s -

Y o y

G r o w

t h ( % )

(2.5)%

(2.0)%

(1.5)%

(1.0)%

(0.5)%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1 Q 0 6

2 Q 0 6

3 Q 0 6

4 Q 0 6

1 Q 0 7

2 Q 0 7

3 Q 0 7

4 Q 0 7

1 Q 0 8

2 Q 0 8

3 Q 0 8

4 Q 0 8

1 Q 0 9

2 Q 0 9

3 Q 0 9

4 Q 0 9

1 Q 1 0

2 Q 1 0

U K C l o t h i n g

P r i c e s -

Y o y

G r o w

t h ( % )

Source: Eurostat, Haver, Bernstein AnalysisNote: Reflects 'Harmonized Index of Co nsumer Prices'

Source: Eurostat, Haver, Bernstein AnalysisNote: Reflects 'Harmonized Index of Consumer Prices'

Apparel retailers have already guided that they are planning to raise prices in the face of highersourcing costs and higher taxes down the road. Next, for example, has anticipated they would be

planning to increase prices c.8% next year. This comes on the expectation that the consumer demandenvironment in the UK is likely to stay stagnant, and that price and margin sacrifices would not beconducive to volume gains on the back of consumer price elasticity. H&M also suggested they may belikely to raise prices although they could consider moderating price increases if faced with the opportunityto gain share.


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We expect a more difficult sourcing environment will further accelerate a secular transition inEuropean apparel retailing.

This trend is particularly obvious in the UK, where we have one of the most advanced apparelretailing environment. A new generation of value leaders pure discounters like Primark and groceryretailers like Asda and Tesco are progressively squeezing the middle ground while the fashion intensive

portion of the market is standing firm at 1/3 of the total, albeit with high churn among winners and losers.Traditional retail channels, general stores, and department stores encumbered with low productivity,lower scale, higher costs and weaker consumer appeal are losing ground ( Exhibit 18 to Exhibit 20 ).

Exhibit 18The Quantitative and Qualitative Development of Value Apparel Retailers is Squeezing the Middle Ground TheChallenge for M&S and Next is to Retain Price Competitiveness and/or Improve Fashion Attractiveness

2001 2009

Value Leaders, 10.4%- Supermarkets

- Pure Discounters

Value Leaders, 20.8%

- Supermarkets- Pure Discounters

Tesco, Asda,Primark, etc.

Differentiated Players, 33.4%- Clothing Multpiles

- Footwear Multiples

Differentiated Players, 31.1%- Clothing Multpiles- Footwear Multiples

River Island,Top Shop, Monsoon,

H&M, Zara, etc.

Traditional Channels, 27.6%- Clothing & Footwear Independents

- Traditional mail order- Market Salls

Traditional Channels, 22.6%- Clothing & Footwear Independents

- Traditional mail order- Market Salls

Multi Category Stores, 10.1%- Department Stores

- General Stores

Multi Category Stores, 13.6%- - Department Stores

- General Stores

MassFashion

Marks & Spencer10.4%

ValueLeaders

MiddleGround

Next5.1%

Marks & Spencer11.1%

Next3.9%

Source: Bernstein Analysis


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Exhibit 19Within the UK, grocers have gained material share of theapparel market

Exhibit 20Leading specialist discounters such as Primark havealso experienced significant share increases

6.7% 6.7%

7.3%7.6%

8.0%

8.6% 8.8%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

2004 2005 2006 2007 2008 2009 2010e

G r o c e r -

U K C l o t h i n g

M a r

k e t S h a r e

2.3%

2.7%

3.2%

3.9%

4.4%4.8%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

2004 2005 2006 2007 2008 2009

P r i m a r

k -

U K C l o t h i n g

M a r

k e t S h a r e

Source: Verdict, Bernstein Analysis & Estimates Source: Verdict, Bernstein Analysis

We expect value players will take the opportunity to increase their price leader advantage, to flextheir sourcing muscle and to push the middle ground harder. This is likely to be more relevant in theUK short-term, where value leaders are already well developed, but should just further increase themedium-term opportunity for material apparel discount development in continental Europe (please see our reports UK Retail: Supermarkets and Non-Food - Part 1: The Rising Role of Supermarkets in UK Apparel

Retailing and European Apparel: The Opportunity for Apparel Discounting in Europe, Part 2 , published on04-Jun-10 and 15-Jul-10, respectively) see Exhibit 21 and Exhibit 22 . The onus on middle ground

players to shape-up becomes even more urgent. We would welcome a move by M&S to accelerate its directsourcing and supply chain rationalization plans in this context.
http://reports.bernsteinresearch.com/researchlinks/view.aspx?eid=Z%2bPI%2b7wW4%2fQcUo7Buz5xJk%2f5bJSD57S8fAlZJ54U6APmzEY8KEhAe00UIgdnCKqxhttp://reports.bernsteinresearch.com/researchlinks/view.aspx?eid=Z%2bPI%2b7wW4%2fQcUo7Buz5xJk%2f5bJSD57S8fAlZJ54U6APmzEY8KEhAe00UIgdnCKqxhttp://reports.bernsteinresearch.com/researchlinks/view.aspx?eid=G2GHyHvq7i%2b%2b5L6sVRTixGl8rXekNkVrO%2bkuiQHbH8S4YcuS9uu%2bTYBFjUrW8jr7http://reports.bernsteinresearch.com/researchlinks/view.aspx?eid=G2GHyHvq7i%2b%2b5L6sVRTixGl8rXekNkVrO%2bkuiQHbH8S4YcuS9uu%2bTYBFjUrW8jr7http://reports.bernsteinresearch.com/researchlinks/view.aspx?eid=Z%2bPI%2b7wW4%2fQcUo7Buz5xJk%2f5bJSD57S8fAlZJ54U6APmzEY8KEhAe00UIgdnCKqxhttp://reports.bernsteinresearch.com/researchlinks/view.aspx?eid=Z%2bPI%2b7wW4%2fQcUo7Buz5xJk%2f5bJSD57S8fAlZJ54U6APmzEY8KEhAe00UIgdnCKqx


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Exhibit 21The UK seems most penetrated by discount players vs.other key European markets

Exhibit 22Using discount penetration in UK A&F as a guide, weestimate the blank opportunity could be c.10bn

23%

21%

18%

12%

8%

0%

5%

10%

15%

20%

25%

UK France Germany Spain Italy

E u r o p e a n

D i s c o u n

t A p p a r e l

M a r k e t

276

218

48

10

0

50

100

150

200

250

300

Total A&F Split

E U A & F M a r

k e t V a l u e

( ' 0 9 , b n

)

Non-Discount(80% )

Discount(21%) Current

Add'lImmed.Opport.

Source: Verdict, Company Reports, Bernstein AnalysisNote: Verdict aggregates some smaller brands which may not be co nsideredpure discounters.

Source: CIA World Factbook, Verdict, Bernstein Analysis & Estimates

We also expect that leading mass fashion retailers such as ITX and H&M should be advantaged inthis situation. Inditex is less exposed to Asia and is not experiencing sourcing price inflation in its

proximity locations - this should mute the effect of higher prices in Asia alone. Both Inditex and H&Menjoy significant scale - both globally, with sourcing operations worldwide and within each sourcing market

they should therefore be best equipped and most proactive in managing the adverse sourcingenvironment: (a) shifting their geo sourcing mix, (b) flexing their higher bargaining power.

It is also clear that further continuing GM% gains as we have seen from mass fashion players are noton the cards going forward.

Both ITX and HMB have managed to increase their GM% substantially in the past 12 years,achieving 830bps and 1,082bps GM% expansion respectively ( Exhibit 23 and Exhibit 24 ). Higher GM%and lower tax rates have been the two most important drivers of ROIC improvement, as we have shown inour report European Apparel Retailing: History and Opportunities for Capital Efficiency , published on 30-

Nov-09. GM% gains have been achieved in a competitive retail environment where other players wereobviously experiencing the same favorable FX and sourcing trends hence also depend on company-specific actions. But there is no doubt that a falling USD and expanding sourcing base in China have helpedthe mass fashion players and the industry.
http://reports.bernsteinresearch.com/researchlinks/view.aspx?eid=S5MFBjIx1pWR6lFUDIOfIlC6aZCLqp%2b93eyqGv6sFYhwYrvAMBdTCO8Bz6hCBqFChttp://reports.bernsteinresearch.com/researchlinks/view.aspx?eid=S5MFBjIx1pWR6lFUDIOfIlC6aZCLqp%2b93eyqGv6sFYhwYrvAMBdTCO8Bz6hCBqFC


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Exhibit 23Inditex has increased its GM% by >800bps since '97

Exhibit 24H&M has experienced an even greater GM% boost atc.1,080bps

Inditex

49%

50%

51% 51%52% 52%

50%

54%

56% 56%57% 57% 57%

44%

46%

48%

50%

52%

54%

56%

58%

60%

62%

64%

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

G r o s s

M a r g

i n ( % )

+830 bps('97 to '09)

H&M

51% 51%

53%

51%52%

55%56%

57%

59% 59%

61%62% 62%

44%

46%

48%

50%

52%

54%

56%

58%

60%

62%

64%

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

G r o s s

M a r g

i n ( % )

+1,082 bps ('97to '09)

Source: Company Reports, Bernstein Analysis Source: Company Reports, Bernstein Analysis

We expect sourcing opportunities to continue to expand, as apparel manufacturing remains a lowtech / low capex industry with very low barrier to entry. Having said that, the current juncture is likelyto bring GM% headwinds, as subdued demand trends in developed markets combine with rising demand inEMs and higher manufacturing costs in China. SG&A cost control and space growth are likely to stand upas the key earnings growth drivers going forward, with GM% expansion providing neutral or negative

contribution, unlike in the '01-'09 period ( Exhibit 25 and Exhibit 26 ).

Exhibit 25Inditex: Drivers of net earnings growth, '09 vs. '01, m

Exhibit 26H&M: Drivers of net earnings growth, '09 vs. '01, m

7%

-36%35%

75%

19%

0200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2 0 0 1

E a r n

i n g s

L F L G r o w

t h

S p a c e

G r o w

t h

G r o s s

M a r g

i n

O p e r a

t i n g

E x p e n s e s

O t h e r

2 0 0 9

E a r n

i n g s

M i l l i o n

3%-2%

-20%46%

75%

-1%

02,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

2 0 0 1

E a r n

i n g s

L F L G r o w

t h

S p a c e

G r o w

t h

G r o s s

M a r g

i n

O p e r a

t i n g

E x p e n s e s

I n t e r e s

t

T a x

2 0 0 9

E a r n

i n g s

S E K M i l l i o n

Source: Company Reports, Bernstein Analysis Source: Company Reports, Bernstein Analysis


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Exhibit 31Spandex Prices in China US$/Kilo

Exhibit 32Viscose Filament Prices in China US$/Kilo

2.5

3.5

4.5

5.5

6.5

7.5

8.5

9.5

10.5

11.5

12.5

J a n - 0

6

A p r -

0 6

J u

l - 0 6

O c

t - 0 6

J a n - 0

7

A p r -

0 7

J u

l - 0 7

O c

t - 0 7

J a n - 0

8

A p r -

0 8

J u

l - 0 8

O c

t - 0 8

J a n - 0

9

A p r -

0 9

J u

l - 0 9

O c

t - 0 9

J a n - 1

0

A p r -

1 0

J u

l - 1 0

S p a n

d e x

P r i c e s

i n C h i n a ,

U S $ / k g

3.5

3.7

3.9

4.1

4.3

4.5

4.7

4.9

5.1

5.3

5.5

A p r -

0 6

J u

l - 0 6

O c

t - 0 6

J a n - 0

7

A p r -

0 7

J u

l - 0 7

O c

t - 0 7

J a n - 0

8

A p r -

0 8

J u

l - 0 8

O c

t - 0 8

J a n - 0

9

A p r -

0 9

J u

l - 0 9

O c

t - 0 9

J a n - 1

0

A p r -

1 0

J u

l - 1 0

V i s c o s e

F i l a m e n

t P r i c e s

i n C h i n a ,

U S $ / k g


Exhibit 33Polyester Prices in China US$/Kilo

0.5

0.75

1

1.25

1.5

1.75

2

J a n - 0

6

A p r -

0 6

J u

l - 0 6

O c

t - 0 6

J a n - 0

7

A p r -

0 7

J u

l - 0 7

O c

t - 0 7

J a n - 0

8

A p r -

0 8

J u

l - 0 8

O c

t - 0 8

J a n - 0

9

A p r -

0 9

J u

l - 0 9

O c

t - 0 9

J a n - 1

0

A p r -

1 0

J u

l - 1 0

P o

l y e s t e r

P r i c e s

i n C h i n a

( P S F 1 . 4 D / 3 8 m m

)

U S D $ / k g

Source: Emerging Textiles, Bernstein Analysis


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Disclosure Appendix

Valua t ion Methodology

We establish price targets for companies in our coverage by applying a target relative P/FE multiple (vs.MSCI index) to our forecast estimates, assuming a constant market P/FE multiple. We use 10E and 11EEPS estimates and MSCI P/FE multiples.

We rate Inditex outperform we use a relative target multiple of 1.75x and obtain a target price of 60. Werate H&M outperform and use a relative target multiple of 1.75x vs. MSCI and thus obtain our price targetof SEK 275.

We rate M&S outperform with a price target of 410p by using a target relative price earnings multiple of 1.1x. We rate Next market-perform and target a relative market multiple of 1.0x, yielding a TP of 2,300p.

Risks

Inditex

A risk to our Inditex price target could come from a subdued consumer and demand environment. Slower demand would reflect in weaker like-for-like growth. This, in turn, would negatively affect both theopportunity to contain SG&A cost development further and achieve gross-margin expansion. Such adevelopment would be even more negative, were it to appear in Inditexs domestic market, where Inditexremains largely exposed with 32% of sales. While the Spanish macro has deteriorated, we see that weaknessin Spain seems to be priced in at this point, at least judging from our long-term LFL growth to relative PEFregressions.

Continuing wide front international expansion at Inditex deviating from an expansion focus intoEurope (the new domestic market for Inditex) and selected Asian markets would increase SG&A costinflation pressure as well as the risk on our outperform stance. Transition in senior management roles seemsnow successful and established, reducing organization risk. Continuing broad market or sector-specific

corrections could pose additional risk on the high Inditex multiple implied in our target price, especially inthe face of further bad news in the financial services sector.

H&M

We see downside risks to our current investment stance. Weak LFL development could put a strain onSG&A, which has traditionally been managed with high discipline. H&M has increased the fashion contentand the "intangible" value of its collections; this entails a higher fashion risk, in our opinion: a collectionmiss from low customer appeal of celebrity designers could increase mark-downs, weighing on LFLdevelopment and gross margin. The comparables to the Madonna collection in 1H08 seem particularlysteep. To this, one should add execution glitches and teething problems of the new COS format, which isnow seemingly credited to succeed by the market, but remains very small in absolute terms.


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M&S

We would see downward risk to our recommendation in case LFL growth remains subdued or in negativeterritory. The shape of UK consumer demand in 10e will be of the essence, as we have shown that apparelretailers' relative share price performance tends to be aligned to LFL growth. If the new CEO settles on a

plan with too much emphasis on growth and capex after his strategy review, this would also be regarded asa negative.

Next

From a more secular viewpoint, investing in Next requires a positive view on its ability to increaseconsumers' perceived value, as Next tries to trade up and defend margins. This is a sensible strategic goal,considering the incessant growth of value retailers like Tesco, Asda, and Primark. Customer appreciation of the new collections is only beginning to emerge. While early signs indicate consumer willingness to "tradeup" and buy into new, higher priced Next products, the Signature collection remains a small portion of totalsales (c.3-4%) and does not seem enough to offset for Next the broader, contingent slow-down in UK apparel demand. Continuing lackluster top line progress could hamper Nexts ability to meet revenue andmargin expectations, forcing it to cut prices (and margins) to stem market share decline down the road.


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SRO REQUIRED DISCLOSURES

References to "Bernstein" relate to Sanford C. Bernstein & Co., LLC, Sanford C. Bernstein Limited, and Sanford C. Bernstein, a unit ofAllianceBernstein Hong Kong 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, generatinginvestment banking revenues.

Bernstein rates stocks based on forecasts of relative performance for the next 6-12 months versus the S&P 500 for stocks listed on theU.S. and Canadian exchanges, versus the MSCI Pan Europe Index for stocks listed on the European exchanges (except for Russiancompanies), versus the MSCI Emerging Markets Index for Russian companies and stocks listed on emerging markets exchanges outsideof the Asia Pacific region, and versus the MSCI Asia Pacific ex-Japan Index for stocks listed on the Asian (ex-Japan) exchanges - unlessotherwise 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.

Not Rated: The stock Rating, Target Price and estimates (if any) have been suspended temporarily.

As of 09/15/2010, Bernstein's ratings were distributed as follows: Outperform - 44.7% (1.7% banking clients) ; Market-Perform - 48.5%(1.0% banking clients); Underperform - 6.8% (0.0% banking clients); Not Rated - 0.0% (0.0% banking clients). The numbers in parenthesesrepresent the percentage of companies in each category to whom Bernstein provided investment banking services within the last twelve(12) months.

Accounts over which Bernstein and/or their affiliates exercise investment discretion own more than 1% of the outstanding common stock ofthe following companies MKS.LN / Marks & Spencer Group PLC.

An affiliate of Bernstein received compensation for non-investment banking-securities related services from the following companiesMKS.LN / Marks & Spencer Group PLC.

In the next three (3) months, Bernstein or an affiliate expects to receive or intends to seek compensation for investment banking servicesfrom ITX.SM / Inditex SA, HMB.SS / Hennes & Mauritz AB, MKS.LN / Marks & Spencer Group PLC, NXT.LN / Next PLC.

12-Month Rating History as of 09/16/2010

Ticker Rating ChangesHMB.SS O (RC) 06/23/10 M (RC) 01/29/07ITX.SM O (RC) 03/26/07MKS.LN O (RC) 05/19/10 M (RC) 10/16/09 O (RC) 09/03/09NXT.LN M (IC) 05/26/06

Rating Guide: O - Outperform, M - Market-Perform, U - Underperform, N - Not RatedRating Actions: IC - Initiated Coverage, DC - Dropped Coverage, RC - Rating Change


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OTHER DISCLOSURESA price movement of a security which may be temporary will not necessarily trigger a recommendation change. Bernstein will advise as andwhen coverage of securities commences and ceases. Bernstein has no policy or standard as to the frequency of any updates or changes to itscoverage policies. Although the definition and application of these methods are based on generally accepted industry practices and models,please note that there is a range of reasonable variations within these models. The application of models typically depends on forecasts of arange of economic variables, which may include, but not limited to, interest rates, exchange rates, earnings, cash flows and risk factors that aresubject to uncertainty and also may change over t ime. Any valuation is dependent upon the subjective opinion of the analysts carrying out this

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CERTIFICATIONS

I/(we), Luca Solca, Senior Analyst(s), certify that all of the views expressed in this publication accurately reflect my/(our) personal viewsabout 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 publication.

Approved By: NK

Copyright 2010, Sanford C. Bernstein & Co., LLC, Sanford C. Bernstein Limited, and AllianceBernstein Hong Kong Limited, subsidiaries of AllianceBernstein L.P. ~ 1345 Avenue of theAmericas ~ NY, NY 10105 ~ 212/756-4400. All rights reserved.

his publication 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,vailability or use would be contrary to law or regulation or which would subject Bernstein or any of their subsidiaries or affiliates to any registration or licensing requirement within such jurisdiction. This publication is based uponublic sources we believe to be reliable, but no representation is made by us that the publication is accurate or complete. We do not undertake to advise you of any change in the reported information or in the opinions herein.his publication was prepared and issued by Bernstein for distribution to eligible counterparties or professional clients. This publication is not an offer to buy or sell any security, and it does not constitute investment, legal or taxdvice. 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 vestments 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

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