UPDATE 4-H&M cost control cushions fall in profits

Thu Sep 29, 2011 11:39am EDT

* Pretax down 15 pct to 4.9 bln SEK vs consensus 4.7 bln

* Gross margin 58.6 pct vs consensus 58.1 pct

* Inventories higher than expected, Sept trading held back

* Shares up 6 pct on smaller markdowns than feared (Adds analyst, company comment, updates shares)

By Anna Ringstrom and Veronica Ek

STOCKHOLM, Sept 29 (Reuters) - Hennes & Mauritz (HMb.ST) accelerated its expansion plan and said it was gaining market share as it delivered a fall in third-quarter profits that was smaller than feared.

The world's no.2 fashion retailer suffered a 15 percent drop in third-quarter profit, hit by costs such as higher cotton prices. It said sales so far in the fourth quarter were below its expectations and markets remained challenging.

At 1410 GMT, H&M shares were up 6.1 percent at 208 crowns, outperforming the STOXX Europe 600 retail index after having lost 24 percent in the last 12 months.

H&M, with more than 2,300 stores in 41 countries, made a pretax profit of 4.9 billion crowns ($716 million) from June through August, beating a Reuters poll forecast of 4.7 billion.

The impact on margins of higher markdowns to shift stock was less than expected. The gross margin shrank to 58.6 percent from 60.5 percent.

The Swedish group said its strategy of absorbing higher costs helped it to win market share.

"H&M continues to gain market share in a challenging environment," Chief Executive Karl-Johan Persson said. "We see it as a proof that customers appreciate our work on the customer offering."

The budget retailer, which will launch a collection by Italian designer Donatella Versace in November, also raised its target for store openings this year to 265 from 250.

"This was going to be the most challenging quarter, so I think they've done a good job," said SG Securities analyst Anne Critchlow.

MARGIN RECOVERY SEEN, DEMAND UNCERTAIN

The pressure on input costs seen over the past year is easing but retailers in Europe, where H&M has most of its business, face slackening demand amid austerity measures and an increasingly gloomy economic outlook.

H&M said end-August stocks were higher than planned and September sales undershot expectations, raising concerns that big markdowns will dent margin recovery in coming months.

Sales were up 3 percent in local currencies Sept. 1-27. Analysts said that equated to a decline of 5-6 percent in same-store sales, following a flat performance in August.

"Sales in October and November will be decisive for the markdown level in the fourth quarter," H&M cautioned.

Persson told Reuters September sales were hit by weak consumer confidence in Europe as well as warm weather. "It's difficult to see what is what," Persson said. "September, I think, is most related to weather."

Inditex , the world no.1 apparel retailer, has said its sales growth had slowed since end-July.

"There is a clear risk that (H&M's) 4Q markdown will be higher than expected," Liberum analysts said.

ABG Sundal Collier analysts, with a "buy" rating on the shares, said the gross margin trend was overall less of a worry than turnover. "H&M has better than expected cost control. The sales trend however, continues to be more uncertain."

After four quarters of profit falls, analysts see H&M starting to recover from the fourth quarter. Persson told a news conference the outlook on costs and currency moves was brighter, though the effect from cotton prices would still be negative in the fourth quarter.

Shares in H&M, which sells some 85 percent of its collections ranging from catwalk trendy to tailored classics in Europe, have lost a quarter of their value since last year's record high, when concerns first arose about its margin.

But the stock -- like that of "cheap chic" rival Inditex -- trades at a much higher multiple of forecast earnings than those of rival clothing retailers like Gap and Next , due in part to historically stronger profit growth.

"Without gross margin gains or meaningful like-for-like growth, this is a business growing at nearer 10 percent than 20 percent," Liberum analysts said.

H&M postponed the launch of its U.S. online business to autumn 2012 from spring. Persson said there would be no online launches next year besides that one. Inditex's flagship Zara brand recently went online in the United States. ($1 = 6.775 Swedish Crowns) (Additional reporting by Mark Potter in London; Editing by Hans-Juergen Peters and Elaine Hardcastle)

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