INDITEX: Financial Annual Report Examination

Introduction

Inditex is among the world's largest fashion retailers consisting of eight brands (Zara, Massimo Dutti, Pull&Bear, Bershika, Stradivarius, Oysho, Uterque, and Zara Home). The company and the brand sell in 202 markets via its online platform and consists of over 7,000 stores located in 96 markets (Inditex, 2017). The company was started in 1963 as a small family business that was making women's clothing. It has, however, grown over the years, with the customer being at the center of everything that they engage in. The company has grown as a single company and explored the global market by incorporating the vital elements of fashion production that include the produce design, manufacture, distribution, and retail that brought their customers closer to the products that they required at friendly prices. This report provides an examination of Inditex annual financial report by analyzing various aspects of the company. Some of the aspects under consideration include the key sources of finance, analysis of its risky levels, the key elements of working capital and the associated strengths and weaknesses of the company, the risks that it is exposed to and an evaluation of the success of corporate restructuring activities that it has undertaken over time.

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The major sources of finance for Inditex include debt and equity (Kieschnick, Laplante & Moussawi, 2013). According to the Inditex annual report (2017), the company consists of a shareholding structure that is made up of four types of shareholders, i.e., institutional investors, Pontegadea Inversiones SL, Partler 2006 SL, and Individuals, all of whom contribute to a total of 3,116,652 000 shares. As of 31 January 2018, Inditex's share capital amounted to EUR 93,499,560.00. The shares are of the same class and all of them carry the same voting and economic rights. As of 31 January 2018, the company's share price was trading at EUR28.87 per share. From the company's annual financial report 2017, it is evident that Inditex obtains its funding from both debt and equity contributions.

As at 31st January 2018, Inditex had an equity contribution of EUR 13,522 million and a debt contribution of EUR 6,709m. Concerning gearing as a measure of the risky levels of the company, we get:

Net gearing ratio=Total debt

Total shareholders equity

Net gearing ratio=EUR 6,709m

EUR 13,522

m=0.4962=0.496*100%=49.62%

According to Omar, Koya, Sanusi & Shafie (2014), an optimal gearing ratio would be primarily determined by the individual company in comparison to other companies within the same industry. However, the basic guidelines for a good or bad gearing ratio indicate that a gearing ratio higher than 50% is considered highly levered or geared, hence the company is at a greater financial risk; a gearing ratio lower than 25% would be considered low-risk and a ratio between 25% and 50% is considered an optimal or normal risky level for well-established companies.

In this case, Inditex, with a gearing ratio of 49.62% is considered a normal-risk investment by both investors and lenders. Therefore, in times of a recession, low profits and higher interest rates, the company would be less susceptible to bankruptcy and loan defaults. The gearing ratio represents the financial risk levels of the company, i.e., a company with too much debt is highly likely to fall into financial distress as opposed to a low one. Capital obtained from creditors is riskier compared to money obtained from the company's owners since the creditors will have to be paid back regardless of the performance of the company (Omar, Koya, Sanusi & Shafie, 2014). Both lenders and investors analyze a company's gearing ratio since it reflects the levels of risk involved with investing or loaning the company. A company with too much debt levels is likely to default in the event of a variation in the prevailing interest rates on loans or a sudden jump in rates. Inditex has relatively lower debt levels (EUR 6,709m) compared to equity (EUR 13,522) hence is likely to attract lenders and investors.

Working capital refers to the difference between current assets and current liabilities (Sagner, 2010). The major components of the current assets in Inditex include cash and cash equivalents, receivables (Trade and income tax) and inventory, while a major component of the current liabilities includes payables (Income tax payables and trade and other payables).

Cash Management

Cash is one of the vital components of current assets. It is needed to perform basic activities within the firm that range from acquiring raw materials to the marketing of finished goods (Singh, 2008). Inditex is showing strength in cash management. This is observed from the increase in cash and cash equivalents from EUR 4,116m in FY 2017 to EUR 4,931m in FY 2018 indicating an increase in money held inform of cash for daily business operations.

Receivables Management

This refers to any claim for money that is owed to the firm from customers that may arise from the sale of goods or services in the normal course of business. Inditex receivables (trade and income tax receivables) as at 31st January 2018, stand at EUR 888m. However, this was a decrease from the previous year, where is stood at EUR 968m. Therefore, Inditex has a weakness in receivables management and this can be attributed to higher delinquency costs or formulation of poor credit policies among others.

Inventory Management

Inventory forms a vital part of the total working capital. A firm should aim at holding inventory for purposes of transactional, speculative and precautionary motives (Sagner, 2010). Inditex has strength in inventory management. According to the Inditex annual report 2017, the company recorded an increase in inventory from EUR 2,549 in FY 2016 to EUR 2,685 in FY 2017. From the above, strengths include cash and inventory management (result in an increase in current assets hence increase the company's profitability) while weaknesses include receivables management (results in a decrease in current assets and hence reduce the company's profitability).

Accounts Payable Management

Payables or creditors are a vital component of the working capital of a company. They provide an unplanned source of financing the working capital. Effective payable management enhances the company's reputation and results in a steady supply of materials. It is a cheaper source of finance since it doesn't attract interest (Kieschnick, Laplante & Moussawi, 2013). The major payables for Inditex include income tax payable and trade and other payables. Inditex has strength in inventory management as indicated by its reduction in trade and income tax payables from EUR 5,325m in FY 2017 to EUR 5,027m in FY 2018. Moreover, the level of inventory is not excessively high to represent wasteful or too low to put the company at the danger of losing out on sales.

Inditex views risks as any potential event that may result in a negative impact on the attainment of the company's objectives or on the daily business operations. The risks associated with the company can be grouped into the following categories:

Business environment risks: These refer to risks that stem from the external factors that relate to the group's business. The category involves risks that relate to difficulties in adjusting to the market in which the group operates in with regards to processes of procurement, distribution, and sales. The geopolitical, social, demographic and economic changes in the various countries may have an impact on the effective achievement of the business goals (Scott, 2004).

Regulatory risks arise when the group is exposed to the various laws and regulations that are inforce in the various countries where it operates. These risks include tax, employment, customs, industrial, trade and consumption and intellectual property regulations.

Reputation risks include those that have a direct impact on how the company is thought of by its stakeholders who include customers, shareholders, employees, and suppliers. The risks arise from inappropriate management of issues that relate to social responsibility and sustainability with reference to their products' safety, corporate image and social networks among others (Murray, 2004).

Foreign exchange rate risk arises due to the global operation of the Group in countries outside the EU (Brown, 2001). The various currencies used include the Russian ruble, US dollar, Mexican peso, Chinese renminbi, Japanese yen, and Sterling pound among others. A depreciation of the company's non-Euro currencies led to a negative impact on the company's growth rate in net sales.

However, Inditex has been effective in managing the associated risks over time. The Group constantly carries out feasibility research for each new market or business store with the aim of highlighting any pessimistic scenarios to reduce the risks associated with the business environment. To control the regulatory risks, the company established the Model of Compliance System overseen by the General Counsel's Office (Sparrow, 2011). Reputation risks have been controlled by implementation of a Compliance Programme in line with the Code of Conduct for Manufactures and Suppliers via Pre-assessment and social audits. The foreign exchange risks are managed by established financial or natural hedging systems and constant monitoring of the fluctuations of the foreign exchange inflation rates. The company is successful in managing the risks since they are experienced in the new markets and felt by the company. This can be seen by the manner in which Inditex has been effectively been acquiring new markets over the years, i.e., Miami, Lima and San Francisco in FY 2017 and increasing its net sales progressively since FY 2014 ('Inditex annual report,' 2017).

Inditex has engaged in various corporate restructuring activities in recent years. In 2014, the company went into a partnership with Tmall with the aim of reaching more Chinese shoppers (Morris, 2014). This partnership was aimed at strengthening its position in the country that was already the second biggest by store numbers. The partnership was a success as it joined other brands such as Burberry, Gap and Calvin Klein on the Tmall platform. The online store provided the first point of sale for Uterque in the country, following on the footsteps of Zara, Massimo Dutti, Zara Home, Pull and Bear, Bershka, Oysho and Stradivarius (Morris, 2014).

The company continued with its supply system while following along the paths of other heavy weights in the fashion industry such as Chanel and LVMH by adding its suppliers to its collection of investments (Rodriguez, 2017). It successfully acquired its largest textile supplier and is already in charge of all the capital requirements of its largest supplier (Indipunt SL). The company is based in Arteixo with Inditex as its sole shareholder.

Inditex has also engaged in various divestment deals. In 2017, the company selected German fund Deka Immobilien to sell a portfolio of 16 stores that were put on sale for approximately EUR 400 million (Venkatesh, 2017). The operation, which was led by Savillis-Aguirre Newman, marked a milestone in Inditex's history. With the divestment strategy, the company would be able to sell small historic stores and continue to focus on its operations in the flagship stores, as it has always done in the past. Approximately 80% of the portfolio in the divestment strategy corresponded to the centers in Madrid, Barcelona, and Lisboa, while the rest of the stores were located in Cordoba, Valencia, Seville, Palma de Mallorca, Zamora, and Ciudad Real among others.

Inditex opened a five-storied high-street store as an expansion strategy to Mumbai, using the flagship brand, Zara (Venkatesh, 2017). The company also launched its online store...