By Sonya Dowsett
LA CORUNA, Spain (Reuters) - Inditex, the world's biggest clothing retailer, missed full-year earnings expectations on Wednesday, held back by flat margins and a stronger euro, which curbed sales growth at Zara and its other brands.
The Spanish group said sales rose 7 percent in the first five weeks of the new financial year as shoppers bought items from the spring/summer collections like belted linen blazers and floral A-line dresses from Zara.
But with gross margins set to remain stable this year, investors worried that the group's growth is now slowing after it closed smaller stores at a much faster than expected pace last year to focus on bigger stores and online sales.
Shares in Inditex tumbled more than 5 percent after the results and were down 3.7 percent at 25.31 euros by 1131 GMT.
"Whilst most retailers would be very pleased to report 7 percent sales growth (at constant currency rates last year), this is less than half the rate of growth reported by Inditex just a couple of years ago and we believe it is evidence that the group's growth profile is slowing sharply," Morgan Stanley said in a note.
Inditex's shares trade at 23 times full-year earnings, compared to 18 times earnings for shares of Swedish rival H&M, whose profits have also disappointed in the face of tough competition.
Inditex says it does not discount out of season unlike rivals like H&M and Gap who marked down prices in the run-up to Christmas to clear inventory. However, this makes it harder for Inditex chains like Zara and Pull & Bear to compete in a depressed clothing sector where year-round discounts have become the norm.
The cash-rich group, controlled by founder Amancio Ortega, announced a 17 percent increase in its dividend, although that was overshadowed by its disappointing earnings.
Last year, the group, which also owns upmarket chain Massimo Dutti and underwear store Oysho, had said it planned to open 300 to 400 stores in the 2018 financial year and close 200, but it ended up opening 370 and closing 355, almost double its initial plan.
"This process of adjusting their store estate is surprising investors and happening faster than people expected," said Alistair Wittet, European equities portfolio manager at Comgest, which holds 11.19 million shares in Inditex and is the 13th biggest investor according to Refinitiv data.
"That naturally weighs somewhat on sales growth in the short term, but I think is the right strategy long term," he added.
A stronger euro dragged on profits for the year ended Jan. 31 as the group generates more than half of its sales in other currencies and then books those sales in euros when reporting results.
Gross margin was 56.7 percent for the year, compared to 56.3 percent in the previous year. Chief Executive Officer Pablo Isla said the company had achieved healthy margins despite the negative currency impact and said he expected stable margins in 2019.
Inditex reported profits of 3.44 billion euros (2.9 billion pounds) for the year ended Jan. 31, up 2 percent on the previous year, on sales of 26.15 billion euros. That missed a consensus estimate for net profit of 3.49 billion euros and sales of 26.45 billion euros, Refinitiv I/B/E/S data shows.
Fourth quarter operating profit of 1.29 billion euros was a 3 percent miss on its expectations, said investment bank UBS.
The retailer said its overall online sales grew by more than a quarter in the year ended Jan. 31 to generate 12 percent of total sales.
That is slightly below competitors like H&M, where online sales are 14.5 percent of total, and lags average online penetration rates in developed countries like the United States, for example, where online sales make up 27 percent of total apparel sales.
Inditex estimated total like-for-like sales would grow by 4 percent to 6 percent in the current financial year, ending Jan. 31, 2020, after rising 4 percent in the financial year just ended.
Inditex's proposed 17 percent increase in its total dividend to 0.88 euros for the year that ended means it is paying out 80 percent of its earnings, versus 69 percent last year, said Anne Critchlow, an analyst at Societe Generale.
"That's a big step-up in payout ratio," she said. Inditex had a large net cash position of 6.7 billion euros as at Jan. 19.
(Reporting By Sonya Dowsett; Additional reporting by Helen Reid in London; Editing by Paul Day and Susan Fenton)