Everyone loves Esprit, well almost

PUBLISHED : Friday, 25 February, 2005, 12:00am
UPDATED : Friday, 25 February, 2005, 12:00am

Yesterday's 17.55 per cent run-up in the shares of clothes-seller Esprit Holdings underlines just how much the market loves this stock.

Even though the company has turned in earnings surprises on a regular basis over the past few years, Wednesday's announcement of 76.2 per cent interim profit growth in the second half of last year still managed to stun.

At double the expected profit growth, the magnitude of the increase caught the market wrong-footed. In response, analysts scurried to revise their forecasts upwards and investors rushed to buy the shares, driving the stock to a record closing price of $55.25.

Amid the general euphoria, however, a few professional portfolio managers were quietly selling. For some long-time owners of the stock, yesterday's rally carried the share price beyond a reasonable valuation and into the territory of unrealistic hype. For them, the buying frenzy was a welcome opportunity to scale back their holdings and book their returns from a stock that has risen almost fivefold over the past 30 months.

The profit takers were a minority, however. Most investors praised Esprit's business model and talked enthusiastically about the company's growth potential.

'Over the past few years, Esprit has consistently surprised on the upside,' Baring Asset Management director of Asian equities Khiem Do said. 'The company's global franchise is gaining traction. They are introducing the right type of clothing at the right cost and at the right margins.'

Although headquartered in Hong Kong, expanding in Asia and building a presence in the United States, Esprit still derives the bulk of its earnings from Europe, where the company has managed to sustain handsome sales growth, expanding aggressively into new countries from its established retail base in Germany.

'Esprit is doing very well, selling cheap Asian-made clothes into the expensive European market,' said one Hong Kong-based retail analyst, who predicted it would see annual earnings growth of about 25 per cent over the next three years.

Not everyone is so bullish. Some portfolio managers question Esprit's ability to continue to produce the stratospheric growth rates the market now expects. They say its stock price no longer appears cheap compared with more established European and US firms.

Sustaining profit growth close to Wednesday's levels certainly will be tough. Alongside tax gains, Wednesday's results were flattered by the euro's 13 per cent gain against the Hong Kong dollar over the second half of last year.

However, it is far from certain that the euro will continue to rise. Already this year, it has slipped back by 3 per cent against the US and Hong Kong currencies.

But it is not the currency risk that worries the sceptics so much as their view that after yesterday's rally, Esprit is priced at about 19 times predicted earnings for this year.

That puts the company nearly on a par with far more established US retailers such as Gap or Abercrombie & Fitch, which are trading on an average price-earnings ratio of 22 times, and within sight of much larger European competitors such as Spain's Inditex Group, the owner of the Zara chain of clothes shops.

At these levels, argued Chakara Sisowath, the managing director of investment house Comgest Far East, Esprit was no longer a compelling value story. He sees the huge gains of recent years as the result of a one-off rerating of the stock by investors, as they have revised their perceptions of Esprit from an Asian manufacturer into a European retailer with global ambitions.

With a tiny share of even its main German market, Esprit still has a long way to go before it can threaten its larger rivals. It seems that at $55.25, Esprit's stock is priced for a lot of growth the company has yet to deliver.