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REUTERS/Denis Sinyakov
Morgan Stanley thinks H&M may have some rocky years ahead.
PROFIT PROBLEM

H&M’s current growth rate won’t save it from a profitability pickle

By Chase Purdy

New H&M locations have steadily opened across the globe for years, but the company is still staring down the possibility its profits could decline into a tailspin, say analysts at Morgan Stanley.

In a report out this month, the investment bank questions sales performance at the Swedish retailer, specifically the amount of money it brings in for every square meter of store space it operates. The chain continues to open new stores at about the same 15% rate, but profits aren’t following, the analysts said.

“We think a mathematical tipping point is approaching, and there is a risk that profits fall sharply by 2020,” the report states. By sharply, they mean as much as 40%.

Here’s another look at the trend, this time looking at overall operating profit:

There is precedent suggesting H&M proceed with caution, the bank said. Between 2001 and 2007, British retailer Dixons—formerly known as DSG—also began bringing in less profit for each square meter of store space. That led to a two-year, 70% drop in profit that caused the company’s shares to lose nearly 90% of their value, the report states. Dixons changed its leadership, reorganized, and eventually merged in 2014 with an electronics company, Carphone Warehouse.

So far, H&M’s space has grown at a faster clip than its profit per square meter has fallen, leading to modest increases in profit. But it’s likely that won’t hold indefinitely.

“If the rate of space growth remains [steady] and profit densities continue to decline by their historical average rate, mathematically, it is inevitable that profits will fall every year from now on,” the analysts said. “Even if our thesis does play out, it is difficult to predict the timing of when the shares would begin to fall sharply.”