(Bloomberg Gadfly) -- Hygge hugs can't solve everything.
Hennes & Mauritz AB deserves credit, as Gadfly has argued, for creating and investing in new concepts. Trendy Nordic style store Arket is the latest to join the stable.
The trouble is, it is the core H&M brand that's causing the company's latest profit pain. The parent is attempting to address this both by adding new names and fixing the problems at the flagship chain. But a nasty stock build up means neither are being appreciated. The shares fell as much as 7 percent on Thursday.
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The namesake brand has become the squeezed middle, between more premium names and Primark at the bottom end. The march of the Associated British Foods Plc owned retailer in the value segment of the clothing market has made H&M's cheap chic not quite as cheap as it used to be.
In response to the pressures on the core chain it has also been investing in less-sexy areas, such as its online business -- which in some established markets now accounts for 25 to 30 percent of sales -- the supply chain, and tools to help it get the right garments in the right place at the right time.
That is necessary given that the amount of stock in the system has got out of control, and it still has some way to go. The markdowns necessary to clear the excess inventory weighed on the gross margin, which fell from 54 percent to 51.4 percent in the third quarter.
Inventories still picked up, and accounted for 16.6 percent of sales on a rolling 12-month basis, as of August 31. That looks high, even accounting for the typical gain ahead of the crucial autumn/winter trading period.
The company said that in the current, fourth, quarter, inventories are at a healthier level. And H&M is taking action to prevent another buildup. Autumn/winter orders are down more than 10 percent from a year earlier, compared with a gain of almost 10 percent in the same period last year.
The company has also given itself more flexibility to order within the season by shortening lead times. That way it can take a leaf out of rival Inditex SA's book. It can more easily adjust its stock depending on what sells well and what doesn't, as well as external factors, such as the weather.
It should also get some help from a weaker dollar -- it sources about 80 percent of its products from Asia, where suppliers are usually paid in dollars, compared with about 30 percent at Inditex.
H&M's inventory troubles have dragged not only on profits but also the shares, which are down about 17 percent so far this year.
The discount to its Spanish rival has widened, with H&M shares trading on a forward price earnings ratio of about 18 times, compared with Inditex's 26.
H&M is right to be creative with its new concepts and spend where it counts, but that won't be reflected in its valuation until investors are convinced it has tackled the plumbing in its core operation.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.
To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net.
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