Why ASOS plc Shareholders Aren’t Crazy To Stay Put At £33

ASOS plc (LON:ASC) is not cheap, but its shares could continue to rally in the next few weeks, argues this Fool.

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Since a trough of £17.8 in mid-October, ASOS (LSE: ASC) stock has rallied by 85% to £33 — but the question is why? 

Nick Robertson, CEO and founder, recently got rid of a large 10% stake — this was bad news, as trailing trends for the stock show. At the same time, several brokers have questioned the feasibility of the retailer’s expansion plans abroad.

What’s next then? 

Overvalued? 

Everybody wants to know whether ASOS is massively overvalued. I reckon ASOS is a very risky investment indeed, but at £33 a share it could turn out to be a decent candidate for a diversified portfolio, even assuming a couple of profit warnings — off the back of unsafe margins — are on their way in 2015. 

After all, its current and forward valuations signal that it’s not incredibly important for ASOS to grow as a profitable entity: it’s just important that it grows a lot every quarter, just as it has done in recent years. 

To back up my statement, I found evidence in the marketplace: ASOS shareholders are in good company, although the shares of other similar businesses have been holding up much better than those of ASOS in the last couple of years. 

Vipshop Holdings & Mercadolibre

I’ve spent several hours doing research to determine whether the stock of any other comparable business looks similarly overpriced, and I found these two companies: Vipshop and Mercadolibre

Never heard of them before? Well, me neither, but if you are invested in ASOS or you are interested in possibly buying shares, you ought to know a few things about these two businesses and their relative valuations. 

Vipshop is engaged in online product sales and distribution. A Chinese company listed in the US, its core financials are striking similar to those of ASOS; no debts combine with low operating profitability, which is offset by higher revenue growth than that of ASOS. VipShop’s net profitability, as gauged by net income, is forecast to be roughly in line with that of ASOS’s at about 3.9% in 2015. 

At 40x adjusted operating cash flow and more than 60x earnings, Vipshop trades in line with ASOS, although Vipshop is much bigger than ASOS both by sales and market cap. Its financials, one may argue, are only slightly better than those of the UK fashion retailer, but that’s fully reflected in Vipshop’s one- and two-year trailing performances — +133% and +1,032%, respectively — which compare with -50% and +20% for ASOS.

Mercadolibre: Profit Vs Growth

Elsewhere, Mercadolibre is an e-commerce platform, with core operations in Brazil, Argentina, Mexico and Venezuela. To cut a long story short, Mercadolibre is not growing as fast as VipShop (its growth rate is more similar to that of ASOS), but it’s much more profitable, with a net margin at 14%. Just like ASOS, its balance sheet is debt-free, and its shares are similarly expensive, at 70x forward earnings, and 30x forward adjusted operating cash flow. It has had its fair share of problems in the last 18 months, and the shares have been volatile, but have gained 43% of value in the last 12 months and 53% in the last two years.

Moreover, Mercadolibre pays dividends, which begs an obvious question: should ASOS take heed and release value?  

Very simply, ASOS shareholders are not crazy to stay put right at £33 a share, but for their holdings to double to last year’s level, either grow must speed up above consensus estimates — revenues are forecast at £1.15bn and £1.4bn in 2015 and 2016, respectively — or ASOS should find a way to push up its operating profitability, maybe by implementing tougher rules on refunds.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK owns shares of ASOS. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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