AMZN Amazon.com Inc

By Stephen Wilmot 

In a fast-growing sector, worrying about competition misses the point. The ambitions of Amazon.com Inc. in clothing retail pose a bigger threat to high-street fashion chains than they do to online rivals Zalando and ASOS.

This is one lesson of an expectation-smashing second-quarter update from Zalando. Since its 2008 foundation by Rocket Internet as a European copy of Amazon's Zappos.com website, this Berlin-based company has become Europe's largest online fashion retailer after Amazon. But its shares have fallen this year as investors have fretted about weak first-quarter margins and Amazon's renewed push into fashion.

Those worries now look overblown. The company said Tuesday that its second-quarter adjusted operating margin would be between 7.5% and 9.5%. The consensus of analysts had expected 5%, so earnings upgrades are inevitable. The shares jumped 17% in morning trading.

Until the company releases full figures and holds a conference call next month, the reasons for the profit beat will remain somewhat mysterious. The company noted "operating leverage"--the mathematical drop-through of strong sales growth to the bottom line--but second-quarter sales growth in the 24-26% range was in line with analyst forecasts. At the same time, management insisted it was keeping its foot on the gas pedal with investments.

This muddy picture will do nothing to clear Zalando's reputation for unpredictable financial performance, and the shares will doubtless remain volatile. But even after Tuesday's jump, they look cheap on 1.7 times prospective sales, relative to those of smaller U.K. peer ASOS on over 2 times.

The two companies have slightly different focuses. ASOS targets the market for 20-something fashionistas globally, whereas Zalando pitches itself at a wider demographic, but only in Europe. ASOS places more emphasis on fashion and curated content, Zalando on cutting-edge logistics and web technology. Yet these differences can be exaggerated: both are growing sales at about 25% a year as they take market share from bricks-and-mortar retail, and both should now make full-year margins of roughly 5%.

The key reason why ASOS might warrant a higher valuation is that its focus on fast fashion and the millennial niche better protects it from direct competition with Amazon. But focusing on the Amazon threat is misleading. The U.S. giant already has a higher market share in European fashion than its local peers, according to research group Euromonitor, so the competition is nothing new.

There's a reason why most clothes are sold by specialist retailers; the online world may be no different. As long as Zalando and ASOS keep up with Amazon's logistics operation, and keep their current edge in website design and function, they should be able to grow at least as fast as more and more clothes shoppers move online.

It is time to consign those Zalando shorts to the back of the wardrobe. This is a market with growth for all.

Write to Stephen Wilmot at stephen.wilmot@wsj.com

(END) Dow Jones Newswires

July 19, 2016 12:21 ET (16:21 GMT)

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