BRIEF EVALUATION OF THE CAPITAL STRUCTURE OF INDITEX

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Introduction.

The purpose of the present report is examining the financial statement of the Spanish global company Industria de Diseño Textil (Inditex), evaluating the capital structure of the

selected company, risks, source of finances, advantages and disadvantages of the capital structure and decisions about strategic investments.

Secondly, it wi ll be considered the organisational fi nancial performance as a whole, the financial performance of Inditex compared to its rivals and its context and the company's

goals and stakeholder expectations in order to critically evaluate its success or failure.

Lastly, the financial statements will be interpreted and discussed to explain the relationship between the financial statements and the organisational performance. Having considered this, it will be given recommendations to validate of refuse the decision-making of the

organisation based on the analysed financial information and finally, it will be offered a brief conclusion.

On the other hand, it is noteworthy that the report will only analyse the most notorious characteristics of the financial statement of Inditex. Therefore, it wi ll be limited in its

purpose, leaving a more profound evaluation for subsequent research.

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1. Part A. Capital structure of Inditex.

1.1. Inditex.

Inditex is an important company in the industry of retailing and apparel and it has 8 different brands: Zara, Bershka, Pull and Bear, Zara Home, Massimo Dutti, Oysho,

Stradivarius and Uterqüe, which, permits Inditex to be diversificated and attract different age groups and market segments (Surrador do Couto, 2014: 2). 1.2. Capital structure: debt vs equity.

In Inditex, the capital structure is funded from equity and its debt is insignificant. In fact, “the debt ratio has been almost zero” caused by the fact that the company generates a

good cash flow and it is reinvested into the company, opening new stores, under a strategy of expansion (Surrador do Couto, 2014: 31).

Concerning the equity strategy of Inditex, Inditex “uses little debt in its capital structure as supported by a debt to capital ratio of 0.26” (Financial Times, 2016), which, is small

according to Gallo (2015), who considers that some ratios are good if they are as high as possible, like profit margins, “but with debt-to-equity, you want it to be in a reasonable range” and less than 1 is appropriate.

To contextualise this ratio, “companies have two choices to fund their businesses, borrow

money from lenders or get money from equity” and issuing equity with a small amount of debt will reflect a financial stability. It is considered that stable, “publicly traded companies have ratios between 2 and 5 […] any higher than 5 or 6 and investors start to get nervous”

(Gallo, 2015). The only exception is in banking, in which, is common “to see a ratio of 10 or even 20”, but this is a special industry in this regard (Gallo, 2015).

To further illustrate Inditex capital structure compared to other companies, it is relevant to show that Apple or Google have ratios likely to be well below 1 and it is mostly considered

to be good (Gallo, 2015). Thus, a 0,26 debt to equity ratio shows profitability and small debts, which, reaffirms that Inditex “capital structure is characterized by the low debt/equity

ratio as a result of the practically non-existent financing and the strength of its equity” (Inditex, 2016: 227).

1.3. Equity valuation of Inditex.

Similar to the debt to equity ratio, it is essential to evaluate the equity issued by Inditex and its profitability. In this manner, the stock price of Inditex is important and according to Bloomberg Markets (2016), the current Inditex stock price is €30.73 (18 July 2016) per

share and Inditex has issued more than €3 billions shares with a market capitalisation of €95.76 billions.

Share price 30.73

Market Capitalisation €95.76 billions

1 Yr Return 0.56%

Table 1: Inditex (Bloomberg Markets, 2016).

In the light of the current Inditex's equity characteristics, it is decisive to analyse the long

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term Inditex profitability for shareholders to evaluate if the company equity is seen as

reliant and successful. In 2001, when Inditex issued equity for the first time, the share price was €3.6 and 15 years later, in 2016, the share price is €30.75 (Google finance, 2016),

which, involves a 754% increase for investors. This is a definitely good investment for shareholders and it reinforces the trust in the

financial strategy of Inditex, even in times of crisis in Europe. Considering this, Inditex stock prices has performed well and the equity is evaluated as very profitable to attract

investors.

1.4. Profitability and risks.

As the report's objective is appraising the financial statement of Inditex, it is critical to

check the profitability of Inditex and its external threats.

First of all, Inditex profitability is increasing every year and it presented a net profit of

€2,882 in 2015, which, is positive after an important strategy of expansion and investments (Inditex Annual Report, 2015). In fact, it provided a surplus to raise the confidence in the

capital structure of Inditex and its financial decisions.

On the other hand, there are threats from the global business environment that might

affect Inditex's capital structure like cotton price’ changes that affect Inditex and consequently, Inditex’s strategy and its share price (Surrador do Couto, 2014: 3).

Additionally, Inditex capital structure is threaten by the “high degree of exposure to different currencies” and it is well-known that currencies changes are “hard to forecast”

(Surrador do Couto, 2014: 3). This is especially important for Inditex because it is present in almost 100 countries, which, expose the company to changes in currencies that might

affect the capital structure in case of alterations in the currencies of Inditex's main markets. 1.5. Advantages and disadvantages of the capital structure.

As the company has taken on relatively little debt and thus, low risk, the cost of debt is

insignificant and financing the company by equities is a good investment for shareholders (Tudó et al, 2011: 59).

For this reason, this is an advantageous capital structure supported by a successful financial performance, which, provides sufficient resources to make sure that there is no

risk of bankruptcy and the debt is completely able to be handled. On the other side, it is remarkable that most of the shares are in the hands of the

company's owner (59.294%) and the dividends paid out to shareholder in 2015 is €1,6 billions, which, is a relative low amount to pay compared to suppliers, almost €13 billions

(Inditex Annual Report, 2015: 150).

As a final reflection, the capital structure of Inditex is appropriate for the company’s goals

and even, if it is limited to just one way of funding, it enhances the financial performance of Inditex as most of the profits are reinvested.

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2. Part B. General assessment of the financial performance.

2.1. Inditex financial performance compared to its rivals and industry.

Retailing industry, in which, Inditex takes part, is growing quickly in spite of the difficult times that has been experiencing the global economy (Surrador do Couto, 2014: 31).

Nevertheless, in the particular case of Inditex, it has performed above the average in its industry, which, is explained by various factors, such as: diverse age groups, diverse

market segments, “portfolio diversification with different brands” and a business model that emphasises on international investments (Surrador do Couto, 2014: 54).

In detail, Inditex is ahead of its competitors like Hennes & Mauritz (H&M) or GAP, which, are starting to struggle compared to Inditex (Chaudhuri and Kowsmann, 2016).

As an illustration, H&M has increased sales from €19 billions to €22 billions (Hennes & Mauritz, 2016), which, is undoubtedly, a well financial performance under the current

global financial circumstances. However, lnditex also increased its sales from €14 billions to €20 billions (Inditex, 2016) and it means a 42% increase of profits, while the H&M's

profits increase is just 15%. Similarly, it is noteworthy that Inditex's shares remain stable in the stock markets over the

past years (over €30 per share), while competitors like GAP has experienced a fall that surpass 50% from 43,54 in 2014 to 17,43 in 2016 (Bloomberg Markets, 2016b) and H&M

has also experienced a decline of 30% fall from 341,27 Sweden Krona (SEK) in 2014 to SEK 260.40 in 2016 (Bloomberg Markets, 2016c).

As has been noted, the financial performance of Inditex in comparison to its competitors in the retailing industry is superior and profitable for investors. In this regard, the performance

of Inditex in its industry is better than the average in the financial field.

2.2. Return on equity (ROE) and Earning per share (EPS).

Now, to analyse the specific characteristics of the Inditex's equity, i t will be evaluated the

ROE and earning per share of Inditex. The ROE “measures the amount of net income returned as a percentage of shareholders’

equity” and it indicates the company's efficiency at generating profits. (Tudó et al, 2011: 40), while the EPS is obtained by dividing a company's profit by “its number of common

outstanding shares” (Nasdaq, 2011).

Considering both concepts, the ROE of Inditex “don’t have a clearly trend and they are fluctuating around the 30% approximately” (Tudó et al, 2011: 40). In detail, in the last years it has been fluctuating around 30%, but in 2015 it reported a ROE of 26% (Inditex,

2016: 225) and it is considered to be good percentage according to Gallo (2016) But, obviously, as an investor, “you want the ROE to be as high as possible” (Gallo, 2016).

In this aspect, it is noteworthy that H&M, the rival in the European market of Inditex has a ROE of 38.97% in 2016 (Financial Times, 2016b), which, makes H&M win in some

financial spheres.

Having considered the Inditex's ROE, the EPS of this company is 0,934 in 2015 (Financial

Times. 2016) and it was 0,803 (Inditex, 2014: 4). Thus, the EPS is increasing, but ROA

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and EPS varies widely in various companies and industries, so it should be used

accompanied by other measures (Menon, 2013).

2.3. Main financial indicators: Inditex's net sales, net profits, costs and liquidity.

As ROA and EPS are not decisive measures by themselves and they should not be used

in isolation (Menon, 2013), it is relevant to evaluate other organisational measures like net

sales, net profits or liquidity.

In the first place, Inditex had net sales for €20,900 billions with a net profits of €2,882 in 2015 and a regular cash flow of €3,897 billions (Inditex, 2016: 20).

Inditex also had good liquidity cash or cash equivalents, more than €5 billions in 2015. (Inditex, 2016: 227) and this way, the company is not exposed “to significant liquidity risk”,

as it keeps enough “cash to meet outflows” (Inditex 2016: 197).

In contrast, payments made to suppliers for the purchase of raw materials, goods and services were €12,943 and employees wages €3,335 (Inditex, 2016: 150). Therefore, Inditex costs were considerable, but the company is profitable after all, which, is a

successful model.

To emphasise and explain the importance of these main financial indicators of Inditex, its competitors net sales were as follows: “H&M with $20.2 Billion, Fast Retailing (Uniqlo) $16.6 Billion, Gap $16.4 Billion, Primark $7.5 Billion, Abercrombie & Fitch $3.7 Billion,

Mango $2.1 Billion” (Loeb, 2015).

As noted above, Inditex net sales were bigger than its competitors, which, means that the company is leading the industry today. However, H&M is very competitive as it had 19% sales increase (Hennes & Mauritz, 2016: 1) and it will remain being an important

competitor due to its good financial results.

2.4. Company's goals and stakeholder expectations.

The relationship of Inditex with its stakeholders seems to be solid and reliable. Inditex

(2016b) states that dialogue and communication with stakeholders is crucial. Indeed, “i n order to respond to the expectations of each different group, Inditex remains in constant

communication with them so that the issues that are of greater interest or concern to them can be identified” (Inditex, 2016b).

Under those circumstances, the principal Inditex's stakeholders are: shareholders,

employees, customers, environment, community and suppliers.

To illustrate this point and explain the company's goals and relationship with these groups'

expectations, it will be exemplified the relationship of Inditex with employees and communities.

First, to meet employees expectations and Inditex's goal of keeping a “highly-motivated team”, the company has hired 152,854 people of 90 diverse nationalities (Inditex 2016: 80)

and management's employees have access to shares plans (Inditex 2016: 117). Moreover, there is no gender discrimination to keep a high morale in the work -team because 76% of

workers are women and 24% are men (Inditex, 2016: 144).

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Second, Inditex approach to communities is based on “ensuring the programmes

developed have the broadest possible reach and impact” (Inditex, 2016b) and to meet this

goal, the company has invested more than 35 millions in communities and have donated

more than 1 million products and have supported 361 organisations.(Inditex, 2016: 144).

As have been shown, Inditex relationship with its stakeholders is close and it includes various groups. In summary, it is successful but some of these indicators could be

improved in the coming years, for instance, it is possible to invest more than €35 millions in the communities with net profits near to €3 billions, especially, in developing countries where working conditions could be tougher.

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3. Conclusions.

The assignment has discussed the capital structure of Inditex, its benefits and possible

flaws, the debt to equity ratio and its impact in the organisation, the characteristic of the equity issued by Inditex, the comparison of Inditex with other companies in the same industry, its alignment with the organization's goals and certain features to measure the

financial performance.

Following this, the most notorious findings of the topics covered in the report is that the Inditex capital structure is, indeed, successful and it has generated benefits for all stakeholders, which, allows the company to pay dividends, even, in the circumstances of

global crisis and when competitors were struggling to maintain the growth.

In effect, the financial performance of the company is excellent as it has provided an interest rate of 754% for Inditex's shareholder since the first time equity was issued and most of the critics are non-financial, like critics to the management of Inditex in developing

countries and workers exploitation by outsourced companies.

In summary, “I strongly believe that Inditex has a huge growth potential and since the stock price is currently undervalued, it is a company to take into consideration and a good investment opportunity” (Surrador do Couto, 2014: 54).

Recommendations.

It is suggested to raise the investment in communities as the quantity already invested is still humble for the company revenues. It could be beneficial to the

company because it would increase the organisational reputation and corporate social responsibility perception.

It is recommended to open a small percentage of the company's shares to diverse

shareholders because current shareholders mostly represent the same group. In

effect, a small percentage of shares to diverse groups will not affect the decision making in Inditex and i t would provide more investments opportunities and increase

funds.

It is advisable to continue the capital structure and equity strategy of Inditex as it

has been demonstrated to be financially successful and satisfy stakeholders' expectations.

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List of references.

Bloomberg Markets (2016) Industria de Diseño Textil SA. Online at:

http://www.bloomberg.com/quote/ITX:SM [Accessed: 18 July 2016]. Bloomberg Markets (2016b) GAP. Online at: http://www.bloomberg.com/quote/GPS:US

[Accessed: 19 July 2016].

Bloomberg Markets (2016c) H&M. Online at: http://www.bloomberg.com/quote/HMB:SS

[Accessed: 19 July 2016].

Chaudhuri, S. & Kowsmann, P. (2016) Zara Owner Inditex Stays Ahead of the Competition. The Wall Street Journal. Online at: http://www.wsj.com/articles/zara-owner-inditex-profit-

beats-forecasts-1465968167 [Accessed: 17 July 2016]. Financial Times (2016) Equities: Industria de Diseño Textil. Online at:

http://markets.ft.com/research/Markets/Tearsheets/Financials?s=ITX:MCE [Accessed: 17 July 2016].

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Hennes & Mauritz (2016) Full Year Report. Online at: http://about.hm.com/content/dam/hm/about/documents/en/cision/2016/01/1642932_en.pdf

[Accessed: 18 July 2016]. Inditex (2015) Annual report 2014. Online at:

https://www.inditex.com/documents/10279/175443/4.+Cuentas+consolidadas+2014versi%C3%B3n+ingl%C3%A9s+COMPLETA.pdf/3db38f4d-5532-4eda-b8fa-1db72f9836dc

[Accessed: 18 July 2016]. Inditex (2016) Annual report 2015. Online at:

https://www.inditex.com/documents/10279/18789/Inditex+Anual+Memory+2015+web.pdf/d8ce551b-fad0-4294-b160-03160cde32dd [Accessed: 18 July 2016].

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http://www.forbes.com/sites/walterloeb/2015/03/30/zara-leads-in-fast-

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http://www.morningstar.co.uk/uk/news/105269/the-limitations-of-earnings-per-share.aspx

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Appendices.

Appendix 1.

Source: Inditex´s income forecast (Surrador do Couto, 2014: 59).

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Appendix 2.

Source: Industria de Diseño Textil SA (Bloomberg Markets, 2016).

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Appendix 3.

Source: Inditex’s sales growth (Surrador do Couto, 2014: 33).

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Appendix 4.

Source: Historical Income Statement, Balance Sheet, and Cash Flow Statement (Surrador

do Couto, 2014: 56).