2010.09.26 0118PM Sanford European Apparel Retail Gauging The Rutledge

September 17, 2010
Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Andrea Rosso • andrea.rosso@bernstein.com • +44-207-170-0568
Matt Wing • matthew.wing@bernstein.com • +44-207-170-0578
European Apparel Retail: Gauging the Impact of a More

Difficult Sourcing Environment
16/09/2010 TTM EPS P/E

Closing Target Rel.
Ticker Rating CUR Price Price Perf. 2009A 2010E 2011E 2009A 2010E 2011E Yield
ITX.SM O EUR 57.03 60.00 35.6% 2.11 2.57 2.98 27.0 22.2 19.1 1.9%
HMB.SS O SEK 254.10 275.00 22.6% 9.90 12.01 12.70 25.7 21.2 20.0 3.2%
MKS.LN O GBp 376.10 410.00 -4.4% 32.70 32.05 34.92 11.5 11.7 10.8 4.4%
NXT.LN M GBp 2170.00 2300.00 14.6% 185.57 207.59 228.52 11.7 10.5 9.5 3.7%
MSDLE15 1125.11 69.48 94.50 109.85 16.2 11.9 10.2 4.0%
O – Outperform, M – Market-Perform, U – Underperform, N – Not Rated
Highlights
 European and American Apparel Retailers are bound to experience a more difficult sourcing
European General Retail & Luxury Goods
environment in Asia going forward. Chinese apparel manufacturers are continuing to experience upward
cost pressures, as we had pointed out in our recent research (please refer to the report: European Apparel
Retailers: Sourcing Costs to Rise in 2011, published on 22-Mar-10).
 Raw material prices have continued to rise in 2010 YTD – in China, Cotton is now 25% up yoy and
Synthetic fibers are 12% up on average. (a) Cotton prices in China are now at an all time high of 2.69
$/kg. Heavy rains and floods in Pakistan have contributed to inflate prices, as production and transport
were negatively affected. In fact, the price of cotton in Pakistan has risen >60% in 2010 YTD. India's
recent decision to set an annual cap to its cotton exports is not helping either; (b) Wool prices in
Australia are now at 1,056 $ cents/kg (18.5 micron) – and increase of c.20% from one year prior. (c)
Synthetic fiber prices generally have also been experiencing inflation in 2010 YTD, with viscose up
16% yoy, nylon down -3.7%, polyester up 16% and spandex up 22%;
 Labor costs have continued to increase in Asia. Tight employment conditions in China
(unemployment official figures as of 1Q10 were at 4.2%, down from peak levels of 4.3% in '08 and
'09) are continuing to push wage inflation in apparel manufacturing. Chinese apparel manufacturers are
trying to move up the value chain in their product focus and attempting to offset higher prices with
shorter lead times and smaller order lots. Other lower cost markets are also experiencing pressure. In
Bangladesh, the lowest cost producer, the government decided to bring the minimum wage in the
apparel manufacturing industry from $25/month to $44/month;
 Chinese apparel manufacturers are experiencing high capacity utilization. This is coming from
higher domestic market demand – as we had picked up during our discussions with apparel
manufacturers in China in spring 2010 – and rebounding export volumes. Apparel imports to the U.S.
from the world – for which we have data covering all of the 1H10 for total apparel – have risen c.16%
yoy vs. 1H09 in volume terms. The rebound was particularly strong in 2Q10, when cotton T-shirts and
woven shirts were up over 30% (vs. c.13% in 1Q10). Textile exports from China are strongly up, with
a particularly sharp rebound in May and June, at c. +33%. Fabric exports are rising in the 40s, with
clothing exports recovering in the high 20s. Knitted is growing much faster than woven apparel.
See Disclosure Appendix of this publication for important disclosures and analyst certifications.
September 17, 2010
 Currencies have moved against apparel retailers, especially in Europe. Currencies have moved
against apparel retailers, especially in Europe. When we look at yoy exchange rates of apparel
manufacturing countries to the EUR in 2Q and 3Q 2010 – which should be relevant for the SS11
season – we see the USD appreciating +7.1% in 2Q10 yoy and +10.8% in 3Q10 to date yoy to the
EUR, with the CNY appreciating +7.2% and +11.6% and the TRY appreciating +9.1% and +9.4% vs.
EUR. When we look at the UK, we see the USD appreciating +3.8% in 2Q10 yoy and +6.3% in 3Q10
to date yoy to the GBP, with the CNY appreciating +3.8% and +7.1% and the TRY appreciating
+5.8% and +5.0% vs. GBP.
 We expect apparel retailers will adjust to higher sourcing prices increases in China by shifting their
geographic sourcing mix. Nevertheless, mix shifts are likely to have practical limitations short-term,
given the material share of Chinese apparel imports to both the EU and the USA.
 China's share of European Union woven and knitted apparel imports has grown to 48% and 41% at
the end of 2009, up from 39% and 29% respectively 4 years ago. In the USA, the Chinese share of
total apparel imports in volume and value has grown to 38% and 35% at the end of 1H10, up from
30% and 27.5% respectively in 1H08.
 Besides, import statistics are also not likely to show meaningful geographic mix shifts for a few
months - as we expect sourcing price increases are only going to hit starting with the SS11 deliveries.
These should come into Europe and the USA in 4Q10 and 1Q11;
 We anticipate apparel retailers will react with higher retail prices.
 Analysis of retail price inflation in Europe suggests we are now back for a few months in a benign
inflationary environment for retailers. In the UK, apparel retail price inflation has moved to the
positive in Apr-09, has stayed at around 3.0% in 1H10, and has recently moved to 3.5% in Jul-10 –
suggesting disciplined end-of-season SS10 clearance behavior and GM% defense on the back of
guarded sourcing volumes. In Europe, we see that apparel retail price inflation has been close to flat in
1H10 at c.-0.5% – in Italy, for example +0.3%, in Germany +0.7%, in France +0.4%.
 Apparel retailers have already guided that they are planning to raise prices in the face of higher
sourcing costs and higher taxes down the road. Next, for example, has anticipated they would be
planning to increase prices c.8% next year. This comes on the expectation that the consumer demand
environment in the UK is likely to stay stagnant, and that price and margin sacrifices would not be
conducive to volume gains on the back of consumer price elasticity. H&M also suggested they may be
likely to raise prices – although they could consider moderating price increases if faced with the
opportunity to gain share.
 We expect a more difficult sourcing environment will further accelerate a secular transition in
European apparel retailing.
 This trend is particularly obvious in the UK, where we have one of the most advanced apparel
retailing environment. A new generation of value leaders – pure discounters like Primark and grocery
retailers like Asda and Tesco – are progressively squeezing the middle ground – while the fashion
intensive portion of the market is standing firm at 1/3 of the total, albeit with high churn among
winners and losers. Traditional retail channels, general stores, and department stores – encumbered
with low productivity, lower scale, higher costs and weaker consumer appeal – are losing ground;
 We expect value players will take the opportunity to increase their price leader advantage, to flex
their sourcing muscle and to push the middle ground harder. This is likely to be more relevant in the
UK short-term, where value leaders are already well developed, but should just further increase the
medium-term opportunity for material apparel discount development in continental Europe (please see
2
September 17, 2010
our reports UK Retail: Supermarkets and Non-Food - Part 1: The Rising Role of Supermarkets in UK
Apparel Retailing and European Apparel: The Opportunity for Apparel Discounting in Europe, Part 2,
published on 04-Jun-10 and 15-Jul-10, respectively). The onus on middle ground players to shape-up
becomes even more urgent. We would welcome a move by M&S to accelerate its direct sourcing and
supply chain rationalization plans in this context;
 We also expect that leading mass fashion retailers such as ITX and H&M should be advantaged in
this situation. Inditex is less exposed to Asia and is not experiencing sourcing price inflation in its
proximity locations – this should mute the effect of higher prices in Asia alone. Both Inditex and H&M
enjoy significant scale – both globally, with sourcing operations worldwide and within each sourcing
market – they should therefore be best equipped and most proactive in managing the adverse sourcing
environment: (a) shifting their geo sourcing mix, (b) flexing their higher bargaining power
 It is also clear that further continuing GM% gains as we have seen from mass fashion players are not
on the cards going forward.
 Both ITX and HMB have managed to increase their GM% substantially in the past 12 years,
achieving 800bps and 1,082bps GM% expansion respectively. Higher GM% and lower tax rates have
been the two most important drivers of ROIC improvement, as we have shown in our report European
Apparel Retailing: History and Opportunities for Capital Efficiency, published on 30-Nov-09. GM%
gains have been achieved in a competitive retail environment – where other players were obviously
experiencing the same favorable FX and sourcing trends – hence also depend on company-specific
actions. But there is no doubt that a falling USD and expanding sourcing base in China have helped the
mass fashion players and the industry;
 We expect sourcing opportunities to continue to expand, as apparel manufacturing remains a low
tech / low capex industry with very low barrier to entry. Having said that, the current juncture is likely
to bring GM% headwinds, as subdued demand trends in developed markets combine with rising
demand in EMs and higher manufacturing costs in China. SG&A cost control and space growth are
likely to stand up as the key earnings growth drivers going forward, with GM% expansion providing
neutral or negative contribution;
 We rate ITX, HMB and MKS Outperform with target prices of €60, SEK 275 and 410p, respectively. We
rate NXT Market-perform with a target price of 2,300p.
3
September 17, 2010
Investment Conclusion
European and American Apparel Retailers are bound to experience a more difficult sourcing environment in
Asia going forward. Chinese apparel manufacturers are continuing to experience upward cost pressures, as
we had pointed out in our recent research (please refer to the report: European Apparel Retailers: Sourcing
Costs to Rise in 2011, published on 22-Mar-10).
Raw material prices and labor costs have continued to rise – in China, cotton is now +25% up yoy;
synthetic fibers are up +12% on average in '10 YTD; tight employment conditions are continuing to push
wage inflation in apparel manufacturing. Chinese apparel manufacturers are also experiencing high capacity
utilization from higher domestic market demand and rebounding export volumes. In addition, key sourcing
currencies (USD, CNY, TRY) have moved against the EUR and GBP (hence against European apparel
retailers) in 2Q and 3Q10 to-date, i.e. the sourcing period for the SS11 season.
We expect apparel retailers will adjust to higher sourcing prices increases in China (a) by shifting their
geographic sourcing mix (though this is likely to have practical limitations short-term, given the material
share of Chinese apparel imports to both the EU and the USA) and (b) with higher retail prices.
We expect a more difficult sourcing environment will further accelerate a secular transition in European
apparel retailing. We expect value players will take the opportunity to increase their price-leader advantage,
to flex their sourcing muscle and to push the middle grounder harder. This is likely to be more relevant in
the UK short-term, where value leaders – e.g. pure discounters like Primark and grocery retailers like Asda
and Tesco – are already well developed, but should just further increase the MT opportunity for material
apparel discount development in continental Europe.

The onus on UK middle ground players (e.g. Next and M&S) to shape-up becomes even more urgent. We
would welcome a move by M&S to accelerate its direct sourcing and supply chain rationalization plans in
this context.
We expect that leading mass fashion retailers should be advantaged in this situation as both Inditex and
H&M enjoy significant scale, globally (with sourcing operations worldwide) and within each sourcing
market. They should therefore be best equipped and most proactive in managing the adverse sourcing
environment. Nonetheless, GM% gains such as we have seen from mass fashion players in the last 12 years
(+800bps at Inditex; +1,082bps at H&M) do not seem to be on the cards going forward.
We rate ITX, HMB and MKS Outperform with target prices of €60, SEK 275 and 410p, respectively. We
rate NXT Market-perform with a target price of 2,300p.
4
September 17, 2010
Details
European and American Apparel Retailers are bound to experience a more difficult sourcing
environment in Asia going forward. Chinese apparel manufacturers are continuing to experience upward
cost pressures, as we had pointed out in our recent research (please refer to the report: European Apparel
Retailers: Sourcing Costs to Rise in 2011, published on 22-Mar-10).
Raw material prices have continued to rise in 2010 YTD – in China, Cotton is now 25% up yoy and
Synthetic fibers are 12% up on average. (a) Cotton prices in China are now at an all time high of 2.69
$/kg. Heavy rains and floods in Pakistan have contributed to inflate prices, as production and transport were
negatively affected. In fact, the price of cotton in Pakistan has risen >60% in 2010 YTD. India's recent
decision to set an annual cap to its cotton exports is not helping either; (b) Wool prices in Australia are now
at 1,056 $ cents/kg (18.5 micron) – and increase of c.20% from one year prior. (c) Synthetic fiber prices
generally have also been experiencing inflation in 2010 YTD, with viscose up 16% yoy, nylon down -3.7%,
polyester up 16% and spandex up 22% (Exhibit 1 and Exhibit 27 to Exhibit 33 in the Appendix).
Exhibit 1
Raw material prices have continued to rise in 2010 YTD
Raw Material Prices (USD) - Yoy Growth (%) 2007 2008 2009 2010 YTD
Cotton Spot Price in China 2.4% 6.5% (0.3)% 25.3%

Cotton Spot Price in Pakistan 10.8% 8.0% (11.8)% 63.7%
Wool Prices in Nanjing* 46.3% 5.8% (21.4)% (11.0)%
Wool Prices in Australia (18.5 micron)* 19.9%
Synthetic Fibers:
Nylon Filament Prices in China 8.9% 3.5% (20.7)% (3.7)%
Spandex Prices in China 60.8% (30.7)% (11.2)% 21.6%
Viscose Filament Prices in China 16.0% 3.8% (1.5)% 15.5%
Polyester in China 8.3% (9.4)% (2.5)% 16.3%
Source: Emerging Textiles, Bernstein Analysis

Note (1): Yoy growth calculated by comparing the average price over the respective period.
Note (2): 2010 YTD through 15-Sep-10 for all materials except Wool (through 15-Mar-10).
Note (3): 2010 YTD wool prices in Australia reflect 1-year change as of 15-Sep-10.
Note (4): 2-Month change for wool prices in Australia has been an increase of 9.71%.
Labor costs have continued to increase in Asia. Tight employment conditions in China (unemployment
official figures as of 1Q10 were at 4.2%, down from peak levels of 4.3% in '08 and '09) are continuing to
push wage inflation in apparel manufacturing (Exhibit 2 to Exhibit 4). Chinese apparel manufacturers are
trying to move up the value chain in their product focus and attempting to offset higher prices with shorter
lead times and smaller order lots. Other lower cost markets are also experiencing pressure. In Bangladesh,
the lowest cost producer, the government decided to bring the minimum wage in the apparel manufacturing
industry from $25/month to $44/month (Exhibit 5).
5
September 17, 2010
Exhibit 2 Exhibit 3
Chinese urban unemployment rates have declined from China's textile industry PPI has turned sharply upwards
peak levels in '08 and '09
4.5% China: PPI: Textile Industry

China, Unemployment - Urban Rate (%)
4.4% 9%
8%
7%
4.3%
6%
Change YoY - %
5%
4.2% 4%
3%
4.1% 2%
1%
0%
4.0%
(1)%
(2)%
3.9% (3)%
(4)%
May-07
May-08
May-09
Jan-07
Mar-07
Jul-07
Sep-07
Nov-07
Jan-08
Mar-08
Jul-08
Sep-08
Nov-08
Jan-09
Mar-09
Jul-09
Sep-09
Nov-09
Jan-10
Jan-10
Mar-10
3.8%
1Q04
3Q04
1Q05
3Q05
1Q06
3Q06
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
1Q10
Source: Haver, China National Bureau of Statistics, Bernstein Analysis Source: Haver, China National Bureau of Statistics, Bernstein Analysis
Exhibit 4
Labor shortages in China have begun to push up wage costs for Chinese apparel manufacturers
100% 90%
90%
75%
% of Polled Companies
80% "… I get calls from factories every day but I can't find workers for
70% them. Companies and governments need to find a way out. High
60% wages can only solve the problem in the short term".
50%
40% - Zhang Quanshou , NPC deputy and chairman
30% of Shenzhen Quanshun Human Resource Co.
(per China Daily, "Workers Call the Shots", 11-Mar-10)
20%
10%
0%
% Increased Salaries to Keep or % Lowered Criteria for New
Attract Staff Recruits
Source: China Daily, "Workers Call the Shots" (11-Mar-10), Bernstein Analysis
Note: Poll reflects responses of 300 companies and was conducted by Taihe Consulting Company.
6
September 17, 2010
Exhibit 5
Bangladesh raised the minimum wage in the apparel manufacturing industry from $25/month to $44/month in Jul-10
$50
Textile Minimum Wage - Bangladesh ($/month)

44
$45
$40
$35
$30
25
$25
$20
14
$15
$10
$5
$0
Pre-'06 2006 Jul-10
Local (Taka) 950 1662.5 3000
Source: BBC, Oanda, Wikipedia, Bernstein Analysis
Chinese apparel manufacturers are experiencing high capacity utilization. This is coming from higher
domestic market demand – as we had picked up during our discussions with apparel manufacturers in China
in spring 2010 – and rebounding export volumes. Apparel imports to the U.S. from the world – for which
we have data covering all of the 1H10 for total apparel – have risen c.16% yoy vs. 1H09 in volume terms –
see Exhibit 6. The rebound was particularly strong in 2Q10, when cotton T-shirts and woven shirts were up
over 30% (vs. c.13% in 1Q10). Textile exports from China are strongly up, with a particularly sharp
rebound in May and June, at c. +33%. Fabric exports are rising in the 40s, with clothing exports recovering
in the high 20s. Knitted is growing much faster than woven apparel (Exhibit 7).
Exhibit 6 Exhibit 7
Apparel imports to the U.S. has risen strongly in 1H10, Apparel imports into the U.S. from China have outpaced
particularly in 2Q10 imports from the worldwide market in aggregate
From World From China

US Imports 2009 1Q10 2Q10 1H10 US Imports 2009 1Q10 2Q10 1H10
Value Value
Apparel (11.8)% 2.4% 14.8% 8.4% Total Apparel 2.5% 14.9% 18.6% 16.8%
Cotton (11.0)% 1.9% 14.4% 8.0% Men Cotton T-Shirts 68.6% 31.8% 63.3% 47.7%
Wool (25.6)% 0.3% 3.6% 2.2% Women Cotton T-Shirts 87.0% 100.9% 34.7% 61.3%
Volume
Volume
Total Apparel 10.7% 29.1% 24.2% 26.4%
Apparel (6.1)% 11.4% 19.5% 15.5%
Men Cotton T-Shirts 157.5% 31.7% 51.1% 42.7%
Cotton (8.1)% 11.2% 17.2% 14.2%
Women Cotton T-Shirts 204.2% 147.2% 48.1% 80.3%
Wool (15.6)% 10.5% 5.8% 7.6%
Source: Emerging Textiles, Bernstein Analysis Source: Emerging Textiles, Bernstein Analysis
7
September 17, 2010
Currencies have moved against apparel retailers, especially in Europe. Currencies have moved against
apparel retailers, especially in Europe (Exhibit 8). When we look at yoy exchange rates of apparel
manufacturing countries to the EUR in 2Q and 3Q 2010 – which should be relevant for the SS11 season –
we see the USD appreciating +7.1% in 2Q10 yoy and +10.8% in 3Q10 to date yoy to the EUR, with the
CNY appreciating +7.2% and +11.6% and the TRY appreciating +9.1% and +9.4% vs. EUR. When we
look at the UK, we see the USD appreciating +3.8% in 2Q10 yoy and +6.3% in 3Q10 to date yoy to the
GBP, with the CNY appreciating +3.8% and +7.1% and the TRY appreciating +5.8% and +5.0% vs. GBP.
Exhibit 8
Key sourcing currencies have appreciated vs. the EUR and vs. the GBP in 2Q and 3Q 2010, which should be relevant
for the SS11 season
Sourcing CCY vs. EUR Sourcing CCY vs. GBP

USDEUR CNYEUR TRYEUR USDGBP CNYGBP TRYGBP
2Q09 0.7347 0.1076 0.4678 0.6464 0.0946 0.4115
2Q10 0.7870 0.1153 0.5106 0.6707 0.0983 0.4353
3Q09* 0.7031 0.1029 0.4680 0.6081 0.0890 0.4048
3Q10* 0.7787 0.1148 0.5121 0.6466 0.0953 0.4252
2Q, yoy% +7.1% +7.2% +9.1% +3.8% +3.8% +5.8%
3Q, yoy% +10.8% +11.6% +9.4% +6.3% +7.1% +5.0%
Source: Factset, Bernstein Analysis

Note: Calendar quarters; * 3Q to-date, from 01-Jul to 15-Sept
We expect apparel retailers will adjust to higher sourcing prices increases in China by shifting their
geographic sourcing mix. Nevertheless, mix shifts are likely to have practical limitations short-term, given
the material share of Chinese apparel imports to both the EU and the USA.
China's share of European Union woven and knitted apparel imports has grown to 48% and 41% at
the end of 2009, up from 39% and 29% respectively 4 years ago (Exhibit 9 and Exhibit 10). In the
USA, the Chinese share of total apparel imports in volume and value has grown to 38% and 35% at the end
of 1H10, up from 30% and 27.5% respectively in 1H08 (Exhibit 11 and Exhibit 12).
Exhibit 9 Exhibit 10
China has gained woven clothing import share (value) A similar trend can be observed in the import of knitted
vs. EU27 countries clothing for the EU27
Woven Clothing Knitted Clothing

50% 48% 50%
46%
45% 44% 45%
41%
Value Share - %
Value Share - %
39% 40%
40% 40% 39%
35% 35%
31%
29%
30% 30% 27%
25% 25%
20% 20%
2005 2006 2007 2008 2009 2005 2006 2007 2008 2009
8
September 17, 2010
China's volume share of total apparel imports into the The trend in China's value share (of U.S. apparel
U.S. has increased >800bps since 1H08 imports) tells a similar story
40% 38.1% 40%

35.1%
35% 35%
30.0%
Volume Share (%)
30% 30% 27.5%
Value Share (%)

25% 25%
20% 20%
15% 15%
10% 10%
5% 5%
0% 0%
1H08 1H10 1H08 1H10
Besides, import statistics are also not likely to show meaningful geographic mix shifts for a few
months - as we expect sourcing price increases are only going to hit starting with the SS11 deliveries.
These should come into Europe and the USA in 4Q10 and 1Q11.
We anticipate apparel retailers will react with higher retail prices.
Analysis of retail price inflation in Europe suggests we are now back for a few months in a benign
inflationary environment for retailers. In the UK, apparel retail price inflation has moved to the positive
in Apr-09, has stayed at around 3.0% in 1H10, and has recently moved to 3.5% in Jul-10 – suggesting
disciplined end-of-season SS10 clearance behavior and GM% defense on the back of guarded sourcing
volumes (Exhibit 13). In Europe, we see that apparel retail price inflation has been close to flat in 1H10 at
c.-0.5% – in Italy, for example +0.3%, in Germany +0.7%, in France +0.4% (Exhibit 14 to Exhibit 17).
Exhibit 13
UK apparel retail price inflation turned positive in Apr-09 and has been c.3% in 1H10, suggesting disciplined end-of-
season SS10 clearance behavior and GM% defense on the back of guarded sourcing volumes
8.0%
6.0%
4.0%
Growth (yoy, %)
2.0%
0.0%
-2.0%
-4.0%
-6.0%
-8.0%
-10.0%
17-09-06
12-11-06
7-01-07
5-03-07
29-04-07
24-06-07
19-08-07
14-10-07
9-12-07
3-2-08
30-3-08
25-5-08
20-7-08
14-9-08
09-11-08
4-1-09
1-3-09
26-4-09
21-6-09
16-8-09
11-10-09
06-12-09
31-01-10
29-03-10
23-05-10
18-07-10
Source: Kantar (f.k.a. TNS), Bernstein Analysis
9
September 17, 2010
EU27 Consumer Prices – Clothing (Yoy growth, NSA) Italy Consumer Prices – Clothing (Yoy growth, NSA)
0.5% 3.0%
2.5%
EU27 Clothing Prices - Yoy Growth (%)
Italy Clothing Prices - Yoy Growth (%)

0.0% 2.0%
1.5%
1.0%
(0.5)%
0.5%
0.0%
(1.0)%
(0.5)%
(1.0)%
(1.5)% (1.5)%
(2.0)%
(2.0)% (2.5)%
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
Source: Eurostat, Haver, Bernstein Analysis Source: Eurostat, Haver, Bernstein Analysis
Note: Reflects 'Harmonized Index of Consumer Prices' Note: Reflects 'Harmonized Index of Consumer Prices'
Germany Consumer Prices – Clothing (Yoy growth, NSA) France Consumer Prices – Clothing (Yoy growth, NSA)
3.0% 3.0%
2.5% 2.5%
UK Clothing Prices - Yoy Growth (%)
UK Clothing Prices - Yoy Growth (%)
2.0% 2.0%
1.5% 1.5%
1.0% 1.0%
0.5% 0.5%
0.0% 0.0%
(0.5)% (0.5)%
(1.0)% (1.0)%
(1.5)% (1.5)%
(2.0)% (2.0)%
(2.5)% (2.5)%
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
Source: Eurostat, Haver, Bernstein Analysis Source: Eurostat, Haver, Bernstein Analysis
Note: Reflects 'Harmonized Index of Consumer Prices' Note: Reflects 'Harmonized Index of Consumer Prices'
Apparel retailers have already guided that they are planning to raise prices in the face of higher
sourcing costs and higher taxes down the road. Next, for example, has anticipated they would be
planning to increase prices c.8% next year. This comes on the expectation that the consumer demand
environment in the UK is likely to stay stagnant, and that price and margin sacrifices would not be
conducive to volume gains on the back of consumer price elasticity. H&M also suggested they may be
likely to raise prices – although they could consider moderating price increases if faced with the opportunity
to gain share.
10
September 17, 2010
We expect a more difficult sourcing environment will further accelerate a secular transition in
European apparel retailing.
This trend is particularly obvious in the UK, where we have one of the most advanced apparel
retailing environment. A new generation of value leaders – pure discounters like Primark and grocery
retailers like Asda and Tesco – are progressively squeezing the middle ground – while the fashion intensive
portion of the market is standing firm at 1/3 of the total, albeit with high churn among winners and losers.
Traditional retail channels, general stores, and department stores – encumbered with low productivity,
lower scale, higher costs and weaker consumer appeal – are losing ground (Exhibit 18 to Exhibit 20).
Exhibit 18
The Quantitative and Qualitative Development of Value Apparel Retailers is Squeezing the “Middle Ground” – The
Challenge for M&S and Next is to Retain Price Competitiveness and/or Improve Fashion Attractiveness
2001 2009
Differentiated Players, 33.4% Differentiated Players, 31.1%

- Clothing Multpiles - Clothing Multpiles
- Footwear Multiples - Footwear Multiples
Mass
Fashion River Island,
Top Shop, Monsoon,
H&M, Zara, etc.
Next Marks & Spencer Next Marks & Spencer

3.9% 11.1% 5.1% 10.4%
Multi Category Stores, 13.6%

Multi Category Stores, 10.1%
- - Department Stores
- Department Stores
- General Stores
- General Stores
Middle
Traditional Channels, 22.6%
Ground - Clothing & Footwear Independents
Traditional Channels, 27.6%
- Clothing & Footwear Independents - Traditional mail order
- Traditional mail order - Market Salls
- Market Salls
Value Leaders, 20.8%

- Supermarkets
- Pure Discounters
Value Leaders, 10.4%
Value - Supermarkets Tesco, Asda,
Leaders - Pure Discounters Primark, etc.
Source: Bernstein Analysis
11
September 17, 2010
Within the UK, grocers have gained material share of the Leading specialist discounters such as Primark have
apparel market also experienced significant share increases
9.0% 8.8% 5.0% 4.8%

8.6%
Primark - UK Clothing Market Share

Grocer - UK Clothing Market Share
4.4%
8.5% 4.5%
8.0%
3.9%
8.0% 4.0%
7.6%
7.5% 7.3% 3.5% 3.2%
7.0% 6.7% 6.7% 3.0% 2.7%
6.5% 2.5% 2.3%
6.0% 2.0%
5.5% 1.5%
5.0% 1.0%
2004 2005 2006 2007 2008 2009 2010e 2004 2005 2006 2007 2008 2009
Source: Verdict, Bernstein Analysis & Estimates Source: Verdict, Bernstein Analysis
We expect value players will take the opportunity to increase their price leader advantage, to flex
their sourcing muscle and to push the middle ground harder. This is likely to be more relevant in the
UK short-term, where value leaders are already well developed, but should just further increase the
medium-term opportunity for material apparel discount development in continental Europe (please see our
reports UK Retail: Supermarkets and Non-Food - Part 1: The Rising Role of Supermarkets in UK Apparel
Retailing and European Apparel: The Opportunity for Apparel Discounting in Europe, Part 2, published on
04-Jun-10 and 15-Jul-10, respectively) – see Exhibit 21 and Exhibit 22. The onus on middle ground
players to shape-up becomes even more urgent. We would welcome a move by M&S to accelerate its direct
sourcing and supply chain rationalization plans in this context.
12
September 17, 2010
The UK seems most penetrated by discount players vs. Using discount penetration in UK A&F as a guide, we
other key European markets estimate the blank opportunity could be c.€10bn
300 Add'l
25% 23% Immed.
European Discount Apparel Market
10 Opport.
21% Discount
250
EU A&F Market Value ('09, €bn)

20% 18% (21%) 48 Current
200
15%
12%
150
276
10% 8%
218
100
Non-Discount
5% (80% )
50
0%
UK France Germany Spain Italy 0
Total A&F Split
Source: Verdict, Company Reports, Bernstein Analysis Source: CIA World Factbook, Verdict, Bernstein Analysis & Estimates
Note: Verdict aggregates some smaller brands which may not be considered
pure discounters.
We also expect that leading mass fashion retailers such as ITX and H&M should be advantaged in
this situation. Inditex is less exposed to Asia and is not experiencing sourcing price inflation in its
proximity locations - this should mute the effect of higher prices in Asia alone. Both Inditex and H&M
enjoy significant scale - both globally, with sourcing operations worldwide and within each sourcing market
– they should therefore be best equipped and most proactive in managing the adverse sourcing
environment: (a) shifting their geo sourcing mix, (b) flexing their higher bargaining power.
It is also clear that further continuing GM% gains as we have seen from mass fashion players are not
on the cards going forward.
Both ITX and HMB have managed to increase their GM% substantially in the past 12 years,
achieving 830bps and 1,082bps GM% expansion respectively (Exhibit 23 and Exhibit 24). Higher GM%
and lower tax rates have been the two most important drivers of ROIC improvement, as we have shown in
our report European Apparel Retailing: History and Opportunities for Capital Efficiency, published on 30-
Nov-09. GM% gains have been achieved in a competitive retail environment – where other players were
obviously experiencing the same favorable FX and sourcing trends – hence also depend on company-
specific actions. But there is no doubt that a falling USD and expanding sourcing base in China have helped
the mass fashion players and the industry.
13
September 17, 2010
Inditex has increased its GM% by >800bps since '97 H&M has experienced an even greater GM% boost at
c.1,080bps
Inditex H&M +1,082 bps ('97

64% 64% to '09)
62% 62% 62% 62%

+830 bps 61%
('97 to '09) 59%
60% 60% 59%
58% 57% 58% 57%

57% 57%
56% 56% 56%
Gross Margin (%)
Gross Margin (%)

56% 56% 55%
54% 54% 54% 53%

52% 52%
52% 51% 51% 52% 52%
51% 51% 51%
50% 50%
50% 50%
49%
48% 48%
46% 46%
44% 44%
97
98
99
00
01
02
03
04
05
06
07
08
09
97
98
99
00
01
02
03
04
05
06
07
08
09
19
19
19
20
20
20
20
20
20
20
20
20
20
19
19
19
20
20
20
20
20
20
20
20
20
20
Source: Company Reports, Bernstein Analysis Source: Company Reports, Bernstein Analysis
We expect sourcing opportunities to continue to expand, as apparel manufacturing remains a low

tech / low capex industry with very low barrier to entry. Having said that, the current juncture is likely
to bring GM% headwinds, as subdued demand trends in developed markets combine with rising demand in
EMs and higher manufacturing costs in China. SG&A cost control and space growth are likely to stand up
as the key earnings growth drivers going forward, with GM% expansion providing neutral or negative
contribution, unlike in the '01-'09 period (Exhibit 25 and Exhibit 26).
Inditex: Drivers of net earnings growth, '09 vs. '01, £m H&M: Drivers of net earnings growth, '09 vs. '01, £m
2,000 20,000 46% -20%

35% -36%
1,800 18,000 -2% 3%
1,600 7% 16,000
75% 75%
1,400 14,000
SEK Million
1,200 12,000
€ Million
1,000 10,000
800 8,000
19%
600 6,000 -1%
400 4,000
200 2,000
0 0
LFL Growth
Growth
Gross Margin
Expenses
Operating
Other
Earnings
Earnings
LFL Growth
Growth
Gross Margin
Expenses
Tax
Operating
Earnings
Earnings
Interest
Space
Space
2001
2009
2001
2009
Source: Company Reports, Bernstein Analysis Source: Company Reports, Bernstein Analysis
14
Cotton Spot Price in China -
Wool Prices in China - Cotton 328 Grade - US$/kg
Domestic Wool Top 66S - US$/Kg
Exhibit 29
Exhibit 27
6
7
8
9
10
11
12
1.4
1.6
1.8
2
2.2
2.4
2.6
2.8
Jan-06 Jan-06
Apr-06 Apr-06
Jul-06 Jul-06
Oct-06 Oct-06
Jan-07
Jan-07
Apr-07
Apr-07
Jul-07
Jul-07 Oct-07
Oct-07 Jan-08
Apr-08

Jan-08
Apr-08 Jul-08
Jul-08 Oct-08
Appendix – Raw Material Price Detail
Jan-09
Oct-08
Apr-09
Jan-09
Jul-09
Apr-09 Oct-09
Jul-09 Jan-10
Cotton Spot Price in China – 328 Grade (US$/Kilo)
Oct-09 Apr-10
Jul-10
Wool Prices in Nanjing – Domestic Top 66S (US$/Kilo)

Jan-10
Cotton Spot Price in Pakistan -

Nylon Filament Prices in China,
Cotton Grade 3 - US Cents / lb.
US$/kg
Exhibit 30
Exhibit 28
2.5
2.7
2.9
3.1
3.3
3.5
3.7
3.9
4.1
4.3
4.5
40
45
50
55
60
65
70
75
80
85
90
95
100
Jan-06 Jan-06
Apr-06 Apr-06
Jul-06 Jul-06
Luca Solca (Senior Analyst)
Oct-06 Oct-06
Jan-07 Jan-07
Apr-07 Apr-07
Jul-07 Jul-07
Oct-07 Oct-07
Jan-08 Jan-08

Apr-08 Apr-08
Jul-08 Jul-08
Oct-08 Oct-08
Jan-09 Jan-09
Nylon Filament Prices in China – US$/Kilo
Apr-09
Apr-09
Jul-09
Jul-09
Oct-09
Oct-09
Jan-10
Jan-10
Apr-10
Apr-10
Jul-10
Cotton Spot Price in Pakistan – Grade 3 (US Cent / lb.)
Jul-10
15
September 17, 2010
• luca.solca@bernstein.com • +44-207-170-5008
Polyester Prices in China (PSF 1.4D/38mm)
Spandex Prices in China,
USD $ / kg
US$/kg
Exhibit 33
Exhibit 31
1
2
0.5
0.75
1.25
1.5
1.75
2.5
3.5
4.5
5.5
6.5
7.5
8.5
9.5
10.5
11.5
Jan-06 Jan-06 12.5
Apr-06 Apr-06
Jul-06 Jul-06
Oct-06 Oct-06
Jan-07 Jan-07
Apr-07 Apr-07
Jul-07 Jul-07
Oct-07 Oct-07
Jan-08 Jan-08

Apr-08 Apr-08
Jul-08
Spandex Prices in China – US$/Kilo
Jul-08
Polyester Prices in China – US$/Kilo

Oct-08 Oct-08
Jan-09 Jan-09
Apr-09 Apr-09
Jul-09 Jul-09
Oct-09 Oct-09
Jan-10 Jan-10
Apr-10 Apr-10
Jul-10 Jul-10
Viscose Filament Prices in China,

US$/kg
Exhibit 32
3.5
3.7
3.9
4.1
4.3
4.5
4.7
4.9
5.1
5.3
5.5
Apr-06
Jul-06
Oct-06
Luca Solca (Senior Analyst)
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Viscose Filament Prices in China – US$/Kilo
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
16
September 17, 2010
• luca.solca@bernstein.com • +44-207-170-5008
September 17, 2010
Disclosure Appendix
Valuation Methodology
We establish price targets for companies in our coverage by applying a target relative P/FE multiple (vs.
MSCI index) to our forecast estimates, assuming a constant market P/FE multiple. We use 10E and 11E
EPS estimates and MSCI P/FE multiples.
We rate Inditex outperform – we use a relative target multiple of 1.75x and obtain a target price of €60. We
rate H&M outperform and use a relative target multiple of 1.75x vs. MSCI and thus obtain our price target
of SEK 275.
We rate M&S outperform with a price target of 410p by using a target relative price earnings multiple of
1.1x. We rate Next market-perform and target a relative market multiple of 1.0x, yielding a TP of 2,300p.
Risks
Inditex
A risk to our Inditex price target could come from a subdued consumer and demand environment. Slower
demand would reflect in weaker like-for-like growth. This, in turn, would negatively affect both the
opportunity to contain SG&A cost development further and achieve gross-margin expansion. Such a
development would be even more negative, were it to appear in Inditex’s domestic market, where Inditex
remains largely exposed with 32% of sales. While the Spanish macro has deteriorated, we see that weakness
in Spain seems to be priced in at this point, at least judging from our long-term LFL growth to relative PEF
regressions.
Continuing “wide front” international expansion at Inditex — deviating from an expansion focus into
Europe (the new “domestic” market for Inditex) and selected Asian markets — would increase SG&A cost
inflation pressure as well as the risk on our outperform stance. Transition in senior management roles seems
now successful and established, reducing organization risk. Continuing broad market or sector-specific
corrections could pose additional risk on the high Inditex multiple implied in our target price, especially in
the face of further bad news in the financial services sector.
H&M
We see downside risks to our current investment stance. Weak LFL development could put a strain on
SG&A, which has traditionally been managed with high discipline. H&M has increased the fashion content
and the "intangible" value of its collections; this entails a higher fashion risk, in our opinion: a collection
‘miss’ from low customer appeal of celebrity designers could increase mark-downs, weighing on LFL
development and gross margin. The comparables to the Madonna collection in 1H08 seem particularly
steep. To this, one should add execution glitches and teething problems of the new COS format, which is
now seemingly credited to succeed by the market, but remains very small in absolute terms.
17
September 17, 2010
M&S
We would see downward risk to our recommendation in case LFL growth remains subdued or in negative
territory. The shape of UK consumer demand in 10e will be of the essence, as we have shown that apparel
retailers' relative share price performance tends to be aligned to LFL growth. If the new CEO settles on a
plan with too much emphasis on growth and capex after his strategy review, this would also be regarded as
a negative.
Next
From a more secular viewpoint, investing in Next requires a positive view on its ability to increase
consumers' perceived value, as Next tries to trade up and defend margins. This is a sensible strategic goal,
considering the incessant growth of value retailers like Tesco, Asda, and Primark. Customer appreciation of
the new collections is only beginning to emerge. While early signs indicate consumer willingness to "trade
up" and buy into new, higher priced Next products, the Signature collection remains a small portion of total
sales (c.3-4%) and does not seem enough to offset for Next the broader, contingent slow-down in UK
apparel demand. Continuing lackluster top line progress could hamper Next’s ability to meet revenue and
margin expectations, forcing it to cut prices (and margins) to stem market share decline down the road.
18
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represent the percentage of companies in each category to whom Bernstein provided investment banking services within the last twelve
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 Accounts over which Bernstein and/or their affiliates exercise investment discretion own more than 1% of the outstanding common stock of
the following companies MKS.LN / Marks & Spencer Group PLC.
 An affiliate of Bernstein received compensation for non-investment banking-securities related services from the following companies
MKS.LN / Marks & Spencer Group PLC.
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from ITX.SM / Inditex SA, HMB.SS / Hennes & Mauritz AB, MKS.LN / Marks & Spencer Group PLC, NXT.LN / Next PLC.
12-Month Rating History as of 09/16/2010
Ticker Rating Changes
HMB.SS O (RC) 06/23/10 M (RC) 01/29/07
ITX.SM O (RC) 03/26/07
MKS.LN O (RC) 05/19/10 M (RC) 10/16/09 O (RC) 09/03/09
NXT.LN M (IC) 05/26/06
Rating Guide: O - Outperform, M - Market-Perform, U - Underperform, N - Not Rated

Rating Actions: IC - Initiated Coverage, DC - Dropped Coverage, RC - Rating Change
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Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

European Apparel Retail: Gauging the Impact of a More

16/09/2010 TTM EPS P/E

O – Outperform, M – Market-Perform, U – Underperform, N – Not Rated

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

apparel discount development in continental Europe.

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Cotton Spot Price in China 2.4% 6.5% (0.3)% 25.3%

Source: Emerging Textiles, Bernstein Analysis

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

4.5% China: PPI: Textile Industry

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Textile Minimum Wage - Bangladesh ($/month)

Source: BBC, Oanda, Wikipedia, Bernstein Analysis

From World From China

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Sourcing CCY vs. EUR Sourcing CCY vs. GBP

Source: Factset, Bernstein Analysis

Woven Clothing Knitted Clothing

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

40% 38.1% 40%

30% 30% 27.5%

Value Share (%)

Source: Kantar (f.k.a. TNS), Bernstein Analysis

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Italy Clothing Prices - Yoy Growth (%)

UK Clothing Prices - Yoy Growth (%)

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Differentiated Players, 33.4% Differentiated Players, 31.1%

Next Marks & Spencer Next Marks & Spencer

Multi Category Stores, 13.6%

Value Leaders, 20.8%

Source: Bernstein Analysis

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

9.0% 8.8% 5.0% 4.8%

Primark - UK Clothing Market Share

7.0% 6.7% 6.7% 3.0% 2.7%

6.5% 2.5% 2.3%

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

EU A&F Market Value ('09, €bn)

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Inditex H&M +1,082 bps ('97

62% 62% 62% 62%

58% 57% 58% 57%

Gross Margin (%)

54% 54% 54% 53%

We expect sourcing opportunities to continue to expand, as apparel manufacturing remains a low

2,000 20,000 46% -20%

Source: Emerging Textiles, Bernstein Analysis

Wool Prices in Nanjing – Domestic Top 66S (US$/Kilo)

Cotton Spot Price in Pakistan -

Source: Emerging Textiles, Bernstein Analysis

Source: Emerging Textiles, Bernstein Analysis

Polyester Prices in China – US$/Kilo

Viscose Filament Prices in China,

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Luca Solca (Senior Analyst) • luca.solca@bernstein.com • +44-207-170-5008

Rating Guide: O - Outperform, M - Market-Perform, U - Underperform, N - Not Rated

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