Big upgrade for ASOS

"We're all looking for our own ASOS" an investor told me recently at a company presentation in the City. It's true: the AIM darling has shot the lights out since its IPO in 2001 and patient investors have made a mighty dime. But it's not too late to make even more on the online retailer if UBS is correct.

Operating in an ultra-competitive and fast-paced industry, ASOS has earmarked a chunk of its margin for the next few years to reinvest for growth. This has moderated its recovery, and boohoo.com has outperformed in terms of share price this past year. But UBS now believes ASOS is undervalued.

With its price investment and delivery options paving the way for 22% average sales growth over the next three years, earnings per share is tipped to rise by 20-25% for the next five years.

UBS analyst Adam Cochrane reckons operating profit margin will remain at 4-5% until 2020, as profits are reinvested into its digital platform, pricing and product offer. As its warehouse capacity improves and advertising costs are amortised over the longer-term, a 7% target is possible.

Clearly confident, Cochrane has upgraded his target price from 4,450p to 5,500p, implying 15% upside from here. The shares, which currently enjoy support at the 50% Fibonacci retracement level from the February 2014 record high, trade on a forward enterprise value/sales multiple of 2.2 times. For Amazon it's 3.2 times.

Moving away from simply aggregating brands on an online retail platform, ASOS is becoming an online fast fashion play. Ensuring that its range can adapt to changing trends and weather, the group now sources between 20-30% of its products on shorter timeframes. The investment into its technology platform is offering customers a more tailored and user friendly offer. This has all been welcomed by those in the City.

"In terms of increasing differentiation we think this is a very sensible strategy and improves sustainability of profit growth via higher barriers to entry as well as capturing a larger part of the online market," says Cochrane. "In our view this increased sustainability should be rewarded with a higher valuation."

With its high valuation typical of high-growth, fledgling sectors, ASOS hasn't been regarded as cheap for a long time. The group currently trades on 82 times forward earnings, a premium to its fellow internet retailer Boohoo, on a price/earnings (PE) multiple of 60 times.

Before ASOS embarked on its self-help investment programme, its share price doubled in 2013 as investors saw momentum leading to higher margins and sales.

However, the shares quickly collapsed by three-quarters as the retailer shifted its priorities to long-term stability. The road to recovery has been slow, but ASOS is much less of a risk play today.

"In our view management now has better operational risk controls and has been more disciplined about its guidance so there is reduced earnings expectations risk," says Cochrane.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.