When a retailer’s profits nosedive by half, alarm bells would usually sound. But Zara is an unusual retailer.

When Zara, one of the UK high street’s most formidable operators, posted a 57% slump in pre-tax profits across its UK business in the year to January 31, a sharp intake of breath seemed, on the surface, entirely warranted.

But do spiralling profits mean Zara is struggling in the UK?

To answer, this we have to look at the reason behind this profit plunge.

Zara Westfield London fascia

Zara has invested in store upgrades across the UK

It’s certainly not down to dwindling sales. Despite a stagnant fashion market in the UK, Zara managed to notch up an impressive 10% rise in revenue to £772.5m over the past year.

The retailer says its bottom line slumped because of a 7% rise to a whopping £312m in what it terms “selling and distribution costs”. The bulk of this stems from its investment in store upgrades in Brighton, Oxford, Leicester and, most significantly, London Westfield Stratford, which opened last May and boasts automated order and collection points and a self-checkout area.

The store has been heralded as a blueprint for Zara’s ambitions for its 63-strong UK store estate. The fashion retailer has also flagged that it will continue to open stores, which means this drag on profitability is unlikely to end soon.

But does that matter?

Retail analyst Richard Hyman says in the increasingly difficult UK market, few brands are growing profits. 

He explains: “We’ve entered a period that will determine the next generation of how retail looks. I think that there are far too many mouths to feed, we have to see a big shake out, so the important thing is to exit this period [of volatile trading] in a competitively stronger position than you entered it, and Zara will be in a competitively stronger position. A fall in profitability doesn’t really matter very much. If they are struggling in this market, God help anyone else.”

During these challenging times, Hyman says sales growth is more representative of a business’ strength.

“The key thing when you look at performance in the UK in this market is the top line performance, which continues to be very strong [for Zara],” he says, pointing out that it is outshining rivals such as Topshop, H&M and River Island in the UK.

“People have to stop judging a company’s performance against that same company’s historic performance, and judge it next to their peer group,” he says. “Nobody is going to be able to deliver the kind of trading performance they have previously in this market.”

Hyman also believes Zara’s decision to continue to invest in upgrading its existing store estate is a savvy one – even if it does result in a drag on the bottom line for Companies House filings.

“The important thing is to exit this difficult period in UK retail in a competitively stronger position than you entered it, and Zara’s investments mean it will be in a competitively stronger position. Against that, a fall in profitability doesn’t really matter very much,” says Hyman. 

Still on trend

What is crucial is that Zara has strong brand equity and is creating products that shoppers want.

The fashion retailer is the brand of the moment. This summer you seemingly couldn’t walk 100 metres in London without spotting the black and white spotted Zara dress. So popular was the dress that it has even spawned a dedicated Instagram account for photos of people spotted in it.

This is a business that knows how to identify trends and appeals to price-conscious shoppers across age and size ranges.

A common refrain from industry experts is the UK is also a very small puzzle piece in what is a much larger jigsaw of Inditex’s operations. Only 63 of Zara’s 2,123 stores are on UK shores.

Unlike a business that relies primarily on the troubled UK market for growth, Inditex can drive sales and profit growth via a number of different markets and fascias.

The retail group recorded a 5% uplift in like-for-like sales across the group in the six months to July 31, 2019, while net income increased 10% to €1.5bn (£1.3bn) and EBITDA rose 48% to €3.4bn (£2.9bn) on an IFRS 16 adjusted basis.

With this engine behind it, Zara’s UK division can afford to weather the bracing UK storm and continue to invest in stores – even if it means its bottom line doesn’t make for pretty reading.