Here's why you should avoid owning Zegna shares: Morgan Stanley

Investing.com -- Morgan Stanley (NYSE:MS ) analysts have urged investors to take a cautious stance on Ermenegildo Zegna's (NYSE:ZGN ) stock, assigning the company a "relative underweight" rating. 

With a price target of $7.20—representing a slight downside from its current $7.39—analysts point to several challenges that could hinder Zegna’s performance in the near to medium term. 

Despite its reputation as a heritage luxury brand, Zegna faces structural, strategic, and market-specific obstacles that make its shares less attractive in the current environment.

Zegna’s heavy reliance on Chinese consumers is among the most significant risks outlined by Morgan Stanley. The group derives more than 35% of its revenue from Chinese nationals, a figure much higher than its peers. 

This dependence has proven problematic as the luxury market in China continues to recover slowly. While competitors like LVMH managed modest gains in the region, Zegna's underperformance—reporting consistent declines in key segments this year—highlights the fragility of its position.

The company is undergoing a major strategic overhaul, realigning its three primary brands—Zegna, Thom Browne, and Tom Ford (NYSE:F ). 

While this initiative holds potential for long-term growth, it demands significant upfront investments in marketing, retail expansion, and operational improvements. 

Such expenditures come at a time when global luxury demand is facing headwinds, amplifying the risks of execution missteps.

Thom Browne, known for its niche appeal and "shrunken suit" style, has been a growth driver for Zegna in recent years. However, as the brand matures, its momentum is slowing, and its ability to scale further may be limited. 

Similarly, Zegna’s acquisition of Tom Ford’s fashion business in 2023 is not expected to yield profits until at least 2026. These challenges place further strain on Zegna’s financial performance, particularly in a soft luxury market.

Morgan Stanley also flags Zegna's dependence on its Triple Stitch shoe line, which has been the primary growth driver for its core Zegna brand. The Triple Stitch accounted for 75% of Zegna’s growth between 2019 and 2023 and is projected to contribute significantly to 2024 growth as well. However, this reliance poses risks, as any decline in the product’s popularity could leave a significant gap in the company’s performance.

The luxury group’s push to expand its direct-to-consumer business and retail network requires significant spending on personnel and marketing. Combined with inflationary pressures, these investments are likely to weigh on margins in the short term. 

Zegna’s EBITDA margins, already trailing industry leaders like Hermès, face further pressure as it lays the groundwork for its strategic transformation.

At 19x projected 2025 earnings, Zegna trades in line with the sector average. However, Morgan Stanley notes that this valuation leaves little room for upside, especially when compared to peers such as Hermès, Prada (OTC:PRDSY ), and LVMH, which offer stronger growth prospects and fewer execution risks. 

Analysts caution that Zegna's ability to sustain or improve its valuation depends on flawless execution of its strategy—a tall order given the current challenges.

Morgan Stanley’s estimates for Zegna’s EBIT in 2025 and 2026 fall 5.5% and 7.7% below consensus, reflecting expectations of slower top-line growth and constrained margins. 

With anticipated sales growth of just 3.8% between 2024 and 2027—well below the industry average—Zegna is unlikely to attract significant investor enthusiasm.

Source: Investing.com