Boohoo Plunges on Latest Profit Warning; Pressure on Margins

Boohoo Profit Warning: Shares in fast fashion retailer Boohoo (LON:BOO) fell to new multi-year lows today as the latest guidance revealed that profits would miss forecasts. This perhaps came as no surprise as many retailers have been struggling. Studio Retail, AO World, and Joules have all warned recently. However, BOO is the largest of these companies and attracts a large private investor following. The chart makes grim reading:

This was one of the pandemic’s big winners as the share price soared to over 400p in 2020. Factors behind this were that shops were closed, and people had more disposable income. However since then the newsflow has almost entirely been bad for the company. Some of this is quite general; for example increased shipping costs. But some is quite specific: for example governance scandals involving sweatshops in Leicester, and the questions of who their acquisition benefited. More lately there have been worries about the under-the-radar rise of Shein, a direct competitor to international sales.

The fall in share price has been spectacular if we also consider that on this timeframe dilution has been fairly minimal (c.10%) and that no dividends have been paid in this time either.

What did the Boohoo profit warning say? 

This comes in a trading update. Their trading year ends on 28 February, so covers the period to the end of November. We get straight into it:

Boohoo has seen gross demand growth in the Period exceed that achieved in each
of the first and second quarters of the financial year, however expectations
for the financial year ending 28 February 2022 will be lower than previously
guided. This is as a consequence of significantly higher returns rates
impacting net sales growth and costs, with continued disruption to our
international delivery proposition impacting international demand, and
significant ongoing pandemic-related cost inflation.

There is a lot to pick out here. Returns are a pain for these businesses as they are basically paying shipping two ways and gain no revenue. But this is a cost of doing business. Reasons why they could be higher could be poor execution by the business; it should be expected that a cheaper business like BOO may have lower returns rates.

The international sales are more of a problem. Here we see strong growth in the UK (32%) offset by Europe (-12%), Rest of the World (-21%) and the US (-14%). BOO are using the word of the moment here:

It is the view of the board that the factors currently negatively impacting
the business are primarily related to the ongoing impact of the pandemic and
are, therefore, transient in nature.

This may prove to be optimistic. But the effects of this have hit the business in a big way:

Adjusted EBITDA margin for the year is expected to be 6% to 7%, compared to
previous guidance of 9% to 9.5%, implying adjusted EBITDA of between £117
million to £139 million.

In some respects this may have been predictable. Brokers have downgraded their forecasts as a result. However the range is still quite wide here, and indicates that much depends on Christmas trading. With the Omicron variant in the UK decimating the social scene for the very immediate future this may be another headwind.

Boohoo: The Business

Notwithstanding the issues the growth seen at Boohoo has been spectacular. Only opened in 2006, the company could be said to be one of the pioneers of the ‘disposable’ clothing trend. It sold own brand clothes at extremely cheap prices. Cheap clothes are nothing new, but the additional overlay of marketing added a degree of desirability to their products. They were one of the first companies using social media ‘influencers’ to promote goods, a practice that is now widespread.

At the outset there were very few competitors in the market. Primark were still much smaller, and competitor ASOS also dealt more in branded goods. This allowed Boohoo to have a large cost advantage over many mid-priced players such as Zara or Next.

However most of the growth has only come recently, since the company IPO’d:

There are probably few other businesses which have grown revenue by 10 times in the last 6 years. And up to the pandemic at least, these profits came at very good margins. With capital expenses much below that of the cash generated, and with no dividends to pay the cash started to build.

In recent times this cash has been used for several things. The main one was acquisitions. Boohoo became a buyer of other businesses, primarily the mid-market brands that it helped to destroy. Debenhams, Arcadia Group, Karen Millen, Oasis and Warehouse were previous high-street staples. In each case they were bought out just before they collapsed at rock-bottom prices. Their brands live on, but their shops do not.

More contentious was the acquisition of PrettyLittleThing; this business was co-owner by Boohoo founder Umar Kamani and his brother. At a headline £324m, this was the biggest deal by far but questions remained if shareholders got the greatest use of this cash. After 2020 the company does not report PLT results as a separate segment, concentrating now on geography.

International Woes

Another issue is that the company does not break down international costs, relying on something like this:

It is clear that the USA is the most important overseas market. Revenue of £435.1m is over 10 times what it was in 2017 (£40.1m). However, times have changed a little, especially with respect to competitors Shein and ASOS which do have distribution facilities. The timelag was never bad – a Boohoo delivery could get to the US in 3-4 working days if one paid for Express shipping. But with shipping logistics stretched, these kind of times may be harder to achieve. Another factor is that with costs up, returns get more expensive to process as the ship cost is paid both ways. Typically clothes have a very high returns rate. With Boohoo selling cheaper clothes a slight uptick in returns could affect profits strongly.

Most of these problems can be gotten around with making distribution centres in different countries. But this is an expensive undertaking and is a source of competitive advantage for retailers such as Amazon. Boohoo assert that these works are underway and should be complete by 2023. This seems quite a long way off considering that the US was an important market for some time.

All this has an effect on cash. As mentioned, Boohoo’s cash levels had been increasing but a string of acquisitions have depleted this. The company also has purchased a Soho-based head office for £72m. After many years of cash generation it seems as if we will now have a period where that cash is now eaten up. The broker note shows cash dipping to £137m in 2022 before recovering.

Is the Boohoo profit warning a buying opportunity? 

It seems strange that the prospects for the business have deteriorated so quickly. But it is true that the Boohoo of 2019 is not the Boohoo of 2021. Whilst they may be right that some of the factors are transitory, the emergence of Shein appears to be an elephant in the room nobody wishes to discuss. This company is mooted for a $47bn IPO in New York, which puts it at many times the size of Boohoo. By 2023 it may well be too late, and the result being a UK company without the necessary impact or expertise to outfight bigger domestic names.

However, this must also be put alongside the share price, which is at new lows. The UK is the main market and is still growing at a very quick rate. Other brands which used to be good may also be continued to be bought out – French Connection, Ted Baker, Superdry for instance. With Primark declining to get involved online, there is nothing to say that Boohoo could continue to dominate.

Zeus go for a target price of 286.5p which I think is a tad high. I don’t disagree that there is good upside if things can work out, but also going against that I think the chances of becoming a true global player have receeded. The continued corporate governance issues and stale bulls I also think will give downward pressure, so it may be a long time before anything happens. You could not rule out even more bad news coming if Christmas is poor, but the strong UK growth offers some protection. 3/5.

Leave a Reply