Will Boohoo shares recover?

It has been a tumultuous month for Boohoo.

The online fast fashion house saw its shares climb to a record high at the end of June, driven by the company’s lean and agile business model that has continued to perform well during the coronavirus crisis.

It has been able to quickly respond to pandemic-induced trends, such as the switch in demand from eveningwear and holiday clothing to tracksuits and other loungewear. Its youthful customer base has continued to spend, and its online-only model has thrived whilst traditional retailers on the high street are struggling to survive.

Despite experiencing a marked drop in demand when lockdown was introduced, it quickly returned to growth by the end of April and that seems to have only continued to improve. Revenue in the three months to the end of May shot up 45% - delivering solid double-digit growth across all its geographies and established brands.

But Boohoo shares lost nearly half of their value between 30 June and 15 July, rocked by allegations that its low-cost model is underpinned by a troublesome supply chain. Shares have recovered some of their value but are still trading over one-third less than the all-time high. It has been enough to knock Boohoo off its perch as the most valuable company listed on AIM, and the fact that it lost the title to rival ASOS makes it all the more hurtful.

Read more: Boohoo shares tumble after allegations against its suppliers

We have a look at the allegations that have injected volatility into Boohoo shares and what the long-term impact may be, as well as a look at whether the sell-off in Boohoo shares has been overdone.

Boohoo’s supply chain comes under scrutiny

Boohoo’s supply chain has come under severe scrutiny after reports from The Sunday Times suggested a garment factory in Leicester that supplies Boohoo’s Nasty Gal brand was paying staff below minimum wage and not adhering to lockdown rules.

The paper sent in an undercover reporter that said the factory had continued to operate when the city was put into a local lockdown, all without any additional measures taken to protect to staff. It was then argued that this could have contributed to the rise in cases in the area. The reporter was also told to ‘expect £3.50 an hour’, well below the minimum wage of £8.72 for over-25s. Other media outlets reported that some furloughed workers were being told they would not receive their government support if they didn’t continue to work.

Boohoo launches lengthy investigation into its UK supply chain

Boohoo responded by stating it was ‘shocked and appalled by the recent allegations’, adding it was ‘committed to doing everything in our power to rebuild the reputation of the textile manufacturing industry in Leicester’.

One of the reasons Boohoo is able to keep costs down is because it designs its own clothing but outsources the manufacturing. In terms of assets, it has two major distribution centres that it uses to ship its products around the UK and the world. This means it makes sense for the company to source clothing made close to home, and around 40% of its products are made in the UK, which it argues protects thousands of jobs that would otherwise be lost to cheaper foreign workers abroad.

Leicester is the country’s hub for garment making and Boohoo is thought to be its biggest customer. A report by Labour Behind The Label, which campaigns for garment workers’ rights around the world, said Boohoo was ordering up to 400,000 units from Leicester per week during lockdown in April, up from 120,000 in a ‘normal’ week. This is thought to account for up to 80% of Leicester’s entire capacity, which is met through a number of small factories.

Boohoo has tried to add some clarity to the situation. It said the company subject to media reports was not a ‘direct supplier’, meaning it was a company that was used by one of its own suppliers. It said the garments were not made in the UK but in Morocco, and were simply being repackaged in Leicester so they could be sold in the UK. It also said that its ‘investigation to date has not found evidence of suppliers paying workers £3.50 per hour’.

Those claims have, so far, held up. No less than seven different UK authorities – ranging from anti-slavery and immigration to the police and the council – found no foul play in their initial round of investigations, but we can expect more surprise inspections going forward.

Plus, it has already attracted the attention of politicians, who have pledged to clean up Leicester’s garment industry, where concerns over conditions have been rife for years. Home secretary Priti Patel said the claims were ‘truly appalling’ and said the government was committed to stamping out malpractice.

Boohoo said it would not hesitate to end its relationships with any suppliers that were not meeting its code of conduct, and that this ‘includes very clear expectations on transparency about second tier suppliers.’

It has launched an independent review of its UK supply chain which will be led by Alison Levitt QC and committed £10 million to ‘eradicate supply chain malpractice’. It has also accelerated its review of its third-party supply chain and its ethical audit.

The investigation will not be quick, which means this issue will linger over Boohoo for at least the rest of this year. It will set out the scope of the review by the end of July, but said it intends to provide updates when it releases its interim results in September, and again when it publishes a trading update for its ‘peak’ trading season in January 2021.

It then intends to inform shareholders about how it will ensure Boohoo is sustainable when it releases its annual results in April or May 2021. That suggests its supply chain will be under the spotlight for some time.

How damaging will the investigation be?

The problem for Boohoo is that investors have become concerned that its low-cost, fast fashion model is underpinned by underpaid workers that are treated unfairly. We won’t know how true this is – if at all – until the investigation starts to give us some answers.

But, regardless, this has highlighted a major problem for Boohoo and other fashion firms. The fact Boohoo said it was ‘shocked’ by the situation shows how opaque its supply chain is. Boohoo concerns itself with its ‘direct suppliers’ – those that supply the end product – but not the other businesses used by those suppliers. It has highlighted the need for greater transparency in the supply chain, and that will have to become a top priority for Boohoo if it wants to assure investors.

The Conservative chair of the Environmental Audit Committee, Philip Dunne, sent a letter to Boohoo’s co-founders Mahmud Kamani and Carol Kane that said it was ‘shameful’ Boohoo didn’t know what was going on. ‘It is incredible that, over a year since the committee highlighted illegal working practices in its supply chain, Boohoo has publicly denied any knowledge of what has been happening for years,’ he said.

The letter also accused Boohoo of being ‘unwilling to engage with trade unions’ and the Ethical Trading Initiative (ETI), which is an independent body that promotes workers’ rights. ‘Last year Boohoo told us that it was going to join the ETI. We note it has not done so. It is shameful that it took a pandemic and the ensuing outrage about working practices in their supply chain for Boohoo finally to be taken to task for turning a blind eye,’ said Dunne.

For now, the damage is being done to its reputation. That hasn’t been helped by the fact it said it would pay up to £150 million in bonuses to its board and founders so soon after accusations that factory workers are being grossly underpaid came to light. The fact the bonuses are only based on the company’s share price performance – rather than the business itself – has also raised eyebrows.

Some of its major shareholders have flagged concerns. Jupiter Asset Management, the second largest shareholder in Boohoo behind co-founder Kamani, actually raised its stake in the business after the allegations were made to capitalise on the slump in its share price. But Standard Life Aberdeen, apparently not convinced, was reported to have dumped almost all of its stock in Boohoo just days after the allegations were made.

Boohoo’s wholesale business has also been hit after a number of retailers, including rivals ASOS, Next and Zalando, all pressed pause on buying Boohoo’s clothing until they get clarity over the situation. However, the wholesale division accounts for just 4% of Boohoo’s annual revenues, and just 1.4% of sales in the first quarter, so this loss is highly manageable.

The fashion industry being accused of dodgy supply chains is nothing new, but the fact Boohoo has been caught out in the UK has brought it into the spotlight because, quite simply, people pay more attention when the problem is on their doorstep rather than elsewhere.

The main task will be increasing transparency of its entire supply chain and addressing whatever horrible truths that could unveil.

Will Boohoo be able to recover?

Still, we are yet to see any evidence that its reputation has been harmed to those that matter the most, or that its young customer base has been turned off Boohoo’s brand. Sales figures will be closely watched over the coming quarters, but there is little expectation that demand has been severely hit by the allegations.

At worst, the investigation will reveal that Boohoo’s supply chain is not fit for purpose and that the cost of production goes up, which in turn would push up prices because of Boohoo’s cost-plus model. But this shouldn’t pose too much of a problem for Boohoo because it boasts superior profitability over its rivals, so it can afford to absorb higher costs if it must.

For example, ASOS generates more than twice the amount in revenue than Boohoo but at a lower margin. Boohoo’s edge comes from the fact it sells its own products and has a lean model that outsources everything, from manufacturing to information technology (IT), whereas ASOS and others sell more third-party products bought from other labels.

ASOS said earlier in July that revenue in the three months to the end of June had risen by 10% year-on-year.

Boohoo vs ASOS

^{Source: Company reports. Boohoo’s financial year runs to the end of February whilst ASOS runs until the end of August}

Boohoo could also re-evaluate its dedication to UK manufacturing, which it has said it remains committed to. It could always source more products abroad, especially if the economics become even more attractive as the investigation could lead to higher production costs in the UK.

Boohoo’s reliance on the UK has already slowly withered over the years – it sourced over 70% of all goods domestically back in 2014 – but it has gradually sourced more from overseas as it has expanded into new territories.

However, it would risk further damage to its reputation if it decided to dump UK manufacturing because of increased costs if it is revealed it has been gaining an advantage from underpaid workers and poor conditions for so many years.

All-in-all, Boohoo should be able to recover. Nothing untoward has been discovered as of yet but it is highly likely that some problems will arise considering how long Leicester’s garment industry has been under scrutiny.

Are Boohoo shares a good investment?

Boohoo shares have taken a big knock in July, which could be an ample opportunity to buy a stock that was otherwise going from strength to strength. Although the investigation will add some uncertainty this year it is unlikely to detract away from the long-term fundamentals of the business that still look incredibly strong.

Boohoo will capitalise on the coronavirus crisis

Boohoo began as one brand, but is rapidly growing into a fashion house. It bought two more brands, PrettyLittleThing and Nasty Gal, in 2017, and then went on to buy the MissPap, Karen Millen and Coast brands in 2019 – all of which have grown rapidly under Boohoo’s ownership.

For example, PrettyLittleThing’s annual sales have rocketed from just £55 million when Boohoo bought it to over £500 million in the most recent financial year. It recently purchased the remaining 34% of PrettyLittleThing it didn’t already own, which it said was ‘expected to be significantly earnings enhancing on a fully diluted basis with immediate effect’.

Boohoo has a tried and tested model. It looks for distressed but well-known brands that still have their heritage intact, makes them available purely online, and brings them altogether using its expertise in logistics, IT, e-commerce and back-office functions that makes them all more efficient and profitable. This is further enhanced by the fact that its two distribution centres – in Burnley and Sheffield – are becoming increasingly automated. Most of the brands it has bought fell into administration and needed rescuing, which means it has managed to buy them at relatively low prices.

While most retailers are bunkering down and trying to weather storm, Boohoo is proactively ready to capitalise on what will undoubtedly be a slew of opportunities in the wake of the coronavirus crisis. Many firms, including rival ASOS, have raised money to shore up their balance sheets in recent months, but Boohoo is the only one to have raised cash for the specific purpose of buying more brands.

Boohoo raised just under £198 million in mid-May (before the allegations were made) after issuing 58.1 million shares, equal to about 5% of the share capital at the time, for 340 pence each to institutional investors.

‘The group intends to use the net proceeds […] to take advantage of numerous opportunities that are likely to emerge in the global fashion industry over the coming months,’ said Boohoo.

The retail industry has been one of the hardest-hit by the coronavirus pandemic and many brands will fall into trouble. Boohoo intends to use this opportunity to snap-up more brands at rock-bottom prices and add them to its growing fashion house.

It has already bought Oasis and Warehouse for just £5.25 million from Hilco Capital, which had rescued the two firms out of administration. Those two brands alone generated almost £47 million in annual sales in the year to the end of February.

The fact Boohoo is ready to spend and expand also demonstrates the strength of its balance sheet. Unlike the vast majority of big-name stocks in the UK, Boohoo entered the crisis with more cash on its balance sheet than debt and following the fundraise in May it has around £350 million in net cash to play with.

The fact it has remained cash generative throughout the crisis only underpins this strength and will allow it to make the initial investments it needs into its new brands to get them going. Capital expenditure in the current financial year is expected to be around £60 million to £80 million.

Boohoo expects to maintain profitability and grow sales in 2020

Confidence in Boohoo should also rise considering it is one of the few stocks that has attempted to provide guidance for 2020, with most stating the economic outlook is far too uncertain to forecast what this year will bring.

Boohoo has said it expects annual revenue in the year to the end of February 2021 to grow by about 25% year-on-year. Although that is far below the 44% reported in the last financial year, double-digit growth is nothing to be sniffed at in the current climate.

It also expects its adjusted earnings before interest, tax, depreciation and amortisation (ebitda) margin to be between 9.5% to 10%, broadly in line with the 10.2% reported last year. Plus, those targets are in line with its medium-term goals to deliver 25% annual sales growth a margin of 10%.

‘This guidance reflects our expectation for an ongoing period of consumer uncertainty, likely promotional intensity in markets in which we operate, as well as continued near-term carriage inflation for some of our overseas markets. This guidance also reflects ongoing investments into our more established brands as well as anticipated investments into new and recently acquired brands through the course of the financial year,’ Boohoo said.

How to trade and invest in Boohoo shares

The supply chain investigation will cause some uncertainty and could prevent Boohoo shares reaching their full potential, but Boohoo is likely to recover from any problems that arise. It will have to make its supply chain more transparent which could dig up some hard truths to address, but it has the opportunity to lead from the front and get on top of it.

It could push costs up but Boohoo has the ability to absorb them or pass them onto customers without hampering its low-cost model and, once it is over, the pressure will move onto those retailers that are yet to do the same and the threat to Boohoo should be removed.

The main threat that could cause this to spiral is if the allegations and investigation lead to lower demand and sales are hit. Still, if that does happen, then it may be hard to judge whether it is being driven by the coronavirus or concerns about the company’s ethics among consumers. However, if its next update shows it has continued to deliver strong growth then that will be a sign that the situation has not impacted its business.

Otherwise, the picture for Boohoo is buoyant and bullish. It is a lean and agile business that has proven it can adapt when it is needed. It is armed with a strong balance sheet and it is one of the only stocks in London actively looking to take advantage of the coronavirus crisis, rather than just trying to survive it, by snapping up the brands that will not fare as well this year.

Brokers are bullish on Boohoo in the wake of the allegations and the stock continues to boast an average Buy rating among brokers. With an average target price of 369.29p, brokers believe the sell-off in Boohoo shares has been overdone and the average target price suggests there is over 43% potential upside versus its current share price. ASOS is also rated a Buy by brokers but its target price suggests there is a lot less potential upside on offer right now.

Read more: Is the ASOS share price worth £40 per share?

Source: IG data, with target prices from Shares Magazine

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