Boohoo - Destined to end in tears?

http://www.boohooplc.com/


The London IPO market is enjoying a strong spell at the moment, with AO World (LSE:AO) and Poundland (LSE:PLND) showing strong price rises on their IPO price. With a growing pipeline of companies looking to take advantage of bullish investor sentiment, it is good news for investors as they are presented with an increased number of investment opportunities. However, these opportunities can be very risky, especially with some IPOs being completed at inflated price, so being able to distinguish which ones are overvalued, is of utmost importance. Boohoo (LSE:BOO) is one of the most recent IPOs, following in the path of Pets at Home (LSE:PETS), and has already been marked up 40% upon its 50p IPO price. Closing its first day of trading at 70p, Boohoo has 1.12 billion shares in issue, the market therefore valuing the company at a lofty £784m.


As is the case with IPOs, there is insufficient trading activity to be able to identify and reliable trends, so technical analysis is very limited. Old Mutual, Odey Asset Management, BlackRock and Standard Life all have material stakes in Boohoo (x > 3%). Institutions could continue to sell down their stakes in pursuit of a quick profit having acquired shares at the 50p IPO price. Following stake sales, directors hold ~30% of the shares in issue, and are locked in for at least 18 months.

I'll therefore jump straight into the company's operations. Boohoo is a pure-play online fashion retailer that markets own brand products. Founded in 2006, the company designs, sources and sells a range of clothing, shoes and accessories to its target market which are 16-24 year olds. The focus has predominantly been on females, although a new BoohooMAN range was introduced last year to try and exploit the male market. Many investors have likened this business model to that of ASOS (LSE:ASC) whose share price action over the last decade has been nothing short of eye-watering. To put ASOS into perspective, back in 2004 they were trading at 5.5p - the share price is now 6350p. You don't need a calculator to work out that many millionaires would have been born out of ASOS' success, and it has therefore turned into one of the most loved companies, but also the biggest company trading on AIM.

What investors will know is that ASOS is trading on an exceptionally high price-to-earnings ratio that is over 100. For a company that is growing earnings at a double figure rate, that PER is very rare, and many investors in the market believe the company to be completely overvalued - a bubble ready to burst. After all, most retailers are valued on PERs less than 25 during bull markets. Boohoo's IPO places the company on a similarly sky-high valuation to that of ASOS (that I will cover later). There is an important point to be made here - there is likely to be an invisible tether between Boohoo's share price and ASOS' share price, as the investment community considers them to be very similar, even though there are some differences. Therefore, if ASOS' share price rises significantly, I would expect Boohoo's share price to track that, and vice versa. Both companies are still growing rapidly.

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For that reason, I deem it important to analyse ASOS' current chart position to try and glean potential future movement. As per the chart on the right, despite ASOS' past strong performance, there is reason for concern with the potential for a double top at 7000p if the upward support breaks down. The glimmer of hope is that the indicators are closing on in being oversold, but there is a real risk of a top being formed. In the meantime, if the support does hold then the bullish outlook remains intact, and the current period could be seen as consolidation just below the 7000p resistance. The next couple of weeks will be of importance for technical traders of ASOS. I would imagine that there is a lot of money ready to short the stock once the technical picture starts to falter. After all, the fundamentals shouldn't support such a high valuation.

That brings up the question as to whether ASOS should be considered as an exception or as the rule for fast growing retailers. Without a doubt I would consider it an exception, and that Boohoo shouldn't command such a high valuation. Early trading in Boohoo will set a precedent as to whether or not high valuations for fast-growing online retailers will be seen as the rule or not. What ASOS does prove is that there is an excellent market opportunity for 'trendy' online clothing retailers. Their UK retail sales last year grew from £205m to £276m, which is roughly 35 percent higher. In addition, the UK online clothing market is expected to climb rapidly to £11 billion by 2016 (from £6 billion in 2012). That presents companies with a potentially lucrative market opportunity, and many of the big names such as Debenhams and Next taking a position. Less major, yet still large, names such as New Look also occupy the space, and there are many competitors.

Boohoo operates in many other countries though - it actually sells products into over 100 countries, albeit its main presence is limited to a few countries, which include the UK, Ireland and Australia. Aside from the solely online competition, Boohoo does of course face competition from "Bricks and mortar" based businesses. In the UK, that competition includes River Island, but more importantly, Primark. Those businesses have however, not prevented Boohoo from greatly growing market share and revenues. In terms of basic market presence, typing 'Women's clothing' into the Google in the UK, brings up Boohoo as the second link, just behind ASOS. It admittedly does not feature highly on slight changes to the search entry. One disadvantage that Boohoo has over ASOS, is that ASOS has free standard (within 4 days) for all UK orders. That compares to Boohoo who charge unless orders total over £40. That is simply a case of scale. Nonetheless, Boohoo holds a strong position within the market though, with 2.3m active customers (people who have placed an order within the last 12 months). That compares to ASOS' 7.9m active customers. Long-term plans are in place for expansion into the US, Scandinavia and potentially even China, although the latter will be subject to a trial period to test demand levels and delivery capabilities.

Why did Boohoo float? It was actually only one of the options considered by the board, one of the other options being a sale of the business. The float raised £300m, which would have made the valuation look reasonable, except £240m was used to repay convertible loan notes held by major shareholders, which included the joint CEOs. Net proceeds of the placing amounted to £46.1m; £6.5m of that will be used to expand their round-the-clock warehouse in Burnley from 150k sq. ft to 250k sq. ft, and a further £2.5m will be put towards a mortgage repayment. The rest was unallocated but will be used for improving IT infrastructure, further marketing campaigns, and for working capital. The company are also planning to release a mobile site and possibly an app later in 2014.

The board of Boohoo is rather odd in composition, in that it features joint CEOs - Mahmud Kamani and Carol Kane. That can be construed as both a positive and a negative. There is plenty of board level experience with Petar Cvetkovic (CEO of transport logistics firm DX Group) a non-executive Director, and Peter Williams (Formerly a senior independent director at ASOS) the non-executive chairman.

The important point that sets Boohoo apart and allows it to enjoy strong margins, is that it controls the whole design and manufacture process of its goods, thereby allowing it to cut out the 'middlemen'. That also allows Boohoo to move very quickly to exploit new trends in the market. The 16-24 clothing market is a fast-moving environment where trends can change very quickly, so that ability to be the front-runner is a clear benefit. That, combined with their low price strategy where the average product price is £17, has meant the products are appealing, and that can be seen through phenomenal revenue growth from £24.5m in 2011 to £91.9m that can be seen in the table below.


The margin improvement has come on the back of a decision to streamline their production process, so it is unlikely to grow much further given that the emphasis remains very much on the low price point. The revenue growth experienced is strong as well - if you annualise the 2014 results on a symmetrical basis, revenues would show up as being 64% higher. Post-tax profits have tracked that higher to £6.84m, or £8.21m for the year as a whole, so by no means is Boohoo an outright blue-sky story. That said, the figures makes the current valuation of £784m look extremely stretched, with Boohoo trading on a PE ratio close to 100. Of the £91.9m in revenues, circa 63% was generated from the UK, circa 9% from the rest of Europe, with the remaining 28% across the rest of the world (ROW). The greatest growth was seen in the UK and the ROW.

Many investors are probably wondering how a valuation such as Boohoo's can be justified. Aside from the precedent set by ASOS, the strong growth potential is attractive to some investors as they realise that in a few years time the company could be trading on a much lower set of valuation metrics. For example, assume that revenues continue to grow at hit £200m two or three years down the line. Assuming a 59% gross margin and that administrative and distribution expenses grow by 1.8x (which is less than revenue growth), then operating profit would come out somewhere around £36m. Using a 20% corporation tax rate (which is what the UK will likely tend to over the next couple of years), and the post-tax profit would come out at around £29.12m. That translates to earnings per share of 2.6p, or a PER of 26.9. If that scenario were to materialise, that valuation would be justifiable. However, investing now for risky returns 2-3 years down the line is certainly not a scenario that is remotely attractive to me. After all, the demise of companies such as Abercrombie and Fitch over the last few years is testament to the risks involved in the industry.

At the end of December:
- Cash stood at £8.27m (although this would have been boosted by the float proceeds)
- Boohoo had a strong balance sheet with tangible assets of £28.4m vs. total liabilities of £22.7m. Even before the cash influx, that is solid backing with tangible assets covering total liabilities 1.25x over
- There were strong cash flows with net cash generated from operations standing at £7.82m

It's important to know where Boohoo sits amongst both its bricks and mortar, and online peers. I've done a very basic comparison below.

Whilst no specific measure is useful in its own right (especially since I haven't included enterprise value), what this does do is build up a picture. Boohoo is trading on a Market Cap/Sales ratio of 7.1, which is remarkably higher than that of ASOS, and is significantly higher than the LSE peer group average of 3.2. The price-to-earnings ratio for BOO is also exceptionally high at 95.6, although it is lower than the forecast PERs for ASOS. All that this does confirm is that BOO is overvalued on traditional valuation metrics, relative to its peer groups. It is therefore difficult to see upside unless the next forecast PER is much lower (x < 50) - expectations for that have not yet been released.

On that basis, Boohoo is a clear-cut short opportunity...except that it is not. The market is buoyant at the moment, and as it stands, the ASOS growth story remains intact, and that will have positive connotations for Boohoo. I firmly believe that the company is grossly overvalued on a 1 year viewpoint, but what ASOS has demonstrated is that a company can remain that way for extended periods of time. Longer-term, it is feasible that Boohoo can grow into its current valuation and beyond, if growth rates pick up beyond current expectations - short-term forecasts appear challenging, though. For that reason, I am reluctant to put a Sell tag on the company - downside is quite likely, but the very short-term timescales for that don't make it a comfortable proposition. On the other hand, I am in no way remotely interested in putting a Buy tag on Boohoo as it is simply too speculative, and the short-term growth seems to have already been more than priced in by the market. Is it destined to end in tears? It's not a foregone conclusion, but in my opinion, the share price outlook is currently skewed to the downside for the next 12 months. No Rating.

9 comments:

  1. The collapse commences. Down 6% this morning! Good call

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    1. Overpriced rubbish springs to mind. Good review as always el1te

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  2. You make some very good points. The LSE market is bubbling at the moment with gulf marine IPO underway and JUST EAT and HOUSE OF FRASER all lining up. Exciting, but dangerous !

    CraigJ

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  3. great article

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    1. Looking at todays action at ASOS and BOOHOO, your call was nothing short of superb.

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  4. Cracking call. I just closed my short at 40.5p

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  5. OK even more cracking now!

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  6. My man, great call! was going to buy on another paper at 40p added to watch list and woke next day to 20p. Woow glad it was a watch list. This guy needs a clap peeps. I got so so so so lucky, wish I read this first!

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  7. Some good news recently... Does it look like Boohoo is strengthening its position?

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