boohoo Stock: Deep Value For The Long-Term Investor (2024)

boohoo (LON:BOO)(OTCPK:BHOOY) is an online fast fashion retailer which is based in the UK. The company was a "lockdown winner" as traditional brick-and-mortar retail was shut down and customers purchased loungewear online. However, since that point, the business has been at the forefront of many scandals, such as supply chain issues and short seller reports. Management responded well to the scandals and implemented a supplier transparency plan. However, the low-margin fast fashion business had its profits squeezed by higher freight costs. Then this was combined with lower consumer demand and higher returns. Overall this concoction of headwinds has resulted in the share price being butchered by 91% from its all-time highs in 2020. The stock is now trading at its lowest ever share price, below prices seen in 2017 and at the lows of the 2020 stock market crash. The stock is now undervalued intrinsically and relative to historic multiples. In addition, revenues are much higher and the business is much larger after a series of acquisitions. In this post, I'm going to break down the company's business model, financials, and valuation, let's dive in.

Ecommerce Business Model

boohoo was founded in 2006 by Mahmud Kamani a Manchester, UK based entrepreneur who had humble beginnings selling clothes on a market store, before moving online and leveraging his supplier connections. The business then became the king of fashion e-commerce thanks to its "runway to retail", fast fashion model. boohoo had a tremendously fast supply chain, which enabled them to spot the latest fashion trends at a catwalk show, before creating inspired pieces online for its consumers, in a matter of weeks. The company was also a pioneer in social media marketing, with over 65 million followers across its multiple brands and 19 million customers globally. In addition, a recent study from UBS analysts shows fast fashion brands on TikTok such as Pretty Little Thing (a boohoo brand), Shein (Chinese competitor), Fashion Nova and Gymshark had more "likes" than incumbent fashion giants such as Nike, over the past three months. This is a positive sign given the engagement restrictions on platforms such as Instagram which has led to a rise in competitor social media apps such as Vero. The business leverages its social media platforms to do a form of market research, asking users if they prefer "dress A" or "dress B", this data is then fed back to suppliers who can order more of the most popular items.

boohoo group is also a pioneer in influencer or celebrity marketing. The business has built connections and done joint fashion collections with the likes of the Kardashians, Paris Hilton, Floyd Mayweather, P-Diddy, and even Jennifer Lopez. The most recent collaboration is with Kourtney Kardashian, as you can see from the website screenshot below. The company's value proposition is clear, feel like a celebrity and dress like a celebrity all for a cost-effective price. Notice, the below dress is just £25 ($27). For perspective, as a man in the UK, I would pay over double that price, £45-£50 for a pair of standard jeans at another outlet.

As an extra data point it is clear, that the business sells items for as little as £3 ($3.21) when on sale (see below image). Now although this is an enticing value proposition to customers, I do believe this is part of the business's profitability issue, as it's very difficult to make a profit on a £3 to £10 dress even during good times, but when supply chain inflation increases you can see the issue. I will dive into the profitability issues more deeply in the financials section.

As mentioned previously the company benefited strongly from pandemic sales in 2020, and they used this momentum to acquire a series of new brands. For example, the iconic department store chain Debenhams fell into bankruptcy in 2020 and boohoo acquired its brand and online business for £55 million, in early 2021. I personally think this was a solid move and played into the classic Warren Buffett strategy of "being greedy when others are fearful". However, I would have liked to see the business acquire Topman, as that brand aligns better with their primarily younger demographic. Competitor Asos beat them to the punch and bought Arcadia Group's Topshop, Topman, Miss Selfridge and HIIT brands for £265 million. boohoo's brands now include boohoo, PLT, Karen Millen, Coast, Burton and many more.

Mixed Financials

boohoo recently announced mixed financial results for the first half of 2022. Group revenue was £882 million ($940m) down 10% from the £976 million ($1B) generated in the first 6 months of 2021. This decline was mainly driven by slightly lower consumer demand and higher return rates. For example, Gross sales before returns increased by 4%, which was more positive but still a far cry from prior growth rates of over 50%. The good news is revenue has increased by 56% since 2019, while the company's stock price is down 86%.

In the revenue by region table below you can see boohoo's largest market the UK, saw its revenue decline by 4% due to lower consumer demand and higher return rates. However, the US market was the real loser as it saw revenue decline by an eye-watering 29%. This was partially driven by longer lead times on deliveries with orders taking approximately 10 days. This results in poor customer service, especially given the developed US market and its abundant Amazon (AMZN) prime delivery. The good news is boohoo has invested in a US distribution center which is expected to go live (phase 1) by mid-2023. This is expected to slash delivery times down to just 3 days for ~95% of the US. Thus for long-term investors, there is hope for the business assuming customers don't jump to a competitor such as Chinese Shein in the meantime (more on that in the risks section).

Despite the headwinds, it should be noted that the company's active customer base has increased by 47% since 2020, to 19.1 million. In addition, the average order value is up by 30% since 2020 to £56.38. However, conversion rates have slid down by 20 basis points to 3.06%. I reason this could be due to tepid consumer demand, in addition, if a customer sees long wait times they may cancel orders.

Gross profit was squeezed by 13% year over year to £464 million ($495m), but was up by 51% since 2019 and thus positive overall. Operating profitability is the main issue as its margins have been decimated over the past 6 months. Adjusted EBITDA was £35.5 million in the first 6 months of 2022, down an eye-watering 58% from the prior year's levels. In addition, adjusted profit before tax, was just £6.2 million in the first half of 2022, down an eye-watering 90% year over year, from the £63.8 million generated in the first half of 2021.

I also like to analyze the operating margin trends as I believe "adjustments" can skew the financial picture. In 2019, the business generated £65.3 million ($86.7m) worth of profit on £856.9m ($1.1B) in revenue, at a 7.6% operating margin. By the first 6 months of 2021, boohoo's operating margin was squeezed to 2.6%, with £24.6 million in operating profit on £975.9 million in revenue. However, in the first 6 months of 2022, the business's operating profit has gone negative, with minus £15.2 million ($16.2).

This profitability decline has been mainly driven by a combination of softer consumer demand, higher return rates, and logistics inflation. Higher freight costs and logistics inflation has affected many businesses including the king of e-commerce Amazon. I believe all markets move in cycles and economic conditions change over time, thus I expect long-term inflation costs to subdue. The US distribution center will also help to reduce these costs. In addition, the business has invested in the automation of its Sheffield distribution center. The total costs for this project are estimated to be £125 million with £11 million occurring during the first half of 2022. The company expects this project to go live in September, which will increase manufacturing efficiency and have a five-year payback period.

The business has £225 million inflow from a £325 million revolving credit facility. This has resulted in net debt of £10.4 million and cash balance of £314.6 million.

Advanced Valuation

In order to value boohoo, I have plugged the latest financials into my advanced valuation model which uses the discounted cash flow method of valuation. I have forecasted a conservative 4% revenue growth for next year and 6% revenue growth per year over the next two to five years.

I have also forecasted the business's pre-tax operating margin to increase to 7% over the next 3 years, which is a return to prior levels before the recent freight cost tailwinds. I expect margins to improve over time, based on the company's investments into new distribution centers, automation, and a general easing of supply chain constraints.

Given these factors I get a fair value of £0.60 per share, the stock is trading at £0.33 per share at the time of writing means which it is ~45% undervalued. As mentioned prior these are fairly conservative estimates and thus future growth could easily return to over 10% as the newly acquired brands come online and are integrated more efficiently.

As an extra data point, boohoo is trading a Price to Sales ratio = 0.22 which is ~90% cheaper than its 5-year average. In addition, competitor ASOS ('LON:ASC') has seen its stock price slide down by ~92% from all-time highs, due to similar industry-wide cost inflation issues and is trading at a similar Price to sales multiple = 0.15.

Risks

Supply Chain Issues/Low Margins

The main risk for boohoo and the entire fast fashion industry is its low profitability, which has been driven mainly by higher freight costs. I personally believe the industry as a whole should just raise prices slightly in order to protect profits, but I'm not an activist investor or on the board of directors, so cannot push this change forward. The good news is the business is "investing for the future" and with new facilities coming online soon, this should help to ease issues as the general market corrects.

Competition

Chinese competitor Shein is gaining traction and now has the largest percentage of market share of the fast fashion industry in the USA. The business has also recently closed a funding round that valued the business at $100 billion, a giant relative to boohoo and ASOS which combined are worth less than $1 billion at today's stock prices. This means Shein has significant firepower to take advantage of the volatility in the market and can also benefit from economies of scale. The good news from a branding perspective is that boohoo looks to have a much stronger and "cooler" brand with its host of celebrity connections such as the Kardashians. Whereas Shein has gone for a "micro-influencer" approach which is more cost-effective but results in less brand power.

Final Thoughts

boohoo is a much larger business today by revenue, active customers and brands than it was two to three years ago. However, the business is facing cost inflation which is squeezing margins and has decimated profits. boohoo has faced a storm of scandals and headwinds which haven't helped the company. But for long-term investors, these look to be just short-term headwinds. As boohoo builds out its distribution capabilities and freight costs subdue, the stock looks to be undervalued at this point and likely to bounce back within the next two years.

Deep Tech Insights