Why investors are giving corporate wrongdoers the boot
Thursday 16 Jul 2020 Author: James Crux

Shares in once high-flying Boohoo (BOO:AIM) have fallen by 44% so far in July with professional fund managers and retail investors losing patience with the online fashion group’s poor ESG (environmental, social and governance) practices.

Shares believes the Boohoo blow-up sets a precedent for how investors will react to the next company that messes up in terms of ESG factors.

The increasingly ESG-principled investment community simply isn’t going to stand for poor practices in terms of governance, sustainability and the treatment of employees. It will turn bearish on a stock that breaches ESG guidelines in a heartbeat, ejecting the name from portfolios, institutionally and retail managed alike.

HOW BOOHOO MESSED UP

The ESG theme is heavily in demand with investors, particularly among the millennial cohort, who are concerned about the fate of the planet and wish to invest their money with companies that are trying to make the world a better place.

The key catalyst for the Boohoo share price collapse was allegations that workers at factories supplying its clothes are paid less than the minimum wage and weren’t adequately protected from coronavirus; a charge of complicity with modern slavery in effect.

These claims only compounded concerns over Boohoo’s actions in buying companies from connected parties and the egregiously large incentive plans put in place for directors.

Selling cut-price clothing, while at the same time making a decent margin, is a volume business. It necessitates a hard-nosed approach to costs. We’re in no position to point fingers, but the fast fashion industry is an area of the market ESG-focused investors need to keep an eye on.

FASHION INDUSTRY DISASTER

Owned by Associated British Foods (ABF), Primark has been one of the fashion retail industry’s major success stories, but its reputation was sullied by the 2013 collapse of an eight-story commercial building, Rana Plaza, in Bangladesh.

Primark sourced from New Waves Bottoms, a supplier operating in Rana Plaza which contained five clothing factories. Most of the people in the building at the time of the collapse were garment workers and more than 1,100 people died, with many more left with life-long debilitating injuries.

Reports suggested the lowly-paid workers had been ordered into the building on the day of the disaster despite cracks in the building having been reported just the previous day.

Post-Rana Plaza, the clothing industry’s deadliest accident, ESG-cognisant consumers probably asked themselves how a T-shirt costing as little as £2 could ever be responsibly made.

Primark deserves credit for the numerous steps it has taken to become more responsible and more vocal concerning its commitments to producing responsible fashion in the wake of Rana Plaza.

Among the first retailers to sign the Accord on Fire and Building Safety in Bangladesh, the discounter was also one of the first to ensure the factory victims and families affected by the collapse received financial support and food aid immediately following the disaster.

Poor ESG practices aren’t restricted to the fast fashion sector. At the luxury end of the spectrum, Burberry (BRBY) has previously drawn the ire of the ESG crowd for burning millions of pounds worth of unsold clothes to protect its upmarket brand, although the trench coats-to-cashmere scarves purveyor has garnered plaudits for obtaining energy from renewable sources and its coronavirus relief efforts are commendable.

Burberry retooled its Yorkshire factory to make gowns and sourced surgical masks through its global supply chain, life-saving initiatives that ESG-principled investors shouldn’t forget once the pandemic has passed.

WHY INVESTORS TURNED TED(DY) BEARISH

Before Boohoo, quirky British fashion label Ted Baker (TED) offered an exemplar of how a strong brand built over decades can be swiftly impaired when ESG principles are breached.

Shares in Ted Baker approached the £30 mark in 2015, yet a sharp downswing in fortunes leaves them swapping hands at a shredded 69p today. This demonstrates just how brutal shareholder value destruction can be when a business unravels.

Ted Baker’s stock market value was unstitched over time by a string of profit warnings around margin pressures, competition, weak consumer spending and an unhelpful exposure to the structurally challenged department store sector.

These external factors were masking deep-rooted internal problems that had set the demise of the business in motion.

More recently, the market was spooked by the departure of dominant founder and CEO Ray Kelvin in 2019; though denied by Kelvin, ‘hugging’ claims made by some employees didn’t sit well with shoppers, especially in the #MeToo era.

Also weighing on sentiment were the internal controls and governance issues that led to a material inventory miscalculation that proved the previous management didn’t have a firm grip on the numbers.

Once regarded as one of retail’s high-quality names, bombed-out Ted Baker is now very much a contrarian trade from an investment perspective.

A new management team, led by chief executive Rachel Osborne, has outlined a bold turnaround strategy dubbed ‘Ted’s Formula for Growth’, which includes ambitious sales and profit targets and demonstrates faith in the future of the brand.

Analysts at Liberum Capital say the near-term focus for management will be on fixing the internal ways of working, reorienting the supply chain and taking cost out of the business.

BOOHOO BACKLASH BEGINS

A few short weeks ago, digital fast-fashion purveyor Boohoo was being applauded for continuing to grow during the pandemic.

It had (seemingly) wrong-footed short-seller ShadowFall too, by bringing forward the acquisition of the remaining 34% minority stake in PrettyLittleThing from Umar Kamani, the son of Boohoo co-founder and executive chairman Mahmud Kamani, and Paul Papworth.

Despite poor corporate governance manoeuvres including this connected party transaction, and criticism over an incentive scheme that would see directors share £150 million based only on share price performance and with no shareholder vote, investors bid the shares up to new record highs.

The tide turned following a weekend expose in The Sunday Times, which reported that workers at one of Boohoo’s Leicester suppliers were being paid as little as £3.50 per hour.

There were further allegations that workers were forced to work throughout the COVID-19 lockdown without social distancing measures being implemented or protective equipment available.

ASOS (ASC:AIM), Next (NXT) and Zalando then dropped Boohoo’s brands from their websites, although Boohoo bulls pointed out that 95% of its sales are made through the online fashion firm’s own websites.

Boohoo said it would launch an immediate independent review of its UK supply chain, £10m would be invested into the supply chain to improve ESG credentials and it would further boost its internal audit structures led by ethical specialist Verisio and bureau Veritas. It also committed to appointing two new non-executive directors to beef up the board. Ironically, it said it would pay close consideration to any candidates who had proven skills in dealing with ESG issues – a little too late, perhaps.

All these steps could start to help rebuild confidence that Boohoo intends to do the right thing. Chief executive John Lyttle said the board was ‘deeply shocked by the recent allegations about the Leicester garment industry’ and reiterated how ‘seriously we are taking these matters’.

Boohoo stressed it would not hesitate to terminate any relationships where non-compliance with its code of conduct is found, adding: ‘Our commitment to an incremental £10 million of investment demonstrates our resolve to enforce the highest standards of ethics, compliance and transparency for the benefit of all garment workers.’

BOYCOTTING BOOHOO – THE POWER OF INFLUENCERS

Despite this statement, long-run fan Shore Capital said it was time to sell the shares, pointing out that Boohoo’s sales will be impacted by not being on the ASOS, Next and Zalando websites in the short term.

The broker also drew attention to a surge in social media hashtags including ‘#BoycottBoohoo” and highlighted that millennial consumers are interested in sustainability as well as business ethics.

Social media can help build a brand very quickly as influencers show off a company’s products. However, the reverse is also true.

A social media backlash is now building against Boohoo, with Instagram influencers and former brand collaborators Jayde Pierce and Vas Morgan having turned their backs on the company.

Negative headlines could also heighten awareness over the very nature of the fast fashion model and low-ticket price tags, which mean customers can buy clothes, wear them once and then chuck them in the bin, which is hardly ethical.

Shore Capital also questioned the impact on the cost base, wondering whether Boohoo had been experiencing input prices for goods that might be no longer sustainable. ‘This may put pressure on gross margins and prices could rise, which would negatively impact their competitiveness,’ it said.

The broker also warned that Boohoo had to deliver the outcome of its own investigations and it faces the potential of external enquiries such as a possible police investigation. ‘Until the outcomes are better understood, the stock feels less than appetising for many investors and may be totally off limits for many ESG funds for now,’ added the broker.

We share this conclusion. Do not be tempted by the shares trading on a much lower rating than historically. We believe the reaction to Boohoo’s situation is proof that ESG principles are front and centre for investors and the retailer’s name is now mud.

Investors’ attitudes are changing and any company who messes up on any of the E, S or G factors will be punished in the form of a plunging share price.

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