As the ugly-looking chart illustrates, shares in online fast-fashion retailer Boohoo (BOO:AIM) are down 48% over one year and 80% over five years.

Having enjoyed a boom during the pandemic, the shares have since retreated after a reversal of Covid trends and the return of consumers to brick and mortar shopping, with online fast-fashion peers ASOS (ASC) and Zalando (ZAL:ETR) also in the doldrums.

Boohoo’s growth has slowed markedly in recent periods as a result, with sales also decelerating due to the cost-of-living crisis and increased competition and supply chain costs crimping margins.

However, they’ve recently started to recover thanks to better than expected full-year results, reported on 16 May.

Sales fell 11% to £1.77 billion in the year to 28 February 2023 and Boohoo lurched into the red. Yet revenues and earnings weren’t as low as feared, while CEO John Lyttle insisted there was ‘a clear path to improved profitability and getting back to double digit revenue growth’.

The key question investors want answered is whether the shares are an attractive recovery bet at these levels or will an investment in Boohoo end in tears?

THE BULL CASE

Boohoo, where co-founder Mahmud Kamani and family hold sway over 21.4% of the equity, has lots going for it. It can rapidly produce on-trend fashion pieces at value prices, targets a young customer base with a high propensity to spend on fashion and is renowned for smart celebrity partnerships.

Emergence from the pandemic has been hard for Boohoo, but lockdowns created a captive customer base which enabled the company to take market share; last year’s sales were still 43% up on pre-Covid 2020. Having extended its portfolio in recent years through acquisitions, Boohoo sees a target addressable market of up to 500 million potential customers in key markets.

With a stable of brands including Warehouse, Wallis, Oasis, Miss Pap, Dorothy Perkins and Debenhams, Boohoo expects year-to-February-2024 revenues will remain steady or fall up to 5% year-on-year. 

The retailer believes the first-half period could see a sales drop of 10% to 15% due to its focus on generating a profit from its products rather than heavy discounting just to shift goods. The second half is expected to show a return to revenue growth as Boohoo benefits from easier year-on-year comparatives and investments in price, helped by freight rate declines, product and proposition under management’s ‘Back to growth’ strategy.

Having implemented self-help measures including the simplification of its organisational structure and warehouse network, the AIM-quoted business expects full year 2024 adjusted EBITDA (earnings before interest, tax, depreciation and amortisation) to improve with margins ranging from 4% to 4.5% and a value of between £69 million and £78 million thanks to cost efficiencies and lower supply chain costs.

OPPORTUNITIES DOWN THE LINE

In the medium term, Boohoo aims to enhance profitability, achieve an adjusted EBITDA margin of 6% to 8%, and return to double-digit revenue growth by reducing costs, better managing returns and investing in international opportunities.

A US distribution centre is set to open later this year and a major automation installation in Sheffield is already driving significant efficiencies and capacity. Boohoo has also made progress with its Debenhams digital department store, with roughly 1,600 brands available on the website and a successful relaunch for Debenhams’ beauty operations, and new wholesale partnerships across the UK, Europe, the Middle East and India.

On the balance sheet front, Boohoo sprang a positive surprise with a year-end net cash position of £6 million contrary to the £60 million of net debt called for by consensus, thanks to strong cash generation and a 36% reduction in inventory. This suggests it has the financial flexibility for sustained investment in the turnaround efforts and reduces the risk of an equity raise.

Following the results, Shore Capital upgraded its Boohoo rating from ‘hold’ to ‘buy’ with a fair value of 54p. ‘Our projected full year 2024 forecast EBITDA has been raised by 12%, and there is potential for further gains driven by margin improvements,’ commented the broker.

‘Despite a recent decline in Boohoo’s market share, the upcoming fiscal year offers favourable year-on-year comparisons, along with a streamlined inventory and the phased launch of a US warehouse, which are expected to boost the company’s prospects.’

At 43.5p, the shares trade on an enterprise value to sales ratio of 0.4 based on Berenberg’s 2024 revenue forecast, and a prospective 2025 price to earnings ratio of 25.6 based on Liberum’s earnings estimates.

THE BEAR CASE

Bears will highlight the alarming sales declines in all geographic regions last year – the UK, the US, rest of Europe and rest of world – and trading certainly remains tough for Boohoo, which is feeling the pinch from returns as fickle shoppers send back clothes which don’t fit or items they just don’t fancy.

As Liberum points out, medium-term margins are now guided in the 6% to 8% range, below Boohoo’s historical 9% to 10% level. The broker says the margin pressures facing Boohoo are structural, reflecting higher costs and return rates as well as stiff competition, particularly from feared Chinese fashion retailer Shein.

Boohoo’s gross margin was down 190 basis points to 50.6% last year, in part due to the need to compete by shifting stock at a discount.

Cautious on Boohoo with a ‘hold’ rating and 45p price target, Berenberg warns the online retailer’s return to growth comes at a price. Over the medium term, a key concern for Berenberg’s analysts is the level of margin investment (e.g., in pricing and marketing) required to drive a sustained improvement in the strength of the group’s brands, and ultimately return Boohoo to solid growth.

WHAT COULD GO WRONG?

A further bear point to note is that the youthful demographic which Boohoo services tends to be more aware and engaged with environmental issues and this could impact future demand for Boohoo’s disposable fashion. Previous supply chain issues at Boohoo do not help on this score either.

Berenberg flags the execution risk attached to Boohoo’s likely international infrastructure rollout, as well as the possibility of further supply chain issues arising, though it says the actions taken to remedy these ‘can reduce the risk of pervasive issues arising in the future’.

That said, Berenberg notes that further reports of shortcomings in working conditions at Boohoo’s Burnley distribution centre ‘are likely to represent a setback to any sustained improvement in investor sentiment looking ahead.’

Liberum Capital maintained its ‘sell’ recommendation on Boohoo with a 35p price target following the results, warning that the cost pressures, rise in competition and structural changes in the market with regards to product returns limit Boohoo’s growth and margin prospects longer term.

The broker also stressed that Boohoo hasn’t gained much share of the UK online clothing market in the last three years and has clearly lost market share to Shein in the US and to online marketplaces in Europe.

Liberum thinks Boohoo will struggle to reinvigorate growth even after the opening of its new US distribution centre or at the least the growth could be rather costly.

Liberum concedes the shares look ‘optically cheap’, but with its forecast of negative free cash flow until full year 2025, and Boohoo’s diminished prospects in its key markets and lack of visibility on the scalability of its newer brands, the broker believes there is better value elsewhere for now.

SHARES’ VIEW: While Boohoo shares are cheap relative to history and management sees a path back to growth and profitability, only brave souls should invest ahead of June’s first quarter update.

Structural margin pressures and heightened competition in a notoriously fickle fashion sector suggest the shares could be a value trap. Avoid.

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