Boohoo’s business model may be predicated on slinging out clothes at speed, but earning investors’ forgiveness has been a much slower process. Further disappointments on the back of a scandal about poor treatment of workers in Leicester were always going to burn particularly sharply. Cue a sales and margin downgrade and a double-digit share price drop.
Since last July, Boohoo’s shares have significantly underperformed its fast-fashion rivals Asos and the German group Zalando and a lower forward price/earnings multiple. But marking the shares down so severely is short-sighted.
Selling its own brands means Boohoo typically earns higher margins than Asos, at 8.7 per cent versus its rival’s 5.8 per cent for the first half of the year. But not building its business on merely flogging the wares of third parties also means it has not had to sacrifice profitability to fight to provide the fastest delivery and snazziest app to draw customers in, Peel Hunt’s John Stevenson says.
Costs and acquisitions cut profits at Boohoo by two thirds
If Asos’s growth story is about expanding internationally, Boohoo will be judged by the extent to which it can integrate the brands it has acquired on to its online platform and reinvigorate sales. Its recent purchases Debenhams, Burton, Wallis and Dorothy Perkins were only relaunched this year, but the impressive sales growth delivered by its earlier acquisitions Nasty Gal and Pretty Little Thing, show that Boohoo has the nous to pull off this fusion.
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The Arcadia carve-up may have given Asos the flashier Topshop brand, but Boohoo has broadened its target age demographic beyond a core of 18 to 24-year-olds by snapping up Burton, Wallis and Dorothy Perkins, and at a cut price too. Earlier acquisitions of higher price-point retailers Karen Millen and Coast started this trend. Debenhams will not only further diversify its end-markets by offering homeware, but also superior scale in the beauty business.
Spending this year is due to be £25 million higher than initially guided, at £275 million, primarily due to initial investment on its first US distribution centre and the new Debenhams online sales platform. Net cash sunk to £94 million by the end of August, down from £345 million at the same point last year. But there’s no plans to tap the market for extra cash. High cash generation means it can afford to fund the bulk of capital expenditure via day-to-day business. Analyst expectations are that it will maintain the net cash position that it’s recorded since IPO, forecasting net cash of £224 million at the end of February next year.
Adjusted margin expectations for the year have been cut to between 9 and 9.5 per cent, from previous guidance of 9.5 to 10 per cent. Damage here should have been predictable enough, Asos had already warned that higher freight costs had sapped its margin. But with travel to the US opening up, freight costs may well begin to normalise next year.
In an industry where bargain sales prices are prized, higher costs might be less easy to pass through if it wants to maintain its competitive edge. But the warehouse efficiency benefits reaped from higher spending this year could provide some relief, so too could its newly found heft when it comes to barter with suppliers. Its “test and repeat” model may also help in managing supply chain disruption; management doesn’t anticipate stock shortages.
The last of the 34 operational changes identified as part of its Agenda for Change review are due to be implemented in the next few months. But any reputational damage from supply chain scandals has not yet turned off consumers. Sales growth might be lower than expected this year, but a 20-25 per cent expected rise on tough lockdown comparatives is still the envy of bricks and mortar retailers.
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A US class action against the fast fashion retailer over claims it used fake sales and promotions to entice shoppers remains a shadow over the shares. A settlement out of court seems likely, provisions for the case were included in the £23.4 million set aside for legal claims in last year’s accounts.
Investors could profit from being more patient with the fast-fashion giant.
ADVICE Buy
WHY Share price weakness makes an appealing opportunity to gain exposure to fast sales and profit growth
Ceres Power
This company has all the attributes of the speediest tech stocks. The fuel cell specialist’s forward enterprise value stands at a ludicrous 55 times forecast sales for the next financial year and although a shift away from high-growth stocks and towards recovery plays has let some of the heat out of the shares since January, gains still total just over 350 per cent since the start of last year.
Yet the Aim company is yet to turn a profit. Why are investors frothing at the mouth? The addressable market is vast. Ceres designs and manufactures fuel cell technology under licence for its commercial partners, for which it receives a fee. It then earns royalties based upon the volume of product manufactured by those companies.
Those partners include Bosch, the German technology group, Weichai, the Chinese engine manufacturer, and Doosan, the South Korean heavy equipment maker. About £100 million of a £179 million fundraising was earmarked for developing its electrolysis technology used in areas difficult to decarbonise, such as steel and shipping.
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The focus now is on developing the technology and signing up new partners. But that entails considerable research and development costs and during the first half of the year those expenses rose 44 per cent. That meant that despite revenue more than doubling, the operating loss widened.
The royalty model is a high margin one and the gross margin stood at 72 per cent during the first half of the year. Licence fees accounted for the bulk of revenue generated during the first half, but management is banking on a flow of royalty income driving it into a statutory profit. There is no sign of that occurring any time soon, according to analyst forecasts.
There are some encouraging statements of intent from its commercial partners. Bosch intends to put up to 100 small-scale stationary fuel cell power plants into operation this year and it has agreed a new joint development programme for a 30 kilowatt stationary power system with Weichai, increasing the commercial scope of the agreement. But, essentially, investing in Ceres requires a big dose of faith.
ADVICE Hold
WHY The commercial opportunity is large, but that is already well accounted for in the shares’ pricey valuation
