The below article was initially posted on my Patreon on October 4th 2021.
This week, I want to focus almost exclusively on portfolio holding Boohoo, which reported half year results during the week. At the time of writing this piece, I hadn't taken a good look at the update, and thus I have yet to form an opinion on the news. So let’s go on an unbiased journey and figure out what to do next with the shares.
The stock is down just under 18% since the results, so it’s clear that the market didn’t appreciate the half year. Given Boohoo is a relatively large position in both of my portfolios, now more than ever I need to reassess whether Boohoo is worth keeping, from an unbiased viewpoint.
Boohoo has been under pressure from various sources for some time. The aftershocks from Boohoo’s forced labour scandal have rippled into court cases in the US and have likely caused a reduction of appetite from ESG investors. Including this week’s drop, Boohoo is now down 40% from ATH’s. However, Boohoo’s customer base has remained loyal, and Boohoo seems to have no trouble selling more garments to its customers each year.
With this in mind, let's unpick the latest results, H1 2022 (reporting period March to August 2021), to see what could be in store going forward.
Starting with the top line, revenue growth in the latest half was 20% versus the prior period. This result is pretty significant given Boohoo’s comparable period in the prior year was in an environment where no-one was able to shop in physical stores, so Boohoo’s ‘online only’ model did well. Now that people are able to return to Primark and TK-Maxx on the high street, the environment is a little more challenging for Boohoo to compete. Unfortunately, included in this revenue growth result will be the in-organic growth from the acquisition of Debenhams and other brands such as Dorothy Perkins, Wallis and Burton. Whilst the breakdown of organic (like-for-like) growth isn’t easily found, Boohoo comments in the half year update that:
[In the UK] The six brands acquired since June 2020 contributed 20 percentage points to the growth on the prior year and 28 percentage points on two years ago.
With the UK contributing £566 million to group revenues (up 32% on the prior year), one could infer that acquired brands contributed £86 million to the UK result and that total revenue for the group without the acquisitions would be £890 million. Thus organic growth totalled 9%. This organic result has therefore been largely driven by continued success in Boohoo’s second largest market — the US. Given Debenhams’ prior scale (online sales were £400 million when Boohoo acquired Debenhams), I am glad to see that not all of Boohoo's growth in the half has been driven by Debenhams, as Boohoo has just relaunched the website in April 2021.
Significant revenue volatility occurred during the half. Boohoo’s first half of the year was split between significant outperformance during the first 3 months and a deceleration in the latter 3 months of the half. For Boohoo’s two key markets, the UK and the US, sales in the 3 months March to May were 50% and 40% up on the prior period, versus the next 3 months June to August, where sales were 19% and 8% respectively.
Next plc online picking volume 2021 — Next plc Half Year Report
For the UK result, it would appear Boohoo’s volatile sales growth is in line with the UK industry, given data (seen above and below) from the half year report of one of the largest and most successful UK clothing retailers, Next plc. Here, you can see sales spiking in March where the average spend for UK customers surged compared to the prior year. A cool off in April/May followed before sales picked up again in the summer. Comparatively, Boohoo looks to have had a better August build up into September trading than Next, possibly due to the more summer festival nature of Boohoo’s garments.
UK spend per customer — Next plc Half Year Report
What about in the US, where Boohoo’s growth cooled significantly from 40% to 8% between the first 3 months to the last 3 months of the first half? Well, comparisons here are a little tricky given the different reporting periods for US companies, but we can see from similar peers in the US that Boohoo certainly isn’t doing badly when (lightly) compared. Online-only fast fashion retailer Revolve, which uses a very similar sales model to Boohoo, has published quarterly results for the period April-June. Sales were up a ‘record’ 60% versus the prior year, which is a faster rate of growth than Boohoo. However, it is important to note that Revolve’s sales growth was negative in 2020. Thus on a two year stack, growth is only up 41% versus 2019. Boohoo’s result for the half year showed growth of 24% in 2020, but 126% growth versus 2019. I think it is fair to say that Boohoo has done much better than Revolve in the US over the two year period.
Revolve Q2 net sales — Revolve Investor Presentation
Lastly, let's take a look at Europe, where Boohoo has a smaller but fairly significant business. Here, sales dropped 15% during the half year. Boohoo gave the following reasons for the fall in sales:
The continuing impact of the pandemic on customer demand in Europe has been very pronounced. It is also probable that disruption at EU entry ports caused by changing COVID-19 testing requirements throughout the period and the subsequent delays to delivery times across the continent have weighed on customer demand.
But how are some other European peers performing over a similar timeframe? Is Boohoo’s reasoning a fair reflection of the market? Boohoo’s London based rival ASOS has a large European online retail business to compare Boohoo’s numbers to. ASOS has recently provided a trading update for the four months to June 30th. Looking at 2019, 2020 and 2021 respectively, ASOS' European business has gone from £269 million to £328 million to £388 million, with growth of 20% seen in the latest period. Another key online peer in Europe Zalando had revenue growth of 40% for the first six months of the year. Again, similarly to ASOS, Zalando had revenue growth in 2020, so the 40% growth in the latest period is impressive. In reflection of these strong results for Europe, it would seem Boohoo has significantly underperformed peers in this region who have largely managed to navigate logistical and demand pressures better than Boohoo. Potentially this could be due to Boohoo’s UK heavy logistics and manufacturing, which makes it less nimble in continental Europe compared to peers with large distribution centres on the continent.
So, in summary of top line results from Boohoo’s key markets:
UK — relatively in line with the wider market
US — outperforming over a 2 year period
Europe — a significant under performance
Next, we need to focus on profitability, which has been significantly impacted in the latest half year report. Boohoo reports profitability from a gross margin, adjusted EBITDA and adjusted profit before tax point of view. Here, it is quite difficult to ascertain the real picture given the adjustments and differences between the various metrics. But we shall give it a go!
Starting with the easiest, gross margin, which is revenue minus cost of goods sold as a percentage of revenue. Here, margins slipped from 55% to 54.6%, which is a negligible result and shows that Boohoo’s pricing has held up in line with a mildly inflationary environment.
Adjusted EBITDA margins slipped from 11% to 8.7% as increased logistical costs impacted earnings across the group. Profit before tax was £64 million (-19%) on an adjusted basis and £24.6 million on an unadjusted basis, down 64% for the period, which is where I believe the market to be most concerned.
Looking to the various EBIT impacts adjustments below, it looks as though the end result has been impacted by significant increases to general operating costs, depreciation and amortisation both likely related to the Debenhams acquisition, and a large chunk of exceptional costs related to dual warehousing and restructuring in the aftermath of the Debenhams' acquisition.
Considering the above, I think the exceptional items and adjustments look quite fair, and I am prepared to take them at face value considering they mostly relate to the Debenhams and Dorothy Perkins' acquisitions (which are one off items). So the real concern is with relation to the operating cost inflation from £359 million to £448 million, impacting adjusted EBITDA significantly. Here, Boohoo has estimated Covid-19 has cost them £26 million during the period in increased costs, which you could probably say may ease over the medium term. But the other costs (roughly £80 million) are likely related to Boohoo repairing its supply chain (following the labour crisis) and increased costs from operating as a larger group with the new brands on board.
For me, having now looked at Boohoo’s income statement in some detail, I think much of the recent damage to the bottom line is repairable over the next year or two, as the acquisitions are digested and logistics pressures start to unwind. However, I think we do need to keep in mind that profit margins will continue to be impacted to a small extent as Boohoo cleans up its supply chain and enforces more expensive labour practices.
So, we understand current trading (volatile but heading in the right direction) and profitability (squeezed by various one-off exceptionals and some recurring items), but how is the business setting itself up for the future?
The two key highlights for me in terms of operations was the re-launch of the Debenhams online store post-acquisition and the development of further distribution centres now capable of supplying products of sale value of £4 billion.
Progress at Debenhams certainly looks interesting. With £400 million in online sales prior to being acquired by Boohoo in 2021 (for £55 million), Debenhams has the ability to be a significant growth outlet for Boohoo if the company can make a success of the re-launch. The trouble with Debenhams prior to Boohoo’s purchase was that it only generated £10 million in pre-tax profit, so Boohoo will need to be selective in how it runs the online store. However, if anyone knows how to run a successful online store, Boohoo is up there. So far, Boohoo has re-launched the Debenhams' website, where Boohoo, Nasty Gal and Karen Millen brands feature as the parent looks to utilise Debenhams’ storefront and returning customers as an outlet for its owned brands. There is an ‘unlimited Debenhams’ feature allowing users to stock up on as much free delivery goods for £18.99 per year. Boohoo has also started to revamp the brand with marketing campaigns and additional categories for the website.
Boohoo UK Capacity — Boohoo Half Year Presentation
On the distribution side, the above graphic reflects the expansion across the board for Boohoo’s distribution capacity. With various projects underway throughout 2021-2023, Boohoo is continuing to invest in its supply chain, with scale and automation both priorities for the company. In addition to the UK facilities above, Boohoo is set to open an additional distribution centre in the US by 2023, which will enable the sale of £1 billion worth of goods. With global sales expected to hit just over £2 billion this year, Boohoo is not only anticipating further expansion, but is well resourced to expand over the medium term.
Lastly, looking at guidance, Boohoo is expecting sales growth this year of 20-25%, with an extended medium term guidance re-affirmed at 25% growth per annum. It expects adjusted EBITDA margins to be 9-9.5% for the full year, slightly above the 8.7% recorded in the first half.
So, looking at Boohoo versus some of its online peers mentioned in the review so far, we can compare valuations. Below, you can see the almost mind blowing valuation gap between what investors are willing to pay for international businesses compared to Boohoo and its UK peer ASOS. Both Revolve and Zalando have similar EBITDA margins to Boohoo, and on a 2 year basis nowhere near the same level of growth. Revolve in the US, which has grown revenues at roughly half the pace of Boohoo’s total growth over the last two years, trades at triple the valuation of its UK peer.
All things considered, I am pretty optimistic about Boohoo’s recent performance and believe that the company is quite well positioned for continued growth in line with its 25% target. Near term pressures do exist for the company, and with the exception of performance in Europe, the same pressures exist for the rest of the industry too. But one thing is fundamentally clear, Boohoo’s valuation is now at a steep discount to its immediate peer group, and looking objectively at the fundamentals, it doesn’t look as though Boohoo is a considerably ‘worse’ company. In fact, it could be better than peers (with its unique test and learn model, founder ownership, short lead times and agile manufacturing). One would expect that the valuation gap between similar peers should eventually close, as the wider it gets, the more likely an international business considers acquiring Boohoo given the variance in price multiples.
Given the above, I think there is strong justification to continue holding Boohoo shares for the Twenties Trader Portfolios, and even look to add to the holding in the coming weeks.
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