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Manufacturing Margins?
As we see it, there are two ways to explain BOO, neither especially positive. The first is that, by dint of negotiating skill and good inventory management, the company has managed to get to GBP 300 mln in sales while
remaining profitable. But perils lie ahead, and BOO will revert to the industry mean. The second and more likely possibility is that BOO is creating the illusion of high margins where those margins do not exist. How?
By buying from family-owned intermediaries that bury costs. If that were
the case, BOO could easily compensate these money-losing suppliers with
the generously priced shares.
Given Boohoo’s set-up, such an arrangement would be hard to avoid. Apart
from Boohoo itself, we have found 53 companies registered at 49-51 Dale
Street in Manchester, the Boo headquarters, all owned by Kamani family
members or BOO directors and mostly not part of the listed company.
Public reports say that several of these co-located companies are clothing
wholesalers. Yet they have no web presences, phone numbers, warehouses,
or employees with Linked In profiles. Many of the companies do not even
have financial statements. They are granted filing exemptions for being
small companies or else are identified as dormant. The companies that
have filed financial statements for the most part have a lot of debt.
So, what are these companies doing? Some of them hold or manage property. One is a legitimate restaurant operation. But mostly, they seem to be
paper companies.
Cheetham Hill is also known as a minor
capital of knock-off fashion and accessories. Companies coming out of this
region learn how to manage costs. This is the region where Boohoo was
born Online players come and go, distinguishing themselves with a slightly
different look and a nuanced positioning. The largest and most successful
of the online fashion companies is ASOS (“As Seen On Screen”), which, at
GBP 1.44 bln, is four times the size of Boohoo. Next comes Boohoo, then
the as-yet-unlisted Missguided, which reported GBP 117.2 mln in revenue
in the year ending February 28, 2016, which was half of Boohoo’s revenue at the time. Other local firms include Manier de Voir, Matalan, Lavish
Alice, Little Black Dress, Sosander, She Likes, and more. Those are just the
online companies. Offline/online fast-fashion contenders include The Hut,
Matalan, Topshop, and the oldsters, Zara. H&M, Mango. The Midlands
region, as well as being a center of textiles design and manufacturing, has
birthed a half dozen catalogue-sales companies, and some of these moved
their businesses online.
The Fung Global Retail and Technology report estimated the U.K. online
clothing market at nearly GBP 11 bln in 2016, accounting for 23% of total
clothing sales in the U.K. Online clothing sales grew by 7.5% in 2016, compared with a scant 1% growth for apparel offline, and Fung Global expects
online clothing sales to rise by 10% in 2017.
The founders and partners of Boohoo are Carol Kane and Mahmud Kamani,
who met, according to a published interview with Kane, in 1993, when she
was employed by a Kamani family company, Pinstripe Clothing, as a designer. Mahmud Kamani, whose father reportedly founded Pinstripe, has
been involved in sourcing and clothing wholesale for decades.
They are said almost defiantly to have chosen the name Boohoo a decade
after the spectacular collapse of Boo.com, a sportswear and fashion sales
website that had been started by the Swedish founders of the book website bokus.com. Ernst Malmsten, one of the founders, wrote a book on the
experience called Boo Hoo. Boo.com went down in flames when the inexperienced pair overspent and were unable to manage staff and inventory
expansion. Let’s hope it was not a prophetic choice of names.
The Stock
Boo trades on the Alternative Investment Market (AIM), a sub-market of
the London Stock Exchange. The market cap is GBP 2.937 bln. The company is trading at 123 times TTM earnings, 75x forward earnings, and
more than 10x FY 2017 sales. The Street expects earnings growth of 50%
in 2017 and revenue growth of 58%.
All fine and good for a young internet company. But the stock has gone
parabolic: it’s up 422% in one year. That’s just silly.
Summary View
Boohoo, an online clothing site, is offering a cheap but edgy line of fashion under a powerful brand emotionally connected to its target buyers. Its
growth has been phenomenal. But the hard thing in this business is not
really creating the brand but sustaining it through profitable growth. It’s
science, not art. Right now, Boohoo seems to be stumbling. The growth is
there—BOO has nearly tripled sales in the scant two years between 2015-
2017, from GBP 139 mln to GBP 295.6 mln—but customers grumble about
slipping standards. Spending on marketing has been suppressed but that
probably won’t last. To compete, heavy capital investment lies in BOO’s
near future. The company is unlikely to grow into its rich valuation and
maintain profit levels.
On top of that, Boohoo’s margins seem too good to be true. One-quarter
the size of industry leader ASOS, Boohoo boasts more than double its
ebitda and net margins. Meanwhile, Boohoo buys from a blinding array of
family-owned companies—and then acquires the companies. Even a sincere effort to keep it all at arm’s length would find the arrangements challenging.
The Company
Boohoo.com (BOO LN) is a U.K.-based, online-only “fast fashion” retailer.
Founded in 2006 and listed in 2014, BOO sells private-label fashion products for both women and men, targeting the younger, 16- to 24-year-old
demographic. Already by 2013, 35% of orders were by mobile. By 2017,
mobile orders were 70%.
BOO has developed a great brand, affordable, young, not too sappy but not
off-putting. It suits the Instagram generation, who prefer to order clothes
on their phones rather than visiting shops and who may toss out an outfit
after wearing it once to a party. BOO manages fast inventory turns: it trials a limited number of each design, monitors sales when launched, and
then orders more of the most popular styles. The company’s design process
starts three months ahead of a new season.
BOO hails from the Midlands, the heart of the U.K. textiles and fashion
industry, where small manufacturers ruthlessly pare their costs in order to
eke out perilously thin margins. Boohoo’s home, Manchester, is a hothouse
for online fashion and home as well to ASOS and Missguided, the as-yet
unlisted runner-up in the online fast-fashion world. A century ago, 80% of the world’s cotton passed through Manchester, whose Dickensian brick
architecture housed dyeing, cutting, weaving, and sewing mills. The great
offshoring movement of the 1970s-1990s changed that, and England’s textiles industry hollowed out.
As the large mills folded up and manufacturers moved operations overseas,
fast fashion, with its demand for small runs and quick time to market,
brought small, low-cost textile shops back to Manchester. The Cheetham
Hill area of Manchester is the hot, molten core of the city’s wholesale industry, streets filled with small textiles firms, import-export companies,
and wholesalers.
? Few Are Chosen
Pretty much anyone can go into online retailing. Survivors are those
that can manage their growth, and Boohoo is challenged. Online
reviews suggest that the quality of service is materially declining.
Ebitda has been propped up by cutting marketing costs, but gross
margins are in decline, and heavy capex lies ahead.
? Over-Valued
At 10x sales, the valuation of Boohoo.com is simply too rich. Growing
into its valuation would entail very significant capital expenditure as
well as faultless execution. The stratospheric rise and abrupt decline
of U.S. company Nasty Gal, now acquired by Boohoo, is an object
lesson in how tough that is to do.
? Family Business
Around 50 family-owned companies operating out of the same
premises as BOO create the possibility, if not the reality, of opaque
related-party transactions that could potentially make Boohoo’s
margins appear better than they really are. Some of the co-located
companies are disclosed suppliers. At the time of AIM admission, in
2014, Boohoo was buying 40% of its product from family companies.
? Low Entry Barriers
There are a dozen businesses almost exactly like Boohoo in
Manchester, England, and most of them seem to be struggling to
make money. We don’t see what should give Boohoo a sustainable
advantage.
? We Choose ASOS
Competing against Amazon is very tough, but if anyone can do it,
industry-leader ASOS is the more likely candidate.
https://www.jcapitalresearch.com/uploads/2/0/0/3/20032477/2017_07_14_boo_initiation.pdf