The appeal of boohoo

Robert Stephens, CFA, considers why boohoo’s strategy and business model hold significant appeal in a rapidly changing retail environment.

Online-only retailers such as boohoo have significant advantages compared to bricks-and-mortar shops. Not only do they have reduced business rates and lower costs, they are more closely aligned with changing shopping habits among consumers not just in the UK, but across the world.

The company is seeking to further appeal to evolving customer tastes through its environmental credentials. It is also investing heavily in its supply chain, with automation helping to build a strong foundation for future growth.

Of course, the company faces weak consumer sentiment in key markets such as the UK and US. Management changes may also lead to a period of further change for the business. However, with a variety of brands, a diverse geographical exposure and a marketing function that has been highly successful in appealing to its target demographic, the prospects for the stock appear to be encouraging.

Diverse business

Boohoo is a relatively young business. Founded in 2006, it focuses on offering a range of clothing and accessories for 18-30-year olds, and has gradually expanded to include three main websites. The biggest is boohoo, including boohooMAN, which contributed around 51% of revenue last year. The company also acquired a 66% stake in PrettyLittleThing in 2017, with an option to buy the remainder in 2022. This contributed 44% of revenue last year. Boohoo also acquired Nasty Gal in 2017, which contributed 5% of total sales last year.

Together, the three brands provide diversity for the business. They also highlight its ability to make acquisitions and successfully integrate them. This suggests that organic growth could be supplemented by further M&A activity over the long run. For instance, itrecently acquired women’s retailer Miss Pap for an undisclosed sum.

The company’s geographic exposure has also become increasingly diverse in recent years. Today, it sells its products in a wide range of markets, with the UK supplying 57% of revenue, Europe contributing 13%, the US accounting for 19% of sales and the remainder coming from the rest of the world. International expansion is set to be a key part of its future growth story. This may help to insulate it to some degree from weakness in local markets, as well as providing it with exposure to fast-growing economies where its offering may be better aligned with local consumer tastes than incumbent retailers.

Online appeal

Over the last decade, the percentage of total UK retail sales undertaken online has increased from 5.7% to 18.6%. Improved technology and the increasing confidence of consumers to shop online means that online-only retailers such as boohoo have enjoyed a tailwind. This is showing little sign of slowing down, with 26.8% of total retail sales in the UK expected to be made online by 2022. This means that even if the wider retail sector delivers somewhat sluggish growth over the medium term, online sales growth could remain high. In fact, over the next three years, online retail sales are expected to rise by almost 8% per year.


As well as having the potential to benefit from increasing demand for online clothing and accessories, boohoo also has an advantage over its bricks-and-mortar peers when it comes to costs. It has warehouses in Lancashire and Yorkshire that distribute its products across the world. This provides it with a low-cost base compared to many of its sector peers, many of whom are tied into expensive leases in a wide range of locations across the UK.

Since business rates are based on a property’s value, online-only operators generally pay far less than their high-street rivals. Therefore, while a number of boohoo’s sector peers are gradually moving towards an increasingly omnichannel business model that includes significant investment in their online operations, ultimately, they are likely to be held back by the cost of running a store estate. At a time when consumers are highly price-conscious, this could allow boohoo to offer more competitive pricing or higher margins, than many of its peers.

Growth strategy

Clearly, having a few websites and a couple of warehouses is not enough to produce a successful business. The company has therefore invested heavily in offering a better customer experience than other retail peers. A key part of this strategy has been an investment in its supply chain. For example, it has spent £32 million on its distribution centre in Lancashire, with automation being introduced in April 2019. Not only is this likely to reduce costs, it could also provide faster and more accurate deliveries and returns to customers, helping to differentiate its offering from those of its sector peers.

In order to enhance its competitive advantage, the business has sought to align itself as closely as possible with its target demographic of 18-30-year olds. For instance,the use of celebrities and social-media influencers in its advertising campaigns has helped to build a fast-growing social-media presence that includes 5.9 million followers on Instagram.It has also sought to offer a wide range of sizes to promote inclusivity, and the recent launch of its first dedicated recycled clothing range could resonate with customers in an era where sustainability is a key concern for the 18-30 demographic.

Threats

Although boohoo has a number of growth catalysts, there are also risks facing the business. Notably, the consumer outlook for its two key markets, the UK and US, is highly challenging. In the US, for example, retail sales have increased by just 1.1% in the last nine months, while sentiment in the UK is likely to remain weak as the Brexit process continues. Although clothing is a staple good, there are always opportunities for consumers to trade down to cheaper options, or delay purchases of non-essential items.


As previously mentioned, the company was formed in 2006, with its co-founders managing the business until very recently. While they both remain on the board, and one is executive chairman, a new chief executive has recently been appointed. This could lead to a change in how the company is run, as well as a shift in strategy. Given the success the business has enjoyed over recent years, any changes to its management team may pose a risk to its future prospects.

Outlook

Boohoo’s most recent trading update highlighted that its performance has been strong across its markets, as well as within its various brands. Notably, its growth outside the UK has been strong, with sales growth of 66% in the US and 71% in Europe (excluding the UK) providing it with an increasingly diverse business model.

In the current financial year, it is forecast to post a rise in earnings per share of 24%. Although this is lower than the annualised rise in earnings per share of 54% achieved over the last four years, it still represents a superior growth rate than that of the vast majority of its retail-sector peers. Crucially, boohoo also has the right business model. Therefore, unlike many of its industry peers, it will not need to close stores and reduce headcount.

Although it trades on a price-earnings ratio of 51, this drops to 43 when its current financial year’s forecasts are used. Since double-digit earnings per share growth seems to be likely over the medium term, given the prospects for online operators within the retail industry, the stock could be fairly priced at the moment. Certainly, it is not difficult to find cheaper alternatives within the retail sector. But there are few companies that can offer the level of growth potential that boohoo appears to have.

Investment potential

While the wider retail sector is undergoing a challenging period as it seeks to adapt to changing consumer tastes, boohoo’s business model appears to be fit for purpose within an increasingly online-focused world. The investment it has made in its supply chain and in ensuring it has a buoyant social-media presence could act as catalysts on its growth. It appears to have a significant competitive advantage over its peers in terms of being aligned with customer tastes and having a lower cost base.

The business has evolved into an increasingly diverse operation that is gradually becoming less reliant on the UK. This could help it to overcome potential threats that may be ahead in the near term. Also, the continued presence of its co-founders on the board indicates that its strategy may not deviate significantly from that which has been successful in recent years.

With the company continuing to align itself with evolving customer tastes and being likely to benefit from further investment in its supply chain, it appears to have a bright future within what is expected to be a fast-growing online retail segment. Therefore, although it may not be a cheap stock within what seems to be a heavily discounted sector at the moment, boohoo could generate high returns over the long run.