Interactive Investor

Stockwatch: Has Boohoo's bubble burst?

29th September 2017 10:55

Edmond Jackson from interactive investor

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Does a near 25% drop after latest interim results and the joint CEO unloading £10.7 million worth of equity represent a bursting of the bubble in AIM-listed online fashion retailer Boohoo.com?

Or was it an overdue wiping away of froth from a cult growth stock that continues to offer robust long-term prospects?

Can adept marketing offset rising interest rates?

I've drawn attention to Boohoo repeatedly as "the next ASOS" since 35p in November 2015, given the company is well-attuned to fashion trends and digital buying as well as having a strong balance sheet and cash flow, and nothing that looks "too good to be true".

Comparison with the loftily-rated ASOS, which sustained an annual average historic price/earnings (PE) multiple of 71.3 during 2015 versus 36.2 for Boohoo, was inevitable by the market and, amid keen appetite for growth stocks in a challenged economic climate, Boohoo became a strong momentum play.

On a PE basis it has leap-frogged ASOS this year by way of an average historic multiple of 100 times versus 81.3 for ASOS, and on a 12-month forward basis (assuming consensus forecasts) at about 195p currently Boohoo trades on a similar PE around 60 times like ASOS.

Neither stock has paid a dividend and both are on whopping multiples to net asset value. At current levels, there's no "margin of safety" and sentiment predominates.

It's worth recalling, however, the 2013-14 roller-coaster in ASOS, which saw it rise from 2,530p to 7,050p before slumping to 1,785p This created the base for a three-year bull market to its recent high of 6,425p.

While this offers some comfort to Boohoo holders wondering whether to lock in gains like the joint CEO has just done (selling 9.1% of her overall stake), recent years have provided "hot-house" conditions for growth stocks and debt-driven consumer spending - both of which will be adversely affected if interest rates are at an inflection point upwards.

Boohoo's marketing is highly adept - pitching fast-moving fashion to a youthful audience with the help of social media - but quite whether consumer/investor sentiment will temper henceforth to invalidate a comparison with ASOS' rebound.

Growing revenue at expense of margin?

Thus, after I cited Boohoo at year-end as a prime stock to hold both for 2016 and 2017, its strong rise during the first half-year has forced me to backtrack. It's all very well to say "the business looks great in the long run", but investors' sense of "a view on Boohoo" is primarily the stock and what to do with it.

Last April, with the price at 187p, I queried whether marketing skills could defy margin pressures given Boohoo imports about half its products, mainly from the Far East, amid weaker sterling and as currency hedges expire.

At the end-April prelims management guided for a 10% EBITDA margin in the current year to end-February 2018 and latest interims show a slip from 13% to 10.6%, while the gross margin is down from 55.3% to 53.3%. This is "in line with planned investments in the customer proposition", which probably includes growing turnover via low prices besides product origination.

Revenue growth is correspondingly guided upwards, overall to about 80% from 60% guidance previously, with the Boohoo brand at the upper end of 30% guidance and the acquisition PrettyLittleThing now expected at 150% above its annual trend to end-February 2017.

Or what extent is this due to very low prices "buying revenue"? Amid very strong growth at PrettyLittleThing and "investment in price, promotion and marketing", the group's EBITDA margin is guided down to 9-10%.

Yet, comparing trends in operating margins, the table shows Boohoo's has bumped about in the region of 10% whereas ASOS slipped from 7% in its year to end-August 2013, to about 4.5% since. Thus, both stocks' risk/reward profiles are in question at current elevated price levels.

Boohoo.com - financial summary           Consensus estimates
year ended 28 Feb 2013 2014 2015 2016 2017 2018 2019
               
Turnover (£ million) 67.3 110 140 195 295    
IFRS3 pre-tax profit (£m) 3.2 10.7 11.1 15.7      
Normalised pre-tax profit (£m) 3.2 11.1 12.3 15.7 30.9 42.8 52.5
Operating margin (%) 4.9 10.1 8.5 7.7 10.3    
IFRS3 earnings/share (p) 0.2 0.7 0.7 1.1 2.2    
Normalised earnings/share (p) 0.2 0.8 0.9 1.1 2.2 2.9 3.5
Earnings per share growth (%)   235 10.4 29.4 96.4 33.2 20.3
Price/earnings multiple (x)         88.7 67.2 55.7
Price/earnings-to-growth (x)         1.1 2.0 2.7
Cash flow/share (p) 0.5 0.5 1.1 1.6 2.7    
Capex/share (p)     0.7 1.2 2.7    
Net tangible assets per share (p)     5.5 6.1 5.4    
               
Source: Company REFS              

Interim results reaction is a key test

My sense last April was that anyone holding Boohoo in a tax-free wrapper should strongly consider locking in gains, otherwise paying capital gains tax would reduce your post-tax capital exposure; that the likely prospect was a period of consolidation for the stock with development potential still implying long-term upside.

That's quite what we've seen by way of overall market trend but, given a very strong moving average, the post-interims' sell-off puts the stock below its two-year trend-line, some traders will perceive as a "market break".

Most likely a majority of holders have regarded the stock as overvalued yet were content to play a momentum game while the chart indicated one, hence the rise to 266p by June. Through the summer it traded volatile-sideways, indicating overall buyer fatigue versus those anxious to protect gains.

This emphasised the net reaction to September interims which, clearly have not added enough new information to re-energise bulls, beyond an 8 June trading update. The plunge represents a "moment of truth" as to over-valuation, like when the music stops in a game of pass the parcel.

Equilibrium is no easy guess in the near term; some traders will look to charts but the wider risk appetite counts also.

Frankly, this near-term "topping out" is little different to other prize growth stocks I've introduced and covered here, such as Burford Capital and IQE. It's worth watching this class as indicative whether sentiment is cooling as higher interest rates beckon, at least in the UK and US.

Institutional and non-executive director buying

Yet Old Mutual, Boohoo's largest shareholder, increased its stake from 14% to 15% last August, during the price consolidation. That's taking a very long view, though, even if institutional trades in AIM stocks are largely dictated by what an opposite party wants to do.

Old Mutual's average price will also be much lower, thus it can currently afford a few timing mistakes. All mature bull markets show professional as well as private investors losing a sense for intrinsic value and the liability for sentiment to change, so I wouldn't take this as a cue to buy, though it does convey long-term confidence in the business.

That applies similarly to a non-executive director who has just bought 100,000 shares at an average price of 204.83p: Pierre Cuilleret was appointed earlier this month and it's nowadays expected that non-executive directors will align their interests with outside shareholders, buying stock.

"I look forward to working with the entire board towards strengthening and developing an already successful portfolio of international brands," he said when appointed.

As a serial entrepreneur who founded Europe's number one mobile phone retailer before it was acquired by Carphone Warehouse Group, then ran France's leading video games retailer before its acquisition, it's fair this outlay is modest in his overall wealth context.

News of his "buy" briefly helped turn Boohoo up from a mid-morning Thursday low of 194p, though near-term equilibrium is all down to sentiment. Brokers who have promoted the stock largely continue to do so.

Given a tricky context for UK consumer spending, I continue to think "sell" is prudent if capital protection is the first rule of investing. Boohoo can rally again but there's no valid indicator from where.

So, with fresh money especially, let this jolt to sentiment work itself through.

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