Interactive Investor

Stockwatch: What to do with this massive profit

28th April 2017 10:14

Edmond Jackson from interactive investor

Can Boohoo, the £2.1 billion AIM-listed online clothing retailer, continue to beat forecasts to remain coveted by growth investors?

Nine months ago, analysts' consensus was £21 million normalised pre-tax profit for Boohoo's latest year to end-February 2017, but the company has achieved £30.9 million.

Regarding the current 2018 year, £25.6 million was initially projected, which rose to £35.4 million before the latest results. Now, independent analysts at Peel Hunt have raised their expectation to £40 million, with their share price target up from 180p to 220p (currently 187p) and a 'buy' recommendation.

Manifestly, Boohoo has caught a wave, adeptly marketing fast-moving fashion to a youthful audience with the help of social media.

Established financial analysis is left rather stranded and the crux is guessing how much longevity its brands have, as well as international leverage, as fellow AIM giant ASOS has shown since 2000.

Indeed, when I first drew attention at 33p in November 2015 it was specifically along a rationale: Boohoo was poised to become "the next ASOS", with keener prices.

This area can prosper quite independently of the wider economy, helped by relatively cheap items mainly for 16-24 year-olds - many of whom increasingly live with parents due to soaring property/rental costs, thus have fairly healthy disposable income compared with families saddled with mortgage and credit card debt.

Near parabolic chart and margin pressure

Mind, however, a potential collision between technical and fundamental issues - possibly not enough to disturb long-term growth credentials, but potentially enough to cause consolidation in the shares.

Over the last two-and-a-half years, Boohoo's chart is a near-perfect parabola, with only a brief pause in late 2016 before momentum buyers piled in following a strong New Year's trading update for the four months to end-December.

Indeed, when reviewing "stocks for 2016" at the year-end, I had repeated Boohoo as a prime hold for 2017. But, naturally, one needs to keep weighing the situation.

Versus 187p in the market currently, Boohoo should be capable of earnings per share (EPS) of at least 3p in the medium term (nominally low due to 1,123 million shares issued) implying a price/earnings (PE) ratio in the mid-60s.

Meanwhile, the underlying earnings growth rate will probably be less than 60% given margin pressure from importing about half its product - mainly from the Far East - amid relatively weak sterling and as currency hedges expire.

In its latest financial year, the gross margin slipped from 57.8% to 54.6%, mainly due to planned investments, while the operating margin rose from 7.7% to 10.3%.

Management guides it for about 10% in the current 2018 year, with revenue growth approaching 50% including acquisitions, as if they are more confident of absorbing the foreign exchange issue and possibly raising prices. We'll see.

Even with consensus looking for £47 million pre-tax profit in the 2019 year, earnings growth is liable to moderate relative to the high PE Boohoo now trades on - hence the price/earnings-to-growth (PEG) ratio soaring from an attractive 0.9 to unattractive multiple figures.

This is a crude snapshot measure but, unless Boohoo can surprise again on the upside in years ahead, it implies the shares are richly priced. Which is not to say they can't remain over-priced: at 5,625p (with 83.4 million shares issued) ASOS trades on a forward PEG of 6.2 reducing to 2.1.

Time will tell whether such premiums are justified by dependable superior growth. Mind also a technical aspect, how both stocks have benefited in the last year from portfolios re-allocating from bricks-and-mortar retailers towards major online brands.

This has twinned with a powerful story on fundamentals, to achieve a high rating. Boohoo is especially strong on social media where celebrities and bloggers are paid to promote its clothes.

Despite anecdotal complaints on customer review websites, Boohoo's 29% increase in active customers to 5.2 million over the last 12 months, shows management coping with rapid growth.

Thus, while the consolidated cash flow statement shows a reduction in free cash flow from £6.5 million to £5.4 million, capital expenditure - investment besides acquisitions - rose from £13.6 million to £30.7 million.

Carrot of long-term international development

Despite the risk of profit-taking, long-term investors can take heart from strong international growth potential.

While the chief boohoo brand achieved 33% revenue growth to £173 million, within its total 45% growth to £283 million, the US enjoyed 140% growth to £39.6 million equivalent, while Europe rose 50% and rest of world 40%, with the breadth of product range driving growth.

If management can genuinely leverage its UK success abroad then the group is looking at a good few years of superior growth.

There are over 29,000 fashion styles with over 100 new arriving weekly; and from a marketing base in womenswear the launch of boohooMAN in March 2016 has helped double menswear sales over the previous year.

Moreover, the launch of boohooKIDS late last year is said to have been "highly successful". With mobile devices accounting for 70% of shopping sessions, more country-specific apps will be launched this year besides those used in the group's key markets of UK, USA and Australia.

Websites for the US and Europe have been transferred to a new platform towards faster performance and cost savings. Such advances in logistics should help, although the key focus remains consumer appeal of the boohoo brand.

Net cash and scope for further acquisitions

The circa £15/16 million purchases of PrettyLittleThing.com and Nasty Gal early in 2017 have increased intangible assets by £31 million and started to contribute financially:

"Both brands have huge potential and the acquisitions represent a step change in size, structure and operation of the group."

With no hint as to introducing a dividend policy, however, further acquisitions look likely to generate synergies from investment in online marketing and warehouse capabilities; so, although deals aren't indicated, I'd watch this space.

One's stance on the stock also quite depends where you own it: if in a SIPP or ISA then it's possible to lock in some gains without incurring capital gains tax. That's worth considering in light of many Boohoo holders now motivated to protect gains and the stock chart hitting the dilemma of a rich valuation.

Probability implies a period of consolidation, although the development potential offers long-term upside, so outside any tax shelter it might be better to ride out the dips.

Boohoo.com - financial summary     Consensus estimates  
Year ended 28 Feb2013201420152016201720182019 
         
Turnover (£ million)67.3110140195295.0   
IFRS3 pre-tax profit (£m)3.210.711.115.7    
Normalised pre-tax profit (£m)3.211.112.315.730.937.747.0 
Operating margin (%)4.910.18.57.710.3   
IFRS3 earnings/share (p)0.20.70.71.12.2   
Normalised earnings/share (p)0.20.80.91.1 2.63.2 
Earnings per share growth (%) 23510.429.497.018.222.2 
Price/earnings multiple (x)    85.071.958.8 
Price/earnings-to-growth (x)    0.94.02.6 
Cash flow/share (p)0.50.51.11.6    
Capex/share (p)  0.71.2    
Net tangible assets per share (p)  5.56.1    
         
Source: Company REFS        

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