Is it the right time to buy Boohoo shares?

Is it the right time to buy Boohoo shares?

*Key Numbers*
Revenue grew 27% to £140m and PBT grew 3% to £11m. UK revenue up 33% to £94m, Rest of Europe up 39% to £18m, and Rest of world up 7% to £27m. Active customers up 29% to 3m, orders up 36% to 5.8m, and average order value down 4% to £35.28.
Analysis
I have been quite bullish on Boohoo.com since the drop in January. These full year results don’t reveal any more about the top-line performance but give us an interesting insight into what management is thinking and how they are going to try to turn this around.

I believe we get a slightly new perspective on management, they have been far too optimistic. I am concerned about spending but I see no change in the investment case and we are still getting a good price to take a risk on this summer’s marketing campaign.
Introduction
Boohoo.com is coming out of a period of very strong infrastructure investment. As this ended last year management promised to reallocate spending towards marketing boosting sales growth. Instead of growth, we saw sales growth slow at the end of last year. The question is now whether the company can find a successful marketing strategy for SS/15 and
Sales growth
All the attention is on the top-line but, as always, full year results don’t offer any new data as Boohoo reports quarterly.
The key trend in the full year was UK growth slowing from 47% in the first half to 22% in the second. In the report management attributed this to heavy competitor discounting during a warm autumn season. I am not totally sure this explains it all.
Autumn was brutal, we know this from reports out of other apparel retailers. Boohoo is such a small part of the market though that we have to recognize that marketing fell very short too. Management’s comments at the analyst meeting placed far greater emphasis on marketing, I don’t actually think competition, was mentioned. It is also worth highlighting that sales growth at the March trading update was 13% for the two months to 28th Feb, sales were clearly weak well past autumn.
At the analyst meeting, we also heard a new interpretation of the marketing slowdown: the delayed implementation of the warehouse management system led to a late start on A/W14 marketing. I don’t think we have heard this explanation before but it sounds plausible given the huge amount of infrastructure investment made through the year.
European sales are slightly less relevant but it is worth mentioning that the company was impacted by the weakening euro but re-priced to remain competitive. At constant rates, rest of Europe growth was 47%.
Going forward, our focus has to be on marketing strategy. If management can pull it together than sales growth should accelerate. We get a slightly new spin on went wrong last year from this latest report. I don’t buy the weather excuse, the new explanation regarding the warehouse management system is useful though as this suggests that growth could improve
Marketing strategy
Boohoo appears to be very good at all the back office tasks of online retail but the company’s marketing prowess remains relatively untested. Competitors may have become more aggressive in the second half but it also seems that spending wasn’t optimized effectively. This report give us some information about the company’s marketing strategy for the upcoming season. Relative to where the company was last year it sounds pretty good.
At this time last year, it looked like the company had more TV advertising and billboards. For an online retailer, this doesn’t make sense. Digital marketing is cheaper and more targeted at people who are actually going to buy. Therefore, it is good to see the company place more emphasis on return on investment, social media and the like. I still don’t think it is where it needs to be but it is an improvement.
Marketing spending as a percentage of revenue shrunk by 80bps to 13.2% in the year. Management really pulled back in the second half and, apparently, redirected towards growth markets. I don’t think this geographic reallocation has been mentioned before.
My understanding was that management thought the second half wasn’t going well so, wisely, reduced marketing to 10% of revenue and moved onto planning for SS/15. Apparently this was combined with a reallocation towards regions like the UK and U.S. In my view, the company is too dispersed geographically so I like this reallocation of spending but, again, this appears to be a new interpretation of the past.
Marketing is definitely moving in the right direction. I have no idea whether this strategy will ultimately work but the failure last year has clearly focused the minds of management. The price we are being offered to take this risk is pretty favourable too.
Capital expenditure
One criticism that could be made is that management have focused far too much on building capacity but not enough on actually generating sales growth.
The latest report announces that the company is nearing the completion of, hopefully, the last phase of this investment with capacity for £500m of sales. Given current sales of £140m, we should have enough space for the next few years. Capital expenditure should ease next year although projections for the following years are still quite large. I am not sure exactly why this is, we shall have to wait and see what happens, but it is a significant risk as demonstrated by the low level of profit growth this year.
Investment in the warehouse management system, completed in September last year, has been more useful. The a 9pm cut-off for next day and Sunday deliveries as well as offering return through Collect+ are competitive offerings.
Costs
Profit growth in the period significantly lagged revenue growth. Gross margins actually increased but both distribution and administrative expenses were up significantly too. This is a huge disappointment as the real advantage of an online retailer should be low costs and significant operating leverage.
The increase in distribution and admin was about £19m, this was spent on:
“business expansion, higher marketing expenditure, and investment in improved, more efficient systems and in talented people to support the transition to a publicly-listed company and future growth”.
Adjusted EBITDA did actually grow at the slightly more hopeful pace of 16% but we are still falling short, especially as only £2.1m of the additional costs related to being listed.
I don’t doubt that management care about costs and are aligned with shareholders but, and capital expenditure proves this too, they have been far too optimistic about future growth. Hopefully, we can leverage this cost base next year but this performance is disappointing.
Valuation
The current market cap is £314m, or 28x PBT. We have the cash balance of £54m, 17% of the market cap, and is seeking authorization for a buyback. Ex-cash this trades at 23x PBT.
A lot of people who bought the profit warning are, I believe, going to take a look at this report and just decide they can’t handle it. Rising costs and slow profit growth seem to suggest that this will be a long turnaround.
I think this is partly true but I am sticking to my timetable here. The magic of these businesses is operating leverage. Significantly higher sales can be achieved with minimal incremental costs.
For example, this year we saw very little revenue growth come down to the bottom line. Say we do 20% top-line growth next year, £28m in absolute terms. In theory, as much as 50% of this could flow down to the bottom line. Now I don’t think this will necessarily happen next year, distribution costs probably are going to keep increasing. The point stands though, the multiple is high but justified by the economics of the business.
So the key factor here really is how effective this marketing spending is. The lack of profit growth is concerning but I think this just arises from management’s overconfidence, rather than profligacy. Given the upside, the current price is pretty reasonable. Everything relies on the SS marketing campaign though.
Summary
I am retaining my POSITIVE rating here. The company has more levers to pull than I think investors realise. Share buybacks are one but I also think that the company has made a lot of the infrastructure investment for the next phase of profit growth. I am not entirely convinced that the company still isn’t spending too much but it looks like costs are roughly where they should be for the next stage of growth. Improvements have been made in marketing too, although I still don’t know whether this will work out. Either way, the market is offering us a good price for this risk.
**Outlook: POSITIVE**


This analysis is provided by Mercurius Research and the author has no position in any stocks mentioned. Try Mercurious Research subscription services free for 7 days by .
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By Harry Atkins
Harry joined us in 2019 to lead our Editorial Team. Drawing on more than a decade writing, editing and managing high-profile content for blue chip companies, Harry’s considerable experience in the finance sector encompasses work for high street and investment banks, insurance companies and trading platforms.

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