There was huge excitement last week when online retailer Boohoo.com (BOO) floated on the stock exchange. The Aim-traded shares rocketed from 50p to 75p in short order, although they've now come back slightly, to settle at 63p, giving the company a market cap of £712m. The enormous popularity of the stock (it was the sixth most active security on the first morning of trading with online broker TD Direct Investing) is evidence that there's huge investor appetite for retailers that can offer a compelling internet growth story akin to that of Asos (ASC).
So what exactly is the story? Well, Boohoo is a retail online pureplay targeting the late teen to 20-something market with fashion clothing at reasonable prices. Based in Manchester, it was founded by joint chief executives Mahmud Kamani and Carol Kane in 2006, both of whom worked in the fashion industry for Mr Kamani's father's company, Pinstripe Clothing, a garment and footwear wholesaler.
As well as raising money to pay off debt, the IPO has landed Boohoo with a net cash position of more than £50m with which to accelerate its growth plan and raise its profile. The idea is to expand the product range, such as adding more sizes and foraying into areas such as luggage, makeup and scarves, broaden the target customer range to include 25 to 35-year-olds, increase customer retention, improve marketing efficiency and, critically, expand overseas. The company has already started to develop brand awareness abroad, and there appears to be huge demand here. International sales grew from 10 per cent of the group total in 2011 to 34 per cent in 2013. In the first half of the 2014 financial year, 40 per cent of sales came from outside the UK. Foreign language websites are about to launch in Holland and Scandinavia, following a rollout in France in October.
This all sounds very familiar, but what sets Boohoo apart from the chaff, according to management, is its procurement model. Rather than relying on a number of middlemen operating between third party suppliers and itself, the company has switched to direct sourcing. This, it claims, has improved the gross margin by 10 percentage points to 64 per cent. Unlike Asos, all of the products are own-brand, so it can be more competitive on price. And, because of its strong relationship with suppliers, Boohoo's products can be tested in low quantities for short production runs, with successful lines re-ordered, thereby minimising risk of stock write-offs. The sourcing model also allows Boohoo to react quickly to emerging fashion trends and launch new products each week, transferring from catwalk to closet in as little as six weeks. There are 2.2m active customers on the books (compared with 8.2m at Asos), with 130,000 new clients registering each month.
But what about the financials? Well, historic trading is impressive. Between 2011 and 2013, sales more than doubled from £36.9m to £96.4m, while the adjusted pro forma pre-tax profit more than tripled to £8m. This year, profit is expected to rise 76 per cent to £14.2m on sales of £161m.With this level of growth, you can see why the shares have generated so much interest. But, as you might have guessed, this growth doesn't come cheap. Based on the 63p share price, the stock is trading on 45 times pro forma earnings forecasts for 2015 and 33 times 2016 earnings forecasts. Even the forward two-year PEG ratio, which takes into account future earnings growth, is hovering around 1.6, based on our rough calculations - not exactly a steal.
But is there really any point in valuing the shares? Other online pureplays like Asos, Amazon and Ocado (OCDO) trade on equally eye-watering ratings, but have rewarded shareholders with massive returns. Retail analyst Nick Bubb argues that on an enterprise value to forward cash profits basis, Boohoo's valuation looks more compelling. Using this method, Boohoo's rating is 44, based on a market cap of £712m, net cash of £50m and assuming cash profits of £15m for the year to February. Compare that with a rating of 55 for Asos for the year to August 2014 (or 60 if calculating to a March year-end) and roughly 135 for AO World (AO.) for the year to March.
So, if you think Boohoo can deliver the kind of sales and earnings growth offered up by Asos, and you're willing to pay a premium upfront for that growth, then go for it. But tread carefully and remember that to justify such a premium, the company will have to deliver pretty impressive trading. Any whiff of a slowdown and the shares will take a beating. Asos' second-quarter trading update, which hammered the share price this week, was a stark reminder of this. Retail sales growth slowed to 'just' 26 per cent in the period, marginally lighter than forecast, largely down to weak sales growth in the 'rest of the world' division, where adverse currency movements hit top line trading in Australia and Russia, leaving divisional sales just 3 per cent higher. UK sales growth of 21 per cent was also slightly worse than expected. Investment in warehousing in the UK and Germany has led to double running costs and accelerated investment will mean higher costs this year. This, along with bigger losses related to Asos' start-up in China, means the operating margin will fall to 6.5 per cent and pre-tax profit will be lower than forecast. Broker Peel Hunt has cut its pre-tax profit estimate for the year by 7 per cent to £65m.
