Don’t touch Boohoo with a bargepole – here’s what I’d buy instead

Online retailer Boohoo (LSE: BOO) was one of the pandemic’s big winners, but it has failed to keep investors on board as the world has reopened. Shares in the group have dropped a staggering 83% over the past 12 months, wiping out all of the stock’s pandemic gains and then some. Rival Asos (LSE: ASC) is not far behind.

The company’s troubles have continued to mount as the cost of living crisis starts to hit consumers in the pocket, not just in the UK, but in international markets as well. Management was expecting sales to expand by a mid-single-digit percentage this year. However, revenues fell by 8% to £445.7m over the three months to the end of May.

The company blamed “pandemic-related and inflationary factors” for the decline.

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Sector challenges dominate the story

Boohoo’s challenges are not unique to the company. The retail sector is brutally competitive, and businesses have to work flat out to stay ahead of the competition.

Seventeen years ago, TopShop and its parent, Arcadia Group, dominated the UK retail landscape with nearly 2,000 shops around the world and around 20,000 employees. In 2005, the year Philip Green paid himself a dividend of £1.2bn, the organisation generated an operating profit of £326m (two and a half times Boohoo’s 2021 reported operating profit of £124m).

That was the peak of the company’s success. Last year Boohoo and Asos carved up the corpse of Arcadia between them, paying £355m in all.

The irony is that Arcadia fell behind because it took its position in the market for granted. It was blindsided by firms like Boohoo, which was one of the first UK retailers to harness the power of e-commerce.

Sadly, Boohoo is not the nimble start-up it once was, and now its competitors are catching up, so it needs to keep investing to stay on top.

Last year, the company spent virtually all of its available cash resources (£262m) infrastructure. By the end of February, Boohoo’s cash reserves had dropped to £1.3m. In March management inked a new £325m loan facility to provide funding for growth.

The group has outlined plans to invest £500m and create over 5,000 jobs over the next five years, with up to £120m of this spending falling due over the next 12 months.

Boohoo’s challenges in the US illustrate the problems the group is facing. It wants to expand its footprint in the region, but it is currently stuck with a 10-day delivery service. That’s not good enough for consumers who want to order an outfit on Wednesday to wear on the weekend.

So the firm is having to build its own infrastructure.If Boohoo wants to grow in the region, and stay ahead of the competition, it needs to keep spending.

Boohoo’s reputational issues are lingering too

The combination of falling profits and rising spending is never a good look for a business, especially one that's also been hit by reputational issues.

Indeed, Boohoo’s problems go far beyond the numbers. Over the past couple of years it has been accused of relying on suppliers in Leicester that underpay their workers. There is also a growing movement against so-called “fast fashion” brands due to the impact these clothes can have on the environment.

To its credit, Boohoo is trying to improve its reputation. It has opened a model factory in Leicester with 180 new jobs for workers on guaranteed 40-hour-a-week contracts with holiday And it’s also manufacturing clothing from recycled materials.

Unfortunately, it will take time for the company to rebuild its reputation. Until it does, for many investors the stock will be uninvestable.

Performance is expected to improve, but uncertainty prevails

Management believes Boohoo’s operating performance will improve in the second half of the current fiscal year as consumer demand normalises and it works through logistical challenges.

There are some signs this scenario could play out. “We have seen promising signs from the group’s sales performance in the UK, which has improved month on month in the period and we are looking ahead towards our key summer trading season,” CEO John Lyttle noted in Boohoo’s latest trading update.

As uncertainty is the name of the game right now, I would take this statement with a pinch of salt. Boohoo is maintaining its mid-single-digit percentage annual sales growth target, even though sales fell in the three months to May. It’s going to be hard for the group to make up this lost ground, especially with consumers being battered from every angle. Analysts expect the outlook for the economy to get worse before it gets better.

Considering all of the above, I would avoid Boohoo at all costs. The company operates in a highly competitive market, is having to spend more to stay ahead and it’s facing a tough consumer environment. With headwinds mounting, I’m struggling to see any positives for the business over the next 12 to 24 months.

Refinitiv analyst estimates have fallen consistently over the past 12 months. The average adjusted earnings per share target for 2022 is now 2.9p down from 13.7p last year. And on this basis, the stock is trading at a forward price-to-earnings ratio (p/e) of 22.7.

In comparison, peer Next (LSE: NXT) – which I believe is ahead of Boohoo in the race to build the infrastructure required to support a world-beating aggregation business – trades at a p/e of 11. Granted, Boohoo’s valuation gives no credit for potential growth and earnings upgrades in the months ahead, but based on this valuation gap, Boohoo looks expensive to me.

I’d buy Next instead: Why Next is the only retailer I’d want to own in my portfolio