The problem with Boohoo plc
Hello all.
I know it’s a Monday and not a Sunday. I have exams next week so I’ve been a bit all over the place.
I’d like to talk about BOO’s financial statements this week. This letter will be a bit more forensic, but I hope it’ll teach you something about stocks. The newsletter will have a similar approach to my piece on the Hut Group. I think it will shed some light as to why it has been performing poorly over the pandemic.
The problems at BOO
The once AIM star has had a battering since its peak over the course of the pandemic. The stock has plunged ~68% since its all-time high.
What I find particularly unsettling about its current price is that, if you look at the chart, it’s trading for less than it was in March 2020 during a time of peak fear. The market must be valuing something seriously wrong at BOO for it to be trading less than it was in March 2020.
The serious plunges in the prices that you can see are due to management changing their guidance, not by a bit, but by a serious amount.
In their latest trading update, management absolutely squashed their previous guidance for revenue. Management had originally projected for its investors that revenues would compound between 20% to 25% for the year ending 28 Feb 2022. However, in the latest update, they have revised this projection at 12% to 14%… oof.
To give this some context, some £192m worth of sales have been wiped from expectations. When valuing a company using a DCF, the present value of next years’ cash flows and the terminal value are the most influential variables in the equation. So when management swings their expectations of revenue from 25% to 14% for next year (which is a lot) then the valuations will have to be revised significantly downwards.
Further, revenue as a proportion of TAM is a proxy for the company’s market share. If revenue growth is being downgraded, it implies that competition has got hotter.
A nice bit of corporate finance theory for you there. You’re welcome.
For me, over-optimistic and inflated management guidance isn’t enough to explain why the stock is trading at its current valuations. Remember, it’s trading lower than what it was in March 2020 when the entire globe went - “Well, sh*t.” (And investors went, “lets hoover up some distressed equity, yummy”).
I think the answer lies in their accounts (let’s face it, it always does - nothing profound here). Shadowfall did a great research report into BOO, this is where I got most of this newsletter from.
Since the company first started reporting its accounts in 2014 until its 2020 annual report it had been flattering its cash flows. When a company reports its free cash flow, tax paid in cash should be deducted. BOO wouldn't do this, see here:
As you can see, BOO adds back Tax Expenses when calculating their free cash flow and when reporting their cash flow statements. Very naughty.
Further, BOO would fully consolidate PrettyLittleThing (PLT) despite owning only 66% of PLT. This would mean that when management derives BOO’s FCF from profit after tax (which is what they should be doing), the profit after tax includes ALL the profits PLT has made rather than just 66% of it. In the same way that not deducting tax inflates BOO’s cash flows, not accounting for the minority interest in PLT further inflates the cash flows.
Since PLT made nearly 50% of the group’s profits in FY2021 and is the main contributor to the Group’s growth over the years, fully consolidating PLT seriously inflates its cash flows.
The group has now exercised their option to fully acquire PLT for roughly £250m, likely to be funded at the expense of BOO’s shareholders who, during the pandemic, coughed up some cash for equity when BOO decided to do an “accelerated book build”. This will be a significant cash out flow, thus decreasing FCF even further this year, hence the extremely low share price.
Oh yeh, and by the way, the owner of PLT is the Chairman of Boohoo’s son. Blood is thicker than water, especially when we’re talking about a quarter of a billion quid.
That’s all for this week. I won’t be writing for a bit as I have an essay due 11th and an exam 13th. I hope you had a nice Christmas and have a happy new year.