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Boohoo Group: Visit to Leicester

  • SHORT @ £--

Recommendation: Short (No Change)

Price:

£--

3m ADV:

$20m

Price Target:

£--

Market Cap:

£4bn

Forecast Return:

~50%

Ticker:

BOO LN

Investment Thesis

  • We believe that investors are not adequately foreseeing the significant risks to a likely change in the business model.
  • We forecast EBIT margins to decline from 8% to 4% as the cost of goods sold are likely to increase. Our primary research indicates the cost of manufacturing is likely to increase materially.
  • Numerous corporate governance red flags (e.g. insider selling, departure of accountant mid-term etc.).
  • £1.60 price target provides ~50% downside potential from here.

We last visited Leicester before the COVID-19 pandemic hit in March 2020. Touring the local factory area informed our view that some clothing manufacturers were lacking in their levels of compliance with UK regulations. 

We decided to repeat the exercise in June ’21 and this note updates clients on what we saw, and what it means for the investment case. In summary, we feel that the quality of Boohoo’s suppliers has improved. However, we have concerns on the implied total capacity of Boohoo’s listed suppliers.  

We retain our short stance and acknowledge some improvements in Boohoo’s supply chain, with limited gross margin impact so far. Near-term, there is potential overhang risk, as in June 2021 the founders’ 18-month lock-up expired on their stake (~£600m).


Touring the Leicester Suppliers 

A lot has happened since our first visit to Leicester in March 2020:

  • A Sunday Times exposé in July 2020, revealed that an undercover reporter was allegedly hired for below minimum wage by one of Boohoo’s subcontractors. 
  • Boohoo’s subsequent independent review, led by Alison Levitt, corroborated the exposé, adding: “the allegations of unacceptable working conditions and underpayment of workers are not only well-founded but are substantially true.”
  • Consequently, Boohoo cut 64 suppliers and now works with 75 in the UK.
  • Creation of the Agenda for Change programme to deliver meaningful change to Boohoo’s supply chain and business practices. 

Despite all these changes, Leicester remains key to Boohoo’s supply chain, providing it with ultra-responsiveness to the latest trends. Currently 68 of its 95 factories in the UK are based in the city.
 
We spent the day walking around Leicester’s key area of apparel manufacturing, observed a large selection of factories, and also spot-checked 20 of Boohoo’s suppliers. Although we did not have permission from either Boohoo or the manufacturers to visit the premises, we could see into some factory operations: it was a warm day and several factories had doors open for ventilation. The quality of the Boohoo suppliers’ sites (e.g. buildings, loading bays, facility upkeep) that we observed was better in comparison to what we had seen in 2020, and superior to some non-Boohoo suppliers in Leicester (e.g. those based in the infamous Imperial Building). 

Exhibit 1: Selection of Boohoo’s Leicester Suppliers

Source: The Analyst Lens (June 2021)

 

UK Supplier Capacities Look Insufficient

In aggregate, 2,675 employees are reported to be working at Boohoo suppliers, but we consider this too few relative to Boohoo’s UK supply. We cannot reconcile how the 2,675 employees manufacture sufficient stock for Boohoo even if they have exclusive contracts. This opinion is based on the following assumptions: 
 
We estimate Boohoo’s UK COGS are ~£320m and the implied wage bill of all its suppliers is ~£53.5m. This translates to a staff cost-to-sales ratio of 17% for the suppliers, which we consider too low given:
 
1. The high component of labour in the cost of manufacture: we believe the ratio should be closer to 50%.
 
2. The suppliers are unlikely to manufacture exclusively for Boohoo, implying an even lower staff cost-to-sales ratio. 
 
  • UK COGS of ~£320m for FY’21:
    • £800m COGS in FY’21.
    • 40% UK.
  • Wage bill of £53.5m assumed for the suppliers:
    • They work exclusively for Boohoo. 
    • All 2,675 are full-time.
    • Average wage is £20k.
 

What are the possible explanations? 

1. Boohoo have moved more production overseas and its UK COGS are less than we assume. We consider this unlikely given we believe the UK is key to Boohoo’s responsiveness and Boohoo has reiterated its commitment to UK manufacturing. 

2. The number of workers listed on the manufacturers list is understated. 

3. We are wrong on our sales-to-staff cost ratio.

We have asked the company on this point and will update clients when we find out.

 

Boohoo’s New Factory 

Boohoo is building a new factory in the North East of Leicester with the intention that it becomes a centre of excellence to educate local factories on best practice. Boohoo intends to operate the factory with a partner through a joint venture. 

The factory is on the site of a former car showroom that is ~25,000 sq ft. Once open, Boohoo intends on employing +85 workers and plans to produce 20,000-25,000 items per week. 

Boohoo originally had hopes that the factory would be open by September 2020. Clearly this has not happened, with the site still very much in the construction phase. A site workman informed us that the factory is now on track to be opened by November 2021.

Exhibit 2: Boohoo’s New Factory

Source: The Analyst Lens (June 2021)

 

Progress Since Independent Review

Boohoo has made some significant changes to its supply chain since Alison Levitt’s Independent Review in September 2020. The main points are:

  • All suppliers have been audited, with 280 audits of suppliers between July and November.
  • Suppliers that have failed audits have been dropped, and Boohoo now works with far fewer suppliers in the UK.
  • Boohoo no longer allows its suppliers to subcontract out. 
  • Boohoo has published its UK manufacturing list.
  • The Garment and Textile Workers’ Trust has been established with a £1m investment from Boohoo.
  • Boohoo buyers now abide by responsible purchasing practices.

Conclusion 

We retain our short stance and acknowledge some improvements in Boohoo’s supply chain, with limited gross margin impact so far. We struggle to reconcile the number of manufacturing staff, relative to what we assume to be Boohoo’s UK cost of goods sold, which may indicate that Boohoo have shifted some supply away from the disclosed Leicester suppliers. Near-term there is also potential overhang risk as the founders’ 18-month lock-up expired on their stake (~£600m) in June 2021.

 

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