Stockwatch: Is this the next ASOS?

Is "the next ASOS" taking shape? ASOS soared from 50p in 2005 to 7,050p by early 2014, and at 3,200p it now trades on a multiple of 55 times forward earnings - having averaged 85 times in 2014 - while paying no dividend. Capitalised near £2.7 billion, this AIM stock is expected to grow earnings modestly in its current year, possibly in a 30% range the year after.

Likewise on AIM, at about 33p, Boohoo is capitalised at £375 million, likewise pays no dividend, and trades on about 26 times projected earnings for expected growth of 27-28% (see table). The company is strongly cash generative - hence no need for debt - and subtracting £60 million net cash on the balance sheet brings the price/earnings (PE) ratio down to 20 times for the underlying business.

Both stocks are plays on change in the fashion market towards faster turnaround, led by online trends in fashion awareness and ordering. Having five times greater sales than Boohoo, the longer-established ASOS gets Barclays' endorsement as a top stock-pick following positive feedback for its spring/summer 2016 previews. There is, however, no room for error here.

Over-priced start on the market

Boohoo floated at 50p in March 2014 amid euphoria, jumping immediately to 85p and settling at 70p. It had slumped to 22p a year later. This means an awful chart for a debut stock, as if the founding family cashed in £240 million then the business proceeded to warn.

Objectively, the family stake was reduced to about 44% otherwise institutions would not get involved in a controlled company (over 50%); and, yes, the company eventually warned - but not until January 2015, after a warm autumn and challenging retail conditions clipped expected growth.

Fashion retailing is inherently subject to this kind of issue - ASOS has had its own problems - which is something shareholders must be steeled for. Sports Direct warned much sooner after floating in 2007, its stock slumped and was cold-shouldered, yet has ten-bagged from end-2011 prices. Boohoo's first year on the market has been far from ideal, but recent progress is encouraging.

Getting its act together, towards a global brand

Interims to end-August showed revenue up 35%, with international representing 35% of the total, and active customers up 32% - amply qualifying as a growth business. The gross margin slipped slightly, albeit still strong at 60.1% (ASOS on 49.9%), helping cash rise 8% like-for-like to £60.4 million, or 5.3p per share.

The autumn/winter marketing campaign #WeAreNow was said to be supporting good progress in the second half year, with up to 100 fashion items hitting boohoo.com daily. The range of partners is being extended, also use of a wholesale channel, to grow the brand internationally. Items sold are chiefly dresses, tops, jackets and shoes, also swimwear - mainly to 16-24 year-olds.

Part of the challenge for the average investor is getting your head around a customer psychology where items may only be worn once or twice. Radio Four has just broadcast an illuminating interview with a 16 year-old girl who has a £150 monthly allowance from her father for make-up and clothes alone; being oriented towards who's wearing what on the street, in social media, and publishing herself. Her days kick off with all this on Facebook, Twitter, Instagram. Call it an epidemic of narcissism breaking out, yet Boohoo is well-positioned to capitalise.

Improving customer reviews?

There is another dilemma for investors trying to get a grip on product/service quality. Google Boohoo and you see mixed quality/service claims, although I recently notice those at Trustpilot improving to "Great", 7.7 out of 10 overall, based on 115,758 reviews.

Some criticism continues in some reviews, but you can find similar at ASOS, which ranks 4.7 out of 10 - "Poor" - on Trustpilot, based on 1,516 reviews.

A dilemma with such reviews is something usually going wrong somewhere in a fast turnaround business, versus customer expectations, and complaints liable to be vented online. Mind also how online businesses increasingly prompt customers to post reviews, hoping to balance out any criticism - i.e. with determined effort, a company can enhance its profile this way. By all means check the trend in reviews, albeit with a pinch of salt.

Potential to resist a UK consumer slowdown

Boohoo appears well-attuned to a social trend of fashion - and its purchasing - being played out increasingly in the digital world. Some trends can prosper even in a downturn, helped by low prices and customers addicted to the "pep-up" of new clothes for a night out. It was evidenced similarly by well-managed urban pub chains during the 2009-11 austerity period when a majority of Brits did not compromise on eating/drinking out.

Traditional retailing stocks are wary of a downturn after another consumer credit binge, and industrial cyclicals are rated cautiously, hence a precious few stocks with growth are likely to enjoy a premium.

It's still early times for Boohoo, as an AIM stock, but the shares trade on a PE multiple of just over 20 times ex-cash, with underlying growth currently expected in the high 20% area. Such a "PEG ratio" (PE versus growth) below 1.0 is the classic measure of a growth stock.

Balance sheet ticks boxes nicely

At the end of August, intangibles represented only 6.2% of net assets, with no capitalised goodwill. There's no debt either, and the ratio of current assets to current liabilities was a strong 2.5 times, mainly due to £60.4 million cash. The cash flow statement shows cash continuing to rise after investing activities i.e. growth is amply self-financing. Thus, Boohoo has strong financials without looking "too good to be true".

The market appears cautious to ascribe a higher rating after the first year's volatility, until there is more of a track record. Yet, since January, the stock has been in a rising - if volatile - trend, its price just recently falling from a 2015 high of 39p to 33.5p - pretty much on the recent trend-line.

The crux issue how Boohoo will perform long-term is "marketing to teenage girls". In this respect management broadly has its act together, and as an online store Boohoo is fleet-of-foot with a bold brand now established. Girls' lives appear fixated around imaging themselves so. Despite risks with fast-moving fashion and its reputation online, the stock, therefore, looks attractive to accumulate.

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.