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Premium Research: Is Boohoo.com plc The Next ASOS plc?

This research has been produced by the Motley Fool’s Special Projects team, as part of our premium investing team’s recent exploration of the UK small-cap sector. Led by the Head of UK investing, this team is dedicated to providing our premium members with the best investment ideas. We hope you enjoy this free research!

Across the UK, and indeed the world, fashion-focused shoppers are buying more and more of their wardrobe online.

This undeniable trend saw the value of online fashion plays Boohoo (LSE: BOO) and ASOS (LSE: ASC) shoot up, only to come crashing back down when results from both companies disappointed investors last year.

Boohoo floated at 50p and currently languish at 28p. ASOS shares now change hands for £39.95 but had risen as high as £70.40, or a 76% premium to today’s price.  

But are their growth stories still intact and are they buys at these new prices?

Apples and Oranges

The two companies are often talked about as if they were in direct competition with each other, but I believe their business models are sufficiently different for this not to be the case. 

ASOS sell a huge number of brands, from Adidas to Kurt Geiger to Zucca. Chances are, ASOS stocks every fashion brand you have ever heard of and then some. It wants to become “the world’s No.1 online fashion destination for 20-somethings globally” and the investment thesis relies on it achieving this.

You see, as ASOS grows it can offer its clothes to more customers. The more customers it has, the more important it is for brands to be represented on it. An increase in brands should attract more customers, which in turn should drive margin expansion as the business benefits from scale. All together this creates a virtuous circle, a very attractive proposition for an investor.  

The company has had its problems this year: a warehouse fire, heavy discounting in the industry and a prudent acceleration of investment in the business have all caused profits to fall below expected levels.

These issues are all temporary in nature and, given the solid top-line growth (27% last year), earnings seem in a good position to pick up the pace.

A Shrewd Operator

Boohoo exclusively sells its own-brand product, a strategy that has seen it maintain margins significantly higher than ASOS.

The company seems to have strong grasp on costs of making its product, a luxury ASOS does not have. While ASOS’s gross margin of 48.6% is strong, Boohoo’s 61.5% is stronger. This resulted in net income margins of 3.5% and 7.1% respectively for the two companies.

But Boohoo’s strategy comes with its own risks, too.

Because it creates its own products, the pressure from the tumultuous world of fashion trends will never ease up. Boohoo, as with most fashion companies, is only a few years away from irrelevance if the quality of its offering falls…

While Boohoo might look like it comes out on top here, I think the numbers are misleading. ASOS has the potential to be a true behemoth of fashion, whereas Boohoo is a simple retailer with well-run operations.

Both have potential to deliver exciting returns but the ceiling for ASOS as a business is much higher.

Valuation

I believe that at current prices, the market is expecting Boohoo to grow profits at around 25% for a few years before tailing off.

While this is certainly not unachievable for Boohoo, as the company’s 23% profit growth in the first half of this year shows, I feel the company is near fully valued. I need a slightly larger margin of safety before I’d invest.

The market seems to be pricing in rip-roaring growth for ASOS, too. I am a staunch believer in ASOS’s brand, but again I would need a slightly lower price to get in.

Our Verdict

I’d keep an eye on both of these companies – a small market correction could leave them looking quite attractive once more.

While these two companies do make it onto our watch list, our Head of UK Investing has identified a company that we believe has "breath-taking" potential. This little-known company has just emerged from a balance-sheet transformation, leaving it in a prime position to rocket.

Better yet, we think the market has missed its "new-look" potential.

An innovative product that could double in sales, a net cash position and a potential US expansion are all catalysts we think could send the share price sky-high!

Click here to discover how this overlooked growth stock could enrich your portfolio.

Zach Coffell has no position in any shares mentioned. The Motley Fool UK owns shares of ASOS. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.