Fast fashion vs the catwalk: will plc or Burberry Group plc win this fight?

Is your money better off with Burberry Group plc (LON: BRBY) or plc (LON: BOO)?

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One is a 10-year-old online-only operation selling £10 dresses while the other is a 160 year-old name brand selling goods from £300 scarves up to £20,000 alligator skin handbags. (LSE: BOO) and Burberry (LSE: BRBY) may not have much in common when it comes to the products they sell, but for investors looking for exposure to the retail industry, these two are worth comparing.

Fast fashion retailer Boohoo has taken advantage of shifting habits among its 16-24-year-old target demographic to increase revenue 40% last year, the sort of growth Burberry can only dream of. This growth has been driven by continued expansion into the US and Australia that increased non-European sales 56% year-on-year.

The market has responded well to these impressive numbers and sent the shares up over 35% in value year-to-date, although they’re still below their 2014 IPO price. This rally in shares mean they’re now valued at a princely 34 times forward earnings. This is a very high multiple, but for a high growth company such as Boohoo, it may be worth it.

Yet there are reasons to question whether Boohoo will be a long-term winner. Its operating margin — ie, operating profit as a percentage of revenue — has fallen from 9.8% in early 2014 to its current level of 7.7%, a worrying slide. While some of this was certainly from investing in new infrastructure and marketing, it also shows that Boohoo has little pricing power. 18-year-olds buying £15 jeans have many stores they can buy from and there’s little reason for customers to be loyal to Boohoo. This has long been the Achilles Heel of youth retailers and Boohoo certainly doesn’t appear to me to have solved this problem. Selling cheap clothing to a fickle demographic may work for a few quarters or even years, but eventually I believe Boohoo’s growth story will come to an end.

The China syndrome

David Cameron may be a big fan of Chinese President Xi Jinping, but Burberry shareholders would be forgiven for holding a grudge as the luxury retailer’s sales growth has ground to a halt amidst Xi’s anti-corruption drive. Global like-for-like retail sales dropped 2% over the past six months as high-rolling Chinese tourists’ spending fell significantly in Hong Kong and Paris alike. Management isn’t expecting this to trend to reverse soon and has warned of a “challenging” external environment affecting future sales.

As growth has slowed, Burberry has turned towards internal cost-cutting to preserve margins. Cost controls will be critical as operating margins dropped from 17.5% to 16.3%. It’s critical that Burberry doesn’t deal with slowing growth by discounting products and attempting to increase volume as rivals such as Coach have done in the past. That would not only result in lower margins, but could also end up damaging Burberry’s brand name and pricing power for years to come.

Analysts are expecting earnings to fall over the next two years as Chinese demand slows and developing world sales remain flat. But, if management can stabilise margins and continue creating high-demand clothing, Burberry would be my choice over Boohoo thanks to its brand name and subsequent pricing power.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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

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