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Why I don’t think the risk is worth the reward with Boohoo Group stock

It has been a rocky week for investors in Boohoo Group (LSE: BOO) stock. Over the weekend, The Sunday Times released a story alleging that a factory in Leicester producing clothes for Boohoo-owned brand Nasty Gal is engaging in modern slavery. This caused a 46% fall in the share price, until Thursday when the stock rallied 27%. Institutional investors have seen this fall as a buying opportunity, as have other Fools. However, I believe that the risk is too high and investors should sell Boohoo Group shares.

The reputational damage has already been widespread. ASOS and other retailers have dropped Boohoo from their stores. Boohoo’s target customers, who are aged 18 to 30, will also be particularly outraged by this news. As a group, they are known for conscientious buying habits. The industry is shifting away from fast fashion, which Boohoo relies on. So, even if the reports of modern slavery are exaggerated or found to be false, I would argue that owning Boohoo Group stock is risky due to this shift towards more ethical fashion.

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This is also not Boohoo’s first strike. In 2018 The Financial Times levelled similar accusations at the company, making the claims of ignorance from executives appear dubious. This pattern indicates to me that there could be serious problems with Boohoo’s supply chain. To prevent further damage, it will have to go through the costly and disruptive process of investigating and replacing its suppliers. This may result in higher costs as it will have to approach more ethical factories to repair its reputation. Any change of this magnitude would raise serious concerns over Boohoo’s business model. That is why I believe that Boohoo Group’s stock has a highly risky and uncertain future.

Boohoo also has other risks that investors should be wary of. The company is currently engaged in a $100 million lawsuit in the US over false promotions and misleading pricing. If this lawsuit results in a fine then the company’s finances could be significantly damaged.

Also, in May of this year Shadowfall, a UK-based hedge fund that specialises in short selling, released some damaging research. Shadowfall claims that Boohoo has overstated and manipulated its free cash flow for the last six years by 67%. If true, this means that the company is producing significantly less cash than it is trying to claim. The research also suggested that Boohoo would have to pay significantly more than it claimed for the acquisition of the last 34% of Pretty Little Things. In response to this, BOO announced the purchase of that 34% a few days later. To some this proved Shadowfall’s research wrong, however, I’m not so sure myself. 

Any accusations of financial impropriety should send investors running, in my opinion. These factors mean that even if the company manages to recover from the current reputational damage, it still has many headwinds that make the future of Boohoo Group’s stock arguably very uncertain.

Boohoo is one of the fastest growing companies in the UK and the stock price may even recover. However, a pattern seems to be emerging of unethical and illegal behaviour, if the allegations prove true. Eventually, I believe that this house of cards will collapse and, when it does, I would not want to hold Boohoo Group stock.

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Charles Heighton has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended boohoo group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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