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What will the recent scandal mean for Boohoo shares?

Online fashion retailer Boohoo (LSE: BOO) has had a bad month. Starting with concerns over poor working conditions related to coronavirus, it quickly emerged things could be even worse. According to the Sunday Times, factories in its supply chain could be paying workers as little as £3.50 an hour.

Understandably, Boohoo shares are currently down more than 30% this month. Though scandals can often be short lived and quickly recovered from, I can foresee a few potential problems for Boohoo shares.

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The unknown, unknown

My colleague G A Chester quotes Warren Buffett, saying “You see a cockroach in your kitchen; as the days go by, you meet his relatives”. I like this analogy, and unfortunately it is usually true.

This may be the first problem to emerge regarding Boohoo’s supply chain. If the company was unaware of this issue, then it is more than likely unaware of others. What’s more, now everybody will be looking.

Aside from the hit to its reputation, which can be damaging (especially for modern, fashionable brands), it may very well have yet unknown direct financial costs. The company will have to find other suppliers.

It will also have to monitor its production facilities more. It is highly likely that Boohoo will need to spend more to avoid a repeat of this situation. This is something it should have been doing all along, but it will still likely hit its profits to one extent or another.

Of course another option would be to move its production out of the UK altogether. But moving to a country with lower labour costs, would involve some slow downs of production and higher transportation costs.

Investor confidence in Boohoo shares

An even greater problem, however, may be investors selling their Boohoo shares. Earlier this month, Standard Life Aberdeen – one of Boohoo’s biggest shareholders – sold almost all of its stock because of the allegations. Meanwhile Next, ASOS, and Zalando all dropped Boohoo lines from their websites while they await the company’s response.

Boohoo may be able to recover its reputation if it handles this well, but big investors selling their stock and losing its different selling avenues could have far more lasting damage.

Ready to buy?

My fellow Fool Edward Shelton points out some insider buying of Boohoo shares recently. Like him, I usually see this as a bullish sign. For me though, I have to keep going back to Warren Buffett’s cockroach problem. I suspect we may still see more problems emerging before things start to turn around.

I’m sure there is potential for this sell off to offer a buying opportunity, but I am not convinced that Boohoo was as strong as I would have liked even prior to this news. I think there is some way to go yet before the Boohoo share price really begins to make gains.

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Karl has no position in any of the shares mentioned. 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.