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As the Boohoo share price falls, should I buy?

Image: Coats Group

Clothes retailer boohoo (LSE: BOO) has been falling out of fashion with investors lately. The Boohoo share price has retreated 18% so far this year, although it is still 5% higher than it was 12 months ago.

Here’s why I think the Boohoo share price is declining – and what I plan to do next.

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Challenging times

The company is well known for its cheap clothes. But in recent years boohoo has also made headlines about how it can offer such low prices. It has been criticised for the labour conditions at the factories of some suppliers. Reputational damage has piled up for the online purveyor of cheap clothes.

That has been challenging for boohoo shares in a couple of ways. The first concern is that socially conscious shoppers may decide to shun the firm, which risks a fall in sales. The second concern, which I think could do bigger damage to boohoo over time, is that the criticism could lead to it having to change its business model. The company has been built around a fast fashion ethos of “pile ‘em high and sell ‘em cheap”. But if suppliers pass on increased labour costs, that could affect the company’s profitability or low-price business model.

Improving business outlook

I’m not sure that such negative press has affected the company’s financial performance so far. In the year to February, for example, revenue leapt 41% and post-tax profits were up 28%. That is hardly the performance of a business in crisis, albeit the fact that revenue growth outstripping profit growth suggests that the company may indeed be wrestling with profit margin compression.

It was a similar story in the company’s most recent results, which covered its first quarter. Revenue was up 32% versus the prior year period. That was driven by strong performance in the UK and US, where revenue rose 50% and 43% respectively. As the company’s largest markets, that is impressive.

The company has been trying to assuage critics, with new moves to improve transparency of its UK supply chain. It has also integrated apparel brands including Dorothy Perkins, Wallis, and Burton, which I think could help it grow further.

Why the boohoo share price is falling

Despite the stream of upbeat news, the boohoo share price has been moving in the opposite direction to sales. Why?

I think part of the reason is nervousness in the City about whether more supply chain problems lurk ahead. A quick glance at the boohoo website today, for example, shows polka dot belted culottes on sale for just £2. The production and supply chain economics of such prices remain difficult to reconcile with the costs of doing business in a developed market like the UK.

Boohoo seems to understand its customer base very well, which helps explain its rocketing sales. I don’t get the impression that its handling of supply chain criticisms is damaging its business much.

If anything, I think the share price fall simply reflects a cooling down of an overheated share price. With a price-to-earnings ratio of 37, the shares are still expensive in my view. I wouldn’t be surprised if they continue to fall, especially if growth slows. At the current boohoo share price, I won’t be buying any for my portfolio.

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Christopher Ruane has no position in any 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.

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