I have had my eye on a growth share that has had a fall from grace. Over the past year, it has suffered from a lot of bad press and warned on profits. The shares are now 70% below where they were a year ago, at the time of writing this article earlier today.
So, is this a potential value trap or a buying opportunity for my portfolio?
Perfect storm
The growth share in question is boohoo (LSE: BOO). The former stock market darling has been flirting with penny share status over the past month.
There are a few reasons that many investors have soured on boohoo. Most boil down to concerns about its supply chain. That includes alarm about conditions in factories that supply the fast fashion company. But there have also been worries about the impact of inflation on raw materials and logistics costs. Factors like those can combine to reduce profits even if revenues grow. Indeed, in the nine months to the end of November, sales were up 16% on the year before and a very impressive 65% on the figures from two years before. Despite that, the company still said that it was lowering financial expectations for the year.
Pointing to the nature of the challenges, like inflation and supply chain disruption, the company portrayed them as “transient in nature”.
Turnaround prospects
I agree with that analysis. Boohoo is wrestling with challenges that are not unique to it. I also think some of these problems will go away in the next several years if inflation starts to fall again.
But boohoo has made a rod for its own back in some ways. The very cheap prices at which it sells clothes means it has less financial room for manoeuvre than some retailers when it comes to absorbing cost inflation. It also explains (although I do not think justifies) some of the labour practices for which critics have blamed boohoo, even if they are carried out by contractors not the company itself. As long as boohoo’s business model focusses on very cheap clothes, reputational risks will remain. If they damage the consumer appeal of the brand, that could hurt both sales and profits in future. I do think boohoo has taken some concrete steps to try to improve labour conditions in its supply chain lately, though.
I think the long-term opportunity here outweighs the short-term risks. Boohoo’s very strong revenue growth illustrates the strong demand it has created. I expect it to keep doing that. Its growing operations in the US could be a significant driver for revenues and earnings in the coming years. Sales there for the nine-month period were 89% above their pre-pandemic 2019 level.
A growth share for my portfolio
Given that analysis I think the boohoo share price fall has been overdone. It now trades at a price-to-earnings ratio of 22 based on last year’s earnings. This year, earnings will likely fall. But given its long-term growth potential I think the valuation looks cheap. As it grows revenues and inflationary pressures ease, I expect strong earnings growth in the medium term. I would consider adding boohoo to my portfolio at the current share price to hold for the coming years.
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Christopher Ruane 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.
