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21 September 2020

BOOHOO: WHERE DID IT ALL GO WRONG?

With London Fashion Week underway, this year sustainable and ethical brands are very much in vogue. The sustainable fashion sector in the UK is currently valued at £50 million, a small proportion in comparison to the total value of the UK fashion industry, currently estimated at over £60 billion.

However, with the consumer now much more savvy and aware, brands need to consider their responsibilities and how they stack up when it comes to Environmental, Social and Governance (ESG) ratings –as has been demonstrated with Boohoo.

Boohoo has been a darling of the stock market. Since its IPO back in 2014, the company has throttled the retail industry into awe. Shares were topping 400p at their peak, and the company was snapping-up anything in its wake; Karen Millen, Coast, Oasis, the business seemed adamantine.

But since an undercover report from the Sunday Times, accusing the company of breaching the Modern Slavery Act, all this seems to have changed. Boohoo admitted it did not know the identity of a supplier alleged to be paying workers as little as £3.50 an hour at a factory displaying the name Jaswal Fashions.

Boohoo added at the time that it was taking “immediate action to thoroughly investigate how our garments were in their hands”. The business has plans to build a “model factory” in Leicester, in a move to bring its manufacturing operations in-house, while hiring Alison Levitt, a leading QC, who is leading the investigation into whether Boohoo suppliers have complied with regulations on wages and working practices. A £10m investment has also been made to “eradicate supply chain malpractice”.

When it comes to Environmental, Social, and Governance (ESG) Boohoo seems to be making all the right noises. The above, alongside the recent termination of contracts with suppliers and subcontractors, reflects the company’s “zero-tolerance” approach.

The case feeds into a much greater issue over the illegality of the Leicester manufacturing world, which is the UK’s largest clothing manufacturing hub, where some workers are paid below-legal wages in abhorrent working conditions, and comes at an awful time for Boohoo, given the adjacent reports over the flouting of social-distancing rules, the undemocratic awarding of executive pay, and the UK hedge fund Shadowfall’s short-selling attack. All these events have fused to create a barrage of negative press and accusations, which seem to have destabilised the Boohoo juggernaut. The Home Secretary, Priti Patel, asked the National Crime Agency (NCA) to investigate claims of modern slavery in Leicester’s clothing factories, describing the allegations as “truly appalling”.

That initial inspections found no evidence of offences and MSCI, the rating and index provider reiterated that Boohoo is an ethical investment; Aberdeen Standard may have dumped its stock, but how it was holding a hefty chunk of Boohoo shares in its ESG mandates opens a Pandora’s Box of further questions. There is clearly need for tighter standards when setting ESG investment mandates. Transparency and clarity are crucial and, until now, Boohoo had been inconsistent on both counts, yet managed to be awarded a double A rating by MSCI, its second-highest ranking. In its June report, MSCI said Boohoo had a “low reliance on supply chains in regions with poor working conditions” and “relatively strong supply chain labour policies and practices”. These quotes prove the need for fund managers and investors to undertake their own due diligence; relying on third-party ESG assessments is a risky game.

For now, the claims are merely allegations, albeit extremely serious, and until any judicial decision has been legally made, it is pointless to put the hammer down against the company. Yet, serious questions remain; sceptics are asking how a company can sell dresses for as little as £7, while posting superior operating margins. However, this is largely down to Boohoo’s superior business model, in which it outsources much of its IT. That gross margins, which reflect the difference between the cost of goods and their sale price, are comparable with other retailers, paints a positive picture for Boohoo. Those who naively argue that the business has been rort with labour costs, granting it an unfair advantage, are clearly missing the crux of the issue. There is more to Boohoo’s strength than its alleged delitescence over costs.

This episode marks the first occasion when investors have started to question Boohoo’s business model. The share price has been robust despite previous headwinds; namely, when Boohoo was accused of playing a part in Leicester’s Coronavirus outbreak, when the founders sold £143m of their shares in December 2019, and when the board granted a potential £150m bonus scheme. The signs were already there; one-third of shareholders voted against the company’s remuneration report just last month.

From an ESG perspective, Boohoo has taken the correct first steps. However, with the Group manufacturing around 75% of clothes in Leicester, the legal proceedings which are being brought will create further market noise and add downward pressures to the share price. We don’t think this episode will evaporate Boohoo’s clientele, and although profits and margins may be put under pressure in the future, this remains a well-oiled business, operating in a high-growth arena.

Fundamentally, the real test will be how customers respond to the allegations and the company’s handling of them. If shoppers decide the company has done something wrong, despite clear denials to the contrary, or merely start to question whether disposable fast fashion is a trend they still wish to follow, then Boohoo’s multi-billion stock market valuation could start to unravel.

Equally, they may just shrug and decide that they just like the products and prices on offer, regardless of what may be happening in the supply chain. Moreover, the emerging recessionary environment may act as a tailwind for Boohoo, with consumers feeling more comfortable spending £7 on a dress, as opposed to the £35 one might spend in Zara. Only time will tell.

Please note that investments and income arising from them can fall as well as rise in value. Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.
 
BOOHOO: WHERE DID IT ALL GO WRONG?
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