Throughout 2016 and early 2017, Boohoo (LSE: BOO) shares proved the firm to be a market darling.
Between the beginning of 2016 and the middle of 2017, the stock produced a return for investors of nearly 640%, smashing almost every other companies’ performance record over the same period.
However, since peaking in June 2017, the share price has languished. In fact, the shares have fallen 19% since then, underperforming the FTSE 250 by a staggering 27%.
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Nevertheless, despite this recent performance, I believe that the share price could be gearing itself for a sudden move higher, and it could even be the bargain of 2018.
Story stock
Boohoo became a story stock in 2016. As investors rushed to get in on the company’s growth, its valuation exploded. Still, even though the underlying business has multiplied in size, it has not kept up with investor expectations.
It now looks as if the shares are taking a breather, allowing the fundamentals catch up.
For example, the share was changing hands for nearly 140 times forward earnings in 2016, an eye-watering valuation usually reserved for the fastest growing tech stocks and blue sky opportunities. And even though earnings per share jumped 96% during 2017, it was not enough to justify the premium valuation.
Now, after two years of rapid growth, the shares are starting to look more attractive again. While the stock might not qualify as a value investment, trading at 55 times forward earnings, when compared to projected earnings growth of 41% for 2019 and 26% for 2020, this valuation is no longer as outrageous as it once was. Boohoo also has a history of surpassing market expectations.
But it’s not just the lofty valuation that has been responsible for the company’s underperformance in recent months. The City is also worried that increasing competition from the likes of Asos (LSE: ASC) is weighing on profit margins, requiring higher levels of capital expenditure to stay ahead of the game.
Fighting for customers
For its part, Asos has also seen investors turn away from the company in recent months. After topping out at a little over 7,600p in March, the stock fell to a low of 5,930p before rebounding.
Even after this modest recovery, however, it is still trading 14% below the all-time high.
Compared to the Boohoo share price, it looks expensive. Analysts are expecting the company to report earnings per share growth of 25% for 2018, followed by an increase of 23% for 2019. However, even though it is expected to grow at a slower rate than its smaller peer over the next two years, the market has awarded its shares a much higher valuation. Specifically, shares in Asos are currently trading at forward P/E of 69, falling to 56 next year.
As Asos is Boohoo’s only real comparable here in the UK, I believe it is sensible to compare these two companies on a valuation basis, and it’s not clear to me the bigger firm deserves the higher multiple, especially considering it’s lower growth rate.
The one advantage it does exhibit is its more extensive and more established international presence, although Boohoo is investing heavily in its international businesses to try and close the gap.
This brings me back to Boohoo’s spending plans. Asos has proven that it can expand profitably while still growing profits. But as Boohoo’s growth continues, the company has some work to do on this front.
Still, while the City frets about its profit margins, the company’s management does not appear to be concerned. Indeed, management recently guided that the group’s profit margin (earnings before interest, tax, depreciation and amortisation) would be 9% to 10% for 2018-19 and remain at this level for the foreseeable future. Moreover, as my Foolish colleague Alan Oscroft recently pointed out, with £133m of net cash on the balance sheet, the enterprise has plenty of capital to fund its expansion plans.
The bottom line
So overall, considering the above, I believe the Boohoo share price could be set for a substantial move higher in 2019.
As the company continues to turn out earnings growth and matches profit expectations, the market will likely reward the firm by placing a higher valuation on its stock — one that’s closer to that of Asos. And with this being the case, I believe this growth champion could be the bargain of 2018.
