Burberry: Buy Now For A Recovery?

30th Jul by Roland Head

16 comments 2115 reads

I’m a Burberry (LON:BRBY) shareholder and have held the stock for a number of years.

My decision to invest was based on the traditional resilience of the luxury market, and my view that Burberry is a valuable and durable heritage brand. I paid a weighted average of just over £15 per share for my personal holding and believed -- at the time -- that this represented an attractive long-term entry point.

I think that's potentially still be true. But it’s fair to say my view on the company has been tested by developments this year. The luxury market has slowed and Burberry has suffered additional self-inflicted problems.

The share price is down 45% year-to-date and the dividend has been suspended after a second profit warning in seven months.

This Stock Pitch is an effort to clarify my thinking on Burberry. Are the shares as cheap as they might seem right now?

Summary

Pros:

Luxury heritage brand with 168 years of history
Shares trading at a post-2010 low could be very cheap if business recovers
Burberry could attract bid interest at this level

Cons:

The company has struggled to elevate its offering and may have to sacrifice margin to undo the damage
China’s slowing economy means consumer spending has weakened; buyers’ tastes may be changing
Burberry shares are only cheap if profits recover

Profile

About the stock

Burberry is a luxury British fashion brand. It’s listed in the Consumer Cyclicals sector, within the Specialty Retailers industry group.

The company floated on the London market in 2002 and is currently a member of the FTSE 100, with a market cap of £2.6bn and a recent share price of 747p.

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As the smallest company in the index at present, I imagine it’s quite likely Burberry will be demoted to the FTSE 250 in the next index reshuffle.

The StockRanks show high quality and value scores but an extremely low momentum score.

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A high QV score fits the classic profile of a contrarian stock and this is reflected in the company’s current StockRank Style rating:

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I am instinctively attracted to the…

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djlcollinge

30th Jul

The evidence from recent company statements (e.g. Macdonalds alluded to difficulties) suggests a continued decline in the Chinese economy. One for the long term on value grounds but not in my time horizon. Macro arguments dissuade me from this share.

rhomboid1

An excellent thought provoking article Roland Burberry (LON:BRBY)

This article also seems insightful https://www.theguardian.com/bu... about the challenges…particularly when trying to mine the golden seam that is high priced bags & shoes…when your brand heritage is all about coats.

Your point about China growing their own luxury brands is obviously a critical one…see the auto industry as an exemplar

johnsmith68

Another super helpful and insightful article - thanks Roland. I recently threw in the towel simply because I believe there are better opportunities for my greatly diminished cash pile than trusting in the turnaround potential here.

I believe things will get worse before they get better here. I'm concerned that they have invested such an enormous amount of Capex and brand capital into the elevation strategy that it will be difficult to unwind even if they do wish to target a lower value consumer.

The last report if I recall correctly indicated that they were only around 50% done with the store upgrade programme and if they pivot now, many of the upgraded stores may not be in the best locations for a revised strategy (are Michael Kors customers shopping on Bond Street?). If they double down and continue with elevation then they need to continue uprating the remaining store estate at significant Capex cost whilst suffering from declining revenues.

In short, they seem to be stuck between a rock and a hard place at exactly the wrong point of the cycle and also at a time where social media has accelerated the fickleness of consumer tastes. I'm not so sure that "heritage" counts as strongly as it once did. The likes of Nike and Adidas are starting to see this too with challenger brands taking market share.

I can absolutely see the investment case here but the likes of Ted Baker, Superdry, French Connection and a slew of others demonstrate that fashion can be brutal and I'm not sure how valuable the brand is anymore especially since it has left behind one audience and failed to really gain traction with its new target audience.

For me, this is one to wait and watch from the sidelines. I'd be happy to miss out on any early recovery gains until it becomes clear that a turnaround is truly underway. In the meantime as you say, it may well get subsumed into one of its larger competitors but being frank, I see this ending up in Mike Ashley's stable long before LVMH come knocking!

Wolf of Small Street

Chinese consumer trends appear to be changing, consumer confidence is awful. Last 3 or 4 days I've read

"BYD Co. may eclipse Tesla Inc. in annual electric vehicle sales this year as demand surges in China"
"Apple Inc. lost ground in China’s smartphone market in the June quarter after local companies like Huawei Technologies Co. surged ahead. IPhone shipments there slid 3.1% during the period, compared with an 11% year-on-year rise among Android-powered competitors, according to market tracker IDC. That squeezed Apple out of the top five handset makers in the country for the first time in four years."
"German exports to China in May suffered one of their biggest falls, underlining the faltering trade between the two countries even before escalating tensions threatened higher tariffs on key shipments.
The Federal Statistical Office said on Friday that German exports to China dropped 14 per cent to €7.5bn in May from a year earlier, underlining how what was once a major source of growth for Europe’s largest economy has become a source of vulnerability."

The fact this is regular news, and I've paid attention to it (haven't before) may be signalling the bottom is close, but Id prefer for the trend to change first.

doctor dave

Great commentary Roland, as ever. I'm quite surprised to see you have just bought Burberry, it seems against your usual style of purchase if I may say so....(unless maybe you have held it all along). For me, I will be waiting to see it bumping along the bottom and then finally showing some green shoots before I consider it.

Tortoise investor

Agree. Why not just wait until there is clearer evidence of a turnaround either at Burberry (LON:BRBY) or among luxury stocks more generally? Sure we might miss the bottom but given how much the share price is down there should still be very decent upside at the point of more positive newsflow.

The Ox 2906

He’s long from £15 so not a recent purchase. If one waits until the turnaround is evident or underway you’ll have missed it potentially or at least 20/30% of the price recovery, you may also miss an opportunistic bid. I don’t see it going the way of Superdry, there's too much history and cache to the brand but it will definitely take time and investment to realign the product offering. Thanks very Roland for a very in-depth and interesting read.

Roland Head

Thanks, doctor dave,

I've held Burberry (LON:BRBY) for a while - I bought the shares during the pandemic, when its valuation and dividend record seemed attractive to me.

I also averaged down at around £10 in May. This recent purchase seemed clever at the time, but possibly less so with hindsight!

Roland

Boon

IMO there is likely to be takeover interest for Burberry (LON:BRBY) from either one of the big luxury stables or from Private Equity.

So maybe the investment thesis here is... at what price could a takeover offer be made and accepted?

Certainly a strategic takeover by a luxury fashion house makes sense. There's cost synergies to be had. Problematic store leases can be reassigned to another luxury brand in the portfolio. Debt can be refinanced with cash or at cheaper rates. Also it would be an ego thing for the founders of those luxury houses to own the Burberry trophy.

Graham Wells

31st Jul

WOWS,

I’ve heard it said before that when Chinese companies suffer with sales, they don’t cut production. They just find new markets and sales, even if it means discounting and other dubious means, no doubt backed by the state. Might explain why Apple and Tesla are losing market share and Chinese products are overtaking them. That’s why a trade war with China would be very dangerous and highly distructive to the world economy.

Graham.

yadi

Brilliant article Roland. What a detailed analysis. It’s a delight to read even when the company doesn’t interest me.

As you said, the luxury market is down and all the fashion houses are suffering.

Burberry maybe tempting and definitely the one for traders or those interested in special situations.

For me I rather add to my holdings in L’Oreal which reported today. The share is up 2% despite missing expectations. This tells me it may have hit the bottom.

Trident

When I walked through a Chinese City based luxury brand shopping malls in the 'good days', it never seemed that full, with lots of store staff looking at their phones, but now I would imagine it must be virtual tumble weed blowing through. Many normal general shopping malls are quieter, apart from the food outlets which are ever popular and well attended. Food is always generally affordable for the insatiably food orientated Chinese citizen, luxury goods are something that can be put on the back burner.

aflash

So what does the chart tell us?

Steep rise, steeper fall.

If there is a bounce, those trapped will sell. Not much short interest so not much hope from covering.

Thanks to Rol and everyone else for the fundamental arguments.

AnonymousUser1976835

3rd Aug

Do you want to buy when a cyclical company is doing great with all cylinders firing or when it is in the downturn where demand is "on the back burner"?

Spender71

Neat reply.

roddy10

6th Aug

Roland - excellent note.

A couple of comments from me:

1. An important element of fashion valuations is growth in the top line and a corresponding or greater expansion in the operating profit.

2. For instance looking at Stockopedia I see that LVMH has grown its topline by 13% CAGR, Operating profit by 18% CAGR and Net Profit by 19% with EPS 19.2%. Obviously not all of it is organic.

3. This brings me onto the next point. LVMH has grown by acquisitions where it has kept 'front of office' but stripped out logistics / fulfilment and various central costs. The typical LVMH acquisition is a medium / small sized brand where the brand's gross margins will expand rapidly under LVMH due to reductions in the costs I mention; at the same time LVMH can immediately help with third party distribution (eg into department stores etc) and over time with site acquisitions for shops etc - so revenue growth. Some of the cost savings are also reinvested into marketing and design / new products. (In some ways the Tiffany acquisition was unusual by LVMH). So the result is that LVMH delivers revenue growth with margin expansion.

4. The Americans (ie US Investors) have only relatively recently discovered 'luxury fashion' leading, I would argue to the acquisitions that built up Tapestry and Capri. However in both cases it will be seen that sales growth, operating profit and margins have not been particularly impressive. This leads to some anxiety re the new CEO of Burberry. (Additionally there is an issue of % of future profits that will end up in his pockets rather than that of shareholders).

5. In the LVMH case I discussed stripping out costs by sharing logistics. I think it is important to understand that the term 'luxury' contains many subsectors. LVMH owns drinks brands (Champagne), luggage to clothes etc. Cross sub-sector joint logistics is hard and sometimes nonsensical eg a handbag or coat should not be distributed in a chilled lorry carrying champagne to a supermarket. I think this is one of the key issues that Tapestry and Capri did not understand initially (eg shoes and handbags do not necessarily get sold in the same venue or the same team in the same venue - obviously less extreme than the champagne and handbag example. Also delivery cycles are different for shoes (lots of sizes and different rate of stocking) vs eg handbags - more seasonal).

6. Fashion brands are often described by analysts as reliant on their heritage. I think that really misses the point - a lot of fashion today is built on INNOVATION in the past. Shackleton, Amundsen and Mallory did not wear Burberry because of 'branding' but because Burberry provided differentiated and innovative products that suited a purpose. In a similar way people forget that Louis Vuitton was an innovator in travel with the flat-topped trunks (the flat-top allowed stacking - may sound obvious now!). Innovation requires R&D, risk and difficult problems to solve. Pure 'design' may be reproducible. As an aside, though 'designers' reached a pinnacle with Sir Jony Ive at Apple it is worth remembering that Apple has made a number of innovations along the way (or bought in / licensed / partnered innovations).

7. I was an avid follower of Superdry and indeed at one time an investor. (And have also invested in Capri in the past etc). Historically I have been always tempted by assets trading 'cheap'. However as I have grown older I have realised that turnarounds can take years - and during that time one has to wear a lot of restructuring costs.

8. Superdry is also instructive for another reason. Hired in 'management' / 'professional management' is often a 'coupon collector' rather than focussed on longer term value. In the Superdry case they overdistributed the brand and overexpanded out of its niche (eg too much wholesale and too much extension to other customer segments). As a result of the short term sales benefit, they assumed this was sustainable and overstocked - leading to massive inventory. (Of course, in the short term an increase in inventory allows you to spread cost and make it appear that your gross margin is expanding). Similar comments to overexpansion in retail outlets (really you want the stabilised sales and sales growth of a venue after the initial excitement has faded).

9. Thus getting to Burberry, I think the jury is still out. It will be interesting to see if the new CEO undertakes any major writedowns of inventory, stores or big headcut cuts.

10. Anyway - thank you for an excellent writeup

(Minor niggle - I think you inadvertently put £3,968M rather than £2,968M for the 2024 revenue number.)

Burberry: buy now for a recovery?

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Roland Head

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