10 iconic UK shares: Burberry

The next in our series of articles using fundamental analysis to examine the prospects of 10 iconic FTSE companies.

Burberry logo
Source: Bloomberg

Reasons to watch

  1. Fresh expansion in new geographical areas outside the Far East
  2. Rising dividend payouts to compensate for slowing growth
  3. Resilient luxury market

History

Few firms can have seen so decisive a turnaround in their image as Burberry. From being a brand associated with the lower end of the market, it has now come to symbolise the luxury end, especially given its prominence in China.

The company’s history goes back to the 1850s, but it has only really become a fixture of the stock market landscape since its listing as a public company in 2002. From that point on, the chief executive, Angela Ahrendts, led the way in transforming the company into an icon of British style, a strategy that paid off handsomely in China and the far east.

A slowdown in Chinese growth and a clampdown on luxury gifts has made life more difficult for the firm, but it maintains its place as a global brand, recognised around the world. 

Fundamental analysis*

The mention of worsening conditions in China was enough to produce a dire reaction in Burberry shares this morning, with investors clearly concerned that the company’s engine of growth is stuttering. The news got worse with an admission that margins were likely to be squeezed. Matters weren’t helped by fellow luxury firm Mulberry rolling out its third profit warning this year. Travel sales have been a stalwart of Burberry’s business too and these will not be immune from potential restrictions relating to Ebola.

Markets are looking to the future much more nervously than at any time over the past two years. Burberry’s downbeat outlook comes at a bad time and will put the shares under further pressure beyond today’s drop. Advocates of the company have stepped in regularly over the past year to defend the £14 level, but a drop through here would put the focus on the April low around £13.50.

Shares in Burberry are still up an astronomical 800% from their 2008 low, but since 2012 it has been a choppy ride. At one point the shares were in danger of breaking below £10, although the bounce from this point was an impressive 60%.

The company’s most recent update, in July, reassured investors that had begun to worry that Burberry was losing its grip on sales in China. In the three months to the end of June, Burberry saw revenue rise by 17% to £370 million, while like-for-like sales (i.e. those at stores open for at least a year) were 12% up, although this was down from 13% in the preceding year.

The company, which derives so much of its revenue from overseas, was at pains to point out that the current strength of sterling was beginning to have a noticeable impact on profits and margins. In another particularly prescient warning, it observed that its high dependence on tourism revenues would mean that any drop in such sales would be a major problem for the firm. Given the increase in concerns surrounding potential travel restrictions regarding Ebola, this warning cannot be disregarded.

New stores are still being opened, both in the UK and abroad, with fresh initiatives in Madrid and Milan a welcome sign that Burberry is looking to reduce its dependence on sales in the Far East.

Having provided stellar capital growth in the past five years, Burberry is now shifting to more of an income stock, a sign perhaps that growth is slowing to a less spectacular rate. A current yield of 2.2% is far from derisory, and management plans to increase the payout over the coming three years to a ratio of 50% of earnings from the current 40%.

The big question with Burberry is the growth outlook. For a company with such a focus on China, the worries over growth here are enough to keep management awake at night. The World Bank has noted that growth will ‘moderate over the medium term’, which is a roundabout way of saying that the days of 10% GDP growth in China are long past. Combine this with a crackdown on the purchase of luxury goods by top officials, which was such a key part of Burberry’s growth in the early part of the century, and you have a situation where the current PE of 20 begins to look rather high.

Even so, the PE is a long way down from the 2011 high around 30, while the current price-to-book valuation of 4.6 is much lower than the post-crisis peak of around 7.7. As long as China does not run into a ‘hard landing’ (i.e. where GDP growth falls below 7% a year) then investors can be relatively sanguine about Burberry’s prospects. The luxury market has proven itself to be broadly immune to sustained downturns, providing a firmer base for revenues than may first seem to be the case. 

*What is fundamental analysis?

Fundamental analysis seeks to examine a security by measuring its value through the use of financial and qualitative factors. Essentially, fundamental investors believe that each share is a piece of a company, and that the company can be analysed to determine whether the current share price indicates whether the company itself is undervalued (trading at a discount) or overvalued (trading at a premium).

The overall objective is to determine the underlying value of a company, and use comparisons with similar companies to determine if the business is likely to be successful or otherwise. Crucially, a company cannot be overvalued or undervalued in isolation. Instead, fundamental analysis compares a company to its peers in the sector, to the broader market, and to past valuations, to determine whether the current valuations are appropriate. 

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