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Burberry - Outlook weak, shares drop sharply

Steve Clayton | 18 May 2016 | A A A
Burberry - Outlook weak, shares drop sharply

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Burberry Group plc Ordinary Shs 0.05

Sell: 2,075.00 | Buy: 2,077.00 | Change -6.00 (-0.29%)
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Results for the 12 months to Mar 31 are closely in line with company guidance provided to the market as recently as April. Adjusted pre-tax profits were down £35m to £421m on sales of £2.52bn. Earnings per share fall 9% to 69.9p and net cash rises £108m to £660m.The dividend is increased by 5% to 37p and Burberry say they will pay the same or higher for FY17.

Burberry are guiding toward a weak outcome for 2017, with trading conditions still described as challenging and lower expectations for medium term luxury growth. A new capital framework was announced, along with plans to eliminate £100m of costs over three years and invest into product and sales to drive revenues ahead of the broader luxury market. Burberry also announced that they expect the luxury market to grow more slowly in the years ahead.

The shares dropped around 3% in early trading.

For the current year, new stores will add a low single-digit percentage to retail sales, with 15 mainline store openings planned. Wholesale revenues will fall around 10% in H1 as US customers take a more disciplined approach to inventory management. FX rates currently suggest a tailwind of around £50m versus 2016 rates, slightly weaker than last anticipated. Licensing revenues will fall around £20m, reflecting the move in Japan from a licensed model to a company-managed store estate.

Since the April trading update, Burberry say the environment remains challenging and whilst the company will achieve ongoing cost savings of around £20m, these will not come free of charge and the company also feels it needs to raise the performance related pay budget by around £20m. Overall, this will lead to profits around the low end of analysts' current expectations, with a greater bias to the second half than last year.

Our view:

We like Burberry for its robust balance sheet and its successful development of a global luxury brand. Longer term performance has been excellent, but the current slowdown in Chinese demand has caused weakness in the share price, since a peak of over 1870p in February 2015.

Margins are clearly coming under pressure. Cash generation has long been a strength of the business and analysts expect the cash balance to rise towards a billion pounds in the years ahead, explaining the company's decision to commence a share buy-back, of initially up to £150m.

Luxury consumers are not risk-free clients, but they tend to be resilient, because wealth is typically more durable than income. But trading conditions are still tough especially because Hong Kong, where demand is very weak, was an important market for Burberry. China's crack-down on graft has hit demand; the practice of "gifting" luxury goods to officials in return for influence is deeply, deeply out of favour with the new leadership in China. Until the last of the froth is blown off Chinese demand, Burberry will struggle to grow as fast as it used to.

The capital structure review has not produced any radical changes, just a commitment to a progressive dividend, which initially means a flat pay-out as earnings fall. Burberry say their plans to invest in product and sales staff and the restructuring of ranges to focus on a single label, will lead to growth well ahead of the luxury sector. But there is precious little evidence of this in the near term.

The company is steering toward the bottom of the current range of analyst forecasts. That suggests a further decline in profits in the current year.

Longer term, we still like Burberry, and the picture will look very different, as and when the Chinese luxury customer shows any signs of recovery, especially in Hong Kong and Macau. But for now, downgrades are the order of the day.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.