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Burberry: Tough at the Top

Steve Clayton | 13 July 2016 | A A A
Burberry: Tough at the Top

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Burberry Group plc Ordinary Shs 0.05

Sell: 1,692.50 | Buy: 1,694.00 | Change 11.00 (0.65%)
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Following fast after the news that Chief Executive, Christopher Bailey is to step back into a primarily creative role, with a new CEO joining from fashion house, Celine, Burberry has announced a Q1 trading statement. The direction of travel is little changed, but the strength of the headwinds has increased a degree. Offsetting that, recent currency movements, if rates now hold steady, have been positive.

Retail:

Overall, retail sales of £423m were flat on an underlying basis and up 4% in reported currencies. Comparable sales were 3% lower following the addition of 3% of net new selling space.

All three regions, Americas, Europe and Asia Pacific reported low single-digit percentage declines in comparable revenues. Outside of Asia, the common theme was double-digit declines in sales to the travelling luxury consumer, counterbalanced by better domestic demand. In Asia, sales in Hong Kong and Macau are still down sharply year on year, but Q1 showed an improvement over the previous quarter, whilst Mainland Chinese sales were flat. UK retail sales picked up toward the end of the quarter.

Digital remains a key growth channel and customers are reported to be responding well to recent innovations. New ranges are selling better than replenishment items. The cost pressures referred to in earlier trading updates persist.

Wholesale:

The outlook here has deteriorated since May and Burberry now expect revenues throughout the year to be weaker, including a decline of over 10% in the first half. US wholesale customers have significantly tightened their control of inventory, and ordering patterns in other regions are also cautious.

Licensing:

Revenues are still expected to roughly halve (2016: £42m) following the ending of the Japanese license.

Currencies:

If rates remain at current levels, profits should benefit by around £90m compared to the rates in force last year. This is a £50m increase from the levels previously guided. Facing the Future:

At the prelims, Burberry announced plans to drive longer term growth through focusing on product design, retail productivity and their e-commerce strategy, whilst changing the ways of working to drive costs down. These plans are said to be progressing well, even if cost pressures remain. The group is confident of hitting the (modest) financial goals outlined with the prelims, which at the time implied a decline in profits compared to FY16. The improved currencies position could lead to a reported outcome a little better than this, if maintained. The new CEO is expected to join early in 2017 and in the meantime, Burberry is commencing a £150m share buy-back programme.

Our view:

We like Burberry for its robust balance sheet and its successful evolution from British manufacturer of iconic trench coats to 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.

The store estate is still modest, trading from approaching 220 own stores, plus 214 concessions in department stores, 62 franchise stores and 58 outlets globally, leaving plenty of scope to expand the retail business, as and when the right sites come up.

Margins are clearly coming under pressure. Taking the fragrance offer back in-house will dilute near term, but ultimately should see profits rise. Analysts expect this to lead to a growing cash balance, with consensus forecasts suggesting a steady rise towards a billion pounds of net cash in the years ahead.

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 and Burberry seem to be really suffering from the wider reluctance of Chinese tourists to spend like they used to.

The challenge posed by this is clearly worsening and whilst the group is promising cost cuts and a share buy-back, there is little to get excited about near term. The new CEO, Marco Gobbetti, joins early next year and will have his own vision of how to reinvigorate the group. Until then, the near term outlook is muted in many areas, the only bright spot currently being the pick-up seen last quarter in Hong Kong.

Longer term, we still like Burberry, the business has a robust balance sheet and throws off a lot of cash. Luxury goods have been a good sector to be exposed to, because clients are prepared to pay handsomely for that special item, leading to good margins, most of the time. Burberry still has plenty of potential, but it could take a while for the good news to outweigh the bad.

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 disclosure for more information.