Buy into Burberry's creative revival

Burberry is a high-end British luxury fashion brand, producing accessories, clothing and beauty products. As of the group’s full-year results, it had 430 directly operated stores and 44 franchise outlets. It generates the bulk of its revenues – 41 per cent – from the Asia Pacific region. 

Burberry has been in operation since 1856, and its iconic check pattern is instantly recognisable to fashion lovers the world over. Strong positioning has helped it generate reliably fat profit margins and a return on capital employed consistently in excess of 20 per cent. No fashion brand can be viewed as unassailable, but management invests heavily in design – not least through hiring designer Riccardo Tisci, an alumnus of rival fashion giant Givenchy – to maintain its market-leading position.

Mr Tisci has been charged with leading the group’s creative transformation and his initial collection, which reached stores in February, was hotly anticipated. He has been with Burberry for more than a year, but it wasn’t until this financial year’s first-quarter trading update – which covered the 13 weeks to the end of June – that investors could get an idea of his impact. Management praised an “excellent consumer response” to the new lines, leading like-for-like sales growth to come in at 4 per cent, roughly double what analysts had expected. 

This is reassuring as management has bet big on Mr Tisci’s ability to revitalise the brand, and has said that by the time the next annual report comes out – it is usually released in June – “substantially all” of its products will be designed by him. Mr Tisci’s product offering already accounted for around half of the stores’ offering by the end of this financial year’s first quarter.

The Chinese market has cast a shadow over the group in recent months. In January, shares in a range of luxury goods companies fell sharply after Apple (US:AAPL) said it had sold fewer iPhones in the region than expected, hinting at a softening in demand for luxury goods among Chinese consumers. Burberry’s like-for-like sales growth in China slipped to low single digits in the most recent financial year, from high single digits in the previous period, but Mr Tisci appears to have broken the spell, with sales in mainland China up by “mid-teens” in the three months to June. 

Meanwhile, management is on a two-step “transformation journey”. At present, it is in the initial stage, stripping costs out of the business, closing some stores and refurbishing others. Its efforts generated cumulative savings of £105m by the end of the 2018-19 financial year. That amount is expected to reach £135m by 2022.

While managing the “creative transition” under Mr Tisci’s leadership, management expects revenues and adjusted operating margins to be broadly stable in 2019 and 2020. The second phase – tellingly named “accelerate and grow” – is expected to bring high-single-digit revenue growth and “meaningful” improvements in operating profit margins.

The transformation plan also needs heavy investment to generate organic growth, and capital spending is due to almost double between 2019 – when it was £110m – and 2020, when it will approach £200m. From 2021-23, capex is expected to be in the £190m-£210m range.

At around 2 per cent, the dividend yield is not enough to make a compelling income case for the shares, but management has also shown a willingness to return excess cash to shareholders. It has been buying back shares since 2018, purchasing £350m in the initial year, followed by £150m in 2019 with another £150m expected in 2020, which, in effect, will come close to doubling the yield.