Burberry: Pricing In The Challenges (OTCMKTS:BURBY)

Burberry (OTCPK:BURBY) is a struggling company in a poorly performing Consumer Discretionary Sector and even weaker luxury goods segment. This is clearly reflected in the stock price, which has dropped -54% in the past year. However, there is clearly value in this classic and instantly recognisable global brand and the drop should present a buying opportunity very soon, despite poor earnings.

Earnings

Preliminary earnings for FY 2024 were released on May 15th, and they were not received well. The stock closed down -6.3% at $14.36, very near to the $14.15 low of 2024 and close to making new four-year lows. Revenue and earnings are down on FY ’23

The FY figures reflect a solid H1 and a much weaker H2,

Comparable store sales -1% with robust H1 up +10% offset by a challenging H2 -8%.

This is likely a macro factor, as retail sales and consumer sentiment have both been on the slide in 2024. Actually, I just published an article on the cooling consumer discretionary sector (XLY) so it is no surprise to see a stock like BURBY struggle in the last six months. A chart of the S&P Global Luxury Index shows price has been at lower highs since 2021.

The Good

Some segments have outperformed. Outerwear grew by a high single digit percentage in the year, led by Heritage rainwear. Scarves grew by a double-digit percentage. These pulled up the underperforming segments such as footwear, resulting in FY24 retail comparable sales of -1% (CER). This isn’t exactly “good,” but in a tough environment it could have been a lot worse.

The dividend looks safe for now.

The Directors propose that a final dividend of 42.7 pence per Ordinary Share is paid in respect of the 52 weeks to 30 March 2024. Subject to approval by shareholders of the Company at the Annual General Meeting on 16 July 2024, the dividend will be paid on 2 August 2024 to shareholders on the register on the record date at the close of business on 28 June 2024. The ex-dividend date is 27 June 2024 and the final day for dividend reinvestment plan (‘DRIP’) elections is 12 July 2024.

At current prices, the dividend yield is an attractive 5.21%. There was no mention of a further share repurchase program, which ended in December ’23 and bought back £400 million worth of its shares.

The Bad

Profit margins dropped from 20.5% to 14.1% due to inflation and lack of pricing power. Combined with stagnant sales, the overall outlook for FY ’25 is not promising.

In the context of a still uncertain external environment, we expect H1 to remain challenging. We expect to see the benefit of the actions we are taking from H2.

These actions include cost savings “to enable us to offset the impact of inflation in the second half.”

One thing I don’t like to see is debt levels rising at unsustainable levels.

Net Debt/Adjusted EBITDA was 1.4x, above our target range of 0.5x to 1.0x. The increase in leverage from 0.5x at 1 April 2023 has been driven by lower profitability, working capital outflow and the share buyback programme.

Discontinuing the buyback program will help the situation, and it did absolutely nothing to support the share price anyway, in my view. A reduction in leverage below 1.0 would be a good sign.

Valuation

Adjusted diluted EPS fell from 122.5 in FY ’23 to just 73.9. This breaks a period of decent growth.

Obviously, the market knew earnings would be weak. There have been profit warnings and price has been on a downwards trend for over a year. It’s hard to believe the stock was making new all-time highs as recently as last year.

The fall in price means BURBY currently has a PE ratio (TTM) of 15.3. Actually, the -54% decline over the last year outweighs the -40% drop in EPS. We could therefore say the poor earnings are likely priced in. Indeed, the price action on the day of the release supports this view – while the share price dropped, it held a higher low with the April low.

Even though FY ’24 earnings may be mostly priced in, the concerning outlook for H1 ’25 may weigh further. The forward PE ratio is 19.69. Again, a challenging ’25 wouldn’t come as a major surprise, but there could be further weakness in the share price near-term and I will therefore look to buy around the 2020 low of $12.31 which is another -14% drop. At that level, BURBY would have a market cap of below $5B and be a potential takeover target. Furthermore, there is a low bar to potentially beat earnings expectations and a better profit margin could deliver an upside surprise.

Risks

A dividend cut is a concern in the longer-term should profits continue to decline.

BURBY is influenced by macro factors. Consumer weakness could be an issue going forward. Inflation is also a risk and has been a major contributor to the fall in profit margins.

Daniel Lee is Burberry’s creative director, and the new lines have not had the impact hoped. There is a risk BURBY sales decline further if the brand is seen by consumers as neither fashionable or luxury.

Conclusions

FY ’24, and especially H2 ’24 have been very challenging. However, much of this can be attributed to macro factors – inflation has eaten into profit margins, consumer sentiment is poor and retail sales have been stagnating. Under this context, BURBY sales and revenue have held up fairly well.

I think the large drop in earnings has been mostly priced in by the -54% drop in share price in the last year. BURBY could soon be a good value play and FY ’25 has a low bar to beat expectations. I therefore think the 2020 low of $12.31 is an attractive entry.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.