BBRYF - Burberry's Valuation And New Strategy Make It A Potential Takeover Candidate

2023-04-11 02:37:35 ET

Summary

• Burberry's strategy had strayed into the risky area of fast moving fashion; now it is going back to its more classic heritage styles.
• The new management team's new strategy has lifted morale at the company and is focused on improving margins.
• The stock trades at a discount versus European peers and could be a takeover target.

Burberry Group plc ( BURBY ) and Aston Martin Lagonda ( AMGDF ) are the only listed, independent, UK luxury brands. Both names, each who have their own strong heritage have had their struggles in recent years, but the high fashion company has a new lease of life and is a potential takeover target .

Burberry’s classic check pattern is highly recognisable and in and of itself has strong brand value. The company which is most famous for its expensive but high-quality signature trench coats, which have been around for over 100 years, struggled at the start of this century as its check pattern became ubiquitous, widely pirated and started to become associated with the “nouveau riche” classes and hooliganism. This damaged the brand’s luxury status, and it took a great effort for the company to repair this misappropriation. The company reduced its product lines and moved away from check dominated clothing and accessories.

Today the brand image has been repaired, and is no longer worn by the masses, thanks to the expensive price tags and more streamlined inventory management enabling Burberry to never discount products. While it’s true a Burberry bag isn’t in the same price bracket as Hermes and other such ostentatious brands, a Burberry bag’s appearance in a recent episode of the hit HBO drama Succession , which made the implication its owner wasn’t wealthy enough to be in the ultra-high net worth club, still was good advertising for Burberry as according to data provided by Google, searches for “Burberry tote bag” rose by over 300% after the product was shown on that episode.

Burberry is London’s only global luxury fashion house, but it has historically underperformed its Paris and Milan based peers, perhaps because the brand, in the growth markets of Asia, isn’t necessarily associated with the image of European old money style.

New strategy

The last few CEOs have tried valiantly to make Burberry a brand for the West’s elites and Asia’s newly wealthy. The reasons for this are due to the higher margins achieved by its French and Italian competitors.

In 2017 then-CEO Marco Gobbetti tried several measures to make its brand more exclusive, including limiting supply of its flagship trench coat and a revamping of Burberry’s own stores. A new chief creative officer, Riccardo Tisci, tried to reposition part of the brand towards street fashion, but this didn’t align with the brand’s heritage. These ideas didn’t really work and Gobbetti quit in 2021 and Tisci followed out the door soon after.

New CEO Jonathan Akeroyd, in my opinion, has the right strategy. He is not trying to compete with French and Italian high fashion. Instead, he is emphasising Burberry’s Britishness and its heritage of high-quality clothing for outdoors and formalwear. Out is the street fashion, and coming back is the focus on classic, high quality products. A friend who works at Burberry tells me this new strategy has raised morale as most staff didn’t like the previous direction. Akeroyd is also now targeting growth in revenues from £2.8 billion to £4 billion over the following 3-5 year period.

Burberry has always been strong in the segments of trench coats and scarves, thanks to its strong brand tradition in these lines. Now, it is looking to create more higher selling products across bags, shoes and accessories, and is looking to build on its strengths in leather goods.

Burberry, founded by Thomas Burberry nearly 170 years ago, is and should be a “heritage” brand. This means it should focus less on the fast-moving fashion or trend cycle, which it has been trying to compete in for the last 20 years or so. Currently, about half of its sales come from newly designed products. Fashionistas, according to reviews in the Financial Times have so far been impressed with new chief creative officer Daniel Lee’s early launches. Lee, a young Brit, came from Italian label Bottega Veneta. The idea is he can find the balance between releasing new fashionable products while keeping the company’s brand focused on its classic Britishness and values of heritage.

Completing the changes in the C-suite has been the appointment of new chief financial officer Kate Ferry, joining from the private luxury auto-manufacturer McLaren Group last month. The brand transformation appears to be complete too. Burberry has eliminated markdowns in its mainline stores, which helps protects brand equity and gross margins. The cheapest shirt costs about $500 and pricing on leather goods has been raised quite a lot.

China

Once upon a time, Japan was the key growth market and Burberry managed to crack that country and it remains popular there. Now, obviously, China is the key market, as it is the largest luxury market after the US. Before Covid, 40% of Burberry sales were in China. In May we will get Burberry’s full year results and we will likely see rapid year on year grown in China thanks to its post-lockdown reopening and the “revenge buying” following three years of Zero-Covid policy.

For investors, I don’t think it should matter if Burberry is not seen in the same vein as Louis Vuitton or Gucci, owned by LVMH ( LVMHF ) and Kering ( PPRUF ) respectively. What matters is if Burberry can raise its margins towards those of its European luxury peers. As Britain finds its identity post-Brexit, Burberry will represent UK style and design, and this will be different from European ideas of fashion.

For Burberry’s stock price to grow however, we just need to see improving revenues and profitability. A new upgrade of its global store network should be complete by the end of 2026 and this will help gradually boost margins as an upgraded shopping experience promotes higher price points and therefore margins.

Valuation and reasons for including in your portfolio

There’s another reason to buy Burberry too. Portfolio diversification. The luxury sector has the unique characteristic that rich people, as a group, always have a high level of disposable income, and this means the sector has a good degree of protection from macroeconomic shocks. Customers are not as price sensitive and cost inflation can always be easily passed on. This gives the sector an inbuilt hedge feature compared to other retail sectors.

New management’s turnaround of Burberry’s positioning could be seen as a risk. But the stock trades on a forward P/E of 18x for its current financial year, compared about 27x for LVMH and Hong Kong listed, Italian fashion house Prada ( PRDSY ). Burberry’s Piotroski F-Score is a healthy 7/9 meaning it is basically a value stock, and its Altman Z-Score of 4.8 means its financial strength is extremely robust. Burberry isn’t so large that it couldn’t be bought out by private equity or taken over by LVMH or Kering.

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