SIF Folio: Burberry is fashionably expensive but could offer value

Upmarket fashion firm Burberry was a top FTSE 100 faller on 13 May, when the company published its 2020/21 results. So I’m intrigued to see that this popular stock now qualifies for the relaxed version of my SIF buying screen.

It seems that when Stockopedia’s computers digested Burberry’s latest accounts, the firm’s value, quality and momentum metrics came more closely into line with the affordable growth remit of the SIF portfolio.

To recap briefly, trading in the SIF portfolio is governed by a set of rules. I select shares to buy from my buying screen. Periodically, this screen dries up and does not provide any new opportunities. If such a dry spell extends for four weeks, then I relax my valuation criteria slightly to broaden the pool of potential purchases. It’s this relaxed screen that Burberry now qualifies for.

Why do I like Burberry?

Most of the big European luxury brands have been consolidated into larger groups. Kering and LVMH are probably most relevant to Burberry (LON:BRBY) shareholders. These two French groups control many of Europe’s best-known luxury brands.

Like Burberry, these luxury groups trade on their European heritage, but generate much of their income from Asia, especially China. 

I think it’s possible that Burberry will one day be acquired by Kering or LVMH. In the meantime, I’m attracted to the group’s 165-year history, strong brand, and high profitability. Broadly speaking, my view is that only modest sales growth is needed to generate attractive shareholder returns.

Growth plus increased premiumisation are the twin goals of CEO Marco Gobbetti’s turnaround strategy. Since recruiting chief designer Riccardo Tisci in 2018, the pair have launched well-received new product ranges which have supported an increase in full-price sales. 

This year will see discounting banished altogether from the group’s main stores, in a continued effort to move the brand further upmarket.

One point to note is that Burberry’s fiscal year runs from April-March. This means that the last two financial years have both been disrupted significantly by Covid-19 (given the earlier onset in China). 

As a result, the company has not yet managed to achieve a return to top-line growth. Indeed, Burberry’s revenue has fallen every year since 2017. The company’s adjusted profits are also still below the record highs seen in 2017 and 2018. 

Mr Gobbetti still has much to prove. But I expect to see performance improve as normality returns.I think this could be a good time to take a closer look at Burberry.

Value: Reassuringly expensive

I’d be alarmed if Burberry shares exhibited too many of the traits of a value stock. This isn’t a business that should be cheap unless it has serious problems. 

Fortunately, Burberry continues to look reassuringly expensive. The stock’s ValueRank of 38 reflects a historic P/E of 36, a dividend yield of 2%, and some other expensive-looking valuation metrics:

Admittedly, the price/free cash flow ratio of 17.9 looks more reasonable and implies a free cash flow yield of 5.6%. That’s not unattractive, in my view. However, last year’s results make it clear that cash generation was boosted by various one-off factors, such as lease concessions and spending cuts. I expect these to reverse over the coming year, cutting free cash flow.

Happily, Burberry’s balance sheet remains robust. Net debt was just £101m (including lease liabilities) at the end of March, representing just 0.1x EBITDA. That doesn’t concern me at all.

My view: Are Burberry shares expensive? Last year wasn’t typical, but my sums indicate that the shares are trading on around 22 times five-year average profits. To me, that looks like fair value. I don’t think this stock is too expensive to consider buying.

Quality: room for improvement

Burberry’s QualityRank of 93 suggests a profitable, cash-generative business. On the whole I think that’s true, but as we’ve already seen, free cash flow was boosted last year by one-off factors.

The company’s statutory operating profit also benefited from a number of one-off adjustments last year:

Burberry’s management appears to have been too cautious when calculating impairment charges early in 2020. This has resulted in a significant proportion of these non-cash charges being credited back to profits this year.

As a result of these unusual events, I don’t think Burberry’s reported operating profit of £521m is very meaningful. In this unusual case, I think the company’s adjusted figure of £396m is more accurate as a means of measuring operating profitability.

Burberry’s adjusted operating margin for 2021 was 16.9%, up from 16.4% in 2020. As you can see from the screenshot below, these figures are consistent with the company’s pre-Covid performance. 

(The margins calculated by Stockopedia for 2020 and 2021 are based on reporting operating profit. They include the impact of last year’s impairment charges and this year’s credits.)

My view: On balance, I don’t have any serious concerns about the financial quality of Burberry’s business. The big question for me is whether Burberry can capitalise on returning normality and deliver a further year of improvement.

Momentum: Encouraging

Last week’s results included a rather cautious outlook statement which suggested to me that both like-for-like sales and margins could be a little disappointing this year:

After an initial wobble last week, the market seems to have taken a more optimistic view. As a result, Burberry shares have a MomentumRank of 97 and are only around 10% below pre-Covid highs. 

As usual, I’ll break down this score into its two main components.

Price momentum: The StockReport graphic shows us that Burberry’s technical momentum indicators remain positive:

Earnings estimates: Consensus forecasts for FY22 and FY23 have been tweaked higher since last week’s earnings release. However, sentiment remains measured, with a consensus rating of ‘hold’:

Looking at the numbers in more detail we can see that current forecasts price the stock on a FY22 P/E of 25.5, falling to a P/E of 22.5 for FY23:

My view: I don’t think this valuation is outrageous, but I guess there’s still not much room for disappointment.

My decision

My view on Burberry stock is that it’s probably trading at around fair value at the moment. I wouldn’t be averse to buying at this level, although naturally I’d prefer to pay a little less.

However, the decision on whether to trade this week is out of my hands. As I’ve bought shares for SIF in each of the last two weeks, my rules prevent me from buying stocks that don’t qualify for my full-strength screen. 

I’ll need to wait a few weeks to see if I’m able to relax my valuation criteria and buy Burberry. Hopefully, my enforced patience will be rewarded with a better buying opportunity down the line. 

Watch this space – and as always, let me know what you think about Burberry in the comments below.

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