SIF Folio: Is it time to buy Burberry?

In May I wrote about upmarket fashion group Burberry. I commented that I liked the stock, but would like to pay a little less for it. At the time, my buying rules prevented me from adding Burberry to the SIF Folio, as it didn’t satisfy all of my screening tests.

I’ve returned from two weeks off to find that Burberry has become cheaper since May. The stock now comes within a whisker of satisfying all of my buying rules. More on that shortly, but first here’s a chart showing the share price action so far this year. 

It seems that Burberry has first excited and then disappointed the market:

I think it’s worth revisiting the major events that have driven the firm’s share price this year.

• 20 Jan 2021: In its Q3 update, Burberry warns that the “short-term outlook remains uncertain”. Sales in the final quarter of calendar 2020 fell by 5%.

• 12 March 2021: The company says trading has improved. The board now expects “revenue and adjusted operating profit to be ahead of consensus expectations”. 

• 28 June 2021: CEO Marco Gobbetti says he will leave the business at the end of 2021, after less than five years. Burberry’s share price slumps, partly because investors are worried that chief designer Riccardo Tisci might follow Gobbetti out of the door.

• 16 July 2021: The company says it has made “an excellent start to the new fiscal year”. Like-for-like store sales are 90% higher than last year and 1% higher than pre-Covid levels (i.e. Mar-June 2019).

• 11 November 2021: Burberry reports half-year sales “back at pre COVID-19 levels” with adjusted operating profit ahead of the comparable pre-Covid figure. A new CEO, Versace boss Jonathan Akeroyd, has been appointed. The board is comfortable with consensus forecasts for the year ending 27 March 2022. 

So far, so good. Burberry’s sales have recovered, the company has acted promptly to appoint an experienced new CEO, and Mr Tisci has not quit. 

In my view, the outlook is broadly positive. However, the market doesn’t seem to share my optimism. Burberry’s share price has fallen by 10% since I covered the stock in May, leaving the shares on a rolling forecast P/E of 21. That compares to an equivalent figure of about 25x in May. 

The current P/E is more in line with the stock’s historic average than it was in May, supporting my view that the shares are more attractively valued than they were six months ago.

Does BRBY pass my buying rules?

SIF is a rules-based portfolio. I can only select stocks which satisfy my rules for buying new shares. Running Burberry through the SIF checklist reveals that it just falls short of passing all my rules:

However, closer inspection shows that the extent of these failures is fairly marginal. The first failure relates to earnings yield, which I use as a key valuation metric:

The second relates to the stock’s price/earnings growth (PEG) ratio, a measure made famous by the late Jim Slater, who targeted stocks with a PEG of less than 1.0. I use a more generous threshold of 1.2 for my screening:

Burberry’s PEG ratio is slightly higher than my rules allow. But it’s been almost four weeks since I last added a stock to the portfolio. After a four-week dry spell, my rules allow me to relax this criteria slightly. 

On balance, I think I can consider Burberry for SIF without breaking my system.

Diversification concern?

One of the few areas of the portfolio where I do have some flexibility is diversification. While I aim to avoid duplicating exposure to specific sectors or industries, I don’t have any hard criteria to measure this.

The portfolio already contains one business with exposure to global fashion. That company is Coats, which is one of the world’s largest makers of yarn and zips. 

Should I rule out Burberry due to my ownership of Coats? I’ve considered this, but I don’t think it’s necessary. In my view, Coats’ performance is likely to reflect wider cyclical patterns of demand. 

As a luxury brand, I think Burberry is less exposed to such general cyclical risks. Instead, I believe the group’s future performance will be more closely linked to its ability to attract new customers and strengthen the appeal – and pricing – of its distinctive products.

I may be wrong in this assessment. But I’m not going to exclude Burberry on account of the portfolio’s existing exposure to the much broader clothing market.

StockRank review

Stockopedia’s algorithms have a somewhat mixed view on Burberry. An overall StockRank of 73 masks a fairly broad range of factor scores:

SIF doesn’t use the StockRank directly to select stocks, but I do use many of the metrics that lie behind these factor scores in my screening rules.

I’m not going to look at quality, value and momentum in as much depth as I usually do. I did that only six months ago. Instead, I just want to highlight a few key points.

Quality: Burberry’s financial quality reflects its strong balance sheet, profitability and cash generation. In my view, these factors are a key element of the stock’s investment appeal. 

The high QualityRank reassures me that these attractions remain intact. I can also see this from a quick look at the StockReport:

Value: Luxury doesn’t come cheap and nor should the shares, in my view. If Burberry was trading on a low valuation with a high yield, I’d see that as a likely sign of decline.

The stock’s ValueRank of 50 reflects its pricey nature, but I don’t see anything to be too concerned about. Burberry shares trade on around 20 times trailing earnings and offer a well-supported dividend yield of around 2.4%.

The stock’s earnings yield (EBIT/EV) of 7.95% is only a fraction below my 8% target. Put differently, that’s an EV/Operating profit multiple of 12.5x. In my view, this is likely to be an attractive valuation for a growing business.

Momentum: The only big change since my last piece is in the MomentumRank, which has fallen from 97 in May to just 45 today. This decline reflects both the weaker share price performance and a more cautious earnings outlook for FY23:

My decision

The outlook for Burberry remains somewhat uncertain. Designer Riccardo Tisci might still leave if he doesn’t gel with incoming boss Jonathan Akeroyd. Burberry might fail to deliver the hoped-for growth and margin improvements.

On the other hand, Burberry is a venerable luxury brand that seems to have survived the pandemic without lasting damage. Until the events of last year intervened, my impression was that Tisci and Gobbetti were moving the business in the right direction.

In addition, Burberry is one of a small number of European luxury groups that remain independent. As such it could become an acquisition target – perhaps for sector heavyweights such as Kering and LVMH.

On balance, I think Burberry shares look reasonably valued at current levels. I’m also satisfied that they fulfil the requirements of my buying rules, with the minor exceptions noted above.

I’m going to add Burberry to SIF this week, and to my own portfolio. Please let me know what you think about Burberry and the luxury market in the comments below – I really value your feedback, which helps shape my future planning.

Disclosure: At the time of publication, Roland owned shares of Coats.

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