Burberry: Luxury Stock Outfitted With an Attractive Growth Story

| About: Burberry Group (BURBY)

Stock price: p659 ($9.57 US)
Conclusion: Great management, attractive growth story in luxury goods . We reiterate our valuation target of p790-p800 per share for Burberry (OTCPK:BURBY).

FY10: Sales up 7% to £1280m (+1% organic-5% H1 +6% H2). EPS +17% to 35.1p
Guidance F11 confirmed: +10% space in retail +10% wholesale including Spain.

Burberry has weathered the recession particularly well

  • Sales have resisted thanks to retail (up 15% organic). Same store sales grew 7% (H1+2% H2+10%), combined with 8% new space. Wholesale and licencing were more affected, declining by 15% and 6% respectively.
  • Retail/Wholesale margin bounced back 180bp to 11.6%, driven by a sharp upturn in gross margin (+760bp) partly offset by higher operating expenses. Gross margin benefited from improved pricing, less clearance, cost efficiency and the switch from wholesale to retail.
  • Net cash position at 31 March was £262m, vs £8m a year ago. FCF reached £300m (£120m F09) helped by improved working capital (+184m inflow) and lower capex.
  • EPS exceeded expectations, increasing by 17% in F10.

F11: Accelerating Investment-Fixing Spain

  • Increasing investment. Capex will almost double to £170m, with 20-30 new mainline stores (131 currently) in Americas and Asia. Start up losses in Latam, India and Japan will increase £5m. Operating expenses in marketing, sales and distribution will be up as a percentage to sales (around 50% vs 48.1% F10). Termination of licences and wholesale accounts should cost the group £5-10m.
  • The negative impact on margin will be partly compensated by improved gross margin thanks to higher full price sell-throughs and sourcing benefits.
  • The restructuring in Spain should lead to 50% fall in revenues and a trading loss of £10m, as retail and wholesale move from local to global collection.
  • Looking for double digit growth top line and mid single digit bottom line. Sales could reach £1450m in F11 (up 13%, +9% organic), margin in retail/wholesale should slightly erode (40bp to 11.2%) as a result of growth initiatives taken this year, EPS could increase 6% to 37p (we include trading loss in Spain) and return to mid teens growth in F12.

Longer term: mid teens growth prospect

  • New retail space should add 10% growth for the next three years.
  • Wholesale remains underpenetrated in the US (7% of sales) and in Asia.
  • Non apparel gaining share (35% of sales)
  • Menswear to benefit from the first global collection following the non renewal of licences.
  • Childrenswear (4% of sales) could represent 10% of revenues over time.

Burberry trades at 18xP/E and 9xEV/EBITDA based on 2010 calendar estimates. We expect the stock to further re-rate based on its superior EPS growth potential. Our valuation suggests 20%+potential return.