Burberry (BURBY) Q3 2016 Trading Update Call (Transcript)

| About: Burberry Group (BURBY)

Burberry Group PLC (OTCPK:BURBY) Q3 2016 Trading Update Conference Call January 14, 2016 4:00 AM ET

Executives

Dave Jones - Investor Relations

Carol Fairweather - Chief Financial Officer

Analysts

Antoine Belge - HSBC

John Guy - MainFirst

Elena Mariani - Morgan Stanley

Thomas Forte - Brean Capital

Thomas Chauvet - Citigroup

Tom Gadsby - Liberum

Mario Ortelli - Bernstein

Rogerio Fujimori - RBC

Julian Easthope - Barclays

Warwick Okines - Deutsche Bank Research

Carol Fairweather

Good morning and welcome to Burberry’s Third Quarter Trading Update Conference Call. With me this morning is Dave Jones from our Investor Relations team. I will make a few brief comments on this morning’s announcement and then we will be happy to take your questions.

In a tougher external environment for luxury than we were expecting, retail revenue for the third quarter was up 1% underlying. Comparable sales were unchanged year-on-year, an improvement from Q2 but below our internal functions considering Hong Kong and the United States. The trading pattern throughout the quarter was uneven with a very late Christmas. Accessories were more resilient than apparel which was impacted by the unseasonably warm weather in many of our key markets.

Ahead of the New Year and in what remains a challenging external environment we currently expect FY2016 adjusted PBT to be broadly in line with current market forecast. This outcome will be supported by further reduction in the performance related pay charge additional discretionary cost savings and an FX benefit of about £10 million.

So let me take you through the revenue detail by region. In Asia-Pacific, comparable sales improved versus Q2 with the mid-single digit decline in the quarter. Mainland China and Korea both returned to growth and our relatively small business in Japan once again posted exceptional growth. Hong Kong and Macao again still comparable sales decline by over 20% with the continuation of very weak foothold for us and to the sector.

To give you an indication of the adverse impact of these markets, comparable sales to Asia-Pacific would be up by a mid-single digit percentage, excluding Hong Kong and Macao and the comp to the Group as a whole would have been 3% positive rather than unchanged. EMEIA achieved mid-single digit comp growth consistent with the second quarter, with an improvement from domestic customer offset by slowing but still positive growth from travelling luxury customers, although these patterns vary by country.

The UK, our largest market in EMEIA became more challenging in the third quarter with a slowdown from travelling customers particularly Chinese and Middle Eastern consumers likely related to the strength of sterling compared to the euro. However, this is more than compensated for by Italy and Spain which continued to deliver growth in excess of 20% and a strong performance from Germany. These performances were underpinned by the travelling luxury customer but we also saw a return to growth among the continental Europeans at home.

And finally in the Americas, we saw the region improve to marginally positive growth in the quarter with Canada, Brazil and Mexico together, again up double-digits and the U.S. local consumers returning to growth.

So before turning to 2017, let me just highlight some of the positive results for the quarter. First, digital commerce outperformed in all regions, seeing the benefit of our investments in both mobile which now represents the majority of traffic to the dotcom sites and with improved conversion as our fastest growing digital channels. And also, the rollout of the single pool of inventory models into our largest digital market the U.S. and the UK, following the trial in China. While we continued to work with companies including Apple, Google, DreamWorks, and WeChat, to ensure newness in our brands’ reach.

Second, given that Q3 is more heavily weighted towards domestic customers we were pleased to see them return to growth in all three regions helped we believe by a good response to our festive initiatives in terms of marketing, customer service and products where small leather goods and scarves, including monogramming were highlight. And finally, our focus on retail productivity drove positive results in terms of improved conversion of both in store and online globally. Initiatives included better leveraging our customer insights and Burberry private client programs, incentivizing our services differently and fast tracking bestselling lines including ponchos, lightweight cashmere trench coats, new quilts and key bag shapes including the Banner bag.

So before we take your questions, a few words on the outlook for 2016 and ’17. As you work through your model, we will as usual, in April give specific guidance on the contribution from new retail space, wholesale and licensing. And please remember that Japanese licensing will step down by about a further £15 million compared to 2015, ’16. On operating expenses while we will remain very focused on tight cost control, underlying cost pressures persist across the whole sector and we currently expect around a mid-single digit increase in our OpEx.

With the uncertain outlook for luxury as you would expect we are responding by accelerating our productivity and efficiency agenda, particularly looking at our ways of working while addressing how to optimize new organic revenue growth opportunities, the resulting investment plans and that capital structure. And we will provide updates on all of these at the preliminary results in May.

So thank you. And we’d now be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Antoine Belge of the HSBC. Please go ahead.

Antoine Belge

I've got three questions please. So first of all -- so back in October, you gave this mid-single digit guidance for comps, which was a bit unusual for you, since you usually don't give that type of guidance. So what was on your mind then? And what was different, apart from the warm weather and maybe the attacks in Paris?

The second question is on your PBT guidance. Actually not so much for this year, but when we look at next year given that you said that OpEx would rise mid-single digit. I think when I look at consensus today, I see people expecting like a mid-single digit increase in PBT. So in your view, is it possible for PBT not to be down next year? And so if you could shed some light on the way your performance-related pay works, because obviously with a 60 million saving this year, the PBT next year will be highly dependent on that PRP.

And finally, I think in the press release you mention that you will be looking at your capital structure. What does it mean? Would that mean for instance, that you could be returning cash to shareholders? Thank you.

Carol Fairweather

So Antoine in terms of your first question in terms of mid-single digit guidance, I think you’re saying where did we come in unchanged and how did that change. I think when we spoke to you in November that was -- we said that the world remained very uncertain out there. But what happened subsequently was clearly the events in Paris which I think affected consumer sentiment and the travelling luxury consumer globally.

We talked about the U.S. being very uneven and that persisted throughout the quarter and we’ll report in terms of what we’re seeing in terms of U.S. wholesale accounts. So the U.S. was another area where perhaps we were impacted. And of course Hong Kong where we had seen some improvement through October albeit it still declining I think our internal assumption was not that it would continue over minus 20 down. And therefore, that also impacted. So I would say it was broadly -- the significant continuing declines in Hong Kong which we hadn’t assumed. The U.S. remained uneven possibly impacted by unseasonably warm weather and consumer sentiment, but that’s really why we ended up flat for the quarter albeit we would have been up 3 at Hong Kong and Macao.

And then turning to PBT for next year, when we’re saying that at the moment it's too early to guide on a number of the metric, what we are flagging is that the environment does remain uncertain. In light of that as you would expect we are responding by effectively accelerating our productivity and efficiency agenda. And also anticipating how consumer demand and its evolving luxury world will continue to change and therefore, looking at what new growth opportunities there maybe by channel region or product lines.

And what we’re saying is we’ll come back and update you on all of that in May and I’ll come on to your points in capital structure in a moment. And therefore I don’t think we can guide specifically today on ’16, ’17 because we’re saying it does remain uncertain. We’re saying that we do see underlying OpEx increases in the business, the annualization and rent increases. On PRP to your point, again that’s not a matter we can make the planning assumption but it will really be for the remuneration committee to agree what level of PRP should we reinstated once we have grown up our budget.

And therefore, there is lots more work to do in terms of the budget. But what we’re saying today is that in light of that we are responding by accelerating productivity agenda particularly looking at our ways of working and really looking at future growth opportunities. And then to your point on capital structure and that will very much determine as we come and talk to you in May around growth opportunities, the investment plans required and therefore what that means in terms of running an efficient balance sheet. So the plan is to come back to you in May with all of that.

Operator

Our next question comes from the line of John Guy of MainFirst. Go ahead please.

John Guy

Just a couple of questions from me. Just with regards to the digital outperformance, if you could highlight the quantum of the outperformance please. Secondly, could you give us an update in terms of how your inventory position stands? It was obviously very well managed during the first half of the year, so I just wanted to get a handle on any particular changes over the quarter. And could you update us in terms of any potential savings that you'll make? I appreciate it's a very small part of your business anyway, but on the discontinuation of the watches line, which is probably something a bit overdue, and I think probably quite welcome as you focus more on your core areas. Maybe start with those three please.

Carol Fairweather

So, digital, as you know, John, we don’t ever spit out our digital performance separately that’s not how we think about it or the consumable, what we are saying though is that if you do look at the pure digital metrics they did outperform our main line stores. We’ve always talked about the fact that you can’t look at one in isolation of the other. We do think that comes off the back of those and the investment we continue to make in digital. So the fact that we have rolled out these single pools of inventory in the UK collect in store is now 219 of our stores. So all of the investments we make in digital and particularly in mobile, I think you heard me say that over half of our traffic now comes through via mobile devices. And so that the investments we made in our mobile platform this year I think is what’s enabled us to deliver that against strong performance in digital.

In terms of the inventory position, I mean at the end of December I am comfortable with where we are from an inventory perspective. And then in terms of the watch license as you say this is very much about focusing on our core categories and it's really about making sure that we’re dedicating our time and the space in our store to driving those core categories. So no significant cost savings, but just another item onto the productivity agenda.

John Guy

Okay and then maybe just a follow up on the OpEx, and clearly you're guiding to that mid-single digit inflation, which is not just Burberry specific. When you think about upward only rent reviews, and you think about the longer-term picture, I appreciate that Hong Kong, at the moment, all of your stores are still profitable. But if you still believe, or if you start to believe that the market is going to be on a prolonged structural decline, then that might not necessarily be sustainable. So over the longer term, should we start to think about the possibility of you downsizing your Hong Kong operations, and potentially allocating capital elsewhere?

Carol Fairweather

John as you say all of our stores remain profitable and since we’ve seen the more challenging environment Hong Kong we have been out renegotiating, when we talked to you about in November about reducing our floor space at Pacific Place, albeit it remains our flagship store in Hong Kong. I think we will continue to responsibly manage the portfolio as we move forward as we do in all markets, as all stores come up for rent reviews and leases come to the end we always look at whether we want to stay there, relocate, or expand, or whatever and won’t do anything different in Hong Kong but just behave responsibly as you would expect us to.

So nothing new to announce today in relation to Hong Kong, as you say all the stores do remain profitable and we’ve taken action we talked before about actions around staff, actions around rent review to protect profitability in that difficult market.

Operator

Our next question comes from the line of Elena Mariani with Morgan Stanley. Go ahead please.

Elena Mariani

I just wanted a couple of clarifications, the first one is on these additional savings that you've identified. If you could please give us a better idea of how much of this is of the additional cost savings you have identified is going to be recurring going forward, and what is exactly the saving coming from? And then the second question is about the gross margin. What is actually implied right now in your PBT guidance and what should we expect also for next year? Thank you very much.

Carol Fairweather

So, in terms of additional savings, as you remember, between June and November we took out over £20 million of planned investments in people, in other areas of projects and discretionary spend across the business. And we have moved through what has been another challenging quarter that rigorous and robust cost discipline has been maintained in light of that. We have continued to look at how we don’t replace people when they leave, or how we reallocate headcount, how we become more efficient in our ways of working, critically reviewing all discretionary spend. And that’s allowed us to take out over another £5 million worth of cost compared to when we last spoke to you.

And that will remain, so those costs that we have avoided this year will not go back in next year clearly. All we’re saying today is there is some underlying cost pressure in the business from the annualization of new store rent increases that the £25 million we have saved against that plan this year absolutely stays out. And then we’ll look at what else we can delivery in terms of future savings under this accelerated productivity agenda really looking at our ways of working.

And then in terms of gross margins and it’s only a sales update so we haven’t got anything new to say on the gross margin I think what we’ve said to you in the past is that don’t look for a lot of expansion from those margins, it's currently around that 70% level. And so, it’s not going to be a key growth driver for us.

Operator

Our next question comes from the line of Thomas Forte from Brean Capital. Go ahead please.

Thomas Forte

I wanted to find out a little more information on to what you attribute the improvements in conversion for your mobile and digital efforts. Thank you.

Carol Fairweather

I think we know that more and more people are going to mobile device. We’ve made it much easier for people to shop off of that side. We’ve improved our payment mechanism we’ve got the single pool of inventory so when people come to the site on a mobile device now it previously say that look for inventory from that site and we weren’t in stock in our digital warehouse, they wouldn’t have seen, really been able to purchase that. Now given we’ve opened up these pools in the UK, The Americas, that’s it’s really a combination of all of the investment we continue to make in our digital platforms be it mobile single pool of inventory payment system. So, the ongoing investments which we believe is delivering returns.

Operator

Next we have a question from the line of Thomas Chauvet with Citigroup. Please go ahead.

Thomas Chauvet

I've got three questions please. The first one, I'm trying to understand a little bit FY17, various moving parts beyond like-for-like assumptions. Just a clarification on FX. So the £10 million benefits first of all for FY16, is it based on the spot GBP/USD at the end of December, so £1.48 or closer to £1.44 which would probably imply further benefits in March ‘16. And was wondering what math you've done internally if you apply £1.44 GBP/USD, maybe a weaker GBP/euro, what does it do to next year's profit? Would maybe £15 million £20 million benefit be a realistic assumption?

On your OpEx growth guidance for next year, is it in constant currency the mid-single digit? And I understand the £25 million of OpEx savings won't come back next year. But are you actively looking to take more costs out? Have you identified costs potentially not taken out this year but that you could look to remove next year? And I assume also this cost guidance excludes the PRP. And finally, could you elaborate a little bit on what you are seeing in Mainland China, the return to positive LFL? Are you assuming like some of your peers that trends have bottomed out? I would also think that the RMB weakness, maybe the travel fear factor to some parts of Europe would bring back some Chinese tourist demand onshore. Is it what you've seen and what you're perhaps expecting for the rest of the year?

Carol Fairweather

So in terms of your FX question or FY17, so the FX this year was done at the 31st of the 12th month, which as you say was close to 148 and where we’re tracking instead around 144. So at today’s rate there would be a little bit further benefit. But clearly we update you of the closing rate to each quarters and that will be factored in. So, at today’s rates yes possibly a tad more, but remember the FX benefit we’ve talked to you about today also the FX benefit that we saw through November and December compared to when we last spoke to you, not just for the last three quarters.

And as you say, at today’s rates there would be a benefit next year we haven’t thoroughly worked through our budgets yet and therefore we’re not quantifying that at the moment. But yes at today’s rates there would be a benefit from FX next year. In terms of OpEx yes the guidance in the constant currency. As you say the £25 million of costs we’ve taken out this year we will not be reinstating next year. But we are absolutely actively looking at where we can drive more cost efficiencies out of the business. And therefore there will be continual focus on all discretionary costs together with a bit more detailed review of our ways of working, how we would become more efficient as an organization and that’s what we’ll come back and update you on in May.

And then in terms of China we’re pleased that returned to growth. There is an improvement both in footfall and conversion and I think it's really down just to all the initiatives that we’ve had in place over festive in terms of soft tracking, using our customer insight best in that market. I don’t think we’re brave enough to say it's necessarily on an improving trend, but we’re certainly pleased with the end to the third quarter performance. And clearly as we look into the fourth quarter it’s all eyes down for Lunar New Year where we’ve got lots of exciting initiatives as well.

And then you asked about the RMB weakness and whether that was right, clearly it may but remember as it may drive depending on where FX rates are to you’re rather than necessary for the UK, so there may be a benefit but we’ll have to wait and see.

Thomas Chauvet

And have you measured the demand of the overall Chinese cluster globally in the third quarter versus maybe Q2 or H1? That Chinese demand, is it improving?

Carol Fairweather

It was down low single digit in second quarter and actually is now down mid-single digit. Importantly, we saw growth in Mainland China, Hong Kong and Macao remained very-very difficult. We still saw growth in Europe from the Chinese tourists for the low rates and in the second quarter.

Thomas Chauvet

Okay, so Chinese demand overall is slowing down a little bit?

Carol Fairweather

Yes.

Operator

Our next question is from the line of Tom Gadsby of Liberum. Go ahead please.

Tom Gadsby

A quick question on wholesale, I know you've only just given bare bones on that today. But Nordstrom commented at their Q3 update in November that they were going to be paring back on inventory given what was happening in the U.S. at the time. How has that affected your order book? Is anybody else doing similar, what's the order book looking like for the next year?

Carol Fairweather

In terms of -- we guided back in November for our H2 wholesale outlook and we said that apparel and accessories we did expect it to down mid-single digit, but there has been no change to our guidance since we spoke to you in November. We did say that was reflecting cautious ordering by wholesale customers globally but no change to our wholesale guidance today.

Tom Gadsby

Well what about that -- that's for the balance of this year, but what about for spring/summer?

Carol Fairweather

As we said, we’ll come back and guide in April as we always do, so for the first half of next year.

Operator

Our next question comes from the line of Mario from Bernstein. Go ahead please.

Mario Ortelli

Three quick questions for me. You mentioned that the winter was very warm and the festive season started very late. Should we expect more volumes or markdowns this season? And did you make any change in your markdown policy starting maybe before or with higher percentage of discount? The second question is, given the volatile environment and your cost cutting measures, are you reviewing the CapEx that you will assign for this fiscal year 2015-‘16? And the last question is, the underlying phase for this quarter were below your internal projection. How are you changing your internal projection of estimate for Q4?

Carol Fairweather

In terms of the weather had any impacts on markdown or duration of sales, nothing significant to call out. In fact, our sale period we had planned to be slightly shorter than last year and we very much stuck to that. We did see people going on sale earlier in certain markets, we didn't change the timing of our sales and our markdown cadence overall was exactly in line with what we had planned. So, nothing really significant to call out in terms of any change to our markdown strategy.

And remember we’ve got quite a lot of replenishment product in there. So although the unseasonably warm weather may have impacted our outerwear sales in this quarter, half -- over half of our outerwear sales is probably on replenishment anyway.

And then in terms of volatile environments in CapEx review, of course, we constantly reprioritized and we look at our capital expenditure plans and we'll continue to do that as we go through the balance of this year and next year. So, nothing new to call out, We had talked about CapEx maybe moderating as we looked forward, but we'll come back in May and update you with our guidance for the following year and then in terms of underlying sales in Q2 being below our expectations, yes they were for the reasons we just chatted about previously earlier on the call. In terms of Q4 we're not guiding, but safe to say it's Lunar New Year, in the same way that we had a great festive campaign, we've got all of our teams working very hard, we've got special products in the stores for Lunar New Year, we've got a dedicated marketing campaign and all of our teams remain very-very focused on driving conversion.

Operator

Our next question is from the line of Rogerio of RBC. Go ahead please.

Rogerio Fujimori

I have three questions, the first one about pricing architecture. I know you constantly monitor pricing versus peers, but some peers like Prada are talking about the need of slowing regional price caps further, so do you believe there's further work for Burberry as well? Or are you satisfied for now with the current situation? Second question about Japan. Could you give us an idea about how much Japan accounts as a percentage of your total retail/wholesale sales today? And my third question is about the inventories. You have been tightly managing inventories. Could you give us some color on your inventory position at the end of December? Thank you.

Carol Fairweather

So, in terms of pricing, nothing new to announce there. As you say we’ve got our pricing strategy in place and we've monitoring as we always do, but nothing specific to announce today from us in terms of pricing. In terms of Japan, I think it's around 2% of retail/wholesale sales globally as we said small for us, but we did see a gain in a great growth off of the tiny base. And then in terms of inventories as I said earlier I think we're comfortable with that inventory position, at the end of December we'll continue to tightly manage that as we move forward.

Operator

[Operator Instructions] Our next question comes from the line of Julian from Barclays. Please go ahead.

Julian Easthope

I suppose one of the downsides of being last in the queue, I always end up asking the nerdy questions, so here it goes. I think there's probably been about a 10-year incubation period for the Accounting Standards Board to come up with their lease standard, so I just wondered if you'd taken a look at the implications of that and whether it will have implications for your -- the capital structure comments that you’ve made in your call?

Carol Fairweather

I mean shortly we have had our team looking at that for some time. I know it was issued earlier this week and we're busily working through what that means. Clearly there's a lot of work to do. I mean I don't think fundamentally, I think it's an accounting rather than a -- commercially, we still need to look at how we want to run the business than rather than being driven by accounting standards, but lots of work to do to understand how that will change our reported numbers as we look forward.

Unidentified Company Representative

But when we look at capital structure, you know we always look at our lease adjusted net debt rather than the actual just straight net cash position.

Julian Easthope

And the lease adjusted net debt that you have is, is that materially different from the accounts -- the new standard that they put out?

Carol Fairweather

We're working through that at the moment Julian and I think the way in which we're looking at the moment I think it's helpful to it, we need to understand exactly what that will look like when we have to put that onto the balance sheet but we'll come back and begin guiding on that. We're working through how that will look. Clearly we've got a couple of years to prepare for it, but trust me my accounting teams are gearing up for it.

Operator

We have a question from the line of [indiscernible] of Deutsche Bank. Please go ahead.

Warwick Okines

It's Warwick Okines from Deutsche Bank. Sorry, you may well have mentioned this right at the start, but I would have missed it. Have you said what the total PRP and bonus reduction year-on-year in the current financial year is expected to be?

Carol Fairweather

So, we said there was around 30 million savings year-on-year when we spoke to you in November. We're saying it could be around double that now, so it may be around 60, but we've still got the fourth quarter to go and remember the total PRP charge related to the in year bonus part and also to the LTIP charge which also depends on future growth. So, as we go through this quarter finalizing this year’s number and our outlook for the next couple of years then we will true that number up, but we’re saying possibly around 60, something like that at the moment.

Warwick Okines

And obviously, for next year, lots of uncertainties and I'm sure you'll report back in May with a bit more clarity on this cost line as well. But are there some commercial reasons why you'd have to rebuild that in the year ahead? Competition for talent I'm really thinking about.

Carol Fairweather

I mean it’s absolutely a matter for the RemCo and not for management to decide. But clearly, they will be factoring all of that in as they decide what an appropriate level of PRP is to back to reinstate next year. But remember it go away [audio gap] and therefore it will looked at through that lens as you would expect us to be but that’s a RemCo matter and we’ll be able to update you in May on where we land on that.

Carol Fairweather

So, no more questions. In conclusion, the third quarter has been tougher than we were expecting. But our focus on growth and cost control has driven a number of positive results, which support FY 2016 profit. While the outlook for the sector remains uncertain, we are responding to this with an intent focus on optimizing new growth opportunities and accelerating our productivity and efficiency agenda whilst always protecting and building the brand. So thank you and we look forward to speaking to you again on the 14th of April when we have our second half trading update. Thank you.

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