Burberry: Superior Medium-Term Growth Outlook

| About: Burberry Group (BURBY)
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Stock price: p812 ($12.43 USD)

Conclusion: Strong start in Q1 coupled with the buy out of Chinese franchises lead us to upgrade our valuation target for Burberry (OTCPK:BURBY) to p900-p920 per share. As a result, we reintegrate Burberry in our invesment list.

Q1 sales: up 27% reported to £291m (+21% organic-+24% excluding Spain). guidance 2011 unchanged.

F11 numbers roughly unchanged notwithstanding a strong start.

  • We have slightly increased our sales forecast for retail to account for better comparable store sales (+10% in Q1).
  • Q1 growth in wholesale and licensing should not be extrapolated. Revenue in wholesale (+46% organic) benefited from the re-phasing of deliveries in the first quarter enabled by supply chain efficiencies. Sales in licensing (+14% organic) were boosted by timing differences related to the Japanese apparel licence.
  • We look for £1458m sales, implying +17% sales (excluding Spain) for the rest of the year. This is clearly well ahead of competitors in the luxury sector, owing to the strong momentum of the Burberry brand.
  • As to margin, we continue to expect a slight erosion due to the conjunction of higher operating expenses related to the store network expansion, start up losses in new markets and termination of licences and wholesale accounts, combined with a trading loss in Spain (included in our numbers unlike management reporting). We expect EPS to increase 6% to 37.2p (including Spain) and to jump +26% next year to 46.7p.

The acquisition of Chinese retail operations is great news.

  • Burberry pays £70m from its cash resources (autumn 2010) to acquire 50 stores located in 30 Chinese cities, making £75m retail sales (year to December 2009) and £14m EBIT. A franchisee will hold a 15% stake in the business.
  • The deal should be EPS neutral this year and add up to £20m to group operating profit next year, implying a better yield than the current return on cash.
  • Strategically, the deal should further enhance Burberry’s medium term growth profile by increasing its exposure to Asia Pacific (28% of sale by 2012) and to retail (67% of sales projected by 2012).

Burberry trades at 22x and 18.3xP/E based on our 2010 and 2011 forecast. We think the stock deserves to trade at a premium to the luxury sector, owing to superior medium term growth potential (cf May 27 comment). Our DCF suggests around 13% upside potential.