Through strong execution, Burberry (BRBY) has transformed from an essentially licensed/wholesale business model with inconsistent regional product and brand presentation into a strong monobrand luxury player with consistent message, good control over distribution, and a global presence.
Burberry is the category leader in its trench coat business, enabling it to generate high operating margins in this category through scale and pricing power. It benefits from a high degree of control over distribution, which allows it to correct operational mistakes more quickly, showcase the brand in key locations in global capitals, avoid excessive discounting, and retain stronger negotiating clout with wholesale partners.
Burberry was one of the first of its peers to invest in digital front- and back-office systems. It aggregates customer data across channels and regions, which helps it to target marketing campaigns better and can act as an input in product development and merchandising. While demand for luxury products is linked to GDP growth and an increasing number of wealthy and middle-class people, we believe Burberry and its leather goods and apparel peers could engage the existing customer pool to purchase more through product innovation.
In the longer run, growth should come from China, where despite a GDP slowdown, consumption should be supported by growing wages as the labour pool shrinks. Growth should be also supported by increasing incomes in India and Latin America, where Burberry has established a presence.
Analysts Upgrade Burberry
We are raising our fair value estimate to £17.20 per share from £16.40 mainly as a result of the time value of money effect and changes to the British pound forward curve.
We expect low-single-digit revenue growth in 2018, driven by wholesale account rationalisation in the United States and the licensing of the beauty division. We expect a pickup in other product category growth, driven by fashion and new products, with increased demand from existing clients in a slower industry cycle point. We believe accessories will outperform in the short run, as that’s where the company’s marketing efforts are channelled.
Burberry could benefit both from the growth in middle-class customers across the globe as well as demand from existing middle-class customers, boosted by growth in their incomes. Although adding new wealth at a slower pace than in the past, China presents a major opportunity through increasing consumption share of GDP and pent-up demand from the second middle-class generation. We expect Japan, where Burberry has taken over the license, to increase from around 2% currently to around 4% of sales over five years. This would still be below peer revenue in Japan, owing to real estate constraints in this market.
We expect better leverage in selling, general, and administrative expense in the longer term, as retail expansion slows and growth in demand results in higher same-store sales. Some overlapping costs would also be taken out, helping the bottom line, and beauty licensing is margin-accretive.
