Burberry’s (BRBY) shares fell sharply as it announced a new strategy together with second-quarter results. The new strategy focuses on continuing a brand image elevation towards luxury positioning, which involves rationalising non-luxury distribution channels in the North American and European markets, expanding leather goods and accessories offerings, and refreshing apparel with new designs.
Distribution rationalisation, which will involve some store closures, will result in flat sales in the 2019/20 financial year. Management expects high-single-digit revenue growth and strong operating leverage thereafter.
Morningstar equity analysts are keeping the fair value estimate of £17.20 a share and narrow moat rating – which means Burberry has a slim competitive advantage – intact as the company announced its new strategy together with second-quarter results.
The 10% pullback in the shares today to £17.82 leaves the shares trading in line with our fair value estimate. We expect to push our growth and margin forecasts back by a few years as distribution channels are rationalised, but this will not result in a material change to our fair value estimate, given the expected uptick in growth thereafter.
We agree with management’s aim to enhance the luxury positioning of the brand, as we think the luxury industry is more resilient and has more pricing power and higher barriers to entry than mid-price and premium apparel. We see Burberry already well advanced in brand elevation through taking over distribution control, building retail flagship infrastructure, and increasing prices at an estimated high-single-digit rate annually over the past years.
Price-wise, Burberry is positioned in line with its established luxury peers, so just minor tweaks to pricing will be needed. From a distribution standpoint, exiting lower-quality and discounting channels should help elevate brand perception.
While the strategy is plausible, it also contains risks. Focus on newness increases fashion risks, especially in categories where the Burberry brand is less established than peers; for example, the already crowded leather goods space.
New Products Essential for Future Success
Although Burberry has strong assets to build on – global brand recognition, distribution control and presence in key fashion capitals, category leadership in outerwear – performance will increasingly depend on the success of new product designs.
It is also concerning that, with the departure of Christopher Bailey, Burberry is left without a design head at a time when design and creativity are taking strategic centre stage. We consider the creative transition in our cautious near-term outlook, and there could be upside to results should it happen earlier than expected and prove successful.
Second-quarter results were in line with our expectations with continuing improving performance in Europe and Asia and continuing slight declines in the United States. New product introductions continued to resonate with consumers, and profit improved on the back of cost-saving initiatives, favourable timing of operating expenses, and continuing benefits from the pound's depreciation in the first quarter.
