I’m very wary of the recent gains in many retail stocks – they appear about as justified as an MP’s expense claim. In particular, with rising unemployment hitting disposable incomes (once redundancy payments have been spent), then short of a miracle, the luxury goods sector looks vulnerable.
So what about Burberry, the maker of iconic camel, red and black check clothes and expensive accessories such as £750 hand-bags?
Burberry (LSE: BRBY), tipped as a BUY by Deutsche Bank
The fashion house is proving more resilient than most. But even so, it still saw a 12% decline in pre-tax profit to £175m for the year ended March, despite being helped by a weaker pound and cost-cutting. It also said that conditions would remain “challenging”, and that like-for-like (LFL) revenues would fall in 2009. Hardly enough to support the 130% leap in the share price over the past six months.
The bulls point out that its UK stores are benefiting as the weak pound persuades Europeans to go bargain-hunting in London. Some are even arguing that this is a prelude to a high-street turnaround. No chance. Hawk-eyed travellers and handbag addicts may be able to cushion the impact of a recession short term, but there are dark clouds ahead. The German economy is in freefall and retail fads rarely survive more than a year or so.
Also, the board’s strategy to expand floor space by 10%-12% this year, as demand is softening, seems strategically misplaced. If there isn’t the hoped-for V-shaped recovery and LFL sales say fell by 10% this year, this would affect the bottom line due to high operational leverage. A brand that’s a winner in the eyes of fashion experts is no use if consumers can’t afford to pay its prices, in which case opening more stores could prove disastrous.
The City expects 2009 turnover and underlying EPS of £1.2bn and 27.4p respectively, putting the shares on a heady p/e ratio of 13.5. I’d value the stock on an eight times operating profits multiple, assuming sustainable margins of 12%, giving an intrinsic worth of roughly 260p a share. Of course, there’s a chance Burberry could be taken over. But with the private-equity boys licking their wounds from past forages into retail, there’s no guarantees.
So while Burberry has weathered the storm, the recent rally looks fragile. If you’re sitting on gains, now would be a good time to pocket the profits.
Recommendation: TAKE PROFITS at 378p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments