Burberry’s second-half like-for-like sales rose 6%, with the bulls proclaiming that the well-heeled will continue splashing out on its luxury trench-coats, scarves and £750 handbags. But a five-fold increase in the share price since late 2008 looks overdone. Here’s why.
First, despite improved demand for luxuries, such as Porsches and Dom Pérignon champagne, this sector is highly cyclical. Once the effects are felt of fiscal tightening in China and Europe’s public-sector spending cuts, this discretionary spend sweet spot will turn sour.
Second, Burberry’s 17% operating profit margins look too good to last – aggressive competition, rising unemployment, higher taxes and further falls in property values will soon deter cash-strapped consumers.
Third, Burberry’s British stores have been temporarily boosted by tourists flocking to London looking for branded bargains. But hawk-eyed travellers and handbag addicts can only cushion the impact of a recession in the short term. The Spanish economy, which makes up 8% of revenues, is in freefall, air-fuel taxes are taking off and the euro is under pressure.
Burberry (LSE: BRBY), rated a BUY by Evolution Securities
So the board’s strategy of expanding floor space by 10% this year seems ill conceived. Falling revenues would have a disproportionate impact on the bottom line, due to the firm’s operational leverage. Yes, the brand may currently be flying high, but if not enough consumers can afford its posh garments, opening more stores could prove disastrous.
The City is forecasting 2010 turnover and underlying eps of £1.43bn and 39.5p respectively. This puts the shares on a p/e ratio of 20 – quite a premium to its peers. I would value the stock on an eight-times ebitda multiple, assuming sustainable margins of 15%, or about 540p per share.
Sure, the firm could be taken over, but with private equity still fighting shy of retail stocks, that’s unlikely. So if you’re sitting on good gains, take them. The next trading update is due on 13 July.
Recommendation: TAKE PROFITS at 800p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments