Time to get established
Its decision push upmarket is cogent as the luxury world evolves into a more globally dispersed one. It is the length of the lead time that the 161-year old luxury group envisages it will take to establish a position “firmly in luxury” that has frustrated investors. Burberry (LON:BRBY) sees £120m cumulative annualised savings in 202o. But these will be more than offset by a £15m restructuring charge in 2019 and an £150m-£160m annual capital expenditure rate in 2019 and 2020. The group makes clear that revenue and profit growth, plus “meaningful” operating margin improvement are unlikely before 2021. Margin for error is further reduced because Burberry plans to ramp capex to £190m-£210m from 2021 as well. In short, Burberry’s strategy update makes sense as it will equip the group for the new world of luxury, but it is essentially a profit warning. Rough calculations suggest market forecasts for 2019 need to come down by around 7%; some of the more optimistic ones by as much as 10%.
Promising interims
Were it not for the weight of the strategy refresh, we think there’s little doubt Burberry’s half-year profits would have triggered a reasonable stock price lift on Thursday. Most results were in-line-to-slightly-better than forecasts. Digital sales growth and signs of improving loyalty in all regions were highlights. Additionally, beauty appears to have turned a corner, vindicating the decision to return to a partnership structure after Burberry tried going it alone for about two years. Other signs that Burberry remains financially underpinned included quickening free cash flow growth- that will come in handy in view of the strategy rethink. A cash conversion ratio rising above 100% also means Burberry was operating more efficiently in H1.
Were to pin disappointment
Few major investors will have much quarrel with the aims of the strategic update. Rather it is the low hurdle for the ramp to improvement that is a deeply negative surprise. The effect on the stock, which was trading down 12% at the time of writing, has been exacerbated by the uprating over the last year and a half. The stock gained more than 40% between mid-June last year and Wednesday’s close, as hopes built that installation of CEO Marco Gobbetti, renowned in the luxury world, would accelerate growth. But his sound plan of action appears to offer a lower hurdle for near-term performance than investors expected. The shares could now drift lower into year-end as the investment rationale versus European rivals, for instance LVMH, weakens further.
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