Everyone’s talking about FTSE 100 stock Burberry

Burberry (LSE: BRBY) announced a trading update last Friday. Uh-oh, I thought, this is bad news.

For one thing, the company had issued a profit warning in its previous trading release. And, for another, Friday’s announcement was a week ahead of schedule.

Under stock exchange rules, a company must notify the market “without delay” of any change that would be “likely to lead to substantial movement” in its share price.

Burberry’s announcement provoked a 14% drop in its shares when the market opened.

What’s going on with this iconic British fashion house and FTSE 100 stalwart?

Profit warnings

In November, Burberry had warned that a “slowdown in luxury demand globally” was impacting trading. It advised that if this continued, its operating profit for the year to 30 March would be towards the lower end of the previously expected range of £552m-£668m.

In Friday’s update, it revealed it had experienced “a further deceleration in our key December trading period.” And that management now expects operating profit to be in the range of £410m-£460m. That’s 17%-26% lower than November’s downgraded guidance.

Yet the shares fell only 14% when the market opened. Furthermore, they rallied to end the day down less than 6%. It seems the market had already largely priced in the risk of a second profit warning.

Not alone

Commentators have pointed out that Burberry’s French and Italian peers have also suffered from weaker demand, and that demand will sooner or later return.

This is true enough, but I think there’s a more fundamental consideration for anyone mulling the prospects and appropriate valuation of Burberry as a long-term investment.

True luxury

You may remember that through the noughties Burberry acquired an unwanted association with Z-list ‘celebs’ and ‘chav culture’. Since then, it’s been intent on moving itself up the hierarchy of the luxury market.

Progress hasn’t been helped by a revolving door on the chief executive’s office and shifts in creative direction. But ascending to the select club of ultra-luxe brands has remained the unchanging dream.

Current chief executive Jonathan Akeroyd, who succeeded Marco Gobetti less than two years ago, told us on his first conference call: “The ambition to be a ‘true luxury’ brand remains absolutely the right strategic positioning for Burberry.”

Work in progress

Akeroyd has refocused Burberry on ‘Britishness’ and ‘Heritage’, and brought in English designer Daniel Lee to replace Riccardo Tisci as the company’s Chief Creative Officer.

Lee unveiled his first collection (autumn/winter 2023) last February, and the “new modern British luxury creative expression for Burberry” is still in the early stages of execution.

As last year’s premiere of the final season of HBO’s hit TV show ‘Succession’ showed, Burberry has work to do to move its brand identity further upmarket.

‘Most offensive bag’

A huge talking point when the season opened was the use of a £2,500 Burberry tote as a signifier of a ludicrous attempt by a gauche outsider to fit in at a gathering of the ultra-wealthy.

Reportedly, the shows creators had tapped sources in New York’s highest social echelon and asked them: “What is the most offensive bag a woman could bring to something like this.“

Online searches for ‘Burberry tote bag’ apparently rocketed, and presumably it sold product on the back of it.

Ultra-luxe, aspirational luxury, affordable luxury? As long as it’s making money, what does it matter to investors where exactly Burberry sits in the market?

Profit margins

Basically, the higher up the luxury pyramid a brand can climb, the higher the profit margins, and the higher the price investors will be willing to pay to own a share of the business.

On an historical five-year view (excluding the anomaly of Covid-ravaged 2020), Burberry’s average annual operating profit margin was 18%. This compares with, for example, luxury multi-brand conglomerate LVMH Moet Hennessy Louis Vuitton at 23% and Hermès at 37%.

The profit margins are reflected in the average price-to-earnings (P/E) multiple investors have been willing to pay for the three stocks over the same period: Burberry (18x), LVMH (28x) and Hermès (52x).

What’s in store?

There’s no guarantee Burberry will successfully move up the luxury hierarchy and achieve the ultra-luxe margins that would merit a re-rating of its shares to a much higher P/E.

Having said that — and notwithstanding the current weak demand across the sector — the depressed shares do look cheap to me, even if it can’t migrate up from its current aspirational luxury positioning and margins.

Indeed, I wouldn’t rule out a takeover bid from a luxury brands group or private equity house.

The post Everyone’s talking about FTSE 100 stock Burberry appeared first on The Motley Fool UK.

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Graham has no position in any of the shares mentioned in this article. The Motley Fool UK has recommended Burberry Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.