Burberry

1.     OverviewBurberry is a British luxury fashion house, specialising in outerwear, sunglasses, fashion accessories, fragrances, and cosmetics. It made its name in haute couture through the iconic Burberry trench coat, designed in 1914 by Thomas Burberry, the founder of the brand. He was commissioned by the British War Office to produce a coat suitable for an officer engaged in ‘modern’ warfare which was conducted mainly in the trenches (hence the name). Burberry is also famous for its tartan ‘check’ design, which has become widely copied by imitators seeking on capitalise on its distinctive brand identity. As they say, imitation is the sincerest form of flattery.

Burberry currently has 214 mainline stores, 213 concessions within department stores, digital commerce, and 57 outlet stores, with 16 mainline stores opening in 2014.

As a sign of its strengthening clout, Burberry ranked ahead of both Ralph Lauren and Hugo Boss in Interbrand’s ‘Best Global Brands’ report, coming in at 73rd place. It has two main channels of distribution: Wholesale, and Retail. Retail channels accounted for 71%, or £1,807 million, of revenue, while wholesale channels accounted for 26% , or £648 million, of revenue, in 2014. Revenues from the retail channels grew by 14% (underlying) and 9% (comparable sales growth).

Wholesale channels include sales to department stores, multi-brand specialty accounts, travel retail and franchisees who operate 67 Burberry Stores, and Beauty (its cosmetics wing) products to 80 distributors worldwide. There was 6% underlying growth in 2014, although  without Beauty it was only 1%. Beauty had wholesale revenues of £175 million, increasing by 25% (underlying) on 2013.

The rest of Burberry’s revenues, £68 million, are generated by a third channel, Licensing, of which 80% comes from Japan. Its Japanese licence is due to expire in the 2015/16 financial year.

Let us now focus on the regional breakdown of Burberry’s revenues. For 2014/15, the Asia Pacific region generated 38% (9% underlying growth; retail more than 85% of revenue) of retail/wholesale revenue, the EMEIA region 35% (12% underlying growth; retail about  65% of revenue), and the Americas 27% (16% underlying growth; retail 65% of revenue). In the EMEIA region, half of mainline sales were made to travelling customers, and in America, they experienced high digital penetration (twice the global average).

We will know look at Burberry’s revenues, broken down by products. They are broken down, by size, into five categories, in the following order: Accessories (36%; £892 million; 12% growth; Mens represented 20% of accessories sales), Womens (30%; £743 million, 11% growth), Mens (23%; £557 million; 10% growth driven by sales of Heritage trench coats), Beauty (8%; $185 million; 26% growth underpinned by launch of My Burberry fragrance), and Childrens (3%; £78 million; 1% growth driven by Wholesale).

2.     Market DriversThe demand for luxury good is highly dependent on the economy. Boom times will drive consumption upwards, while times of stagnation or recession will decrease demand for luxury items, as compared to necessary goods such as food and beverage.

Tourism and exchange rate differentials are also factors in determining demand of luxury goods. For example, Chinese tourists avoided Hong Kong, a traditional destination for those who aim to buy luxury goods, due to pro-democracy protests in 2014, and instead visited Europe, where spending on luxury goods increased in in the first four months of 2015 by 67%. They were also attracted by the weak Euro, which made luxury items relatively cheaper. This has encouraged tourists to buy and resell these goods at home on the grey market, in a practice termed as ‘parallel trading’, and this may affect sales at home, with brands worried about their products’ perceived authenticity. Thus, in a way, macroeconomic trends are also relevant in assessing trends of luxury product sales.

Marketing is always a key component when it comes to generating revenue, for any luxury brand worth its salt. You have to let your customers know about the latest seasonal trends, who’s wearing what, and so on.

Burberry’s has invested very heavily in digital marketing since 2009, with more than 60% of its marketing budget going towards this segment. As a result, in 2014, Burberry.com became the brand’s largest store in terms of traffic and sales, with a presence in 44 countries, and available in 11 different languages. They have also appealed to customers through social media channels, showing their flexibility in changing with the times, as an indicator of strong continued growth. They have started allowing buyers to customize their trench coats online on their website, in addition to launching a website, artofthetrench.com. which seeks to showcase photographs everyday wearers of their trench coats, and encourages users to upload photographs of themselves wearing a trench coat. Lastly, users of Burberry’s line of Kisses lipstick can literally kiss the screens of their smartphones, and send a kiss to anyone as an email.

This strategy of moving its retail offline has probably not contributed to Burberry’s inventory turnover ratio, which stood at 1.927 days in 2014, in contrast to Ralph Lauren’s ratio of 2.61 days, and Abercrombie & Fitch’s mammoth 2.78 days, implying decreased efficiency in generating revenue on its inventory.

Partnerships are highly important in the luxury branding market. They can add associations to existing brand equity. Burberry has partnered with Amazon, the largest online retailer in the United States, and Tmall, or Taobao Mall, the largest B2C (direct to consumer; 51.3% of market share in terms of product sales online) and 7th most visited website in China. They have also broken into the online luxury shopping market in South Korea, launching a dedicated store on SSG.com there. The U.S. remains the largest market in the world for luxury goods, with spending of 64.9 billion Euros in 2014, more than China, France, Italy, and Japan combined (64.5 billion), although purchases by Chinese consumers represented one-third of the global market.

Luxury goods tend to enjoy large profit margins, relative to other industries, due to low raw material costs. Burberry reported an operating profit margin of 18.9% across 5 years from 2011 to 2015. In comparison, EasyJet (in the budget airline industry) had an operating profit margin of 9.3%, while the pharmaceuticals industry had an operating profit margin of 22% (based on figures by GSK, Pfizer, and Novartis).

3.     Competition Christian Dior - Like Hugo Boss, the Paris-based Dior creates similar product lines and competes with

Burberry in European, American, and Asian markets. Coach - The U.S. luxury retailer competes with Burberry's fashion accessories product line. Hugo Boss - The German luxury retailer produces the same product lines as Burberry and competes for

European, American, and Asian market share. LVMH Moet Hennessy - LVMH's Fashion business, with brands such as Marc Jacobs and Louis

Vuitton, competes directly with Burberry's Retail business. LVMH also has profitable wine and leather goods businesses.

Ralph Lauren - Ralph Lauren competes with Burberry in luxury mens, womens, and childrens’ apparel, fashion accessories, and fragrances, in mostly similar regions of Europe, Asia, and the Americas.

4.     Benchmarking and Ratio AnalysisProfitabilityGross Profit: Although Burberry’s figures have been in decline over the last 4 years, which averaged 65.1%, it is still healthy at 64.7%. Ralph Lauren gross profit: 53.1%. LVMH: 64.4%.

Net Profit: Burberry’s figures in this segment declined on average over the past 5 years, which averaged 13.8%, but again, it still seems strong at 13.3%. Ralph Lauren net profit: 8%. LVMH: 17.2%.

Sales Growth: Burberry shows heavy decline in this segment over the past 4 years, which averaged 16%, compared to 8.3% this year, probably due to its online market presence entering a mature development stage. Ralph Lauren only displayed sales growth of 0.3%, while LVMH continues to impress with a sales growth figure of 13.1%.

PerformanceReturn on Equity: Burberry’s figures in this segment have continually been in decline over the past 4-5 years, and it currently stands at 24%, compared to the average of 27.4%. However, this is still better than Ralph Lauren’s showing of 15.5%, although LVMH again beats them both with an ROE of 22.6% for the last twelve months as of 30 June 2015.

ActivityInventory Turnover: Burberry lags behind its closest rival in this regard, with an inventory turnover ratio of 1.6 (holding steady over the last 5 years), to Ralph Lauren’s 2.8, which had been steadily increasing from the previous years. LVMH, however, seems the least efficient, with a ratio of 1.0.

‘Increasing inventory turns reduces holding cost. The organization spends less money on rent, utilities, insurance, theft and other costs of maintaining a stock of good to be sold. Reducing holding cost increases net income and profitability as long as the revenue from selling the item remains constant. Items that turn over more quickly increase responsiveness to changes in customer requirements while allowing the replacement of obsolete items. This is a major concern in fashion industries.’

Days of Sales Outstanding: Burberry has an excellent track record on this, but with a DSO of 34.834 days for 2015, it has been worsening over its average of 30 days over the past 5 years. This shows that its ability to keep its accounts receivables low has been degrading.

Days Payable: Contrastingly, Burberry has quite a high number of days payable of 63.948 days, meaning that it has a good relationship with its creditors, and is highly trustworthy on delivering on its promises, potentially giving it a great reputation. This was much improved over its 2014 figure of 72.468 days.

LiquidityCash Conversion Cycle: Relatively low at 148.881 days for Burberry, less than the 154.81 days it takes for Ralph Lauren. This figure has been decreasing over the past 3 years, mainly due to large decreases in the days of inventory on hand.

Current Ratio: Burberry’s current ratio has been on a clear upward trend over the past 5 years, with a figure of 2.29 in 2015, a large upward movement on its average of 1.742. This is lower than Ralph Lauren’s ratio of 2.8. For now, this is merely indicative of both of their abilities to cover their liabilities at least twice over.

Defensive Interval Ratio: Burberry’s ratio has been generally declining over the past 5 years, down to 244 days in 2015, from 290.5 days in 2011, and below its average of 246.45 days. This is in direct contrast to the upward trend exhibited by the current ratio.

SolvencyDebt-to-Equity Ratio: Burberry’s D/E ratio has been significantly declining over the past 5 years. It now stands at 0.045, down from 0.23 in 2011, and way below its average of 0.176. This is also much lower than Ralph Lauren’s D/E ratio of 0.2, and LVMH’s ratio of 0.3, signifying that is not as highly leveraged than them. This sign of financial stability, potentially makes Burberry more attractive to investors, although this could also mean that Burberry’s plans for growth and expansion as not as aggressive as those of its competitors’.

Interest Coverage Ratio: Burberry’s interest coverage ratio had also been booming over the past 5 years, standing up 118 in 2015, up from 58.98 in 2011, giving it a massive ability to pay off the interest in its outstanding debt. This stacks up very well against Ralph Lauren’s ratio of 24.3, and LVMH’s 42.8.

5.     ProspectsBurberry continues to expand its presence in Asia, both physically with more stores opening, and online on social media platforms, with a specific focus on Asia (for example, the first luxury store to launch on Kakao, Korea’s largest social media platform, and a partnership with LINE, Japan’s leading social media platform). This will serve to enhance its reach and target audience. However, I personally feel that Burberry should be wary of over-exposure, as luxury brands depend on a certain level of scarcity and unavailability, in order to appeal to customers.

As a luxury brand, Burberry’s fortunes are tied to the economic performance of certain markets. China’s recent slowdown has been a particular worry for luxury brands in general, with Burberry experiencing weak revenue growth over the past 2 years. China’s clampdown on corruption and extravagant spending may also hurt Burberry’s growth prospects there, with its shares falling by 8% since the start of the year. Additionally, the luxury market is a rigid one, with customers staying loyal to the same brands. It may not be easy to convert followers of any other brand to start shopping with Burberry, hence making the prospect of capturing additional market share look small.

As Europe remains in the grip of the migrant crisis, together with a slow recovery, Burberry’s prospects there may seem dim as well. Indeed, the region where revenue growth was strongest was in the Americas, and Burberry would be wise to focus their attention there, as the nascent economic recovery continues to pick up speed, caused by raising of interest rates by the U.S. Federal Reserve.

Burberry may have made missteps in opening stores in Turkey and Russia, both of which are experiencing weak economic growth in recent years, with massive unrest on Turkey’s borders, and the Russian economy experiencing low growth rates due to economic sanctions by the West.

While Burberry is considerably well-diversified in geographical terms, its 3 sub-brands do not show any significant variation on the essential Burberry luxury theme, with the cheapest collection, Burberry Brit, offering trench coats which still cost anywhere from the high-hundreds to the low-thousands in terms of Sterling Pounds. Burberry may have great depth and width under its product lines, but they are all still relatively highly priced. Thus, Burberry does not really have different target markets, with its products mainly catering to the very well-heeled. This could lead to unstable revenues in different or difficult economic climates.

Burberry should use its significant holdings of cash and current assets to pursue expansion, perhaps by acquiring new brands, or inventing them. This is also helped by their low D/E ratio, which could enable them to take on more debt to fund their expansion plans. Only so would Burberry be able to diversify its risks, and improve the sustainability of its business. In the meantime, I would highly advise against betting on Burberry. Even though its fundamentals appear to be solid, in the longer-term, they would need to show that they are relying upon more than their trademark trench coat to convince me to root for them. Given that they recently poured £50 million into the construction of a new factory in the U.K., which would enable them to treble their trench coat production, this does not appear likely to happen any time soon. Burberry’s size and well-established brand name might enable them to survive for the time being in the global luxury market, but given that competitors such as LVMH have successfully branched out into alcohol, watches, and fashion accessories, it should be high time that Burberry consider a different strategy, albeit in a manner that would not devalue its brand name.