British fashion house Burberry (OTCPK:BURBY) is on a solid post-pandemic recovery trajectory, with an attractive business strategy. I think it’s a purchase.
Business has picked up
The company’s third-quarter business update showed that, compared to pre-pandemic (“LLY” or “last last year” – a strange usage in English), same-store sales rose 1% in the first half of the year. This suggests that sales have returned to pre-pandemic levels.
Something else to note here, which I think could bode well for the company’s future profitability, is that the last quarter saw a drop in sales compared to the equivalent quarter before the pandemic, but an increase significant full-price sales. This reflects a conscious decision by the company to stop markdowns in its mainline and online stores. I think it’s always the right decision for a premium brand, because discounts just trick shoppers into buying on sale and reduce the pricing power of the brand. In my opinion, one of the reasons why brands like Burberry tend to discount is that they don’t have the cachet of a real luxury brand like Hermès or Floris, so try to create a cachet of luxury while sometimes returning to price discounts. To build a luxury brand over the long term – with the attractive margins that this entails – I think you have to avoid price discounts and instead invest in the brand itself. Burberry is moving away from discounts and focusing on brand building, with 50 new concept stores expected by the end of this year. I view this strategic shift as a positive for the business and hope that it will result in higher profit margins in the years to come.
Even the ongoing pandemic restrictions in Asia haven’t posed big problems for the band. Same-store sales growth in Asia-Pacific in the last quarter remained stable compared to two years ago, while it increased by 8% in the Americas. Geographically, the problem area is in Europe, the Middle East, India and Africa, where there was a 17% decline. It’s not as bad as the 25% drop seen in the first half of the year, but it’s still a concern. The company attributed this mainly to a continued decline in the number of tourists to these areas, as they accounted for around 40% of pre-pandemic revenue there. With outbound Asian tourism likely to remain significantly reduced for the foreseeable future, I expect this to continue.
The dividend is likely to increase in the future
After cutting the dividend during the pandemic, the company restored its last annual dividend to its pre-pandemic level of 42.5 pence per share. At the current share price, this equates to a return of 2.7% which I consider attractive. Last year, the dividend was covered 2.2 times by basic earnings per share. The free cash flow coverage of the dividend is around 1.4 times.
Although the dividend has simply returned to its previous level, I am optimistic that the company will return to healthy dividend growth. It raised this year’s interim dividend by 2.6%.
The company has a history of dividend increases before the pandemic. Given its coverage, I see room for the company to continue to increase its dividend in the years to come.
I wouldn’t buy Burberry just for its dividend, as I see much better income options elsewhere in the market. But given the other positive attributes of the company’s investment record, I see its dividend yield and potential for continued dividend growth as attractive to me.
Appraisal seems cheap
My last Burberry rating was just over a year ago, when in Burberry: Continuing Signs of Recovery, I rated the company as a Buy. Since then, the company has lost about a fifth of its value.
Based on its most recent earnings per share, the company is currently trading on a P/E ratio of 17. I consider this cheap given Burberry’s strong brand and promising market outlook. If the current strategy is successful in increasing profit margins, earnings should increase. This means that the forward-looking P/E ratio will actually be lower.
Burberry’s share price has only gained 2% in five years. But it continues to build its brand, has attractive earnings and potential for dividend growth. At the current price, I see it as a buy.