Burberry shares punished for pessimistic outlook

Burberry stock is the biggest FTSE 100 faller this morning after the firm said it saw difficulties ahead, even though first-half results were buoyant.

The UK-based firm which has transformed during an 158-year history from a seller of raincoats to a maker of luxury fashionable goods, fragrances and cosmetics said total underlying sales for the six months ended September 30 rose 14% to GBP1.1bn year-on-year.

Retail sales grew 15% to £74m, in line with analyst consensus forecasts.

Burberry said the strong performance was seen across all regions and digital growth was also continuing.

Wholesale revenue rose 13% to £317m.

Burberry’s operating outlook darkens

However, the high-profile retail firm has joined a list of its sector peers in warning it expects earnings to weaken going forward as the operating environment becomes more difficult.

Burberry particularly singled-out demand from European and Chinese customers as expected to soften, amid a persistently weak economic climate in the former, and a slowdown in the latter.

For its second half to 31st March 2015, Burberry expects wholesale revenue at constant exchange rates to be down by a “mid-single-digit percentage” reflecting a more cautious approach from customers selling to the European consumer and in Asian travel retail markets.

The firm also noted the Ukraine crisis was hitting demand in Russia whilst anti-government demonstrations in Hong Kong added to concerns about a slowdown in China.

It warned that even if exchange rates remain at current levels, full impact on retail/wholesale profit in 2014-2015 would still be material.

Rebasing its 2013-2014 retail/wholesale profit for current effective exchange rates would have reduced reported profit by about £25m, the company pointed out.

However, despite its caution, the firm’s chief executive, Christopher Bailey, stressed the firm was determined to make the most of the forthcoming winter and festive seasons, during which retailers often make the bulk of revenues for the year.

“Looking ahead, while mindful of the more difficult external environment, we have never been better prepared internally for the all-important festive periods”, Bailey said

Operating margin is ‘on watch’

Even so, Burberry’s note of caution will sound an alarm for investors, many of whom will have already had the stock ‘on watch’ after the firm raised a question mark over its operating margin in July.

Whilst reporting first-quarter results, Burberry said exchange rates would reduce the year’s retail and wholesale profit by about £55m and slice 1.5 percentage points off the adjusted operating margin leaving it around 16%.

It doesn’t seem as if today’s results have changed the picture from July significantly.

By the same token though, it would seem premature to conclude operating performance has significantly worsened since July, especially ahead of the all-important Christmas retail period.

Similarly, Burberry’s narrowed premium to peers in price-to-earnings ratio terms (18.4 on a forward basis for Burberry versus a 16.1 peer average) also seems about right, considering Burberry will remain amongst the few luxury firms capable of reporting double-digit revenue growth, even if its pessimistic outlook proves accurate.

Do momentum and volume favour a collapse of the stock price uptrend seen over the last couple of years or so?

I’m reluctant to call that point either, as yet. I suspect that so long as the margin outlook doesn’t deteriorate further and Burberry has a reasonable Christmas, the stock would be unlikely to be sold lower than nearby supports.

The stock is trading 4.4% lower at 1413p having lost almost 6% earlier.