Burberry’s strategy update has taken the shine off a reasonable set of interim results.
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 sees £120m cumulative annualised savings in 2020. 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%.
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.
Where 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.
The worst day for Burberry shares in half a decade has in fact merely reestablished the range the shares traversed between March and as recently as October. This will be little solace for shareholders. Technically speaking though, so long as Thursday's fearsome looking candle -- check out the wicks -- doesn't extend further to the downside, the stock will almost certainly close above its crucial 200-day moving average, with the range intact. True, reestablished resistance at 1838p, will again pose a hurdle. Again, on the bright side, support at 1718.6p has also withstood the fiercest attack by Burberry bears for years, suggesting the threshold needn't give way in the near term. That said, momentum, as measured by the Relative Strength Index (see RSI sub-chart) does not look promising, pointing almost vertically downward at the time of writing. If broken, there will be little safeguard for the stock before the lower range limit of 1567p. Naturally, investors would prefer not to contemplate life beyond that because if it transpires, it will be accompanied by a rapid rise in volatility. The most obvious aspects of the stock's structure would also be well and truly broken. Should sentiment have a rethink, shares will almost certainly drift back to the upper limit of the range over the medium term, although they're unlikely to breach it until the 21-day exponential moving average inverts higher. It did the opposite on Thursday.
Burberry share price chart - daily
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