Burberry's a great company – but don't buy the shares

By Deputy Editor Tim Bennett Nov 18, 2009

Tim Bennett

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In a year when many companies have been cutting dividends, Burberry (LSE:BRBY) just delivered a pleasant surprise by raising theirs by 4%. That boost comes on the back of first half results that CEO Angela Ahrendts described as "solid". But, despite these promising signals, investors should be wary.

Burberry is one of the best fashion businesses in the market. It knows what sells - snazzy trench coats - and how to innovate successfully - the scarf-cum-hood 'snood', for example. What's more, it was quick off the blocks to cut 1,000 staff and reduce stock levels as the recession bit.  Indeed, if I was going to fill my Christmas stockings with any luxury retailer's stocks, this would be the one. But I'm not. Burberry's problem is that it's in the wrong sector.

That's because for all retailers - and luxury brands in particular - Christmas 2009 looks like being the year of the Scrooge. Final sales figures are never quite as bad as doomsters expect. But that's just as well this time around, as retail consultants Verdict predict that UK non-food sales will drop by 2.5% in the fourth quarter. That may not sound like much, but the implication is that, for the first time since the late 1980s, shoppers will spend less this year than last.

Some of that is down to last year's VAT cut which artificially boosted sales back then (so even 'normal' sales this year would be down by comparison). But this year's Christmas hangover looks set to kick in early for the UK's shopkeepers as the threat of unemployment and lingering doubts about the strength of any recovery sap the will to spend.

Meanwhile, despite a valiant effort to slash costs, Burberry's profits for the first half were still down 24% - £56.8m against £74.8m a year earlier. There's only so much more cost cutting a firm that runs its own retail chains can implement. Meanwhile if stock levels are cut much further, the firm risks 'stocking out' if there is even the merest uptick in demand, notes JP Morgan. More likely, however, is that demand from many of its wholesale customers - largely department stores - will continue to fall as the bigger chains batten down for a rough festive ride. Even Burberry concedes as much, noting that wholesale revenues fell 23% in the first half. And it expects a further decline to come.

But perhaps the biggest concern is that Burberry's shares are no longer cheap. Having more than doubled since the start of the year, Burberry trades on a forward price-to-earnings ratio of 19 and a toppy price-to-earnings-growth ratio (given the economic backdrop) of 2.4 (where less than one represents good value). That leaves the dividend yield down at a modest 2.03%. In short, there are other sectors (big pharma springs to mind) that offer higher yields for less risk should the economy 'double dip'.

So, although Burberry is a great fashion business, for now it's not a great share.

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Published in Tips & advice | More articles by Tim Bennett

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