Financial Analysis of Burberry Company

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Financial Analysis of Burberry Company

1. Analytical review

1.1 Introduction

This section of the report presents an analytical review of the financial performance, position and reporting of Burberry, using the most recently published financial statements and other information available. The work looks to analyse the financial strengths and weaknesses revealed by the financial statements, including profitability, liquidity, asset utilisation and gearing. This is followed by a review of the market perception of the company in terms of its stock price performance and response from the analyst community.

1.2 Profitability

Table 1: Profitability

Ratios

2018

2017

2016

Gross margin

69.4%

70.7%

64.5%

Operating margin

15.0%

14.4%

14.7%

Net margin

10.7%

10.5%

11.5%

 As can be seen from the table above, the profitability of Burberry has fluctuated in recent years, across its gross margin, operating margin and net margin. However, these fluctuations have been somewhat varied in this size and their direction. In particular, from 2016 to 2017, the company saw a sizeable increase in its gross margin, from 64.5% to 70.7%, which indicates the company was able to earn more revenue from its direct costs of production, potentially through higher prices (Dyson, 2010). However, at the same time the company saw its operating margins fall from 14.7% to 14.4%, and net margins fall from 11.5% to 10.5%. This is indicative of a increase in fixed costs over this period, and particularly an increase in the tax payable by the company (Burberry, 2018). At the same time, from 2017 to 2018 the reverse happened, with gross margins declining to 69.4% from 70.7%, whilst operating margins rose from 14.4% to 15.0%, and net margins rose from 10.5% to 10.7%. This process was accompanied by a fall in the company’s overall level of revenue, indicating a process of consolidation and an overall reduction in the company’s operating expenses and finance costs as a result, helping to turn the gross profits from selling products into higher net profits for shareholders (Burberry, 2018).

1.3 Liquidity

Table 2: Liquidity

Ratios

2018

2017

2016

Current ratio

2.79

2.90

2.77

Quick ratio

2.04

2.01

1.87

 The company shows a strong level of liquidity performance. In particular, both its current ratio and its quick ratio are some level above the 1.00 safe level at which the company is able to pay all of its current liabilities out of its current assets, and also cover all of its current liabilities out of its current assets without a reliance on selling its inventory (Atrill and McLaney, 2011). In fact, both the current ratio and the quick ratio have risen overall over the period of the analysis, with the current ratio rising from 2.77 to 2.79, whilst the quick ratio rose from 1.87 to 2.04. This indicates an improved liquidity position, giving the company higher amounts of cash to spend on investing to generate future profits, as well as a more secure dividend and overall financial position. Much of this can be linked to a general rise in the company’s cash reserves, which rose from £711 million in March 2016 to £844 million in March 2017 and then to £915 million in March 2018 (Burberry, 2018). However, this raises questions about the extent to which the company is hoarding cash which it could use better by either investing it profitably or returning it to shareholders, either as dividends or through buybacks and other options. This may indicate that the company is actually harming shareholder value creation due to its high levels of unproductive working capital in the form of a large pile of cash (Berk and DeMarzo, 2010).

1.4 Asset utilisation

Table 3: Asset Utilisation

Ratios

2018

2017

2016

ROE

20.6%

16.9%

14.4%

ROCE

28.8%

23.2%

18.5%

Asset turnover

1.23

1.15

1.09

 The company has shown a steady increase in its asset utilisation over the period of the analysis. In particular, its return on equity (ROE) has risen from 14.4% in 2016 to 16.9% in 2017 and 20.6% in 2018, showing a strong ability to generate returns on shareholder’s equity. At the same time, its return on capital employed (ROCE) has risen from 18.5% in 2016 to 23.2% in 2017 and 28.8% in 2018, showing a strong ability to generate returns on the capital employed by the business. Burberry is aided, to a degree, in this process by the fact that it does not have any long term debt, only some small short term overdrafts, and hence its capital employed is entirely in the form of shareholder’s equity. At the same time, the company has been aided by a fall in its net assets from £1.7 billion in 2017 to £1.4 billion in 2014, helping to drive up its returns on both shareholder’s equity and capital employed (Burberry, 2018). This is a result of decreasing asset values, particularly property and trade receivables, and increasing liability values, particularly trade payables. Such a development may indicate the company is being too aggressive in squeezing customers for payment whilst deferring paying its own bills, which could hurt its margins in the long term (Drury, 2015). As such, the rise in returns, as well as the rise in asset turnover from 1.09 in 2016 to 1.15 in 2017 and 1.23 in 2018 may be a result of aggressive payment and collection policies which may be hampering the company’s margins, and causing the issues observed when analysing said margins.

1.5 Competitor analysis

Table 4: Competition Analysis

Ratios

Burberry

Ralph Lauren

Gross margin

69.4%

60.7%

Operating margin

15.0%

8.1%

Net margin

10.7%

2.6%

Current ratio

2.79

2.24

Quick ratio

2.04

1.76

ROE

20.6%

4.7%

ROCE

28.8%

14.4%

Asset turnover

1.23

1.01

Dividend per share (pence / cents)

30.3

200

Closing share price (pence / cents)

1696

11074

EPS (pence / cents)

82.1

199

P / E Ratio

20.66

55.65

Dividend yield

1.8%

1.8%

Dividend payout ratio

36.9%

100.5%

Source: Burberry (2018); Ralph Lauren (2018)

 As can be seen from the analysis above, Burberry’s performance compared to that of Ralph Lauren has been very favourable. Burberry achieves a higher gross margin of 69.4% compared to 60.7% for Ralph Lauren. This in turn feeds into higher operating margins and net margins, with Burberry’s figures of 15.0% and 10.7% being much higher than Ralph Lauren’s figures of 8.1% and 2.6%. In addition to this, Burberry also has stronger liquidity performance, with higher current and quick ratios, although this may be a result of Ralph Lauren investing more of its cash rather than holding onto more unproductive liquidity. Burberry’s activity levels are superior, with a much higher level of ROE and ROCE, aided by the higher debt levels of Ralph Lauren, which holds around $600 million of total debt versus almost no debt for Burberry.

 However, despite this poorer financial performance, Ralph Lauren continues to pay out a high level of dividends, in fact paying out a higher dividend per share than its total earnings per share in the most recent financial year. This may be a signal from managers that the current performance issues are temporary and the business is expected to return to strong performance in the future. Indeed, despite the poorer performance, Ralph Lauren continues to trade off the same dividend yield as Burberry, indicating that the market values its dividends the same as those of Burberry (Frankfurter and Wood, 2003). In fact, this allows Ralph Lauren to trade off a price / earnings ratio of 55.65, compared to just 20.66 for Burberry, indicating that the market is confident that Ralph Lauren will soon improve its levels of financial performance and justify its high share price. This hence indicates that the market does not expect that the poor financial performance of Ralph Lauren compared to Burberry will persist in the future (Atrill and McLaney, 2011).

1.6 Market perception of the company

Figure 1: Burberry share price performance

Source: Thomson ONE Banker (2018)

Table 5: Burberry Market Performance

Figures

2018

2017

2016

Dividend per share (pence)

30.3

28.4

26.8

Closing share price (pence)

1696

1660

1365

EPS (pence)

82.1

77.9

69.9

P / E Ratio

20.66

21.31

19.53

Dividend yield

1.8%

1.7%

2.0%

Dividend payout ratio

36.9%

36.5%

38.3%

 As can be seen from the graph above, Burberry has shown a steady increase in its share price since 2009, with some peaks in the past few years followed by declines. In particular, the company’s most recent performance has shown a rise to a peak in September 2018, followed by a decline to its current price, which at around 1800 pence per share is still higher than its 2018 closing price. In general, over the period of the analysis, Burberry has shown an improvement in its market performance, with the share price moving from 1365 pence per share in 2016 to 1660 pence per share in 2017 and 1696 pence per share in 2018. This indicates that, despite the concerns raised above over the company’s payment and collections policies, and the potential issues with fluctuating margins, the market as a whole is satisfied with Burberry’s performance.

Some of this can be linked to the company’s strong rise in earnings per share from 69.9 pence in 2016 to 77.9 pence in 2017 and 82.1 pence per share in 2018, as well as the steady dividend growth from 26.8 pence per share in 2016 to 30.3 pence per share in 2018. These have meant that whilst the company’s share price has risen, its P/E ratio has remains fairly stable around the 20 mark, showing that the market is recognising the increasing earnings and returns of the company, rather than altering its judgement of future prospects. The company’s dividend payout ratio has also remained broadly stable, moving from 38.3% in 2016 to 36.5% in 2017 and to 36.9% in 2018. Such a stable payout ratio indicates that management is not trying to use the dividend to signal any future expected changes in performance, but is rather keeping the dividend stable and thus signalling confidence around the company’s ability to maintain its performance levels in future (Frankfurter and Wood, 2003).

2. Assessment of the environment

2.1 Introduction

This section of the work will provide a clear and detailed assessment of the macroeconomic environment within which Burberry operates, including its current and planned operations. In addition to this, the work will consider the microeconomic aspects of the firm’s operations, including aspects related to demand and supply for its products, as well as issues of market structure and competition.

2.2 Macroeconomic environment

 The political analysis of Burberry can begin with a consideration of the macroeconomic concept of political geography. Specifically, under this concept, geographical associations can provide value to companies and their brands, provided there is a supporting association between country and brand (Pike, 2013). With regards to Burberry, the company is able to benefits from a brand which is seen as strongly ‘British’ creating high levels of demand amongst global markets and consumers and protecting against macroeconomic influences from unemployment and inflation. However, this also makes the brand vulnerable to changes in the standing and image of the UK in the world, which may create macroeconomic issues around the ongoing Brexit process and the resulting standing of the UK in the world. The other main political issue faced by Burberry is the ongoing trade in counterfeit and imitation goods. This trade is facilitated by governments who overlook to trade of counterfeit goods, particularly those which are manufactured in countries limited trademark protections (Kirkwood and Tanner, 2017). This represents a significant threat to Burberry’s luxury position and profit margins.

Burberry has a luxury brand image which helps to protect it against economic downturns such as the global financial crisis, and other economic uncertainties and downturns. However, the company has still faced challenges from the economic conditions in many markets where it operates, including poor economic growth rates and government austerity policies, requiring a new focus on efficiency improvements in order to maintain margins, particularly in the European markets where it operates (Carmiagnani and Zammori, 2015). This can be seen to be part of Burberry’s efforts to improve its operating and net margins, and look to enhance ROE and ROCE through aggressive payment terms, in order to cope with economic uncertainty. The company is also seeing benefits from targeting emerging markets, where economic growth rates are high and balance of payments are healthier, which supports demand for luxury fashion products, particularly those like Burberry with a rich and distinctive heritage (Henninger et al, 2017).

In general, the aspirational and hedonistic social behaviour and trends in the luxury fashion market mean that Burberry is isolated from many macroeconomic trends such as unemployment, which tend to affect mass market goods. This in particular is driven by large scale trends focusing on demand for high quality luxury products which are not available to the mass market, allowing people with money to differentiate themselves and enhance their own self image through their consumption behaviours. As such, luxury brands such as Burberry can avoid any price elasticity, provided they maintain the exclusivity of their image in order to avoid issues of brand dilution which can occur if their products are too widely worn (Tokali, 2012). This helps explain why Burberry has avoided excessive revenue growth in recent years, and has seen its share price increase despite a slow rate of sales growth and even some falls in sales, as the company is not exposed to macroeconomic trends and thus does not see a strong influence from cost pressures.

In addition to this, technological developments in the macroeconomic environment have helped protect the luxury fashion industry from supply side pressures. In particular, new developments in transportation and communication technologies help to support the efficient production, transportation, distribution and sale of products across a global market without significant cost increases. This includes the development of technologies such as Radio Frequency Identification (RFID) which can be used to track products through supply chains and ensure they are handled and produced to a high level of quality and efficiency (Guercini and Milanesi, 2017). RFID technology can also be used to address counterfeiting risk by tracking products through the supply chain, providing verification for consumers that their Burberry products are genuine (Kirkwood and Tanner, 2017). Burberry has also used social media to create a much larger opportunity to connect with customers around the world and market to them, again helping to limit exposure to any macroeconomic fluctuations such as unemployment, poor economic growth or a negative balance of payments in individual markets (Escobar, 2016).

2.3 Microeconomic environment

The primary factor driving the microenvironment, and affecting the operations of Burberry, is the demanding luxury fashion customer. Evidence indicates that “in the luxury fashion retailing industry, consumers can be categorized into the groups of fashion leader and fashion follower. These two groups influence one another and create social influences in the market” (Shen et al, 2017, p89). As a leading luxury fashion company with a desire to maintain its operations in developed nations whilst looking to expand into emerging markets, Burberry must thus be able to target the fashion leaders through their marketing efforts. This particularly includes celebrities and other potential brand advocates and influencers, such as social media stars, who can influence other customers and enhance the desirability and image of the Burberry brand. In addition, consumers are increasingly engaged by brands in the value co-creation process. This refers to the growing ability of luxury fashion companies to work with their customers in order to define the nature of define luxury in their products, helping enhance their ability to meet customer demands in this area (Choi et al, 2016). This will be vital for Burberry if it wishes to benefit from growing digital market opportunities, and to connect with younger luxury fashion consumers.

The other main microeconomic factor affecting Burberry is the role of suppliers in the luxury fashion industry. There are a vast number of suppliers in the global fashion industry, providing a range of materials, labour and other inputs across global supply chains. Most of these suppliers are based on lower cost emerging economies, where the low wages help enhance margins and support price competition (Guercini and Milanesi, 2017). However, using these suppliers can create challenges for luxury companies such as Burberry, as there is the risk of brand damage from being associated with exploitative low cost fashion manufacturing. As such, luxury fashion companies are potentially better advised to adopt more local production, particularly suppliers who align with their critical success factors (Brun et al, 2017). For Burberry, if the company wishes to succeed in expanding its operations into new markets, it may thus need to strengthen its claims to British values by ensuring it has sufficient amounts of its supply chain in the UK.

This process may be complicated by the fact that the market structure of the luxury fashion market is highly intermediated. In particular, intermediaries are often used to play important roles in organising the process of manufacturing and sourcing, as well as supporting marketing activities and effectiveness (Guercini and Milanesi, 2017). In theory, this can help companies to focus on their core activities of designing and marketing their luxury fashion concepts and maintaining their brand, whilst the supply chain and retail operations can be handled by skilled intermediaries. However, for a luxury brand like Burberry, this may create the risk of losing control of its production and marketing activities at the customer level, which could harm the brand image. Burberry thus needs to consider how it will organise its supply chain, particularly as it looks to achieve expansion through its new e-commerce platform which now offers its products to over 150 countries, but is facilitated by the Farfetch intermediary (Burberry, 2018).

The final important issue to consider is the nature of competition in the luxury fashion industry. This is a key microeconomic influence however, unlike many industries and other parts of the fashion industry, luxury fashion companies do not compete on price, but rather on quality and brand image (MarketLine, 2017). This includes efforts to compete based on brand values, such as Burberry’s British image, as well as competition through endorsements and celebrity adverts, as well as efforts to create a unique self image to appeal to discerning consumers. As such, luxury fashion companies need to ensure their operations are based on a competitive strategy which enhances and differentiates the value perception of their products in the eyes of consumers, in order to ensure these consumers are willing to pay large amounts in order to purchase and wear the company’s products (Roncha and Montecchi, 2017). The pinnacle of a luxury brand is thus the ability to be recognised as integral to their customers’ self identity, and in turn gaining a degree of protection from the marketing efforts of other competitors. In order to achieve this, Burberry must ensure it only targets small market segments in its expansion efforts, thus ensuring its new operations have the benefit of this protection.

3. Concluding remarks

In general, the analysis of Burberry indicates that the company is performing quite strongly, and this is being recognised by the company’s shareholders. Within the analytical review of the company’s accounting and financial performance, there is strong evidence to suggest that Burberry is producing stable profits and margins, albeit with some fluctuations in recent years. This appears to be linked to the company’s efforts to enhance its margins in the long term, something which is a stated goal of the business (Burberry, 2018). In particular, in the competitive market environment of the luxury fashion industry, Burberry needs to ensure it remains focused and efficient, as well as being highly differentiated. This requires a significant level of investment and ongoing commitment of resources to the company’s competitive strategy and marketing practices, which will mean the company’s efforts to improve margins must be seen as a long term process. As part of this, Burberry has eschewed all long term debt financing, helping to reduce finance costs and thus ensure margins are maximised. The company has shown a steady increase in its asset utilisation over the period of the analysis due to an aggressive focus on improving payment and collection terms, which is likely to support long term financial outcomes, provided it does not create any problems for the company with its customers and suppliers.

The strong financial performance of Burberry is in contrast to that of its competitor Ralph Lauren. Burberry achieves higher gross margins than Ralph Lauren, indicating that Burberry is more effective at maintaining a luxury image and position, and hence a price premium of its products above their cost of production. Burberry also enjoys higher operating margins and net margins, showing that the company is successful at transforming its price premium into efficient profits for shareholders. Burberry’s stronger liquidity performance, with higher current and quick ratios, does add to concerns that the company may be holding too much cash, although Ralph Lauren also has current and quick ratios above the 1.00 safe level, indicating this may be normal practice for the industry. Burberry’s low level of debt is also justified by its much higher level of ROE and ROCE than Ralph Lauren, as well as a stronger level of asset turnover. However, despite Burberry’s superior financial performance, Ralph Lauren continues to pay out a high level of dividends, and enjoys a high share price relative to its earnings. The higher price / earnings ratio of Ralph Lauren indicates the market may be more confident in its future financial plans, and ability to increase its profits above those of Burberry.

Despite the strong share price showing of Ralph Lauren, Burberry’s financial and economic performance has been recognised by investors, with a steady increase in the company’s share price over time, indicating that the business is being rewarded for its efforts to increase shareholder value. In particular, Burberry has maintained a steady increase in its dividend with its earnings per share, helping to maintain a high dividend payout ratio, although the dividend yield on the shares is somewhat on the low side. At the same time, the company’s closing share price for each financial year has roughly reflected the earnings per share growth over that year, with the result being that the price/earnings ratio for the company has remained roughly constant over the period of the analysis. This indicates that the business is being recognised by shareholders for the actual value it has created, but that future plans and strategies are not influencing shareholders’ overall view of the company and its value. As such, this gives the image of a company which is keeping up with market expectations, but is not doing anything particularly effective to surpass them.

This stable performance level can be viewed in the context of the overall luxury market and its macroeconomic and microeconomic drivers. In particular, whilst Burberry benefits from political geography and social demand for its products, it has experienced some economic challenges, and these may intensify with the Brexit process. Counterfeiting also remains an issue which may keep margins down, as the more expensive genuine Burberry products become the more attractive counterfeit products will become. Burberry thus needs to focus its efforts on new ways to ensure high levels of distinctiveness in its brand and offerings, and keep itself differentiated from rivals. One of the main ways in which Burberry can achieve this is to focus on the use of digital technology and social media as methods of interacting with customers. This will be particularly relevant for Burberry’s planned expansion in its e-commerce operations to 150 countries. In particular, the company can look to use digital technology to target new and younger consumers, particularly consumers from emerging markets, who are increasingly affluent but may need persuading of the value of the Burberry brand.

At the same time, Burberry needs to ensure it is able to continue to focus its marketing and brand image on its British heritage, particularly focusing on its iconic products such as the trench coat. This brand image may take some damage from the ongoing Brexit process, and thus it will be important for the business to be alert to this and to maintain its own positive image in the face of any political challenges. The company should also be aware of the political risks Brexit may pose to trade with the rest of the EU, and thus look to increase its marketing focus on emerging markets, which may be more resilient to the short term disruption from Brexit, and where the social environment will hopefully continue to view British brands as desirable. In addition to this, Burberry needs to continue to take action to address the ongoing threat of counterfeiting. This will include investing in RFID technology in order to track products through the supply chain and help provide verification around genuine Burberry products, thus showing customers which products they can trust. Provided Burberry can address these challenges, it should be able to continue to achieve its goals of superior returns and improving margins, and also succeed in its plans to expand its e-commerce operations further.

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