Description

Burberry (BRBY) Short Thesis

2024/03/31

Background

After the record-high growth of luxury sector in 2021-2022, we have first seen the sector returning to a normalized pace in 3Q23.

In 2022, global luxury market grew +22% yoy on current currency or +15% yoy on constant currency basis, vs. the sector’s historical average growth at 7-10% yoy, according to the Bain-Altagamma report. Key players in the sector also enjoyed share price rally and multiple expansion, e.g. share price of LVMH / Hermes / Richemont increased by 77% / 123% / 93% from 2021/01 to 2Q23 peak, and their NTM P/E expanded from 20x to 25-30x for LVMH, 35-40x to 50-60x for Hermes, and 15-20x to 20-25x for Richemont.

The feast has come to an end. We’ve seen notable share price correction since mid-July due to lower expectation for 2H23 and 2024E sector growth. In the 3Q23 earnings release - LVMH reported +9% revenue growth on constant currency basis, missed consensus by 2.5%. Kering revenue declined by 9% on constant currency basis, missed consensus by 3%, and all brands were declining. Hermes was the only company that has beaten the consensus, with revenue growing at 15.6% on constant basis, vs +13.6% consensus growth. However its growth slowed down from >20% in 2022-2Q23 to 15.6% in 3Q23. More companies’ earnings are yet to be released…

In short, the sector now faces further valuation correction in the next 6 months. Luxury brands, as scarce assets and long candidates for global investors in longer-term, here the key is to find out the right short or pair candidates, and to build short position at a good timing while monitor the catalysts closely.

Short Candidates Screening

I personally categorize luxury companies into 6 buckets, namely, the giants, stars, cows (cash cow), strugglers, turnaround, and dogs (Exhibit 1). A brand can transit from one category to another. For example, a giant can become a cow, and then a struggler – Kering was a giant in 2015-2020, and then experienced 2 years of Gucci slow down in 2021-2022 (becoming a cow) while other brands like YSL and Balenciaga are still growing, and now gradually turn into a parent of 4 problematic kids (becoming a struggler; all major brands were declining in 3Q23 and also facing management transition issues)

• Giant: The leading companies / brands in its segment, enjoying both high growth and strong cash flow. Usually revenue scale >EUR10b
• Stars: Smaller companies with increasing brand awareness and rapid growth. Usually revenue scale around EUR1-3b
• Cow: Large companies / brands with average-to-no growth, but still have stable cash flow due to its brand reputation in decades. Usually revenue scale >EUR5b.
• Turnaround: Turnaround stories of strugglers or dogs. A good example is Prada.
• Struggler: Companies with worsening brand awareness and declining trend in revenue for quarters. At the same time usually facing management team transition issues.
• Dog: Companies with weak brand awareness and declining trend in revenue for years. Usually have low P/E ratio <10x.

To screen the short candidates, I suggest that we choose from strugglers, dogs, turnaround, and cows bucket in market downturn, and also consider valuation multiples. (Exhibit 2, 3)

• The Dogs and Strugglers during sector down-turn. For dogs, be cautious for names extremely low valuation and potential turnaround situation
• The Turnaround and Cows with high valuation, and large gap between guidance / expectations and reality
• The Stars with sudden / unexpected slow-down
• The Giants in extreme negative market conditions

Suggested short candidates according to fundamentals and valuation (weak growth outlook and high valuation)

In the next section, I will spend time on a deep-dive of Burberry.

Exhibit 1: Sector mapping

Exhibit 2: Short candidate screening

Exhibit 3: Valuation summary

Source: Capital IQ, as of 2024/03/31

Burberry: Short Thesis

Burberry Group is a single-brand British luxury fashion house established in 1856. The brand was famous for its British Royal Warrant, classic style, and trench coat. However, Burberry’s advantages yesterday turned into its bottlenecks today.

In 2015-2019, the luxury sector growth was fueled by new money and younger customers. Loud luxury typically performed better than quiet luxury. Brands tended to hire designers with extremely strong personal styles. Early-comers to the game have enjoyed outsized growth, for example, loud brand as Gucci, led by Alessandro Michele, achieved 25% revenue CAGR in 2015-19. However, late-comers like Bottega Veneta and Burberry did not enjoy much growth, but have diluted their classic brand core value.

Exhibit 4: 2015-19 case studies

After Covid since 2020, the sector’s trend has returned to “old-money aesthetics”, and quiet luxury has outperformed the sector. Previous winner like Gucci now faces problem to restore their classic brand image. Not as lucky as Gucci, Burberry did not enjoy the previous wave in 2015-10, but faced the same problem since 2021. Again, Burberry made a late decision to early terminate the contract with Riccardo Tisci and to hire Daniel Lee as Chief Designer.

Key debate here is, whether Daniel Lee is capable enough to restore Burberry classic brand image, and regain customer traction? I will breakdown this into 3 topics: 1) Daniel Lee’s personality, his story with Bottega Veneta, and whether he is a suitable person for Burberry, 2) The changes that Daniel Lee brought to Burberry, and channel feedback.

1. Daniel Lee’s personality, his story with Bottega Veneta (not a successful story), and whether he is a good fit for Burberry?

Daniel Lee is an idealist, not very commercial, and has strong persistence in his design.

He attracted BV due to his unique personal iconic design in women handbags, and he broke up with BV as he was just too self-centered. A few examples could elaborate here:

• He doesn’t have any social media accounts, and he made the decision to close down all social medial accounts for BV in 2021. Kering was provoked by this move.
• Kering suggested BV to have online live showroom during covid, as lots of other brands does, to increase the brands’ influence as international travel was restricted. Daniel Lee refused to have live showroom, and insisted to host the show through private club.

Strong personal style as such, is he a good fit to Burberry? My initial judgement is “likely not”

• If we review the recent designer appointment by luxury brands, we can note that they tend to hire designers with less personal style. However, Daniel Lee continued his strong style to Burberry. In Burberry’s latest ad for 2023 Fall/Winter season, it even mentioned that “Daniel Lee” in their ad slogan.
• Daniel Lee is strong in women handbags, now ready-to-wear. The skillset is a mismatch to Burberry.

2. The changes of Burberry’s new design, and channel feedback

Daniel Lee has brought in several changes in his 2023 Fall/Winter series (Exhibit 5)

• Changed brand font to a more classic style. Notice that this is the second time that the brand decided to change its font since 2019 (from classic, to stylish, and back to classic)
• Re-introduced horse icon to its major series, and suspended Tisci’s “TB” logo. The TB logo was widely used in basic items like T-shirts. It took Burberry almost 2 years to gain customer traction with their TB logo, but they didn’t even harvest the late success in 2021. After Tisci’s departure, the items with TB logo will gradually phase out, and we see them flooding into outlet channels.
• New design of the plaid pattern with more vivid colors. Just like Daniel Lee’s iconic green color to BV, he brought the new blue, yellow, and purple colors to Burberry’s new season, and re-designed the plaid pattern.
• Significant price increase to women handbags. Though the industry brags about Daniel Lee’s design in handbags, his new designs for Burberry had very blurred brand image. People can barely tell which brand it is. You can say it’s from BV, Prada, or Tod’s, but not Burberry. Design as such, the company still decided to price them at ~2x of Burberry’s previous series.

Exhibit 5: Burberry’s key change in 2023

Channel feedbacks: mostly negative

• From wholesalers: not positive on the new designs, especially on the price increase. They don’t believe the new handbag designs with higher price will bring the brand to a next level. On contrary, the new price level will bring Burberry to same price band with brands like Louis Vuitton, Fendi, or Celine, whereas their previous battle field was with Gucci or Chloe (weaker rivals).
• From customers: fewer times of visits in 2023. Most customer expressed their concerns around the brands too frequent changes to its core designs. It makes Burberry into a fashion house, not a luxury house. They also complained about the design and price increase of handbags.
• From outlet channels: One major outlet manager in China indicated that Burberry and Gucci are the two best-selling brands in outlet, as they have the most complete range of SKUs and sizes, and the deepest discounts compared to other brands. Outlet is known as a contrarian indicator to a luxury brands. Good sales in outlets usually indicate problems for the brands normal channels.

TP and valuation

In the next 12 months, I think the stock price will have ~15% downside from slowdown in revenue growth as base case, and bear case of >30% downside from multiple contraction and revenue growth slowdown

• Valuation multiple:
  • Base case: The company currently trades 16x NTM P/E, which is 1 standard deviation below its historical average at 20x. Since the company’s share price has corrected 20% since September, here I assume valuation multiple to be stable.
  • Bear case: Burberry’s NTM P/E to return to 5-year low at 13x, it represents 19% downside from current share price.
• Revenue and profit: If macro economy continues to slow down, and we assume Burberry is to follow Kering’s pattern, Burberry’s revenue growth to turn to -10% yoy in FY25 (Mar-25). It represents 15% downside from current share price.

Catalyst

Earnings Release in April => Probably will guide down earnings target