2016 has so far been a bull year for most asset classes in general. Equities, Bonds, Commodities, Real Estate have all had positive gains for the year so far. And even within these broad based asset classes, individual components like consumer staples, utilities, gold, oil, treasury bills and the like have all benefited from this ‘buy everything’ phenomenon.
But on the other hand, many traditional retail stocks have had a torrid time of late. Whether you look across the Atlantic to the likes of JC Penney (JCP) and Macy’s (M) or within Europe itself, many retail business have seen there share prices fall and remain low. Two businesses that caught my eye as a result of depressed share prices have been Next and Burberry. Both companies have seen their share prices fall by over 30% during this past year and this has caused them to offer tremendous value. And like any value investor, when opportunities like this arise, you pounce on it.
Next and Burberry are two different kinds of fashion retailers, Next is predominantly a UK middle market retailer and Burberry a global luxury goods company. Whilst both cater for different markets and have different demographics, they both have great fundamental and excellent brand equity. Both companies pay a healthy dividend which is well covered and notwithstanding the trading difficulties which precipitated the derating of the shares, the core franchises are strong enough to sustain robust cash generation, equating to free cash flows yields of 6%+ in both cases.
Burberry has suffered as the downturn in emerging markets has hit performance, while Next has been in the doghouse with many investors who are not keen on UK retailers in a world of online, and uncertain economic times.
Whilst most people readers on this site would agree with purchase of next at P/E of 11.2, they would be more sceptical about the higher end Burberry which was bought at a P/E of 17 considering the slowdown it has faced in China and the impending recession.
Burberry is a wonderful company with a great brand name
The share price of Burberry has been falling over the past year due to being hit by downgrade after its trading updates and results. The included the disappointing news that like for like retina sales were down 5% year-on-year for the 4th quarter. The far east in particular tended to be a problem as Hong Kong and Macau had like for like sales down 20%. The fall in sales in China was even worse than most people had expected and due to this, the net result has been an approximate 10% cut to 2016 earnings forecasts. Whilst Burberry does not look good right now, I have bought into a depressed share price as I do expect this to be a great stock in the years to come.
So why did I buy Burberry. In the most simplest of terms, it is a wonderful company with great fundamentals. This is what one of my favourite investors, Nock Train, has had to say on the company. Burberry has no debt. Indeed it has cash or cash equivalents on its balance sheet amounting to around 10% of its current market capitalisation. This is both a comfort and a signal of the conservative way this company is run. Burberry is a fashion and luxury franchise and therefore prone to swings in demand for its products – either because of shifts in taste or belt tightening. We’d be a lot less insouciant if there was financial gearing layered on top of fashion risk, but instead the company can continue to invest in its various highly promising growth initiatives even as earnings come under pressure.
Buffett says somewhere that it is only in investment bankers’ research that earnings go up every year in a straight line; in the real world most companies suffer dislocations or fallow periods, during which, it is important to recognise, they may still be creating additional value. In other words progress in earnings is not the only measure of corporate success (though I’m not so starry eyed as to deny that in the end the earnings are what really matter). With Burberry we accept that earnings will likely be more volatile than a defensive stock, like GSK, and, as a result, there are other indicators that need to be looked at. For example, its continued success with digital marketing is a very important indicator for future profitability. It is great to see Burberry’s relationship with its customers deepening and with 36 million social media followers it is succeeding and leading the fashion/luxury industry.
But the key question is – Is brand equity per Burberry share increasing? It is possible on occasion that brand value and cash earnings fall out of step; as brand spend is maintained during a downturn, for instance. But in the long run the correlation between brand equity per share and earnings per share will be strong. So I’m very interested in the performance of Burberry in the Interbrand consultancy’s annual survey of the 100 most valuable brands in the world. Burberry entered that top 100 for the first time in 2009, placed as the 98th most valuable brand on the planet. By 2013 it had reached #77 and last year 73rd most valuable. In the meantime the capital value ascribed to Burberry’s brand by Interbrand has increased by over 90%. This progress suggests that long term initiatives to build on Burberry’s unique heritage are paying off. And, frankly, I don’t see a cyclical setback for Burberry in Asia as any meaningful hit to this brand equity, even if it has, evidently, hit current earnings.
It’s worth remembering too how rare a franchise like Burberry is globally. In that Interbrand top 100 perhaps only Vuitton, Hermes, Gucci and Prada can compare – although all of these, wonderful though they are, are not really competitors for Burberry’s particular expression of British chic and elan (funny how one uses French words to express these matters though). What’s more, in addition to Burberry there are only four other brands in the whole 2015 top hundred owned by UK quoted companies (HSBC, Shell, Johnnie Walker and Smirnoff). This underlines the rarity value of Burberry for an investor in UK equities and why we’re so keen to stick with and build our investment.
Despite all the above I worry you may think I’m cutting the company too much slack, dazzled by its fashion bling. So let me conclude by noting another factor we monitor and value about Burberry: its ability to pay and grow dividends. The maiden dividend as a public company in 2003 was 3p. Last year it paid 35.7p, a sum which is still forecast to be twice covered by 2016 earnings. The shares offer a starting yield, then, of over 3.0%, with much more dividend growth to come. This is the power of investing in a great brand.
In short, what the analysis above is trying to say is that Burberry is one of those companies you buy for the long run and enjoy the the great returns on equity it reproduces and the cash it throws off in the form of dividends. The company sits on close to 1/2 a Billion in cash, it has no debt, it’s profit margins are up 16.7% and has a typical ROCE well above 30% It’s still expected to chunter out profits in excess of £440m this year and it has a long history of doing so. I’m hazarding a guess that the China fear factor is way overdone and it some point (again pick one) you’ll be laughing all the way to the bank.
My Purchase of Burberry and Next
I actually both both stocks in mid July but have been so swamped with work, I did not have time to write this article. Better late then never hey!
I bought 10 shares of Burberry at a price of 1210p a piece. The company pays dividends twice a year, once in January and another in July. Based on this years dividends, I am expected to receive £4 in dividends a year but based on the companies impressive record of Dividend growth, it certainly expected to be more than this.
On the same day as my Burberry purchase, I bought 3 shares of Next at a price just above 5000p a piece. Again, the company has an exemplary record of dividend growth as it has increased its dividend by over 200% over the past 10 years. I am expecting to receive £8 in dividends a year but as mentioned above, due to the power of dividend growth companies, I am certainly expected to receive more than this over the next 12 month.
To many, getting £12 in dividends a year from these two companies would be no cause more celebration. Many would say what’s the point of investing if you are only getting a pittance every year. What I say is that it important to look at the overall portfolio. These stocks just add to the diversification of my existing collection of stocks which already include oil companies, telecoms. healthcare companies, insurers, supermarkets, utilities, gold miners, consumer staples and property. Whilst £12 on its own certainly does not look like a lot, it brings my total estimated annual dividend in this portfolio to £820 for the year! Now that is worth investing for. It just goes to show that anybody can become financially independent by just investing a little at a time. The slow road often leads to the greatest success!