Burberry; China challenge for Bailey UPDATE

20th May 2014: Ahead of Burberry’s full-year results, Jasper Lawler looks at Burberry’s economic condition and currency fluctuation warnings and how this will affect its preliminary results. Within the report Jasper discusses: • How economic conditions such as the rise in revenues will impact its results • How the strength of the sterling could affect international sales • The impact of having a new Chief Executive and the uncertainty around his lack of CEO experience Indications so far are that Burberry has weathered all storms, coming out as dry as a customer wearing one of the company’s infamous trench coats. According to the trading update on April 17th, group sales rose 19% to £1.3bn in the six months to March 31st with £928m coming from retail sales. That’s an improvement from the 14% growth in the first half with demand especially strong in China. Cause for concern though is the company’s reiteration of its warning that full-year results could be affected by economic conditions and currency fluctuations. Economic conditions Economic conditions may be starting to impact on Burberry’s results. The CFO Carol Fairweather spun the rise in revenues despite a drop in store traffic as a sign of brand strength. Be that as it may, it’s not as good for future revenues as having a top brand with a rise in footfall. The company has gone some way to redress the declining footfall by investing in initiatives such as ‘click and collect’ which proved a major difference-maker for brick and mortar stores in the UK this past Christmas. This will only go so far, as the declining footfall is likely a symptom of a decrease in overall demand, which will affect online sales too. Luxury goods competitor LVMH Moet Hennessy Louis Vuitton cited growing domestic demand again in Europe as reasons for its improving fashion sales in the last quarter. With economic growth according to latest GDP figures flat in France and negative in Italy this may turn out to be wishful thinking. Retail sales growth in China has continued to slow, growing 11.9% annually in May, a percentage point lower than May 2013. Burberry will need to stay one step ahead of the changing consumer environment in China. More sophisticated tastes and anti-corruption charges hampering the once wide practice of gift-giving in China has seen buyers shy away from the flashy brand labelling of old. This brings with it a host of new alternative fashion line competitors, not least from local Chinese designers increasingly confident in their own national style. Currency fluctuations The British pound has recently come down after being worth 1.7 US dollars in early May but still remains close to multi-year highs. The Bank of England has indicated it will raise interest rates in the first half of 2015. This is faster than any other nation in the G7, so the pound should continue to attract speculative flows from investors looking for a higher return on their cash. The higher the pound relative to Asian currencies, the relatively less competitive Burberry’s exports become to comparable local products, not to mention each sale is worth less when converted back to pounds. However, the advantage of luxury products is that they have a lower price-elasticity of demand, meaning a change in price has a relatively small effect on the decision to buy when compared to more essential items. The company also hedges its international currency exposure. A new CEO By placing their Creative Director Christopher Bailey as the new Chief Executive, the company should have a better chance of quickly adapting to creative challenges emanating from changing economic conditions. The uncertainty surrounds whether Bailey’s lack of CEO experience will mean the creative team responding to the wrong corporate strategy. Earnings per share are expected to grow 7% to 76.68p annually on revenue of £2.33bn. Given last year’s performance, the slowdown in Chinese retail sales and the loss of their pioneering CEO Angela Ahrendts, the forecast does appear a bit of a stretch. Burberry will report first quarter earnings on May 21st - the first under new management. Mr Bailey will be under particular scrutiny and particular emphasis will be placed on his strategy and its impact on the company’s earnings now and going forward.