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Is Burberry Group plc to be snapped up, or avoided, as profits fall?

Image: Burberry: Fair use

A business I’ve never invested in is fashion. There are companies I admire that are great at hitting the right note every time, and there have been plenty of successful investments in the sector over the years, but I’m always minded of how the fickleness of fashion can change overnight and what a ruthlessly competitive industry it is.

Luxury squeeze

I was reminded how quickly fortunes can change when I read first-half results from Burberry (LSE: BRBY)  this morning, and noted a 24% fall in adjusted pre-tax profit to £146m.

That’s in line with expectations, but the company is having to cut 15%-20% of its product lines as the luxury goods market is coming under pressure. While the falling pound has created a bit of a mini-boom here in the UK from foreign visitors, key overseas markets like the US and Hong Kong have been tough.

It’s never good for a luxury brand owner to have to cut costs, and I can’t help wondering if Burberry might have lost its way a little since the 2014 departure of Angela Ahrendts who was very much the driving force behind the business for much of the previous decade.

In May the company told us it was embarking on a plan to save around £100m by 2019, and we heard today that it’s “on track to deliver planned cost savings of around £20m in FY 2017.” But I’m a little surprised that Burberry is to go ahead with a further £50m share buyback when it’s trying to save cash elsewhere.

The interim dividend was lifted 3% to 10.5p, and the shares are down 2.5% to 1,440p as I write, so is this a buying opportunity?

I’ve been impressed by Burberry before, but after a slump throughout 2015, the shares have put on a mere 5.5% over the past five years, and dividends have been averaging only around 2.5%. Right now, with fashion markets under pressure, I see a forward P/E of 19 as a bit too high for those lacklustre returns.

Is cheaper better?

Looking at the less exclusive Next (LSE: NXT), we see a company that isn’t targeting the wealthiest of customers, but is providing fashion that is good enough to be noticed yet at prices that aren’t too demanding. On that score, I’ve admired Next as a company for some time.

But Next shares are down today too, by 2% to 4,958p, possibly because fashion investors are a bit spooked. Next had a tough third quarter, as expected, reporting a 3.5% fall in full-price sales in last week’s update. That consisted of a 5.9% fall in Next Retail sales, with the firm’s online sales remaining disappointingly flat.

Next’s double-digit EPS rises came to an end in the year to January 2016, with a gain of just 5%, and that’s forecast to drop to just 1%-2% per year this year and next. But the P/E has come down too, to around the 11.5 level, so is Next a good bargain?

Next’s dividends should be yielding around 3.5%, which is better than Burberry’s and is above the FTSE average. The firm enjoys lower margins than high-end fashion, but it could be a safer haven in these troubled times.

Still, the recent falls in both shares show how risky it can be to be in non-essential retail stocks when economic slowdowns come along.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended Burberry. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.