Why I’d dump this expensive mid-cap stock for this FTSE 100 giant

Paul Summers thinks this luxury brand is a great buy on recent price weakness.

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Shares in upmarket fashion retailer (and Meghan Markle favourite) Mulberry (LSE: MUL) have lost momentum in 2017, dropping roughly 10% in value since the start of the year. Will today’s interim results from the £600m cap usher in a return to form? I’m not convinced. 

Unaffordable luxury

As updates go, this morning’s figures were something of a mixed bag.

Despite the “uncertain” economic and political climate, a “steady performance” was seen in the UK thanks to increased spending by tourists in the capital. New products have been well received, with the company’s Amberley bag — released in June — becoming “an instant bestseller“. Progress has also been made overseas with its agreement with Onward Global Fashion allowing Mulberry to build a presence in Japan where it now has five stores.

As a result of these developments, total revenue for the six months to the end of September came in at £74.5m with retail sales growing 2%. Gross margin increased by £1.9m, thanks partly to lower markdown sales.

On the downside, like-for-like sales declined by 1% (although this appears to have reversed since the end of the reporting period). Thanks to increased investment in marketing and the company’s retail network, a pre-tax loss of £600,000 was also recorded.

While these numbers aren’t awful, my biggest issue with Mulberry remains its obscenely high valuation. A forecast price-to-earnings ratio of 99 for the current year looks absurd when you consider that even ‘expensive’, fast-growing online fashion giants Boohoo and ASOS trade on 65 and 62 times forecast earnings respectively. As a result, it’s hardly surprising that Mulberry has a PEG ratio of 6, suggesting that the shares represent very poor value based on the amount of earnings growth expected.

Factor-in negligible (and stagnant) dividends and stubbornly low returns on capital employed and I suggest those wanting to make money from this business may be better off investing in its products rather than its stock. 

A ‘cheaper’ alternative

FTSE 100 behemoth Burberry (LSE: BRBY) is, in my view, a far better buy than Mulberry.

In what must surely be regarded as yet another example of a nervous market overreacting, shares in the retailer tumbled in early November following the announcement by new CEO Marco Gobbetti that he would be taking the brand further upmarket and cutting sales to not-luxury-enough stores in the US. 

As strategies go, I think this is a sound decision for a company whose appeal depends on the exclusivity of its products. By restricting availability, you increase desirability.

Aside from this, the company’s interim numbers (also revealed in November) were better than the market was expecting with adjusted operating profit of £185m being far higher than the predicted £167m. 

Trading at 22 times forecast earnings for the current year, Burberry is clearly still an expensive stock to buy. Compared to Mulberry, however, it looks a steal. 

Thanks to its sizeable net cash position, the company is in robust financial shape and generates consistently high returns on sales and the capital it invests. While unlikely to appeal to income investors, the stock also comes with a forecast 2.4% yield, fully covered by expected profits.

Although some investors may still be concerned by the forthcoming departure of creative chief Christopher Bailey,  I think Burberry remains a solid pick for those willing to hold for the long term.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Burberry. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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