Burberry’s (LSE: BRBY) share price is up 81% from its 9 September 12-month traded low of £5.56.
Such a large price rise does not necessarily mean that the stock is overvalued. It could be that the underlying business is simply worth more than it was previously.
However, it could also be that the price has overshot the fair value of the stock. In this event, a downward correction to its true value is likely to occur over time, in my experience.
I re-examined the business and ran the key numbers to find out which is true here.
The underlying business
Burberry’s struggles began even before Covid broke out in 2020. The firm acknowledged that it had focused on being modern at the expense of celebrating its heritage.
Its attempt to move even more upmarket through much higher pricing also alienated the important aspirational luxury customer segment.
Matters came to a head in the first quarter of fiscal year 2024/25, with profit warnings and the suspension of its dividend.
At that point, it announced its ‘Burberry Forward’ plan involving refocusing on core design motifs, improved marketing, and cost-cutting.
That said, its full-fiscal year 2024/25 results released on 14 May showed revenue down 17% year on year to £2.461bn. They also showed a reported operating loss of £3m – a 101% decline from the previous year’s £418m profit.
Over the same period, its reported operating margin swung from a healthy 14.1% to a sickly -0.1%. Spending more money than is being made is clearly an unsustainable model for any business and is a huge risk. Another is that it will not attract sufficient business from former clients or new ones to turn these numbers around.
That said, analysts forecast its earnings will increase 48% a year to end-fiscal year 2027/28. And it is earnings that ultimately drive any firm’s share price and dividends over the long run.
How does the share price look?
The first part of my assessment process for any stock is to compare its key valuations with its competitors.
On the price-to-book ratio, Burberry currently trades at 4.1 against a peer group average of 3.4. These firms comprise Kering at 1.5, Christian Dior at 3.3, LVMH at 3.4, and Capri Holdings at 5.5.
So Burberry is very overvalued on this measure.
It is overvalued as well – albeit less dramatically — on its 1.5 price-to-sales ratio compared to its competitors’ 1.4 average.
The second part of this process is to run a discounted cash flow (DCF) analysis using other analysts’ figures and my own.
This identifies where any firm’s stock price should be, derived from cash flow forecasts for the underlying business.
In Burberry’s case, these reflect the very strong earnings forecasts over the next three years.
Therefore, the DCF for the firm shows its shares are currently 52% undervalued at their present £10.05 share price.
So their fair value is £20.94.
Will I buy the stock?
The only reason I will not buy it is that it currently has no dividend yield. I am focused on stocks that return over 7%.
Otherwise, it looks to me like its strong earnings forecasts should drive up its share price a long way over time.
Consequently, I think it well worth the consideration of investors whose portfolios it suits.
