Burberry Group plc Crashes Lower: Is It Cheap Enough To Buy?

Shares in upmarket fashion firm Burberry Group (LSE: BRBY) fell by as much as 12% this morning, after the company issued a trading update containing a thinly-disguised profit warning. The firm said if faced an “increasingly challenging environment for luxury, particularly Chinese customers” and its latest sales figures seem to confirm this.

While total revenue was broadly unchanged during the first half, sales fell by 6% in Asia Pacific, a region which accounted for a chunky 38% of sales last year. This decline was offset by flat sales in the Americas, and strong sales growth in Europe and the Middle East.

Although these figures aren’t disastrous, they aren’t great either. The market expects Burberry to deliver growth, which now seems unlikely in 2015/16.

Was it a profit warning?

Burberry narrowly avoided issuing a formal profit warning in today’s update by saying that it expects full-year profits to be “broadly in line” with the forecasts of those analysts who have updated their forecasts during the last three months.

Luckily, the firm did provide some numbers to clarify its expectations. Adjusted pre-tax profit is expected to be in the region of £445m, slightly lower than last year’s figure of £456m. My calculations suggest this means adjusted earnings per share are likely to be about 75p. At the current share price of 1,245p, this puts Burberry shares on a forecast P/E of 16.5 for the current year.

Too soon to buy?

Burberry shares have now fallen by around 35% from their 52-week high of 1,929p. In my view it could still be too soon to catch this falling knife, but there is still a lot to like about Burberry as a potential investment.

Firstly, Burberry is not at any risk of financial distress. At the end of last year, the firm had net cash of £552m. Free cash flow was £300m, double the amount needed for last year’s 35.2p per share dividend. Burberry’s dividend is expected to rise by 6% this year to give a prospective yield of about 3%. I expect this payout to be safe and don’t see any significant risk of a dividend cut, given the firm’s net cash status.

A key test will be whether Burberry can maintain its profit margins. Last year, the firm reported an operating margin of 17.5%, highlighting the pricing power of the Burberry brand in stronger market conditions.

The second half could be better

It’s also worth remembering that the second half of the year is normally more profitable than the first, as it includes the key Christmas and New Year periods. Last year, two-thirds of Burberry’s sales took place in the second half of the year.

The firm says that it has reallocated marketing spending to try and maximise performance during the festive period. Cost-cutting is being accelerated across the business and expansion is continuing, often through low-cost concessions within larger stores.

Personally, I’d wait for Burberry’s interim results, at least, before deciding whether to buy, sell or hold. I suspect the shares may drift a little until the market gets fresh information about second-half sales.

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Roland Head 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.