In this section we are considering the Annual Report 2009-10 of Burberry and will compare Burberry’s performance in this year with the previous years’.
When financial year 2009-10 started i.e. April 2009, Burberry’s main issues of concerns were weak and highly uncertain consumer spending environment (because of prevalent recession). Following which group’s main goals were established:
Expense Reduction
Working Capital Management
Indeed, they succeeded up to a remarkable level under most strategic, operational and financial measures. Performance of Burberry was among the best relative to its peers either public or private.
Highlights of Burberry’s important strategic and operational decision in 2009-10:
£50 M cost efficiency program-helped in reduction of Cost of Sales
Upgrading wholesale distribution and restructuring the operations in Spain
To maximize Gross Margin, continued to reduce assortment size across categories-resulting in increased Gross Margin from 52.1 % to 59.7%
Improved inventory management- inventory reduced 36% over year
Added 21 stores with 9% space extension
These mentioned decisions helped Burberry perform strongly in 2009-10 and resulted in improved financial strength. Key financial strengths during the period are:
Total revenue growth 7%- Revenue £1.3bn
Adjusted operating profit increased 22% – £220M increase
Diluted adjusted EPS increased 16% to 35.1p
Financial Ratios:
Financial ratios are widely used be managers, shareholders, creditors and analysts for all kind of purposes. Firth (1975) proclaimed that these can be used for two purposes. These are:
To compare company’s latest performance with its performance in earlier periods
To make comparisons with corresponding ratios of other firms
Following is an analysis of the company’s financial ratios and a comparison with the preceding year and its peers:
Profitability Ratios:
Return on Capital Employed (ROCE):
Formula: Net profit before tax/ (All shareholders’ fund + long term debt)
Significance: Profits earned from the two major sources of finance for the company viz. investment by shareholders- shareholders’ fund and financial institutions mostly- long term debt.
The effectiveness of the management in utilising the funds is indicated by ROCE. The return for the FY 2009-10 is 26.03%. It shows a significant change when compared to the previous year’s return of NEGATIVE 2.78%. A quick glance at the operating profit for the last two years reveals the reason behind such a big leap forward. The company has performed tremendously in the last financial year. From an operating LOSS of £9.9M for the year ended 31 March 2009 to a significant operating PROFIT of £171.1M for the year ended 31 March 2010, shows the efficient and effective measures the company had adopted over the year. Even if the comparison is made between adjusted operating profits (after considering the exceptional items) for the last two years, we can see a significant difference of £39.1M (219.9-180.8). All of this shows that the business is effectively earning on shareholder’s fund and long term debt generated.
Ratio
Formula
Significance
Net margin
Net profit before tax/ Total revenue
The net profit percentage on the entire revenue earned for the financial year
Gross margin
Gross profit/ Total revenue
The gross margin percentage on the revenue earned for the financial year
It is the one of the most commonly used profitability ratio. It shows the net margin with respect to the amount of sales. In 2010 it got increased from -1.34% (2009) to almost 13%. In 2009, Burberry reported negative profit i.e. loss. Main reasons behind this were:
High Cost of Sales in 2009 (12.5 % higher than 2010)
Higher operating cost (6.71%)in 2008-09 which was mainly because of
Goodwill impairment in global market(mainly Spain) – £116.2 million
Relocation of headquarters
Store impairment and onerous lease provisions
Increase in NPM shows that Burberry has controlled its costs effectively in 2009-10. It demonstrates effectiveness of Burberry at converting sales into actual profit.
Gross Margin: There is an increase from 55.41% (2009) to 62.82%. It shows that Burberry has increased its gross profit by 7.4 p per £1 of turnover. It is because of higher sales and low cost of sales in 2010.
Sales Growth:
Formula: (Present sales- Previous sales) / Previous sales
Sales increased from £1200M (2009) to £1280M (2010) i.e. an increase by almost 7%.
Adapted: Burberry Annual Report 2009-10
Sales growth is one of the KPIs. The above graph shows the revenue earned by Burberry in the last five years. The overall growth shows the increasing trend followed by the company in spite of its macro-economic conditions. This proves the company’s ability to capture the market being a luxury brand.
Liquidity Ratios:
They show the company’s ability and the ease with which it can lay its hands on liquid cash. In other words, these ratios signify the liquidity position of the company. The main components of these ratios are the current assets and current liabilities which are also the factors that determine the working capital of the company.
Current Ratio:
Formula: Total Current Assets/ Total Current Liabilities
This is the one of the best known measures that indicates the liquidity position of the company. There is an increase in Current Ratio in 2010 as compared to 2009 which indicates that Burberry has improved its ability to meet the payment schedule of its current debts. The change from 1.36:1 in 2009 to 1.53:1 in 2010 shows the efficiency in working capital requirements. Having current assets equivalent to 1.53 times of current liabilities shows a moderate approach from the management – not being too aggressive by holding less current assets nor too conservative by holding more current assets leading to high opportunity cost.
Quick Ratio/Acid Test:
Formula: (Total current assets-stock)/total current liabilities
It measures company’s ability to meet short-term obligations with its most liquid assets. An acceptable ratio should be at least 1:1. However in 2009 it was .87 which is not sufficient. An increase from .87 to 1.2 over a period of one year demonstrates that Burberry has stronger liquidity position than it had before.
Shareholders’ POV:
Collier (2009) state that
“Dividends are a decision made by directors on the basis of the proportion of profits they want to distribute and capital needed to be retained in the business to fund growth.” (p.114)
Shareholders’ invest in a company’s stock with the motive of higher returns through dividends or capital gains. The idea of investing in the shares of a company may give higher returns compared to the other secure investments like bank. However, the risk is also more. The investors measure the prospects of a stock under various scales. Few of them are as follows:
Dividend per share (DPS):
Formula: Dividends paid/ number of shares
Often DPS is the measure of a company’s performance because it indicates how profitable a company is over a period of time. In Burberry’s case, its excellent performance is reflected through the increase in the dividend per share paid to shareholders.
“As at 31st march 2010, Burberry had 435,024,782 ordinary shares, of which 77,215 were held as treasury shares, shares that have been bought back by the issuing corporation and is available for retirement or resale; it is issued but not outstanding; it cannot vote and pays no dividends.” (http://wordnetweb.princeton.edu/perl/webwn?s=treasury%20shares)
As per annual report, Burberry has proposed dividend of £45.7M, which is 20% higher than last year (£37.7M). This increases its dividend per share to 10.5p from 8.65p. It also increased interim dividend, which is declared and distributed before the calculations of company’s annual earnings, per share slightly from 3.35p to 3.50p during year. So, the total dividend per share is 14p for the year ending 2010 giving a 17% increase from 12p in 2009.
Dividend Yield:
Formula: Dividend per share/ market value per share
It shows the relationship between dividends and market share by expressing a company’s dividend as a percentage of its share price. However, dividend yield fluctuates with share price.
Burberry’s share’s price was 276.25 on 27 March 2009 and 725.00 on 1 April 2010. (http://www.google.co.uk/finance?client=ob&q=LON:BRBY)
Using its share price value at financial year end, dividend yield is 1.93% in 2010 and 4.3% in 2009. This need not represent that Burberry has decreased its value in investors’ eye. This fall is because of 163% increase in share price of Burberry, which made increase in dividend less significant.
Dividend Payout Ratio:
Formula: Dividend paid / (profit after tax i.e. net income) or the ratio of dividend per share and earnings per share.
“It helps in predicting how well earnings support the dividend payments. Investors seeking high current income and limited capital growth prefer companies with high Dividend payout ratio. However investors seeking capital growth may prefer lower payout ratio because capital gains are taxed at a lower rate.” (http://en.wikipedia.org/wiki/Dividend_payout_ratio)
For 2010: it is 14/36 = 38.88 % 2009: 12/31= 39.2%
It is almost similar in both years, which shows that Burberry is maintaining the balance between interest of shareholders and expansion of business.
Earnings per share (EPS):
Formula: profit after tax or net earnings/ number of shares
Burberry calculates EPS on the basis of both diluted and basic. When all convertible securities such as convertible preference shares, convertible debts, convertible debentures and warrants exercised; number of outstanding shares increases. This is called Diluted weighted average number of shares, the basis of Diluted EPS.
As number of outstanding shares increases, Diluted EPS is always lower than Basic EPS. It is more accurate to use a Diluted EPS over the reporting term; because the number of shares outstanding can change over time (We can observe this in annual report that Burberry has always mentioned diluted EPS).
In 2010, Diluted weighted average number of shares was about 442 million with dilution effect of 9.3 million. In 2009, it was 438.1 million with dilution effect of 6.8 million. Earnings were £81.4 million in 2010 as compared to loss of 6 million in 2009, because of reasons mentioned before. This leads Basic EPS to 18.8p (-1.4% in 2009) and Diluted EPS to 18.4p (-1.4% in 2009).
Using details of exceptional items in note 4 of annual report 2009-10, adjusted earnings are £155.2million and £132.1 million for 2010 and 2009 respectively. This leads to Adjusted Basic EPS to 35.9p (30.6p in 2009) and Adjusted Diluted EPS to 35.1 (30.2 in 2009).
Increase in Adjusted Diluted EPS by 17 % is mainly because of 17 % increase in adjusted profit as weighted number of shares is almost same. This increase represents better performance of Burberry in 2009-10.
Price-Earnings (P/E) Ratio:
Formula: Market value per share/ EPS
“It is the valuation of company’s current share price compared to the per share earnings. This ratio reveals the popularity of a stock because it reflects how much people are willing to pay for it” (http://library.thinkquest.org/3298/NoFrames/help/glossary.html).
The P/E ratio can be interpreted as “number of years of earnings to pay back purchase price”, ignoring the time value of money (http://en.wikipedia.org/wiki/P/E_ratio).
For 2010 P/E ratio is 725/35.9= 20 and for 2009 it is 276/30.1= 9.2
There is almost two times increase in P/E ratio. This is because of increase in share price by 163%. This increase makes Burberry’s stock more attractive than previous year.
Bottom line:
The above analysis from a shareholder’s POV leaves an overall positive impact on the investors or the potential investors. Considering the shareholders’ return, profitability, growth rate the company has been maintaining and the increasing trend in the share value, it would be more than likely a wise decision to invest in the Burberry’s stock.
Gearing effect:
Tools used:
Gearing ratio: long-term debt/ (shareholders’ funds + long-term debt)
This ratio gives the proportion of funds which is borrowed from outside in the entire capital employed, than from the shareholders (through issue of shares). This is also called the leverage ratio. The method of introducing debts in place of equity is referred to as “trading on equity leverage”
Collier (2009) states that
“Higher the gearing, higher is the burden on repaying the debts and the associated interest. Also, if profits turn down, there are substantially more risks carried by the highly geared business.” (p.108)
However, there is a relationship between risk and return which is to be analysed. Higher proportion of long term debt signifies two issues:
Higher return for shareholders
Less tax burden
Burberry in 2009 has a gearing of 52.72%. For the year ending 2010, it is 43.06% i.e. 56.94% of equity. This shows that their almost half of the sources of finance is through long term borrowings. The effect of generating finance through debts than through equity is shown on the return the shareholders are enjoying. It also shows the company has been closely monitoring tax burden. This is because the provision made for the interest obligation/payment is reflected in reducing the profits, thereby a lower tax on lower profits.
However, the debts carry with them the interest obligation and repayment commitments. This way the company has been trying to balance between debt and equity. In the financial year 2009-10, the company has reduced its debt content trying to be a little conservative. The capital structure can be considered to be moderate.
Interest cover: Profit before interest & tax/ interest payable
This represents the profit available, to meet the interest obligation, in terms of the interest payable (number of times). Higher interest cover leaves less strain on the profits and giving a cushion with profit AFTER interest and before tax.
Profit before interest and tax: Interest payable:
For 2010: £171.1M £6.2M
For 2009: £ (9.9) M – Loss £13.4M
Interest cover for the year 2009-10 is 27.6 times. This is a highly impressive cover leaving a comfortable position. Considering the loss in the previous year and still maintaining this is very efficient. The decrease in interest commitment this year can be related to the reduction in the debt content of the capital structure (gearing ratio).
Financial Risk Management – Overview:
Burberry deals with variety of financial instruments viz. derivatives, short term and long term borrowings, trade receivables/payables etc. It also combines with variety of financial risks. However, the risk management is carried out by a dedicated ‘Group Treasury’ under the approval of Board of Directors.
Guidelines/ Tools:
To reduce the financial risk and ensure sufficient (OPTIMAL) liquidity position
Work closely with the business requirements
Uses derivative instruments to hedge certain risk exposures
Market Risk:
Foreign Exchange Risk:
Risk: Multiple foreign currency transactions because of international operations
Tools/Policies:
Entering into forward foreign exchange contracts
Hedge anticipated cash flows in each major foreign currency
Monitor the desirability of hedging the net assets of the overseas subsidiaries when translated into Sterling for reporting purposes.
At 31 March 2010, the Group has performed sensitivity analysis to determine the effect of non-Sterling currencies strengthening/weakening.
Price Risk:
Risk: Fluctuations in employer’s national insurance liability due to movements in the share price.
Tools/Policies:
Entering into equity swaps at the time of granting share options.
Monitor the fluctuations in the liability on a continuous basis.
Cash flow interest rate risk:
Risk: Fluctuations in the interest rates.
Tools/Policies:
Use interest rate swap derivatives to manage fixed and floating rate borrowings within limits.
Credit Risk:
Risk: Possible bad debts.
Tools/Policies:
Wholesale sales only with appropriate credit history/check.
Retail sales only through cash or major credit cards.
Maximum credit risk exposure is classified separately and attended.
Liquidity Risk:
Risk: Maintaining sufficient cash balance.
Tools/Policies:
Maturity profile is established – All short term creditors, accruals, bank overdrafts and borrowings within one year.
Compliance with all the committed banks’ credit guidelines.
Capital Risk:
Risk: Returns to shareholders and other stakeholders; Maintain Going concern.
Tools/Policies:
Maintain strong credit rating.
Appropriate capital structure mix – debt and equity.
Adjustments according to the economic changes and its strategic objectives.
Analysis of the above:
All of the above represents the measures adopted by Burberry to meet the Financial Risks. The company having a dedicated risk management team in order to face the risks gives a confidence in the minds. However, they should be continuously aware of the fact that a large corporate like Burberry will have to attend to growing/new risks by anticipating well in advance. They may include a deeper analysis in the following areas:
Working capital cycle: Inventory management, EOQ/JIT methods, optimum cash model.
Financing needs. Other sources of finance can be analyzed like debt factoring.
Capital budgeting decisions before expanding or investing on a project.
WACC – Weighted average cost of capital is to be considered before deciding the capital structure. Comparisons with the market rate and interest rates prevailing.
The overall financial risk management shows the company’s ability to address almost all the possible risks efficiently and effectively.
Conclusion:
With comparison to most of the essential parameters, it can be concluded that Burberry plc showed a promising performance in the last completed financial year 2009-10. Not just with regard to the financial performance, but also in satisfying the shareholders’ with competent returns. A bird’s eye view shows the company has made a great comeback this year with a significant profit. However, a deeper penetration/analysis into the last year financials reveals that the loss made in 2008-09 is because of high cost of sales with a difference of £59.8M compared to the recent year, goodwill impairment charge to the extent of £116.2M, relocation of HQ costing around £7.9M and other expansion charges.
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Also, the above report shows the company’s transparency in complying with the Corporate Governance and commitment in attending to its Corporate Social Responsibility, employees’ welfare etc. Burberry showed continuous interest in brand integrity, being a true leader in luxury brands, and market growth through expansion. Indeed, highly motivated. All this leads to only reaffirm the company’s continued efforts in excelling beyond horizons among its peers – financially, ethically, and morally!
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