burberry book

8/17/2019 Burberry Book

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Equity Research

BRBY.LOUTPERFORM*

Price (02 March 04): 351p

3 March 2004

Europe/United Kingdom

Luxury Goods

MARKET WEIGHT

Burberry GroupOUTSTANDING TRACK RECORD OF VALUE CREATIONWe believe management has created outstanding shareholder value by turning around the existing

business and making sensible acquisitions of brand licensees and distributors.

STRONG GROWTH PROSPECTSBurberry brand sales exceeded £2bn in 2002/03 but are mainly generated through licence andwholesale channels in Japan, Spain and the US. In our view, capture of a greater share of the brandvalue chain offers further value-creating growth potential. We believe possible integration ofdistribution in Japan (not currently in our estimates) is the main positive catalyst for Burberry.

INITIATE WITH AN OUTPERFORM RATING, TARGET PRICE 400PWe believe Burberry has an attractive valuation and lower transactional FX exposure than its luxurygoods peers. We initiate coverage of Burberry with an Outperform rating and a target price of 400p.The GUS lock-up is due to expire in November 2004. We see this as a potential opportunity to investrather than stock overhang.

Rich pickings?

FOR IMPORTANT DISCLOSURE INFORMATION relating to analyst certification, the Firm’s rating system,valuation methods and potential conflicts of interest regarding companies that are the subject of thisreport, please refer to the Disclosure Section at the end of the report. U.S. Regulatory Disclosure: CSFBdoes and seeks to do business with companies covered in its research reports. As a result, investorsshould be aware that the Firm may have a conflict of interest that could affect the objectivity of thisreport. Investors should consider this report as only a single factor in making their investment decision.

research team

Anaïs Lallich44 20 7888 [email protected]

Neville Pike44 20 7888 [email protected]


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Burberry Group 3 March 2004

2

Burberry Group BRBY.L OUTPERFORM*

Strategic analysis

Existing strengths: Strong and proven management team. Licensing growth delivershigh incremental return on incremental capital. Heritage products. Flexibility inproduction process. Lower transactional exchange exposure than luxury goods peers.

Existing weaknesses: Low vertical integration hinders capture of margin onmanufacturing. Low gearing into potential Japanese upside. Apparel segment, whichhas increased fashion risk, accounts for most of company's profits. Scope for further

repositioning?Existing opportunities: Retail network expansion and widening of distribution.Expansion of Burberry brand. Development of accessories in Spain and especiallyJapan. Increased distribution of Burberry London (Intl) line, especially in Japan.

Existing threats: Control over licence and wholesale accounts. Company is mono-brand and trademark check is core, so increased fashion risk? Reliance on third partiesin Japan.

Company description

Burberry is a global high-end apparel company that has recently grown into a multi-product lines business through brand extension.

200

300

400

500

600

700

Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Nov-03

Price Price relative

ROIC/WACC

0%

5%

10%

15%

20%

25%

30%

31 Mar 02A 31 Mar 03A 31 Mar 04E 31 Mar 05EROIC WACC

REV/IC Op. margin

1.60

1.65

1.70

1.75

1.80

1.85

1.90

31 Mar 02A 31 Mar 03A 31 Mar 04E 31 Mar 05E

0%

5%

10%

15%

20%

25%

Rev/IC Op. margin

EV/EBITDA (at historical prices)

0.0

2.0

4.0

6.08.0

10.0

12.0

31 Mar 02A 31 Mar 03A 31 Mar 04E 31 Mar 05EEV/EBITDA

Source: FTI, Company data, Datastream, CSFB (EUROPE) LTD. EstimatesThe price relative chart measures performance against the FTALLSH indexOn 02/03/04 the FTALLSH index closed at 2267.9On 02/03/04 the spot exchange rate was £0.66/eu 1. - eu1.22/US$1

Price (02 Mar 04) 351 (p)

Target price (12 months) 400.00 (p)

Analyst's Coverage Universe LUXURY GOODSWeighting (vs. broad market) MARKET WEIGHT

* Stock ratings are relative to the coverage universe in each analyst's or eachteam's respective sector.

Year 3/02A 3/03A 3/04E 3/05E

Revenues (£ m) 499.2 593.6 670.7 731.6

EBITDA (£ m) 104.3 135.7 162.3 180.9

Pre-tax profit (£ m) 84.8 85.1 130.4 146.3

IC (p m) 269.60 325.30 376.62 426.98

CSFB adj. EPS (p) 12.13 14.64 18.14 20.25

ROIC (%) 24.9 27.5 27.9 27.2

P/E (x) 28.94 23.98 19.34 17.34

P/E rel (%) 181.45 138.98 127.09 124.69

Dividend 2003 (p) 3.01 Free float (%) 34

Dividend yield (%) 0.9 Number of shares (m) 495.20

Net debt/equity (3/04E, %) -22.6 Current WACC (3/04E, %) 7.6

Historical valuation

Year 3/02A 3/03A 3/04E 3/05E

Y/E closing price (p) 490.00 312.00 351.00 351.00

Market cap. (£ m) 1,145.9 1,175.5 1,738.2 1,738.2

End year debt (£ m) -21.3 -79.6 -103.6 -103.6

Other liabilities (£ m) 20.0 29.2 29.2 29.2

Enterprise value (£ m) 1,144.56 1,125.12 1,663.73 1,663.73

Key historical ratios

EV/Revenue (x) 2.3 1.9 2.5 2.3

EV/EBITDA (x) 11.0 8.3 10.3 9.2

EV/IC (x) 4.2 3.5 4.4 3.9

P/E at closing price (x) 40.4 21.3 19.3 17.3

Performance over 1mth 3mths 12mths

Absolute (%) 2.0 -22.0 30.0

Relative (%) -1.7 -25.5 0.8


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3

Figure 1: Burberry Investment Summary

Share price 351.0p As of 2-Mar-04

Rec. and Target price OUTPERFORM 400.0p

Potential up/downside (%) 14.0% Mar 04E Mar 05EPBT 130 146

Mar 04E Mar 05E EBITDA 162 181Current At TP Trading Range* Current

P/E (x) 24.0 27.3 11.1x to 20.1x 19.3

EV/EBITDA (x) 12.4 14.6 6.7x to 11.6x 10.3* Average year high and year low since July 2002

- Development of retail square footage with a focus on increasing retail presence in the US and non Japan Asia.

- Repositioning of men apparel segment.

- Development of accessories.- In the medium-term, we believe Burberry will have the opportunity to extract value from improving its supply chain management.- Possible integration of distribution in Japan (not currently in our estimates) is the main positive catalyst for Burberry - We believe this will likely be

through development of accessories within Burberry London (International) line- Intentions of GUS?

- Outsourcing of production activities provides increased flexibility EPS Sensitivity BRBY.L- Lower transactional exposure combined with lower inventory holding period imply low risk profile 10% Turnover 9.9%

BUT 1% EBITA margin 4.4%- Burberry is mono-brand and trademark check is core so increased fashion risk?

- GUS fundamentally seller: overhang or opportunity to invest?

- We believe creation of shareholder value to date has been in part as a result of astute picking of low BRBY.L

hanging fruits after years of brand neglect. In our view, the challenge now is to find significant value Revenue growth Mar 04E* 13.2%enhancing growth opportunities. EPS Growth Mar 03A 20.7%

- In the future, we believe that Burberry's advantage from superior pricing power may be diminishing. EPS CAGR Mar04E-Mar06E 12.1%- After strong share price performance post listing, share price momentum has recently slowed - Burberry has

underperformed our CSFB Luxury Goods Index by 10% since 20/11/2003. * Excluding FX effects

- Strong and proven management team.- Outstanding track record of shareholder value creation since April 2000.

- Low vertical integration into production provides flexibility and low transactional exchange exposure.- Growth in licensing activities delivers high incremental ROIIC but upside in revenues is limited to increased royalties

- High fixed assets and working capital efficiency

- Burberry has strong fundamentals and an outstanding track record of value creation from expansion and acquisitions of brand licensess and distributors- We believe Burberry has substantial scope to develop sales of Burberry branded products and capture a greater share of the brand value chain- Key long-term catalyst is development of sales of International Burberry London line in Japan, mainly through accessories.- Relative valuation offers potential upside.

Fundamentals - 4

Investment Rationale - 4

Value - 3

Catalysts - 4

Risks Containment - 4

Business Momentum - 3

3

4 4

3

4 4

Value Catalysts Risk Containment Business Momentum Fundamentals Investment Rationale

Source: Company data, CSFB estimates


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4

Investment summary

Burberry is a high-end apparel (60% of 02/03A revenues) and accessories (29% of

02/03A revenues) business. According to company data, total global retail value of

products sold under the Burberry name exceeded £2bn in the year ending March 2003.

Burberry’s business model has evolved substantially over the past few years after

concerted management focus instigated by the company’s main shareholder, GUS Plc,in 1997. Through turnaround of a neglected brand and sensible acquisitions, Burberry

has delivered outstanding shareholder value (average incremental return on incrementa

invested capital of 34.7% over the last three reported years).

However, in our view the current focus of distribution on licensing (10% of 02/03A

turnover but 45% of EBITA) in Japan and wholesale (52% of 02/03A turnover) in Spain

and the US effectively leaves the company with a low gearing to upside potential in

consumer demand in these key markets (Japan represents over 50% of brand sales,

and Spain and the US together account for around 25%).

We believe Burberry has opportunities for future value creation through expanding sales

of Burberry-branded products and especially seizing opportunities to capture a greatershare of the brand value chain.

In particular, we believe the key positive catalyst for the stock will be the actions taken

with regard to Japan. The main licences on this market will likely run until 2020, but the

licence on the Burberry London (International) line will expire in June 2005. The

Burberry London (International) line has been key to the successful repositioning of the

Burberry brand in Europe and in the US, and we believe there is substantial scope to

develop sales of this product line in Japan, mainly through accessories.

In our view, other key positive catalysts for the stock include the development of retail

square footage with a focus on increasing retail presence in the US (where the group has

just 26 directly operated stores (DOS) compared with 86 for Louis Vuitton and 39 for PoloRalph Lauren) and non-Japan Asia; the repositioning of the men apparel segment and the

development of accessories. Also, in the medium term, we believe Burberry will have the

opportunity to extract value from improving its supply chain management.

Burberry is not a traditional luxury goods company. Rather, we believe Burberry's

business model has attributes of both retail and luxury goods companies.

Figure 2: Summary drivers of value

Burberry Bulgari Gucci Hermès LVMH Richemont Swatch

Geographical mix 4 3 3 3 2 3 3

Business mix 2 2 3 5 4 2 2

Pricing power 2 2 3 5 4 1 4

Working capital 5 1 4 4 3 2 3

Vertical integration 1 2 4 4 3 1 3

Management 4 3 2 5 4 1 4

Design / quality 3 3 3 3 3 3 3

Total 21.0 16.0 22.0 29.0 23.0 13.0 22.0

Low score High score

1 2 3 4 5

Structural

Operational

People

Source: CSFB research

Burberry brand sales

exceed £2bn

Outstanding value creation

Main positive catalyst is

Japan, in our view

Other positive catalysts

include . . .


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5

Overall, Burberry is not highly vertically integrated. Most of production activities are

outsourced and integration into retail though increasing still remains rather low.

Significantly, the company has a degree of natural hedging against currency

movements as it has a high diversity of cost and revenue split on the wholesale and

retail segments. Also, because Japan is operated as a licence, Burberry has much

lower transactional exchange exposure on the yen. This lower transactional exposure,

combined with a lower inventory holding period (117 days in 2002/03A), implies that

Burberry has a lower risk profile than other luxury goods companies. Although

diversification of sourcing has helped flexibility and costs, paradoxically, it does lower

the degree of strength obtained from brand legitimacy. In terms of other risks, the

extension of activities in Japan will likely be a difficult task, requiring brand migration

and careful management of existing relationships. In addition, we believe Burberry has

higher fashion risk as it is mono-brand and relies heavily on check.

Our overall assessment of the investment case for Burberry within our luxury goods

universe has been made according to five criteria: Value (how inexpensive is the stock);

Catalysts (what company-specific events will make the stock perform); Risk (risk factors

relating to the stock); Business momentum (is business getting better); and

Fundamentals (best fit with our drivers of value in the sector).

Figure 3: Investment summary


Value 3 2 2 3 4 2 4

Catalysts 4 2 3 3 3 2 3

Risks 4 2 5 3 3 3 3

Business momentum 3 2 3 4 4 2 3

Fundamentals 4 3 4 5 4 2 4

Investm ent Rationale 4 2 3 3 4 2 4

Recommendation OUTPERF. UNDERPERF. NEUTRAL NEUTRAL OUTPERF. UNDERPERF. OUTPERF.

Current Price 351.0 p € 7.3 € 69.8 € 164.0 € 62.5 SFr 33.7 SFr 166.3

P/E multiple at curre nt price

2003E 19.3 26.1 21.6 29.7 28.1 22.0 19.8

2004E 17.3 23.6 27.8 26.7 22.8 18.3 16.8

Target Price 400.0 p € 6.3 € 73.2 € 145.0 € 62.5 SFr 24.0 SFr 185.0


1 2 3 4 5

Source: Datastream, CSFB estimates

A further factor in the Burberry investment case concerns the position of GUS. In July

2002, Burberry was partly listed on the London Stock Exchange. GUS today owns

approximately 66% of Burberry and has for several years described this investment as a

non-core holding. We believe GUS’ placing of an 11% stake in Burberry in November

2003 reinforced market expectations that Burberry’s free float could increasesubstantially over the next few years. GUS’ lock-up expires in November 2004; we see

this as an opportunity to invest rather than stock overhang.

In summary, our view is that Burberry has strong fundamentals and long-term catalysts,

together with an outstanding track record of value creation. We initiate coverage of the

stock with an outperform rating and a 12-month share price target of 400p, based on

DCF valuation. This represents a 14% potential premium to the closing price on

2 March 2004.

Business model between

relevant retail and luxury

goods companies

A preferred play in the

sector

GUS relationship

Initiating with an

Outperform rating and a

400p target price


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6

Figure 4: Turnover and EBITA by class of business

55%

45%

90%

10%

Wholesale & Retail Licence

57%

43%

11%

89%

Wholesale & Retail Licence

EBITA

Turnover

EBITA

As of March 2001

Turnover

As of March 2003


Figure 5: Turnover by geography,

02/03A

Figure 6: Turnover by product category,

02/03A

Asia

Pacific

25%

Other

1%

Europe

50%

North

America

24%

Others

1%

Men

27%

Women

33%

Accessories

29%

Licence

10%

Source: Company data Source: Company data

Figure 7: Burberry sales and EBITA by channel and geography (02/03A)

Burberry - Sales by channel and region of destination

UK RO Europe Americas Japan RO Asia Total sales

Wholesale 11% 22% 9% 1% 8% 52%

Retail 10% 7% 14% 0% 8% 38%

Licence 0% 0% 0% 8% 0% 10%

Total 21% 30% 24% 9% 15% 100%

Burberry - EBITA by channel and region of destination

UK RO Europe Americas Japan RO Asia Total EBITA

Wholesale 6% 12% 5% 1% 4% 28%

Retail 7% 5% 10% 0% 5% 27%

Licence 2% 2% 2% 38% 0% 45%

Total 15% 20% 17% 39% 10% 100%

0-5% 5-9% 10-19% 20% +

Source: Company data, CSFB research. * Assumes consistent margin across regions—CSFB assumption

Importance of contribution

from licensing . . . but

wholesale and retail EBITA

growing

Asia Pacific represents

25% of Burberry’s reportedturnover, but Japan alone

accounts for over half of

Burberry brand sales

Importance of Spanish

wholesale operations to

turnover

Contribution of Japan

licensing agreements to

group profitability


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7

Figure 8: Stores

4534 41

47 49

66

10

6264

1417

18

23 23

0

40

80

120

160

Mar 00 Mar 01 Mar 02 Mar 03 Sept 03

DOS Co nc es sions Outlet s to res

Korea a cquisition in

June 2002 added

47 concessions

As of H1 results

Source: Company data

Figure 9: Efficiency Matrix Figure 10: Average IC & Turnover growth

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04E

Mar-05E

1.0

1.5

2.0

2.5

3.0

5% 10% 15% 20%

NOPAT Margins

A v g . I n v . C a p i t a l T u r n s

Sector Avg. IC x

Sector Avg.

NOPAT Mg.

0

200

400

600

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04EMar-05EMar-06E

-20%

20%

60%

100%

140%

Average IC Turnover Growth

Av. IC Growth

Source: Company data, CSFB estimates Source: Company data, CSFB estimates

Figure 11: Price and Price Relative Figure 12: Summary of brands

3/3/04

J A S O N D J F M A M J J A S O N D

100

150

200

250

300

350

400

450

Burberry Group

Burberry Group relative to Luxury Goods Narr ow Index

Sourc e: DATASTREAM

Main lines

Burberry Prorsum (High fashion range)

Burberry London International (Core collection)

Spain

Thomas Burberry

Burberry London

Japan

Burberry LondonBurberry Blue Label

Burberry Black Label

Scotch House

Others

Accessories (Handbags, scarves, shoes)

Product Licences (Fragrances, Eyewear...)

Main lines



Spain

Thomas Burberry

Burberry London

Japan

Burberry LondonBurberry Blue Label


Scotch House

Others



Source: Datastream Source: Company data, CSFB estimates

Burberry’s efficiency profile

has changed substantially,

mainly as a result of

acquisition of Spanish

licensee


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8

Strategic assessment

Burberry is a high-end apparel (60% of 02/03A revenues) and accessories (29% of

02/03A revenues) business. Although Burberry has achieved significant retail expansion

over the past few years, the distribution still is mainly focused on wholesale (52% of

02/03A turnover) and licensing (10% of 02/03A turnover but 45% of EBITA). Key to

Burberry are the management of licensing relationships in Japan (Sanyo Shokai and

Mitsui & Co) and wholesale relationships in the US, and in Spain (El Corte Ingles).

Burberry also has licensing agreements for certain growing product lines such as

Eyewear, Fragrances, Timepieces, Childrenswear, etc.

On the positive side, growth in licensing activities requires little additional capital and

has high EBITA margins and so delivers high incremental return on incremental

invested capital. However, if demand rises, Burberry's upside potential in revenues is

limited to increased royalties, which represent only a fraction of sales under its brand

name. It does not benefit from any operational gearing on licensed products. Also, the

importance of wholesale and licensing operations raises control issues, as Burberry

effectively relies on external parties for a large part of group EBITA.

Over recent years, Burberry has reduced the level of in-house manufacturing activities

to concentrate on core outerwear products where the brand has the greatest legitimacy.

This ensures that Burberry retains key manufacturing skills, while allowing it to fully

capture the value that is added on products that have less fashion risk. Integration into

manufacturing is lowest on fashion lines and non-core products, which exhibit greater

volatility. In this case, products are sourced from third parties mainly located in Europe.

This provides increased flexibility and reduces transactional exposure but reduces the

margin and value capture from manufacturing.

SWOT analysis

A summary SWOT analysis is given in Figure 13.

Figure 13: Burberry: SWOT analysis

Existing Strengths Existing Weaknesses

- Strong and proven management team

- Licensing growth delivers high incremental return on

incremental capital

- Heritage products

- Flexibility in product sourcing

- Lower t ransactional exchange exposure

- Low vertical integration reduces capture of margin

and value from manufacturing

- Low gearing into Japanese upside

- Apparel segment which has increased fashion risk

still accounts for most of company's profits

Opportunities Threats

- Retail network expension + Widening of wholesaledistribution

- Extension of apparel offering

- Further development of accessories in Spain and

especially in Japan

- Increased distribution of Burberry London

(International) line, especially in Japan

- Conflicting interests of GUS and external Burberryshareholders?

- Reliance on 3rd parties in Japan

- Control over licensees and wholesale accounts

- Company is mono-brand and trademark check is

core so increased fashion risk?

- Counterfeiting


Burberry’s distribution is

focused on wholesale and

licensing

Licensing implies lower

gearing to potential upside

in consumer demand

Outsourcing of

manufacturing activities


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9

Drivers of value

We have identified seven key drivers of value in the luxury goods sector, our ‘design for

success’. For further detailed discussion on the drivers of value, please refer to our

report, Luxury goods: Handbags at five paces , dated 12 May 2003.

We illustrate in Figure 14 the positioning of Burberry's business model with respect toeach of these seven drivers. Clearly, Burberry is not a traditional luxury goods company.

Rather, we believe Burberry's business model shares common features with those of

relevant retailers and luxury goods companies. This positioning in Figure 14 is not

qualitative and does not intend to define ‘good’ versus ‘bad’ but rather to enable better

assessment and understanding of Burberry's business model.

We position Burberry by reference to two competitive sets made of independent

European quoted companies covered by CSFB research. The luxury goods competitive

set is made of Bulgari, Gucci, Hermès, LVMH, Richemont and Swatch. We assume a

relevant retail competitive set includes: Hugo Boss, Hennes & Mauritz and Inditex.

Figure 14: Positioning of Burberry's business model

Geographical Mix

Business Mix

Pricing power

Working capital

Vertical Integration

Management

Design / Quality

Structural

Operational

People

Retail Luxury Goods


On four out of the seven identified drivers, we believe Burberry is more comparable to

companies included in our relevant retail set.

1) Regarding geographical mix, Burberry has low transactional exposure due to

outsourcing of production activities, which allows production in various countries and

currencies. Also, the company has much lower transactional exchange exposure to the

yen because Japan is operated as a licence.

Positioning betweenrelevant retailers’ and

luxury goods companies’

business models


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10

2) Working capital analysis shows that Burberry's cash conversion cycle is short due to

inventories, including low raw materials and WIP materials and mainly finished goods.

This is a direct consequence of the importance of third-party suppliers, which effectively

take on a large share of Burberry's inventories.

3) Burberry is not highly vertically integrated. The company is responsible for or

oversees the design of all ranges and lines but has deliberately limited production

capacities. Despite recent acquisitions of licensees in Spain and distributors in Koreaand the Asia Pacific, combined with ambitious retail extension, over 50% of the total

global retail value of products sold under the Burberry name are sold through licensees

in Japan and 52% of reported turnover in 02/03A was realised through wholesale

distribution.

4) On management, CEO Rose Marie Bravo has a retail and wholesale background

having previously served as President of Saks Fifth Avenue in the US and Chairman

and CEO of Macy's Magnin speciality division.

Burberry's business mix consists almost entirely of apparel and accessories. We

position it mid-way between our relevant retail and luxury goods companies set, as

Burberry’s business mix seems comparable to that of H&M, Hugo Boss and Inditex butalso to that of Gucci and Hermès.

On pricing power, Burberry has common characteristics with both competitive sets. On

one hand, Burberry sells premium products in a high-quality distribution network. This

positioning is synonymous with higher prices and higher distribution costs. However, the

company has much lower transactional exchange exposure than the luxury goods

companies and therefore does not need to make up as much revenue in times of

adverse exchange-rate movements. Also, Burberry has in the past increased fees due

by its Japanese licensees, Sanyo Shokai and Mitsui & Co.

On design and quality, Burberry is clearly akin to the luxury goods companies set.

Burberry has core heritage products, a high fashion range (Burberry Prorsum ) launched

in 1999, a core high-end Burberry London (International) product line and a well-

recognised Design Director, Christopher Bailey, who previously worked at Gucci and

Donna Karan.

Armed with the diagram shown in Figure 14, and assessing the positioning of Burberry's

business model, we will now evaluate the company's performance relative to its peer

group. Figure 15 below summarises our assessment of the performance of Burberry

alongside the companies of the luxury goods universe for each of the seven drivers of

value. This analysis is made in both relative and absolute terms. We look at how

companies compare with one another, but we also set our analysis in a broader context

and assess their performance on an absolute basis.

Assessment of

performance against

drivers of value


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11

Figure 15: Summary drivers of value


Geographical mix 4 3 3 3 2 3 3

Business mix 2 2 3 5 4 2 2

Pricing power 2 2 3 5 4 1 4

Working capital 5 1 4 4 3 2 3

Vertical integration 1 2 4 4 3 1 3

Management 4 3 2 5 4 1 4

Design / quality 3 3 3 3 3 3 3

Total 21.0 16.0 22.0 29.0 23.0 13.0 22.0


1 2 3 4 5

Structural

Operational

People


Geographical mixBurberry reports in British pounds. Assuming no variation from exchange rates as of

5 January 2004, we expect a favourable euro movement of 7.3%, an adverse yen

movement of 2.0% and an adverse US dollar variance of 10.3% for the year endingMarch 2004. We expect that the trade-weighted impact of exchange movements on

Burberry revenues will be –0.5%.

Figure 16 and Figure 17 below show Burberry's geographical mix of revenues and

currency exposure.

Figure 16: Geographical mix of revenues

02/03A

Figure 17: Estimated currency mix

02/03A

Asia

Pacific

25%

Other

1%

Europe

50%

North

America

24%

Euro

32%

Japanese

Yen

23%

British

Pound

21%

US Dollar

24%

Source: Company data Source: Company data, CSFB estimates

However, the revenue exposure is only one element of the equation. From discussion

with Burberry management, we understand that the Burberry London (International) and

Burberry Prorsum lines are manufactured as follows: 20% in the UK, 70% in Italy and

10% in other countries including the US, where Burberry owns a factory. Burberry

London (Spain) and Thomas Burberry (mainly sold in Spain) are manufactured locally

out of Spain, Portugal and Morocco. Finally, the Japanese lines, Burberry Blue and

Black labels, Burberry London and Scotch House are made 100% locally.

Vertical integration

2 Bulgari

1 Burberry4 Gucci

4 Hermès

3 LVMH

1 Richemont

3 Swatch


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12

The diagram shown in Figure 18 is a simplified presentation of Burberry's exchange rate

exposure. It shows how Burberry is positioned compared with the relevant retail and

luxury goods competitive sets by reference to two metrics: diversity of revenue split (X

axis) and diversity of cost split (Y axis).

Figure 18: Summary presentation of exchange-rate exposure

Diversity of revenue split

D i v e r s i t y o f c o s t s p l i t

LuxuryGoods

4 - Hedged

2 - Transactional exchange exposure1 - Domestic Goods

3 - Deflationary pressures

BurberryRetail

Cornershop


- Quadrant 1 (low diversity of cost split and revenue split) “corner shops”, i.e. local

retailers of locally produced goods, which due to the domestic nature of their business

do not have exchange exposure.

- Quadrant 2 (low diversity of cost split and high diversity of revenue split) includes

luxury goods companies, which typically sell their products globally but manufacture

them in euros or Swiss francs. The value proposition of these products is often closely

linked to particular geographical regions (e.g. Swiss watches). This discrepancy

between cost and revenue currencies gives rise to transactional exchange-rate

exposure, accentuating the impact of adverse currency movements, especially if

inventory turns are low.

- Quadrant 3 (high diversity of cost split and low diversity of revenue split) includes

retailers, which source their products from a wide variety of regions and in a variety of

currencies but sell them in a small number of markets. The ability to source products

from a variety of third parties in all countries gives rise to intense competition on prices

and therefore leads to deflationary pressures.

- We position Burberry in Quadrant 4, i.e. high diversity of cost and revenue split. On the

wholesale and retail segments (i.e. 90% of 2002/03A turnover), we believe that Burberry

has a natural hedge against currency movements, as it manufactures products in

several different countries and currencies and sells them in the US, Asia Pacific and


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13

Europe. Also, because Japan is operated as a licence, Burberry has much lower

transactional exposure on the yen. Figure 19 shows our estimates of Burberry's split of

sales and cost of goods sold (COGS) by currency for the year ending March 2003.

Figure 19: Split of turnover and cost of goods sold by currency (02/03A)

Pound (£) Euro () Dollar ($) Yen (¥) Total

Pound (£) 5% 6% 5% 16%Euro () 16% 26% 12% 54%

Dollar ($) 7% 7%

Yen (¥) 23% 23%

Total 21% 32% 24% 23% 100%

COGS

Turnover

Source: Company data, CSFB research

From the analysis shown in Figure 19, we conclude that Burberry is long US dollar

revenues and long euro costs with a neutral exposure to the yen. Therefore, we believe

that Burberry has lower transactional exchange exposure than other luxury goods

companies.

Business mixThe luxury goods companies show a great diversity of business mix across a variety of

different product areas including, fashion and leather, watches and jewellery, perfumes

and cosmetics, wines and spirits and luxury retailing. Being mainly focused upon one of

these segments—"fashion and leather"—through its womenswear, menswear and

accessories product categories, Burberry is more narrowly focused.

While the fashion and leather segment is our preferred luxury segment, we believe

Burberry has increased fashion risk relative to its luxury goods peer group due to three

main reasons.

1) The company is mono-brand.

2) The apparel segment accounts for a vast majority of revenues and profits.

3) The trademark check remains core even if its visibility has been subtly adjusted over

the past few years. Today, the apparel collection is made up as follows: 10% with the

check as an obvious logo, 10% with the check as a seasonal variation, 40% with the

check as a lining and the remaining 40% of the collection is check free.

However, it is fair to point out that the various Burberry product lines provide the

company with a reasonable range of price points.

Business mix

2 Bulgari

2 Burberry

3 Gucci

5 Hermès

4 LVMH

2 Richemont

2 Swatch


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Pricing powerThe ability to raise prices without negatively affecting demand is, in our view, critical to

long-term value creation in luxury goods. This is particularly so at a time of downward

pressure on revenues resulting from adverse currency movement. Looking at EBITA

margin relative movement (as we had previously done for the rest of the Luxury Goods

sector) does not provide very useful information on pricing power in the case of

Burberry, considering the changes the company has been through over recent years.

However, the analysis in Figure 20 leads us to conclude that Burberry does have pricing

power. Retail sales (excluding the impact of the Korea acquisition) have increased over

the last few years, quicker than retail square footage, leading to a progression in retail

sales per square foot. In the meantime, EBITA margin on the Wholesale and Retail

channel has increased. If sales per square foot have increased as well as margins, then

this is prima facie evidence that the growth has been achieved without having to resort

to additional discounting.

Figure 20: Extension of retail sales and square footage (excl. impact of Korea acquisition)

£ in millions, unless otherwise stated

Mar-01 Mar-02 Mar-03 Mar-04E Mar-05E

Retail Sales 143.2 156.9 228.4 262.7 288.9

Revenue Growth 9.6% 45.6% 15.0% 10.0%

Retail Square footage (sq ft m) 262,774 310,073 353,273 393,593

Retail Square Footage Growth 18.0% 13.9% 11.4%

Retail Sales per square foot (£) 597 737 744 734

Wholesale and Retail Margin 7.6% 9.6% 12.1% 13.5% 13.8%


Our analysis is backed by discussions with the company, which confirmed that EBITA

margin progression over recent years was partly explained by increased prices, together

with increased volumes. Pricing has increased as part of the repositioning, and Burberrytoday sells premium products in a high quality distribution network. Higher prices partly

compensate for higher distribution costs.

Company policy is to pass the adverse impact of exchange rates on to customers.

Management stated that for the Spring 2003/04 collection, US dollar denominated retail

prices would increase by about 3%. As regards next autumn’s collection, US dollar

denominated retail prices should increase by 3–4%. Although these increases are lower

than those announced by other luxury goods companies, including LVMH, an important

factor to take into account is that Burberry has lower transactional exchange exposure

than other European luxury goods companies and therefore does not need to make up

as much revenues in times of adverse exchange-rate movements.

Finally, Burberry has increased royalty fees due by its Japanese licensees, Sanyo

Shokai and Mitsui & Co. The Japanese licensing agreement was renegotiated in late

2000 and runs until 2010, with a ten-year renewal close based on volumes. The next

and last increase in royalty fees will take place in January 2005 and will represent £3m.

From then on, there will be no increases until 2010.

In the future, we believe that Burberry's advantage from superior pricing power may

however be diminishing. Retail prices have increased as part of the repositioning which

Pricing power

2 Bulgari

2 Burberry

3 Gucci

5 Hermès

4 LVMH1 Richemont

4 Swatch


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15

is now largely complete. In addition, there is no further increased in Japanese royalties

planned until at least 2010 and possibly 2020.

Working capitalWe believe that inventory holding periods become highly significant during periods of

fluctuating exchange rates. After successive adverse foreign-exchange movements in

recent years, companies with high inventory holdings and transactional exposure are

effectively locked into sustained downward pressure on margins, in our view. With a low

inventory holding period (117 days in 2002/03A) and a low transactional exposure,

Burberry has a risk profile lower than companies in our luxury goods competitive set.

The table in Figure 21 shows the details of Burberry's cash conversion cycle as well as

the average inventory holding period for the luxury goods and relevant retail competitive

sets. For the purpose of this analysis, we show inventories of "watches and jewellery"

companies (Bulgari, Richemont and Swatch) separately.

Figure 21: Burberry working capital analysis and inventories comparison2000 2001 2002 2003E 2004E 2005E

Burberry

Inventory - future days COGS 157 121 121 117 117 117Days sales in trade receivables 23 60 57 53 53 53

Accounts payable (days COS and SG&A) -29 -44 -40 -38 -38 -38

Cash conversion cycle 151 137 138 132 132 132

Inventory: Luxury Goods competitive set (excluding Watches and Jewellery)*

Gucci 168 205 213 200 200 200

Hermès 209 224 236 210 210 210

LVMH 265 292 274 265 260 250

Average 214 240 241 225 223 220

Inventory: Watches and Jewellery companies*

Bulgari 588 657 599 600 610 610

Richemont 371 461 440 420 405 405

Swatch 198 227 240 226 224 225Average 386 448 426 415 413 413

Inventory: Relevant Retail competitive set*

Hennes & Mauritz 108 82 75

Hugo Boss 121 149 162

Inditex 70 83 72Average 100 105 103

Source: Company data, CSFB estimates *Based on future days COGS.

Inventory turns are closest to our relevant retail set of companies and especially H&M.However, it is important to point out that even if Burberry has lower inventories than

companies in the luxury goods sector, it still bears an indirect economic risk. Production

by third parties is made at the request of Burberry and, if a supplier does not manage to

sell its stock of Burberry-branded products through the ‘fault’ of Burberry, then Burberry

will generally either purchase the inventories or compensate the supplier through other

means. Discussions with management confirmed that although Burberry does not own

the title to inventories held at third parties, it does bear a degree of economic risk

attributable thereto.

Working capital

1 Bulgari

5 Burberry

4 Gucci

4 Hermès

3 LVMH

2 Richemont

3 Swatch


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The acquisition of the Spanish licensing operations, in June 2000, has contributed to

better working capital management. The Burberry Spain acquisition included a well-

developed supply chain capability, which has been inspirational to the rest of the

company. In addition, Burberry has begun a pilot programme looking at direct shipping

of finished goods from suppliers to wholesale accounts in specific regions, which also

contributes to shorten the company's cash conversion cycle.

Vertical integrationOverall, Burberry is not highly vertically integrated. Most of production activities are

outsourced and integration into retail though increasing still remains rather low, with a

marked preponderance of wholesale and licensing activities. On balance, we prefer

companies that are highly integrated into production, as it reinforces the legitimacy of

the brand, and into retail, as it enables higher capture of margin and economic value

from these elements of the product value chain.

Figure 22 shows fixed asset efficiency for Burberry compared with our luxury goods set

and our relevant retail set. Burberry fixed asset turns are relatively high, and if the

intensity had been calculated based on the retail value at brand sales, rather than

reported turnover, then the fixed asset turns would have been much greater and thelevel of vertical integration indicated manifestly lower.

Figure 22: Retail distribution and fixed asset efficiency

1999 2000 2001 2002

Burberry

Number of directly operated stores 45 34 41 47

Growth in number of stores -24.4% 20.6% 14.6%

Fixed Assets turns * 3.9 4.3 4.0 3.7

D&A (excl. G/W) to sales 2.5% 2.6% 2.8% 3.2%

Fixed Asset turns of Luxury Goods competitive set *

Bulgari 7.2 7.7 8.0 8.8Gucci 3.6 4.8 3.7 2.8

Hermès 3.3 3.6 3.1 3.0

LVMH 3.0 3.4 2.9 3.3

Richemont 6.1 5.3 4.3 4.6

Swatch 3.6 4.1 3.9 3.6

Fixed Asset turns of Relevant Retail competitive set *

Hennes & Mauritz 11.0 7.4 7.5 8.7

Hugo Boss 10.0 10.6 6.6 6.0

Inditex 2.3 2.5 2.6 3.0

Source: Company data, CSFB estimates.

* Excluding adjustment for operating leases due to lack of comparable data.

In terms of integration into manufacturing, Burberry is responsible for or oversees the

design of all ranges and lines but has chosen to limit in-house production capacities.

The strategy adopted as part of the brand repositioning has been to maintain

manufacturing competency in core outerwear products and outsource the rest of the

production to specialised third-party suppliers with few long-term agreements.

Vertical integration

2 Bulgari

1 Burberry

4 Gucci

4 Hermès

3 LVMH

1 Richemont

3 Swatch


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As regards integration into retail, despite recent acquisitions of distributors in Spain

(June 2000), Korea (March 2002) and Asia Pacific (December 2001) and ambitious

retail extension, over 50% of the total global retail value of products sold under the

Burberry name are sold through licensees in Japan and 52% of reported turnover in

02/03A was realised through wholesale distribution.

The table in Figure 22 highlights the growth in directly operated stores. Yet retail

represented only 38% of turnover in the year ending March 2003. Total retail sellingspace expanded from approximately 260,000 square feet as of March 2002 to

approximately 360,000 square feet as of March 2003 (including 50,000 square feet

attributable to the ‘Korea’ acquisition), and company guidance suggests above 400,000

square feet of selling space as of March 2004.

Looking at licensing and wholesale arrangements, Burberry has long lasting and key

relationships with Sanyo Shokai and Mitsui & Co, its Japanese licensees, and with

wholesale accounts in the US and especially in Spain (El Corte Ingles). Burberry also

has licensing agreements for certain growing product lines such as Eyewear,

Fragrances, Timepieces, Childrenswear, etc. On the positive side, licensing growth

delivers high incremental return on incremental capital and outsourcing of production

provides added flexibility. However, we believe low vertical integration hinders thecapture of margin and also economic value on manufacturing, and the licences in Japan

result in a low gearing into potential upside. Also, the high importance of licensees and

wholesale accounts raises control, dependence and legitimacy issues, in our view.

Overall, Burberry’s fixed asset turns are

- Higher than for Hermès, LVMH and Gucci, as the company is less vertically integrated

and captures lower value from the product chain.

- Lower than for Bulgari and Richemont. But in the case of watches and jewellery

companies, fixed asset intensity is less of an issue because the cost of materials and

the inventory holdings period are so high.

- Lower than for H&M and Hugo Boss, which is to be expected in our view, considering

H&M and Hugo Boss are pure retailers.

We believe that the low level of integration of Burberry represents an opportunity for the

company. In our view, Burberry has scope to increase integration into distribution,

particularly in Japan.

ManagementConsistent with plans to reinvent Burberry as a luxury brand, a new management team

was hired by GUS Plc from 1997. The most publicised of these appointments was the

hire of Rose Marie Bravo to the position of CEO. Ms Bravo had previously worked as

President of Saks Fifth Avenue in the US and had an extensive knowledge of

merchandising and distribution, together with a valuable wholesale understanding and

network.

Management has focused on:

1) eliminating inappropriate wholesale accounts, mainly to put an end to parallel trading;

2) renegotiating Japanese licences agreements;

Management

3 Bulgari

4 Burberry2 Gucci

5 Hermès

4 LVMH

1 Richemont

4 Swatch


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3) closing unprofitable and non-core retail stores; and

4) acquiring the Spanish licensee and the Asian and Korean distributors.

Our assessment of management has been made on the premise that management

should be judged on its historical record and on the merits of the strategy for taking a

group forward and should be held to account for its performance in successfully

delivering against this strategy.

As shown in Figure 23, Burberry has consistently delivered incremental return on

incremental capital. Incremental ROIIC has averaged 34.7% between the last three

reported years.

Figure 23: Returns on invested capital and incremental invested capital


Mar-00 Mar-01 Mar-02 Mar-03 Mar-04E Mar-05E Mar-06E

Invested capital 86 238 270 325 377 427 498

NOPAT @ 30% tax 13 48 63 82 98 109 123

ROIC 30.1% 29.7% 24.9% 27.5% 27.9% 27.2% 26.5%

ROIIC 23.1% 47.7% 33.2% 31.8% 22.0% 19.0%


We believe management has delivered outstanding value creation in turning Burberry

around, both through existing operations and acquisitions. Management has a proven

ability to generate returns. In our view, the challenge now is to find significant value-

enhancing growth opportunities.

Figure 24 shows the direction of our invested capital turn and NOPAT margin

assumptions going forward. We believe ROIC improvement will be driven by margins

rather than invested capital efficiency.

Figure 24: Efficiency matrix

Mar-00 Mar-01

Mar-02

Mar-03Mar-04E

Mar-05E

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0% 2% 4% 6% 8% 10% 12% 14% 16%

NOPAT Margins

I n v e s t e d C a p i t a l T u r n s

Sector Avg.

NOPAT Mg.

Sector Avg. IC x

WACC lineat 7.6%



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Design/qualityIn 1998, Roberto Menichetti joined Burberry as Design Chief and Creative Director. The

following year, Burberry launched the high-fashion Prorsum range, featured at the Milan

fashion week. This range is the source of inspiration of other Burberry lines. It was

established to reinforce Burberry’s luxury goods positioning and be a source of indirect

marketing through the attraction of considerable media attention. In May 2001,

Christopher Bailey was appointed to replace Mr Menichetti. Mr Bailey joined from Gucci,

where he had been working since 1996 as Senior Designer, and previously worked as a

designer for Donna Karan.

Also, as part of the repositioning, the Burberry London (International) line has been

upgraded through the rationalisation of sourcing, pricing and product variations.

In our view, the absolute core business of a luxury goods company is in product design

and brand management, as this establishes the ‘DNA’ of a brand. It follows then, that

design and quality of products is a key driver of value creation. As with management,

design and quality in the luxury goods industry is linked to abilities, personality and the

reputation of certain high-profile ‘stars’—and there are many of these in the sector.

If evaluation of management is unavoidably highly subjective and also highlycontentious, then in our view, the evaluation of design and quality issues is the most

highly subjective and potentially the most contentious. Accordingly, we do not

distinguish between the merits of the various companies.

Design / quality

3 Bulgari

3 Burberry

3 Gucci

3 Hermès

3 LVMH

3 Richemont3 Swatch


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Relationship with GUS

GUS originally acquired Burberry in 1955. After Burberry's repositioning in the late

1990s, GUS decided to float 23% of Burberry on 18 July 2002. After a further placing in

November 2003, GUS’ remaining shareholding in Burberry is approximately 66%.

Ongoing relationships between GUS and Burberry are regulated by the "Relationship

Agreement" signed on 11 July 2002. The rights and obligations of GUS under thisagreement depend on the percentage of issued share capital held by GUS and are

summarised in Figure 25 below.

Figure 25: Summary presentation of relationship agreement

Minimum Shareholding (15%)

Controlling shareholding (>30%)

Majority

shareholding (>50%)

Currently GUSowns 66% ofBurberry

- GUS has the right to appoint

the Chairman of BRBY’s board

- GUS is provided with BRBY’sbusiness plan after board approval

-GUS can appoint up to 1/3 of directors

- GUS provided with specific information (incl.management accounts, board minutes and press releases)

-Independence of BRBY is maintained in accordance with listing rules andmajority of non-executive directors on BRBY’s board are independent

- 2/3 of BRBY’s executive directors independent from GUS

- GUS does not take any action with could prejudice BRBY’s listing

- GUS is entitled to nominate one of the directors

- All transaction are conducted at arm’s length and on a normal commercial basis

- Directors who have a conflict of interest are not entitled to vote at board’s meetings

- BRBY provides certain legal and regulatory information to GUS


We believe there is an inherent risk associated with GUS’ controlling shareholding in

Burberry. GUS interests could conflict with those of external Burberry shareholders. In

addition, GUS has the discretion to sell a further stake of its shareholding in Burberry or

transfer a controlling interest in Burberry to a third party, which could adversely affect

the price of Burberry's shares. Following the 11% placing in November 2003, GUS

undertook to not sell further shares in Burberry for a period of 360 days from the date of

completion of the placing (24 November 2003).

GUS has for several years described Burberry as a non-core holding. We believe that

under Lord David Wolfson, GUS’ CEO until the late 1990s, GUS considered selling the

business but couldn’t find an offer that it thought the business deserved. In order to

maximise value for its shareholders ahead of a potential exit, GUS has been a willing

provider of support and capital. GUS appointed Rose Marie Bravo and provided

management support in Burberry’s renegotiation of its Japanese licensing agreements.

Relationship agreement

Burberry is considered as

a non-core holding by GUS


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Under GUS’ control, Burberry has been given the funds to buy control of operations in

Spain and Asia Pacific ex-Japan and to build out a store network.

From the point of view of GUS’ shareholders, we believe this loyalty has paid off.

Burberry represents 8.9% of March 2004E and 9.7% of March 2005E sales, and 16.0%

and 17.1% of the respective years’ operating profits. GUS’ 66% stake in Burberry would

be worth £1,319m at CSFB’s target price of 400p. This dwarfs our projected year-end

net debt of £957m and provides considerable liquidity to balance the company’ssignificant off-balance-sheet lease liabilities, which we estimate at about £3.46bn

following the acquisition of Homebase in November 2002. This presents GUS with an

interesting conundrum about how best to make use of the proceeds of any further

reduction in its stake, as full repatriation would likely tend to reduce its credit rating,

which is only just investment grade (Moody’s Baa1 stable and Standard & Poor’s BBB+

positive). We do not believe that GUS would incur any tax liability on the disposal under

current UK tax policy, so tax efficiency would not affect GUS’ decision-making about

how to exit its position, in our view.

GUS Analyst: Nathan Cockrell +44 20 7888 0320

Burberry is an important

provider of liquidity to GUS


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Financial analysis and projections

Background

Burberry was founded in 1856 when Thomas Burberry, then aged 21, opened an

outfitters shop in Basingstoke. Business flourished and several years later, in 1879,

Burberry invented gabardine, a weatherproof and resistant fabric. This process, which

was patented in 1888, is at the root of the company's development. Interestingly,

Burberry lived around the same time as Louis and Georges Vuitton. In fact, in 1888

also, Georges Vuitton invented and patented the chequered canvas pattern and a few

years later, in 1896, he registered the Louis Vuitton Monogram canvas as a trademark.

In the early 1900s, Burberry was chosen as a supplier of officers' raincoats to the British

army. During the First World War, the original raincoat design was adapted, leading to

the creation of the ‘trench coat’ and a few years later, the Burberry check, registered as

a trademark, was introduced as a lining. Building on the company's success, Burberry

expanded internationally, selling its products in France, the US and Japan.

In 1955, Burberry was acquired by GUS. Over the following decades, we believe that

implemented distribution strategies for retail, wholesale and licensing channels lacked

focus and resulted in Burberry exercising lower control over its brand. Additionally, the

company suffered from a lack of investments in key operational and support functions,

in our view. In the late 1990s, GUS decided to reposition the brand "in line with its luxury

heritage" and hired a new management team, led by Rose Marie Bravo. This strategy

having been successful, GUS decided to crystallise part of Burberry's value, which

resulted in the partial flotation on 18 July 2002 of 23% of the company. After a further

placing in November 2003, GUS’ remaining shareholding in Burberry is approximately

66%.

Figure 26 summarises Burberry’s brands, and Figure 27 shows Burberry’s turnover by

geography.

Figure 26: Summary of brands Figure 27: Turnover by geography 02/03A

Main lines



Spain

Thomas Burberry

Burberry London

Japan

Burberry London

Burberry Blue Label


Scotch House

Others



Main lines



Spain

Thomas Burberry

Burberry London

Japan

Burberry London

Burberry Blue Label


Scotch House

Others



Asia

Pacific

25%

Other

1%

Europe

50%

North

America

24%

Source: Company data Source: Company data, CSFB research

Brief history


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EVA ® analysis

Figure 28 plots invested capital turns against NOPAT margins over the period March

2000A—March 2005E.

Figure 28: Efficiency matrix Figure 29: Average IC & turnover growth

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04E

Mar-05E

1.0

1.5

2.0

2.5

3.0

5% 10% 15% 20%

NOPAT Margins

A v g . I n v . C a p i t a l T u r n s

Sector Avg. IC x

Sector Avg.

NOPAT Mg.

0

200

400

600

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04EMar-05EMar-06E

-20%

20%

60%

100%

140%

Average IC Turnover Growth

Av. IC Growth

Source: Company data, CSFB estimates Source: Company data, CSFB estimates

The chart illustrates that the efficiency profile of Burberry has substantially changed over

the last few years (by way of additional explanation, the further away a point on the

chart is from the origin, the higher the ROIC).

1) Burberry's average invested capital turns decreased substantially in the year to

March 2002, reflecting mainly the impact of the Burberry Spain (June 2000) and Asia

(December 2001) acquisitions. Notably, the £151m acquisition in Spain represented a

modest 7.6 EBIT multiple. In addition, the upgrade and extension of the retail network

weighed on asset efficiency.

2) However, the decrease in asset efficiency was compensated by a substantial

increase in NOPAT margins between March 2000 and March 2002, mainly due to the

Burberry Spain acquisition and the renegotiation of the Japanese licensing agreements.

The Spanish licensing operation had a hefty operating margin (+15% in the year to

March 2000, +14.4% in the year to March 2001).

Figure 28 also illustrates that:

- Invested capital turns are still well above the sector average. This is consistent with

lower integration into manufacturing and the importance of licensing and wholesale

operations.

- NOPAT Margins are above the sector average. This is explained by the licensing

activities, which have very high EBITA margin. In the year to March 2003, licensingrepresented 45% of EBITA with an EBITA margin of 89.7% compared with 12.1% for

the 'Wholesale and Retail' segment.

In Figure 29, we illustrate that, according to our forecasts, Burberry continues to steadily

invest capital to sustain future growth in turnover.

Impact of Burberry Spain

acquisition on efficiency

profile


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In our view, too much attention is paid to the absolute level of ROIC in any one year

relative to WACC, rather than the directional movement of the ROIC-WACC spread.

Invested capital is essentially an historical figure and is therefore of less relevance.

What matters to value creation is how incremental capital is invested in the business to

derive incremental returns to shareholders. In our view, within the luxury goods sector,

Burberry has been second to none in terms of value creation over the period since April

1999. As shown in Figure 30, using a standard cash tax rate of 30% throughout the

period (to better enable comparison across periods and groups), incremental ROIIC

over the period March 2000 to March 2003 was 28.7%, well above the company's

WACC of 7.6%.

Our conclusions from this analysis are:

- Through the repositioning of the brand, Burberry has created outstanding shareholder

value. We believe that this has been in part a result of astute picking of low-hanging

fruits after years of brand neglect, as well as sensible brand extension and acquisitions.

- Historical acquisitions (Spain, Asia, Korea) have proved that they have contributed to

shareholder value. The Spanish licensing operations were acquired for £151.1m, a very

reasonable 7.6x EBIT multiple. Also, the acquisitions in Spain, Asia and Korea offergreat development potential, in our view.

- Going forward, our estimates assume that EBITA margins are going to improve

slightly. Regarding the 'Wholesale and Retail' segment, we assume changes in

business mix, sourcing and pricing will drive EBITA margins up. On the 'licence'

segment, we believe that the EBITA margin will benefit until March 2005 from the last

scheduled increases in fees payable by the Japanese licensees (representing around

£3m each year). We assume net working capital will grow in line with sales (i.e. NWC

turns will remain constant), and we increase fixed assets in line with sales growth,

taking into account Burberry's retail expansion plans. This results in ROIC at 28.1% in

the year to March 2004E, 26.8% in the year to March 2005E and 25% in the year to

March 2006E.

Figure 30: Returns on invested capital and incremental invested capital


Mar-00 Mar-01 Mar-02 Mar-03 Mar-04E Mar-05E Mar-06E Mar-00 Mar-03to Mar-03 to Mar-06

Invested capital 86 238 270 325 377 427 498 239 173

NOPAT @ 30% tax 13 48 63 82 98 109 123 69 41 ROIC 30.1% 29.7% 24.9% 27.5% 27.9% 27.2% 26.5% 28.7% 23.7%

ROIIC 23.1% 47.7% 33.2% 31.8% 22.0% 19.0%

NOPAT @ cash tax rate 13 46 63 82 98 109 123 69 41 ROIC 29.4% 28.6% 24.9% 27.5% 27.9% 27.2% 26.5% 28.9% 23.7%ROIIC 22.2% 53.3% 33.2% 31.8% 22.0% 19.0%

Incremental


Outstanding creation of

shareholder value through

existing business and

acquisitions


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Projections

Figure 31 shows a summary of our projections for the group. The details of our

estimates are shown in Figure 51 to Figure 53.

Figure 31: Burberry: Summary of earnings data


Mar-02A Mar-03A Mar-04E Mar-05E Mar-06ETurnover 499.2 593.6 670.7 731.6 796.3

EBIT 85.4 110.3 133.6 149.5 168.9Margin (%) 17.1% 18.6% 19.9% 20.4% 21.2%

Net income 56.5 52.2 85.3 95.9 108.9CSFB EPS (Pre GW & excep.) (p) 12.13 14.64 18.14 20.25 22.82


We believe that several sales, profitability and capital efficiency drivers provide Burberry

with interesting growth opportunities in the years ahead.

Sales projections and driversOur revenue assumptions are given in Figure 32. The headline growth in revenue

results from combination of assumptions regarding the underlying organic growth in

turnover and the effects of changes in foreign-exchange rates.

Figure 32: Burberry: Revenue growth assumptions

Headline Organic

Mar-02A Mar-03A Mar-04E Mar-05E Mar-04E Mar-05E

Wholesale 20.9% 6.3% 11.5% 8.0% 11.1% 12.2%Retail 9.6% 45.6% 15.0% 10.0% 15.8% 15.0%Licence 16.8% 9.0% 13.0% 11.0% 14.6% 13.8%Total Burberry 16.7% 18.9% 13.0% 9.1% 13.2% 13.5%


We have assumed that exchange rates remain constant at levels as of 5 January 2004:

euro/pound = 1.49, dollar/pound = 1.89 and yen/pound = 201.5. On the basis of such

consistency, we expect that the average euro exchange rate for 2003/04E relative to the

pound will strengthen by 7.3% on top of a 3.8% positive variance in 2002/03A. For the

dollar, we estimate a negative currency impact of 10.3% in 2003/04E on top of an 8%

adverse movement in 2002/03A. For the yen, we estimate the adverse currency

variance in 2003/04E to be 2.0% on top of a 5.2% adverse variance in 2002/03A.

We believe that Burberry should benefit from substantial top-line growth opportunities in

the coming years thanks to:

- sustained growth in retail square footage;

- development in the US and non-Japan Asia; and

- repositioning of men apparel and development of accessories

In addition, we believe there is further upside potential in revenues to be gained from

the development of the Burberry London (International) line in Japan. This is not

currently factored into our estimates.

Sales projections

Sales drivers


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Sustained growth in retail square footageAccording to company guidance, retail square footage will expand by around 12% in the

year to March 2004 and then by around 10% for the next two years. This sustained

retail expansion should drive top-line growth. By way of comparison, we estimate that

Louis Vuitton DOS have increased from 244 to 318 since 1998, which we believe

represents an average yearly increase in retail square footage of 15%.

Figure 33: Burberry: Expansion of retail franchise

Mar-02A Mar-03A Mar-04E Mar-05E Mar-06E

Square Footage Growth 37% 12% 10% 10%

Incr. Retail Square Footage 97,226 43,200 40,320 44,352

Retail Square Footage @ YE 262,774 360,000 403,200 443,520 487,872

Number of DOS @ YE 41 47

19% attributable to

Korea acquisition


In particular, Burberry plans to focus retail expansion on the US and Non-Japan Asia

(see below). In addition, we believe that Burberry may look to open a new DOS in

Madrid (Currently Burberry has only one DOS in Spain, in Barcelona, opened in

Summer 2002). Also, the company says Italy is an important market. So far, there is

only one Burberry store in Milan, which opened in Fall 2003. However, on Friday,

27 February, Burberry announced plans for a new 8,000 square feet store in Rome, on

Via Condotti, to open in late 2004.

Development in the US and non-Japan AsiaBurberry had 47 DOS as of March 2003, including 26 stores in the US. The company

believes that there is room for further retail expansion in this market and plans to open

three or four new stores a year. The US market represented 24% of revenues in

2002/03A, helped by wholesale contribution. By way of comparison, Louis Vuitton

currently has 86 stores and Ralph Lauren 39 stores in the US.

As regards non-Japan Asia, acquisition of distributors in the region were made only

recently (Korea in March 2002, Hong Kong, Singapore and Australia in December

2001). Burberry believes there is still work to be done on the integration of these

acquisitions in order to maximise their potential upside. Burberry will accompany

development these regions by gradually adding stores in order to increase its retail

presence.

Retail square footage will

expand by around 12% in

2003/04E and then by

around 10% for the next

two years

Retail expansion in the US

Completion of Asian

acquisition integration


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Repositioning of menswear and further development of accessoriesBurberry has four main product segments: womenswear, menswear, accessories and

licences (Figure 34).

Figure 34: Turnover by product category 2002/03A

Others1%

Men27%

Women33%

Accessories29%

Licence10%


Menswear is the least invested of these categories, even though Burberry was originally

a men’s brand. This is due to the fact that Burberry's repositioning has been driven by

an initial focus on womenswear and later accessories. Figure 35 and Figure 36 clearly

demonstrate the discrepancies in terms of growth patterns between the different

segments. Management has said that Burberry will now focus its efforts on menswear,

as it believes this segment can be developed further. Menswear represented 27.4% of

turnover as of March 2003 and womenswear 33.3%. However, in terms of brand sales,the two segments generated approximately the same value. This is due to the fact that

part of menswear is licensed.

Figure 35: Detailed progression of menswear and womenswear sales

Mar-00A Mar-01A Mar-02A Mar-03A

Menswear

Sales £73.8m £142.4m £149.4m £162.8m

% of turnover 32.7% 33.3% 29.9% 27.4%

Growth YOY 93.0% 4.9% 9.0%

Womenswear

Sales £63.4m £134.7m £165.2m £197.9m

% of turnover 28.1% 31.5% 33.1% 33.3%

Growth YOY 112.5% 22.6% 19.8%


In addition, management believes there are opportunities to further develop the

accessories segment. This segment is mainly made up of handbags, scarves and

shoes, with handbags being the largest accessories product category. Accessories rose

Burberry is originally a

men’s brand

Accessories could

represent 35% of turnover

in the medium term


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from 22.2% of turnover in the year to March 2000 to 28.6% of turnover in the year to

March 2003. The company believes that accessories could represent 35% of turnover in

the medium term. One of the drivers of this progression is expected to be shoes, which

were launched in Autumn/Winter 2002 and are designed to complement the apparel

collection. In accordance with management’s comments, we believe that accessories

represent only a small percentage of sales in Spain and Japan. These two markets

therefore will be areas of focus for the development of the accessories segment.

Figure 36: Detailed progression of accessories sales

Mar-00A Mar-01A Mar-02A Mar-03A

Sales £50.2m £98m £125.8m £169.5m

% of turnover 22.2% 22.9% 25.2% 28.6%Growth YOY 95.2% 28.4% 34.7%


Further development of Burberry London (International) line in Japan

In addition, we believe there is further upside potential in revenues to be gained from

the development of the Burberry London (International) line in Japan. This is not

currently factored into our estimates.

Burberry has eight main product lines worldwide. Burberry Prorsum is the high-fashion

range, Burberry London (International) is the core collection, and Thomas Burberry is

sold mainly in Spain together with Burberry London (Spain). Burberry Blue and Burberry

Black labels are sold exclusively in Japan, as well as Scotch House and a locally

sourced Burberry London line (see Figure 54 for details of Burberry lines and

positioning).

The Burberry London (International) line has been key to the repositioning of the

Burberry brand, and we believe there is further scope to develop sales of this product

line, especially in Japan.

Currently, the Burberry London (International) line is hardly developed in Japan

compared with Burberry Blue and Burberry Black labels, Burberry London (Japan) and

Scotch House . After the expiration of the international Burberry London (International)

licence in June 2005, Burberry will have the flexibility to freely develop this line in Japan.

We believe this represents a substantial opportunity in terms of top-line growth,

especially with the development of Burberry London (International) accessories.

In order to avoid confusion between the Burberry London (International) and Burberry

London (Japan) lines , we illustrate in Figure 37 their characteristics and positioning.


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Figure 37: Characteristics and positioning of Burberry London (International) and Burberry

London (Japan) lines

- Core collection

- High-end positioning- Key to the turnaround of the Burberry brand

-Strong womenwear and accessories segments

-Main markets currently are in Europe and the US

- Products mainly sourced in Europe and the UK

- Sold only in Japan and made locally

- High quality apparel but lower positioning thanBurberry London (International) line (lower pricepoint)

- Weaker accessories mainly due to licensesheld by small local manufacturers

Burberry London (International) line Burberry London (Japan) line


A summary of the main implications of the relevant Japanese licensing agreement is

shown below, in Figure 38.

Figure 38: Summary presentation of relevant Japanese licensing agreements

- Mitsui and Sanyo have an exclusiveagreement to distribute the Burberry London (International) products in Japan.

- These distribution arrangements expire inJune 2005.

Burberry London (Japan) lineBurberry London (International) line

After June 2005, Burberry effectively has “carte blanche” todevelop the Burberry London (International) line in Japan.Development of accessories will be facilitated by expirationof licensing agreements on accessories of Burberry London(Japan) line.

- Mitsui and Sanyo have the right to design,market and distribute Burberry London (Japan)products until 2020.

- 16 licensees in Japan produce accessories forthe local Burberry London (Japan) line. Thesearrangements expire in June 2005.


In Japan, Mitsui & Co. and Sanyo Shokai have the exclusive right to sell the Burberry

London (International) products until June 2005. They also have the licence to sell the

locally sourced Burberry London (Japan) products until 2020, as part of the Japanese

licensing agreement, which also includes Burberry Blue and Burberry Black labels. Also

a group of other licensees in Japan has the right to produce the accessories range of

the Burberry London (Japan) line. Mitsui and Sanyo assist Burberry in monitoring andmanaging these licensees; these arrangements terminate in June 2005.

Taking these elements into consideration, we believe that when Burberry will have the

opportunity to freely develop the Burberry London (International) line in Japan, after

June 2005, the company will focus initially on the accessories segment. In our view, the

development of accessories of the Burberry London (International) line would be

facilitated by the termination of licensing agreements on accessories of the Burberry

London (Japan) line.


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In our view, the opportunity to develop Burberry London (International) accessories in

Japan after June 2005 is compelling.

1) Currently, sales of accessories in Japan are limited. According to Burberry

management, the locally sourced Burberry London line is made of high-quality apparel,

but accessories are weaker, mainly because they are not manufactured by Mitsui & Co.

and Sanyo Shokai but by smaller local players.

2) Over the last few years, Burberry has substantially developed accessories sales inEurope and the US, which in our view provides the company with valuable experience in

this segment.

3) Through the Japanese licensing agreements, Burberry benefits from Mitsui’s

capabilities in supply-chain management and logistics and Sanyo’s abilities to design,

produce and distribute Burberry’s apparel. In our view, these long-lasting relationships

are key to the success of the Burberry brand in Japan. As mentioned above, it is a

group of smaller licensees that produces accessories for the Burberry London (Japan)

line. Therefore, the initial focus on accessories within the Burberry London

(International) line should allow Burberry to not directly compete with its two main

licensees and therefore should not have an adverse impact on Burberry’s relationshipswith Mitsui and Sanyo.

4) Accessories generally have higher gross margin relative to apparel partly because of

the higher proportion of continuity products and lack of size differences (except for

shoes).

5) The higher proportion of continuity products and lack of size differences (except for

shoes) referred to in point 4 should also facilitate adaptation to the local market. Appare

products require cutting and sizing adjustments, which is not the case for accessories.

In addition, we believe the greater proportion of continuity products could facilitate

logistics aspects.

6) Accessories have a wide range of price points, which should provide accessible entrypoints to the Burberry brand.

In the longer term, we would expect Burberry to continue to develop other product

ranges within the Burberry London (International) line in Japan. Capture of a greater

share of the product value chain in Japan represents a great opportunity with substantia

upside potential, in our view. However, we believe it is fair to point out that development

of Burberry London (International) line is not without risk and challenges. In order to

achieve successful roll-out of accessories in Japan, Burberry might need to first

establish the premium positioning of the Burberry London (International) line in Japan,

as distinct from the lower positioned Burberry London (Japan) line. Also, Burberry will

have to continue managing its licensing relationships with Mitsui and Sanyo on the other

product lines.


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Profitability estimates and driversGoing forward, we estimate that Burberry should be able to further improve its EBITA

margins by 121bps by March 2006 (see Figure 39 for details). This is broadly consistent

with management guidance. For the 'Wholesale and Retail' segment, we believe

changes in business mix, retail presence, pricing and supply-chain management should

drive EBITA margins up. On the 'licence' segment, we believe that the EBITA margin

will benefit until March 2005E from the last scheduled increases in fees payable by the

Japanese licensees (representing around £3m each year).

Figure 39: EBITA margins assumptions by class of business

Mar-00A Mar-01A Mar-02A Mar-03A Mar-04E Mar-05E Mar-06E

Wholesale & Retail -3.4% 7.6% 9.6% 12.1% 13.5% 13.8% 14.5%Licence 81.5% 86.2% 89.0% 89.7% 88.5% 89.0% 89.0%Total Burberry 8.2% 16.1% 18.1% 19.7% 20.9% 21.3% 22.0%


We believe that the main drivers of the reasonable improvement in profitability that we

expect at Burberry are the following:- improved business mix;

- increased retail presence;

- price increases;

- supply-chain management; and

- increase in fees on Japanese licences.

Improved business mixIn our view, the development of the accessories segment will be an important factor

behind margin improvements in coming years. In fact, accessories generally havehigher gross margin due to the absence of size differences and the higher proportion of

continuity products. Handbags are the largest accessories product category for

Burberry, and cashmere scarves have historically been a core product. However, the

positive impact on profitability is slightly mitigated by the growing importance of shoes,

which require a wide assortment of sizes and variations.

Increased retail presenceBurberry is guiding to sustained retail expansion over the coming three years. Figure 40

shows the split of Burberry sales by channel as of March 2003.

Development of

accessories


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Figure 40: Turnover by channel (02/03A)

Retail38%

Wholesale52%

License10%


Figure 41 shows the growing importance of retail sales within Burberry.

This increased focus on retail should contribute to higher EBITA margins as sales

through the retail channel effectively capture the entire mark-up on products as opposed

to just the wholesale margin.

Figure 41: Progression of retail sales


Mar-00A Mar-01A Mar-02A Mar-03A Mar-04E Mar-05E Mar-06E

Retail Sales 99.1 143.2 156.9 228.4 262.7 288.9 314.9Retail Sales as a % of turnover 44% 33% 31% 38% 39% 39% 40%Retail Sales Growth YOY 44.5% 9.6% 45.6% 15.0% 10.0% 9.0%

Burberry Total Sales Growth YOY 89.5% 16.7% 18.9% 13.0% 9.1% 8.8%


Price increasesCompany policy is to pass the adverse impact of exchange rates on to customers.

Management stated that for the Spring 2003/04 collection, dollar-denominated retail

prices would increase by about 3%. As regards next fall’s collection, dollar-denominated

retail prices should increase by 3–4%. Although these increases are lower than those

announced by other luxury goods companies, including LVMH, an important factor totake into account is that Burberry has lower transactional exchange exposure than other

European luxury goods companies and therefore does not need to make up as much

revenue in times of adverse exchange-rate movements.

Retail channel effectively

captures the entire

mark-up on products as

opposed to wholesale


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Supply-chain managementBurberry also has purchasing power with its third-party suppliers; especially when

increasing the size of an order, the company has room for negotiating lower prices. As

well, we believe there is value to be extracted from inventory management, but this will

take time and we currently assume that inventories grow in line with sales, i.e. inventory

turns remain constant.

Increase in fees on Japanese licensing agreementsThe Japanese licensing agreement with Sanyo Shokai and Mitsui & Co was

renegotiated in late 2000 and runs until 2010, with a ten-year renewal clause based on

volumes. The final increase in royalty fees (before 2010) is due to take place in January

2005 and will represent £3m. From then on, there will be no increases until at least

2010.


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Valuation and catalysts for change

Discounted free-cash-flow analysisIn order to value Burberry, we have taken into account a discounted free-cash-flow

model. We also show in this section a comparison with multiples of industry peers and

the results of our analysis under the CSFB HOLT valuation framework

burberry book

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