Burberry checked as shares slump

Burberry's check design has become desperately unfashionable among UK investors after a modest profit warning lit up trading screens in red, a colour that is very much in vogue with retail investors in the current market.

Shares in the luxury fashion house slumped 16 per cent yesterday despite the company reporting its fifth consecutive quarter of double-digit growth. The stock vied with Debenhams for the title of worst-performing retailer of the day as a slew of disappointing news from the likes of Tesco and Blacks Leisure added to the High Street gloom.

Yet Burberry, perhaps more than other UK retailers, may have cause to be frustrated at that reaction to its performance over the peak Christmas trading period. The global fashion house only has a very small exposure to the embattled UK High Street and its shares had already been under pressure in the lead up to the results on concerns that US consumer had become more cautious when buying luxury items. Yet despite the company reporting growth of 19 per cent in the US – its largest market – in the third quarter, its shares still took a battering.

In the last three months of 2007, Burberry's total revenue increased 26 per cent to £254m, driven by a 74 per cent rise in its wholesale revenue. Yet analysts were less impressed with the company's like-for-like sales growth of 6 per cent, which was nearly half the rate of the increase in the first half.

Burberry described retail sales as "modestly behind plan". Stacey Cartwright, chief financial officer of Burberry said that the slowdown related to a problem with a new IT system in its retail operation which meant that for two weeks in November, some stores were left "crying out for stock". "The replenishment module was not as efficient as we needed it to be. It was a one-off," she said. The fashion house also suffered from problems in Spain where its sales fell.

However, it was the company's earnings guidance that really spooked investors after Ms Cartwright admitted that hitting full-year earnings expectations "looks a bit of a stretch". Analysts had pencilled in earnings, before interest and taxation, of £210m and many trimmed forecasts as a result of the cautious outlook. Burberry also indicated that in the year to March 2009, when it is expected to report earnings between £220m and £260m, that it would "feel much more comfortable at the lower to middle end of this range".

The warning partly came as a result of discounting which boosted sales but will impact margins in the short term. Melanie Flouquet, an analyst with JP Morgan, said: "Higher marked-down sales should weigh on (the) gross margin in the second half of 2008 but this negative should be partly offset by a favourable product mix and lower handbag sourcing costs this year." She argued that despite the growth slowdown, Burberry had achieved a "good showing in a tough retail environment". Ms Cartwright said that she felt the company had "taken a pounding" on the back of strong results. The fall yesterday was its largest decline since it was spun out of GUS, owner of Argos, in 2002, and added to a decline of over 30 per cent over the past year.

Although listed luxury stocks such as LVMH and Hermes have fallen in the past two months on concerns about the US consumer market and a profit warning from high-end jewellery chain Tiffany, Burberry has underperformed its closest peers. Some analysts attribute this to the company's listing in the UK where it is traded alongside the likes of Marks & Spencer and Tesco which face very different challenges to the luxury brand.

Ms Cartwright argues that the company's wealthy customer base is less prone to belt-tightening than in other market demographics, providing it with some protection from the worst effects of the credit crunch. "It would be difficult to say we won't be affected, but we are more insulated than other brands because of the customers we have," she said, pointing to the company's continued growth in the US, where the most expensive lines are showing the strongest growth.

Maureen Hinton, a leading retail analyst at Verdict, said: "It's not all doom and gloom. Burberry delivered sales growth of 26 per cent and the like-for-like growth isn't bad when you consider clothing and footwear retailing has had such a tough time over the past six months. Burberry still has a great growth opportunity in the US, China and other emerging markets."

Burberry has made significant progress in turning itself into a global luxury brand. It has also widened its product set outside the apparel market and is now famous for expensive handbags – such as the $3,000 (£1,525) Knight bag favoured by Cameron Diaz.

The move away from its traditional designs and into new products started in the 1990s under the leadership of Rosemary Bravo, and current chief executive Angela Ahrendts has picked up the baton and forged ahead with the transformation of the company. It has targeted expansion in the US and emerging markets such as China where Burberry designs have cache as being the "Best of British". It has also innovated in terms of using its famous camel, red and black check motif on its products to push into the very high-end consumer market.

Ms Cartwright said Burberry intended to focus on expensive shoes in 2008. "The luxury consumer is now attracted to Burberry and if we continue to evolve and develop all our products, it will stand us in good stead for 2008," she said. The company is trialling a smaller store format in the US called "Icon" which sells a larger proportion of accessories, such as bags and shoes, compared to its existing retail model. Although she would not confirm whether Burberry will aggressively expand the format, she said: "We're definitely onto something there."

A brand that appeals to all tastes

The Burberry brand may have substantial cache overseas as a "Best of British" luxury design but the company is still often associated in the UK with "chav" culture. A quick visit to the campsite at V Festival in Essex proves the point, where inebriated youths wearing faux-Burberry baseball caps skip through a sea of tents, gazebos all sporting the famous camel, red and black design.

Yet the "chav" effect has forced Burberry to find more stylish ways to incorporate its iconic design into its luxury products that appeal to big spenders. Chris Cleaver, managing director of consultancy Brandsmiths, said: "The trick was to make the 'Burberryness' of the item less obvious. Its products have become known for a stylishness that is much more subtle." Despite its transformation, Burberry's products are "still quite classic and English in cut, style and design," according to Mr Cleaver.

Yet Burberry's transformation into a global fashion brand to rival Gucci and Prada has been slow. Founded in 1856, the company came to prominence by equipping polar explorers like Ernest Shackleton before the War Office commissioned it to equip soldiers with its waterproof trench coats during World War One. It developed its famous check in the 1920s.

"It was more about practicality than style," according to brand expert Jonathan Gabay. However by the 1970s, the style's association with the upper classes meant that it "felt a bit stuffy – it was as rigid as its checks" according to Mr Gabay and it wasn't until the 1990s that the company pushed the design as a luxury brand that became popular with celebrities, hip-hop artists and "chavs".

Mr Gabay said that Burberry's more subtle designs are now "cool among the right sort of people" but the company still needs to work toward striking a balance between selling ultra-expensive luxury items and more mass-appeal products.