Can Burberry engineer chart breakout?

Like the eerie mist that invades every nook and cranny in a horror film, it's not just investors in commodity cyclicals that have experienced chills down their spine since China's latest crash. Luxury goods brand Burberry has lost nearly half its value since the summer, but one broker reckons now is time to buy.

Sentiment towards luxury items don't necessarily evaporate just because global markets go through a rough patch. UBS is confident recent turbulence hasn't put a dent in spending, and analyst Helen Brand reckons Burberry is being too conservative.

"The outlook for our sector remains uncertain as the consumer and environment evolve," Burberry boss Christopher Bailey said in last week's third-quarter update. The creative director expects wholesale revenue to be flat this financial year, with new retail space generating low single-digit percentage growth and retail/wholesale profit rising just £10 million higher. Licensing revenue is likely to be down by about 40% at constant exchange rates.

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It's Burberry's lower exposure to fashionable tourist destinations like Japan that has caused sales to slip 1.5% over the last six months, not brand weakness, argues Brand. With in-depth analysis ranking Burberry in line with its luxury peers, the analyst reckons its strong digital presence and a focus on handbags will help drive like for like growth of 4% in 2017.

A 20% retail/wholesale cash earnings margin should also be achievable, although this won't happen quickly. Burberry's product mix will restrict its margin to 15.7% in 2016, compared to 25% at some industry peers. There could be some room for adjustment from an operational cost standpoint, but all management's incentives are based on pre-tax profit growth, warns UBS.

If Burberry did achieve a 20% margin, the broker's target price would soar by 100p. Hiking its rating from 'neutral' to 'buy', Brand believes the shares are worth over a third more at 1,500p. The group trades on 15.9 times 2016 earnings forecasts, which is around 8% lower than the firm's long-term average. UBS estimates sit 10% below consensus for 2017.

After topping 1,900p in February 2015, Burberry's share price has plummeted 40%, although the shares have enjoyed a small bounce from lows of 1,047p at the beginning of this year. The shares are currently testing the upper tramline of its most recent negative trading channel.

"We believe the stock is almost discounting in our downside case -3% like-for-like in FY17," says Brand. "Given its strong ranking with the Chinese consumer, brand elevation opportunity in the US, strong digital presence and Japanese roll out, we see this as unwarranted."

In addition to potential capital growth of around 33%, with a dividend pay-out ratio moving above 50%, Brand reckons buybacks could underpin the share price.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.