LONDON (Reuters Breakingviews) - Burberry’s new boss is taking a big gamble on delayed gratification. Chief Executive Marco Gobbetti’s plans to take the British brand upmarket will mean no sales or operating margin growth for more than two years. Disappointed investors who lopped almost 1 billion pounds off Burberry’s market value on Thursday will now be unforgiving. Only flawless results and the right new designer will prevent a further slide in the share price.
Gobbetti, the former boss of LVMH-owned brand Celine, outlined some of the costs of polishing Burberry’s image. Capital expenditure will grow to 150 million to 160 million pounds annually, up about 50 percent from last year. As a result, Burberry’s operating margin, which is already a quarter or more below the level of its peers, will stagnate. That’s a huge disappointment for investors. The company’s shares were as recently as Wednesday valued almost as richly as Gucci-parent Kering, which is trading at 23 times expected earnings for the coming year. That record high valuation for Burberry was 25 percent above the average of the past five years.
The new CEO could have opted for a more crowd-pleasing sales recovery by competing with cheaper U.S. labels Coach and Michael Kors. A volume-led rebound in revenue would have quickly secured margins of 20 percent or more and boosted Burberry’s share price by 80 percent over three years, according to Bernstein estimates. Going upmarket is the tougher and riskier proposition. Even in the best-case scenario, Burberry’s share price will increase by just 13 percent, Bernstein reckons.
But it’s probably the right choice. If Gobbetti can pull it off, Burberry’s profitability should finally catch up with peers Kering and LVMH. And while he is testing investors’ patience, Gucci’s turnaround suggests his timeline is realistic. Kering’s marquee brand took about 20 months to show convincing results after hiring a new CEO in late 2014. Everything from new marketing tactics to finding a top-notch replacement for designer Christopher Bailey, will have to be flawlessly delivered to prevent a further dip in the company’s valuation.