By Seerat Sandhu (Scripps College), Udhaav Jhunjhunwala (Singapore Management University), and Chirag Gupta (New York University)
Edited by: Callum Magee (University of Glasgow) and Charlie Solnik (California Polytechnic University)
Overview of the Deal
The luxury retailer, Burberry Group Plc entered the bond market for the first time ever to issue a benchmark-sized, medium-dated, sustainability bond worth £300 million in the month of September. The funds from the issuance are expected to boost the company’s liquidity profile and help provide funds to finance ‘eligible green projects.’
The luxury brand’s issuance comes amidst a rising global trend towards sustainability and sustainable finance. Being the first of its kind, the issuance is set to act as an inspiration for other luxury brands to tap into the capital markets in the future. The bond issuance has received a Baa2 credit rating by Moody’s and reflects a stable outlook.
The proceeds from the issuance will help the company implement new technologies and strategies needed to emerge through the pandemic. It will also help the company meet its long-term sustainability goals.
Macroeconomic Trends
The fashion industry has been on high alert since the onset of the coronavirus pandemic. Brick and mortar stores have been experiencing a rapid decrease in footfall. This decline, coupled with the impact that reduced air travel has had on luxury sales at airports, has had a material effect on the business of high fashion brands like Burberry. Hence the pandemic has materially altered the cash generation abilities and revenues of brands such as Burberry due to slow economic growth and different policies pertaining to store reopenings. At the global level, leading fashion houses such as Neiman Marcus, J.C Penney and Roberto Cavalli have filed for bankruptcy, while many more can sense the impending doom.
Digital innovation and integration have been integral to mitigate the pandemic related risks and brands have been pushed to produce innovative methods to bypass the traditional marketing channels. Most retail brands have been offsetting the losses in Europe and North America by expanding their reach in China, where demand has relatively bounced back to earlier levels. Burberry has already been leveraging technology to widen its reach in China and the South Asian markets, and the pandemic has further hastened the process. The Company’s emphasis on customer engagement through digital platforms has helped it weather the pandemic related business disruptions better than many of its competitors.
The rise of sustainability has been shaping businesses world over, and the fashion industry is no exception. The fashion industry by itself accounts for 20 to 35 percent of microplastic flows into the ocean. Due to the heightened awareness surrounding sustainability, organizations are shifting to using cleaner materials and processes. According to McKinsey, a ‘Materials Revolution’ is well underway, with companies undertaking huge innovation and R&D costs to switch to bio-based materials and more ethical practices. Hence, companies have been tapping into the bonds market to fund the costs associated with such a shift. In fact, Moody’s raised its 2020 forecast for issuance of sustainable, green, and social bonds to $375 billion. Hence, the Burberry bond issuance is in sync with the broader market trends pertaining to rising in sustainable financing. Being the first luxury brand to approach the capital markets for a green bond, the company is expected to act as a trendsetter for many more similar issues in high fashion in the near future.
Company Details
Burberry is a British luxury fashion house and one of the most notable and recognised fashion brands in the world. Burberry is primarily engaged in designing, manufacturing, retailing, licensing and wholesaling of clothing and apparel. With over 400 stores across the world, they operate through a multi-channel retail strategy with a diversified network of company-owned, franchisee, wholesale and online stores.
Founded in: 1856
Headquartered in: London, United Kingdom
CEO: Marco Gobbetti
Number of Employees: 10,161
Market Cap: £6.3 billion
EV: £6.8 billion
LTM Revenue: £2.63 billion
LTM EBITDA: £522 million
LTM EV/Revenue: 2.6x
LTM EV/EBITDA: 9.2x
Figure 1: Current Capital Structure
Credit Ratings
Credit Rating agency Moody’s gave a Baa2 long-term rating to fashion giant Burberry group plc for the first time and a Baa2 rating to the company’s planned senior unsecured notes.
The current rating outlook for Burberry is stable reflecting a belief in the company’s solid position in China, owing to strategic partnerships and programmes. Consequently, the rating will help the company weather pandemic related headwinds as the Chinese markets have been the fastest to bounce back. Further, the company’s well established e-commerce networks and technological adaptability are expected to help boost its performance amidst the pandemic.
The company has a strong liquidity position due to its access to a £300 million revolving credit facility and £600 million in proceeds from Her Majesty’s Treasury (HMT) and Bank of England’s Covid Corporate Financing Facility (CCFF). The bond issuance will further help boost the company’s liquidity and provide additional insulation to the company in the event of a second wave of coronavirus cases.
Figure 2: Bond Structure
Projections and Assumptions
Why was this deal done?
Burberry’s solid liquidity position can be considered as an indicator of the brand’s financial health and raise questions about the need for additional funding. However, the reputational benefits associated with issuing the first sustainable bond in the luxury fashion industry and setting the benchmark for their competitors should make the entire exercise valuable. Additionally, the green bond will bring long-term debt into Burberry’s capital structure and help them gain a new source of funding while the attractive interest rate of 1.125% will likely help them reduce their cost of capital on a blended basis.
The company has announced that the proceeds of the bond will be used to further the sustainability initiatives taken by them as described in their Sustainability Bond Framework. Some of the initiatives that Burberry outlined include reducing greenhouse gas emissions from their warehouses and buildings as well as implementing responsible sourcing practices across their supply chain.
Short-term Analysis
Burberry has been at the forefront of innovation with respect to greater sustainability across its entire operations. In April 2020, Burberry launched ‘ReBurberry Edit’ as part of their Spring/Summer collection which consisted of 26 unique styles, each made from Burberry’s state of the art sustainable materials. The launch of this collection coincided with the unveiling of exclusive sustainability labels across key product categories which provides buyers insights and details about the product across a range of sustainability-linked criteria.
The bond has been issued in compliance with Burberry’s Sustainability Bond Framework, which outlines three distinct categories for which the bond proceeds can be used: green buildings, sustainable management of natural resources and land use, and pollution prevention and control. Burberry has been actively engaged with its supply chain partners to ensure these goals are met at every step in the process. As of August 2020, 16 supply chain partners of Burberry have switched to renewable energy sources. These green practices will prove monumental in terms of promoting competitors of the company to consider sustainability in their practices.
Burberry is currently focusing on corporate responsibility, including animal welfare and sustainable cotton farming. MSCI, a leading ESG rating provider, rates Burberry as ‘AAA’, which is the highest among 29 companies rated in the textiles, apparel, and luxury goods industry. Sustainalytics ranks Burberry as 1/188 in the textile and apparel industry for their ESG efforts which further reduces the potential for green-washing and provides ethical investors with added confidence in Burberry’s green motivations. The bond sale is also expected to offset sales which fell by almost half and prompted 500 job cuts worldwide.
Long-term Analysis
Burberry has set ambitious targets in its ‘Responsibility Agenda’ for the five year period ending 2022. The proceeds from the bond will go towards achieving these targets in the three areas for which the proceeds are earmarked. Some of the key goals set out by them are:
Reducing emissions, improving energy efficiency and sourcing a greater proportion of their energy from renewable sources to achieve a zero carbon footprint by 2022 in their operational use
Using 100% renewable electricity by 2022
Reduce waste generation through reusing, repairing, donating, and recycling unsaleable products
In addition to these goals, Burberry is also working closely with partners across its supply chain, manufacturers, retail landlords as well as the broader community to create positive social impact across various programmes.
The benefits of these initiatives are likely to be seen in many forms. Firstly, as consumers become environmentally conscious and increasingly aware of what they are purchasing, Burberry can attract consumers who actively look out for ethical brands and products. Secondly, as asset managers become more conscious of their portfolio companies' ESG performance, Burberry is primed to be their first choice in the fashion industry as evidenced by its Sustainalytics and MSCI ranking. Thirdly, green financing and green bonds are becoming increasingly popular with investors since the returns on these products are comparable to traditional bonds but the volatility associated with them is significantly lower especially when markets are stressed.
All of these factors combined means that Burberry finds itself in a unique position where it can cement its position as a leader in sustainability in the fashion industry by meeting their sustainability goals.
Financial Ratio Analysis
Figure 3: Burberry Key Financial Ratios
Burberry saw slight improvements on its Return on Capital, Return on Equity and Return on Assets in the period from 2016 to 2019 before seeing a sharp decline in 2020 which can be attributed to weak performance due to the Covid-19 induced lockdowns. It remains to be seen whether they are able to reach the pre-pandemic levels going forward.
They have maintained relatively stable EBIT and EBITDA margins in the last few years with a slight decline in the last two years. On the other hand, Net Income margins saw an increase in 2019 and a sharp decline in 2020 possibly due to Covid-19 lockdowns and the impact it had on the entire fashion industry. Net Income margins will probably not see a rebound until the pandemic has eased and consumer spending sentiments return to pre-pandemic levels.
The company is relatively under leveraged and had no debt on its balance sheet until this year. With the issuance of the latest green bond, it seems that the company is moving towards optimizing their capital structure by taking on more debt to take advantage of the interest tax shield and lower their blended cost of capital.
The Cash Conversion Cycle has seen a significant improvement from 178.2 days to 119.3 days in the last 5 years showcasing greater efficiency of operations. The improved efficiency is also visible in the higher Accounts Receivable Turnover and Inventory Turnover ratios.
Risks and Uncertainties
The adherence to strict health protocols and social distancing measures has presented a challenge to luxury brands that pride themselves on offering a rich (in-person) customer experience. These brands have been pushed to adapt to newer E-commerce channels in record time. Like other market players, Burberry will have to come up with unique strategies to offer an interactive and personalized customer experience via virtual platforms and technology. The company will have to curate content for social media and meet the needs of its consumers in newer, more efficient ways than before. A failure to do the same has the potential to threaten the company’s future performance and existence.
The increasing pressure to address sustainability and incorporate technology during this period of extreme uncertainty and low earnings poses additional operating risks to the company. Unlike its competitors, Burberry does not hold a diversified portfolio of product offerings and operates through a single brand. The company is highly susceptible to fashion risks and changes in consumer tastes because it generates revenue solely through its apparel line.
With a rapid increase in layoffs and unemployment rates, the pandemic has undermined the paying capacity of individual households. This fall in discretionary income has affected the appetite for luxury goods. This change in consumer habits and sentiments with regards to the consumption of luxury goods directly affects the performance of high fashion brands like Burberry in the short-run. Although, as per speculation, the demand for luxury brands is expected to bounce back post-pandemic, the company still faces huge risks pertaining to change consumer preferences in the long run which may persist long after the effects of the pandemic have worn down.
In recent years, Burberry’s growth strategy has been heavily reliant on its expansion in China. The company launched a game called ‘RatBerry’ in China in its efforts to engage with the younger customer demographic. It has also partnered with the Chinese tech giant Tencent for the development of a unique flagship store in Shenzhen . The store, which opened in August 2020, blends the digital and physical realms to offer a unique shopping experience. Burberry has been making huge investments in China and the pandemic has further accelerated this trend. Companies are relying on Chinese sales to offset the losses caused by the loss of business in Europe and North America. Although the Chinese market offers enormous growth prospects, it also poses additional risks in terms of political instability and government restrictions.