Valuation

Study the target: Burberry

First is to get the following information by check on Burberry’s website, Financial
times and Bloomberg to calculate Burberry’s valuations. Which would make a clear
judgment that Burberry was worth buying or not.

Dividend Discount Model

There are many kinds of Dividend Discount Model, according to the situation of
Burberry I decided to use the Two-stage Dividend Discount Model. This model works
best for firms that maintain a policy of paying out most of residual cash flows, and we
would find out that Burberry is this kind of firm as said by following calculations
(Aswath, 2012). Also consistent with the annual report of Burberry in recent five years,
Burberry is in a high growth rate and it seems can maintain it for a specific time
period after the sources that cause the high growth rate had disappeared. So the two-
stage Dividend Discount model will be the most suitable model for Burberry’s
valuation analysis.

As shown in the Table 1, I searched Burberry’s earning per share, dividend per share,
payout ratio and return on equity of the past five years. The average payout ratio and
ROE are 42.6% and 30.0% separately.

Table 1 Historical EPS, DPS, Payout ratio and ROE

Year EPS DPS Payout ratio ROE
2010 35.1p 14.0p 39.8% 26.9%
2011 48.9p 20.0p 40.9% 33.1%
2012 51.6p 25.0p 48.4% 33.3%
2013 70.0p 29.0p 41.4% 27.0%
2014 75.4p 32.0p 42.4% 29.6%
5 Year Average 42.6% 30.0%
Expected Growth Rate 17.2%

I assume Burberry will experience a stable growth period, and this will leads
Burberry’s cost of equity to 7.58%, and the expected growth rate would be very close
to UK economy growth rate of 2.00%. As a result the return on equity would be
30.00%, and the payout ratio that is in stable growth will be 74.73% as calculated.

In table 2 I calculated the present value by the cost of equity rate in high growth
9.63%, I got this number by calculated the WACC in the Discounted Cash Flow
Analysis, which will be listed below. First I put them together to calculate present
value of dividends during high growth period.
 Second, I calculated the present value of terminal value, I set up a constant model to
predict it and I finally got the Burberry’s share price 1917.32p, which is higher than
the recent Burberry’s share price 1797.00p.

Table 2 Burberry Share Price

Expected Growth
Present Expected Growth 17.21
Year EPS DPS Rate in stable 2.00%
Value Rate in high growth %
growth
Cost of Equity Cost of Equity
2016 103.59p 44.15p 40.27p 9.63% 7.58%
in high growth in stable growth
2017 121.42p 51.75p 43.06p EPS 2014 75.4p DPS 2014 32p
199.45
2018 142.33p 60.66p 46.04p Expected EPS6 Expected DPS6 149.05p
p
High growth 42.62 Stable growth
2019 166.83p 71.10p 49.22p 74.73%
pay-out ratio % pay-out ratio
2670.1
2020 195.54p 83.34p 52.63p Terminal Price
p
PV of Terminal 1686.1
PV of Dividend 231.22p Share Price 1917.32p
Price p

Assessment of DDM Valuation

The Dividend Discount Model provides a means of developing an explicit

expected return for the stock market. It’s forward looking and flexible; users
could make the model fits to reality as probable.

But also this model has some weak-point. For example, the two-stage dividend
discount model, the first problem is in defining the length of the high growth
period (Aswath, 2012). It’s too difficult to predict all the numbers and convert
them into a specific period. And the second problem is the growth rate is high
during the initial period and is transformed overnight to a lower stable rate at
the end of the period (Aswath, 2012).

Also this model would be broken down if the discount growth rate is higher then
the cost of equity, it is weaker than we thought. But in a word, this method still
fits the Burberry financial situation.
Discounted Cash Flow Analysis

Table 3 historical Operating Data

Historical Period LTM
Operating Data FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 FY 2015
Sales 1185.1 1501.3 1857.2 1998.7 2329.8 2519.4
% Growth -1.36% 26.68% 23.71% 7.62% 16.57% 8.10%
Less: Cost of Goods Sold (423.9) (491.6) (558.3) (556.7) (671.3) (725.8)
% Sales 35.77% 32.74% 30.06% 27.85% 28.81% 28.81%
Gross Profit 761.2 1009.7 1297.4 1442.0 1658.5 1767.6
% Margin 59.5% 67.3% 69.9% 72.1% 71.2% 70.2%
Operating Expenses &other
(544.7) (707.6) (916.9) (1023.9) (1190.5) (1162.9)
operating Revenue
% Sales 46% 47% 49% 51% 51% 46%
EBIT 216.5 302.1 380.5 418.1 468 604.7
% Margin 21% 24.3% 25.2% 26.5% 26% 24%
Less: Taxes (58.8) (83.2) (100.6) (91.5) (112.1) (114.1)
NOPAT 157.7 218.9 279.9 326.6 355.9 490.6
Plus: Depreciation& Amortization 52.3 62.6 87.6 111.2 138.6 126.0
% Sales 4% 4% 5% 6% 6% 5%
Less: Capital Expenditures 69.9 108.4 126.1 158.1 129.5 163.8
% Sales 6% 7% 7% 8% 6% 6.5%
Less: Increase/Decrease in Net
-61.6 -93.4 16.7 -174.8 73.9
Working Capital
Unlevered Free Cash Flow 140.1 111.5 148.0 296.4 526.7
 Table 4 Historical Working Capital Data
Historical Period LTM
Working Capital Data FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 FY 2015
Current Assets
Accounts Receivable 108.3 119.2 131.9 144.3 209.3 186.4
Day sales outstanding
33.4 29.0 25.9 26.4 32.8 27
(DSO)
Inventory 166.9 247.9 311.1 351 419.8 397.7
Day inventory held (DIH) 143.7 184.1 203.4 230.1 228.3 200
Prepaid Expenses and
471.7 476.2 569.2 468 578.6 680.2
Other
% Sales 39.80% 31.70% 30.60% 23.40% 24.80% 27.00%
Total Current Assets 767 870.1 1017 967 1210 1264

Current Liabilities
Accounts Payable 62,1 85.8 118.8 118.2 174.3 145.16
Day Payables outstanding
53.4 63.7 77.7 77.5 94.8 73
(DPO)
Accrued Liabilities 120.4 164.6 162 184 189 237
% Sales 10.10% 11.00% 8.70% 9.20% 8.10% 9.40%
Other Current Liabilities 319.3 283.9 316.4 261.1 268.8 377.9
% Sales 26.90% 18.90% 17.00% 13.00% 11.50% 15.00%
Total Current Liabilities 501.8 543.3 596.8 563.5 631.7 759.9
Net working capital 265.2 326.8 420.2 403.5 578.3 504.4
(Increase)/ Decrease in
NWC n/a -61.6 -93.4 16.7 -174.8 73.9

Project Free Cash Flow

 I have selected the last five years performance of Burberry to get information of its
financial performance. Because as a big company, five years period would set me a clear
of Burberry’s current situation. And typically, the target’s free cash flow for a period of
five years will be projected (Joshua& Joshua, 2009). So, I will projected them by the
information I found at the Bloomberg Terminal.

Table 5 Projections
Projection
period
Operating Data FY 2015 FY 2016 FY 2017 FY 2018 FY 2019
2794.
Sales 2519.4 3066.8 3306.3 3637.5
7
10.90
% Growth 8.10% 9.70% 7.80% 10%
%
(805. (1048.
Less: Cost of goods sold (725.8) (883.5) (952.5)
2) 0)
28.81
% Sales 28.81% 28.81% 28.81% 28.81%
%
1969.
Gross Profit 1767.6 2165.9 2334.2 2588.1
1
70.20
% Margin 70.20% 70.20% 70.20% 70.20%
%
Operating Expenses &other 1298.
1162.9 1429.9 1540.7 1715.1
operating Revenue 4
% Sales 46% 46% 47% 47% 47%
EBIT 604.7 670.7 736.0 793.5 873.0
% Margin 24% 24% 24% 24% 24%
(113.
Less: Taxes (114.1) (115.2) (116.7) (115.6)
4)
NOPAT 490.6 557.3 620.8 676.8 757.4
Plus: Depreciation& Amortization 126.0 139.7 153.3 165.3 181.9
% Sales 5% 5% 5% 5% 5%
(181.
Less: Capital Expenditures (163.8) (199.3) (214.9) (236.4)
7)
% Sales 6.50% 6.50% 6.50% 6.50% 6.50%
Increase/(Decrease) in Net Working
73.9 -55.1 -54.4 -48 -66.3
Capital
Unlevered Free Cash Flow 526.7 460.3 520.4 579.2 636.5

Projections
I projected Burberry’s growth by using the numbers I found in Bloomberg Terminals; I estimated
the sales of Burberry would be 2519.4 in 2015, 2794.7 in 2016, 3066.8 in 2017, 3306.3 in 2018
and 3637.5 in 2019. I got these results by search Burberry’s comparable companies, and I held
the cost of goods sold constant of 28.81% of sales and held the gross profit margin and EBIT
margin constant as 70.2% and 24%. With these constant we can get a completely form of
Burberry’s projections.
I also projected the tax, Depreciation& Amortization, Capital expenditure and the changes to
project the free cash flow of Burberry. With the EBIT and Tax, I got NOPAT.
Since Depreciation& Amortization were constant as a percentage of sales of 5%, which was set
up by me, I can calculate the rest part easily.
And about the Capital Expenditures, I set it constant as 6.5% of sales according to its historical
levels.

Table 6 Working Capital Projections

Projections period
Working Capital Data FY 2016 FY 2017 FY 2018 FY 2019
Current Assets
Accounts Receivable 206.7 226.9 244.6 269.1
Day sales outstanding (DSO) 27 27 27 27
Inventory 441.2 484.1 521.9 574.2
Day inventory held (DIH) 200 200 200 200
Prepaid Expenses and Other 754.6 828.0 892.7 982.1
% Sales 27.00% 27.00% 27.00% 27.00%
Total Current Assets 1403 1539 1659 1825
Current liabilities
Accounts Payable 161.04 176.7 190.5 209.6
Day Payables outstanding (DPO) 73 73 73 73
Accrued Liabilities 263 288 311 342
% Sales 9.40% 9.40% 9.40% 9.40%
Other Current Liabilities 419.2 460.0 495.9 545.6
% Sales 15.00% 15.00% 15.00% 15.00%
Total Current Liabilities 842.9 925.0 997.2 1097.2
Net working capital 559.6 614.0 662.0 728.3
(Increase)/ Decrease in NWC -55.1 -54.4 -48.0 -66.3

Change in Net Working Capital Projections

I held the Day sales outstanding and Day payable Outstanding as constant to calculate the
accounts receivable and accounts payable, and I also held the DIH and the accrued liabilities,
Other current liabilities as constant to get the final results of change in Net Working Capital
projections.
 Table 7 WACC Calculations
Burberry’s Capital Structure
Debt to Total Capitalization 4.20% Equity to Total Capitalization 95.80%
Preferred Equity to Total Capitalization 0.00%
Cost of Debt Cost of Equity
ST Debt to Total Debt 1 Risk-free Rate 1.66%
Note Rate 0.44% Beta 0.99
Cost of ST Debt N/a Expected Market Return 10.12%
Cost of LT Debt N/a Equity Risk Premium 8.46%
Total Pre-tax Cost of Debt 0.44% Cost of Equity 10.04%
Tax Rate 24.11%
Debt Adjustment Factor 1.36
After-tax Cost of Debt 0.33% WACC 9.63%

Calculation of Weighted Average Cost of Capital

I got some of the data of table 7 in Bloomberg Terminal, such as Note Rate, Tax rate, Risk-free
Rate, and use these numbers I got the WACC of 9.63%.

Table 8 Comparable companies’ exit multiple

Name EV/ EBIT Name EV/ EBIT
Median 15
TED BAKER PLC 22.27 RALPH LAUREN CORP 10.94
NEXT PLC 13.43 CHRISTIAN DIOR SE 8.39
HERMES
22.13 BROWN (N) GROPU PLC 11.92
INTERNATIONAL
PRADA S.P.A. 15.72 KERING 13.92

As you see in the Table 8, I had found some comparable companies in Bloomberg Terminal and I
also found their EV/EBIT rate to get the median, which I think would be helpful in calculating
the companies’ exit multiple.

Table 9 Comparable companies’ exit multiple

Exit Multiple Method Implied Perpetuity Growth Rate
Terminal Year EBIT (2019) 873 Terminal Year Free Cash Flow (2019) 636.5
Exit Multiple 15 Discount Rate 9.63%
Terminal Value 13095 Terminal Value 13095
Implied Perpetuity Growth Rate 4.32%

Perpetuity Growth Method Implied Exit Multiple

Terminal Year Free Cash Flow
636.5 Terminal Value 11989
(2019)
 WACC 9.63% Terminal Year EBIT (2019) 873
Perpetuity Growth Rate 4.32% WACC 9.63%
Terminal Value 11988.63835 Implied Exit Multiple 14

In Table 9, I calculated the implied exit multiple use the perpetuity growth method. And I
believed that the Burberry is a mature company now, it is growing in a steady growth rate, so I
set the Exit multiple of 15.

Calculation of Enterprise Value

I discount the terminal value and free cash flow in table 10 and I finally got the
Enterprise value of Burberry, it is 8689.9, and the Burberry’s enterprise value now is
7922.6. So according to this result we definitely should buy Burberry.

Table 10 Enterprise Value

Projection Period
WACC: 9.63% FY 2015 FY 2016 FY 2017 FY 2018 FY 2019
Unlevered Free Cash Flow 526.7 460.3 520.4 579.2 636.5
Discount Period 0.5 1.5 2.5 3.5 4.5
Discount Factor 0.96 0.87 0.79 0.72 0.66
Present Value of Free Cash Flow 503.04 401.0 413.5 419.8 420.8

Terminal Value Enterprise Value

Terminal Year EBIT (2019) 873 Present Value of Free Cash Flow 420.84
Exit Multiple 15 Present Value of Terminal Value 8269.1
Terminal Value 13095 Enterprise Value 8689.9
Discount Factor 0.6
Present Value of Terminal Value 8269.1

Assessment of DCF Valuation

DCF valuation has many advantages, it focus more on fundamental information and it
calculated based on cash flows, which reflects the value of projected free cash flows. Also
it is independent compare to other methods (Joshua& Joshua, 2009). But the most
important reason why almost of all the bankers are using this method is because of its
flexibility.
 But this method also got many problems, it forecast the figure based on projects, so it is
impossible that there is no mistakes, the financial market changes all the time (Chris&
Frank, 2010). And it is sensitive to change, a small change could influence whole project.

Multiples’ Valuation
According to the Bloomberg Terminal, I found following comparable companies
as the initial selected companies.
Table 11 Burberry’s Comparable Companies from Bloomberg Terminal
TED BAKER PLC HERMES INTERNATIONAL
NEXT PLC KERING
ESPRIT HOLDINGS LTD PRADA S.P.A.
BROWN GROUP PLC TOD'S SPA
INDITEX X5 Retail Group NV

And in order to get the best suitable companies I looked up their subsector, operating regions
as well as their size. Then I finally selected 5 companies, as presented in table 12.

Table 12 Burberry’s Final Comparable Companies

TED BAKER PLC
NEXT PLC
KERING
PRADA S.P.A.
INDITEX

Table 13 Burberry’s Comparable Companies financial information

ES Net
EV/EBITDA EBITDA ES P/E Ratio ES Net Debt
Income
Median 13.1 874.45M 21.4 522.47M -156.26
BURBERRY 12 586.79M 21.2 338.57M -489.6M
NEXT 11.6 974M 16.5 653.78M 533.35M
KERING 12.1 1680M 16.5 976.12M 2880M
TED BAKER 17.5 71.18M 29.6 43.35M -0.08M
PRADA S.P.A. 13.1 774.9M 26.5 391.16M -312.44M
INDITEX 19.5 3430M 33.2 2100M -3680M

The most appropriate valuation range for Burberry should be relied on the multiples of the best
comparable companies, which are NEXT PLC and KERING PLC. As showed in Table 13, the
two closest comparable companies that trade in the range of approximately 11.5-12.5
EV/EBITDA and their estimated range of the P/E Ratio is 16.0-17.0.
So I used these two range to calculate the enterprise value for this year and next year. Then I
 have the range of current implied enterprise value 6748M-7335M, and the range of 2016 implied
enterprise value 5780M–6358M.

Table 14 Burberry’s Implied Enterprise Value

EV/EBITDA Implied Enterprise Value ES P/E Ratio 2015 ES Net Income 2015 Implied Enterprise Value 2015
11.5 6748M 16 5780M 4928M
12.5 7335M 17 6358M 5266M

Assessment of Multiples’ Valuation

The multiples’ valuation method is based on public data, which means if the market is
fairly priced we could get the correct valuation. But this method also based on the
valuation of other companies, which means we will miss something like weakness,
opportunities and so on.
But using this method we could calculate the valuation easily and we can use it to
compare with other companies.