Head To Head: Next vs Burberry

Published in Investing on 5 October 2012

Which blue-chip fashion firm should you buy today?

In this series, some of your favourite FTSE 100 (UKX) shares go head to head in a three-round contest for superiority.

In Round 1, the firms fight on earnings; in Round 2, on dividends; and Round 3 is a battle of the balance sheets. The winner will be the company that has racked up most points at the end of the contest.

Stepping into the ring today are fashion firms Next (LSE: NXT) and Burberry (LSE: BRBY).

The shares of Next and Burberry have respectively outperformed and underperformed the FTSE 100 over the past three, six and 12 months. Over six months the Footsie is up 2%, but Next has soared 22% while Burberry has plunged 35%.

Let's take our seats at ringside.

Round 1: earnings

Recent share price3,570p1,020p
Last year price-to-earnings (P/E) ratio14.116.2
Current year forecast P/E13.015.1
Four-year earnings per share (eps) compound annual growth rate (CAGR) (%)1318
Current year forecast eps growth (%)87
Operating margin (%)1720

Sources: Digital Look, Morningstar, company reports. Winners in bold.

In a close-fought round, Next takes three points, scoring strongly on relative P/E and sneaks the point on forecast earnings growth. Burberry takes two points for superior historic earnings growth and operating margin.

It's worth noting that Burberry's P/E has been considerably higher in the past: in the 20-25 area. The luxury fashion house's recent share-price performance is a good example of what can happen when market expectations of continued high earnings growth moderate to a less dynamic level, such as that seen in the current-year forecast eps growth.

Round 2: dividends

Last year dividend yield (%)2.52.5
Current year forecast dividend yield (%)2.82.7
Four-year dividend CAGR (%)1320
Current year forecast dividend growth (%)1111
Forecast dividend cover2.72.4

Sources: Digital Look, Morningstar, company reports. Winners in bold.

The second round is even tighter than the first. There's only one point -- four-year CAGR -- where one of the companies is significantly superior to the other. Burberry takes that point, but Next scores by a narrow margin on forecast yield and cover, while the pair share the spoils on historic yield and forecast growth.

Round 3: balance sheet

Price-to-book (P/B) ratio259
Net gearing (%)271-39

Sources: Digital Look, Morningstar, company reports. Winners in bold.

Burberry finishes strongly, taking both points in the final round. Next's gearing is very high, while the negative number for Burberry indicates net cash on the balance sheet.

Burberry's strong performance in round three prevents a clean sweep of round wins for Next. However, the companies are all square when it comes to the overall points tally, which is six points apiece.

Post-match assessment

The contrasting share-price performances of the two companies of late have brought their P/E and dividend yields much closer together than they have previously been. Nevertheless, Next remains ahead of Burberry on these ratings.

Next's P/E is broadly in line with the Footsie average, while its well-covered dividend gives a yield below the average. This suggests to me that the company is fair value at best at the current share price, though it deserves credit for consistent historic and forecast earnings and dividend growth, which are all broadly in lockstep.

Meanwhile, Burberry would be a snip on its current P/E if it can return to the high-teens earnings growth it's shown in the past and the shares re-rate to their previous P/E. However, analysts are forecasting eps growth of 14% for 2013-14 after the current-year forecast of 7%, so perhaps Burberry's current P/E of around 15 is a fair reflection of its prospects.

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> G A Chester does not own shares in any of the companies mentioned in this article. The Motley Fool has recommended shares in Burberry.

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