The FTSE 100 slump we’ve seen this week could be a good chance to buy quality stocks at bargain prices. Today, I want to look at two companies I’ve been watching for a while. I reckon both firms could be contrarian buying opportunities at current levels.
A quality brand
Throughout history, wealthy people have been willing to spend generously on fashion. In recent years, the Chinese market has been the main driver of growth in demand for luxury goods.
One company that’s performed well in this sector is FTSE 100 luxury retailer Burberry Group (LSE: BRBY). Naturally, the company’s business has been hit by the coronavirus outbreak in China. The Burberry share price has fallen by nearly 30% so far this year.
However, the reports I’ve seen recently suggest that outbreak is easing in China. Factories are getting back to business and travel restrictions are being relaxed. I suspect that over the next few weeks, we’ll see China getting back to business as usual.
That should be good news for Burberry, which said in February it had closed 24 of its 64 stores in mainland China. The remainder were operating reduced hours, with “significant footfall declines.”
Look at the numbers
I see this as a quality long-term stock that could be attractive at current levels. Firstly, Burberry has been in business since 1856. This suggests to me the brand has a proven and long-lived appeal.
Secondly, the company is highly profitable. Over the last year, it’s generated a return on capital employed of about 20% and an operating margin of nearly 17%. These figures are well above the FTSE 100 average.
Cash generation is good too and debt is minimal. Burberry consistently reports a net cash balance at the end of each year. Its most recent accounts showed net cash of £670m.
Growth has been inconsistent over the last few years. But prior to the coronavirus outbreak, the company was reporting strong figures for sales from new designer Riccardo Tisci’s collections.
The Burberry share price is now trading close to 1,500p. At this level, the stock is priced at 17 times 2020/21 forecast earnings, with a dividend yield of nearly 3%. I think the shares are worth a closer look at this level.
A contrarian opportunity?
Jet engine firm Rolls-Royce Holdings (LSE: RR) share price has fallen by more than 35% over the last year. The stock was falling even before the recent market sell-off, as investors questioned progress with the group’s turnaround.
I was uncertain too. But I’ve been reassured by the group’s latest set of accounts, which showed a big improvement in profitability and cash generation. Another attraction is that despite recent extra spending, the group still has very low levels of debt.
Of course, the coronavirus is a potential concern. Although I think the group’s profitable long-term maintenance contracts on existing aircraft should be safe, I am worried about the outlook for new orders. However, Rolls also operates in the defence and power generation markets, so it’s not completely dependent on passenger aircraft.
This FTSE 100 firm expects to generate £1bn in free cash flow in 2020. That would price the stock at just 10 times free cash flow, which looks cheap to me. I believe this could be a good time to start buying Rolls-Royce for a long-term portfolio.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Burberry. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020