Luxury companies have been able to counter the crisis and generate huge profits over the last years. As a consequence, the stocks are currently trading at their highest level but could remain a good option to strengthen a portfolio and lower its volatility. However, luxury companies are difficult to value because their perspectives are mainly based on subjective criteria such as creativity, image or brand power, that are complicated to analyze.
The objective of this article is to highlight the Keys to understand and analyze luxury companies and draw their operating framework for the upcoming years.
According to Bain and Company, revenues should grow by 4% to 5% in 2013 and by 5% to 6% annually until 2015. It accounts for a growth 50% faster than the global GDP. The sector should benefit from the economic growth in emerging markets such as China and Brazil but also from the rise of upper middle classes.
This kind of company is not easy to quantitatively value because their main characteristic is their brand and the image that they convey to the customers. As a consequence the management could be prone to boost its value instead of the net profits for instance, which makes the financials difficult to read and interpret. Moreover a young brand can be destructed in no time and new challengers can arise very quickly. Luxury companies will have to strengthen their portfolios and adapt their strategy to the new consumption trends.
Here are some interesting criteria to use when analyzing a luxury company:
-Composition of the brand's portfolio. It tells us about the positioning of the company and its long-term strategy. I believe that the investor should first invest in firms that clearly focus on high quality and expensive luxury products and manage their brand portfolio that way. The demand for those products increases despite the crisis and the margins remain high. Too much product diversification would consume a lot of cash and could be misunderstood by the customers but also by the workers. Premium segment products remain the structure of the company and strengthen the image.
For instance, the fact that Kering sold FNAC (a retail company) in order to focus on the premium segment with brands such as Gucci can be seen very positively.
However, it appears that new segments arise and should drive the revenues over the next years. According to Bain, more "HENRYs" (High Earnings, Not Rich Yet) become potential customers each year, with 10 times as many HENRYs as ultra-affluent individuals.
In conclusion I believe that the brand portfolio should include at least a premium segment brand, a HENRY/upper middle class oriented brand and an accessory/perfume brand (with a huge and resilient customer base) but maintaining a global coherence.
-Geographical diversification. The capacity to generate revenues from all continents and especially emerging markets (mainly China now and then Brazil) is part of the business model and should be considered as a key criterion to value the company.
According to Bain and Company, several areas can be underlined as growth drivers:
- South America, notably Brazil and Mexico
- Asia, notably Southeast Asia
- Middle east, especially Dubai that attracts foreign luxury consumers
These areas could become luxury hubs and drive the revenues at long term. According to a Bain partner in Milan, "We are seeing a more even distribution of global growth. In turn, brands are refocusing from short-term, reactive hot spot thinking to long-term sustained growth strategies."
A luxury company is truly global or is nothing.
-The place of production should absolutely remain local even though it triggers higher costs, in order to maintain the quality and protect the luxury brand. The margins must be maintained through the capacity to increase the sale prices.
The evolution of sale prices and margins are interesting criteria to analyze.
-Capacity to master the supply chain. A luxury company should be able to manage the whole supply chain, from the suppliers to the distribution, in order to control the quality of the production process and protect the margin. An interesting criterion to watch could be the number of craftsmen acquisitions every year or the number of stores owned.
For instance, Luxottica (LUX) has been able to develop a vertical integration and master the whole supply chain. It made the company more flexible and able to react and adapt quickly to its environment.
-The capacity to innovate and become digital will then be Key in order to drive the revenues in the medium term. I believe that people now look for superior customer experience including more innovation, product personalization and digitization.
Luxury brands should massively invest on online tools and develop digital platforms in the short term, which might impact negatively the FCFs.
Innovation is hardly measurable. However, we can get a snapshot of the company's creativity and focus on innovation through its communication and marketing strategy.
-Ownership and key players are two criteria to watch very carefully because many luxury companies such as Hermes for instance are still owned by one or several families, which could trigger less decision power for the remaining investors. The image of the luxury company can also be linked to a person like an entrepreneur (Bernard Arnault for LVMH) or a designer (Karl Lagerferl for Chanel), which can be risky. A poor decision or the loss of a key player could have a huge impact on the company.
As a long-term investor, I would avoid LVMH for this simple reason.
LVMH (OTCPK:LVMHF) is a French luxury goods conglomerate founded in 1987. It employs more than 90,000 people and operates more than 3,200 stores worldwide. LVMH's main brands include Louis Vuitton, Dior but also Bulgari or Sephora. The company has been able to develop a strong brand portfolio over the last years thanks to an aggressive acquisition strategy. LVMH has increased its sales as well as its dividend over the last years. The French company is well diversified as 36% of the sales come from Asia and 23% come from the USA. I believe that it's a good way to catch the rebound in the US and the growth in emerging markets.
Kering (OTC:PPRUF) (formerly known as PPR) is a French company owned by François Pinault. It developed a brand portfolio focusing on luxury goods (Gucci, Balenciaga) and sporting goods (Puma). The firm recently sold La FNAC (electronic goods) in order to focus on its core business, which was seen very positively by the analysts.
The share price has increased by 46% over the last year but I believe that Kering can keep benefiting from this reorganization.
Kering is to me the global luxury company stock that has the most potential with a PE ratio still low.
Richemont (OTCPK:CFRUY) is a Swiss luxury group founded in 1988 employing now more than 24,000 people worldwide. Its brand portfolio includes Cartier, Chloé, Lancel or Van Cleef & Arpels.
Richemont's strength is mainly its positioning in the Premium segment especially with watches and jewelry that are sold between $5,000 and $10,000, which makes the company resilient to the world-wide slowdown. The stock has consequently had the most spectacular growth over the last years.
EPS ttm €
Dividend yield (%)
Source: Yahoo Finance
Luxury companies are difficult to value because their business results from intangible assets such as a brand, creativity and innovation. As a consequence, I believe that many small entities like Moleskine for instance don't have enough visibility in the financial markets but could be great opportunities.
Moreover, the sector's giants are viewed and analyzed by the investors as "simple" companies without taking into consideration specific criteria we discussed. The share price could then be misunderstood by the market.
Last Monday, a rating agency specialized in luxury companies was created. I hope it will shed the light on the sector and make it easier to benchmark and invest in.