Valuing LVMH Group Through 'The Cult Of The Luxury Brand,' Part 2

| About: LVMH-Moet Hennessy (LVMHF)

Summary

In my last article, I began the process of applying the "Spread of Luxury" model from the book The Cult of the Luxury Brand to LVMH Group.

In this article, I finish that process by calculating the company's per capita sales in each region, then projecting what those sales will be in the future.

Though it is obvious that the company's sales will grow due to global economic development, my results quantify what that growth might be.

Using our estimates for that growth, we can then calculate the annualized total return for a long-term holder of the company's stock.

In a recent article, I described how The Cult of the Luxury Brand, Radha Chadha and Paul Husband’s book on the luxury industry in Asia, could be used to predict the industry’s growth on that continent.

The book argues that luxury consumption in Asia grows through a series of stages as Asian nations become more developed. As a country passes through each stage, its per capita luxury consumption rises, until it reaches the “Way of Life” stage, in which its luxury market has become saturated. The major market that best exemplifies this stage is Japan.

This model, known as the “Spread of Luxury” model, was interesting to me because it reminded me of how Warren Buffett conceived of Coca-Cola (KO) as an investment. Even though the company’s stock looked fairly valued by traditional metrics, Buffett knew that per capita Coke consumption abroad was likely to rise until it approached U.S. levels. Because of that, Coca-Cola’s stock was actually undervalued because the company could look forward to decades of growth.

Similarly, based on the “Spread of Luxury” model, the major luxury conglomerates should be able to look forward to decades of growth as per capita consumption in Asia outside of Japan approaches Japanese levels. However, what is important is quantifying this growth. After all, anyone can predict that luxury consumption in Asia—and the entire developing world—will grow as those regions become wealthier. What matters to investors is how much it will grow and how much luxury companies will benefit. By calculating this, we will be able to see whether such companies might be undervalued, and thus might make good investments.

The first company I will make such calculations for is LVMH group (OTCPK:LVMHF) (OTCPK:LVMUY). LVMH, the owner of such brands as Louis Vuitton, Bulgari, and Marc Jacobs, is the world’s largest luxury goods company. Thus, it is a logical first choice for our valuation method.

Examining LVMH’s Global Per Capita Sales By Region

In my last article, I calculated LVMH’s sales in each of its sales regions, as defined by its annual report:

Source: LVMH 2016 Annual Report

This required combining the company’s sales in each region and the company’s sales to tourists from each region. The latter addition was important. Based on my calculations, about half of the company’s sales to customers from Asia and “Other Markets” take place outside of the customers’ home regions. Because the “Spread of Luxury” model focuses on the luxury consumption levels of customers’ home regions, not the regions where they shop, it was critical to calculate the company’s total sales to customers from each region.

Those sales can be seen in this table of data from my last article:

LVMH 2016 Global Sales, by Customer Region of Origin

Sales (million euros)

Percentage of Sales

To Japanese Customers

3,429.4

8.9%

To non-Japanese Asian Customers

16,360.3

42.4%

To U.S. Customers

7,825.2

20.3%

To European Customers

6,201.9

16.1%

To “Other Markets” Customers

4,801.7

12.4%

Total

38,618.5

100.0%

It is worth noting that the calculated total sales do not equal LVMH’s actual 2016 global sales of 37,600 million euros. This is due to the rounding that occurred in my last article in estimating sales to tourists from each region. Fortunately, this error is slight—about 1% of sales.

To estimate LVMH’s growth, we need to calculate not only the company’s total sales to customers from each region, but also its per capita sales:

LVMH 2016 Per Capita Global Sales, by Customer Region of Origin

Sales (million euros)

Approximate Population (Millions)

Per Capita Sales

To Japanese Customers

3,429.4

127.0

€ 27.00

To U.S. Customers

7,825.2

321.4

€ 24.35

To European Customers

6,201.9

743.1

€ 8.35

To non-Japanese Asian Customers

16,360.3

4,309.0

€ 3.80

To “Other Markets” Customers

4,801.7

1,932.2

€ 2.49

Total

38,618.5

7,432.7

These per capita sales fit the global per capita luxury sales trends I presented in my first article about The Cult of the Luxury Brand. Japan and the U.S. have, by far, the highest per capita luxury sales. Europe’s sales are lower than what one would expect from the center of much of the world’s high fashion. This is because our results include both sales in wealthy Western Europe and less developed Eastern Europe. Per capita sales are much lower in the rest of Asia and the rest of the world, with sales in Asia a little higher due to higher sales in China, South Korea, Hong Kong, and other areas.

Predicting LVMH Sales Growth Through 2050

Using these results and the “Spread of Luxury” model, we can project LVMH’s sales growth over the next several decades.

In my first article about The Cult of the Luxury Brand, I estimated that the Asian luxury goods market should become saturated around 2050. That is my guess for when non-Japanese Asian per capita luxury consumption reaches 60% of Japanese levels. I used Japanese levels as a proxy for maximum possible consumption because Chadha and Husband’s book uses Japan as its example of a country in the final, “Way of Life” end stage of luxury consumption. However, I also assumed that luxury consumption outside of Japan would never fully reach Japanese levels due to differences in culture and development.

In that article, I also estimated that Japanese sales would grow at 0.5% per year, befitting a saturated market. Like Japan, the United States is also a saturated market unlikely to grow at more than 0.5% a year in the long run. Thus, we can assume that LVMH’s sales in those markets will grow at that rate over the next several decades.

In contrast, for Europe and the rest of the world, calculating growth rates requires us to estimate what per capita luxury goods consumption will be in those regions in 2050. Like Asia, I believe Europe will be significantly developed by then. However, I do not believe per capita luxury consumption will be as high as that for Asia. Chadha and Husband’s book argues that Western luxury brands are uniquely popular in Asia due to cultural and social factors.

Thus, if per capita luxury goods consumption in Asia outside of Japan will hit 60% of Japanese levels, per capita luxury goods consumption in Europe is more likely to reach something like 60% of U.S. levels. It makes sense, in my mind, to benchmark European consumption rates on the U.S. rather than Japan, given the closer cultural connections between the two regions. Moreover, I think we should be conservative and assume that consumption will not entirely reach U.S. levels. This takes into account cultural differences between the two regions. It also takes into account the likelihood that Europe as a whole will not be quite as wealthy as the U.S. (just as my estimate for Asia takes into account the likelihood that Asia will not be quite as wealthy as Japan).

Finally, we need to determine a 2050 per capita consumption level for the “Other Markets” region. If we assume consumption there lags European and Asian levels in 2050, a reasonably conservative consumption rate is 40% of Japanese consumption levels.

Having made these assumptions, we can start building the table for LVMH’s sales in 2050:

LVMH 2050 Per Capita Global Sales, by Customer Region of Origin

Sales (million euros)

Approximate Population (Millions)

Per Capita Sales

Comments

To Japanese Customers

€ 31.83

Assumes 0.5% Annual Growth

To U.S. Customers

€ 28.71

Assumes 0.5% Annual Growth

To European Customers

€ 17.22

60% of U.S. Sales

To non-Japanese Asian Customers

€ 19.10

60% of Japanese Sales

To “Other Markets” Customers

€ 12.73

40% of Japanese Sales

Total

The next step is, of course, to figure out what the populations of each region will be so we can calculate what sales will be in each region. Fortunately, the United Nations recently released a projection of that. Using that projection, we can fill in the rest of the table:

LVMH 2050 Per Capita Global Sales, by Customer Region of Origin

Sales (million euros)

Approximate Population (Millions)

Per Capita Sales

Comments

To Japanese Customers

3,463.1

108.8

€ 31.83

Assumes 0.5% Annual Growth

To U.S. Customers

11,185.4

389.6

€ 28.71

Assumes 0.5% Annual Growth

To European Customers

12,324.4

715.7

€ 17.22

60% of U.S. Sales

To non-Japanese Asian Customers

98,328.7

5,148.1

€ 19.10

60% of Japanese Sales

To “Other Markets” Customers

43,404.5

3,409.6

€ 12.73

40% of Japanese Sales

Total

168,706.1

9,771.8

If our assumptions play out as expected, LVMH will have about 168,706 million euros in sales by 2050, or around 4.4 times its existing sales. This increase corresponds to a compounded annual growth rate of 4.57%.

LVMH’s Expected Total Return

There are three sources of investment returns. They are, assuming all other factors stay equal:

  1. Sales growth.
  2. Dividends
  3. Changes in valuation (Price to Sales ratio)

This is a well known fact, though it is commonly represented in terms of earnings rather than sales. However, if you assume a company’s margins are constant, then you can substitute sales for earnings. I will use sales because that is what we have been calculating.

We now have numbers for two of these three drivers for LVMH’s future returns. We have estimated the company’s sales growth to be 4.57% per year. We cannot know what the company’s dividend policy will be in the future, but a reasonable estimate is that the company’s dividend yield will be the same as its present yield of 1.74%.

Similarly, there is obviously no way to tell what the company’s Price to Sales ratio will be in 33 years. However, the company’s current P/S ratio is 3.05, corresponding to a Price to Earnings ratio of 29.04. If we assume that a more reasonable P/E ratio for a high quality company whose markets have become largely saturated is 20, then the company’s P/S ratio in 2050 will be 2.10. This P/S ratio decline corresponds to an annualized drag on share prices of -1.12%.

LVMH Annualized Total Return

Sources

Contribution to Total Return

Sales Growth

4.57%

Dividends

1.74%

Change in Valuation

-1.12%

Total

5.19%

If you add up the three sources of investment returns for LVMH, the result is an annualized return of 5.19% between now and 2050.

Conclusions and Caveats

On the one hand, this is a fairly uninspiring result, given how much work has gone into it. On the other hand, I think it is interesting for several reasons.

First, though not very high, it is higher than what one would expect from simpler methods of calculating the company’s expected returns. For example, inverting LVMH’s P/E ratio results in an earnings yield of 3.44%. This is much lower than 5.19%, in the context of the long time frame we are considering.

This is reminiscent of the situation with Warren Buffett’s purchase of Coca-Cola. When Buffett invested in Coca-Cola in early 1989, the stock was “going for about 16x its 1988 profits,” according to The Compound Investor. This corresponds to an earnings yield of just 6%, much lower than the double-digit returns Buffett actually earned from his investment. The difference, came from the company’s future growth, which Buffett realized made the company’s stock undervalued, even if it wasn’t undervalued using traditional metrics such as P/E ratios.

Of course, today, everyone knows about the power of “Growth at A Reasonable Price,” or GARP investments. The point of my article is not to say that LVMH will grow due to the increasing wealth of the developing world. That’s already obvious to everyone. Rather, my article is intended to quantify that growth so that investors can see how much growth they can look forward to in LVMH, not just that there will be growth.

After all, many investors make poor investments based on vague macroeconomic theories such as “oil prices will go up” or “interest rates will fall.” Even when their macroeconomic predictions are correct, they often lose money because they don’t take the second step of calculating how those predictions will actually affect their investments. This article is meant to take that next step and make those calculations with respect to LVMH.

Those calculations, unfortunately, do not predict anything as promising as Buffett’s investment in Coca-Cola. Instead of the double-digit annual growth Coke enjoyed in the 90s, my estimate is that LVMH will grow at a much more sedate 4.57%, leading to a total annual return of 5.19%. However, this may underestimate the company’s future returns. This is because, though I think my estimates have been reasonable, they have also been conservative.

For example, the calculations that went into that growth estimate were based on global luxury goods growth rates in the past two decades. Those growth rates included the effect of inflation. Because inflation in the euro, the currency used to calculate luxury sales, has been modest over that period, the effect of inflation on those growth rates has been modest as well. If you believe that the euro will experience significant inflation over the next three decades, then LVMH’s growth will be much higher than 4.57%.

It is also worth noting that the growth rate I have estimated is an annualized rate. It is the growth rate LVMH will experience if luxury goods consumption rises linearly from now until 2050. However, real economic growth is not linear but rather more logarithmic. It begins quickly and tapers off as it approaches saturation. Because of that, an investor in LVMH will actually enjoy a higher total return than the 5.19% calculated above if part or all of the investor’s holdings is sold before 2050. This is because the part that is sold off will have enjoyed a greater than 4.57% growth rate due to the logarithmic nature of actual growth.

Additionally, my estimate assumes that LVMH’s margins will remain the same from now to 2050. This may be overly pessimistic. As one figure profiled in The Cult of the Luxury Brand notes, China will not be “a profitable market domestically in the next three to five years because of the cost of doing business,” including “the establishment of new stores [and] the establishment of distribution channels.” Though this quote is from the mid-2000s, there is no reason to believe that the costs of growth are not affecting LVMH’s profitability in emerging markets today. As those markets develop, it is reasonable to expect that margins will rise due to falling costs of expansion.

Similarly, it may be overly pessimistic to assume that LVMH’s dividend rate will remain constant. As the company’s growth slows and it spends less on expansion, it will have more money to pay out as dividends. This will boost total returns beyond my estimate above.

Finally, all of the estimates in this article are just that—estimates. As I noted in my first article on The Cult of the Luxury Brand, it is almost impossible to predict what will happen in the next 30 years. We can make some general assumptions about the world and then see what logically results from those assumptions. That is what I have tried to do in these articles about LVMH. However, no company, especially not one as large as LVMH, can be boiled down to a few simple assumptions. Any potential investor in the company would be advised to do much more research before investing.

Having applied the lessons of The Cult of the Luxury Brand to LVMH group, we can now use the same model to estimate the future growth of other companies in the industry. The next company I will consider using the "Spread of Luxury" model is Compagnie Financière Richemont, the owner of such brands as Cartier, Dunhill, and Piaget, which I will analyze in my next article.

Disclaimer: The content here is not meant as investment advice. Do not rely on it in making an investment decision. Do your own research. The content here reflects only the author's opinions. Those opinions might be wrong. This content is meant solely for the entertainment of the reader and its author.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The Amazon links in this article are associated with my Amazon Affiliates account. If you purchase items through those links, I will receive a small commission, but there will be no additional charge to you.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

About this article:

Expand
Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Tagged: , Apparel Stores, Books, France
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here