Kering: Dressed In Gucci From Head To Toe

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About: Kering SA (PPRUF), PPRUY, Includes: LVMHF, LVMUY, PUMSY
by: Silver Coast Research
Summary

French luxury-goods conglomerate Kering released record Q4 and yearly earnings.

Many of Kering's brands reported healthy growth, but Gucci remains by far the main driver of the group's performance.

I discuss the Gucci-dependence, which can be seen both as a strength and a weakness.

Kering SA (OTCPK:PPRUF, OTCPK:PPRUY) continued a series of strong results from the world's top luxury brands, reporting record earnings for FY 2018. Expectations were high, but Kering still managed to exceed them, as Gucci's performance continued unabated. Gucci has been a resounding success under the leadership of creative director Alessandro Michele.

Its growth has made it by far the main contributor to Kering's earnings, to the extent that an investment in Kering is now effectively an investment in Gucci. The investment case goes down to one's degree of confidence in Gucci's prospects. Though I prefer the safety of the more diversified LVMH-Moet Hennessy Louis Vuitton (OTCPK:LVMHF, OTCPK:LVMUY), I can understand Gucci's appeal.

A Brilliant 2018

Kering's Q4 earnings confirmed the positive trend seen in previous quarters. Revenue for FY 2018 increased by 26%, and operating leverage worked wonders as operating income grew by 47% and net income more than doubled (+108%):

Kering 2018 results

Source: company's annual report

Growth was strong across all geographies, and Q4 performance in Asia Pacific (as with LVMH) eased the market's concerns about a decelerating China:

Kering revenue by geography

Source: company's annual report

The performance translates into EPS of €22.36 from continuing operations (discontinued operations include the Puma (OTCPK:PUMSY) stake which Kering sold in H1 2018). With net debt almost irrelevant at 0.4x EBITDA, the French conglomerate decided to raise the dividend by 75%, to €10.5 per share.

Kering EPS and dividend

Source: company's annual report

At this point, one could be tempted to attribute Kering's performance to a favorable luxury goods market in 2018. While it's true that the market was supportive, it's worth noting that Kering's growth rates were well ahead of the market's average (which was +6% according to the chart below):

Luxury goods market growth 2010-2018

Source: company's annual report

Undoubtedly, not all luxury brands are created equal, and Kering's results came from the intrinsic performance of its portfolio, in particular, Gucci's exceptional success.

Gucci is the key to Kering's performance

A look at Gucci's financials is enough to realize how critical Gucci is to Kering's fortunes. The Italian fashion house recorded operating income of €3.3bn, an amount that dwarfs Yves Saint Laurent's, the second largest contributor to Kering's earnings:

Gucci 2018 results

Source: company's annual report

Even more strikingly, Gucci's €3.3bn operating income makes up about 83% of Kering's total recurring operating income (€3.9bn). The French conglomerate is well aware of the strategic importance of its crown jewel and will keep fostering the brand's growth. Among potential developments are high jewelry, fragrance, and cosmetics to capitalize on Gucci's appeal.

Gucci strategy

Source: Q4 results presentation

Kering also intends to develop E-commerce for Gucci, consistent with the high proportion of millennials (62%) among the Italian brand's clients:

Gucci client metrics

Source: Q4 results presentation

The demographics (age groups, emerging markets) clearly favor Gucci's development, and it's only natural to see Kering trying to further capitalize on the brand's success. On the flip side, Gucci's achievements have created a Gucci-dependence that investors must be aware of when assessing Kering's prospects.

Two ways to look at the Gucci-dependence

Gucci: a unique brand

There's no denying that Gucci is a fantastic asset. We highlighted above some of its strengths: it enjoys tremendous popularity among a key demographic, the millennials. It's been quite successful in China. Such tailwinds are expected to prop up Gucci's expansion going forward.

At the center of Gucci's success is one man, creative director Alessandro Michele. The Italian, who's been with Gucci since 2002, was appointed to the prominent position in 2015. The choice was perceived as a bit of a gamble at the time, but the move has paid off handsomely for Kering.

Michele is a fascinating character, who managed to reinvigorate a Gucci brand whose sales were stagnating at the time. The creative director managed to re-position Gucci in order to appeal to millennials, rejuvenating the design, and making well-regarded moves such as going fur-free. Those interested in Michele's spectacular work can refer to this article.

Weakness: a bet on Gucci's continued success

Kering has grown dependent on Gucci. The brand has been a tremendous asset for the French conglomerate, and there is room for further growth, with sales potentially catching up with Louis Vuitton if the trend continues. But if for whatever reason, Gucci's popularity faded, Kering as a whole would suffer.

In addition, Gucci itself has arguably become dependent on Alessandro Michele as much as Kering is dependent on Gucci. Michele, to some extent, is the embodiment of the new Gucci. There's always a risk when companies are too dependent on a key product or a key man - which doesn't mean that the risk is not worth taking.

Takeaways

Kering has gone from strength to strength in the past couple of years, on the back of Gucci's stellar performance. Under the leadership of creative director Alessandro Michele, the Italian fashion house has asserted itself as one of the most valuable brands in the sector.

The flip side is Kering's dependence on a single brand, despite the quality of the rest of the portfolio (Yves Saint Laurent, Balenciaga...). I personally invested in another leading luxury conglomerate, LVMH, because of what I consider superior diversification. However, if one believes that Kering will continue to ride Gucci's success, the stock is not overly expensive at a P/E of 20 based on the FY 2018 results.

Disclosure: I am/we are long LVMH. 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 opinions and views expressed in this article are for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security, investment strategy or market sector.