Despite Short-Term Risks, The Safe Yield Of 7 Percent Makes Hugo Boss A Value Play (OTCMKTS:BOSSY)

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Summary

Hugo Boss has reached a price level where it has not been traded for many years.
I think a window has opened up for investors where there is an excellent opportunity/risk ratio.
The dividend alone, which is covered more than twice by cash flow, attracts with a yield of about 7 percent.
The market also does not seem to sufficiently value the progress made by management.
Compared to its competitors, Hugo Boss has a very attractive valuation. It is also trading at a large discount compared to its own historical operating performance.

Introduction

Regarding Hugo Boss (OTCPK:BOSSY), a window of opportunity may have opened up for investors to buy cheaply in the shadow of the macroeconomic uncertainty and high volatility in the markets. In my previous analyses, I have always said that I would wait with buybacks. In general, to be honest, I have been very reserved towards the company and have (only) briefly considered selling outright. However, I still held the shares. This was mainly due to my long-term investment approach and dividends. Even if I thought a small cut was possible here, the expected return was satisfactory enough for me as a cash flow oriented investor. The "conclusion" of my last analysis on Hugo Boss sums up my mindset appropriately.

Hugo Boss is doing better operationally than many expected. Therefore, it was right not to sell my shares. However, the preliminary figures for the fourth quarter reveal that not everything is yet running smoothly at the company. Nevertheless Hugo Boss has the momentum on its side right now. However, I will not buy any new shares, but simply collect the juicy dividend in May. I think a reduction is possible here. But it should not be too high. Hugo Boss may even keep the payout stable.

In the course of the Corona Shock, however, the share price has now approached its multi-year lows again. At present, Hugo Boss is only a very small part of my portfolio. I will continue not to sell. Instead, I am considering using the situation to increase my existing positions. I will explain the reasons for this in this article.

Why a repurchase may make sense now

As a long-term investor, short-term fluctuations in a company's business are not important. Nevertheless, I am considering increasing my shares in Hugo Boss a little. Right now is a good time for that. These are the reasons.

Better than expected results

First of all, Hugo Boss has announced quarterly and annual figures. Given the uncertainties in the market, the figures would mark them as quite surprisingly good. Not only did the company have to deal with costly internal restructuring, but the unrest in Hong Kong had also had an extremely adverse effect on business last year. The same is true for the Corona epidemic. Nevertheless, the annual results were solid.

Revenue was up by 3 percent. EBIT (EUR 333 million) was down only 4 percent. According to the earnings statement, this is attributable to a lower gross profit margin as well as an increase in operating expenses. The return on equity was 20 percent. For 2020, the company expects revenue growth within a range of 0 percent to +2 percent. EBIT is expected to be between EUR 320 million and EUR 350 million. The company generated record sales in Europe, Asia/Pacific and in the licensing business in particular. Only the American business is still very weak.

(Source: Annual report 2019)

Furthermore, Hugo Boss achieved a rising ratio of free cash flow to assets, suggesting that the company is using its assets to collect cash in a better efficient manner:

(Source: Annual report 2019)

Given that and taking a more long-term investment approach into account, the company has developed quite stably during the last 10 years.

(Source: Annual report 2019)

Strategic focus

There were specific reasons for the poor operating performance that began in 2015. Due to the expensive expansion of stores, Hugo Boss was significantly less profitable. This led to profit warnings, a drastic dividend cut and the subsequent crash of the Hugo Boss share in 2015. After this price shock, the new CEO Langer had to fight hard against poor performance. In particular, unprofitable businesses had to be closed down and the focus shifted to just two brands, Hugo and Boss. Therefore, Hugo Boss started to focus on its four strategic growth drivers:

The quadrupling of sales in the online business.
Significant improvement in retail sales productivity.
Above-average growth in Asia.
Two brand policy: Significant sales increase for Hugo.

(Source: Annual report 2019)

Hugo Boss plans to roughly quadruple sales in its own online business by 2022 and the company is making progress here. Online growth is accelerating, which I like a lot. Although they still only account for 5 percent of all sales. But this shows the potential that Hugo Boss still has here. Achieving the goal by 2022 is ambitious, but it can certainly be achieved in three years.

(Source: Annual report 2019 and 2017)

They are making progress in their Asia business as well. According to the new strategic focus, the share of sales in the Asia/Pacific region is expected to grow to around 20 percent by 2022. And despite the difficult circumstances, Hugo Boss is delivering. Growth in Asia is higher than the average growth in the other regions.

(Source: Annual report 2019)

Hugo Boss can hope for fundamental tailwind, as the market for luxury goods is expected to continue to grow:

(Source: Further growth in the Luxury Fashion market)

Hugo is also getting a grip on sales for the Hugo brand after two weaker years. According to the words of the company, the brand Hugo is targeting customers who are significantly more expressive and consider their style to be an important element in expressing their personality. To this end, Hugo Boss has opened its own Hugo stores and invested primarily in marketing. With success, it seems. The growth of the Hugo brand was 6 percent and, therefore, above the average growth.

(Source: Annual report 2019)

Thus, the strategy for the Hugo brand seems to be successful. Hugo Boss combines clever marketing (more than 1 million followers on Instagram) with well-thought-out business design. The Hugo Stores have lounges and are extremely digitalized. This seems to appeal to many people. The brand could therefore actually develop into a real jewel over the years.

The safest dividend is the one that's just been raised

In my previous analyses I was still skeptical whether Hugo Boss would be able to maintain the dividend because management plans to distribute 60-80 percent, not of free cash flow but net income to the shareholders (2018: EUR 236 million net income / around EUR 180 million dividends). The company will deviate from this and pay a dividend of EUR 2.75 per share. This is an increase of 5 cents per share. The proposal is equivalent to a payout ratio of 93 percent of Hugo Boss in 2019. The dividend will be paid out on May 12, 2020.

This means that Hugo Boss is far above the actual target range for payouts. Hugo Boss plans to focus more on cash flow in the future and expects to be able to keep the dividend stable. I find this approach okay. Measured in terms of pure profit, however, Hugo Boss's payout ratio is gradually approaching the limit of what makes sense for me. The payout ratio is now as high as it has been for the last 11 years only in 2016 and close to 100 percent.

(Source: Dividend history)

Conversely, an increase of 5 cents is also not significant. That said, I would also have nothing against leaving the already high distribution and not increasing it. As I also said in my last analysis, I would even have considered a reduction of 5 - 10 percent to be reasonable. In any case, the yield is almost 7 percent and I do not complain about it. Measured by cash flow, the dividend is also relatively safe. Hugo Boss will spend approximately EUR 194 million on dividends. The cash flow covers these payments more than twice.

(Source: Annual report 2019)

However, investors should note that cash flow development has not always been constant in recent years. While the free cash flow in 2019 was higher than ever before, the 2020 payouts would not have been covered by cash flow generated in 2018.

(Source: Annual report 2019)

The management will probably know best how far it wants to go. And if management has a positive view of the cash flow development for the next few years, then it is a reasonable approach to push the payout ratio a little bit for one or two years.

The big boys buy

It is also remarkable that large institutional buyers have increased their shares in Hugo Boss. According to a press release:

PFC S.r.l. and Zignago Holding S.p.A., both being controlled by the Marzotto family, increased their voting share in HUGO BOSS AG to a total of 15.45%. Prior to this, the voting share of PFC S.r.l. and Zignago Holding S.p.A. totaled 10.13%

While every investor must do his careful due diligence before making any investment, it seems that the Marzotto family is convinced that a good time to invest in the company has come. Marzotto was itself once the owner of Hugo Boss (until 2007) and therefore knows the company quite well. I think there are reasons why the family is increasing its shareholding right now.

First of all, the Marzottos seem convinced that the company is well on the way to achieving sustainable growth again. This is also consistent with my assessment above. It may also have been a factor in this regard that investment at this point can secure a dividend yield that is not that far from the historical annual return of the Dow Jones or S&P 500. Especially in uncertain times, when book profits are not guaranteed by share price growth, this could be a good argument for cash flow-oriented investors to buy.

Fundamental valuation

Hugo Boss is also clearly undervalued in my opinion. This can be shown by taking a historical view of its own operating business as well as a comparative view with its closest competitors.

First of all, let's take a look at where Hugo Boss's share price currently stands. At the moment (since this year) we are in fact at a price level that the company has not seen for almost ten years. The last time the share price was at such a low level was at the end of 2010:

(Source: Share price is historically low)

If one compares the current share price with the operating performance in 2010, a huge gap becomes apparent. Net sales are now 66 percent higher than in 2010. Gross profit rose by 83 percent and EBITDA by 107 percent since 2010.

(Source: Annual report 2019)

In comparison to its closest competitors, Hugo Boss also appears to be undervalued. Burberry (OTCPK:BURBY), LVMH (OTCPK:LVMUY) (OTCPK:LVMHF), Hermes (OTC:EUHMF) and Kering (OTCPK:PPRUF) (OTCPK:PPRUY) are traded much higher than Hugo Boss:

Conversely, investors will receive a dividend yield of 7 percent this year. This is also much higher than the dividend paid by competitors. However, investors also have to bear in mind that, measured by profit, Hugo Boss also has the highest payout ratio. Nevertheless, the dividend should remain above average for the next few years, even if Hugo Boss should cut the dividend next year due to macroeconomic developments.

When it comes to the metric return on equity, Hugo Boss does not have to duck away from the other companies either. I like the return on equity ratio to measure a company's efficiency.

Things to consider

Of course, investors must bear in mind that the company is facing an uncertain future. This concerns the corona epidemic in particular. Hugo Boss currently expects the effects of Corona to be offset in the second half of the year. However, no one can seriously predict how the epidemic will develop. But this is not a specific problem that only concerns Hugo Boss, but a problem that affects the entire global economy.

Investors must also bear in mind that Hugo Boss has underperformed in comparison to its competitors in recent years. This is mainly due to disappointing growth. In particular, the company has overslept the online business and has invested too quickly and too expensively in the expansion of its stores. But here Hugo Boss has been taking extreme action for some years now. The online business grew by 35 percent. This was strong double-digit growth for the second year in a row.

Hugo Boss also wants to become more profitable. Until now, the EBIT margin has been particularly weak and 2020 was a bad year as well:

(Source: Low EBIT margin)

According to the annual report, EBIT is expected to increase faster than sales in the coming years. Given that, Hugo Boss plans to increase EBIT margin significantly in the medium term. According to the company, this is to be achieved through an improved gross profit margin and an efficiency program focusing on more efficient use of expenses. This should then also improve net income attributable to shareholders. As a result of the poor margin development, net income has fallen considerably over the years.

(Source: Share price is historically low)

I, therefore, believe that the company is slowly but surely turning the corner. However, due to the uncertainties, it may take longer than planned before the efforts translate into results. At the very least, there are good signs that Hugo Boss will continue to pay a high dividend in the coming years.

Investors Takeaway

(Source: Webpage Hugo Boss)

After every analysis of a company, I will use a three-grade rating for this series. Its purpose is to ensure that readers recognize at first glance whether a company might or might not be worth investing in. The three steps rating at a glance.

Buy the jewel now rather than tomorrow if:

There are no downsides and the company has growth potential.*
The upsides outweigh the downsides and the company has enormous growth potential.

Worth an investment (maybe later after a second look) if:

The upsides outweigh the downsides.
The upsides are equal to downsides but the company has growth potential.

No thanks if:

No growth potential in the long term.
The downsides outweigh the upsides.

*Of course, the growth potential is a part of the upsides, but it is also crucial in my final considerations.

Conclusion: The grade for Hugo Boss

Hugo Boss is a company in the luxury goods industry with a very good risk/reward ratio. Compared to its competitors, it has a very attractive valuation. It is also trading at a large discount compared to its historical operating performance. While restructuring measures within the company and macroeconomic uncertainties justify only a small discount, the company is well on the way to solving these problems.

Accordingly, a good time window for investment may have opened up at the moment. Because of the existing macroeconomic uncertainties, it is not a jewel to be bought immediately, but it is close to this valuation. However, there is still some time for your due diligence. These are the reasons for my rating:

The dividend yield of 7 percent is almost as high as the historical average return of the Dow Jones and S&P 500.
The dividend has just been increased (to my surprise) and should remain stable for the coming years. At least I do not expect a significant dividend cut.
From a historical perspective and compared to its competitors, the company is very attractively valued.
However, there is still some time left, as the share will not be traded ex-dividend until the beginning of May.
Macroeconomic uncertainties also remain. However, these concerns not so much Hugo Boss in detail, but the entire luxury goods industry.

Hugo Boss is part of my diversified retirement portfolio. If you enjoyed this article and wish to receive other long-term investment proposals or updates on my latest portfolio research, click "Follow" next to my name at the top of this article, and check "Get email alerts."

This article was written by

The European View

13.1K Followers

Runner of the TEV Blog | Private InvestorI am a long-term oriented investor and in my early thirties. I hold a law degree and a doctorate in law and love investing and talking about my and others' investments. I regularly write about my research and investments on various investor platforms and the TEV Blog. **My articles represent my opinion only and in no way constitute professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions.**

Analyst’s Disclosure: I am/we are long BOSSY. 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.

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