A review of LVMH's (OTCPK:LVMHF) Q1 results left me relatively bullish on the stock. Not only is China showing green shoots of a demand recovery (Fashion & Leather sales rose 50% YoY in the first two weeks of April), but the company's financial strength and aspirational brand positioning should allow it to navigate the COVID-19 crisis relatively well. With consumer appetite still very much intact, I believe LVMH is an ideal play on both a medium-term recovery and the longer-term secular growth story in the luxury sector. To be clear, the stock does not appear cheap relative to near-term earnings but taking a medium-term view, I see LVMH returning to a double-digit growth path, driving EPS above €20/share over the medium-term.
Louis Vuitton and Dior Outperform Through Challenging Times
LVMH's headline numbers were somewhat misleading. Though LVMH posted a 17% organic decline, which was admittedly toward the lower end of the initial -10 to -20% guidance range, the key fashion & leather (F&L) goods division recorded a much lower 10% decline through the worst of the crisis in mainland China.
Source: Investor Presentation
I would also point out that LVMH's F&LG 1Q organic sales of -10% compares favorably to Burberry at -30%, Kering at -15%, and Ferragamo at down 31%. Looking ahead, LVMH's outperformance looks set to widen as management disclosed +50% sales growth in China in early April. This highlights LVMH's ability to maintain wallet share even through a crisis, with the rise likely reflecting the pent-up demand of the Chinese consumer. From the call:
So in April, in the large brands, we've seen very high growth rates in Mainland China, obviously. But we've seen very substantial growth rates, sometimes in excess of 50%. So it really shows the appetite of Chinese people after 2 months of lockdown to come back to stores and come back to their previous pattern of consumption. Obviously, this is only Mainland China.
Meanwhile, watches and jewelry (W&J) was the most heavily impacted due to its outsized exposure to Asia and travel. Much of the weakness was centered around Bvlgari, given its reliance on travel flows, while TAG Heuer and Chaumet benefited from store re-openings (Place Vendôme store in Paris) and product launches (TAG Heuer launched its third-generation luxury connected watch during the quarter).
Source: Investor Presentation
The fact that Q1 results saw the first double-digit decline in sales at LVMH Group in the last decade was not a surprise given the context, but the resilience at F&LG and an emerging recovery in China bode well for Q2. Management withheld guidance this time around, and with Europe and North America still closed, I am expecting all divisions will worsen sequentially in Q2, before improving toward the latter half of the year.
Gaining Traction Online
Encouragingly, LVMH has seen an acceleration in online sales, particularly where it is "already strong." This would seem to imply outperformance at F&L and Perfumes and Cosmetics (P&C), though management was hesitant to offer specifics, the fact that online has offered a "sizable" offset to brick & mortar is a key positive. Online should remain a key theme as stores reopen, with the difficult current brick & mortar environment will likely accelerate the shift toward ecommerce.
I would say that it offsets a sizable, I will not quantify, but a sizable portion of the drop that we are witnessing recently in the brick-and-mortar business due to the closures. So it's quite a significant asset, but obviously, difficult to build in the current environment.
A Potential Recovery Led By Mainland China
The key highlight of the quarter was the sharp improvements in in-store traffic and sales in Mainland China. Not only did most of LVMH's brands posted positive YoY sales growth in the second half of March, but the improvement further accelerated in April, with many of the larger brands (likely (we Louis Vuitton, Dior, and Sephora China) seeing over 50% YoY top-line growth. For context, the base effect here is limited, as sales in Asia rose by 14% YoY in 2019, which implies brand momentum remains strong, and will likely drive share gains in the coming months.
Source:Investor Presentation (2019)
The rebound can also be partially attributed to the fact that stores have only recently reopened, though I'd contend the sharp bounce nonetheless bodes well for the recovery path. However, I do not think management is especially bullish, given it cut 2020 capex by 40% and announced cuts to its executive board remunerations (both moves were unprecedented in size).
Focus on the Cash Flow
Despite the China-driven optimism, I like that management is firmly focused on what it can control - costs and investment. At the operating expense level, selling and marketing costs are being reviewed, with the company already benefiting from reductions in rental costs, particularly in Mainland China, where landlords have generally been more flexible than in Europe and the US.
We try to do it in a partnership spirit with landlords. This has proven quite efficient, notably in Mainland China, where the landlords were, I have to say, very proactive and could be convinced that they should bear a portion of the cost of compulsory closures. In Europe and in the US, reactions are more mitigated. We have gained some rental reduction, but the minority of landlords are being quite inflexible, I have to say.
Unsurprisingly, capex is also set to be cut by 40% this year, while the excess inventory from the spring collection also needs to be addressed. Above-trend inventory levels should thus be expected in 2020, though LVMH has levers (for instance, by extending the sale of Spring/Summer collections). Meanwhile, the 40% cut to capex is largely the result of some projects getting postponed.
The 30% cut to the 2019 dividend (bringing the 2019 dividend to €4.80 per share) reflects management's prudence, as it unlocks €2.3bn of additional balance-sheet flexibility. However, management reiterating the Tiffany acquisition would go ahead (without even a renegotiation) seems odd given the current backdrop.
Stability Through the Cycles
LVMH has historically been resilient throughout the cycles. For instance, LVMH has consistently posted sales growth over the last decade, with 2009 being the only year that saw a drop in group-level organic sales. By segment, F&LG has generally seen lower cyclicality than other divisions and has remained a consistent top-line grower over the last decade. By contrast, W&J has been more cyclical, due to its exposure to wholesale and its higher price points.
Fashion and Leather Goods
Reported YoY % Growth
Watches and Jewelry
Reported YoY % Growth
Source: Company Data
In sum, the LVMH bull case rests on its best-in-class portfolio diversification, strong brand equity for its flagship LV and Dior brands, and its limited exposure to wholesale, with its growing online presence, also potentially offering a new tailwind. Looking through the material slowdown in growth and earnings in FY20, which is well-understood by now, I see the impact of COVID-19 on the LVMH story as temporary, with the company well-positioned to capitalize when a recovery eventually takes hold. Assuming LVMH returns to double-digit earnings growth, in-line with recent EPS growth numbers, I see the path above €20 in earnings per share as intact. This would imply a 17-18x earnings multiple on medium-term EPS numbers, which seems reasonable to me.
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