Hermes International: Luxury Stock With An Expensive Price Tag
Summary
- Hermes remains the third-most valuable luxury brand in the world.
- The business has performed extremely well, and is well-placed to continue doing so.
- It currently trades at a 64% premium to fair value, and is not suitable for prospective investors at present.
Hermes International (OTCPK:HESAY) is a frustrating option to consider. On the one hand, it is a phenomenal business with excellent brand recognition and proven profitability. On the other hand, the stock at present is one that no prospective investor can derive benefit from - regardless of whether they want value, income, or growth.
Many observers of the luxury goods sector may scratch their heads at the above conclusion. After all, revenue in the luxury bag market in 2019 was $38.27 billion in 2019, and is forecast to be $53.56 billion by 2025, with the 2020-2025 period seeing a CAGR of 5.76%. One of the key players in this growth is Hermes, which is projected to enjoy earnings-per-share growth of 11.43% over the next five years.
How is Hermes so prominent in the luxury market? For its 2020 Global Best Brands list, Interbrand ranked Hermes number 3 in the luxury sector - behind only fellow French companies LVMH (OTCPK:LVMHF) (OTCPK:LVMUY) and the privately-held Chanel S.A. - and ranked Hermes number 28 overall. That strong brand is reinforced by Hermes' strategy of opting for uniform brand recognition worldwide rather than catering to local tastes. One famous example of this is the Birkin bag, which can cost up to six figures.
In addition to brand strength, Hermes also retains its prominent position through diversification - in terms of products and in terms of geography. Among the firm's product lines, it is appropriate that the Leather Goods and Saddlery segment contributes the bulk of revenue, as that is the core business Hermes started out with back in 1837.
| Product Line | Revenue (€) | Revenue ($) |
| Leather Goods and Saddlery | 987.9 million | 1.20 billion |
| Ready-to-Wear and Accessories | 473.4 million | 576.14 million |
| Silk and Textiles | 148.4 million | 180.61 million |
| Other Hermes sectors | 228.3 million | 277.85 million |
| Perfumes and Beauty | 98.9 million | 120.36 million |
| Watches | 78.1 million | 95.05 million |
| Other | 68.7 million | 83.61 million |
| Total | 2.08 billion | 2.53 billion |
Figures collated from Q1 2021 report available on Hermes International's investor relations page.
Geographical breakdown is striking in showing how prominent the Asia-Pacific market is, as well as demonstrating the global reach of Hermes.
| Geographical Area | Revenue (€) | Revenue ($) |
| France | 153.1 million | 186.33 million |
| Europe (excl. France) | 227.9 million | 277.36 million |
| Japan | 241.1 million | 293.42 million |
| Asia-Pacific (excl. Japan) | 1.13 billion | 1.38 billion |
| Americas | 290.9 million | 354.03 million |
| Other | 40.6 million | 49.41 million |
| Total | 2.08 billion | 2.53 billion |
Figures collated from Q1 2021 report available on Hermes International's investor relations page.
It is this blend of strong brand presence, product diversification and geographical reach that accounts for Hermes International's profitability - as evident from its 31.86% operating margin, adjusted free cash flow of €995 million ($1.21 billion) and the revenue and net income figures it has reported over the past five years - COVID-19 alone being responsible for the dip in figures that 2020 displays.
| Year | Revenue (€) | Revenue ($) | Net Income (€) | Net Income ($) |
| 2016 | 5.2 billion | 6.33 billion | 1.1 billion | 1.34 billion |
| 2017 | 5.55 billion | 6.75 billion | 1.22 billion | 1.48 billion |
| 2018 | 5.97 billion | 7.27 billion | 1.41 billion | 1.72 billion |
| 2019 | 6.88 billion | 8.37 billion | 1.53 billion | 1.86 billion |
| 2020 | 6.39 billion | 7.78 billion | 1.39 billion | 1.69 billion |
Figures collated from annual reports available on Hermes International's investor relations page.
Hermes does pay a dividend, and in light of its profitability one would expect it to be considerable. But due to the current valuation (more on that later) the stock only offers a 0.39% dividend yield. While Hermes did raise its dividend consecutively for at least fifteen years prior to 2020, the decision was taken to freeze the dividend last year owing to the uncertainty surrounding COVID-19. The potential for future dividend raises is there, given the 34.44% payout ratio.
Furthermore, there are no issues with the balance sheet that would necessitate a frozen or cut dividend going forward: long-term debt of €1.47 billion ($1.79 billion) is more than offset by a net worth of €7.39 billion ($8.99 billion), while total current liabilities of €1.84 billion ($2.24 billion) are offset by total current assets of €6.65 billion ($8.09 billion), cash-on-hand worth €4.73 billion ($5.76 billion) and total accounts receivable of €506.2 million ($616.06 million). All in all, Hermes is in rude financial health.
Nor is Hermes content to rest on its laurels: last year, the firm ran a risk analysis on how climate change could impact its leather and textile operations. This is an effort to strengthen its supply chain, which already has taken account of these risks as Hermes leather, cashmere, and silk are all derived from renewable sources. One recent outgrowth of this is the Victoria bag, which is comprised of leather, canvas, and Sylvania - a form of leather derived from mushrooms in the lab. In addressing the climate issue now, Hermes is showing foresight. But would an investor be equally perspicacious to buy Hermes now?
Prospective investors considering Hermès International for their own portfolio should look to the shares trading on the Euronext exchange under the ticker RMS, as these shares are sponsored by the company - by contrast, the shares trading on the over-the-counter markets under HESAY and (OTCPK:HESAF) are not sponsored. Consequently, in valuing the stock, it is the sponsored shares I will be evaluating.
At the close of market on 06/03/2021, Hermes International traded at a share price of €1,158.50 ($1,409.92) with a price-to-earnings ratio of 87.56, based on earnings-per-share of €13.19 ($16.05). The current P/E is much higher than the already bloated five-year average P/E of 49.61, while the current dividend yield of 0.39% is lower than the five-year average dividend yield of 0.73%. It seems obvious that Hermes International is trading at a premium to fair value - but what is fair value here?
To determine fair value, I will first divide the current P/E by the historical market average of 15 to get a valuation ratio of 5.84 (87.56 / 15 = 5.84) and divide the current share price by this valuation ratio to get a first estimate for fair value of $239.74 (1,409.92 / 5.84 = 241.43). Then I will divide the current P/E by the five-year average P/E to get a valuation ratio of 1.77 (87.56 / 49.61 = 1.77) and divide the current share price by this valuation ratio to get a second estimate for fair value of $796.57 (1,409.92 / 1.77 = 796.57).
Next, I will use a DCF calculation: earnings-per-share over the past twelve months was $16.05, and EPS growth over the next five years is projected to be 11.43%. Using an 11% discount rate - the stock market average - I get a third estimate for fair value of $229.94. Then I will divide the five-year average dividend yield by the current dividend yield to get a valuation ratio of 1.87 (0.73 / 0.39 = 1.87) and divide the current share price by this valuation ratio to get a fourth estimate for fair value of $748.70 (1,409.92 / 1.87 = 753.97).
Finally, I will average out these four estimates for fair value to get a final estimate for fair value of $505.48, or €415.34 (241.43 + 796.57 + 229.94 + 753.97 / 4 = 505.48). On the basis of this estimate, the stock is overvalued by 64% at this time. At this time, current investors should certainly continue to hold Hermes International. But it's hard to justify saying that prospective investors should start a position here - income investors will never beat inflation with a 0.39% dividend yield, growth investors cannot justify a 64% premium with projected earnings-per-share growth of 11.43% over the next five years, and value investors will get little value from paying the current premium that the stock trades at. It is a hold, but not at present a buy.
This article was written by
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.