Luxury is Winning
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Intro |
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Last week, Elon gifted us a painting of absolutist king Louis XIV on his Twitter feed. |
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Possibly to condemn the centralized power of the government or maybe to hint his next Met Gala outfit? We'll take 2 takeaways from it: |
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1. History tends to repeat itself |
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2. Vanity is never off trend |
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Both points will help us reflect on today’s topic, The Luxury Sector (LVMH deep dive) and its resilience to contractionary economic cycles. |
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Industry |
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Typically considered recession-proof due to the non cyclical nature of the industry, the luxury sector benefits from the truism that higher food prices cannibalize on a higher portion of low income earnings rather than on your MD’s bank account. |
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The global luxury goods market is expected to increase from US$309.6B in 2021 → US$382.6B in 2025, at a CAGR of 5.4%. |
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According to Deloitte, revenue for the top 100 luxury goods companies totaled $252B in 2020 (from 2019’s $281B). Still, over 1/2 of the top 100 companies remained profitable, with 13 of them reporting double-digit profit margins. 🙌 |
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Let's dive in. |
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1. History tends to repeat itself |
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The same kid might not stumble upon the same rock again, but others will. |
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Past crises have had different impacts on varied groups (be it luxury conglomerates or independent luxury houses) at different times. This could be attributed to the exogenous and endogenous characteristics of economic cycles. Future downturns won’t have the exact same characteristics as in the past, but there are some lessons to be learned and players who passed the game once are in good shape for another round. |
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We lived through the longest expansionary period 2009-2020, but what happened before and how did the luxury industry navigate those challenging times? |
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America's subprime mortgage crisis exploded in 2007 and it quickly snowballed into Europe's credit crisis. As for the luxury sector, Europe remained the number-one destination for tourists, France in particular – at the Galeries Lafayette, 60% of the total business came from tourists, and within this 60%, between 60% and 80% are Chinese tourists. |
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China emerged as the luxury market star, a market that didn’t even exist 10 years before in 2003. China saved many luxury retailers: Kering witnessed double-digit growth, and Richemont and Zegna, which were otherwise losing money, enjoyed healthy growth in the Asia giant. |
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The United States was yet an untapped market for most luxury brands. Today’s household name Dior showed negative profits until very recently. |
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Overall, even during the years of recession in 2010-2012, most luxury companies realized an annual growth between 10-20% due to Chinese demand. |
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Below is a graph of the major companies back then and their revenues through the recession: |
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Extrapolating to current times: |
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Geography - China was one of the key markets. With current Covid lockdowns, and companies wanting to avoid the Russian market, luxury companies face a different landscape. |
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Sector concentration - A 2018 McKinsey study found that 97% of the entire fashion industry’s profits originated at just 20 companies in the previous year, including LVMH, Kering, Richemont, and Inditex. |
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LVMH is the biggest player in the market, with a market cap of $304.5B (as of 5/17/22). CEO Bernard Arnault, at $147 billion is now worth more than anyone on earth except for Elon Musk and Jeff Bezos. |
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2. Vanity is never off trend |
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Countries evolve through various phases of luxury consumption: |
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1st stage - Deprivation. A country is crushed by poverty. |
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2nd stage - Economic progress. Citizens are lured by luxuries with functional utilities i.e: cars and washing machines. |
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3rd stage - A wealthy class appears and luxury goods start to become a social status symbol. |
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4th stage - A growing middle class grows sufficient resources to permit indulging in luxury brands. And even if they don't, they might feel the need to get the luxury items for the feel to fit in. |
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5th stage - Luxury items become mainstream and luxury becomes more associated with personal tastes and pleasure and not necessarily with wealth or status. |
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By the time of the global financial crisis, 94% of Japanese women in their twenties owned a Louis Vuitton handbag; 92% owned products from Gucci. Japan was in the 4th-5th stage. As economies in Latin America prosper, more population enters into the 4th stage - showcased by fast expansion of LVMH stores throughout Mexico and Brazil - increasing the luxury sector customer base. |
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LVMH |
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Intro |
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Formed in 1987 after a merger between fashion house Louis Vuitton and wine and spirits company Moët Hennessy, LVMH has since become one of the two most valuable companies in Europe (only to be rivaled by Swedish food giant Nestle). |
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The French luxury conglomerate now consists of 75 independently-managed subsidiaries that fall under six branches: |
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Notable brands include, as the name suggests, Moët & Chandon, Hennessy, and Louis Vuitton, but also extend to other prestigious labels like Christian Dior, Fenty, and Tiffany & Co. |
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In 1989, Bernard Arnault (“BA”) acquired the largest stake in LVMH through an internal takeover that culminated in his ownership of 43.5% of LVMH stock and 35% of voting rights. As chairman and CEO, he has run the company under six central principles: |
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These philosophies have guided the company to a prolific number of acquisitions over the past three decades, including Celine in 1996, Sephora in 1997, Fendi in 2001, and more recently, Fenty in 2019 and Tiffany & Co. in 2021. |
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Bull case |
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1. Supply Chain Superiority: LVMH manufactures most of its products with only some limited outsourcing. |
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2. Cheap Expansion Capabilities: With FCF of $18.18B (as of Q1'22), LVMH is well-positioned to continue its strategy of innovation, expansion in new territories, and increase in production capabilities. Its FCF is well above competitors, who would have to fund expansion with more expensive sources/limited capabilities. |
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LVMH FCF $18.18B > INDITEX $6.84B > KERING $4.46B > Luxottica $4.00B |
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3. Experienced Management: BA has come out successful after a few recessions. He and his team are ready. |
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4. Targeted Growth in the Americas region: US is the country with the highest number of female millionaires but yet the American public, outside big burbs, is still being educated on European luxury. |
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The group is seeking to unlock potential in new areas such as Nashville, Atlanta, and Austin, which have appeared as new "luxury hubs". |
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5. Luxury Reinvented – Experiences: LVMH operates restaurants, hotels, and pop-ups in fancy islands worldwide. |
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The house just set itself apart by reopening Maison Dior’s legendary historic birthplace at 30 Montaigne, a new unique holistic luxury experience with a giant store, a hotel, 2 restaurants, pastry shops, a museum, indoor garden, and just about every french word you can attempt to pronounce in between champagne sips. |
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6. Large Family of Brands: LVMH group makes up a big family. Together, they can synergize and share existing resources, take advantage of cumulative sourcing and advertising, create supply-chain efficiencies, and foster economies of scale. With their portfolio of brands, they also benefit from high bargaining power in retail outlets, luxury malls, and luxury streets. |
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On the contrary, globalization may pose a challenge to family-owned SMEs, which account for up to 90% of Italian companies and around 60% of French companies. The threat arises from the lack of financial power that the family-owned luxury goods firms require for international expansion to compete against international conglomerates and to attract buyers to their products. |
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Catalysts |
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1. M&A activity - BA turned LVMH into the giant it is today with strategic management that involved organic and inorganic growth. LVMH has made a series of acquisitions throughout the years. |
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Most recently in 2020, it acquired Tiffany’s for a little less than $16 billion (€13.4 billion). Within a year, LVMH new management on Tiffany’s has generated an available operating cash flow of €13.5 billion - the previous record was €6.2 billion in 2019. The company basically paid for itself within a year. |
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The conglomerate attributes the success to their experienced c-suite of execs and partnering with celebrities Beyonce and Jay Z, which they believed would connect with the public. |
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Other M&A candidates we can think of are Ralph Lauren or Arhaus. The latter went public in Nov 2021 and it’s down 49% since started trading. It would be a dilutive acquisition (P/E of 33.79 compared to LVMH's P/E of 24.33) but with LVMH's secret sauce who knows. |
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2. Canada - The country held lockdowns for the majority of 2021. Consumers have purchasing power and there is a giant Asian population (~18% in 2016) that should start consuming more luxury goods. |
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3. E-Commerce: |
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4. New products and lines - Such as baby line and recycled materials collections. |
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Bear case |
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1. China: Full or partial lockdowns were imposed in dozens of cities in March and April, including a long shutdown of the commercial center Shanghai. |
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China's average monthly GDP in 2021 was $1.4T, the country would stand to lose about $29.8B for each week the lockdown continues. |
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As for the impact on the Luxury Sector, sales of personal luxury goods hit $73B last year, up 36% from 2020, and more than double 2019’s figure. |
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LVMH, however, doesn’t believe this wave of lockdowns in China is worse than in 2020. The group is confident that sales will come back (and exceed) as quickly as restrictions are eased. |
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2. Mature Industry: If growth slows down and results don't surprise Wall Street, unless you invested in some fancy financial products you won't see your investment skyrocket. |
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3. Not a Party in the USA anymore: The United States was the 2nd biggest market for LVMH in 2021. Without stimulus checks and with $8 eggs (inflation) consumers have less purchasing power and less available cash for indulging in that summer bag/shoe. |
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According to analysts at Jefferies, crypto gains likely accounted for up to a quarter of the growth in US luxury sales in 2021. We all know crypto isn't surging anymore, and neither are stocks. |
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4. Bet on creativity. Investing in Netflix was fun …until it wasn't. Content wars are heating up and it’s hard to make hit after hit without burning through a ton of $$$. |
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John Galiano (creative director) revamped Dior’s popularity, Marc Jacobs was the perfect partner for LV, and Michael Kors for Celine. |
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Key Metrics/Valuation: (as of 5/17/22) |
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LVMH actually had a strong start to 2022, despite a massively challenging macro environment. Company beat consensus estimates in Q1’22, with organic revenue growing 23%. |
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Every single business line reported better-than-expected growth, except for the Wine & Spirit segment. This was due to timing issues on the world market, with a calendar shift for the Chinese New Year, as well as ongoing logistical and supply issues. |
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The highlight in the company's results was, once and again, the fashion & leather goods segment, with a 30% YoY revenue growth. |
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Conclusion |
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LVMH is the clear market leader in the luxury world and with its reach, and cross-brand synergies, we expect it to keep outperforming its peers. |
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Q1'22 results show LVMH’s resilience in testing times. For the rest of the year, Covid policies in Asia and inflation in the west could determine the company’s destiny. |
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The new US luxury buyer is younger and interested in what Jefferies dubs “Medal” — music, experience, digital, art and luxury. LVMH hits the jackpot on all of them as it is opening hotels, cafes, museums, and developing NFT art and AI installations. |
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In addition, the brand continues to do what has worked for them in the past - focus of the company was on innovation, expansion in new territories, and an increase in their production capabilities. Contrary to the cost-containment approach, Bernard Arnault stated: “What we have learned in the many crises we have been through is that this (cutting costs) is a mistake, especially when it comes to luxury . . . . If you don’t put your products on sale, consumers feel they are buying something that retains its value . . . . Even during tough times we can continue to invest and during the crises I went through in the past 20 years, we always gained in market share.” |
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It remains to be seen if luxury brands, like Louis XVI, will continue the expansion of their own Versailles gardens extravaganza or heads will roll soon. |
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Sources |
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