EL - Christian Dior: Betting Big On LVMH

2023-05-05 11:54:18 ET

Summary

• Christian Dior French holding company owns 41% of LVMH.
• LVMH has seen revenue grow at a CAGR of 12% in the last 8 years, driven by strong demand for luxury in Asia, which is set to continue.
• Although fashion is cyclical and prone to consumer taste changes, LVMH has shown its ability to share and respond to changing trends.
• The company is highly profitable and resilient to economic conditions, making it a long-term winner.
• With Dior, investors get LVMH at a discount.

Investment thesis

Our current investment thesis is:

• We like LVMH (LVMHF) as a long-term investment. Management has shown an impressive track record of building brands.
• Asia will drive growth in the coming years, with recent performance showing the company's resilience to market conditions.
• Dior (CHDRF) allows investors to partake in this at a discount.

Company description

Christian Dior is a French holding company that is majority owned by the Arnault Family, who hold c.97.5% of the shares. The company holds 41% of the shares of LVMH ((MC)) and 57% of its voting rights. The Arnault Family holds an additional 7% of shares and votes directly.

The ownership structure here is slightly complicated. The Dior brand is owned by LVMH, the listed French conglomerate, not the Christian Dior listed entity. We have illustrated this below for simplicity. Throughout this paper, reference to "Dior" or "the company" will mean the listed entity, as will LVMH. If we reference LV or Dior the brands, we will denote this with "(Brand)".

Share price

Dior's generated impressive returns in the last decade, driven by an impressive increase in demand for luxury, as well as a shift in geographical demand, increasing the market size.

Financial analysis

Presented above is Dior's financial performance for the last 8 years.

Given the structure of the business, our analysis will relate wholly to LVMH, as the relationship between the two businesses will remain directly linked.

Revenue

Diror's revenue has grown at a CAGR of 12%, with only 2 periods of <10% growth (excl. FY20). This consistency is impressive given this represented a period of economic recovery for many countries across the globe, especially in Europe.

A key driver of this growth was the Asia-Pacific region. It is now the largest and fastest-growing market for luxury goods, driven by rising incomes and increasing consumer demand in countries such as China and India. Brands such as Louis Vuitton have pivoted to the market, increasingly positioning their marketing efforts toward consumers from the region. Our view is that this will continue long term as although the development has been rapid, the per capita income of individuals still has a long way to go, with wealth concentrated among the few. Presented below is the current split by geography.

As the illustration shows, revenue is highly diversified. As a luxury goods maker, this is key as an isolated weakness in a region is unlikely to materially impact the business.

This being said, the current market price of LVMH reflects continued growth in Asia, which is what we also expect. This does leave the business exposed from a share price perspective to a slowdown in this specific region. Across the last decade, we have seen growth slow in some locations, particularly Europe, yet the share price impact has never been significant. Estee Lauder ( EL ) recently announced its quarterly earnings and saw its share price drop by 20%. This was due to a slowdown in sales, in particular, from China.

Geopolitical events could have an impact on LVMH. We have seen things heighten on the global stage, in part due to the Russian invasion, but also with Taiwan. The US has moved to protect Taiwan while looking to reduce its reliance on the country. It has gone as far as to ban US companies from selling Semiconductors to China . If things continue to escalate, we could see China move against Western industries, with Fashion being an easy target as it does not provide hard value to its subjects. China will continue to be the biggest risk from LVMH.

In the near term, our view would be that sales in Asia should increase (which could be why EL's share price reacted as it did, markets were thinking as I do). The reason I say this is because China exited its zero-covid policy in late 2022, which contributed to significant disruptions in the country. Following a period of extremely high cases, the country has likely seen an end to the pandemic. This should lead to a rapid increase in Chinese footfall globally, but especially in the Asian region, which one would expect to lead to greater demand. A similar thing was observed in the West during FY21.

Economic considerations

Current economic conditions should be terrible for LVMH. With high interest rates and inflation, consumers are struggling with their cost of living which has led to discretionary spending declining. Despite this, LVMH has remained impressively resilient, with growth continuing across geographies. This is a reflection of who the struggling demographic is. Those that can afford Louis Vuitton, Dior (Brand), and Givenchy are not those whose lives are being materially damaged by current conditions. This suggests LVMH is a great all-weather choice.

Margin

Dior's GPM and EBITDA-M have improved by 3ppts and 6 ppts respectively. The GPM gains are likely a reflection of scale economies, with revenues more than doubling in the last decade. Also, many LVMH brands have been aggressive with pricing, as high demand and product scarcity has allowed the brands to maintain volume.

EBITDA gains come as revenue growth exceeds S&A. One of the key drivers of this is the Arnault effect. Benard Arnault is a genius and has instilled all his children into key positions within LVMH's brands, to continue his legacy (More on the family here as part of our LVMH write up ). He has successfully improved many of the brands within the LVMH portfolio, in many cases from culturally-relevant marketing. What I mean by that is LVMH both dictate trends, as the largest fashion conglomerate in the world, but also is agile to move with the culture. The best example of this is Streetwear, which in the last decade has become the most popular segment in fashion. Louis Vuitton has quietly transitioned its product line toward this, culminating in the recruitment of Virgil Abloh (Off-white founder and Kanye West protege) and the collaboration with Supreme. Not a single person in fashion would have predicted this several years ago. It would be like a Michelin-star restaurant partnering with KFC for a joint menu. This cultural awareness, what I call street smarts, allows LVMH to cost effectively market while still growing its brands.

E-commerce has been disrupting the retail industry and for those in a commanding position, such as the brands within the LVMH umbrella, it has been a positive. LVMH has been rapidly expanding its only presence, focusing on expanding its direct-to-consumer ((DTC)) offering. The benefit of this is that the margins are significantly higher than dealing with a retailer. The advantage LVMH has is that it owns a wide variety of brands, allowing the business to cross-sell through effective marketing. This is one of the reasons margins have continued to trend up.

Q1 results

In the most recent quarter, LVMH experienced strong growth across all of its segments. The key revenue driver is Fashion, which experienced what is nothing short of a monumental gain given the circumstances. We do not think it can continue at this rate but should mean the business pushes toward 10-15% growth in the year.

Balance sheet

LVMH is a conservatively financed business while still choosing to deleverage in recent years. With a ND/EBITDA ratio of 0.9x, the company can continue to conduct M&A to grow.

Outlook

Presented above is Wall Street's outlook for LVMH.

Revenue is forecast to grow at a CAGR of 8%. Given that the impact of future M&A is difficult to quantify, this predominantly reflects organic growth. This is strong in our view and when supplemented with M&A, the business could consistently generate >10%.

Valuation

Presented above is LVMH's valuation relative to Dior's. Dior is naturally trading at a discount to LVMH, as the business has almost an identical EBITDA due to consolidation, but only owns 41% of the shares (plus majority voting).

Dior is currently trading at a 45.2% discount to LVMH, a historical low (Note: Dior and LVMH have a slightly different net debt and EBITDA). The discount fluctuated between 60-70%, but this declined in recent years.

Dior currently owns c.205m shares in LVMH, which at its current share price of EUR874 represents a fair value of EUR1,001 per Dior share, which is a 19% premium. Further, the Dior shares are worth a premium to the market as they represent the majority vote, which allows for key decision-making. This suggests an arbitrage opportunity should the discount between the two reduce.

Final thoughts

We are very bullish on LVMH. The business owns some of the best brands in the world, its ownership/Management is world class and its commercial profile should generate long-term alpha. Investing with Dior allows investors to get in at a discount based on the number of shares held.

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