LVMHF - Hermes Won The Battle Against LVMH In H1-2023

2023-08-01 11:49:34 ET

Summary

• Hermès announced H1-23 industry-leading results that exceeded expectations.
• Revenues totaled €6.7B, reflecting 22.3% growth and operating profit amounted to €2.9B, reflecting 44.0% margins, an improvement of 400 bps.
• The company's results demonstrate it's in a whole different league when it comes to fashion luxury, outgrowing its closest rival LVMH in almost every segment and geography.
• Unfortunately, the stock is too expensive and leaves no room for upside. Thus, I reiterate a Hold.

Hermès ( OTCPK:HESAF ) ( OTCPK:HESAY ) announced industry-leading H1-23 results that exceeded expectations. Revenues totaled €6.7B, reflecting 22.3% growth and operating profit amounted to €2.9B, reflecting 44.0% margins, an improvement of 400 bps.

The company's results demonstrate it's in a whole different league when it comes to fashion luxury, outgrowing its closest rival in almost every segment and geography.

Unfortunately, the stock is too expensive and leaves no room for upside. Thus, I reiterate a Hold.

Introduction

It's been a month since I published my first article comparing Hermès with its closest rival in fashion luxury, LVMH ( OTCPK:LVMHF ). I claimed it trades at an ' Unjustified Historically-High Premium Over LVMH ', as it traded at a 100% premium, compared to the historical 70%.

In the first half of 2023, we got to see the reason for the premium. Unlike LVMH, Hermès is deeply concentrated on the very high end of luxury. The company caters to the extremely rich, the kind of customer that doesn't care about a recession and isn't sensitive to price increases.

And in H1-23, as we'll discuss in-depth, the difference was more apparent than ever. But first, let's go over the results.

H1-23 Highlights

Hermès reported consolidated revenues of €6.7B, a 22.3% (25% c/c) increase from the prior year. Based on its historical seasonality, the luxury house is on pace to deliver over 21.0% growth for the entire year, higher than the initial consensus, and in line with my expectations.

During the period, Hermès opened three leather goods workshops and continued the development of another four. The company opened two stores in Naples, Florida, and Aspen, and renovated three locations in Hamburg, Nanjing, and Abu Dhabi.

Growth was over 20% in every geography, and sales increased by 25% and 26% in operated stores and wholesale, respectively. The geographic exposure didn't change from the prior year, with Asia-Pacific responsible for nearly half of total sales.

Looking at product mix, growth was broad-based, with ready-to-wear leading the way. Perfume and beauty was the lowest performing Hermès product category, with a 10% increase. Leather Goods & Saddlery as a percentage of total sales decreased to 41%, while ready-to-wear took share from the other segments to become 28% of total revenue.

In terms of profitability, Hermès achieved all-time highs, reaching 44.0%. The 190 bps improvement was primarily due to mix and COGs, as the gross margin contributed 114 bps to the total expansion.

Hermès Vs. LVMH

In my previous article, I claimed that:

Covering most of the industry, you'll pretty quickly realize that there's Hermès, then there's LVMH, and then there are others like Kering ( OTCPK:PPRUY ) and Richemont ( OTCPK:CFRUY ). While those others trade at significantly lower valuations, they are incomparable to the two royals of luxury, not in terms of growth, not in terms of margins, not in terms of future prospects, and not in terms of management quality.

And in my opinion, we got a confirmation in the first half of 2023. Hermès and LVMH grew revenues at high double digits, whereas supposed competitors grew at low single digits.

In my view, there are only two alternatives for an investor who wants to get exposure to the true advantages of investing in luxury fashion, and those are, as you can understand by now, Hermès and LVMH. The question that remains relevant is, which one is the better investment.

Beginning with revenue growth, Hermès was only marginally higher with a 14.3% CAGR between 2016-2022, compared to LVMH's 13.2%. However, the gap widened in H1-23 as Hermès grew by 22.3% compared to LVMH's 15.0%. It's important to remember, however, that LVMH is more than 7x larger in terms of sales, so, in terms of absolute dollars, there's no comparison here.

Digging into the specific geographies, we see a huge gap between Hermès and LVMH in the U.S., which is clearly one of the most important geographies in terms of profitability, although the geographic profitability gap for those luxury giants is not similar to what you're used to seeing in other industries. Still, the U.S. is extremely important. And in the U.S., Hermès outgrew LVMH by 16.8 points.

It's important to note that Hermès aggregates the entire Americas together, so there isn't a 100% overlap, but the outperformance is still material. Furthermore, the gap in the Other category is really irrelevant, as it's a €151M category for Hermès, whereas for LVMH is a little over €5.1B.

Continuing with operating margins, it's clear which company has the more profitable business, with an average gap of 13.9% in favor of Hermès. In my view, this doesn't say much about the efficiency of the business, because as we discussed, LVMH derives 50% of its sales from less profitable categories. That being said, it means the gap isn't closing any time soon, and thus, each incremental Euro Hermès generates is more valuable.

In H1, LVMH had elevated marketing expenses, as you could have inferred from the amount of buzz its shows generated, especially the Pharell Williams and Jay Z one.

Is Hermès' Premium Justified?

In the past, Hermès has always traded for a significantly higher multiple than LVMH, with the former's median multiple at 42.1 compared to the latter's 24.7. So by their respective medians, Hermès was historically valued at a 70% premium. Today, the gap is much wider.

Looking at their GAAP P/Es (2022), Hermès is at 62.7 compared to LVMH at 29.8 (ignore the graph above, which is affected by the USD/EUR exchange rate, it's here to demonstrate the overall trend).

Based on current consensus estimates for 2023, LVMH is trading at a P/E of 25.6 and Hermès is at 53.9. Based on my own estimates for 2023, LVMH is at 24.6 and Hermès is at 47.1.

The bottom line is Hermès is getting nearly a 100% premium compared to the historical 70% premium. As I said, both the market and I expect Hermès to continue to outperform LVMH in 2023, but I don't think that justifies an additional 30 percentage points over the historical premium.

For the near term, Hermès should benefit from its concentrated customer mix and higher exposure to Asia Pacific, but over time, LVMH will provide steady growth and could surpass Hermès in FCF margins, with a larger TAM and more diversified offerings.

Thus, I still find the current historically high premium unjustified.

Valuation

I used a discounted cash flow methodology to evaluate Hermès' fair value. I forecast Hermès will grow revenues at a 10.2% CAGR between 2023-2030. I estimate revenues will grow at this pace due to constant price increases, continued store openings, entry into new segments, recovery in China, and steady organic growth.

I project EBITDA margins will increase incrementally up to 47.7% in 2030. In my view, this is a reasonable projection as the company is constantly able to improve margins, but on the other hand, it's expanding lines of business that are less profitable.

Taking a WACC of 7.3% and adding its net cash position, I estimate Hermès' fair value at €1,532 per share, which amounts to $1,687 per HESAF ADR based on the current USD/EUR ratio. This represents a 24% downside compared to the market price at the time of writing.

As I wrote in my previous article, the fact that I believe Hermès trades above its intrinsic value doesn't lead me to a Sell rating, as the company is one of those unique businesses that's always able to exceed expectations, and I don't see any trigger that will cause a selloff, in fact, the opposite is true. As we discussed in my previous articles, consensus estimates are typically way off when it comes to these luxury companies, and I definitely project Hermès will beat expectations in the near term, driving stock momentum.

With immense dividend growth, no debt, and huge room for expansion, I estimate investors who continue to hold will be just fine.

Conclusion

Once again, Hermès proved that it's in a whole different league when it comes to luxury, and LVMH proved it's a close second.

Hermès trades at a historically high premium over LVMH, and its outperformance in H1-23 has demonstrated why.

However, Hermès is uniquely positioned for the current environment, as its customers are truly at a higher level of financial capabilities. When the economic environment becomes a little steadier and more predictable, I expect LVMH's growth will accelerate, and gain back the gap from Hermès.

Thus, I rate Hermès stock a Hold and reiterate a Buy rating for LVMH.

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