LVMHF - LVMH: Highly Attractive Business But Fairly Valued

2023-10-07 08:00:00 ET

Summary

• LVMH is the largest luxury company in the world with very strong pricing power.
• CEO Bernard Arnault's deep industry knowledge coupled with his ownership makes LVMH attractive to investors.
• I assign a hold solely because the stock seems fairly valued at ~$760.

Investment Thesis

Luxury brands such as LVMH Moët Hennessy (LVMHF) can't be built in days, months, or years. It takes decades for a company to develop its brand and create a moat around the business. LVMH is one of those companies that has built trust with customers, enabling high barriers to entry and pricing power. LVMH's pricing power is no joke. The company sells handbags in the range of $400-$36,000. Consumers can buy handbags from any brand, and they will do the job, but they won't have the Louis Vuitton logo on them, which is when brand power comes into play. Don't get me wrong, Louis Vuitton bags are of the highest quality, handcrafted by experienced craftsmen using high-quality materials. But it is still a little astonishing to me how the company has been able to mark-up products for such a high price. LVMH's pricing power clearly shows in its financials, with a gross margin of 68% (up by 200 bps in the last five years), way above that of most of its competitors. Most of the company's pricing power lies in its fashion and leather goods segment, which constitutes around 75% of its EBIT and only 47% of revenue.

Another critical piece of my thesis is management. The CEO, Bernard Arnault, has deep experience and industry knowledge. He turned his father's construction company into a conglomerate luxury company. When acquiring companies, Mr. Arnault seems to focus on quality and what the brand can be worth in the long run. He is an admirer of Warren Buffett, as he once said in an interview with Forbes .

The person who I admire most in business is Warren Buffett. He is a long-term investor and has brilliant ideas and he sticks to them.

The Arnault family has 48% ownership of the company and 64% of the voting rights. I like companies where management has a significant stake because it aligns their views with the shareholders. As for the company's outlook, long-term growth prospects exist, such as continued growth in emerging markets across most business segments and the long runway for luxury demand because people want to stand apart from others and make themselves feel good. According to Statista , the luxury goods market is expected to grow by 3.38%.

Business Summary

LVMH Moët Hennessy is a global producer and distributor of luxury goods. The company owns 70+ brands across wines, fashion goods, perfumes, watches, and more. LVMH is highly diversified; it operates across six business segments: wines and spirits, fashion and leather goods, fragrances and cosmetics, watches and jewelry, selective retailing, and other activities. LVMH has a retail network of over 4,900 stores worldwide and employs over 160,000 people.

Wines and Spirits (11% of Revenue)

This segment includes well-known brands such as Hennessy in cognac and Dom Perignon, Krug, Moet & Chandon, and Veuve Clicquot brands in champagne. The oldest LVMH wine estate, Clos des Lambrays, was founded in 1365. Brands are distributed both via wholesale and directly to at-home and out-of-home consumers. In 2022, the segment's revenue increased, driven by more robust demand across all regions except the U.S. and price increases. As for EBIT margins, they have been pretty stable around the 30%-32% range.

Fashion & Leather Goods (47% of Revenue)

This segment contributes the most to the company's top and bottom lines. Every other segment experienced a major decline in 2020, but fashion and leather goods remained resilient. Brands include Louis Vuitton, Christian Dior, Marc Jacobs, Fendi, Kenzo, Celine, Thomas Pink, Berluti, and Givenchy. The U.S. and Asia fueled most of the growth in 2022.

Perfumes & Cosmetics (12% of Revenue)

The pandemic hit This segment hard, with revenue declining by 23%. The portfolio of brands includes Christian Dior, Givenchy, Guerlain, and Kenzo. The United States, Japan, Europe, and the Middle East were the regions where revenue increased the most.

Watches & Jewelry (7.5% of Revenue)

As you can see, the segment's revenue experienced a significant jump in 2021, driven by the acquisition of Tiffany & Co., which closed in early 2021 for $16.2 billion. Brands for the segment include Bulgari, Tag Heuer, Hublot, Chaumet, and Zenith. For 2022, Europe, Japan, and the United States were the most dynamic regions.

Selective Retailing (~23% of Revenue)

This division includes a combination of third-party brands and LVMHs. Its central concept is Sephora, a leading selective beauty retailer. The segment also consists of the travel chain DFS. The segment's sales dropped in 2020 but have surpassed pre-pandemic highs thanks to its robust pipeline. However, profitability is still an issue for the division.

Recent Earnings

The company reported H1 2023 revenue of €42.2 billion (+15% YoY) and an EPS of €16.94. Most segments experienced double-digit organic growth; adding it up, the company experienced a 17% organic growth YoY. Operating margin didn't improve despite the growth; it shrank by 10 bps year-over-year. Europe and Asia experienced strong growth, but not the same could be said for the U.S.; the region's sales declined by 1%. LVMH shares have risen by 2.81% YTD, compared to 11.53% of the S&P 500 ( SPY ) at the time of this writing.

Risks/Mitigates

Over the last few years, most of LVMH's revenue has been fueled by emerging markets. Asia (excluding Japan) and other markets constitute the company's revenue. Over the past five years, revenue in both regions has increased by 75% and 84%, respectively. The only area that outpaced them was the U.S., mainly due to the stimulus checks in 2021 and 2022. Revenue grew by 28% in 2022. My point is that slow growth in emerging markets and decreased demand for luxury products can hurt LVMH's top line. Other investment risks include a decline in travel, a pandemic, and lower luxury demand.

Valuation

LVMH is trading at a forward PE of 20.86x. Consensus estimates an EPS of €32.69 for FY23. My estimate is €33.29 for FY23 and €35.78 for FY24. On a trailing free cash flow basis, the stock yields over 4.5% relative to its enterprise value. I estimate LVMH's top line to grow at a CAGR of 7% from 2023-2030, driven by price increases, new products, and assertive M&A. As for margins, I forecast gross margin to improve by 140 bps in the same period, driven mainly by price increases.

I used a growth rate of 3.00% (aligned with GDP) and a WACC of 8.80%. I arrived at a value per share of $789 for ( LVMHF ) and ~$158 for ADR ( LVMUY ), which translates into a return of 4% from the current price level of ~$760 ( LVMHF ) and $154 ( LVMUY ). The figures below are EU millions. I used an exchange rate 1.06 to convert my EU value per share into USD. Other assumptions include a 26.50% tax rate, D&A as 7% of revenue, and CapEx as 6% of revenue.

Conclusion

The bottom line is that LVMH has grown into a high-quality company. Bernard Arnault has been able to go from a civil engineer in charge of a construction company to the second-richest (sometimes first) man in charge of the largest luxury company in the world. He has built the company through strategic M&A and brand ownership. LVMH is well diversified across many different segments, unlike other luxury companies. I assign a hold because the valuation seems fair at the price of this writing: ~$760 ( LVMHF ) and ~$158 ( LVMUY ).

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