LVMHF - LVMH: Quality At A Fair Price

2023-12-12 03:10:10 ET

Summary

• LVMH Moet Hennessy is a well-run luxury conglomerate with strong revenue growth and high margins.
• LVMH is expected to continue growing its market share and deliver high-single digit revenue growth in the coming years.
• I present my outlook for the stock.

Dear readers,

Over the past couple of months, I've been increasing my exposure to the Consumer Discretionary sector, because many quality businesses in the sector have reached levels that I consider fair.

These are companies that aren't facing any major headwinds and their prices reflect this, promising no more than 8-12% annual returns. I expect to hold these "forever" and they therefore form a good addition to many of the turn-around value plays which I write about.

Moreover, if my macro base case plays out and interest rates drop next year, then the sector should (historically speaking) outperform. In particular, the sector has a near 100% historical hit rate of outperformance early in the cycle with average annualized outperformance of 10%+.

I wrote an article on one of my favorite European discretionary stocks - EssilorLuxottica ( OTCPK:ESLOY ) not too long ago. Today I want to present my outlook for LVMH Moet Hennessy ( OTCPK:LVMHF ) which is a global luxury conglomerate and arguably an even higher quality business.

Note: Through-out the article I will be referring to the EUR-denominated native shares that trade on the Paris stock exchange under the ticker MC.

What sets LVMH apart?

There are several metrics that put LVMH in a category of its own.

In short, this is an extremely well run business that has demonstrated an ability to grow their top line and bottom line substantially over the years, has maintained (and improved) their margins over the years to a level that most competitors can only dream of. Importantly, this is also a company whose management is closely aligned with shareholders' interests.

The Arnault's family owns 48% of shares and the majority of their family wealth is tied in LVMH in one way or another. As a result, this concentrated ownership (and complete control, as they have the majority of voting rights) doesn't concern me. I actually see it as a positive, because it allows for a long-term mindset, rather than chasing profits quarter to quarter.

LVMH has been on a great run, growing their revenues by a 16% CAGR over the past decade with only two down years - 2014 and 2020.

This year has been equally impressive so far with organic revenues increasing by 14% YoY over the first nine months of the year, driven by strong performance in four out of LVMH's five segments.

These segments are:

• Wines and Spirits: 7.5% of revenue
• Fashion and Leather Goods: 50% of revenue
• Perfumes and Cosmetics: 10% of revenue
• Watches and Jewelry: 13% of revenue
• Selective Retailing: 19.5% of revenue

The only segment with a YoY decline in revenue was Wines & Spirits, with a 7% decline year-to-date, as demand continued to be impacted by post-Covid normalization, particularly in the US.

On the other hand, the largest segment Fashion and Leather Goods grew by 16% YoY and Selective Retailing, which includes brands such as Sephora, grew by as much as 26% YoY.

Going forward, the luxury markets is expected to grow by about 4% per year, which LVMH will most likely surpass, thanks to their demonstrated ability to grow their market share. The consensus is for high-single digit revenue growth for the next couple of years. In particular, EPS growth is expected at 9% in 2024 and 8% in 2025.

Beyond revenue growth, LVMH is very efficiently run with an operating margin of 27% and a net profit margin of 20%, which is significantly above peers. For comparison, the aforementioned EssilorLuxottica has an operating and profit margin of 18% and 13%, respectively. Management has also stated recently that this level of margins is structural and therefore expected to remain.

Valuation

LVMH is not your typical high dividend stock. At these levels, the stock yields "only" 1.7%, which is basically in line with the S&P 500 ( SPX ) dividend yield. But importantly, LVMH's dividend has growth by 19% per year over the last 5 years. Though the increase has come in the past two years alone.

Going forward I see no reason why the dividend should not grow in line with earnings, therefore I expect high-single digit dividend growth. (Note that because this is a French company, there are withholding tax implications to consider, though given the low dividend I don't think this changes the investment thesis).

LVMH is not exactly a hidden gem. The market knows that this is a well-run business that can also be quite anti-cyclical thanks to the nature of the luxury market. As a result, the stock never trades at a cheap valuation. I rarely invest in high P/E stocks, but in the case of LVMH I think the premium isn't going anywhere.

At a P/E of 23x, the stock trades in line with its historical average. And, if it continues to trade at this level, which I think is justified, we could earn a 13% annual return over the next two years. The lowest I'm willing to value a business that's consistently growing by 8-10% and has margins as high as LVMH, the annual return is 21x earnings. At this (bearish) level, the expected annual return is 7%. Hence my expected total annual return of 8-12%. Not the 15%+ I target for my value investments, but more than fair given the limited downside.

If the company delivers the promised earnings growth, which I think is very likely short of a major black-swan event, if would take a multiple as low as 18x earnings for us to lose money on the investment.

Bottom Line

LVMH is not a company that will double your money in a year, or two. At least not from these levels. But it is one of the highest quality discretionary businesses in the world and it focuses on the top-end of the market which tends to be quite anti-cyclical. I like having the stock in my portfolio for diversification and stability and expect it to return 8-12% per year going forward. I rate the stock a BUY here at EUR 740 per share.

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