LVMHF - LVMH: The Reigning Icon And Epitome Of Global Luxury

2023-07-19 07:35:46 ET

Summary

• LVMH has demonstrated resilience and growth in the luxury market, with a significant rebound following the COVID-19 pandemic and a 36% organic sales growth in 2021.
• The rise of the middle class in China has led to a surge in demand for luxury products, with LVMH's brands being highly favored. The recovery of travel retail and Sephora's growth also contribute to LVMH's success.
• Given that there is no real luxury listed company in the US market, owning LVMH stock is a good strategy for US investors.

LVMH (LVMHF) is home to 75 distinguished Houses rooted in six different sectors. I have always regarded LVMH as one of the finest luxury companies in the world, boasting diversified top luxury brand portfolios, broad geographic exposure, and leading operating margins. The luxury industry provides an excellent opportunity to tap into the rising middle class, particularly in emerging countries such as China.

Growth Drivers

LVMH has an impressive track record of solid organic growth, with only two fiscal years experiencing negative organic sales growth. In 2009, their organic sales decreased by a mere 4%, which can be attributed to the challenging economic climate during that time. Furthermore, due to the global outbreak of COVID-19, numerous retail stores were forced to close in 2020, impacting sales. However, LVMH demonstrated resilience and experienced a significant rebound following the pandemic. In 2021, they achieved a remarkable 36% organic sales growth, followed by an impressive 17% growth in 2022. These figures highlight their ability to recover swiftly and excel in the luxury market.

Rising Middle Class in China : In the luxury market, Chinese consumers play a significant role, accounting for approximately one third of global consumption. Asia, excluding Japan, represents 30% of LVMH's group sales. In addition to domestic purchases, Chinese consumers have a preference for traveling abroad to take advantage of lower prices and duty-free options when purchasing luxury products. Based on my estimates, luxury products sold onshore in China have an average selling price that is over 30% higher than in Europe.

With the rise of the middle class in China, there has been a surge in demand for luxury products across various categories, including leather bags, cosmetics, perfumes, watches, and wines, among others. LVMH's brands are highly favored by Chinese consumers, many of which have a history spanning over a century. The longevity and heritage of LVMH's brands contribute to their enduring appeal, making their business highly sustainable in the long term.

Recovery of Travel Retail : Duty Free Shoppers ((DFS)) became part of LVMH in 1997. DFS is recognized as a pioneer and the global leader in the sale of luxury products to international travelers. Its business is closely tied to tourism cycles, and as a result, the travel retail sector faced challenges during the COVID-19 pandemic, with many retail stores temporarily closing down. However, with the post-pandemic recovery underway, I anticipate a rebound in DFS's travel retail channel as more tourists resume their travels to Europe and the United States.

According to McKinsey’s The Chinese Luxury Consumer report , it is projected that China will account for 40% of global luxury spending, with over 70% of luxury purchases being made overseas. This trend is driven by an increasing affinity for outbound travel among Chinese consumers. These findings indicate a significant growth opportunity for the travel retail sector, emphasizing a promising future for DFS and its operations.

Sephora : Since its acquisition by LVMH in July 1997, Sephora has experienced rapid growth in Europe, the US, and Asia. This growth has been achieved through the opening of new stores and strategic acquisitions of companies that operated perfume retail chains. Sephora's unique concept has given rise to a new generation of stores characterized by elegant and luxurious architecture, with separate spaces dedicated to perfumes, makeup, and skincare.

This approach of selective retailing has allowed LVMH to offer direct access to a wide range of products while providing personalized customer assistance. It has also laid the foundation for targeted marketing efforts and enhanced the overall client experience. Selective retailing, represented by Sephora, has become a significant contributor to LVMH's exceptional growth, accounting for approximately 19% of the group's sales.

By leveraging the strengths of Sephora's innovative retail concept, LVMH has been able to tap into the beauty and cosmetics market effectively and create a successful retail experience for customers worldwide.

Broad Luxury Categories : Unlike certain other European luxury companies, LVMH possesses an extensive portfolio spanning multiple product categories. With 75 distinguished Houses rooted in six different sectors, LVMH enjoys significant category diversification. This diversification strategy allows them to mitigate the effects of cyclicality within specific industries. Furthermore, LVMH's broad portfolio provides them with a distinct advantage in terms of brand risk compared to single-category luxury companies such as Kering ( OTCPK:PPRUF ) and Moncler ( OTCPK:MONRF ). By operating across various sectors, LVMH is able to distribute risk and capitalize on opportunities in different segments of the luxury market.

Risks

US Market Growth and Tiffany Integration : In 2021, LVMH made a significant acquisition by purchasing Tiffany for $15.8 billion. The United States represents approximately 27% of LVMH's group sales, making it a crucial market for the company. However, due to the strength of the US dollar, American tourists often choose to purchase luxury products in Europe rather than in their home country. This can lead to a revenue growth imbalance between Europe and the US.

Despite these currency-related challenges, the US market demonstrated strong growth, with a 44% increase in FY21 and a 15% increase in FY22, on an organic basis. LVMH has successfully integrated Tiffany into its operations, and they anticipate that Tiffany's profitability will surpass EUR 1 billion for the first time, considering it was previously only at half of that amount. While the integration of Tiffany under LVMH's umbrella has been progressing well, there is still a possibility of integration risks that need to be managed carefully.

Weak Consumer Discretionary Spending : It is indeed reasonable to be concerned about the impact of high inflation on consumer consumption. However, it is important to consider that the effects of inflation can vary across different income segments. While high inflation may put pressure on low-income families, the shopping patterns of middle-class and high-net-worth individuals, who are LVMH's primary customer base, may be less affected.

Luxury spending is often driven by factors beyond immediate economic conditions, such as status, exclusivity, and personal preferences. Therefore, it is plausible to expect that the impact of high inflation on the shopping patterns of LVMH's target customers may be relatively limited. These individuals may still prioritize luxury purchases and continue to contribute to solid growth in the luxury sector, even in an inflationary environment.

However, it is important to note that macroeconomic conditions can influence consumer sentiment and overall market dynamics. Monitoring consumer behavior and market trends remains crucial for luxury companies like LVMH to adapt and address potential challenges effectively.

Foreign Exchange : Indeed, for US investors holding LVMH's OTC stock, a weak Euro currency can impact the stock price. A weakening Euro relative to the US dollar can result in lower returns for US investors when the value of their Euro-denominated investments is converted back into dollars.

To mitigate the potential risk associated with currency fluctuations, investors have the option to use foreign exchange hedging strategies.

1H Outlook and Valuation

LVMH is scheduled to announce its 1H earnings on July 25th. In Q1, they achieved a remarkable 17% organic sales growth. Considering the recent shift in China's zero COVID policy, where they opened their borders for outbound tourism earlier than expected, I anticipate that LVMH will continue to experience strong growth in Q2. This policy change could have a significant financial impact on LVMH's duty-free and travel retail channel. Therefore, I expect robust sales for 1H FY23.

LVMH has achieved a compound annual growth rate of 13.2% in revenue from 2017 to 2022. Based on my projections, I anticipate LVMH to achieve 11% normalized organic sales growth and 1.3% growth through mergers and acquisitions. Additionally, taking into account the operating leverage, the operating margin is expected to expand to 29.6% in FY32, according to the model.

Other assumptions include 10% of WACC, 4% of terminal growth rate, and 26% of tax rate.

With these assumptions, the free cash flow is calculated to reach EUR 59 billion in FY32. In the model, the present values of FCFF over the next 10 years and terminal are EUR 133 billion and 417 billion, respectively. Adjusting cash, debt and minority, the fair value is EUR 1,083 or USD 1,210 per share, as per my estimate.

End Note

I believe LVMH is a fitting addition to any long-term focused global portfolio. Given that there is no real luxury listed company in the US market, owning LVMH is a good strategy for US investors, as it provides global diversification and allows them to benefit from the increasing affluence of the global middle class. Therefore, I give LVMH a "Strong Buy" rating.

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