CFRHF - Richemont: First Half Results Sent The Sector Into A Spiral

2023-12-08 13:49:48 ET

Summary

• Compagnie Financière Richemont reported a discouraging 5.6% revenue growth and significant operating margin contraction in H1-24.
• The sale of its controlling interest in YNAP is expected to create a more profitable enterprise for Richemont.
• Richemont is expected to return to its historical growth trend in calendar 2024, making it an attractive investment opportunity trading at a historically low valuation.

Compagnie Financière Richemont ( CFRHF ) announced H1-24 results that sent the entire luxury sector into a spiral. The owner of worldly renowned brands like Cartier, Montblanc, Van Cleef & Arpels, and Piaget, reported a discouraging 5.6% revenue growth, along with a significant operating margin contraction, leading investors to question just how bad the results from the sector in general and Richemont specifically are going to get in the near term.

With high-quality businesses like Richemont, buying at a historically low valuation before the recovery begins is usually the right thing to do. I expect the Swiss conglomerate will return to its historical growth trend in calendar 2024, and continue to provide long-term investors with market-beating returns from that point and beyond. As such, I continue to rate the stock a Buy.

Brief Introduction

Richemont owns one of the most iconic luxury brand portfolios, including Buccellati, Cartier, Van Cleef & Arpels, A. Lange & Söhne, Baume & Mercier, IWC Schaffhausen, Jaeger-LeCoultre, Panerai, Piaget, Roger Dubuis, Vacheron Constantin, Alaïa, AZ Factory, Chloé, Delvaux, Dunhill, Montblanc, Peter Milar, Purdey, Serapian, and Watchfider & Co.

The company operates under three reported segments: Jewellery Maisons, Specialist Watchmakers, and Other.

Previously, the group had an Online Distributors segment, which included YNAP and Watchfinder. On 24 August 2022, Richemont announced it had entered into an agreement to sell its controlling interest in YNAP, under which Farfetch and Alabbar will acquire a 47.5% and 3.2% stake, respectively. Upon completion of the sale to Farfetch, Richemont will receive 53.0-58.5 million Farfetch Class A ordinary shares. The Group will also receive $250 million (expected to be settled in Farfetch Class A ordinary shares) on the fifth anniversary of the completion. Farfetch is granted a put-and-call option to increase its ownership of YNAP’s share capital to 100%.

Management expects the sale to be completed by the end of the year, in a process that should result in Richemont becoming a more profitable enterprise, as YNAP is currently a losing business. However, the recent drama surrounding Farfetch's aspirations to go private could delay the completion, or break the deal altogether.

Until the sale is complete, investors should expect to see a significant difference between the company's net income from continuing and discontinuing operations.

H1-24, Financial Overview

Richemont reported consolidated revenues of €10.2B, a 5.6% increase from the prior year (12.0% in constant currency). Based on historical seasonality, the company is on pace to achieve record sales of more than €20B for the year, which is slightly above consensus estimates.

On a geographic breakdown, organic growth was 23% in Asia Pacific, 13% in Japan, 5% in Europe, 9% in the Middle East & Africa, and 1% in the Americas. Another often-looked breakdown is clientele clusters, where the group saw a significant difference between Americans, which grew 3%, Europeans, which grew 8%, and the Chinese cluster, which grew by 50%.

Looking at the channel breakdown, if anyone needed reassurance as to why luxury brands are transitioning from wholesale channels, retail direct-to-consumer continued to outperform with 16% organic growth, compared to 8% in online retail and 5% in wholesale channels.

The group's prominent Jewellery Maisons segment, which aggregates the results of Buccellati, Cartier, and Van Cleef & Arpels, reported revenues of €6.95B, a 10.0% increase from the prior year (16.0% in constant currency). Primarily due to exchange rates, the segment's operating margin declined by 160 bps, leading to operating profit growth below revenue growth.

Adjusted for constant currency, operating profit increased by 20%, and the operating margin improved by 120 bps Y/Y.

The group's Specialist Watchmakers segment, which aggregates the results of A. Lange & Söhne, Baume & Mercier, IWC Schaffhausen, Jaeger-LeCoultre, Panerai, Piaget, Roger Dubuis, and Vacheron Constantin, reported revenues of €1.98B, a 3% decline from the prior year (3.0% increase in constant currency). The segment's operating margin declined by 510 bps, leading to a 23% decline in operating profit.

Adjusted for constant currency, operating profit decreased by 1%, and the operating margin contracted by 100 bps Y/Y.

Lastly, the group's Other segment, which includes the fashion and accessories maisons, Watchfinder, watch component manufacturing, and real estate activities, reported revenues of €1.28B, a 1% decline from the prior year (5.0% increase in constant currency). The segment's operating margin declined by 480 bps, leading to a 111% decline in operating profit.

Now What?

Richemont is trading at a mid-teens P/E ratio over its expected continuing operations EPS for FY24, which ends on March 2024. The company's balance sheet is strong, with enough cash to cover the near-to-mid-term debt and lease payments, and a very reasonable net debt to projected EBITDA ratio below 1.

For those who have been following the luxury sector for more than a couple of years, you should know that this is an industry that grows at a 6%-8% pace. That definitely wasn't the case over the past few years, with companies like Richemont seeing sales grow by a CAGR higher than 20% between FY21 and FY23.

Remember, we're talking about retail. This is not a recurring subscription business, nor it is a business of essential products. I find the fact that Richemont is still able to generate positive growth, despite the extraordinary pull-forward demand, impressive.

However, investors are always focused on the growth trend. When the trend is going downwards, meaning operating profit is declining and growth is slowing, past achievements don't really matter. So, what we need to do is figure out when the trend is going to turn around.

Richemont's slowdown started in its fiscal first quarter of 2024, which is the calendar second quarter of 2023. It is experiencing significant currency headwinds, but assuming those stabilize, we can expect that in fiscal Q1-25, the first overlapping quarter of the more normalized environment, we'll see investors realizing that the underlying growth trend remains intact.

So, fiscal Q1-25 is calendar Q2-24, which begins in four months starting today. It could be argued that it's too soon to buy and that there are worse times ahead. However, I see no reason why Richemont won't return to at least a 20x multiple as it starts showing signs of recovery, which by itself should provide more than a 13% return in the near term, based on the current 17.5x multiple it trades at. As such, I find the current valuation attractive for long-term investors.

Financial Model

I forecast Richemont will grow revenues at a 5.9% CAGR between 2024-2031, in line with market historical growth rates.

I project free cash flow margins will increase gradually, up to 16.5% in 2031, which is slightly below the company FY21 levels. In my view, this is a reasonable projection, as we can see that Richemont is able to maintain its elevated margins despite the growth slowdown. Many luxury companies, Richemont included, confirm that their new margin levels are structural and here to stay. Furthermore, the company's divestiture of the unprofitable businesses should by itself support a margin expansion.

Taking a WACC of 8.25% and adding its net debt position, I estimate Richemont's updated fair value at €131 per share, which amounts to $141 per CFRHF security based on the current USD/EUR ratio.

Conclusion

Following two years of extraordinary, unsustainable growth, the luxury sector was due for a breather, amid a tougher consumer environment and in light of tough comparisons resulting from pull-forward demand.

I mark the second quarter of calendar 2024 as the moment things will turn back around for Richemont, as the company overlaps much easier comps, and the economic outlook becomes clearer.

While I can't call the bottom, I rate Richemont a Buy, as I find a mid-teens P/E multiple compelling enough for investors to start accumulating shares, in order to capitalize on the recovery upside, in addition to the long-term high-single-digit growth trajectory.

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