2024-01-20 06:45:28 ET
Summary
- Kering shares have fallen sharply over the past year, with the luxury goods giant facing both macroeconomic and brand-specific headwinds right now.
- While Gucci's underperformance is stark versus peers like Louis Vuitton, analysts do see EPS bottoming this year.
- At around 13.5x consensus 2023 EPS, Kering only really needs medium-term growth in line with the broader luxury market for the shares to work at their current level.
Luxury goods giant Kering (PPRUY)(PPRUF) has disappointed over the past year, delivering a negative 32% total return in that time amid both macroeconomic and brand-specific headwinds.
Warren Buffett once said that you 'pay a very high price for a cheery consensus' in the stock market - a sentiment that is particularly applicable to cyclical operators like luxury goods companies. Consensus surrounding Gucci owner Kering is far from cheery right now, but that is what makes these shares compelling, as the stock's valuation represents a steep discount to both its historical average and peers. At under 14x EPS, these shares look good value for those with a bit of patience, and I attach a Buy rating to the stock.
Beset By Cyclical Headwinds
Kering derives around 50% of sales and 63% of operating income (ex-corporate center costs) from the Gucci brand. Gucci, in turn, generates most of its sales (a little over 50%) from leather goods like handbags. The remainder of Kering's business comes from Yves Saint Laurent (~17% of operating income), Bottega Veneta (~6%), Other Houses (~8%), which includes Balenciaga and Alexander McQueen, and Kering Eyewear (~7%).
The broader luxury market appears to be entering a slowdown. As a rough rule of thumb, the higher up the pricing chain a brand is, the less sensitive to the economic cycle it is. This has been a hallmark of past luxury downturns, and is why a company like Hermès (HESAY)(HESAF) still generated robust year-on-year organic sales growth of 16% in Q3 2023 (the latest quarter we have data for).
A couple of luxury players have released trading updates in the current earnings season, and so far it looks like the above trend is playing out. Burberry (BURBY)(BBRYF), for example, reported a 2% decline in currency-neutral sales last quarter, with same store sales falling 4%. Burberry has significant exposure to aspirational customers, providing some context to those figures.
In contrast, Swiss jewelry and watchmaker Richemont (CFRUY)(CFRHF) reported 8% currency-neutral sales growth in its fiscal Q3 (which maps to the calendar Q4 2023). Now, this was driven by 12% growth in its jewelry segment, which contains high-end brands like Cartier. Other segments either delivered low single-digit growth or declined year-on-year, again supporting the idea that higher-end brands are proving more resilient.
With all that said, read across to Kering is a little difficult at the moment. I would expect brands like Yves Saint Laurent ("YSL") to struggle in the context of the above, and indeed YSL sales did fall 12% year-on-year back in Q3 on a comparable basis (i.e. constant currency). The issue for Kering is that while its main brand Gucci should ordinarily prove a bit more resilient, it is also facing its own fashion cycle and has been underperforming peers for a while now. Gucci sales fell 7% on a comparable basis in Q3, much worse than the 9% growth posted by LVMH's (LVMUY)(LVMHF) Fashion & Leather Goods segment, which is dominated by Gucci competitor Louis Vuitton, and the 16% reported by Hermès, which typically displays the most resilient performance in downturns.
Now, I don't think that Gucci is a bad brand as such. It's just that fashion is somewhat cyclical as consumer preferences can ebb and flow when it comes to any one label. Even so, the level of recent underperformance is quite stark. Through Q3, sales growth at Gucci (-2% on a comparable basis) lagged LVMH's Fashion & Leather Goods segment by 18ppt in 2023, with similar underperformance (~19ppt) also seen in 2022. Further, between 2019 and 2022, Gucci only registered around 9% sales growth overall, which is around 10-15ppt lower than the broader luxury goods market depending on whose research you use (Kering references Bain-Altagamma and Euromonitor, as per its 2022 annual report ). That is very weak for a brand that should be able to price ahead of the market.
Still Plenty Profitable
While Kering is grappling with both brand-specific and macroeconomic headwinds right now, the firm still remains very profitable. Net income was €1.79 billion in the first half of last year, albeit that was down around 10% year-on-year.
Looking ahead, analysts expect Kering to post €3.1 billion in 2023 net income when it reports in February, equal to around $2.75 per 'PPRUY' ADS. While that would represent a chunky 14% year-on-year fall in local currency terms, analysts do see EPS bottoming here before a muted recovery in 2024. Dividends are always a bit more variable with European companies compared to American ones, and since 2020 Kering's payout has been roughly 50% of net income. Applying that to 2023 EPS consensus implies a circa $1.38 dividend per share ("DPS"), good for a 3.6% yield before withholding taxes.
Attractively Valued
Looking at the above, I'd say Kering shares offer a compelling value case right now. The ADSs trade for $38 apiece as I type (~€348.55 for the Paris-listed ordinary shares), so on subdued 2023 EPS estimates we are on a P/E of circa 13.5x. That is a good 30% below its historical average and, importantly, is based on bottoming EPS.
It further represents a significant discount to the mean of select European luxury peers, as presented below:
The last time Kering stock was this cheap was in Q1 2017. The ADSs delivered a total return of ~115% over the following two years:
Granted, the company's main profit source Gucci is working its way through a slump right now, but it isn't going to underperform the market forever. The company sees the luxury market growing at a 5-7% CAGR out to 2030 as per its 2022 annual report, and I have used the lower-end of that range in my own recent coverage of Burberry , Hermès and LVMH . Assuming flat 2024 EPS and DPS, followed by a 5% CAGR in both thereafter, and assuming the stock's P/E re-rates to around 16x EPS, investors would be looking at 11% annualized total returns here over the next five years. While there are downside risks to consider, upside looks compelling on very reasonable growth assumptions, and I attach a Buy rating to the stock.
Risks
Kering faces brand-specific and macroeconomic risks. In terms of the former, Gucci's underperformance could continue, indicating that its headwinds are more structural than cyclical in nature. Similarly, 2023 EPS consensus could prove too optimistic if the current downturn turns out to be more severe than expected. This could also impact growth assumptions in 2024 and beyond. Similarly, the 5% annualized growth rate expected of the broader luxury goods market rests on certain global GDP assumptions, and it is particularly sensitive to economic growth in China. If those turn out to be too optimistic, luxury market growth will be structurally lower than currently expected, which could have a similarly negative impact on Kering's growth.
For further details see:
Kering: Beset By Cyclical Headwinds; Shares Undervalued