2023-10-26 11:01:13 ET
Summary
- Analysts and investors are starting to worry about the luxury brand industry, making it a good time to take a closer look.
- Luxury brands trade at high valuations due to strong demand, good margins, strong brands, and pricing power.
- Kering SA presents a great deal for value investors in the luxury brand industry.
When analysts and investors start to worry about a certain industry, it is often the best time to start taking a closer look. Recently the luxury sector has gone into a bear market , so here we are. In general, stocks of luxury brands trade at pretty lofty valuations. This is due to robust demand for their products, good margins, strong brands and pricing power. So now even for value investors a great deal has presented itself; Kering SA ( PPRUF , PPRUY ). The third quarter sales figures were released this week and weren't good. Now according to some metrics, it is trading at the lowest levels seen in a decade. However, this French power house is diversifying itself and has significant cash flows. This makes Kering a clear buy in my view.
Intro
It has been over three years since I last wrote about Kering. For those interested to learn a bit more about the company, I can recommend reading that article . At the time I was a shareholder myself, but I considered the company a 'hold'. This was due to its high valuation, such as its P/E which stood at a ratio of around 37 at the time. Also the heavy reliance on Gucci was a bit of a turn-off. After the shares extended their run-up, I got out of Kering and have since moved it to my watch list. Since the end of 2020 there are a few developments that have strengthened the business and make it now more appealing. This combined with the much lower share price warrants a fresh re-examination of Kering as an investment. Prior to that re-examination, lets have a look at how Kering has performed since my last article:
So after having peaked in the summer of 2021, the share price has not yet recovered from its decline. At the moment shares are almost a third lower than in early November 2020.
Worth mentioning is while the American OTC tickers are used in this article, the listing in Paris is far more liquid. For the majority of investors it would make sense to trade the stock there.
Corporate Developments
In my previous article on the company I quoted Morningstar to summarize Kering and in that quote Morningstar wrote the following: 'Its flagship brand is Gucci, which accounts for 60% of revenue and around 80% of operating profits.' This meant in short that Gucci was the main pillar beneath the conglomerate. When one visits Morningstar today to look up Kering, you can find almost the same quote, but with in my opinion better numbers: ' Its flagship brand is Gucci, which accounts for over 50% of revenue and almost 70% of operating profits .' Actually when looking at the H1 2023 figures, Gucci accounts for about 66% of the group's profits:
Source: Kering H1 2023 Report
Going forward there is reason to believe that Gucci's share will shrink relatively further. Acquisitions play a major role in this area. Over the last few years Kering has been very active in this department. It has sold its two watch brands, Ulysse Nardin and Girard-Perregaux , in a management buyout. Given the decline of revenues there and steep losses, I do think this was a smart move. With that divestment, they left the watch making business. The eyewear industry on the other hand is an interesting sector, which Kering considers an area of growth. In fact it was the only segment that grew in the last quarter:
Source: Kering Q3 2023 Revenue Report
The key driver of this growth has been the purchases of Maui Jim in H2 of 2022. This comes after another acquisition in this field with the addition of Lindberg to the portfolio in 2021.
Kering's M&A team did not just focus on their eyewear division. Over the summer they also acquired the high-end luxury fragrance house Creed and they bought 30% of Valentino , the highly recognizable, iconic Italian brand. The option to attain a 100% in a few years was included in the deal. Overall, this should further reduce reliance on Gucci and make the company more balanced. It is still not as good as industry leader LVMH ( LVMUY ), but I like how Kering is slowly transforming into a more well-rounded entity.
Another big development worth mentioning is the fact that Gucci has a new creative designer since early this year. Sabato de Sarno has taken over from Alessandro Michele and last month had his debut for the brand. It is too early to tell how he will influence the brand and its sales, but due to the importance to Kering it should be observed.
Financial Developments
It is fair to say that a lot has happened in the last three years. The post-Covid buying spree has certainly helped producers of luxury goods such as Kering, but conflicts and economic uncertainty are now weighing on sales. Still, compared to 2020, revenues are up over 30%. The balance sheet too is strong, but some debt has been added. But the amount is still easily manageable. The main reason for this increase are the mentioned acquisitions, so given that it improves the overall quality of the enterprise, this is not an issue. A quick check at the cash flow statement reveals that TTM operational cash flow is over 38% higher than FY2020. It is fair to say that financially speaking, Kering is in a very good place.
Valuation
For many makers of high-end goods, you pay a premium for their stock just like you do for their products. Prime examples for this are stocks like LVMH, Ferrari ( RACE ) or Hermès ( HESAY ). For a while the same thing applied for Kering:
It can be of course argued that Kering is not of equal quality as the other companies mentioned. Still, at the current valuation Kering is for this type of company outright cheap. Also when taking other metrics into account:
Source: Seeking Alpha
10 times FWD cash flow for a diversified luxury conglomerate; there are definitely worse deals on the market. In fact, for many metrics, Kering hasn't been this cheap since 2013. To not be a value trap the future shouldn't be too gloomy, but in this case we are talking about a business that sells desirable goods and many of its brands are well established. Recent acquisition Creed has been around since 1760, so there is more to this business than the latest trend.
Risks
In my first article on Kering I stated that the main risk was its valuation at the time. While it seems more attractive now, the stock can always go lower. A global slowdown seems to be a bigger risk at the moment. While high-end buyers will still be able to purchase these goods if the economy tanks, aspirational consumers will be in more trouble. This is a significant portion of the market for these brands and this will hurt sales if this group stays out of the stores. Finally, I'd like to reiterate that being a big brand today doesn't mean that you'll be at the top a decade from now. Younger generations might distance themselves from certain styles or clothes that their parents wear for example. For Kering this risk is still largely embedded in their reliance on Gucci. Luckily this reliance is being somewhat addressed.
Conclusion
Kering was and is one of the largest luxury conglomerates on the planet. As a business it is not equal to LVMH, but that doesn't mean it isn't a good investment. Based on my analysis, the opposite would be true at the moment. The collection of high-value brands keeps growing, the revenue streams are getting more diversified and the price of the stock is in value territory. While momentum might be against Kering, this should not deter the long term investor. This is a high quality business at a reasonable price. Kering is therefore a buy.
Editor's Note : This article was submitted as part of Seeking Alpha's Best Value Idea investment competition , which runs through October 25. With cash prizes, this competition -- open to all contributors -- is one you don't want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!
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Kering SA: Premium Brands At Discounted Prices