2023-07-20 23:39:29 ET
Summary
- Kering, the owner of luxury brands such as Gucci, Yves Saint Laurent, and Balenciaga, is trading at a significant discount, with a 17.7x P/E compared to the peers' average of 27.0x.
- Kering's portfolio has unquestionably high quality, yet the group isn't able to extract its value.
- I've seen many explanations for its discount, but many of them miss the point.
- As the company continues to lag behind the industry leaders in terms of growth, free cash flow, and marketing, it became an activist target, which resulted in a short-term upswing.
- Despite that, the company still has a long way to go before it can narrow the gap with the industry leaders. Therefore, I rate the stock a Hold.
Kering SA ( OTCPK:PPRUF ) the owner of Gucci, Balenciaga, and Saint Laurent, trades at a significant discount compared to its luxury peers.
The discount is so obvious at a 17.7x P/E compared to the peers' average at 27x, it begs the question of whether we have a huge opportunity upon us or whether the discount is justified.
Let's try to answer that question.
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With the end of July approaching, almost every luxury house in the world is set to report its financial results for the first half of 2023. For those interested in reading previous articles I wrote about companies in the industry, here are the links:
- LVMH: 2023 Should Be Another Stellar Year, It's A Buy
- LVMH: Q1 Numbers Show No Sign Of Slowing Down
- Capri Holdings: It's A Value Trap, But A Likely Takeover Candidate
- Tapestry: It's Not Luxury, But It Is An Attractive Investment
- Hermes: Unjustified Historically-High Premium Over LVMH
- Compagnie Financiere Richemont: Turnaround Story Over, But There's Still Upside
I plan to write a pre and post-earnings article on every luxury house. Stay tuned.
Company Overview
Kering is one of the largest luxury groups worldwide, managing a collection of prestige brands in fashion, leather goods, and jewelry, with aspirations to penetrate the beauty market as well. The company's brand portfolio includes Gucci, Saint Laurent, Bottega Veneta, Balenciaga, Alexander McQueen, Brioni, Boucheron, Pomellato, DoDo, Qeelin, and Kering Eyewear.
Kering May 2023 Investor Presentation
The group was founded by François Pinault in 1963, as a timber trading entity. It entered the luxury business in 1999, after acquiring its first stake in Gucci, and expanded in 2001 with the acquisition of the Italian leather goods Bottega Veneta and Balenciaga. Over the years, the group continued to acquire new businesses in China, France, and Denmark, as well as divest non-core activities, leading it to become what it is today.
In 2005, more than four decades after his dad founded the group, François-Henri Pinault was appointed as the group's Chairman and CEO and has been manning the position until this day. The family-owned Artemis group still owns a controlling stake in the company, holding 42.0% of the group's shares. Today, the company employs over 47,227 people and operates more than 1,659 retail locations.
Kering 2022 Investor Presentation
Kering's geographical exposure is pretty similar to LVMH ( OTCPK:LVMHF ), with 39% of sales generated in Asia, 27% in Europe and North America, and 7% in the rest of the world. So exposure to Asia (including Japan) is marginally higher than LVMH, which generated 37% of its sales in Asia, and less than Hermès ( OTCPK:HESAF ), which generates almost 58.0% of its sales in the region.
As I discussed in previous articles, direct-to-consumer channels are an extremely important aspect of luxury, and Kering's is quite impressive with 78% of total revenues generated through its retail channel. This is one of the first foundational metrics to look at with a luxury group, as it's directly linked to the company's profitability, and brand value.
Operating Segments
Kering aggregates its results under five reported segments: Gucci, Saint Laurent, Bottega Veneta, Other Houses, and Kering Eyewear.
Kering Investor Presentation, May 2023
Gucci is by far the largest in terms of sales, responsible for over 50% of the group's total sales. It is also the most profitable segment, with 35.6% EBIT margins. Saint Laurent is second, with 16.2% attributed to the brand, and 30.9% EBIT margins. Third is Bottega Veneta, with 8.5% of sales and a much lower 21.0% margin.
Gucci
The Gucci segment includes the results of Gucci branded products which are distributed through 528 operated stores worldwide as well as through wholesale channels.
Created and calculated by the author using data from Kering financial reports.
Gucci is the crown jewel of the group, growing at a 14.6% CAGR between 2016-2022, maintaining 35% and above operating margins. Between 2019 and 2022, Gucci went through a reorganization of the brand's distribution chain, which culminated in the company surpassing the 90% threshold for sales generated in directly operated stores. In 2022, Gucci generated 91.0% of its sales from operated stores, reflecting €18.1M in annual sales per operated location.
Looking at Gucci's product mix, we see 52% of its sales are attributed to the highly profitable leather goods category. The second largest cohort is shoes, with 21%, followed by ready-to-wear with 15%. Gucci's major region is Asia Pacific, with 36% of sales.
Saint Laurent
The Saint Laurent segment includes the results of YSL branded products which are distributed through 280 operated stores worldwide as well as through wholesale channels.
Created and calculated by the author using data from Kering financial reports.
Saint Laurent is the fastest-growing brand within the group, with a 15.3% CAGR between 2016-2022. The segment achieved all-time high operating margins in 2022, at 30.9%. In 2022, Saint Laurent generated 77.0% of its sales from operated stores, reflecting €9.1M in annual sales per operated location.
Looking at the product mix, we see 75% of Saint Laurent's sales are leather goods, followed by ready-to-wear with 15% and shoes with 9%. YSL's largest region is North America, with 33.0%.
Bottega Veneta
The Bottega segment includes the results of Bottega Veneta branded products which are distributed through 271 operated stores worldwide as well as through wholesale channels.
Created and calculated by the author using data from Kering financial reports.
Bottega is clearly the laggard among the company's three largest brands, growing at an unimpressive 6.8% CAGR between 2016-2022. Furthermore, the brand operates at a lower margin, achieving 21.0% in 2022, still significantly below its 2016 highs. In 2022, Bottega Veneta generated 78.0% of its sales from operated stores, reflecting €5.0M in annual sales per operated location.
Surprisingly, Bottega's product mix leans towards more profitable categories, with Leather Goods responsible for 75% of sales. We can understand that this segment's brand value is not as high as the other two, resulting in a relatively low margin.
Other Houses
The Other Houses segment aggregates the results of the Alexander McQueen, Balenciaga, Brioni, Boucheron, Pomellato & Dodo, and Queelin brands. Their products are distributed through 580 operated stores worldwide as well as through wholesale channels.
Created and calculated by the author using data from Kering financial reports.
Other Houses are growing at an impressive pace, with a 14.7% CAGR between 2016-2022, while significantly improving margins along the way. In 2022, 66.0% of the segment's sales were generated in operated stores, reflecting €4.4M in annual sales per operated location. It seems like it's only a matter of time before some of the brands aggregated under the segment will be awarded a segment of their own.
Looking at the product mix, the margin is even more impressive, with a relatively even distribution between shoes, leather, watches & jewelry, and ready-to-wear.
Kering Eyewear & Corporate
This segment is quite weird, as it aggregates the results of the company's eyewear and beauty businesses with fragmented corporate expenses. We can't learn too much from the segment's results, aside from the fact that its losses are decreasing and revenues are growing.
Created and calculated by the author using data from Kering financial reports.
Ignoring financials, the group recently announced the acquisition of Creed, which is a high-end luxury fragrance house established in 1760. Kering didn't provide numbers, but according to estimates , the deal is valued at around €2B. Creed's results should be aggregated into the Eyewear & Corporate segment, which will probably go through some kind of restructuring in the near future.
The Ugly Duckling Story
The past decade has been pretty stellar for Kering's rivals, who outperformed the market, and Kering, by a significant margin. In the last five years, the gap has worsened. Kering provided investors with a 13.0% total return, compared to Hermès' 244.9%, LVMH's 201.7%, and Richemont's ( OTCPK:CFRHF ) 111.4%.
I've seen many explanations, including the Balenciaga scandal , and general "worse performance" comments. However, I don't think these provide the full explanation. In my opinion, the reason is the company's free cash flows.
Created and calculated by the author using data from the companies financial reports.
With such a significant gap in total return, you'd expect a major difference between their fundamental performance, but in reality, the gap isn't as wide as it seems, except for one metric.
Looking at their FCF CAGRs, the gap is huge. Kering's free cash flows barely grew in the past 5 years, which is primarily a result of stagnant margins, and relatively high lease payments for lower-performing stores.
As we discussed above, the company operates 1,131 Non-Gucci stores, and all of them combined don't generate nearly as much sales or nearly as much profit.
Furthermore, it seems the company's management is less appreciated by the market. Up until 2019, Kering was actually trading at a premium over LVMH. However, coming out of the pandemic, LVMH came out swinging, with 49% growth in 2022 compared to 2019, which is almost double Kering's growth in the period.
In the first quarter of 2023, the gap became even bigger, as Kering reported 2% sales growth YoY, compared to LVMH's 17%.
Its underperformance made Kering a fertile ground for activist investors, and a few days ago, Bloomberg reported the company is gearing up for defending a Bluebell Capital Partners intervention. Sharp investors will find this name familiar, as it's the same fund that tried to shake things up at Richemont.
Investors are probably hoping activist pressure will force improvements in the company, even if failed. Similar to Richemont, a small improvement could lead to a significant multiple expansion, narrowing the gap between Kering and industry leaders. The stock increased by almost 10.0% in the two days following the article, while other luxury stocks stayed relatively flat.
To conclude our story, I believe Kering has many problems to fix before we'll see the valuation gap close. First, FCF needs to improve dramatically, which means the company needs to divest low-performing stores and optimize its cash cycle. Second, the company's beauty ambitions need to bear fruit, and there's a huge deficit here compared to LVMH. Third, and the hardest one, Kering will have to work hard to improve the image of its brands and improve the product mix of Gucci.
For now, I don't see any sign of change. In fact, margins and FCF contracted in 2022, and growth again lagged larger peers by a huge margin. As long as the company continues to grow by 2% while LVMH grows by 17%, the gap will only continue to expand.
Valuation
I used a discounted cash flow methodology to evaluate Kering's fair value. I forecast the group will grow revenues at a 5.0% CAGR between 2023-2030 at the pace of the luxury market.
I project FCF margins will increase gradually up to 17.7% in 2030, as the company realigns its operations and returns to a normal cash cycle.
Created and calculated by the author based on data from Kering financial reports and the author's projections.
Taking a WACC of 8.5% and adding its net debt position, I estimate Kering's fair value at €565 per share, which amounts to $635 per PPRUF ADR based on the current USD/EUR ratio.
Conclusion
Kering has a long way to go before its ugly duckling story ends. The stock has significantly underperformed its peers in the last decade, primarily due to stagnant free cash flows and trailing the industry's growth.
Luxury is all about brand value, and Kering clearly suffers from inferior marketing. We've received evidence as recent as last quarter, in which the company's sales grew by a miserable 2.0%, while LVMH has grown by 17.0%.
Despite activist headlines causing a short-term upswing, the Pinault family still holds significant control over the company and most activist attempts will likely be blocked.
While Kering owns a high-quality portfolio of brands, I find its operations fundamentally worse than its peers, and thus view its discount justified. Therefore, I rate the stock a Hold.
For further details see:
Kering: The Ugly Duckling Tale Continues