2023-11-07 00:26:34 ET
Summary
- Richemont is a Swiss luxury goods company. The company has achieved consistent growth owing to its strong brands, such as Cartier, as well as its growing popularity in luxury goods.
- We expect continued revenue growth in line with what has been achieved historically, although tailwinds from China could improve this in the short term. This said, we highlight that China.
- Margin improvement has been driven by price action, with demand remaining strong in spite of this due to an increase in wealth prior to the successive rate hikes.
- Relative to their peers, Richemont is performing well while being similarly valued. We consider the stock to be undervalued.
Investment thesis
Our current investment thesis is:
- Richemont owns several leading luxury brands, allowing the business to price aggressively and partake in the general growth of the luxury market.
- The company's financial performance has improved in recent years, namely due to margin appreciation. With demand remaining strong, the current margins appear defensible. It appears that the company is now back on track following a period of disappointment.
- Richemont is superior relative to peers on a financial basis while trading at a similar valuation. Investors are concerned about a return to its poor execution but we see the recent improvement as good foundations for a resurgence.
Company description
Richemont ( CFRUY ) is a Swiss luxury goods company founded in 1988. The company specializes in the design, manufacturing, and distribution of high-end luxury products, including jewelry, watches, writing instruments, and fashion accessories.
Richemont's portfolio of luxury brands includes Cartier, Van Cleef & Arpels, Montblanc, and several others. With a global presence, Richemont caters to discerning customers seeking exceptional craftsmanship and timeless elegance.
Share price
Richemont's share price has lagged the market in the last decade, as the company has faced difficulty achieving consistent financial performance during a difficult period in its key segment. In recent years, industry conditions have noticeably improved, contributing to a resurgence.
Financial analysis
Richemont financial analysis (Capital IQ):
Presented above is Richemont's financial performance for the last decade.
Revenue & Commercial Factors
Richemont's revenue has grown at a CAGR of 7% in the last 10 years, a respectable performance. During this period, revenue growth has been volatile, partially due to FX and acquisitions/divestitures, but also the inability to achieve consistency. This growth should also be considered in the context of declining margins for much of this period, also.
Business Model
Richemont owns a diverse portfolio of prestigious luxury brands, each with its unique positioning and customer base. The company focuses on nurturing and expanding the brands within its portfolio while maintaining their individual brand identities, a strategy conducted by many large luxury businesses, such as LVMH ( LVMHF ) and Kering ( PPRUF ). Richemont is primarily in the jewelry business, led by the global phenomenon that is Cartier, with its revenue split as follows.
Segment split (Richemont)
Richemont is a truly global business, with no region representing more than 40% of its revenue. Similar to other luxury businesses, the majority of its revenue is generated from APAC, as China represents the largest luxury market in the world. China has faced issues with Covid-19, as its Government remained stubborn with its zero-Covid policy until late 2022. This significantly impacted both demand in the country and tourism spending. With this now unwinding, we believe Richemont faces a tailwind in the coming quarters due to this.
Geographical split (Richemont)
Richemont distributes its products through a mix of retail boutiques, e-commerce platforms, and authorized third-party retailers. Richemont has identified e-commerce as a key segment for growth, partnering with Farfetch ( FTCH ) (and taking an ownership stake in the business). This involves the partial sale of its YNAP business, an attempt to enter the luxury retail industry.
Richemont places a strong emphasis on preserving traditional craftsmanship techniques while incorporating technological advancements to drive innovation and enhance product offerings. Especially in the horology segment, this is critical. The cost of producing watches can be significantly reduced through the use of machines, but it diminishes the value of the top-tier brands, as consumers expect hand-built watches.
Richemont operates throughout the value chain, from designing and manufacturing to distribution and retailing. This vertical integration allows the company to maintain control over the quality and authenticity of its products, ensuring it maintains the brand's heritage in the process.
Richemont's key selling point is the quality of its brands. Richemont has always been focused on acquiring and developing businesses with a deep brand heritage, affording them sticky demand and integration in their industries. This protects the business from short-term trend changes while allowing for enhancement in value through marketing.
The Cartier example is clear but this is the case for many others. A Lange & Sohne is considered one of the greatest watchmakers in the world and certainly in the top 2 from Germany. Vacheron Constantin is a member of the Holy Trinity of Watchmakers, the three highest regarded watchmakers. Jaeger-LeCoultre is known as the Watchmaker's Watchmaker due to its unrivaled expertise in complex watchmaking. Van Cleef & Arpels is one of the top 5 most highly regarded Jewellery brands.
Luxury Industry
Richemont competes with other luxury goods conglomerates such as LVMH (owns several brands incl. Tiffany & Co and Tag Heuer) and Kering (Ulysse Nardin and Girard-Perregaux), as well as the Swatch Group ( SWGAY ) (Harry Winston, Breguet, and Blancpain), among others. All 3 own a portfolio of luxury brands. Additionally, individual luxury brands within specific product categories pose competition, such as Graff.
Luxury brands compete based on factors like brand reputation, product design, quality, innovation, and customer service.
Consumers seek unique and memorable luxury experiences, prompting companies to create immersive retail environments and offer personalized services. Richemont has done a fantastic job of this, as despite the niche nature of some of its brands, it has ensured that many can still provide this experience. A Lange and Sohne, for example, produces an estimated 5000 watches a year and still gets a shopfront on London's famed New Bond Street (For context, it is rumored Rolex produces over a million ).
In conjunction with its physical footprint, Richemont has ensured adequate focus on e-commerce, an area of growth as consumers value the convenience and ability to shop around. Despite the underperformance of YNAP, Richemont has been quite successful with developing each brand's e-commerce presence. This has been achieved through "boutique exclusives", essentially creating products for its own distribution channel. This supports an increase in the amount of direct-to-consumer sales, improving sales economics. Currently, 26% of sales are via 3rd parties, giving the business further scope for bringing sales in-house.
The growth of the middle class in emerging markets and their increasing purchasing power present significant opportunities for luxury brands. We expect this trend to continue, sustaining the current growth trajectory.
Economic & External Consideration
Current economic conditions, dominated by inflation and elevated rates, could represent a risk to growth and are certainly acting as a drag. This said, it is not materially impacting the growth trajectory. In the last 2 years, Richemont has grown at an average rate in excess of 20%, both volume and price-driven.
In the company's most recent quarter, revenue grew at a +14% rate, with all regions but the Americas up. Importantly, the APAC region is showing a strong rebound, softening the concerns that the Chinese may be retreating. Given the performance thus far, we suspect the business will continue to remain resilient.
Margins
Richemont's margins are extremely strong, although has faced a noticeable decline into FY21. Currently, Richemont has a GPM of 69% and an EBITDA-M of 29%.
The improvement in margins has been driven by pricing. Across the luxury segment, we have seen brands increasing their prices, partially in response to inflationary pressures, but also insatiable demand. Richemont has seemingly conducted a business-wide mandate regarding this, with aggressive pricing across products, and at regular intervals. Anecdotally, I was planning on purchasing a JLC Reverso for ~€8.5k early last year; this same watch is now >€12k. The risk is that consumers will be put off purchases (like I have been) but thus far, this has contributed to an impressive margin bump.
Balance sheet & Cash Flows
Richemont is conservatively financed, with a ND/EBITDA ratio of (0.4)x. This puts the business in a position to conduct further M&A if required. We believe this could act to revitalize the business, with its higher margins allowing the business to utilize predominantly cash.
Further, despite the aggressive pricing, inventory turnover has improved, implying customers are digesting this more positively than expected.
Outlook
Presented above is Wall Street's consensus view on the coming 5 years.
Analysts are forecasting continued growth in line with what has been historically achieved, a reasonable estimate based on the commercial profile of the business. Further material pricing action is unlikely, and growth will inevitably normalize from the heightened levels currently, bringing the business back to a healthy level.
Further, analysts are seemingly buying into the price hikes and our view on defensibility, with margins expected to level off at the FY23 levels, a good performance in our view.
Industry analysis
Presented above is a comparison of Richemont's growth and profitability to the average of its industry, as defined by Seeking Alpha ( 33 companies).
Richemont is a market-leading business financially, with significantly better margins than the average, and a comfortable growth premium. Even if the outlier businesses are removed, Richemont remains superior. This is a reflection of the strength of its brands, alongside its scale superiority. These commercial factors have allowed the business to extract the most value from its pricing, while also keeping brand popularity.
Valuation
Richemont is currently trading at 11x LTM EBITDA and 9x NTM EBITDA. This is a discount to its historical average.
A premium could be argued in our view, given Richemont has spent most of the decade with margins below its current level. This said, conservatively, we would suggest parity with its LTM historical average, which suggests upside of ~27-37%.
Further, Richemont is trading at a discount to its peers on an LTM EBITDA basis (-6.7%) and a NTM P/E basis (-14.8%). Once again, we believe this implies upside. Commercially, Richemont has superior brands, a strong presence in growing markets, and strong DTC sales. Financially, the company is above average in every important way.
For such a large, consistently strong business, a NTM FCF yield of ~6% is highly attractive in our view. We believe negative sentiment in the luxury segment is clouding investor attitudes.
Rumors: LVMH takeover
Given the relative valuation of peers, we believe the risk with this investment is low. The key risk is primarily related to the sustainability of margins, given the large jump in the last year. This said, we are hesitant with the current LVMH rumors.
Rumors began swirling in early 2023 that LVMH is looking to acquire Richemont and if this is not possible, Cartier. Management is expected to be against this move. This would likely value Richemont at a premium, which is currently trading at a 3x NTM EBITDA discount to LVMH.
What we are concerned about is if Richemont sells Cartier. This brand is the crown jewel of the Richemont empire and a key value driver. A sale, even for an attractive price, would materially change the trajectory and value of Richemont.
Final thoughts
Richemont is a high-quality business, primarily driven by its global brands and strong financial position. We believe the company's commercial profile implies a continuation of its current trajectory, although at superior margins. Management has done well to lift margins, with focus now turning to further brand development and a consolidation of the growing interest in its maisons.
With Richemont trading at a discount to its historical average and its peers, we believe the stock is undervalued.
For further details see:
Richemont: Luxury Business With Revenue Growth And Cheap Valuation