In this post I will discuss some reasons why LVMH could be a good investment opportunity during the next couple of years in case the current inflation keeps rising to extraordinary levels.
LVMH Moët Hennessy - Louis Vuitton, Société Européenne (MC:FP) is the market leader within the luxury industry, headquartered in Paris, and integrated by 60 subsidiaries, 75 brands, 175,647 employees, and 5,556 stores. The firm mission is to represent the most refined qualities of Western "Art de Vivre" around the world through a business model marked by creative momentum and a constant quest for excellence, while its vision is to become the world leader in luxury, with a philosophy summed up in its motto “Passionate about creativity”.
LVMH is a multinational corporation and conglomerate, and the only group present in every luxury sector: fashion and leather goods (that account for 48% of total sales), perfumes and cosmetics (10%), watches and jewelry (14%), wines and spirits (9%), and selective retailing and other activities (19%). The company's revenue can also be segmented into the following geographical locations: the United States (26%), Europe (21%, with France accounting for 6%), Asia (42%), and other markets (11%).
1. · Industry prospects by Consultants Bain & Company expect to see CAGR in the sector of between 6% and 8% a year from now until 2025. At this moment, LMVH dominates the fashion segment, which is the main and most competitive segment in the industry. The competition is focused on quality and image so that the barriers to entry and the intensity of rivalry are both considerable. Consequently, the threat of new entrants is relatively low because they find it difficult to survive and most of them are either acquired or kicked out over time. The power of suppliers is low for LVMH because there is a high availability of existing and non-differentiated suppliers, and the company purchases raw materials from suppliers based on the consignment while reducing loss marking and achieving economies of scale. The customer base is mainly composed of high-net-worth individuals who are so loyal to the firm that the bargaining power of buyers is low against its pretty high prices and a strong market positioning.
· What's more, millennials and a rapidly emerging and fashion-conscious middle class are also contributing significantly to speeding up industry growth. In addition, some technological trends to consider are digital content such as NFTs and video games they develop for their websites, which provide a richer and more dynamic experience and engagement to connect with customers than text and flat images. This tendency to value more experiences than goods is driving other expansion strategies for businesses such as high-end hotels, resorts, cruises, and restaurants with killer food.
· LMVH's financial performance has been stronger and improved profitability margins because of several factors, such as e-commerce growth and innovative and more effective marketing strategies. Revenue growth in FY2021 has been 36% compared to FY2020 and 14% versus FY2019. Moreover, operating profit growth has been 115% compared to FY2020 and 52% versus FY2019, and the net income grew 107% compared to FY2020 and 49% versus FY2019. In addition, the company's profitability has also improved during FY2021. Gross margin was 68,3% (versus 64,45% in FY2020; and 66,23% in FY2019), EBIT margin was 26,7% (versus 18,6% in FY2020; and 21,2% in FY2019), and finally net profit margin was 18,74% (versus 10,53% in FY2020; and 13,36% FY2019). All in all, the company showed a strong performance even during the previous pandemic recession.
· Besides, LVMH's financial position stays quite strong if considering leverage levels and cash flow generation together. Regarding its cash flow generation, the company doubled its free cash flow from the previous year without considering an exceptional and successful acquisition of Tiffany in January 2021. The current level of operating cash flow is so high that net debt/CFO is 66% excluding leasing liabilities from the ratio calculation. regarding the financial position, shown by the following company's balance sheet, remains strong even after Tiffany’s integration. As a result of this transaction, intangibles and goodwill accounts have increased considerably, while leverage has not been because of the exceptional cash flow generation during the last fiscal year. Total Debt to Equity is 73.12% and Long-term Debt to Equity is 51.05% while Moody’s and Standard & Poor’s confirm A1 and A+ long-term credit ratings respectively with a stable perspective. All in all, plus considering the positive prospects for the company's performance, it seems the company can deleverage the business in less than two fiscal years.
· The company shows several strengths as an industry leader such as a strong connection to high-quality and recognition of the brands after a rich history and culture, a broad product portfolio with lots of synergies, best celebrities’ endorsements, and a large network of stores, employees, top designers, and countries where the company operates. Furthermore, LVMH also benefits from several growth opportunities, such as new image revamps, the development of new products applying competitive advantages, and the increase in rent per capita in emerging markets. For example, it is now enough for the luxury companies’ profitability to expand rapidly to the Chinese market, which is now the second largest country in total revenue behind the US. In contrast, the major risks are counterfeit as the biggest threat of substitutes for the entire industry, the intense competition the company is managing extraordinarily well by gaining market share YoY, and the talent retention quite well-managed by the labour policies and initiatives commented before.
· From a valuation point of view, the company is trading at P/E ratio of around 20x, lower than other luxury peers such as Moncler or Richemont that get above 28x while holding worse business models. Other luxury companies, such as Swatch Group, Pandora, or Hugo Boss, are trading at lower multiples. However, this second group of luxury companies also targets many middle-class customers, whose products’ demand might not grow within the current inflationary environment. In contrast, I expect the consumption demand for LVMH products to stay robust and growing in this scenario because of the company's narrow-focus strategy, which targets only the richest population as its customer base. All in all, this first group of most expensive luxury products is expected to perform much better than the second one and most industries, and even more in case the economic situation worsens in the following years. Last, the consensus clearly recommends buying the stock and gives the stock an average price target of 775,50 €.
· The company's CEO, Bernard Arnault, holds a reputation and qualifications not questioned by many. He became CEO in 1989 and has stayed in charge of this position while upgrading the company to the industry leadership position and becoming one of the richest people worldwide. Besides several recent insider transactions, he has invested over 17 million EUR in LVMH stocks since the beginning of the year. In fact, the company announced a stock buyback program at the beginning of the year, which means the company thinks its stock is a profitable investment opportunity for the upcoming years.
· The company ownership is divided by institutions (765 institutions that account for 22.9%), the general public (27.2%), and private companies (49.9%).
· The company's recent performance in Q1 has been in line with the consistently sound financial performance demonstrated in the company's past track record. The company achieved double-digit revenue growth (23% in aggregate) in every segment and location except for Asia (excluding Japan) because of recent Covid restrictions and also the wines segment, which only grows 2% due to supply constraints in Hennessy's cognac in the US. Perfumes and cosmetics rebound in Europe with 17% revenue growth YoY, Sephora continues the same tendency in the selective retailer segment by growing 24%, the fashion segment dominates with 30%, and watches and jewelry grow 19% after including Tiffany's integration. After this powerful performance, the company continues its plan for developing online platforms, innovating while reducing costs, and performing accurate decision-making focused on the most profitable opportunities, such as new stores.
· The last Q1 performance and the company's outlook suggest better YoY results for every segment in the next fiscal year. Therefore, this is a good investment catalyst for the next twelve months. However, the company value is expected to grow a lot from the long-term perspective when observing industry prospects and its leadership position.
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