Hermès International
Rare multi-century longevity - what to expect going forward?
Introduction
Hermès International, or Hermès/RMS, is a family-based company that doesn’t need much introduction. At least, that’s what most people would think.
Compared to the much debated LVMH, Hermès is still - as weird as that may sound - flying under the radar and the performance of the entire luxury sector is oftentimes a short-term dominant factor (investors wrongfully assuming “so goes the luxury industry, so goes Hermès”).
It was founded in 1836 and has since demonstrated its exceptional performance. Longevity at its best, and considering that the company has its own league, the management team is laser-focused on the long-term trajectory, not on how the next quarter will unfold or on how competitors are/will be faring.
The company’s strategy is focused primarily on exclusivity, tradition and pricing power: desirability is in fact killing two birds with one stone. Coupled with satellite branches, the monobrand strategy makes the unique selling proposition straight-forward and highly appreciated by its clientele.
Hermès’ management team puts maximizing the terminal growth rate first, which should equate to a premium valuation. Other than more mainstream luxury companies, we believe Hermès is less prone to the spending patterns of aspirational buyers and therefore, the premium valuation is justified and doesn’t necessarily pose a threat to achieving solid returns going forward.
Valuing the company through standardized methods is very likely to put you on the sidelines forever: it’s seemingly never cheap to buy shares (from a relative and absolute point of view as the shares currently trade at 2,300 EUR on the French/home stock market).
So let’s dive into the company, its financials and our expectations reflected in the valuation model. As always, our deep dives aim at contextualizing reported numbers. Looking beneath the surface is critical to modeling properly.
Our investment case boils down to the following key concepts of shareholder value creation:
RMS’ unrivaled pricing power resulting in continued moderate EBIT margin expansion over the foreseeable future (versus FY22, as FY23 benefited from currency hedging effects);
Rock-solid reported ROIC of 58% with a ROIIC of 30-35% and reinvestment rates of 20-30% of NOPAT;
Balance sheet strength and swelling cash position allow for exceptional dividends;
Sustaining a high terminal multiple thanks to the above features, notably, RMS didn’t experience a sales drop in 2008-2009
Maison Hermès: scarcity and diversified product ranges
More often than not, Hermès tends to be associated with the iconic Birkin Bag which costs thousands of dollars. Still, the French luxury concern has many more revenue streams, ranging from Watches to Perfume and so forth. Brand attraction, exclusivity (Hermès sells through its own exclusive store network and through very well selected third-party concessionaries) are at the root of the company’s success.
In the luxury space, building a powerful brand and customer loyalty requires decades (or in RMS’ case even centuries) of patience, craftsmanship and a consistent long-term vision, ideally put forward by a reputable family.
How can Hermès continue to seduce its clientele while almost everyone else fails? Scarcity, is the main answer. Take the Kelly or the Birkin - another of its iconic bags, developed for actress Jane Birkin. Even those with 10,000 euros - the minimum amount for such a bag - can't just go into 1 of 300 stores worldwide. There are waiting lists that, depending on the type of leather and size, can last up to a few years. Demand exceeds the complex method of handmade production. As of today, 75% of all products are manufactured in France.
No better place than social media to capture that desire. Numerous vloggers reveal in videos there their "journey" to an Hermès bag or tell how they won the "Hermès game. Even if it is not obvious, some believe they obtained such a bag faster because they bought many other products from the brand. Hermès, which derives almost half of its sales from leather goods, is busy establishing new ateliers. But whether that will shorten the waiting lists remains to be seen.
A Kelly or Birkin is made only by artisans trained in-house for years, and that process quickly takes 15 hours. "I'm not going to reduce it to 13 hours," CEO Axel Dumas said earlier. Conversely, if targeting scarcity becomes too prevalent, it might be dropping buyers out. Take the secondhand market, where a Hermès luxury handbag can easily cost three times as much. That is not only flattering to the company, it is also a market that is less controllable and makes RMS lose money somehow.
Exhibit I and II provide a product segment breakdown from which we can deduce the notably accelerated revenue growth for RMS’ non-Leather Goods (LG) divisions. Over the past five years, LG has posted a 13.3% CAGR in revenues versus +24.2% for the Read-to-wear Accessories.
Note: our financial analysis will discuss the 2018-2023 period to correctly reflect the impact of IFRS-16
Exhibit I
Exhibit II
