Why Every Lady Needs an Hermès

euronext hermès luxury rms roa roe Dec 25, 2017

by: Tam Ging Wien

- Investing in the Epitome of Luxury


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The iconic Birkins and Kellies have long been a symbol of luxury – an unspoken statement announcing your status and membership into the most coveted of the elite clubs. Carried through a crowd immediately elicits public chatter – love it or hate it, an Hermès is here to stay.

Established in 1873 by Thierry Hermès initially as a harness workshop dedicated to European elites for their horse and carriages. It soon diversified into other products such as saddles, bags and jackets. Hermès was one of the suppliers of saddles to the Czar of Russia and had a leather golf zipper jacket specially made for Edward, Prince of Wales.

It was in the 1930s that Hermès introduced the goods that recognised, know and love today. For example in 1935 released a leather bag known then as the Sac à dépêches (later rebranded as the Kelly) and later in 1937 released their signature designed carrés (scarves). The Kelly got its name from a photo of Princes Grace Kelly, Princess of Monaco trying to shield her pregnant belly from the paparazzi.

Hermès has long renounced mass production so prevalent among its competitors. Only one craftsman every works on one handbag or leather good at any one point of time. Hand stitching a bag can take anywhere from 18 to 24 hours. Attention to detail is painstaking, coupled with limited supply of rare exotic skins, precious metals and materials limits the number of bags that can produce each year. With the ever growing number of clients on the waiting list, admission to the exclusive “Hermès club” could take anywhere from 2 to 3 years.

Hermès International S.A. (Euronext: RMS) currently helm by CEO Axel Dumas boast a revenue of EUR 5.37bil for FY2016.

So, why should all ladies have an Hermès in their portfolio? Here are a several reasons:

  • Because they produce their products with the highest quality and luxurious materials
  • Because their products are made by highly skilled craftsman
  • Because an Hermès always appreciates and can easily be resold in the secondary market due to high demand
  • Because you can match a Birkin or Kelly with virtually anything
  • Because an Hermès is a timeless piece of art
  • Because an Hermès heralds your arrival into a new dawn of style, elegance and luxury
  • Because there is no company quite like Hermès

Why You Need Hermès in your Portfolio

Well because there REALLY is no company quite like Hermès! We will focus a little more the reasons for this unique business.

Source: Hermès International Annual Reports

Hermès has shown a consistent trend of growing is revenue throughout the years. From FY2007 till FY2017, it clocked in an explosive growth rate of 12.81% compounded. Even during the Global Financial Crisis of 2008 and 2009, it had shown growth in its revenue. This indicates that its customers are not even materially affected during the crisis period and can still afford to continue financing their lifestyles despite a financial crisis.

Source: Hermès International Annual Reports

The growth in revenue is mirrored closely into profit and cash flow growth with operating income margins and net margins consistently above 30% and 20% respective. Its free cash flow growth is even more impressive, clocking 21.37% compounded annual growth rate. From the trends of the charts, it doesn’t looks like the growth is slowing.

Its dividend payout and has been remarkably consistent with shareholders receiving special dividends in FY2012 and FY2015. Dividends are also clearly being paid out from its free cash flow. Based on its current price of EUR 441.50 as of time writing, its dividend yield is approximately 0.77%. FY2012 and FY2015 dividend was EUR 7.06 and EUR 7.99 per share respectively. Translated to yield at today’s prices is 1.6% and 1.80% respectively.

Hermès has also managed this phenomenal growth rate with minimal use of leverage. Based on its FY2016 balance sheet, it’s Total Debt-to-Asset Ratio and Total Debt-to-Equity Ratio stands at only 26.9% and 36.8% respectively. EUR 2.3bil out of its massive EUR 6.0bil assets on its balance sheet is in cash and cash equivalents. Hermès is a low debt and cash rich company. With such a massive cash hoard, high cash flow and and low CAPEX, it will not be surprising that Hermès might pay another round of special dividend in FY2018.

With such numbers, it is no surprise that Hermès’ Return-on-Assets (ROA) and Return-on-Equity (ROE) for FY2016 stands at an extraordinary 18.3% and 25.1%. Hermès’ ROA and ROE for the past 10 years has also been gradually increasing. With a presently high cash percentage of its total assets, we suspect that a case is building for another round of special dividends in the next 1 to 2 years.

Source: Hermès International Annual Reports

Breaking down its revenue and operating income by geographic segments, we can see that the Asia-Pacific region and Japan forms a very important part of its business. Nearly 48.1% and 55.2% of its revenue and operating income comes from this region. Europe including Frances is another important region for Hermès.

Source: Hermès International Annual Reports

Further analysing its operating income margins, we find that the Asia-Pacific region and Japan provides Hermès the highest operating margins! Is it because its cost base in Asia is lower? Or is it because they price their products in Asia higher? Humm… ladies, perhaps you could answer this question. A tour to Europe to pick up some Hermès products might do the trick!

Source: Hermès International Annual Reports

Finally, it is clear from the breakdown of their various lines of business, leather goods and saddlery forms the largest fraction of their revenue.

Source: Hermès International Annual Reports

Looking at Hermès’ historical share price, we can clearly see that it has been rewarding shareholders handsomely with prices rising from about EUR 50 to EUR 441 over a 12 year period. That is a 24.3% CAGR!

However, notice that during the 2008 and 2009 Global Financial Crisis, the stock prices took a plunge. This indicates that its stock price is not immune to the sell downs during periods of crisis. Yet at the same time, its revenue and profits continued to show steady growth during the crisis. Perhaps, the best time to pick up some Hermès shares would be during the next financial crisis.

Source: Yahoo! Finance

Surprisingly Fairly Valued Unlike its Products

Given its phenomenal growth rate, high cash hoard, high cash flow, low debt, predictable nature of its business, recession immune and strong branding we expect that the stock price will be trading at a high premium just like its products.

Using the net income CAGR of 12.8%, discount rate of 4.0% and a 15-year discounted cash flow estimation method with no terminal value, we obtain an intrinsic value of EUR 434.86.

Source: Respective Annual Reports

Comparing is Hermès to its peers, we can easily conclude that it has one of the highest Operating Margins, Net Income Margins, ROA and ROE. Its debt levels are also fairly conservative comparatively, only Richemont has a marginally lower debt level.

On the valuation side on the other hand, Hermès is slightly on the higher side with the P/E and P/B Ratio of 42.91 and 10.77.

Summary and Conclusion

Hermès is a very impressive company on many levels. Here are the reasons why all ladies should have Hermès as part of their portfolio:

  • Strong and globally recognisable branding
  • Consistently high revenue growth trend
  • Profits and cash flow trends mirror revenue trends closely
  • Conservative balance sheet
  • Predictable free cash flow
  • High cash holdings
  • High ROE and ROA
  • Potential for special dividends
  • High gross, operating and net margins
  • When you own Hermès in your portfolio, it turns heads!

One risk that we should watch out for is that it operates in a discretionary business and perhaps demand for its products may reduce during times of crisis. However, the revenue, profit and cash flow growth trends during the 2008 and 2009 Global Financial Crisis seems to contradict this assumption.

Based on its current share price, it is fairly valued compared to its peers and from and intrinsic value perspective.

If the share price ever drops to the stage where it presents an investor a high margin of safety, it would certainly be worth considering as an investment. As its stock prices are not immune to a global equities sell down during the financial crisis, perhaps which could be the best time to pick up this stock.

Finally, I don’t think Hermès is just for the ladies, I actually want some too!

 

p.s. Ladies, you are seriously thinking of picking up an Hermès product, you might want to consider the European region outside of France, it seems that their margins there are the lowest! Lower prices perhaps?

 

 

 


Disclosure Statement

The views and opinions expressed herein are those of Tam Ging Wien (“the author”) and do not necessarily reflect the official policy, position or view of the author’s employer, organization, committee or other group(s) or individual(s).

The author at time of writing does not hold any stake in Hermes International SCA.


 

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