The Astonishing Revelation
Step right up, friends and investors! You’re about to witness a remarkable transformation in my investment perspective. After my recent proclamation of LVMH (OTCPK:LVMHF) as a buy, I’ve been on an adventuresome journey through the intriguing world of business leadership and the indomitable will of the Arnault family, the owners of a monumental 48% stake in the company. This revelation has catapulted LVMH to new heights in my valuation model, and as a result, I am bullish and actively acquiring shares.
The Bold and Brilliant Business
You know all those luxurious brands that leave you utterly spellbound? Well, brace yourself, because they all fall under the incredible umbrella of LVMH. Bernard Arnault’s visionary mergers and acquisitions have propelled LVMH to own a treasure trove of the finest brands globally, making it the unparalleled titan of luxury conglomerates. With its resplendent French heritage and opulent DNA, LVMH reigns as the sovereign ruler of luxury. Its business spans eight market segments, with the fashion and leather goods segment, led by Dior and Louis Vuitton, capturing a staggering 49% share. Following closely is the selective retail (think Sephora) at 20%, emerging as the fastest-growing segment with a robust 26% growth in the last nine months. Watches and jewelry (Tiffany, Tag Heuer, and others) make up 13%, with the remaining segments showcased in the accompanying chart.
Unlike other consumer brands, LVMH wields stupendous power in its diversification strategy. While everlasting brands like Dior and Louis Vuitton exude timeless appeal, there’s always the risk of fading relevance, as witnessed in the tumultuous times faced by the enduring brand Estée Lauder (EL), for instance. LVMH boasts significant diversification across industries, brands, and geographies, as seen in the charts alongside. In the improbable event of its core brands losing their luster, there are numerous contingency plans in place. Furthermore, any slowdown in one region won’t inflict severe damage, courtesy of the company’s revenue diversification.
LVMH’s brands reign supreme in the luxury sphere, with three out of the top 10 luxury brands by Brand Finance belonging to LVMH. These brands, with historic legacies spanning centuries, embody enduring resilience and a multi-generational customer base.
The luxury segment’s supremacy lies in its pricing power and unyielding resilience. Unlike other industries, luxury must maintain its exclusivity; it cannot be mass-produced nor reduce prices to spur demand. Its primary mission is to uphold and elevate its lavish profile. While LVMH’s brands may not be as rare as illustrious resources like Hermes (OTCPK:HESAF), they are far from commonplace, amplifying their pricing power. This power is critical, as LVMH’s brands are nearly impervious to inflation. In the face of wage inflation, LVMH can effortlessly hike prices, far less detrimental than lowering them, as the fundamental mission is to safeguard the brand’s opulence.
With the typical luxury consumer less affected by economic downturns, we can anticipate a linear growth trajectory or a less cyclic nature during recessions. This linearity is evident in LVMH’s revenue history and is further underscored by the substantial 14% organic growth in the last nine months year over year even amidst the looming downturn in 2022-2023.
The Lavish Industry
LVMH operates in the luxury industry, expected to burgeon annually by 3.38% (CAGR 2023-2028), with the luxury fashion market projected to experience annual growth of 3.39% (CAGR 2023-2028). Although the last three years witnessed exceptional growth veering off the expected trajectory, LVMH managed to chalk up remarkable market share growth, nearly doubling its global market share from 12% to 22% between 2018 and 2023, per Jefferies. However, our valuation shouldn’t hinge solely on this type of growth.
The recent slump in the luxury industry has unfurled an extraordinary opportunity. Over time, we should brace for high single-digit earnings growth. I believe that through acquisitions, LVMH will continue to amass more market share and achieve modest margin growth.
Family Legacy and Leadership
What fortifies my ascent to a bullish rating on LVMH is my newfound appreciation of the attributes of the family proprietors. The Arnault family, with a powerful 48% stake, continues to ramp up their shareholdings, wielding over 60% of the voting rights. All five of Bernard Arnault’s progeny play pivotal roles in the company, purposefully aligning their substantial family fortune with LVMH’s prosperity. Similar to the extraordinary success of other French luxury brands like Hermes, a 6th-generation family business, the Arnaults’ results are equally striking.
The reasons for the superlative performance of family-owned businesses are eloquently expounded in the words of McKinsey:
The critical mindsets are a focus on purpose beyond profits, a long-term view and emphasis on reinvesting in the business, a conservative and cautious stance on finances, and processes that allow for efficient decision making.
Despite the intense speculation over Bernard Arnault’s successor, he remains an unparalleled and masterful captain of industry, exemplifying genuine concern and dedication to the business. For Arnault, the significance of compensation pales in comparison to the symbol of protocol. The variable remuneration for 2023 is structured on a 60% attainment of quantifiable objectives and a 40% achievement of qualitative objectives. The quantifiable objectives encompass revenue, operating profit, and cash flow, each bearing equal weight.
The Prime Risk Factor
Indeed, Bernard Arnault is a veritable titan, having built this empire from scratch, mastering acquisitions, and boldly deploying ruthlessness when demanded, as evidenced in the Tiffany saga. At 74, he joins the ranks of CEOs well over 70, notably Warren Buffett being a standout example. However, the exact tenure of his reign remains uncertain. The intense speculation over his successor indeed poses a risk, however, my confidence in LVMH’s enduring success supersedes this concern. I trust that Arnault will meticulously select his successor and will likely remain on the board to provide guidance, particularly given that a large chunk of his family’s wealth is vested in LVMH.
Aside from this, there are risks entwined with an economic slowdown, which, though less impactful on the luxury industry, still bears consequences, as observed by Chiara Battistini, Head of European Luxury and Sporting Goods at J.P. Morgan:
While the luxury sector is more resilient, we also note that it has never been immune to macro dynamics and has historically been late cyclical.
The risk of waning relevance looms large over the Dior and Louis Vuitton brands, given their substantial contribution to LVMH’s revenue. There’s also a potential risk stemming from Sephora, currently thriving, but pitted against robust rivals like Ulta Beauty (ULTA).
Valuation always poses a risk, but we will explore that later.
The Pivotal Figures
While LVMH’s recent growth has been spectacular, it’s vital to peer into the future and anticipate continued growth. The market is poised for low single-digit growth, fueled by the ascendancy of the middle class, population expansion, and the economic upliftment of emerging nations. LVMH is projected to exhibit superior top-line growth, propelled by acquisitions and the organic growth of its own brands, such as Sephora. Analysts prognosticate a top-line CAGR of approximately 7% for the next few years. With LVMH consistently surpassing top-line estimates over the last decade, it suggests that this CAGR might tilt slightly higher, albeit not significantly. We can also anticipate a marginal upswing in Free Cash Flow (FCF) per share, considering the observed operating leverage in FCF growth. Absent a consistent buyback program, FCF per share growth is unlikely to outstrip revenue growth significantly.
LVMH also touts elevated and escalating margins, a testament to its pricing power, unwavering even in economic turbulence. Comparative analysis with other luxury players like Hermes is challenging, given that 20% of LVMH’s revenue originates from retail, naturally yielding lower margins. Nonetheless, the 68% gross margin underscores the omnipotence of luxury, while the 26% EBIT margin stands as the next most pivotal figure in conjunction with revenue growth—returns on capital employed (ROCs). LVMH’s ROCs are on an upward trajectory, a crucial factor, as a recent study by Morgan Stanley concluded that a robust and burgeoning spread between a company’s Weighted Average Cost of Capital and its Return on Invested Capital is a defining trait of triumphant companies. These metrics gain added luster considering the diverse businesses within LVMH, hinting at high returns from most of them.
LVMH dispenses a modest dividend yielding 1.7%, manifesting robust growth over the past decade with a 13% compounded annual growth rate and an impressive 22% in the last 5 years. In my estimation, as long as Bernard Arnault is at the helm, akin to Buffett, no dividend is indispensable. I’d much prefer he leverages this cash hoard for quality acquisitions.
LVMH is unquestionably solvent, showcasing the dexterity to retire its net debt within a year of free cash flow, particularly when accounting for the average free cash flow margin over the past 5 years. With the ability to cover its interest a staggering 34 times over, a dismal debt-to-equity ratio, and an Altman Z score eclipsing 3, coupled with a current ratio surpassing 1, LVMH radiates unparalleled financial stalwartness.
The Valuation Conundrum
Let’s weigh the value of this luxury behemoth. Factoring in the average free cash flow margin over the last 5 years, the FCF yield stands at 3.7%, which seems quite reasonable given its caliber. Additionally, when we evaluate it based on the price-to-earnings (P/E) ratio, it’s trading above the averages, hinting at potential for multiple expansion.
However, it’s important to acknowledge that these averages were influenced by the zero interest rate policy (ZIRP) era. Consequently, we might witness the P/E ratio failing to rebound to the 30 P/E domain.