Company Reports

We are maintaining our fair value estimate for wide-moat Hermes at EUR 1,480 as the company reported another solid quarterly sales growth in the first quarter. Despite defensive characteristics during industry slowdowns and exposure to more affluent clientele, we believe Hermes is trading at expensive levels, at over 50 times FactSet consensus forward earnings.

We believe wide-moat Hermes International has carved out a unique niche in the luxury goods industry, which will provide it with continuing superior returns on capital. Hermes’ iconic leather bag styles (part of the more than EUR 5.5 billion leather goods segment) are in limited supply, supporting the brand’s exclusivity perception and providing the company with demand visibility and significant pricing power. Hermes Birkin and Kelly bags are sold in secondary markets and auctions for significantly higher than the initial purchase prices—an impressive feat for soft luxury goods.

We maintain our fair value estimate of EUR 1,270 for wide-moat Hermes as the company reported strong fourth-quarter and full-year results. In the fourth quarter Hermes delivered 17.5% constant-currency revenue growth. This was an improvement from the third quarter (15.6% constant currency sales increase) but a deceleration from a strong first half of the year (25.2% constant currency sales increase). All in all, 2023 constant-currency revenue grew by 20.6%. More notably, Hermes easily outpaced peers, such as LVMH’s fashion and leather division (14% growth in 2023) and Kering (negative 4% in 2023). Strong sales were accompanied by margin expansion to a record 42.1%, up from 40.5% in 2022.

We maintain our fair value estimate of EUR 1,270 for wide-moat Hermes as the company reported strong third-quarter sales at 15.6% at constant currencies. This was still quite a meaningful deceleration from 25.2% growth at constant currencies in the first half. The Americas' performance continued to be remarkably strong with growth of 20.4%, broadly in line with first-half trends. Hermes is outperforming the vast majority of its luxury peers, which have suffered declines in this market in first-half 2023. We believe Hermes to be more resiliently positioned with less exposure to aspirational clients who are more economically sensitive. Sales in Europe also decelerated only slightly to 18% growth in the third quarter (22% in the first half). Asia, excluding Japan, was the weakest market with 10% constant-currency growth. This came in addition to a challenging comparison base (33.7% growth in this market in third-quarter 2022). Sequential deceleration was broad-based across product segments, with the ready-to-wear and watch segments showing the strongest performance in the quarter.

We believe wide-moat Hermes International has carved out a unique niche in the luxury goods industry, which will provide it with continuing superior returns on capital. Hermes’ iconic leather bag styles (part of the more than EUR 4 billion leather goods segment) are in limited supply, supporting the brand’s exclusivity perception and providing the company with demand visibility and significant pricing power. Hermes Birkin and Kelly bags are sold in secondary markets and auctions for significantly higher than the initial purchase prices—an impressive feat for soft luxury goods.

We increase our fair value estimate for wide-moat Hermes by 28% to EUR 1,270 per share as the company reported strong revenue growth and profitability improvement in the first half of 2023. Although we increase our assumptions for full-year profitability slightly, the bulk of our fair value increase comes from our reduced assumptions for the firm's cost of capital. We now assume a 7.5% cost of equity based on below-average systematic risk, 1.5 percentage points below the rate of return investors expect of a diversified equity portfolio. We believe this better reflects Hermes’ low sensitivity to economic cycles, low operating leverage, and low financial leverage. Our fair value implies a multiple of 35 times 2023 estimated earnings, still well below the market multiple of 50 times earnings.

We are maintaining our fair value estimate of EUR 990 per share for wide-moat Hermes as the company reported strong first-quarter sales, helped by continued solid volume growth and price increases.

We increase our fair value estimate for wide-moat Hermes to EUR 990 per share from EUR 700 per share, following another set of stellar annual results. Our fair value increase stems from higher than previously expected growth in 2023 thanks to strong price increases (5%-10% globally with 7% on average, compared with low- to mid-single-digit increases annually over the past few years). We also expect higher long-term sustainable profitability for the firm, with an operating margin around 40% (similar to that delivered in 2022 thanks to exceptionally strong capacity utilization and fixed-cost leverage even as gross margin came under pressure a bit). Further, we increase our phase II growth rate to 8% from 7% and our phase II return on new invested capital from 60% to 70% to reflect our confidence in the superior longevity of Hermes’ brand appeal, strength of execution, and pricing power. Despite the fair value increase, Hermes shares still trade in overvalued territory in our view.

We believe wide-moat Hermes International has carved out a unique niche in the luxury goods industry, which will provide it with continuing superior returns on capital. Hermes’ iconic leather bag styles (part of the more than EUR 4 billion leather goods segment) are in limited supply, supporting the brand’s exclusivity perception and providing the company with demand visibility and significant pricing power. Hermes Birkin and Kelly bags are sold in secondary markets and auctions for significantly higher than the initial purchase prices—an impressive feat for soft luxury goods.

We believe wide-moat Hermes International has carved out a unique niche in the luxury goods industry, which will provide it with continuing superior returns on capital. Hermes’ iconic leather bag styles (part of the more than EUR 4 billion leather goods segment) are in limited supply, supporting the brand’s exclusivity perception and providing the company with demand visibility and significant pricing power. Hermes Birkin and Kelly bags are sold in secondary markets and auctions for significantly higher than the initial purchase prices—an impressive feat for soft luxury goods.

We are maintaining our fair value estimate of EUR 700 for wide-moat Hermes as the company reported continued strong performance in the third quarter, helped by a sales rebound in mainland China and solid performance elsewhere.

We are increasing our fair value estimate for wide-moat Hermes to EUR 700 from EUR 620 per share to account for stronger-than-expected revenue growth and profitability for the group this year and positive currency impact.

We believe wide-moat Hermes International has carved out a unique niche in the luxury goods industry, which will provide it with continuing superior returns on capital. Hermes’ iconic leather bag styles (part of the more than EUR 4 billion leather goods segment) are in limited supply, supporting the brand’s exclusivity perception and providing the company with demand visibility and significant pricing power. Hermes Birkin and Kelly bags are sold in secondary markets and auctions for higher than the initial purchase prices--an impressive feat for soft luxury goods.

We are maintaining our fair value estimate for wide-moat Hermes as the company reported a strong start to 2022 with a 27% increase in first-quarter revenue at constant exchange rates. This compares with 23% organic growth for LVMH and 30% growth for that company's fashion and leather division.

Following a deep dive into recent and historic performance drivers of the main fashion and leather groups’ top brands, we are lifting our fair value estimates for these names: wide-moat LVMH to EUR 510 per share from EUR 394, wide-moat Hermes to EUR 620 per share from EUR 540 per share, and narrow-moat Kering to EUR 590 per share from EUR 455. Fair value increases largely stem from our more optimistic forecasts for the groups’ top brands (Kering’s Gucci, LVMH’s Louis Vuitton, and Hermes) which we expect to grow at 7%, 8%-9% and 8.3% respectively, over the next decade, versus 5.5% expected luxury industry growth. We think the big brands are well positioned to outperform in the longer term as they can afford superior marketing budgets and differentiated real estate, their brand recognition is backed by secondary market success, and they retain control over distribution channels offline and online. Risks to this performance include success-induced complacency, consumer preference shifts, normalization of luxury demand in the United States that was buoyed by a few nonrecurring tailwinds, and China's "common prosperity" push. LVMH and Hermes shares still look expensive, while Kering’s shares are trading in line with our fair value estimate.

We believe wide-moat Hermes International has carved out a unique niche in the luxury goods industry, which will provide it with continuing superior returns on capital. Hermes’ iconic leather bag styles (part of the more than EUR 4 billion leather goods segment) are in limited supply, supporting the brand’s exclusivity perception and providing the company with demand visibility and significant pricing power. Hermes Birkin and Kelly bags are sold in secondary markets and auctions for higher than the initial purchase prices--an impressive feat for soft luxury goods.

We are not making any changes to our fair value estimates for our luxury and apparel coverage list due to Russia-Ukraine armed conflict. The luxury industry’s exposure to the Russia and Ukraine is small, accounting for a low-single-digit percentage of revenue, by our estimates. We believe that the conflict is unlikely to dampen consumer confidence in China (primary long-term growth driver) or the U.S. (driver of growth in recent years). European consumer sentiment (low-20% of industry’s sales) may be affected, should energy-related inflation accelerate meaningfully as a result of conflict; however, Morningstar's view is that the likelihood of gas delivery disruption to Europe from Russia is low. That said, most luxury names in our coverage look expensive to us, and we would recommend investors await a wider margin of error for investment in the sector.

We expect to increase our fair value estimate for wide-moat Hermes, as the company reported strong revenue and profitability development in 2021, ahead of our expectations. We still view shares as expensive, despite a more than 20% decline year to date and would recommend investors a wider margin of safety.

After a perfect storm in 2020, the luxury industry looks poised for a blue-sky scenario in 2021 as a strong sales rebound is driven by resilient luxury consumers' incomes, steady real estate, and strong equity markets as well as savings from previous coronavirus lockdowns, and the psychological need for people to reward themselves after a stressful time. As a result luxury share prices have rallied, leaving many industry players trading near record levels. Nonetheless, we could not identify structural changes in the industry post-COVID-19 that would justify sustainably higher growth and profitability, and hence, valuations. We believe the pickup in gross domestic product, or GDP, and luxury consumption in the U.S. is temporary. Although we expect Chinese consumers to continue driving the industry's growth, we don't expect post-COVID-19 acceleration, while the "common prosperity" drive by the Chinese government could temporarily hurt the industry through higher taxation and adverse sentiment over conspicuous consumption. Finally, although we expect online luxury sales to reach over 30% of the industry's sales over the next decade from low teens in 2019, we don’t expect this shift to meaningfully alter the industry's economics. Luxury companies are likely to preserve their pricing in the channel, thanks to growing control over distribution and the industry's inherent pricing power. While the online channel for the luxury sector looks more profitable than for mass apparel--thanks to higher average order values and lower return rates--the shift is unlikely to result in a major profit increase for companies that already have high in-store sales densities, such as LVMH's Louis Vuitton. Companies with lower sales densities, such as Hugo Boss, could benefit from the shift as long as they manage their store portfolios proactively.

We believe wide-moat Hermes International has carved out a unique niche in the luxury goods industry, which will provide it with continuing superior returns on capital. Hermes’ iconic leather bag styles (part of the more than EUR 3 billion leather goods segment) are in limited supply, supporting the brand’s exclusivity perception and providing the company with demand visibility and significant pricing power. Hermes Birkin and Kelly bags are sold in secondary markets and auctions for higher than the initial purchase prices--an impressive feat for soft luxury goods.