Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm pleased to be joined today by Paul Swinand and Joscelyn MacKay, the securities analysts of Morningstar. We're going to take a closer look at the European luxury-goods makers; see if there is any values there and what the future might hold for these firms. Paul, Joscelyn, thanks so much for joining me today.
Joscelyn MacKay: Thank you.
Paul Swinand: Thanks for having us.
Glaser: So, my first overarching question has to do with the state of the luxury-goods market. Obviously, people just a few years ago were not that excited about spending a ton of money on these very high-end products. Has that demand come back at all?
Swinand: Yes, the luxury-goods market globally is very strong right now. And that is in all countries and across a number of price points. So, as usually when we see demand so strong, the valuations of all the companies are very high as well.
Glaser: You said that there is good demand across all countries. Are there certain regions that are stronger than others?
Swinand: Yeah, definitely the strongest region is emerging markets and particularly China. In 2010, most companies saw 20%-30% growth with stronger growth in China.
Glaser: So it that where they also think that growth is going to continue for the future, they don't all of a sudden Europe becoming a big hotspot for them again?
Swinand: Well, I think again, all regions were strong, so Europe and the United States also showed increases. But a lot of the developed markets, it's hard to imagine that they grow double-digits over the long term.
Glaser: Now, are some of the brands or some of the companies better situated to take advantage of this emerging-markets demand or is it really more broad-based?
Swinand: I think it's very broad-based but some brands are definitely more popular in Asia and China than others. At the same time, I don't know if that means that they'll be the most popular forever. So in one way you could bet that Louis Vuitton bags and Moet and Hennessy alcohols are going to be most popular forever. On the other hand you could say that eventually American companies such as Tiffany & Co. which are now underrepresented in China might catch up and see stronger growth in the future.
Glaser: With demand starting to grow, M&A activity in the sector has picked up. LVMH just made a big deal can you talk to us little bit about it.
Swinand: LVMH bid or struck a deal to purchase Bulgari the Italian luxury jewelry and watch maker for EUR 4.3 billion and that looks like a rather rich price. Bulgari had depressed sales and earnings. So on sales basis it was a little bit of over four times Bulgari's sales. By comparison LVMH is trading at just under 3 times sales. So it look rather rich but I think LVMH is betting that they can really expand both revenue growth in emerging markets and improve their profitability over the long run.
Glaser: So what's your view over the stock right now?
Swinand: Right now I view LVMH as a little bit over valued with about 1.2 price to fair value except it's starting to look a little more relatively attractive compared – on a relative basis it is more attractive than let's say Hermes or in the United States Tiffany which are trading at Hermes is two times fair value and Tiffany is 1.5 price to fair value.
Glaser: Joscelyn, now you look at the fixed income side, the bond side, of LVMH does this deal impact the credit quality of the company at all.
MacKay: Bulgari has about 300 million in debt and as Paul said EBITDA is slowly recovering. But we really don't think there is an overall impact to the company's leverage. It was a $4 billion transaction. Half of which is either going to be in cash or debt the company has over $2 billion of cash on its book. So we really don't see this as very big impact to the credit and bonds really didn't move out quite that much this is something that I think was already captured in the bonds prior to the acquisitions.
Glaser: Are there any other firms that you've seen in this sector that you think might also get into the M&A games soon.
MacKay: We think PPR is definitely ripe for an acquisition. They just divested one of their divisions receiving over EUR 1 billion in proceeds and they've always said that they are looking constantly to add to their sports lifestyle or luxury brands.
Glaser: Now what's your view of the PPR stock and bonds?
MacKay: PPR stock is actually very slightly undervalued turning at 0.95 times fair value. But this stock is really high risk because they are going to divest two more of their divisions which are about a-fifth of sales. So there is just lot of moving pieces right there and they might acquire someone. The bonds though look very, very rich. They trade only 20 basis points on top of LVMH's bonds and we view them as much weaker credit. LVMH is rated A- and PPR is rated BBB minus. So it sounds like you could spend a lot of money both on their goods and on their bonds.
MacKay: That's true.
Glaser: All right Paul, Joscelyn thanks so much for sharing your thoughts with me today.
Paul: Thanks for having us.
Glaser: For Morningstar, I'm Jeremy Glaser.