Kering: After A Huge Drop, A Luxury Discount

seekingalpha05-15

Kering shares experienced a two-years-long drawdown, losing more than half from their peak price.The company experienced an important sales decline, especially from its flagship brand, Gucci.Important...

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A great dividend yield could give some returns in the meantime.   resulmuslu/iStock Editorial via Getty Images Investment thesis Kering (OTCPK:PPRUF) (OTCPK:PPRUY) is a French company, owner of important luxury brands in the fashion sector. My investment thesis for this analysis might seem particularly \"poor\": usually for my investments (and therefore for my analyses) I choose companies that have interesting characteristics from a technological point of view, leadership in their market or in some form \"disruptive\" compared to direct competitors. \"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.\" - Warren Buffet Although I usually agree with the sentence above, in this specific case the price of this \"fair company\" is definitely too \"wonderful\" to not be taken into consideration, and will represent the focal point of my BUY recommendation. The aim of this analysis will be to demonstrate, on the one hand, the effective discount of the share price compared to the market value, and on the other, to verify whether the company has (despite the negative moment) the strength to return to past performance levels. Kering's business model Kering is a conglomerate of prestigious luxury brands, initially founded as a timber trading company, reconverted in the early 90s into retail trade with the acquisition of other businesses, and finally launched into the luxury sector around 2000 with the acquisition of Gucci, still the company's flagship brand. It currently owns many other brands, including Yves Saint-Laurent, Bottega Veneta, Balenciaga, Boucheron, Alexander McQueen. Its direct competitor (with some past rivalries, including legal ones) is LVMH (OTCPK:LVMHF), another French luxury company, undisputed leader of the market. The company, although a conglomerate of various brands, works almost only in the fashion sector (especially leather goods) and it's strongly linked to the Gucci brand, which in 2023 covered alone around half of the total revenues and 65% of the net income.   Total Revenue by brand (Data from Kering 2023 FY report, graph by the Author)   Net Income by brand (Data from Kering 2023 FY report, graph by the Author) In my opinion, this strong connection between the company and its main brand represents a point of weakness, as it partially nullifies the \"differentiation\" from the other brands: in fact, there is an almost exclusive dependence between the sentiment on the company and the results of Gucci, with the remaining half of the revenues to act as an indistinct contour. For this reason, I find the investments made in new sectors really interesting, with the recent opening of Kering Beaute and the continuous investments in the relatively new Kering Eyewear. These new verticals could, on the one hand, create new revenue sources and on the other, break the present Gucci-Kering connection, which could give the company an opportunity to exploit its conglomerate-characteristics. Financial Analysis It is worth taking an in-depth look at the company's financial results, which came from a good decade of growth, but has a big question mark for the future. Kering's main financial numbers (Data and graph by Seeking Alpha) Already from this first graph, Kering's difficulty in the last two years is evident, with slowing revenues and a strong erosion of margins (Net Income and EPS) starting from 2021. The short-term forecasts are even more negative, with the company recently being forced to launch a double profit-warning, first in March (Gucci sales -20% and group revenues -10%) and then recently at the end of April (-40/45% on the operating profit for the first half of 2024) which both caused strong market declines (-14% in March and -9% in April), in a context of already depressed valuations. I want to be super-clear on this point: Kering's share decline is not due to communication problems from the company or silly \"technical\" market reasons: the company has real problems at a fundamental level, and if the same problems have also \"touched\" the direct competitors, they have demonstrated much better resilience to the current market context. Despite this, I find that Kering's problems are not in any way structural, but rather a temporary \"cyclical\" slowdown in consumer preferences and amount of spending, and above all, I do not see any stability problems for the rich finances of the company, which has shown no sign of slowing down in any way its policy of strong investments in the future and returns to investors. Looking at actual debt situation, we can see how company's Net Debt/EBITDA ratio has sharply increased in the last years, but I consider the present ratio (around 2.5x) still a reasonable and not so worrisome value. Kering's EBITDA and Net debt (Data and graph by Seeking Alpha) In terms of revenues, Kering remains one of the top players in its sector, as highlighted by the following graph (with the exception of LVMH, which plays in a league of its own), other competitors in this graph are Hermes (OTCPK:HESAF), Richemont (OTCPK:CFRHF) and Prada (OTCPK:PRDSF), which are all European luxury companies. While Kering, LVMH and Richemont are conglomerates, Hermes and Prada are mono-brand firms. TTM Total Revenue (linear) for Kering and main competitors (Data and graph by Seeking Alpha) It must be highlighted too that before the current slowdown, Kering had historically managed to maintain a better EPS value than its direct competitors EPS growth (linear) for Kering and main competitors (Data and graph by Seeking Alpha) And how, despite the slowdown, the percentage growth in EPS over the last decade in relation to competitors was very interesting. EPS growth (percentage) for Kering and main competitors (Data and graph by Seeking Alpha) Ongoing projects and investments If the company's margins have been severely eroded by the drop in revenues, a significant part of this erosion is also due to a significant increase in investments by Kering, in various directions, some of which I find very interesting from a future perspective. Acquisition and new company's verticals A first expense voice is that relating to acquisitions, a fundamental characteristic of luxury conglomerate groups, and in which Kering has been particularly active in recent years. Among the main acquisitions (and the last in chronological order) I remember the entry into Valentino concluded in November 2023 with an initial share of 30%, and the option to reach 100% by 2028. The expense for the purchase of the first tranche was €1.7 billion, Valentino in 2023 had revenues of €1.35 billion and an EBITDA of €314 million. Another noteworthy acquisition is that made by the newly formed Kering Beauté of Creed in October 2023. Kering Beauté was created last year with the aim of supporting and expanding the activities in the beauty sector of some \"minor\" Kering brands (Bottega Veneta, Balenciaga, Alexander McQueen, Pomellato and Qeelin). Creed fits into the new vertical with its long history in high-end perfumery, and should constitute the backbone of the new division thanks to its iconic nature and current excellent profitability. The expense for the purchase of 100% of the brand was €3.5 billion, Creed had revenues of €250 million in 2023 and an EBITDA of approximately €150 million. Finally, important acquisitions were those made by Kering Eyewear, another rapidly expanding vertical, including UNT in June 2023, a French company specialized in the manufacturing of mechanical components for the eyewear sector, only the latest of the many acquisitions made by the division in recent years . Total Revenue CAGR and milestones for Kering Eyewear (Kering Eyewear 2022 Capital Markets Day presentation) From the graph above, we can see the good growth of this vertical, born in 2014, and which probably represents the most important \"brand\" in luxury eyewear. This \"new\" division achieved revenues of €1.5 billion in 2023. New sales strategy: moving volumes from wholesale to \"house\" retail This is certainly one of the most interesting strategic decisions made by Kering management, which decided to progressively abandon wholesale channel in favor of the retail one. The change is no small matter, given the relatively important volumes that this sales channel guaranteed: Total Revenue for retail and wholesale channels, 2022 vs 2023 (Data from Kering 2023 FY report, graph by the Author) We can see how the new strategy had a strong impact on the company's sales decline, with most brands (except Gucci) actually having an increase in sales in the retail channel over the last year, but an overall decline due to a sharp decrease in the wholesale channel. These numbers refer to FY 2022 vs FY 2023, but we can find a similar trend (even more strongly) in Q1 2024 report. The key question is how the company will be able to exploit this increased control over the sales of its products: in the short term, this could lead to greater margins, but maybe even more important, it should guarantee a strong \"boost\" to the consumer purchasing experience. The company's long-term plan is the significant improvement in the desirability and exclusivity of the brands, which I think could be the most valuable result of this strategic choice. Luxury buildings: real estate investments All luxury companies are in some way invested in the real estate sector, in a continuous race to obtain the most important and visible locations on the world's shopping streets. Kering is no exception and indeed has recently made at least four important acquisitions: two in Paris on avenue Montaigne and rue de Castiglione (unofficial documents attribute a cost of €860 and €640 million respectively), in New York on Fifth Avenue (€885 million) and in Milan in via Monte Napoleone (€1.3 billion). Total expenses in the properties (all acquired between 2023 and 2024) is around €3.7 billion ($4 billion), a considerable figure that cannot be overlooked from this analysis. The reading of these investments is not easy, on the one hand, they could seem like a \"distraction\" from the company's core activities, and value taken away from possible acquisitions and from the valorisation of current brands. On the other hand, by combining these purchases with what has been seen above regarding the new sales strategy, it is possible to note a fundamental consistency with the company's choice to renew the desirability of the brand, and luxury locations are a fundamental basis of this focus. Fair price estimates Let's now try to assign a fair price to Kering's shares using DCF model. I wish to note that these calculations should always be considered as a reference, rather than a price target: the real price of the company will be, as always, determined by the market. Here is a visual recap of the main data used for DCF calculation (historical in dark blue; estimated in lighter blue).   Data used in DCF model (Data from Seeking Alpha, graph by the Author) All historical data is from SA (in USD millions), I usually do not love to tinker too much on DCF averages and numbers because I think that even if sometimes DCF results could be misleading, modifying the base could lead to biased results. Therefore, I left all averages used in the model as calculated from historical data; the required return is calculated on 2023 WACC which is around 7.21%, and then rounded at 7.5% for a little more \"prudential\" results. For a company in a high-margin and high-multiple sector such as luxury, I find this number quite reasonable.   DCF calculation (Data from Seeking Alpha, graph by the Author) The resulting fair price (around $471) seem to indicate a good discount from market valuation of the company. Wall Street analysts are more prudent: the company is currently rated as Hold, with an average target price of €372-$400; it's worth noting anyway that actual price is almost halfway between the low end and the average of analysts' estimates, while high end (even if I think it's very optimistic) is almost the double of actual price. The P/E ratio of the company is at a very interesting level, first of all because the actual value represents a very low level of the company's valuation compared to historical ones. TTM P/E Ratio (linear) for Kering (Data and graph by Seeking Alpha) Even from a comparison with direct competitors, we see how Kering's current P/E ratio is placed in the lowest range of the companies in its sector in the last ten years, and it is curious to see how this \"range\" has also represented for some competitors a kind of \"support\" before the return to more interesting market values (represented in the graph by the horizontal red line). TTM P/E Ratio (linear) for Kering and main competitors (Data and graph by Seeking Alpha) In conclusion, I find the company currently deeply undervalued, and even if the collapse in valuation is certainly justifiable by some difficulties in terms of sales, I believe that the company will be ready, as soon as the situation stabilizes, for a rapid recovery toward more suitable prices in relation to its sector and the history of the brand. Dividend returns Paying an excellent dividend is Kering's \"ace up its sleeve\", in fact, the company has a solid history of continuously growing dividends, which brought to a very interesting dividend yield (currently around 4.2%), richly above the average for its sector.   Kering yearly dividend per share (Data from Morningstar, graph by the Author) From the graph above we can see the interesting growth of Kering's dividends in the last 10 years, with an average CAGR around 14%, and with a fair amount of continuity given that the only drawdown occurred was during the Covid period (where companies of other sectors have completely suspended dividend payments). The strong decline in the share price in recent times, combined with this continuous growth, has led the company to have a very interesting dividend yield compared to competitors, and also close to the highest historical values of its sector.   Average yearly dividend yield for Kering and main competitors (Data from Seeking Alpha, graph by the Author) For 2024 the company confirmed the previous year's dividend despite the already expected market slowdown, personally I find very interesting to see if the drop in revenues in H1 2024 will affect the payment for 2025. Kering yearly dividend payout in % of Net Income and available Cash Flow (Kering 2023 FY report) Currently, Kering's Dividend/Net Income Ratio is already on the higher end of the \"normal\" spectrum, so it's possible to expect some sort of reduction for the next year if sales slowdown were to be confirmed through the rest of 2024. Anyway, in the waiting of improvements from the point of view of fundamentals (and therefore of returns in terms of prices), this good dividend can guarantee some returns during the current \"static\" moment. Risk analysis The main risks of a possible investment in Kering are already included in the development of each of the previous sections, I only want to make a brief summary to highlight the true \"core-risk\" of this investment: at the moment the company presents some problems (real and concrete) which have rightly depressed its market valuation. With short-term forecasts even more negative than the recent past, it is impossible to know with certainty when Kering will reach a turnaround point towards market values more in line with its history and its usual multiples: investing in this company now could represent the classic attempt to catch the \"falling knife\". Taking this into account, I believe it is useful in the event of a buy to maintain attention on three possible \"major risks\" which could represent an alarm bell regarding the prolongation of the company's downturn. Strong reduction in investments: the decline in the company's profits is largely attributable to a \"boost\" in expenses (investments) as well as to the decline in sales. If this phase were to end without apparent results on revenues, it could be a sign of incorrect expenses directions, which could damage the company in the long term. New radical changes in strategy: the company has undertaken a courageous path of brand renewal (in commercial strategies and also at the level of artistic directors), a further radical change of these decisions would be the admission of the limited effectiveness of these choices and therefore of the management \"view\" (as well as creating confusion at an operating level). Strong reduction of dividends: a strong reduction of the dividend for the future may not necessarily represent a bad sign for the company, but it would remove a strong point of appeal, especially if the sales situation has not improved in the meantime. Conclusion As we saw in the previous sections, there are many short-term challenges for Kering, and the investment at this time could in some way be a sort of \"bet\", not so much on the financial stability of the company which in my opinion remain solid, but on the resilience and \"renewal\" capacity of its brands, in particular Gucci. This type of investment deviates from my usual operations (and recommendations) but I consider the company's current market price very interesting taking into account the prestige of the owned brands and the relative rarity of these valuations in a sector (the luxury one) accustomed to multiples much higher than the market average. Having said this, my first firm belief is that the quality and history of the group's brands make the company's return to more suitable sales numbers acceptably \"certain\". Likewise, with very negative short-term forecasts already declared by the company and received by the public (with considerable share drops), the hope is that the worst has already been priced in by the market, and that the following quarters may show some signs of recovery which reassures investors. In the meantime, the current (excellent) dividends can represent a good sort of compensation while waiting for the company to return to a growth level more suited to its usual one.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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