Slow-Growth Luxury Play: The Long-Term Case For Brunello Cucinelli

seekingalpha08-31

Brunello Cucinelli's artisanal, handcrafted production ensures product scarcity and high quality, making it a noteworthy business.The company is investing in new production facilities to double output...

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The resulting analysis has allowed me to define that the archetype of the successful luxury brand lies in scarce, valuable products that are not easily scalable and that contain a perceived higher degree of quality and craftsmanship. Brunello Cucinelli (OTCPK:BCUCY) is one of the companies that I believe it’s worth looking at. The company owns an Italian artisanal manufacturing structure, with handcrafted production exclusively based in Italy. This ensures proof of work, a key feature in most very scarce goods. The product relies on craftmanship and, therefore, is highly dependent on the artisan's skill in using needles, thread, and scissors. It also means that the scaling of production is slow and has to be done over many years. Our thesis here is that the company’s business model is perfect for a time of monetary largesse, the company’s products are both appealing and scarce, giving it the ability to increase revenue at a faster rate than it increases production capacity. Business developments The company posted revenue growth in the order of 14.1% compared to the first half of 2023. The management team expects the profit margin to be close to 10%, which they see as their long-term aspiration. The company is investing in the construction of a new factory in Solomeo, in conjunction with two other production facilities, one in Penne and the other in Gubbio. Together these expansions should allow them to double output by 2030. This is in line with our assumption that they will always scale slowly, and won’t inundate the market with production overnight. The fact that the production operations rely heavily on manual work also means that doubling production means doubling staff. As the management team stated in the 2Q24 earnings call, the company has avoided being positioned among the democratic luxury, or affordable luxury crowd, instead pursuing the concept of gentle luxury. The idea is to avoid diluting the word luxury and to enhance the manual labor and craftsmanship elements in the company’s product to provide a measured and restrained form of luxury. Therefore, quality will include flaws that reflect the human involvement in production, and that should be seen as part of the exclusive character of the products when compared to mass market options. Financials The company shows robust figures for gross, operating, and profit margins. The gross margin seems to be trending towards 50%, while the profit margin is at the desired target of 10%.   YCharts The balance sheet seems to be in good shape, with the debt-to-assets ratio exhibiting a downtrend and currently below 10%, while the liquidity position seems good with a current ratio above 1.2. When we look at a set of peers, we can see that the company performs very well in terms of revenue growth. The only company that performs better in the peer set is Hermès (OTCPK:HESAY).   YCharts Valuation A look at the valuation reveals that the company has a PS multiple of around 5.5, which is a bit higher than Louis Vuitton (OTCPK:LVMUY), but still lower than the 16.23 for Hermès. The 55 multiple for profit is actually higher than Hermès, and that makes me wonder about the rationale for this. It might be because the market sees that Brunello Cuccinelli is growing profits fast.   YCharts The company is executing significant investments in production capacity that should cover the needs until 2035. This expansion is designed to allow a progressive increase in production, which can support a steady growth in revenues. The focus on traditional craftsmanship ensures that the company won’t flood the marketplace with goods and that it will be able to sustain its premium pricing power. The School of Trades initiative should help avoid skill dilution among manual workers and keep the business model healthy for a long time. In this regard, the company resembles Hermès a lot, even if at a different scale. Another common point the company has with Hermès is that it derives 60% of its revenues from the mono-brand stores. The ability to provide a personalized service that delights a highly demanding consumer is critical to command the pricing power that justifies the current valuation. Risks The company operates in fashion markets. Although the company’s products are appealing due to their exclusivity, one cannot rule out that the company might get fashion trends incorrectly and that might impact the company’s sales and profits. Additionally, the management team might dilute the brand through discounting and using more automated production methods to increase profits in the midterm. That would certainly erode the brand equity the company currently enjoys. A recession might also create turbulence for the company. Even if its customers are by nature less sensitive to economic cycles, the truth is that it might still temporarily shrink sales and create liquidity issues for the company. In the end for all the worries, the truth is that Brunello Cucinelli has been the only company in our peer set to come close to Hermès performance in the last 5 years, which goes a long way to demonstrate how well-managed this company seems to be. Seeking Alpha  Conclusion The company's business model is very robust. The company has an expensive valuation, but historically, it has been sustained within a sales multiple of 2.75 and 7.   Ycharts One way to value the company is to create a bull and bear scenario. For the bull case let’s use the 2026 highest estimation and for the bear let’s assume stagnation after 2024. We will assume a diluted share of 68 million (every 2 ADRs are equivalent to 1 FTSE share). Seeking Alpha  We will assume a diluted share of 68 million (every 2 ADRs is equivalent to 1 FTSE share). The results are the following:   Author's computations The results suggest an asymmetric risk/reward proposition favoring the bull scenario. As mentioned, the company valuation seems expensive, but the truth is that the growth implied in the estimates is also very strong, and it might help offset the current high price. In my opinion, the stock has a business model sustained in a very powerful brand, and as long as the management team is capable of nurturing the brand, the business should grow steadily with strong margins. For all these reasons, I am rating the company a buy.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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