Hermes Defies The Odds, But Peers May Offer More Attractive Returns

seekingalpha11-19 20:15

Hermes' exclusivity, heritage, and prestige make it a quintessential luxury brand, resilient against market slowdowns and appealing to ultra-wealthy clientele.Hermes' strategy of scarcity and ...

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All these high-end products symbolize affluence and more than just quality; rather, they symbolize status and exclusivity. However, I see consumers more often than not conflating luxury with premium goods. The difference is that while premium products showcase superior quality and generally cater to upper-end consumers, true luxury goods derive value from exclusivity, heritage, and prestige. Hermès International Société en commandite par actions (OTCPK:HESAY) (OTCPK:HESAF) is a quintessential luxury brand—one of the very few true luxury brands money can buy in the stock market. In my previous analysis of Hermes back in July, I praised Hermes' performance for withstanding the luxury slowdown better than its peers due to its orientation towards the ultrawealthy clientele. Fast-forward a few months, and Hermes continues to demonstrate strength, while some peers such as LVMH (OTCPK:LVMHF) and Kering (OTCPK:PPRUF) report negative revenue growth amidst the weakening consumer behavior in aspirational buyers. Nonetheless, since my last coverage, Hermes' stock has gone virtually nowhere, while the S&P 500 (SP500) delivered a 6.6% gain. However, now that the US stock market is trading at elevated valuations compared to the historical norm, investors have the opportunity to diversify into high-quality equities outside of North America. Hermes, with its proven resilience and exclusive market positioning, offers a compelling case for investors seeking market-beating returns over the long term. Previous Coverage (Seeking Alpha) Hermes Makes Staggering €42.6M per Boutique Hermes has mastered the art of creating desire through scarcity and exclusivity. Since 1837, the company initially focused on the aristocracy in Europe and later started catering to the ultra-wealthy clientele globally via tight control of production and sales through its own boutiques, which ensures its products remain rare and highly sought after. This strategy is rather psychological, tapping into the human desire for social recognition, as owning Hermes items symbolizes status and distinction. One of Hermes' key tactics is to keep customers waiting. For instance, it's highly unlikely to walk into a store and buy a Birkin bag without establishing a previous purchase history with the boutique. First, sales associates will encourage you to buy other products, such as scarves, fragrances, or home goods, to build relationships, building artificial demand for their less desired products before you get a chance to purchase the exclusive items. As long as the brand retains the sought-after image of the few exclusive products, such as Birkin Bag, the company can virtually keep creating demand forever. This strategy of waiting and establishing relationships with the boutique also builds a loyal customer base, driving more frequent and reoccurring sales. Hermes' exclusivity is also reflected in its retail footprint, with just 315 stores (incl. retail outlets) with a staggering efficiency. For instance, in 2023, the full-year sales were €13.42B, resulting in revenue of €42.6M per location, enabling the company to be efficient and continue delivering high-profit margins without needing massive CAPEX. You might be asking why Hermes simply does not sell more of its products, but there are two issues: first, increased sales would result in exclusivity deterioration, and second, Hermes, according to the management, the demand far outstrips supply, with factories running at full capacity. Currently, the company operates 24 leather goods and saddlery workshops, all based in France, with highly skilled artisans. Hermes is planning to open two new facilities in L'Isle-d'Espagnac and Loupes, bringing the total to 26 workshops by 2026, which will be key to driving revenue in the following years. From my standpoint, the risk with Hermes is not the demand but the limited production capacity and lack of artisans, who have to train for years before laying their hands on Hermes-exclusive products. As a result of Hermes' strategy, the company has rewarded its shareholders handsomely, delivering 16.5% annualized price appreciation over the past 15 years, with EPS growing at a similar rate, far ahead of the broader US market. Annualized ROR (FAST Graphs) While this performance is far better than many of its peers, Hermes' earnings are also far less cyclical, with only 1 year of negative growth in the past 20 years. This is thanks to its focus on ultra-wealthy clientele, such as billionaires, celebrities, royalty, and influential figures, who can afford the brand's most exclusive and expensive items regardless of economic situation. That's why, despite the luxury segment slowdown, Hermes managed to deliver 11.3% sales growth in Q3 2024, with solid growth across most regions, and even the Asia-Pacific (excl. Japan) region delivered 0.6% growth, while both LVMH and Kering reported negative sales growth and worse-than-expected sales contraction particularly in China as the country is battling with economic challenges, impacting consumer sentiment, particularly among aspirational luxury customers.   Q3 Results (HESAY IR) In terms of performance across sectors, the company is firing on all cylinders. Leather and Saddlery sales increased 17% in Q3, driven by sustained demand for iconic products and new designs like Constance Élan and Bolide à Dos. During the quarter, Hermes also opened a new factory in Riom, bringing the total to 24, to increase production capacity for the most important sector from a sales standpoint. The Ready-to-Wear and Accessories segment achieved 15% sales growth, thanks to strong momentum from previous quarters and a successful Spring/Summer 2025 campaign with innovative designs for both men and women. On the other hand, Silk and Textiles experienced mild growth, up 2%. The smaller segments, such as Perfume and Beauty and \"Other,\" where we find Jewellery and Home, grew their sales by 7% and 17%, respectively. The only underperforming segment was Watches, down 6% due to thought comparison with last year's high base. Altogether, in my opinion, Q3 was a surprisingly good quarter for Hermes, particularly after the LVMH report, which has set a precedent for the industry that we should expect weakness in leather goods and Asia (excl. Japan). However, Hermes has once again surprised and continues to demonstrate their resilience and superiority in the industry. Recently, I read all of Berkshire Hathaway's (BRK.B) shareholder letters, and I stumbled upon a point about preferred ownership that stood out to me: the value of attracting long-term shareholders over short-term traders looking to earn a quick buck. This approach unlocks stability and reduces stock price volatility, well appreciated by long-term oriented investors, and Hermes' offers this feature. Approximately 66.72% of Hermes' shares are owned by the Hermes family through their holding company, H51, leaving only 33.28% as a free float available for public trading. This substantial family ownership ensures long-term control, protects the company from hostile takeovers—such as the attempted acquisition by Bernard Arnault's LVMH in the 2000s—and safeguards against volatility with few shares trading hands. That's precisely the type of business I want to own in my portfolio, which brings me to another point: valuation. Quality Comes At A Price Hermes is among the highest-quality firms money can buy, and it trades like one, at least according to conventional thinking. Hermes' shares are currently trading at 19% of their all-time high, yet the trailing twelve months P/E is at a multiple of 46.92x, which is not at its historical high end, but it is very premium, no matter how we look at it. That's close to 2x more expensive compared to where the broader US market is trading. P/E Ratio (Seeking Alpha) Looking ahead, Hermes is well-positioned to continue benefiting from its industry-leading pricing power and vertical integration, which could drive its operating margins from the current 36% to over 40% over the next few years. Likewise, if global wealth continues to rise and asset prices appreciate, with more individuals entering the middle class and the high-net-worth population growing, demand for Hermes' products should increase—given the company retains its exclusive image. In my opinion, these tailwinds should easily support annual 11-14% EPS growth for years to come. As per FactSet, analysts are expecting the following growth:   2024 Expected EPS of $4.66, YoY growth of 5%.  2025 Expected EPS of $5.18, YoY growth of 11%.  2026 Expected EPS of $5.82, YoY growth of 12%.  In my opinion, analyst expectations beyond 2024 are very cautious, given that the business has achieved 16.5% annualized growth over the past 15 years. Nonetheless, if we stick to the analyst projections and assume a 15Y average P/E valuation of 44x, Hermes' stock could deliver roughly 10% total annual ROR over the next 2 years. HESAY Valuation (FAST Graphs) Investor's Takeaway All in all, With a 10% expected annual ROR, Hermes is not the most exciting opportunity in the luxury space, but it's a bet on resilience and exclusivity with lesser volatility. In my view, if the luxury market recovers, the more beaten-down stocks, such as LVMH and Kering, have the potential to outperform Hermes' over the next 12-18 months if we see the return of aspirational buyers. I currently do not own any Hermes shares in my portfolio, but if the valuation falls below its 15Y average of 44x earnings, I plan to add a few shares, as this company is one of the finest money can 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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