11 January 2016 Europe Equity Research Luxury Goods
European Luxury Goods Research Analysts SECTOR REVIEW Guillaume Gauvillé, CFA 44 207 888 0321 [email protected] At a crossroads between growth and value Catherine Tillson 44 20 7888 6052 ■ Bearishness on the sector is reaching new highs. New year but same [email protected] volatility and China macro uncertainties. The luxury sector underperformed Specialist Sales: Lindsay Ireland the market by 15% in the last three months, the short interest has risen for 44 20 7883 6895 [email protected] almost all our stocks in 2015, bearishness among the sell side is nearing all-time highs and the sector P/E de-rated to a c.10% premium to European
equities. We believe a poor 4Q and slow growth in 2016 are now partly baked into expectations but we still see downside risk to our +4% organic sales growth forecast in 2016e, broadly in line with current consensus. ■ Pressure on the cost base may be moderating. We remain structurally negative on the sector and we are not yet calling the end of the earnings downgrade cycle. That said, we see encouraging signs as management teams start taking actions to better control costs. Hiring freezes are in place and net store closures are now common practice. In addition, rent inflation is moderating to mid-single digits, more in line with sales trends. ■ The sector remains highly cash generative. Investors no long receive better growth by investing in Luxury vs. European equities. But, do get exposure to long-term cash return optionality. Balance sheets are strong as we estimate a net cash position at sector level by 2016 and FCF generation should improve as capex spend declines, despite margin pressure. We believe Hugo Boss and Hermes have attractive cash return potential. ■ LVMH up to Neutral, reiterate Underperform on Burberry and Kering. Demand recovery is unlikely to rescue the sector so defensive attributes and well-managed cost bases will be the order of the day for luxury stocks in 2016. We think Burberry is structurally challenged and we should see further earnings downgrades. Kering has performed well on expectations of a recovery in Gucci thanks to new products but we expect a slower relaunch and further pressure on Gucci margin. We upgrade LVMH to Neutral in a note published today (see A more stable ship in a rough sea). Figure 1: CS luxury coverage vs. MSCI Europe performances 120
100
80 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16
Source: Thomson Reuters, Credit Suisse research DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access
11 January 2016
Key charts
Figure 2: The bearishness among the sell side is Figure 3: We lack enthusiasm about accelerating close to a 10-year high growth for c.3/4 of luxury clientele European luxury sell-side rating tracker Luxury sales breakdown by clientele (in 2015e) Africa & Middle- 3% 2.35 East, 6% Europeans, 13% 2% Russians, 5%
1% 2.45 LatAm, 6% 0%
-1% 2.55
-2%
-3% 2.65 US, 15% -4% Chinese, 29%
-5% 2.75
-6%
-7% 2.85 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Other Asians, 14% Luxury analyst recommendations rel. to market (+=Buy; -=Sell, lhs) Analyst recommendations (1=Buy; 5=Sell, rhs) Japanese, 12% Source: Thomson Reuters, Credit Suisse research Source: Company data, Credit Suisse estimates
Figure 4: We model +4% organic sales growth in Figure 5: Overall rent inflation for the top 25 streets 2016e, broadly in line with 2015e globally appears to be moderating Luxury sector quarterly organic sales growth Constant currency rental costs for the top 25 streets (Y/Y % chg.)
25% 20%
20% 15% 15%
10% 10%
5% 5% -
(5%) 0%
(10%)
-5%
1Q07 4Q09 4Q14 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 1Q15 2Q15 3Q15
1Q16e 2Q16e 3Q16e 4Q16e 4Q15e Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Y/Y % change 2-yr run-rate Top 25 streets Top 25 street excl. HK Organic sales growth Source: Company data, Credit Suisse estimates Source: Cushman & Wakefield, Credit Suisse research
Figure 6: Tighter control over hiring should lead to Figure 7: For all companies, bar Kering and Cucinelli, we payroll cost trending below organic sales growth expect a next cash position by 2018e Sector headcount (in '000s) and payroll costs (in €) Net debt (cash) / clean EBITDA
280 16% 2.5x 260 14%
240 12% 1.6x 1.1x 220 10% 0.7x 200 8% 0.4x 0.1x 0.0x 180 6% (0.0x) 160 4% (0.1x) (0.5x) (0.6x) 140 2% (0.7x) (0.7x) (0.8x) (1.1x) 120 0% (1.4x) (1.6x) (1.6x) (1.8x) 100 -2% 2007 2008 2009 2010 2011 2012 2013 2014 2015e (2.3x)
Headcount ('000, lhs) Y/Y % headcount chg. (rhs) Y/Y % payroll cost chg. (rhs) Kering Cucinelli LVMH Hugo Boss Ferragamo Swatch Tod's Hermes Burberry Richemont 2015e 2018e Source: Company data, Credit Suisse estimates Source: Credit Suisse
European Luxury Goods 2 11 January 2016
Table of contents
Key charts 3
China to dominate the newsflow again in 2016 6
Pressure on the cost base slightly easing 11 Limited space growth expected in the coming years ...... 11 Easing rental cost inflation at the global level ...... 12 Tighter control over hiring ...... 14
Still a strongly cash generative sector 15 Capex likely to start declining ...... 16 Inventory days expected to stabilise ...... 17 M&A becoming increasingly expensive ...... 17
Investors to gradually focus on cash returns 20 Reducing cash to add value ...... 20 Evaluating the likelihood of cash returns ...... 21
4Q and FY previews 22
Appendix 1: Sector charts 23
Appendix 2: Sector valuation sheet 25
Appendix 3: Prime rental locations data 26
European Luxury Goods 4 11 January 2016
China to dominate the newsflow again in 2016 Luxury is no longer a growth sector. We believe investors no longer receive better earnings growth by investing into luxury stocks relative to European equities. We indeed expect revenue for our luxury stocks to grow in line with global GDP in the next two years slowing from 2.5x GDP growth over the past decade. Similarly, we forecast high-single digit earnings growth in the next two years, below the high-teen average of the past decade (see Figure 10). In the meantime, we note that sales growth has become less volatile as these companies increase their retail share of revenue. The sell-side and investors are getting more bearish on the sector. We have been structurally negative on the luxury sector since our initiation in January 2015 (see Chasing growth despite rising costs published on 29 January). We think that investors are now well aware of the structural issues of the sector in a low growth environment and the overall sentiment has certainly turned more negative than a year ago. According to Credit Suisse stock loan desk, we note that the short interest on all large caps has indeed increased over the past 12 months (see Figure 8). In addition, our sell-side rating tracker has seen negative trends since 2013 and is reaching a 10-year low (see Figure 9). Finally, we have seen significant shifts in market sentiment on the sector in 2015 having been bearish post 1Q, bullish post 2Q when the sector delivered the best growth rate in five quarters and bearish again post 3Q when growth among the Chinese clientele slowed materially. Figure 8: The short interest on LVMH has increased Figure 9: The bearishness among the sell side is to c.4% of free float in 4Q from 2% in 3Q close to a 10-year high Short interest vs. sell-side buy recommendations European luxury sell-side rating tracker
30% 3% 2.35 Ferragamo 2% consensual short 25% Swatch 1% 2.45 0% 20% -1% 2.55 Cucinelli 15% -2%
Tod's -3% 2.65 10% consensual long -4%
Short interest Short outstanding Kering -5% 2.75 5% Burberry LVMH Hugo Boss -6% Richemont - -7% 2.85 - 10% 20% 30% 40% 50% 60% 70% 80% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sell-side buy recommendations Luxury analyst recommendations rel. to market (+=Buy; -=Sell, lhs) Analyst recommendations (1=Buy; 5=Sell, rhs) Source: Thomson Reuters, Credit Suisse research Source: Thomson Reuters, Credit Suisse research
We currently model +4% organic revenue growth in 2016e. This is broadly in line with the +4% rate we expect in 2015e. Sales growth in the sector has averaged +9% over the past decade but we argue that the simple equation of sector growth equally driven by perimeter, price/mix and volumes is no longer valid. As we discuss in a later section, we see store footprint reaching maturity for the mega luxury brands we cover and we continue to see less opportunities to raise price points than in the past. As a result, we believe 2/3 of historical growth will be hard to perpetrate and we therefore forecast mid-single digit sales growth at best for the luxury sector over the next three years. Downside risk to organic growth expectations is becoming more limited, in our view. Sector earnings forecasts for 2015 have come down by 23% since 2012 annual results (see Figure 12). Downgrades in 2013 were primarily related to a stronger US dollar but turned more to underlying fundamentals from 2014. While 2014 was marked by negative revisions on organic sales growth, downgrades in 2015 have been primarily related to margin pressure coming from the heavy cost structures of these businesses. This more than offsets the benefit from a weaker euro. We are now in a position where we feel more comfortable about consensus growth expectations in 2016. According to the
European Luxury Goods 5 11 January 2016
consensus data compiled by Altagamma, sell-side analysts are currently looking for +4% organic growth in 2016, hence in line with our own expectations. Figure 10: Investors no longer received better Figure 11: We model +4% organic sales growth in earnings growth by investing into luxury stocks 2016e, broadly in line with 2015e Revenue and earnings growth for the luxury sector Luxury sector quarterly organic sales growth
50% 25%
20% 40% 15% 30% 10% 20% 5% 10% - - (5%)
(10%) (10%)
1Q07 4Q09 4Q14 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 1Q15 2Q15 3Q15
1Q16e 2Q16e 3Q16e 4Q16e (20%) 4Q15e 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015e 2016e Y/Y % change 2-yr run-rate Y/Y reported revenue growth Y/Y earnings growth
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
We think an acceleration in sales growth is unlikely for c.3/4 of luxury clientele. This mainly includes the Chinese, the North and South Americans, the Russians and the Middle-East clientele (see Figure 13). We break down the sales of our companies by both consumer and destination to better assess the demand dynamics in 2016. Figure 12: The earnings momentum at sector level Figure 13: We lack enthusiasm about accelerating has been negative since early 2013 growth for c.3/4 of luxury clientele Luxury sector earnings momentum Luxury sales breakdown by clientele (in 2015e) Africa & Middle- 300 East, 6% Europeans, 13% Russians, 5%
250 LatAm, 6%
200
150 US, 15% Chinese, 29%
100
50 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Other Asians, 14% FY10e FY11e FY12e FY13e FY14e FY15e FY16e Japanese, 12% Source: Thomson Reuters, Credit Suisse research Source: Company data, Credit Suisse estimates
We analyse luxury goods penetration globally using Credit Suisse wealth data. We look at the aggregate revenue pool of the 10 luxury stocks we cover split by clientele and we relate it to wealth. This tells us how much one consumer group spends on luxury goods per million of wealth (see Figure 14). The caveat of the analysis is that a millionaire typically spends gradually less on luxury goods per one million incremental wealth. As a result, the ratio tends to be biased downwards when there is a large pool of UHNWIs like in the US or Europe. In 2015, household wealth has increased ahead of luxury sales and the biggest change to this metric has been recorded among the Russians in recent years. The ratio shows that penetration has increased dramatically in 2014 but this is the effect of luxury spending not adjusting as fast as wealth which was negatively impacted by the rouble depreciation. Luxury goods penetration in China is coming down. The second biggest move has been recorded among the Chinese for which luxury spending per unit of wealth has dropped >20% since 2012, on our estimates. This has been both a combination of the anti-corruption measures starting in 2013 and the overall market saturation after three
European Luxury Goods 6 11 January 2016
years of euphoria. Based on this metric, the Chinese still spent on average 10x more than their European counterparts and 2x more than the Japanese. The Credit Suisse Research Institute forecasts household wealth in China grow at a +9% CAGR over 2015-2020 but we argue that the Chinese ratio of spending/wealth may continue to come down due to market saturation. As a result, we believe low- to mid-single growth for Chinese spending on luxury is a reasonable medium-term forecast. Figure 14: Luxury sales clientele breakdown per unit of wealth In $ unless stated otherwise 2012 2013 2014 2015e Europeans 433 402 461 447 Russians 3,556 3,853 7,720 6,341 Chinese 5,771 5,380 5,101 4,396 Japanese 1,564 1,879 2,116 2,054 Indians 275 329 298 274 Koreans 5,557 6,006 5,740 5,250 Middle-East 3,259 3,383 3,669 3,584 Africans 883 906 938 938 Brazilians 1,552 1,846 1,900 2,059 North Americans 240 210 206 190 Total 817 762 789 741 Source: Credit Suisse Wealth Report 2014, Company data, Credit Suisse estimates
The stock market correction in China created short-term disruption. The 40% fall in the Shanghai stock market from peak in June to September lows has been particularly unhelpful for Chinese demand of luxury goods in 3Q. Equities may well account for no more than 10% of Chinese household wealth according to our Credit Suisse Banks Team but the magnitude of the stock market correction and the subsequent margin calls on leveraged transactions have impacted both wealth levels and disposable income. But this is not necessarily a bad thing longer term. Besides the governmental measures against ostentatious consumption of luxury goods, the enthusiasm for the stock market among the Chinese and the available income put into stock brokerage accounts diverted money away from the more traditional purchases of luxury products in 2014-15. However, following the sharp market correction in 3Q, the Chinese have arguably lost trust in the equity market. As a result, we believe a bigger share of disposable income may now be spent on luxury goods instead of being invested into equity. We note that 2010 and 2011 were the best years for luxury in China while the stock market declined by c.1/3 over the period. Figure 15: The stock market has absorbed a large Figure 16: The number of stock brokerage accounts share of Chinese disposable income in 2014-15 openings have fallen sharply since May Account openings in China (A+B share, in '000) New investors in China (A+B share, in '000)
14,000 6,000
12,000 5,000
10,000 4,000
8,000 3,000 6,000 2,000 4,000
1,000 2,000
0 0
Jul-14 Jul-15
Apr-14 Oct-14 Apr-15 Oct-15
Jan-14 Jun-14 Jan-15 Jun-15
Mar-14 Mar-15
Feb-14 Feb-15
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14
Nov-14 Aug-14 Sep-14 Dec-14 Aug-15 Sep-15 Nov-15
May-14 May-15
Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15
Jan-12 Jan-09 Jan-10 Jan-11 Jan-13 Jan-14 Jan-15 Jan-08 Source: Wind, Credit Suisse research Source: Wind, Credit Suisse research
European Luxury Goods 7 11 January 2016
We are expecting slower growth of Chinese visitors in Europe. Tourism has been a well-known driver of luxury sales in Europe for years. However, we believe the double-digit revenue growth rate recorded in 2015e on the back of strong touristic flows is not sustainable. The magnitude of the euro depreciation was such that price differentials between China and Europe reached an all-time high early 2015 (see Figure 17) and it took luxury companies a couple of quarters to react by either increasing prices in the eurozone and/or lowering prices in China. Price gaps between the two regions are back to a more normal level and the few rounds of renminbi devaluations during the summer have added uncertainties about the relative strength of the Chinese currency over the euro. In addition, we expect the terrorist attacks in Paris last November to have impacted consumers' holiday destinations. A few years of easy comps in European demand should help sales growth. The majority of the companies under coverage have recently flagged a slight improvement in local demand for luxury goods in Continental Europe. That said, we believe it is more likely to be the result of a few years of easy comps rather than the effect of QE or cheap consumer credit. While the European clientele may be showing signs of stabilisation, we still remain cautious given aggressive price increases between 2012 and 2013 due to high price differentials globally and the rising flow of Chinese visitors. Figure 17: The price differential between China and Figure 18: The price differential between China and Europe has come back to a more normal level Japan remains fairly high Price premium of an LV Speedy 30 bag in China vs. France (in €) Price premium of an LV Speedy 30 bag in China vs. Japan (in €)
60% 40%
55% 35%
50% 30%
45% 25% 22% 40% 20%
35% 15%
30% 10%
5% 25%
0% 20% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 Source: Company data, Credit Suisse research Source: Credit Company data, Credit Suisse research
Japan is likely to be the major beneficiary of tourism flows in 2016. We expect Chinese visitors to keep increasing strongly for the third year running in 2016 (see Figure 19). This is mainly driven by the Chinese having less incentive to travel to Europe, more attractive visa rules implemented in 2015 and no change to price differentials between China and Japan. This currently sits at c.25% for a Louis Vuitton bag due to the weak yen. We also highlight that foreign spending on luxury goods in Japan still accounts for <20% of total purchases, on our estimates. In addition, we note that local demand for luxury has been encouraging in the past couple of quarters after years of muted growth. Louis Vuitton indeed flagged that sales to the local Japanese clientele was up in 3Q for the first time in many quarters. We are getting increasingly less constructive on the US consumer. This is due to three factors. First, the strong US dollar has given Americans more incentive to travel abroad. We argue that Americans typically spend less on luxury products but more on leisure/restaurants than their Asian counterparts when travelling to Europe. For American sales regionally, the impact on domestic sales is compounded by the Chinese having less interest in visiting the US, therefore tourist spending has also affected recent trends. Second, a lower oil price has led Americans to travel more within the US and spend money on 'experiences' rather than material items. Third, the US stock market was flattish in 2015, hence not helping wealth perception. Finally, we think the low ratio of luxury sales
European Luxury Goods 8 11 January 2016
to wealth is deemed to persist in the future for cultural reasons. The US accounts for nearly 50% of wealth among millionaires globally but no more than 14% of luxury sales stem from the American clientele. Figure 19: We expect travellers into Japan from Figure 20: The sales performance of Japanese China to keep growing strongly department stores has remained strong Chinese travellers arriving into Japan
400% 30%
300% 20%
200% 10%
100% 0%
0% -10%
-100% -20%
-200% -30%
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15
Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15
Apr-13 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Oct-13 Apr-14 Oct-14 Apr-15
Apr-13 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Y/Y % change 3-month moving average Y/Y % change 3-month moving average Source: Japan National Tourist Organization, Credit Suisse research Source: Credit Suisse estimates, Credit Suisse research
The falling oil price is unhelpful for demand in Russia and Middle-East. This year Russia's economy has been hit by both the falling oil price, which is tied to the wealth of the most affluent Russians, and by the sanctions put in place during the year. Similarly for the Middle-East, the falling oil price and political unrest should continue to hamper demand. Changing regional exposure to Luxury goods demand. During 2015 we have seen the importance of currency weakness as a catalyst for shifting demand between regions. Following the re-rating of the USD throughout 2015 Chinese tourist flows have changed; heading to Europe, Japan and Korea for shopping to capitalise on the weak currencies rather than the US. We expect Japan to remain the fastest growing region in 2016 while we forecast no growth for the rest of Asia mainly dragged by China/HK (see Figure 21). Figure 21: Quarterly organic sales growth momentum by region 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15e 1Q16e 2Q16e 3Q16e 4Q16e Europe 2% 7% 5% 6% 6% 4% 5% 6% 9% 16% 14% 13% 8% 6% 5% 5% Asia Pacific 11% 11% 12% 11% 7% 4% 1% (3%) (4%) (6%) (7%) (8%) (4%) (0%) 0% 1% Japan 15% 16% 15% 14% 27% (3%) 5% 7% (3%) 30% 18% 21% 11% 11% 7% 10% Americas 5% 10% 9% 9% 9% 9% 10% 11% 9% 10% 7% 7% 7% 6% 6% 7% Total 7% 9% 8% 9% 9% 4% 5% 4% 2% 7% 5% 4% 4% 4% 4% 5% Source: Company data, Credit Suisse estimates
European Luxury Goods 9 11 January 2016
Pressure on the cost base slightly easing Mid-single digit organic sales growth is necessary to keep margins flat. With the transition to retail distribution, our universe of companies have seen a steady increase in their fixed cost base. It now accounts for 2/3 of costs (see Figure 23), and primarily includes payroll, rental expenses, depreciation charges and headquarter expenses. In a currency-neutral environment, we estimate that a mid-single digit revenue growth made up of 2/3 LFL and 1/3 perimeter is required to avoid cost deleverage. Figure 22: Operating margins have been falling Figure 23: Increasing fixed cost base over the past since 2012 decade puts pressure on margins Luxury sector operating margins Total cost breakdown between fixed and variable components
23.0% 22.9% 22.5% 21.3% 20.3% 20.8% 20.0% 19.8% 39% 39% 35% 35% 36% 37% 36% 36% 18.5% 17.2% 16.2%
61% 61% 65% 65% 64% 63% 64% 64%
2007 2008 2009 2010 2011 2012 2013 2014 Fixed costs Variable costs 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015e Source: Company data, Credit Suisse research Source: Credit Suisse
Underlying downgrades have been fairly marked in the past year. In theory, a weaker euro should have led to earnings upgrades in 2015. In reality, 2015 consensus earnings downgrades have averaged 10% in our coverage over the past 12 months. Using our FX sensitivity model, sector earnings should have seen a 15-20% uplift from a weaker euro. We are mindful of the hedging dynamics delaying the positive impact of currency moves but we note that 2016 consensus earnings have also come down by 10% on average for the sector. As a result, the underlying cut to consensus forecasts of >20% has been the highest we have seen in the past decade. We expect more moderate negative earnings revisions in 2016. We do not think the downgrade cycle is over for the luxury sector but we see more limited downside risk to earnings forecasts than a year ago. Although these luxury businesses are not yet in a cost-cutting mode, we see some reassuring signs regarding the cost base. These include store openings, moderating rental cost inflation on a global average and more moderate hiring plans. We discuss these dynamics in the following sections. Limited space growth expected in the coming years White space analysis. We use a simple white space analysis to calculate the global potential for extra stores in active markets. To do this, we assume that the average number of stores per $tr of wealth in Western Europe across all our companies, specifically 0.77 stores/$tr, is representative of saturation. Again, we use our proprietary wealth data from the Credit Suisse Research Institute. Note we exclude Hugo Boss from this calculation as its store network structure differs to the other luxury companies under coverage. Most mega brands in luxury are reaching store saturation. With stores in over 60 countries, we believe Louis Vuitton and Burberry are steadily approaching store saturation and will become more heavily reliant on LFL growth. Figure 24 plots the estimated total extra stores a brand/company would need to reach store saturation in each market it has a presence in against the total number of active markets. We see the companies sitting
European Luxury Goods 10 11 January 2016
within the red area as having exposure to a large number of markets and having well established store footprints in those markets. Figure 24: LV, Gucci and Burberry nearing store saturation Global potential for more stores vs. number of active markets
140 Cucinelli Van Cleef 120
100 Tod's
Cartier 80
60 Hermes
40 Gucci
Burberry Extra stores needed to reach saturation reachto neededstores Extra 20 Ferragamo
LV 0 20 25 30 35 40 45 50 55 60 65 70 Number of active markets Source: Company data, Credit Suisse research
Some smaller brands have potential to expand but are unlikely to do so. Companies which we think still have room for store expansion are Van Cleef & Arpels or Cucinelli, according to our white space analysis. We indeed calculate the potential for >100 additional stores in the case of these brands. However, we note that these are high-end brands that tend to favour brand exclusivity over store expansion. As a result, we doubt whether either of these two brands will reach the same global store footprint as Louis Vuitton or Burberry. Figure 25: Most luxury brands already present in >50 Figure 26: Most luxury brands have reduced the markets globally number of store openings in the past two years Estimated no. of countries the companies have stores/concessions Net new store openings for major luxury brands 70 60
60 50
50 40
40 30
30 20
20 10
10 0 2010 2011 2012 2013 2014 Burberry Tod's Ferragamo Cucinelli 0 Louis Vuitton Burberry Ferragamo Cartier Gucci Hermes Tod's Cucinelli Van Cleef LVMH (Louis Vuitton) Kering (Gucci) Richemont (Cartier) Richemont (Van Cleef) Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Easing rental cost inflation at the global level Rental cost inflation appears to be moderating. We have used data provided by real estate service company Cushman & Wakefield and considered the top 25 shopping streets globally (see Appendix 2). We see rental inflation has grown ahead of organic sales growth for our companies over the past four years (see Figure 27). Constant- currency rental cost increase has indeed averaged 9% since 2011 compared with 7% for
European Luxury Goods 11 11 January 2016
organic revenue. That said, we note that the pace of rental cost inflation has come back in line with organic sales trends in 2015 at around mid-single digit. The slower rent inflation is driven mainly by HK. Since June 2013 rents in the three most expensive areas in HK have declined in total by -16%, constant currency (see Figure 28). We note that the data takes into account the most recently-negotiated leases while lease terms are typically agreed on a 3-year period. As a result it may take another couple of years for HK retailers and luxury brands to capture the full benefits of lower rents. We highlight that our luxury companies have the highest exposure to the HK prime real estate (see Figure 30). This is based on the number of stores each company has on/within each of the top 25 shopping streets/areas across the globe. Figure 27: Overall rental cost inflation for the top 25 Figure 28: Falling rents on most streets in HK have a streets globally appears to be moderating positive impact on total lease expense for luxury groups Constant currency rental costs for the top 25 streets (Y/Y % chg.) Constant currency rental costs in HK (Y/Y % chg.)
20% 60%
50% 15% 40%
10% 30%
20% 5% 10%
0% 0%
-10% -5% Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 -20% Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Top 25 streets Top 25 street excl. HK Organic sales growth Central Causeway Bay Tsim Sha Tsui Source: Cushman & Wakefield, Credit Suisse research Source: Cushman & Wakefield, Credit Suisse research
Elsewhere, rent inflation is slowing. We show in Figure 27 the rental cost development for the top luxury street excluding Hong Kong. Interestingly, the average inflation is coming down, although we note wide disparities between locations. The hot spots in Europe like Rue du Faubourg Saint Honoré, Via Montenapoleone or New Bond Street are still seeing at least high single-digit rent inflation (see Figure 29). In addition, rents for prime locations in Japan have come back to inflation after a decade of only moderate inflation. Figure 29: Hot spots in Europe are still seeing at Figure 30: Companies are most exposed to rent in least high single digit rent inflation Hong Kong Y/Y % change of rents in prime locations (in local c, June'15) Number of store locations in prime rental areas Causeway Bay Tsim Sha Tsui 100% Central Shinjuku 90% Akersgata Kalverstraat 80% Via Tornabuoni Avenue des Champs Elysees 70% Karntnerstrasse/Graben Pitt Street Mall 60% Upper 5th Avenue Newbury Street 50% Goetherstasse Sloane Street 40% The Ginza Maximilianstrasse 30% Madison Avenue Rue du Fauborg St Honore 20% Avenue Montaigne New Bond Street 10% Garcia D'avilla (Ipanema) Via Montenapoleone 0% Rodeo Drive (Beverly Hills) Via Condotti LV Harry Gucci Hugo Boss Hermes Ferragamo Tod's Cucinelli Burberry Cartier Van Cleef Omotesando Winston -15% -10% -5% 0% 5% 10% 15% 20% US Australia Hong Kong Tokyo Austria France Germany Italy Norway UK Source: Cushman Wakefield, Credit Suisse Source: Credit Suisse estimates, exposure to most expensive main streets in each area according to Cushman & Wakefield.
But rents are turning more fixed. Rental costs, both fixed and variable, account for 20% of operating expenses at sector level. Given weak luxury sales in Mainland China, the variable component of rent as a percentage of total is coming down. We also highlight that some rents have been renegotiated into fixed terms in Mainland China a couple of years ago, probably at the peak of the cycle.
European Luxury Goods 12 11 January 2016
Tighter control over hiring Hiring freezes are put in place. There has been some moderation in hiring over the past four years as the increase in headcounts moderated to +5% in 2014 from at least high single digits in the prior four years. We do not have 2015 data yet but we believe headcount growth is likely to continue falling as companies gradually implement hiring freezes or similar measures such as the non-replacement of departing staff. A few companies such as Burberry, Richemont or Swatch Group took such initiatives in the course of 2015. As a result, we could expect headcount and payroll growth to trend below organic sales growth in 2015 and 2016. Figure 31: Tighter control over hiring should lead to payroll cost trending below organic sales growth Sector headcount (in '000s) and payroll costs (in €)
280 16% 260 14% 240 12% 220 10% 200 8% 180 6% 160 4% 140 2% 120 0% 100 -2% 2007 2008 2009 2010 2011 2012 2013 2014 2015e
Headcount ('000, lhs) Y/Y % headcount chg. (rhs) Y/Y % payroll cost chg. (rhs)
Source: Company data, Credit Suisse estimates
European Luxury Goods 13 11 January 2016
Still a strongly cash generative sector The sector should soon turn net cash. Despite margin pressures the sector continues to be extremely cash generative. Companies within our coverage are currently sitting on €15bn of cash as of 2014 and we expect the sector overall to turn net cash in 2016. As a proportion of their total asset base, our coverage of companies has one of the highest proportions of cash in 2014. Using the CS HOLT® database we compare this to the other sectors. We also note that our coverage sits comfortably at 1% net debt to market cap. vs the wider consumer discretionary space at 10%.
Figure 32: Luxury companies having the third highest Figure 33: The luxury sector has the second lowest net proportion of assets held as cash debt as a proportion of market cap Cash and ST investments as a % of total assets (in 2014) Net debt as a % of current market cap (in 2014) 29% 115%
88%
16% 13% 13% 10% 40% 10% 10% 36% 32% 8% 8% 25% 14% 5% 4% 10% 8% 1%
-2%
IT
IT
Telcos
Luxury
Energy
Utilities
Telcos
Luxury
Energy
Utilities
Materials
Financials
Industrials
C. Staples C.
Materials
Financials
Industrials
Health Care Health
C. Staples C.
Health Care Health C. Disctretionary C.
Disctretionary C. Source: Company data, Credit Suisse estimates, Credit Suisse HOLT Source: Company data, Credit Suisse estimates, Credit Suisse HOLT
Richemont, Hermes and Burberry stand out. Of all luxury companies, Richemont, Hermes and Burberry have c.30% or higher of assets in cash and enjoy a comfortable net cash position. For all our companies, bar Kering, we forecast a net cash position by 2019 as free cash flow generation continues to improve (see Figure 34). Finally, we expect the total sector cash pile to almost double from €15 bn in 2014 to €28 bn by 2018e. This is in addition to the assumptions we have already made on dividend growth.
Figure 34: For all companies, bar Kering, we expect a next cash position by 2019e Net debt (cash) / clean EBITDA
2.5x
1.6x 1.1x 0.7x 0.4x 0.1x 0.0x
(0.0x) (0.1x) (0.5x) (0.6x) (0.7x) (0.7x) (0.8x) (1.1x) (1.4x) (1.6x) (1.6x) (1.8x) (2.3x)
Kering Cucinelli LVMH Hugo Boss Ferragamo Swatch Tod's Hermes Burberry Richemont 2015e 2018e Source: Credit Suisse estimates
European Luxury Goods 14 11 January 2016
Overall picture still looks good after lease adjustments. Because retail development has been so crucial for sales growth in luxury, we have chosen to consider operating leases as an asset. We thus capitalise the fixed portion of rent over the average lease term using the average cost of debt. On a lease adjusted basis, the average for the group is 1.7x net-debt/EBITDAR in 2014 falling to 1.2x by 2019e, on our estimates. We note that Hermes and Richemont are the only companies which remain net cash after lease adjustments throughout our forecast period. At <2x lease-adjusted net-debt/EBITDAR, we view financial gearing in the sector as fairly low, which means that most luxury companies could in theory add more debt or distribute cash. Capex likely to start declining Sector capex likely to start declining from 2016 onwards. Capex has been the third largest use of capital after dividends and M&A in the past decade. It has increased relative to sales every year since 2005 (4.8% of sales), to reach 6.5% in 2014, with the sole exception of 2009. Store openings and investments in production capacity have led to rising capex requirements over the period. That said, we highlighted in a previous section that the mega brands are approaching store footprint maturity. In addition, we believe luxury companies are likely to pull back manufacturing investments besides multi-channel as the visibility on the overall demand for luxury products is low. As a result, we expect capex to decline in both absolute and relative terms as soon as 2016 for the majority of the companies we cover (see Figure 35) . But one thing we do have to bear in mind is growing capex per store. Against this backdrop of declining store openings, we admit there is an apparent increase in the investment needed to open a store. This therefore may limit the fall in capex growth. Part of this is arguably due to store size with the opening of flagships for most of the brands we cover over 2010-2013. Part is also down to the growing tendency of these companies to make new stores more exclusive and luxurious, in our view. We have got little data on square footage and store capex at sector level and we thus take Burberry as a proxy for the sector given its good financial disclosure. The differential between total store capex and the number of stores opened has widened over the past three years highlighting the rising cost of these new stores (see Figure 36). The drawback of this analysis is that total store capex includes refurbs. Therefore, we also look at gross value of assets related to store enhancements in relation with square footage. In the case of Burberry, the gross value of these assets doubled in the past eight years (see Figure 37). Figure 35: We expect total sector capex to start Figure 36: Rising capex per new store potentially declining as soon as 2016 limiting the decline in capex growth Sector absolute and relative capex Store capex vs. gross openings of Burberry mainline stores
6 6.5% 7% 140 132 8.0 6.1% 5.7% 5.8% 5.8% 6% 116 7.0 5 5.3% 120
4.7% 4.7% 5% 97 6.0
Thousands 95 4 3.6% 100 4.0% 81 5.0 4% 77 80 3 4.0 3% 60 56 2 3.0 2% 38 40 29 28 25 2.0 1 20 21 23 23 1% 18 16 20 12 1.0 0 - 2007 2008 2009 2010 2011 2012 2013 2014 2015e 2016e 0 0.0 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Capital expenditures (lhs, €bn) Capex as a % of sales (rhs) Lease improvement (lhs, £m) New mainline stores (#, lhs) Lease improvement per new mainline store (rhs, £m) Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
European Luxury Goods 15 11 January 2016
Figure 37: Fixtures, fittings and leasehold improvements In £m unless stated otherwise FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Gross value 193 238 365 395 452 519 669 734 805 Net value 99 116 174 187 223 257 321 320 486 Gross value per sqft (£/sqft) 297 321 432 444 447 453 519 556 595 Net value per sqft (£/sqft) 153 157 205 211 221 224 249 242 359 Average asset life 8.4 8.8 8.5 9.0 8.7 7.2 7.2 7.1 8.0 Source: Company data, Credit Suisse estimates Inventory days expected to stabilise Rapid deterioration in cash conversion cycle. Investment in working capital is generally the fourth biggest use of capital in our coverage. The cash conversion cycle (days of receivables + days of inventories - days of payables) has doubled in the past seven years to reach c.280 days in 2014. The gradual distribution shift into retail has led to an increase in inventory days which has only partly been offset by a small decline in receivables related to wholesale partners. In addition, a product mix towards high-end luxury for most brands have added further pressure on inventory turns. But no further deterioration expected. That said, we do not think the retail/wholesale mix will change much over the next few years as most companies come to the end of this transition. Also, the move towards higher price points or so-called brand elevation has been largely done by most of the luxury brands under coverage. In addition, we notice that some of the most recent launches in watches or handbags appear to be at more affordable price points.
Figure 38: We expect the sector cash conversion cycle to Figure 39: The pace of retail/wholesale shift to moderate plateau in 2016 at c.270 days over the next few years Sector cash conversion cycle (days) Retail share of revenue at sector level
59% 282 58% 273 273 273 57% 254 56% 240 54% 52% 211 51% 48% 173 166 172 47% 142 43% 42%
2007 2008 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e 2007 2008 2009 2010 2011 2012 2013 2014 2015e 2016e 2017e
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates M&A becoming increasingly expensive A select few prioritise growth through acquisition. M&A was the second biggest use of capital in luxury from 2007-2014, accounting for €13bn of spending. However this was not evenly spread across all the companies in our coverage, with the majority of this spending (73%) accounted for by LVMH and Kering, the industry's two biggest consolidators. Most of these deals have been bolt on deals and generally small (Figure 41), typically aimed at filling a void in the existing brand/product portfolio (Bulgari 2011, Loro Piana in 2013, Ulysse Nardin in 2014) or for vertical integration to secure procurement of raw materials (particularly in leather and watch components). Further to this we have seen opportunistic acquisitions of distribution JVs/franchises mostly in emerging markets (Ferragamo, Hugo Boss in China).
European Luxury Goods 16 11 January 2016
Figure 40: Kering and LVMH being the biggest industry Figure 41: Most deals in luxury being small and bolt on consolidators since 2007 since 2007 Aggregated capital spent on M&A over 2007-2014 Value breakdown of deals in the luxury sector Others 12 Swatch 5% 7% 1 10 1 1 2 1 1 8 Richemont Kering 1 1 15% 2 40% 1 6 1 9 1 4 Number of M&A dealsM&A of Number 7 6 6 6 2 4 4 2 0 2007 2008 2009 2010 2011 2012 2013 2014 LVMH <=$0.3bn $0.3-$0.6bn $0.6-$0.9bn $0.9-$1.2bn $1.2-$1.5bn $1.5-$2.0bn >$2bn 33% Source: Company data, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates
Acquiring brands in the DNA of luxury conglomerates. Those that have carried out acquisitions have done so competently, and we fail to see any reason for this to change. Organic growth for the core brands of the two industry consolidators (Louis Vuitton for LVMH, Gucci and BV for Kering) has slowed in recent years and we believe their CEOs still have growth aspirations and an expertise in developing small luxury brands. We indeed cannot think of many acquisitions that have been unsuccessful in the past decade, apart from perhaps Puma by Kering. LVMH and Richemont historically good acquirers according to HOLT. We evaluate the success of an M&A strategy using the CS HOLT M&A scorecard. This measures the 'pricing skill' (whether a transaction was cheap of expensive), 'operating skill' (CFROI® improvement or not in the following three years) and 'growth ability' (growth or not over in the following three years) of each material acquisitions. LVMH and Richemont screen well under this analysis, both falling in the first quartile when ranked against the database of over 2,000 companies (see Figure 42). Kering ranks only in the second quartile, which we believe is mostly due to the misfortunes of the Puma acquisition. Figure 42: LVMH and Richemont have been good acquirers according to HOLT M&A scorecard Company # material Operating skill Growth ability Pricing skill Deal-year Total percentile Material Acquisition Years acquisition deal score score score weighted years average score Richemont 2 72.6 82.1 16.9 65.3 90 2000-1995 LVMH 16 44.3 69.2 68.4 59.1 78 2011-2001-1999-1 Earlier Years Kering 13 64.8 51.1 52.0 56.7 70 2007-2004-2001-3 Earlier Years Source: Credit Suisse HOLT
Appeal for high-quality luxury assets leading to high deal multiples. We continue to expect some M&A activity targeted at small private luxury companies in the medium term. There are indeed numerous luxury brands, particularly in France and Italy, that are facing succession issues or limited access to financing to enter new markets. The options of the controlling shareholders are either to go public or become part of large conglomerate or private equity funds. But deal multiples in luxury have been rich at >3x trailing EV/Sales (see Figure 43) and we would see scope for future multiples to be even higher. First, the top of the luxury pyramid has been the preferred targets in recent years (Loro Piana, Harry Winston, Ulysse Nardin) and these high-quality assets generally command higher multiples. Second, the large luxury conglomerates have deep pockets and are seemingly willing to pay cash. Third, private equity funds have got more cash available that a couple of years ago and are now often ready to pay higher multiples than strategic buyers.
European Luxury Goods 17 11 January 2016
M&A economics not particularly attractive. Because of high deal multiples, we find the payback period of deals tends to be long, with it generally taking more than 10 years to generate any positive economic profit (after taking into account the premium paid on deals or goodwill). For example, analysing the deals involving Bulgari (and LVMH), Hugo Boss (and Permira) and Net-a-porter (and Richemont) we calculate for all of them, a payback period of over a decade. Figure 43: Recent M&A activity has been targeted to high multiple, high-end luxury assets Date Buyer Target Business area Consideration Stake Trailing EV/sales Trailing EV/EBITDA Jul-97 LVMH Sephora Perfume retailer €243 m 100% 1.2x May-99 Richemont Van Cleef & Arpels Jewellery €165 m 60% 2.9x Sep-99 LVMH TAG Heuer Luxury watch SFr1.2bn 100% 2.3x Oct-99 LVMH Fendi Fashion & Leather €295 m 26% 4.2x Jul-00 Richemont Les Manufactures Horlogères SA Luxury watch SFr2.8bn 100% 8.0x 34.9x Dec-00 LVMH Donna Karan Fashion & Leather $ 595 m 100% 0.9x Feb-01 Gucci Bottega Venetta Fashion & Leather $157 m 67% 4.3x Jun-05 LVMH Glenmorangie Scotch whisky £300m 100% 4.1x Apr-07 Permira Hugo Boss Apparel €5.3bn 100% 2.6x 11.6x Apr-10 Richemont Net a Porter Online Retailing' £235m 67% 2.9x Mar-11 LVMH Bulgari Watches & Jewellery €4.3bn 100% c.3x 26.4x Nov-11 Kering Brioni Fashion & Leather €310m 100% 1.5x 14.8x Jul-13 LVMH Loro Piana Fashion & Leather €2.7bn 80% 3.8x 19.2x Jan-13 Swatch Group Harry Winston Jewellery $ 1.0bn 100% 2.4x 13.5x Feb-14 Roberto Cavalli Fashion & Leather €450m Average 3.2x Source: Credit Suisse research, Company data
European Luxury Goods 18 11 January 2016
Investors to gradually focus on cash returns Investors are gradually focusing on the use of cash. The good news for investors is that management teams in luxury have little to worry about surrounding their ability to finance the day-to-day operations and further expansion plans. The bad news is that they must make capital-allocation decisions in an environment where demand for luxury goods is soft and opportunities for expansion are certainly less evident than a decade ago. The risk is that expensive investment decisions are made at the expense of RNOA (Returns on Net Operating Assets). Lease-adjusted RNOA at the sector level has indeed fallen from its peak in 2012 to low teens (see Figure 44). In theory, this should lead to an increase in the cash returned to shareholders as management teams find themselves with few investment alternatives that would generate returns above the cost of capital. Reducing cash to add value Too much cash destroys value. A growing argument for many industries is whether too much cash can weigh on the balance sheet, causing it to be sub-optimal and a hindrance to growth. We know that companies should keep just enough cash to cover their interest, expenses and capital expenditures, and any extra due to emergencies. But how much extra is really needed? The optimal percentage to hold seems elusive and research into the topic reaches different conclusions. We know for sure that having a net cash position is negative to shareholders as they forgo leverage benefits and tax deductibility. We note RNOA has been declining since 2012 and when we include cash the picture is further deteriorated. Over our forecast years, we find cash removes c.200bps from the sector aggregate RNOA (see Figure 45) Figure 44: RNOA has fallen as high-return Figure 45: RNOA are c.200bs lower when including investments have become rarer in the sector cash back into operating assets Sector lease-adjusted RNOA Sector lease-adjusted RNOA including cash
13.3% 12.9% 15.2% 15.5% 13.9% 12.0% 12.9% 12.8% 11.3% 11.7% 11.9% 11.0% 11.2% 11.1% 11.4% 10.5% 10.2% 9.3% 9.6% 9.5% 9.5% 9.6%
8.3%
2007 2008 2009 2010 2011 2012 2013 2014 2015e 2016e 2017e 2007 2008 2009 2010 2011 2012 2013 2014 2015e 2016e 2017e 2018e Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Holding a more reasonable amount of cash could add 10% average upside to our coverage, according to HOLT. HOLT Linkers enable us to input our analysts' forecasts into the HOLT framework and generate a warranted value using the HOLT modelling assumptions. Using the Linkers we are able to flex the amount of cash we forecast to remain on the balance sheet. From 2015 to 2019 we limit the percentage of total assets as cash and assume the balance is paid out in dividends. On average if we limit cash to 5% of assets, the CFROI used in valuation (i.e. the terminal value) increases by 3.2ppt on average. This results in an average boost to valuations of 10%. We note that Kering is the only company that does not benefit from adjusting the amount of cash as it currently holds less than 5% of assets as cash.
European Luxury Goods 19 11 January 2016
Figure 46: CFROI would increase by c.3ppt on Figure 47: An average 10% upside is generated from average if balance sheets were more optimal limiting the cash on the balance sheet CFROI with cash adjustment - CFROI normal Upside to the warranted value using 5% of assets as cash
8% 21% 20% 7% 6% 16%
13%
3% 6% 2% 5% 5% 1% 1% 4% 1% 1% 0%
Hermes Richemont Burberry Ferragamo LVMH Hugo Boss Swatch Brunello Tod's Ferragamo Richemont Burberry Swatch Brunello Hugo Boss LVMH Hermes Tod's Cucinelli Cucinelli
Source: Credit Suisse estimates, Credit Suisse HOLT Source: Credit Suisse estimates, Credit Suisse HOLT Evaluating the likelihood of cash returns Evaluating the likelihood of cash returns. In reality, most of the large luxury conglomerates are controlled by founders/CEOs with strong growth aspirations. Because some of their core assets are nearing maturity and organic growth is fading, external growth is becoming increasingly likely. As a result, we do not think LVMH or Kering will start returning cash to shareholders. We believe ono-brand companies focused on organic growth like Burberry or Hermes are more likely to do buybacks or pay a special dividend. We take this opportunity to review the uses of cash at sector level and the likelihood of cash returns for each of the 10 stocks we cover (see Figure 48). Figure 48: Solvency, cash metrics and likelihood of cash return ND/EBITDA Lease adj. ND/ EBITDA FCF yield Dividend yield Likelihood of cash returns FY1e FY2e FY1e FY2e FY1e FY2e FY1e FY2e Buyback possible at current share price given sound balance (1.1x) (1.3x) 0.9x 0.9x 4.6% 4.8% 3.4% 3.4% Burberry sheet even after lease adjustments. Increase in dividend likely given the shareholding structure Hermes (0.8x) (1.0x) (0.2x) (0.4x) 3.3% 3.8% 1.2% 1.3% with >200 family member unable to monetize their stakes over the next 15 years. Already highest dividend yield in the sector. Current level of Hugo Boss 0.1x (0.1x) 2.5x 2.3x 7.5% 9.0% 5.6% 6.1% dividend sustainable despite margin pressure. Capex to start declining in 2016. Possible. The biggest cash pile in the sector relative to market (1.8x) (2.1x) (0.1x) (0.2x) 4.1% 6.3% 2.6% 3.2% Richemont cap. Focus on organic growth and sound capital allocation. Increase in dividend or special dividend possible given sound 0.0x (0.2x) 2.5x 2.2x 3.0% 4.6% 2.5% 2.9% Ferragamo balance sheet, declining capex. Buyback possible at current share price level but limited by the opting out rules of the Swiss stock market whereby the Swatch (0.7x) (1.0x) 1.2x 1.1x 8.3% 10.2% 2.4% 2.4% majority shareholder has to launch a mandatory offer if their voting rights exceed 49% (The Hayek family controls 37% of the voting rights). Buyback or special dividend unlikely given limited free float (0.7x) 0.2x 2.6x 3.4x 1.8% 4.3% 2.9% 3.1% Tod's and an increase in ND following the Roger Vivier deal. Buyback or special dividend unlikely given current LVMH 0.7x 0.4x 2.3x 2.1x 3.5% 5.5% 2.3% 2.7% shareholding structure and continued appetite on external growth. Buyback or special dividend unlikely given current Kering 2.5x 2.2x 3.5x 3.3x 2.2% 5.2% 2.9% 3.2% shareholding structure, >2x ND/EBITDA position and continued appetite on external growth. Source: Company data, Credit Suisse estimates. Note: prices as of 07/01/15
European Luxury Goods 20 11 January 2016
4Q and FY previews
Figure 49: Quarterly preview summary by company Date Company Reporting Key numbers 14-Jan Burberry 3Q16 trading update - 3Q retail revenue: £594m - 3Q retail comps: -3% (vs. -4% in 2Q, +6% in 1Q) 14-Jan Richemont 3Q16 trading update - 3Q group sales: €3,059m - 3Q group organic growth: +1% (vs. +3% in 2Q, +5% in 1Q) 21-Jan Tod's FY15 prelims - FY group revenue: €1,034m - FY EBITDA: €201m 14-Mar FY15 results - FY retail comps: -5% (vs. -6% in 45w of 2015) Early Feb LVMH FY15 results - 4Q group organic growth: +4% (vs. +7% in 3Q, +9% in 2Q) - 4Q Fashion & Leather org. growth: +2% (vs.+3% in 3Q, +10% in 2Q) - 4Q Wine & Spirits org. growth: +3% (vs. +16% in 3Q, +5% in 2Q) - 4Q Watches & Jewel. org. growth: +8% (vs. +11% in 3Q, +13% in 2Q) - 4Q Selective Retailing org. growth: +6% (vs. +5% in 3Q, +5% in 2Q) - FY group revenue: €35,603m - FY operating profit: €6,458m - FY operating margin: 18.1% (vs. 17.7% in 1H and 18.7% in FY14) 10-Feb Hermes FY15 sales - FY group sales: €4,894m - FY operating profit: €1,532m(31.3% margin vs. 32.5% in 1H and 23-Mar FY15 results 31.5% in FY14) - 4Q group organic growth: +7% (vs. +8% in 3Q, +10% in 2Q) - 4Q leather goods organic growth: +8% (vs. +9% in 3Q, +15% in 2Q) Early Feb Swatch FY15 results - FY organic growth: flat (vs. +4% in 1H) - FY net sales: SFr8,580m - FY operating profit: SFr1,554m - FY operating margin: 18.1% (vs. 18.2% in 1H and 20.1% in FY14) 19-Feb Kering FY15 results - 4Q group organic growth: +5% (vs. +3% in 3Q, +8% in 2Q) - 4Q Gucci org. growth: +1% (vs. flat in 3Q, +5% in 2Q) - 4Q BV org. growth: +6% (vs. +4% in 3Q, +9% in 2Q) - 4Q SL org. growth: +20% (vs. +27% in 3Q, +27% in 2Q) - 4Q Puma org. growth: +6% (vs. +3% in 3Q, +8% in 2Q) - FY group revenue: €11,429m - FY operating profit: €1,656m Feb Hugo Boss FY15 results - FY group organic growth: +3% (vs. -1% in 3Q, +7% in 2Q) - 4Q retail comps: flat (vs. flat in 3Q, +6% in 2Q) 10-Mar - FY EBITDA: €611m (21.8% margin) 10-Mar Brunello Cucinelli FY15 results - FY retail comps: +5% - FY EBITDA: €70m (17.0% margin) 17-Mar Salvatore Ferragamo FY15 results - FY group organic growth: +1% (vs. -1% in 3Q, +2% in 2Q) - FY retail comps: -2% (vs.-2% in 9M, flat in 1H) - FY EBITDA: €308m (21.9% margin) Source: Company data, Credit Suisse estimates
European Luxury Goods 21 11 January 2016
Appendix 1: Sector charts
Figure 50: Hong Kong watches & jewellery: Figure 51: Macau gaming revenues: downturn due continuing negative sentiment YTD to curb on extravagance and reduced tourism inflow Hong Kong Watches and Jewellery retail value momentum Macau casinos gross gaming revenues
80% 80%
60% 60% 40% 40% 20% 20% - - (20%)
(20%) (40%)
(40%) (60%)
Jun-11 Jun-12 Jun-13 Jun-14 Jun-15
Mar-14 Mar-11 Mar-12 Mar-13 Mar-15
Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15
Sep-11 Sep-12 Sep-13 Sep-14 Sep-15
Feb-13 Feb-10 Feb-11 Feb-12 Feb-14 Feb-15
Aug-10 Nov-11 Aug-15 Nov-09 Nov-10 Aug-11 Aug-12 Nov-12 Aug-13 Nov-13 Aug-14 Nov-14 Nov-15
May-14 May-10 May-11 May-12 May-13 May-15
Y-o-Y % change 3 month moving average Y-o-Y % change 3 months moving average Source: Hong Kong Census and Statistics Department Source: Macau Gaming Inspection and Coordination Bureau
Figure 52: Swiss watch exports: difficult to read Figure 53: Swiss watches PMI: slowdown in 2H15 Swiss watch exports - value momentum Swiss Economic Institute survey Adjusted Business Climate
80 40% 60 30% 40 20% 20 10% - - (20) (10%)
(20%) (40)
(30%) (60)
(40%) (80)
(100)
Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15
Aug-12 Nov-09 Aug-10 Nov-10 Aug-11 Nov-11 Nov-12 Aug-13 Nov-13 Aug-14 Nov-14 Aug-15 Nov-15
May-11 May-10 May-12 May-13 May-14 May-15
(120)
Jun-10 Jun-06 Jun-07 Jun-08 Jun-09 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15
Dec-14 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-15 Y-o-Y % change 3-month moving average Dec-05 Source: FHS Source: Swiss Economic Institute (KOF)
Figure 54: Japanese dept. stores: +ve impact from Figure 55: Japanese outbound tourist momentum inbound tourism, especially Chinese in mid-2015 has been on the decline for almost 2 years Japan department stores y-o-y % change Outbound tourists from Japan y-o-y change
30% 50%
40% 20% 30%
10% 20%
10% - -
(10%) (10%)
(20%) (20%) (30%)
(30%)
Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15
Oct-15 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15
Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15
Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15
May-10 May-11 May-12 May-13 May-14 May-15
Y-o-Y % change (avg.) 3 months moving average Y-o-Y % change 3 months moving average Source: Company data Source: Japanese Tourism Marketing Company
European Luxury Goods 22 11 January 2016
Figure 56: International passengers momentum Figure 57: France 4* hotels occupancy momentum International passenger traffic y-o-y % change France 4-star hotels occupancy y-o-y % change
20% 20%
15% 15%
10% 10% 5% 5% - - (5%) (5%) (10%) (10%) (15%) (15%)
(20%)
Jul-14 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-15
Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15
Nov-09 Aug-10 Nov-10 Aug-11 Nov-11 Aug-12 Nov-12 Aug-13 Nov-13 Aug-14 Nov-14 Aug-15 Nov-15
May-10 May-11 May-12 May-13 May-14 May-15
Y-o-Y % change 3-month moving average Y-o-Y % change 3 months moving average Source: IATA Source: MKG Hospitality Database
Figure 58: Credit Suisse luxury indicators dashboard Jan’16 update trend Oct’15 update trend Jul’15 update trend Apr’15 update trend Jan’15 update trend Overall trend Hong Kong domestic property price index Chinese retail sales International passenger travel data U.K. inbound visitor data Japanese dept. store sales US high-end dept. store sales France 4-star hotel occupancy Fine wine index evolution US luxury hotel occupancy European retail sales Chinese real estate price index Hong Kong inbound traveller data Swiss watch exports Japanese outbound traveller data Diamonds 1-carat fine index Hong Kong watch & jewellery retail sales Macau casino revenue Source: Credit Suisse Equity Research
Note: 3-month moving average: growth >20%, growth between 10% and 20%, growth between 2% and 10%, growth from -2% to 2%, decline between 2 and 10%, decline between 10% and 20%, decline above 20%
European Luxury Goods 23 11 January 2016
Appendix 2: Sector valuation sheet
Figure 59: Sector valuation sheet Valuation Metrics Close Target Market P/E EV/Sales EV/EBITDA EV/EBIT Div. Yield Upside Rating Price Price cap CY15e CY16e CY15e CY16e CY15e CY16e CY15e CY16e CY15e CY16e local c. local c. % €m x x x x x x x x % % Richemont O 67 91.0 36% 32,246 19.2x 16.2x 2.4x 2.3x 8.9x 8.3x 10.8x 10.2x 2.3% 2.8% Swatch O 319 450 41% 15,915 14.6x 13.1x 1.8x 1.7x 8.2x 7.6x 10.2x 9.5x 2.4% 2.4% LVMH N 137 145 6% 69,410 19.2x 16.8x 2.1x 2.0x 9.5x 8.9x 11.8x 11.0x 2.3% 2.7% Kering U 145 140 (3%) 18,302 16.0x 14.8x 2.0x 2.0x 11.5x 10.6x 14.1x 13.0x 2.9% 3.2% Hermes N 301 275 (8%) 31,724 31.3x 28.4x 6.2x 5.7x 18.1x 16.4x 19.9x 18.1x 1.2% 1.3% Burberry U 1,078 1,250 16% 6,447 14.7x 14.8x 1.6x 1.6x 7.3x 7.2x 9.7x 9.7x 3.3% 3.4% Hugo Boss O 70 115 65% 4,893 14.0x 12.4x 1.8x 1.7x 8.1x 7.6x 10.5x 9.7x 5.6% 6.1% Tod's N 69 80.0 16% 2,107 20.6x 18.6x 1.9x 1.8x 9.7x 8.6x 12.6x 11.2x 2.9% 3.1% Ferragamo O 20.3 24.0 18% 3,423 20.9x 18.2x 2.5x 2.3x 11.2x 10.0x 13.6x 12.0x 2.5% 2.9% Prada U 20.4 22.4 10% 6,168 17.2x 16.1x 1.7x 1.8x 7.3x 6.8x 11.2x 10.8x 4.0% 4.2% Brunello Cucinelli U 15.2 11.0 (27%) 1,032 30.9x 28.7x 2.7x 2.4x 15.6x 14.1x 21.1x 18.9x 0.8% 0.9% European average* 159,942 17.4x 15.3x 2.0x 2.0x 9.1x 8.4x 11.2x 10.5x 2.5% 2.8% Source: Company data, Credit Suisse estimates. Note: prices as of 07/01/15, *excludes Hermes
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Appendix 3: Prime rental locations data
Figure 60: Prime rental locations data
June '09 June'10 June'11 June'12 June'13 Sept '14 June '15 Units US Newbury Street 125 125 130 130 135 147 150 US$/sqr.ft/yr Rodeo Drive (Beverly Hills) 500 500 500 540 575 675 800 US$/sqr.ft/yr Upper 5th Avenue 1,700 1,850 2,250 2,500 2,500 3,500 3,500 US$/sqr.ft/yr Madison Avenue 875 831 847 1,100 1,100 1,400 1,500 US$/sqr.ft/yr Brazil Garcia D'avilla (Ipanema) 1,292 753* 170 280 280 280 325 BRL/sq.m/month Australia Pitt Street Mall 6,000 6,000 10,000 10,000 10,000 12,500 12,500 AUD/sq.m/yr Hong Kong Central 782 970 1,050 1,200 1,480 1,400 1,250 HKD/sqr.ft/month Causeway Bay 985 1,080 1,260 1,700 1,950 1,770 1,550 HKD/sqr.ft/month Tsim Sha Tsui 720 600 893 1,000 1,320 1,335 1,190 HKD/sqr.ft/month Tokyo Ginza 220,000 230,000 250,000 250,000 290,000 310,000 320,000 JYP/Tsubo/month Omotesando 200,000 210,000 230,000 230,000 250,000 250,000 300,000 JYP/Tsubo/month Shinjuku NA NA NA NA 220,096 230,000 220,000 JYP/Tsubo/month Austria Karntnerstrasse/Graben 260 270 275 275 300 300 300 €/sq.m/month France Avenue Montaigne 6,500 6,500 6,500 8,000 10,000 11,000 12,000 Zone A €/sq.m/yr Avenue des Champs Elysees 10,500 9,500 10,000 13,000 18,000 18,000 18,000 Zone A €/sq.m/yr Rue du Faubourg St Honoré 6,500 6,500 6,500 8,000 10,000 11,000 12,000 Zone A €/sq.m/yr Germany Goethestasse NA NA 220 250 220 240 245 €/sq.m/month Maximilianstrasse NA NA 260 260 260 275 285 €/sq.m/month Italy Via Condotti 6,500 6,700 6,700 6,800 7,000 8,000 9,500 €/sq.m/yr Via Montenapoleone 6,800 6,800 6,800 7,000 7,500 8,500 10,000 €/sq.m/yr Via Tornabuoni NA NA 2,600 2,600 2,700 2,700 2,700 €/sq.m/yr Netherlands Kalverstraat 2,300 2,300 2,500 2,800 2,900 2,900 2,900 €/sq.m/yr Norway Akersgata NA NA NA 10,000 12,000 12,000 12,000 NKr/dq.m/yr UK Sloane Street NA NA 600 760 800 800 825 Zone A £/sq.ft/yr New Bond Street 775 925 965 995 1,150 1,250 1,400 Zone A £/sq.ft/yr Source: Cushman & Wakefield, Credit Suisse research
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Companies Mentioned (Price as of 07-Jan-2016) Brunello Cucinelli SpA (BCU.MI, €15.17) Burberry Group (BRBY.L, 1078.0p) Compagnie Financiere Richemont SA (CFR.VX, SFr67.0) Hermes International (HRMS.PA, €300.5) Hugo Boss (BOSSn.DE, €69.5) Kering (PRTP.PA, €144.95) LVMH (LVMH.PA, €136.6) PRADA S.p.A. (1913.HK, HK$20.35) Salvatore Ferragamo Spa (SFER.MI, €20.28) Swatch Group (UHR.VX, SFr318.8) Tod’s Group Spa (TOD.MI, €68.85)
Disclosure Appendix Important Global Disclosures I, Guillaume Gauvillé, CFA, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin Ame rican and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 1 2-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be a ssigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, wh ich was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is:
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