Robert Way
Investment action
Based on my current outlook and analysis of Hermes International (OTCPK:HESAY) (RMS), I recommend a buy rating. I expect a strong 1Q24 and FY24 performance as high-end consumer demand continues to be very strong, so strong that RMS is able to push through another round of 8–9% pricing growth (a step up from the mid-single-digit price increase indicated in the 3Q23 earnings call). Notably, demand momentum was seen in all regions, particularly with relative share gains against Gucci in China, which saw a big slowdown in Chinese spending.
Basic Information
RMS is a well-known luxury brand with product offerings ranging from accessories to apparel and serves customers worldwide: 56% from Asia, 23% from Europe, 18.6% from the Americas, and the rest from the rest of the world. RMS competes with the other big weights in the luxury retail industry, such as LVMH, Kering, Prada, and the privately owned Chanel brand. RMS is expected to report its 1Q24 performance on April 25 (~ 2 weeks later).
Review
My high-level take is that RMS is going to continue to see very strong sales momentum in 1Q24, based on datapoint provided in the 4Q23 earnings that suggests a strong growth outlook. For one, willingness to spend and spending power among high-end consumers were very strong, as RMS saw double-digit growth across key product categories. In particular, RMS’s largest division, Leather Goods and Saddlery, grew 10.4% in constant currency in 4Q23, where management highlighted strong demand for high-end products. In addition, leather goods came in at 17%, which was at the high end of management’s earlier guide for mid-teen FY23 growth. Strong demand was also seen in ready-to-wear [RTW] and accessories, which grew by 27.5%; other segments grew by 24%; and silk grew by 13%, all on a constant currency basis.
Naturally, I had the concern of whether sales were driven by a particular region or were well spread out across the country, and RMS did not disappoint. In fact, all regions grew double digits in FY23, which means China did very well too. I point out the performance in China because Kering put out an announcement that Gucci sales would fall by 20% due to the Asia slowdown. If we invert this news, it implies that RMS has gained a strong relative share of at least 30% (Gucci 20% decline + RMS “double digits growth” in Asia). In 1Q24, I expect China to remain the focus for RMS’s regional performance as investors look for further signs that RMS is holding on to its share gains. Regarding this, my opinion is that RMS is going to continue doing well in China because management did not mention any slowdown in the FY23 earnings call on February 9. With that, we know that 1/3 of the quarter continues to see strong demand. February has the Lunar New Year, which is a big event that I expect to see seasonally strong demand due to gifting, etc. Hence, 2/3 of the 1Q24 quarter should continue to see strong growth. This sets up a pretty positive outlook for 1Q24 altogether.
Also, this strong performance across all regions reinforced the fact that RMS is a very resilient business and that inflation does not materially slow down the business. On the contrary, I think inflation actually works in favor of RMS because they now have more justification to raise prices, which they did for FY24 and at a higher magnitude. For FY24, management made the announcement of an 8–9% price increase, which is to primarily cover inflationary and currency headwinds, and this is a higher magnitude compared to the mid-single-digit level indicated in 3Q23. Two key takeaways are here. Firstly, it really shows that RMS has the pricing power to keep raising prices, and second, it shows that management is confident that this will not impact volume demand, which cycles back to my point that RMS is a resilient business as a large bunch of its customers are skew towards high loyalty and high net worth customers.
Valuation
Author’s work
I believe RMS can grow at a low percentage for the next few years. Historically, growth has been at high single-digits, but I think low-teen growth is possible in the near-term due to continuous strong pricing growth (continuing from the current trend in FY24 and FY25 as inflation slowly tapers down) and a recovery in consumer demand as the global economy recovers (I see this as recovery growth in the near-term). It is unlikely that RMS will reduce prices (given that this is a luxury brand), so any cost deflation should be margin-accretive. That said, I do not expect the same rate of margin expansion, given that pricing growth should gradually taper. In my model, I expect less than half the magnitude of the increment, to be conservative. In FY26, I expect RMS to generate EUR18.3 billion in sales and EUR6.55 billion in earnings. As sales growth tapers, valuation should gradually see mean reversion towards it 5-year average of 45x forward PE (removing the covid period, which is an outlier period).
Risk
My view on China is positive based on the data points given, which are backward-looking, and given the consumer spending situation in China, RMS could experience the same slowdown that Gucci did. If that happens, it is going to hurt the near-term growth narrative, as Asia is a large part of RMS’s business. It would also put a dent in my bullish view that RMS is a very resilient business (even in subprime, that business grew high single-digits).
Final thoughts
My recommendation is a buy rating. I expect RMS to deliver strong performance in 1Q24 and FY24, driven by continued high-end consumer demand and its ability to raise prices effectively. Strong sales momentum across all regions, particularly in China where RMS gained share against competitors, reinforces the company’s resilience. While a slowdown in China remains a risk, the demand profile so far has been very positive. Looking ahead, I am modeling RMS to see low-teens growth and margin expansion in the near term.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.