Kering - An unfairly unloved stock?
Kering - LVMH's biggest threat
Kering is a luxury group founded in 1963 home to 11 brands generating €20.4bn of revenue in 2022. Listed on the CAC40 with a market capitalization of €70bn (June 2023), the firm’s founder and chairman Bernard-Henri Pinault owns a 42% controlling stake.
Sector & Product Focus
Diagram I: Overview of Kering’s Holdings
Taken from Kering’s official website, 2023
Kering Eyewear is a portfolio of 13 small eyewear brands.
Trends in Sales & Earnings
Graph I: Historical Figures
Organic Growth: Contrary to its competitors, revenue growth was purely organic, thanks to the appointment of new creative directors. No acquisitions were made between 2015 and 2021.
Volatility: Product offering “follows the trend” rather than positioning themselves as traditional luxury staples. Earnings growth can be high and sudden when products are a hit, but the reverse when they are a miss.
Chart I: 2022 Revenue & EBITDA Breakdown by Brand
Diagram II: Revenue Breakdown by Product Category
Gucci and Leather Drive Earnings: A new creative director was appointed this year to Gucci. The novelty could boost sales but comes with a risk of negative customer reception from Gucci’s new look.
Chart II: 2022 Revenue Split by Region
Geographical diversification: Shields part of revenues from significant macroeconomic changes in each of these regions
A Surprisingly Low Valuation
Table I: 2022 Kering EV/EBITDA
Graph II: Kering’s Historical Share Price
Data taken from Factset, 2023
Despite being LVMH’s number one rival, valuation has stagnated, indicating a lack of investor confidence in the company’s prospects. Its low EV/EBITDA multiple (<10x) could be a sign of undervaluation.
Recent events
Balenciaga Scandal: Kering’s fastest growing brand suffered from a scandal around its creative director, which caused caused Kering a 7% drop in 4Q2022 comparable revenue (Kollmeyer, 2023) and missing analyst target.
Acquisitions and Spin-offs: Kering added two luxury brands to its portfolios since 2021and divested from non-luxury and non-fashion investments, diversifying revenues from Gucci and refocusing its business model on only segment of the luxury market (Abboud, 2021).
Concerns around China: Taxes on the highest income earners were expected to increase. (Keown, 2021)
Industry & Business Strategy Analysis
Kering operates within the personal luxury industry (2022 Global revenue: $242.8bn) which yields the second largest average revenue p.a. within the global luxury goods industry (Sabanoglu for Statista, 2023).
Peer Group Overview
We look for firms operating across the same segments and geography as Kering.
Excluding the loss-making Lanvin, the average operating margin of our peer group is 32% (Table II), below Kering’s 36% margin. This is relatively good compared to the rest of the consumer cyclical industry. While, in retail, total COGS is bound to increase with sales, Kering and its peers offset this with significant price markups on their products.
Degree of Competition
We use the framework outlined in the textbook ‘Business Analysis & Valuation’ (Palepu et. al., 2013).
Current Rivalry: High
- Industry growth: Moderately high for such a mature industry
Projected 3.38% CAGR for the next five years (Statista, 2023), with increasing demand from developing countries.
Current players can thus capture more value without stealing market share from their rivals.
Highest source of growth: leather goods segment - a positive indicator for Kering, given its business model is heavily tilted towards leather goods.
- Concentration: Increasing
Poor stock performance of groups of smaller size: investors believe the market will continue to concentrate between the larger players, a positive sign for Kering.
- Differentiation: High
Higher differentiation allows each brand to command greater markups.
Threat of Substitutes: Moderately low
- Fast-fashion companies are quick to replicate luxury products.
- The quality and the brand power are hard to replicate, however.
- Raw material prices make it hard for fast fashion brands to steal market share
Threat of New Entrants: High
- Digital channels have made it easier for new brands to reach customers.
- Customer sentiment shift towards originality, making it likelier for incumbents to go out of style.
Table II: Selected financials of Kering Rivals
Note: Chanel has been included without market data nor price changes as it is a privately held company. The conversion rate of €0.92 per $ was applied to the data. Sources: Factset (2023), Chanel Press Release (2023)
Business Model
Diagram III: Basic Business Model of Luxury Groups
Similarities: Synergies, vertical integration, organic growth, craftsmanship (Cuafano, 2018), as highlighted by the 2022 end of year investor presentations of Chanel, Hermes, LVMH, and Kering.
Differences: Kering’s focuses on fewer segments of the luxury goods markets while peers leverage interbrand synergies across business segments through partnerships.
Competitive advantage:
Kering has the most modern approach to luxury through the high level of independence granted to each of its brands. It was one of the first groups to leverage NFTs and AI in its marketing activities. This is a key differentiator and main value proposition.
Financial Statement Analysis
Overview of Profitability
Graph III: Kering’s Historical Profit Ratios
High gross margins are consistent with a differentiation strategy:
Kering products can command a higher premium. For instance, the 2017 jump in gross margins is largely driven by the nomination of a new creative director at Gucci who differentiated the brand further relative to rivals.
Poor operating margins compared to peers (Graph IV)– Kering fails to leverage synergies:
Pursuing a differentiation strategy generally requires greater operating expenses, but it is surprising to see that Kering has not found a way leverage the synergies between its brand to lower these (contrary to what it claims it does).
Kering’s product offering goes out of fashion faster, and therefore it periodically invests to give its brands a fresh look. Gucci, 7 years after the nomination of a new creative director, is now facing slower sales growth. Kering thus appointed again a new creative director and is reinvesting in marketing and R&D, leading to a drop in Gucci’s operating margins.
Graph IV: Comparison of profitability ratios with Peer Group
ROE
Graph V: Comparison of Historical ROE
Note: We calculate ROE as Net income/Average (This year’s common equity, Last year’s)
Source: Company Financial Statements
We notice that Kering’s ROE has been increasing and much more resilient during COVID than its peers’.
Dupont Decomposition (Table III)
A) ROS – Increased 3x
Aside from the increase in sales, some accounting incongruities may have inflated NI: consistent increases in deferred taxes, decreases in domestic taxes (despite an increase in sales), increases in minority interest, and the following treatment of impairment:
No brand impairment despite Balenciaga scandal: While there was brand impairment in every single year between 2013 and 2020, none was reported in 2021 and 2022.
B) Asset turnover – Sales more than double vs a 43% increase in assets
Some accounting maneuvers and other events may have underestimated total assets:
Cancelation of an increase in deferred taxes with a decrease in intangible assets: The former would have entered equity, and it is unclear why intangible assets could have decreased when a) they wildly consist in brands with indefinite life and therefore are not amortized b) none of these brands have been sold nor impaired.
Share buyback: So far 1.05m shares have been cancelled, bought for an average 610.5 euros, leading to a €641m decrease in assets.
Table III: Dupont Decomposition of Kering’s Return on Equity
Financial Decisions
The only driver of ROE that has not increased is financial leverage (Table III). Either this comes from the marginal cost of liabilities being greater than ROA, or from poor financial management.
Kering’s leverage ratio is in line with its LVMH’s and Richemont, and it actually has one of the highest interest coverage and debt ratios. This suggests that the management team has reached a level of debt appropriate for the firm’s business risk and that optimizes returns. Its liquidity ratios also indicate that in periods of lower sales debt and interest payments should not be an issue.
Operating Efficiency
Table IV: CCC Comparison
While Kering lags behind Hermes, its efficiency measures are still in line or ahead of LVMH and Richemont, which are more comparable in their business model to Kering than Hermes.
Conclusion: Undervalued
Kering’s stock trades at a significant discount while having had the best return on shareholder equity, the same net margins as LVMH’s and even better than Richemont’s, both valued higher. Its management used an effective amount of debt, without warranting concerns regarding solvency nor liquidity.
A concern by investors might be the strong reliance on Gucci to drive earnings. However many other luxury groups, such as Hermès and Christian Dior, rely only on the revenues of one brand and still trade at a higher share price than Kering. Kering’s strategy has also shifted towards more acquisitions in recent years, which should diversify revenue.
Admittedly, SG&A to Sales is too high, which comes from the fact that its differentiation strategy comes with many expenses, but Kering’ net margins are still higher or at the same level as most of its peers.
Perhaps a concern is the future prospects of Kering, since growth plays a determinant in the share price (Gordon Growth formula). However, the main customer segment that Kering is addressing and leads – teenager and young adults – is the one that is growing the fastest.
From a business standpoint, Kering’s modern approach to luxury is a strong competitive advantage that allows it to command a price premium and attract the future generation of customers.
For these reasons, Kering is relatively undervalued and we recommend a long position to investors.
References
Abboud, L. (2021). Kering buys high-end Danish eyewear brand Lindberg. Financial Times. [online] 8 Jul. Available at: https://www.ft.com/content/3c612769-f495-4ade-b375-21ae35f93d0a.
Chanel Limited (2023). Financial Results for the year ended 31 December 2022.
Cuafano, G. (2018). The Kering Group Multi-Brand Business Model In A Nutshell - FourWeekMBA. [online]
FourWeekMBA. Available at: https://fourweekmba.com/kering-business-model/.
Cuofano, G. (2018). Bernard Arnault Empire: LVMH Group Business Model In A Nutshell - FourWeekMBA. [online] FourWeekMBA. Available at: https://fourweekmba.com/lvmh-group-business-model/.
Factset (2023). Kering Company-Security Report. [online] Factset. Available at: https://my.apps.factset.com/navigator/company-security/snapshot/KER-FR [Accessed 21 Jun. 2023].
Hermès (2023). 2022 Annual Results. [online] Available at: https://assets-finance.hermes.com/s3fs-public/node/pdf_file/2023-02/1676575550/hermes_20230217_pr_2022fullyearresults_va.pdf [Accessed 21 Jun. 2023].
Keown, C. (2021). Luxury Stocks Tumble as China Targets the Superrich. [online] www.barrons.com. Available at: https://www.barrons.com/articles/luxury-stocks-tumble-as-china-targets-the-super-rich-51629381376 [Accessed 21 Jun. 2023].
Kering (2022). Press Release - Completion of the Stock Repurchase Programme.
Kering (2023). 2022 Financial Document. [online] Kering. Available at: https://www.kering.com/en/finance/publications/ [Accessed 21 Jun. 2023].
Kollmeyer, B. (2023). Sales at Balenciaga continue to suffer after child marketing scandal. [online] MarketWatch. Available at: https://www.marketwatch.com/story/sales-at-balenciaga-continue-to-suffer-after-child-marketing-scandal-bafa2dcf.
LVMH (2023). 2022 Full Year Results. [online] LVMH. Available at: https://www.lvmh.com/shareholders/agenda/2022-full-year-results/.
Palepu, K.G., Healy, P.M. and Peek, E. (2019). Business analysis and valuation. 5th ed. Andover Cengage Learning Emea.
Sabanoglu, T. (2023). Topic: Global Luxury Goods Industry. [online] www.statista.com. Available at: https://www.statista.com/topics/1110/global-luxury-goods-industry/.