LVMH Stock Is A Buy On Improving Fundamentals (LVMHF)

Louis Vuitton Island Maison, Singapore

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When I think of strong investments, I look for high quality business models with an excellent management team at an attractive valuation. Over the last three years, luxury fashion house LVMH (OTCPK:LVMHF) has gained 84%, transforming its CEO, Bernard Arnault, into a centi-billionaire and, very briefly, the world’s richest person. It’s a quality brand and, unlike Tapestry (TPR) and Ralph Lauren (RL), its brands uniquely target the premium luxury market as more of a diversified conglomerate. The company has ~75 brands, including Christian Dior, Louis Vuitton, Bvlgari, Sephora, etc. and cuts across multiple geographies (866 stores in the US; 512 in France; 428 in Japan; etc.) and multiple product categories. While its arguably best known for its fashion line, 53% of the revenue comes from other categories, including wines & spirits, perfumes & cosmetics; watches & jewelry; and selective retailing / other. It enjoys ~68% gross profit margins with EBITDA margins hovering around ~35%; the strong profitability and recession-resistant customer base thus make it a relatively safe play. And at 16.2x EBITDA, I believe the stock has room for multiple expansion in light of its solid portfolio and industry leadership position.

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Data by YCharts

With that said, 3 of the last Seeking Alpha articles going back to May of last year were a “hold”; 1 was a “sell”; and only 1 was a “buy”. Despite bouncing back nicely from a weak 2020 and having a history of double-digit annual growth, the stock still faces plenty of skepticism. In one article on Seeking Alpha, the point was made that Chinese President Xi Jinping’s intent to “adjust excessive incomes”. Yes, Asia represents a dominant luxury market, but, in my view, it’s a bit of a stretch for investors to extrapolate from one political comment to the long-term outlook on the sector. Socialism is nothing new in China; even if it were to get more socialistic, it’s hard to imagine that LVMH, with its diverse brands, won’t be able to adapt to changes in consumption, to say nothing about the emerging opportunity from the “mass affluent”.

DCF Analysis Indicates Meaningful Upside

To get a sense of the company’s intrinsic value, I ran a DCF analysis. No DCF analysis can provide a perfect picture of future returns for shareholders; however, they can provide an illustrative “story” of the likelihood of different scenarios. I forecast revenue growing at 10% clip in 2026. For a company that has consistently generated double-digit growth, this is reasonable. I assumed EBIT margins expanding to 28%. Capex, increase in net working capital, depreciation, and taxes were flat-lined for simplicity. By 2026, I have EBITDA at EUR 36 billion.

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Source: Created by author using data from Yahoo! Finance

Assuming a terminal EBITDA multiple of 14x and a discount rate of 7%, the stock has nearly 20% upside. In light of the fact that the broader market is highly overvalued, this makes the stock a steal at today’s price that has eroded by nearly 11% YTD. Over the past ten years, the stock has generally traded in the 13-16x range, so I believe my valuation is, if anything, erring on the conservative side.

dcf

Source: Created by author using data from Yahoo! Finance

Taking a look at the sensitivity analysis, you can see that there are considerably more pathways to upside than downside. Should the multiple stay put at around 16x, there’s 33% upside here. It would take the multiple contracting to below the low end of the historical range at 12x and growth falling below 9% to move the stock into the overvalued territory. Importantly, my model reveals that the stock isn’t so sensitive to changes in margins; a 1% change in margin yields less than a 4% change in expected returns. Given the company’s favorable brand perception, I also don’t see margins under pressure to begin with.

Upside Catalysts

There are several catalysts that will cause LVMH to outperform over the next few years. The first is continued acquisitions. LVMH operates in a highly fragmented industry and has the marketing capabilities to meaningfully accelerate brands. The recent acquisition of Tiffany’s back at the start of 2021 illustrates that management is serious about diversifying its brand exposure beyond the ultra-affluent, as well as confidence in the underlying business during the depths of a pandemic. Importantly, the Tiffany’s acquisition was largely covered due to over EUR 13.5 billion in operating free cash flow, so the company is positioned to acquire further brands.

We also need to see continued growth organically. Management delivered 14% organic growth in 2021 over 2019 (2020 was an outlier year), reflecting momentum by the Fashion goods category that posted a 42% growth. Going forward, investors will be focused on Asia excl. Japan, which posted 31% organic revenue growth over 2019 in 2021. Wines & spirits, which posted a 57% y-o-y growth, is also another key category that investors will look towards in potentially correcting the discount to intrinsic value. With brand stores opening and reopening in New York and other major metropolitan areas, LVMH is poised for another wave of growth. As it owns the retail side of equation, LVMH can even profit on competitor products and has the analytics to see which brands are popular to either acquire or further invest in organically.

Risks

There are several reasons why one may be hesitant about LVMH. Firstly, the Arnault family controls 47.3% of the stock, which makes it at risk of having a lack of “outsider perspective”. Moreover, as much as I say that the stock is undervalued, Ralph Lauren and Tapestry both trade at only 8.2-8.4x EBITDA, which is almost half of where LVMH is at. Given the industry leadership position and historical track record of double-digit growth, I believe LVMH warrants this, but the fashion & luxury industry is notoriously unpredictable. It is impossible to say with any degree of confidence which trends may come and go; while LVMH’s brands have shined at the past, it’s arguable as to how much luck played a role in that success. Going forward, LVMH will need to continue to demonstrate brand appeal. Since luxury consumers are often focused on the “next big thing”, it’s not hard to imagine a world where Christian Dior is no longer seen as high end.

Conclusion

LVMH is a high quality business at a discounted price. Although luxury is unpredictable, LVMH’s degree of vertical integration and category leadership position make it better able to pivot than some of its competitors. The track record of double-digit growth is set to continue with foot traffic picking up and continued vertical expansion. Add in a few other transactions like Tiffany’s, and you got a highly diversified portfolio led by an excellent management team with tremendous pricing power. At a time when companies are struggling with congested supply chains and labor shortages, LVMH has the pristine balance sheet and high margins to capitalize on a return from the pandemic. Accordingly, I strongly recommend investing in LVMH.

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