LVMH not feeling the brunt of the recession (OTCMKTS:LVMHF)


Investment thesis

LVMH (OTCPK:LVMHF) is one of the best European companies in terms of cash flow generated due to its supremacy in the world of fashion, and luxury more generally. It posted sensational growth results in the first half of 2022 which have further expanded its competitive advantage. Using a discounted cash flow at LVMH’s current price might be a bit expensive, but it’s not overvalued enough to open a short position. Personally, I would consider a buy over $550, so at the current price, I consider it a hold.

Recession-proof income

In the current period where inflation is at its highest level in 40 years and major central banks are aggressively raising interest rates, it is very complex for a company to be able to perform better than the year former. The recession is now upon us and many companies are already warning their shareholders in advance that the short and medium term results will not be like those of the past. LVMH can be described as one of the few exceptions from a profitability point of view, with the first half of 2022 having achieved excellent results. Apparently, for consumers, a badly troubled macroeconomic environment is not so relevant, probably because those who buy these luxury goods have a strong financial situation.

Evolution of H1 2022 revenue

The analysis of LVMH’s first-half 2022 revenue will be done by starting from the general context and then going into detail.

Evolution of turnover

LVMH Q2 2022

In the first half of 2021, revenues were 28.66 billion euros, while in the first half of 2022 they reached 36.72 billion euros, approximately 8 billion euros more. There was a total growth of 28%, made up of 21% organic growth and 7% favorable exchange rate. LVMH being a European company, the strengthening of the dollar positively affected its profitability, as it made exports to the United States more advantageous.

Change in operating profit

LVMH Q2 2022

As for the operating result, it even increased more than the income. There was a year-over-year improvement of 34% compared to the first half of 2021, and the new operating margin was 27.80% (in the first half of 2021 it was 26.70%). LVMH not only grew in terms of turnover, but also improved its operational efficiency.

Free cash flow operations

LVMH Q2 2022

The only nuance of this H1 2022 concerns the operating free cash flow compared to that of the previous year. There is a deterioration of 1.25 billion euros, mainly due to the change in the working capital requirement. If we hadn’t considered this last element, LVMH would have obtained a better result here too.

Revenue by country

LVMH operates all over the world, so it is necessary to understand the changing revenue trends in different parts of the world.

Organic change in revenue by region

LVMH Q2 2022

From this image, the first thing that stands out is that the Asian segment is certainly the one that suffers the most. In major economies around the world, particularly in Europe, there was significant organic revenue growth. But why is growth in Asia lagging behind the rest of the world? The problem is always the same: Covid-19. China’s Covid-19 policies are among the strictest in the world, and even today many cities have to endure relatively long lockdowns even if only a handful of people are infected. As long as China is so tough on suppressing the virus, the Asian sector will be the most problematic for LVMH.

Geographic income

LVMH Q2 2022

Since in the first half of 2021 38% of LVMH’s revenues came from the Asian segment, this is undoubtedly a brake on growth. To date, the general growth of sales in other countries puts this on hold and makes LVMH less dependent on China. On the one hand, this can be good for encouraging diversification, but on the other hand, LVMH is focusing less and less on its most important geographic segment. To date, revenues continue to grow in the double digits, but in the face of a major recession in the West, the Asian segment likely could have mitigated the losses. Moreover, the Chinese middle class is rapidly increasing its wealth, which could have brought many benefits to a company like LVMH that sells luxury goods.

Turnover by sector

In this section, we will detail the revenue for the first half of 2022 by market segment. LVMH presents a very diversified activity which is not only based on the sale of the main Louis Vuitton brand.

Champagnes & Wines

Champagne and wines

LVMH Q2 2022

This operating segment includes the sale of champagne, wines and spirits under the Moët & Chandon, Dom Pérignon and Hennessy brands. H1 2021 revenue growth was 23% and operating margin improved by 0.50%. Considering this is a saturated market segment, organic growth of 14% is an excellent result.

Fashion & Leather Goods

Fashion and leather goods

LVMH Q2 2022

It is by far the largest market segment for LVMH in terms of revenue as it owns brands such as Louis Vuitton, Fendi, Celine, Christian Dior, Givenchy and Kenzo. Organic growth of 24% in H1 2021 further amplified LVMH’s already dominant position. Suffice it to say that Kering (OTCPK:PPRUF) (the main competitor) in the first half of 2022 achieved a total turnover of 9.93 billion euros, or almost half. And we don’t even consider LVMH’s other market segments. The gap was already overwhelming before, but over the past year it has widened even further.

Perfumes & Cosmetics

Perfumes and cosmetics

LVMH Q2 2022

The Perfumes & Cosmetics segment includes brands such as Christian Dior, Guerlain and Parfums Givenchy. This segment also achieved double-digit organic growth in H1 2022 compared to H1 2021, but saw a 2.3% contraction in its operating margin. Perfumes such as Sauvage, Miss Dior or L’Interdit remain successes on a global scale, but the cost incurred to produce them has increased, which is why the margin has contracted. Overall, the result can be considered positive, but not up to par with other segments.

Watches & Jewelry

Watches and Jewelry

LVMH Q2 2022

This segment includes brands such as Chaumet, Bulgari, Tag Heuer, Zenith and Tiffany. Again, the growth was double digit and in addition, the operating margin increased by 0.60%. Within jewelry, the Tiffany brand is among the most important and, again this year, it has boosted LVMH’s revenues. The style of her jewelry over the years has succeeded in influencing the entire industry: it represents the epitome of competitive advantage.

Selective distribution

This segment is the one that probably surprised the most and includes the sale of products through authorized retailers such as Le Bon Marché Rive Gauche, DFS, Sephora. Compared to H1 2021, there was organic growth of 22% and, above all, the operating margin more than doubled. The increase in Sephora stores in the United States, the gradual reopening of DFS in Australia and the Middle East, and the launch of the new Bon Marché digital platform contributed to this success.

Selective distribution

LVMH Q2 2022

Overall, there was no segment in difficulty, but at most we find segments that have progressed less than others. The distribution and fashion segments are the ones that, in terms of turnover, are the most valued and are also the ones that have performed best, which is why I consider this H1 2022 a success. I don’t expect this growth to be sustainable in the long term, but it certainly further strengthens LVMH’s position in the short term. Its competitive edge is in my opinion among the strongest ever, as it has brands that have been generating consistent and growing cash flow for decades. The quality and image of the products of this company are known all over the world and this is unlikely to change in the future.

How much is LVMH worth?

To understand what LVMH is worth, I will use a discounted cash flow. This model will be built as follows:

  • The cost of equity will be 8% and includes a beta of 0.97, a country market risk premium of 4.70%, a risk-free rate of 3.50% and additional risks of 0.50%. The after-tax cost of debt will be 4.32%.
  • The capital structure considered will be 15% debt and 85% equity, with a resulting WACC of 7.75%.
  • The source of net debt and outstanding equity is TIKR Terminal.
  • Expected growth will be calculated on 2021 free cash flow and will consider 7% through 2026 and 3.50% from 2026 to 2031. I wanted to include conservative growth rates as I expect in the long term, growth tends to stabilize. It is not reasonable to include a double digit growth rate within 10 years.

Discounted cash flow

Discounted cash flow

According to my assumptions, the fair value of LVMH is $610, so the stock is slightly overvalued. I tend to use a margin of safety before buying a company to limit valuation errors, and in this case if I was considering a 20%, I would have to buy that company at $488 per share. That’s quite a way off the current price, but still doesn’t make me think about selling this business. I wouldn’t sell a company with a clear competitive advantage and huge cash flow just because it’s slightly overvalued. We must rule out the fact that to be a shareholder of LVMH there could be an additional premium to pay because it is one of the best European companies. Personally, I would think of buying an initial position around $550, so at the current price, I consider that a take.

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