Transactional Advice Letter (KER) 2022/11/25

Transactional Advice Letter (KER) 2022/11/25

Kering (KER)

On the 11th of November we added Kering (KER:XPAR) to our Global Equity Portfolio at an average price of €550 per share. Kering is the holding company for some of the biggest luxury brands in the world. Their Fashion and Leather Goods Houses include Gucci, Saint Laurent, Bottega Veneta, Balenciaga, Alexander McQueen and Brioni which are renowned worldwide for their exceptional craftsmanship, distinctive creativity and character. The House’s Jewellery brands include the likes of Boucheron, Pomellato, DoDo and Qeelin. They also own a subsidiary, Kering Eyewear, which has grown exponentially due to their extraordinary portfolio of 15 luxury and lifestyle brands.

When one looks under the hood of the Kering group, one of the most striking characteristics is the variety of luxury brands it holds. Throughout the years Kering has developed a business model strategy of aggregating several brands under the same corporate umbrella while uniquely managing each of those brands based on their products and target market. This allows the company to be diversified, while at the same time guaranteeing the operations to be agile via the separately managed brands. This allows the firm to take advantage of synergies between brands and make use of economies of scale. Additionally, a critical aspect is Kering’s vertical integration which they used to strengthen its upstream positioning in the luxury goods market. By taking control of multiple stages in the production and distribution process they are able to reduce costs and expand geographically at a faster rate.

In the past 12 months Kering’s revenue has grown by 23% and their earnings before interest and taxes have grown by 54% largely due to the high popularity associated with their Fashion Brands. When compared to their biggest competitor LVMH, they are more profitable. Kering has a gross profit margin of 74,27% an operating profit margin of 28,68% and a net profit margin of 18,87%. LVMH has lower profitability with a gross profit margin of 68,64%, an operating profit margin of 27,27% and a net profit margin of 18,36%. Additionally, they are in a better position to manage their short- and long-term obligations with liquidity and solvency ratios that trumps LVMH’s. Despite impressive financials and a massive uptick in performance in the past 12 months Kering stock still trades at a 30% discount to its all-time high of €794 which was reached on 13 August 2021.

Concurrently, China which is a big contributor to Kering’s revenue has been battling Covid lockdowns which has suppressed a lot of growth for the country as a whole. As a result this drawdown in economic growth has translated into less revenue from this region. Despite the Covid situation in China still being a problem for the country we believe that once these lockdowns and restrictions ease will see massive tailwinds for the luxury sector as well as other consumer discretionaries. This will further improve Kering’s profitability over the next 12 month period as growth in China resumes recovers to more normal levels.

Despite Gucci being the biggest contributor to revenue and earnings at 50% and 71% respectively, Kering has proven their ability to transfer successful strategies from one brand to another. This is particularly evident with the increased growth we have seen in Kering’s smaller brands such as Yves Saint Laurent and Bottega Veneta which outpaced Gucci over the past 12-month period. We believe this to be a positive progression as the company becomes more diversified and less dependent on a single brand for growth. Yves Saint Laurent and Bottega Veneta has shown a 40% and 20% increase in revenue over the previous 12-month period while Gucci has grown at 18%.

Most of the manufacturing for Kering’s products across its brands takes place in Italy, due to the fact that Gucci produces all its products in Italy. Kering’s revenue breakdown is quite diverse with 26% of revenue coming from North America, 29% Western Europe, 33% Asia Pacific, 6% Japan and 6% coming from the rest of the world. By far, over a 3-year time period, the fastest growing geographical region is North America with an increase in revenue of 85%, the rest of the world at 67% and the Asian Pacific at 28%.

A fast-growing segment under the Kering Group is Kering Eyewear. Founded in 2014, Kering Eyewear has grown to be the second biggest eyewear firm in the world with their focus being on designing developing and distributing eyewear for a complete and well-balanced portfolio of 17 brands, which includes the Houses brands Gucci, Cartier, Saint Laurent, Bottega Veneta, Balenciaga, Chloé, Alexander McQueen, Montblanc, Brioni, Dunhill, Boucheron, Pomellato, Alaïa, MCQ and Puma. Most recently the segment also purchased Maui Jim, recognized for its outstanding lens technology and distinctive Hawaiian heritage. Eyewear serves as an important entry product where younger customers get their first experience of a brand and hopefully develop a taste for more therefore being a real money spinner for luxury brands. This segment was founded with the aim of Kering terminating its licence agreements with the firms that were producing the eyewear for its brands and to rather take over production completely. By producing eyewear in-house instead of licencing out the business to other firms, Kering has greatly increased revenue and its bottom line with Kering Eyewear being their fastest growing segment at a 47% growth rate year-on-year.

Consequently, we believe that Kering has a strong growth trajectory for the near future. We have a target exit price of €700 which would result in a return of 27% from our entry price of €550. With its stock currently trading at a large discount to its fair value we believe that its addition to our Global Equity Portfolio will be lucrative in the short to medium term.

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