CFRUY - Richemont

[Jurgis]

May be you can clarify what specifically you don't like

 

Don't like jewelry, don't like fashion 2x, don't like watches 10x.

 

It's just me, don't pay attention. :)

 

 

[rishig]

May be you can clarify what specifically you don't like

 

Don't like jewelry, don't like fashion 2x, don't like watches 10x.

 

It's just me, don't pay attention. :)

 

That's fine, but just want to clarify that luxury is anything but fashion. I didn't understand this until I talked to people who buy Cartier products (which I did when I started learning about Richemont). These are two different concepts that are easily confused, but they are really quite opposing in reality.

 

Being fashionable is a transient and fragile state that needs to be continually revisited and reimagined. On the other hand, luxury is anything but fashion. The goal in luxury is not to have a bestseller but to have a long-term seller. The Cartier Tank watches have been selling since 1917.  Patrick Thomas, former CEO of Hermes used to say: "When a product sells too much, we discontinue it immediately".

 

The business model of fashion is to make as much money as possible at the start of the season before the item goes out of fashion. As a result, to increase gross margins, everything that costs too much is not used. Production of fashion typically happens in low-wage countries. Fashion model and luxury models are opposing. It may be fashionable to wear luxury, but the demise of a luxury brand equity starts when they start behaving like a fashion brand - using cheap ingredients, moving production away, replacing hand made processes, lowering quality, and losing its identity by trying to be "fashionable". Look through Cartier's history and you will see that it has stayed true to its image.

 

It's fine if you don't like jewelry or luxury watches. I wouldn't spend (or have) the money to spend on luxury. But that doesn't mean it's not a good business that isn't sustainable. There is a reason why Cartier has been deeply ingrained in the minds of those who buy these high priced and unique products for over a century. And it is definitely not because they are "in fashion". Ask Michelle Obama who wears a Cartier Tank (I can bet you it isn't because Cartier is in fashion) - http://www.luxuo.com/celebrities/michelle-obama-wears-a-cartier-watch.html

[Jurgis]

That's fine, but just want to clarify that luxury is anything but fashion.

 

Hmm, maybe I should have said "clothing". :)

 

Richemont has a bunch of clothing brands: Peter Millar, Shanghai Tang, Alaia, Chloe, Alfred Dunhill, Lancel.

 

I may agree with your distinction of luxury and fashion in jewelry and watches.

 

I am not sure I agree with you when we talk about clothing.

 

Although, yeah, I am aware about the haute couture, etc. I don't track the latest trends, especially per country to say whether Richemont clothing labels are "timeless" or fashion wavy.

 

It's fine if you don't like jewelry or luxury watches. I wouldn't spend (or have) the money to spend on luxury. But that doesn't mean it's not a good business that isn't sustainable.

 

I did not say or imply it was a bad business. I said that I don't like it and that it's just me... don't pay attention. :)

[Jurgis]

Rishig,

 

I slept on it and after that I decided that I disagree with you more than I did yesterday. Sorry. :)

 

I think that luxury is subject to fashion. I don't think there is such thing as timeless luxury, although surely if there was something like that I'd say it's high art (Monet, Rembrandt, Da Vinci, Renoir, etc.).

 

Especially, I don't think luxury clothes and luxury watches are timeless irrespective that Michelle Obama or even Her Majesty the Queen wears them. There is a fashion change through generations and things may or may not remain attractive purchases in 10 - 20 years time frame.

 

Sure this fashion changes way slower perhaps than your teen beach apparel. ;) But it's still trendy somewhat and fashion driven somewhat.

 

Not that my opinion change matters. With all the thoughts above, I still don't imply that Richemont is a bad business. So don't pay attention. ;)

[rishig]

Rishig,

 

I slept on it and after that I decided that I disagree with you more than I did yesterday. Sorry. :)

 

I think that luxury is subject to fashion. I don't think there is such thing as timeless luxury, although surely if there was something like that I'd say it's high art (Monet, Rembrandt, Da Vinci, Renoir, etc.).

 

Especially, I don't think luxury clothes and luxury watches are timeless irrespective that Michelle Obama or even Her Majesty the Queen wears them. There is a fashion change through generations and things may or may not remain attractive purchases in 10 - 20 years time frame.

 

Sure this fashion changes way slower perhaps than your teen beach apparel. ;) But it's still trendy somewhat and fashion driven somewhat.

 

Not that my opinion change matters. With all the thoughts above, I still don't imply that Richemont is a bad business. So don't pay attention. ;)

 

My comments of luxury as timeless as opposed to fashion were directed towards Richemont's Jewelry Maisons and Specialist Watchmaker Maisons. It does not apply to the "Other" segment which consists of clothing and leather goods, which contributes a grand total of 0 towards profit.

 

You may disagree (and I will stop arguing after this) but past evidence has shown that Cartier Jewelry and Watches and Van Cleef & Arpels Jewelry (both together contribute 75% of profit) have thrived over time, and it is not because of a fashion or trend. The Specialist Watchmakers (which contribute 25% of the profit) have thrived for more than a century for the same reason. Constantin Vacheron is the oldest swiss watchmaker in the world, more than 250 years old. Fashion has changed many many times in the past, yet these have not been affected. Again, it is because these are not viewed as objects of fashion.

 

You are suggesting that art is timeless but Cartier luxury isn't. I disagree wholeheartedly based on evidence I have seen. Museums worldwide display Cartier because they view it as timeless.

(subtitles in English)

(Search YouTube for Cartier Museums for other videos)

 

I would love to see disconfirming evidence if we can find it and I am open to changing my mind when I see the evidence. If we can find evidence that shows me that Cartier has been subject to whims of fashion in the past or will be in the future, that would totally kill my thesis on pricing power like See's in the long-term and I would sell. Otherwise, I understand you are just going with what you feel in your gut and let's agree to disagree.

[Guest neiljgsingh]

Rishig,

 

I slept on it and after that I decided that I disagree with you more than I did yesterday. Sorry. :)

 

I think that luxury is subject to fashion. I don't think there is such thing as timeless luxury, although surely if there was something like that I'd say it's high art (Monet, Rembrandt, Da Vinci, Renoir, etc.).

 

Especially, I don't think luxury clothes and luxury watches are timeless irrespective that Michelle Obama or even Her Majesty the Queen wears them. There is a fashion change through generations and things may or may not remain attractive purchases in 10 - 20 years time frame.

 

Sure this fashion changes way slower perhaps than your teen beach apparel. ;) But it's still trendy somewhat and fashion driven somewhat.

 

Not that my opinion change matters. With all the thoughts above, I still don't imply that Richemont is a bad business. So don't pay attention. ;)

 

Jurgis,

 

Doubt I can change your mind at this point, but the link that Rishi shared actually answers your question for you---below the picture of Michelle Obama wearing the Cartier Tank is Jackie Kennedy in 1969 sporting the same watch. Yes, the fashion changed (Obama's is bigger as larger dials have become more popular with women, and the design was probably changed to reflect that), but both watches were well-received not for their fashion but because they were Cartier watches. I think this illustrates Cartier is not a trend, which is also supported by a ton of other evidence. See a Sotheby's special on Cartier here and look at the years of the products they're fawning over: http://www.sothebys.com/en/news-video/slideshows/2016/cartier-20th-century-design-drawings-sketches.html#. I saw another Sotheby's page with Cartier handmade jewelry going for literally millions.

 

Now, with some of Richemont's other brands, I can understand having some concern over building long-term brand equity. Chloé, for example, is largely a purse company that I hear is not what it was even a few years ago. But the fortunate part is that Cartier and Van Cleef make up 75% of the revenue, and these two have stood the test of time.

[rishig]

Rishig,

 

I slept on it and after that I decided that I disagree with you more than I did yesterday. Sorry. :)

 

I think that luxury is subject to fashion. I don't think there is such thing as timeless luxury, although surely if there was something like that I'd say it's high art (Monet, Rembrandt, Da Vinci, Renoir, etc.).

 

Especially, I don't think luxury clothes and luxury watches are timeless irrespective that Michelle Obama or even Her Majesty the Queen wears them. There is a fashion change through generations and things may or may not remain attractive purchases in 10 - 20 years time frame.

 

Sure this fashion changes way slower perhaps than your teen beach apparel. ;) But it's still trendy somewhat and fashion driven somewhat.

 

Not that my opinion change matters. With all the thoughts above, I still don't imply that Richemont is a bad business. So don't pay attention. ;)

 

Jurgis,

 

Doubt I can change your mind at this point, but the link that Rishi shared actually answers your question for you---below the picture of Michelle Obama wearing the Cartier Tank is Jackie Kennedy in 1969 sporting the same watch. Yes, the fashion changed (Obama's is bigger as larger dials have become more popular with women, and the design was probably changed to reflect that), but both watches were well-received not for their fashion but because they were Cartier watches. I think this illustrates Cartier is not a trend, which is also supported by a ton of other evidence. See a Sotheby's special on Cartier here and look at the years of the products they're fawning over: http://www.sothebys.com/en/news-video/slideshows/2016/cartier-20th-century-design-drawings-sketches.html#. I saw another Sotheby's page with Cartier handmade jewelry going for literally millions.

 

Now, with some of Richemont's other brands, I can understand having some concern over building long-term brand equity. Chloé, for example, is largely a purse company that I hear is not what it was even a few years ago. But the fortunate part is that Cartier and Van Cleef make up 75% of the revenue, and these two have stood the test of time.

 

I have looked at individual Swiss Watchmaker brands that Richemont owns. I spoke to someone who collects luxury Swiss watches and he was telling me why people buy Patek Phillipe (not owned by Richemont) and Constantin Vacheron watches. My conclusion was the same - this is not a fashion or a trend thing.

 

I put a value of 0 on the "Other" segment. Chloe, Lancel, Peter Millar ..

[thefatbaboon]

Jurgis, I understand why you are skeptical but I agree with the others: there Is a distinction between fashion and super luxury.  In addition to what the others have said, do some research on the following:

 

Rolex submariner. Birthday 16 year old rich kid.

Rolex gold day date. American exec.

Van clef Alhambra. 

Hermes birkin

 

These are badges. Or currency.  That is why the quantum of production is so important. Not fashions or cool or whatever. Of course if mismanaged they can die, but they won't die as a passing fad. They can die if they become manifestly cheap or if over produced. Sort of like if we found that we could make diamonds by smushing two m&ms together.

 

Where there is a question is around the edges: like cartier love bracelets or juste un clou. These probably have meaningful fashion components. Also as others have pointed out. It's important to be confident about a conservative underlying sales rate and adjust sufficiently if there is anomalous overbuying in China.

 

 

[topofeaturellc]

Right. It seems like they own enduring brands. I just wonder what the enduring volume is of those brands.  That's really the controversy.

 

And I don't see OP attempting to address that.

[rishig]

Right. It seems like they own enduring brands. I just wonder what the enduring volume is of those brands.  That's really the controversy.

 

And I don't see OP attempting to address that.

 

I would rather that the enduring volume of these brands is low. Part of the appeal of luxury brands comes from its exclusivity. If I saw Ferraris on the road every 10 minutes, the luxury brand has lost its value. That's why Ferrari caps its production to less than 10,000 vehicles a year. Also, that gives it pricing power.

 

Same thing applies here in my opinion. In the long-term, if Cartier and Van Cleef & Arpels are cared for, the luxury brands should grow by pricing power and very modest (1%-2%) volume growth. In the short run, we have issues that some of the growth may retract, but I think that is a very good thing. Mr. Market is focusing on these issues, while someone who really understands the value of these brands have the opportunity to start building a position.

 

In the long-run, you just have to figure out, what is the fair value of a high ROIC business that grows at 5%-7% (in my presentation). See's did 7% growth over 35 years and produced $1.5B in free cash in aggregate on tangible assets of $80M. Buffett paid 12x EV/NOPAT for this at $25M. Richemont is trading at 15x EV/NOPAT with a fortress balance sheet and NOPAT has been stable for last 3 years despite China slowdown, crackdown in corruption and other issues. 

 

I have a small position here. I don't think their short-term issues will be solved in a quarter or two. I will build the position as long as the pain continues.

[topofeaturellc]

I think you miss the point. What if the cagr ex-china, ex-china derivatives was half that number?

[topofeaturellc]

Look at your slide 12. I could easily argue sustainable revenues are like 7. Coukd also argue normal margins are a few hundred bps lower than today.

 

Im not sure roic is mean reverting here either.  Margin probably is, but the super high returns are a function of the brands, but nearly all of marginal ic is in the boutiques which almsot mathematically have to be lower retun

[rishig]

Look at your slide 12. I could easily argue sustainable revenues are like 7. Coukd also argue normal margins are a few hundred bps lower than today.

 

Im not sure roic is mean reverting here either.  Margin probably is, but the super high returns are a function of the brands, but nearly all of marginal ic is in the boutiques which almsot mathematically have to be lower retun

 

I absolutely get what you are saying. Your argument is valid and that's what Mr. Market is also focused on. Do I have any special insight on how much revenue or margins will fall? No. Very likely we are at cyclical peak for luxury good companies in the short term. Hence it is a small position. But I think Mr. Market is focused on the wrong thing if one is a long-term investor.

 

Having said that, if the pain continues, I am happy to add more as long as the brand is intact. Revenues (due to pricing power and modest volume growth) five and ten years from now will likely be way higher and as the stock drops to say 10x recent earnings, peak earnings probably, I think it would be cheap given its balance sheet and brands.

 

Here are a few quotes from Rupert (from '15 transcript):

 

"We’ve seen this before on a number of occasions, so yes, we have problems in China. Everybody’s got problems in China. How long it’s going to last, I don’t know."

 

"So we’ve seen it before. I’ve been in it with Cartier since 1975, so I’ve seen it before. Our goal is to keep the brand equity [..] and the loyalty of our customers"

 

"So we are fortunate that we have Maisons and products that transcend boundaries and cultures, and that have the brand equity in various countries."

 

"This is a medium to long-term business, and it’s still a great business, because the moats around it, the barriers to entry are so enormous. So, I’m not going to mention the name, but on Sunday I had a meeting and a lunch with somebody that you’ll all know. He’s in the tech business, one of the biggest, really big, and he was saying, ‘Jeez, if I’d only been in the luxury goods business.’ He  says, ‘I never sleep. Every week, every day I read about a new product coming out, and our CAPEX, what we’ve got to spend just to stay ahead, every week, every month. If we slack a year, our business is gone,’ so you know, there are not too many businesses that have got the dynamics.."

 

"Not to extrapolate too much from going to one region. Those people are shopping in Paris today, and by the way, in Dubai again. Dubai was flyover country. They’d land there and keep their money, mostly, their credit cards in their pocket, come to Europe, buy, go home. Suddenly, with a slight adjustment, Dubai Mall is full again. The people are smart, so the same people that don’t buy in Hong Kong are buying in Europe.

 

" What would worry the heck out of me is if the Chinese had to say, ‘Cartier’s not cool,’ or, ‘Van Cleef’s not cool.’ Then I’d be worried, really worried, the brand equity, but I wouldn’t be overly concerned."

 

"You know, we’re always very focused on having all of our stores be profitable. The good news is that we only closed seventeen stores, didn’t cost us anything."

 

"China will continue to grow. They’re highly sophisticated. We already have to take big signs off. It’s discretion. So within the consumption patterns, there’ll be more discretion, less over bling. It’s a very, very quick moving society. Will we have a good market there? Yes. We see it with the travellers. I like the demographics of too few women and too many men. You know, the demographics, the guys are going to have buy more presents, it’s as simple as that. So I’m happy about China."

 

"I’ll take the rap if we do things that may seem irrational. If we maintain advertising spend when the turnover goes down, you’re going to think we’re lunatics, until I explain to you that in two or three years’ time, people are going to remember. I’ll give you one thought. The year before they banned alcohol advertising in France, and I’m not going to mention the name, there was one company, a Scotch whiskey company, that spent like blazes. Everybody remembers that whiskey today. They quadrupled their budget. They said, ‘We don’t have spend for the next three years. Let us now make sure that the last thing that people remember is us,’ and you can see what happened to their sales after that. Now, I don’t know who the guy is who made that decision, but chapeau. He had brains, but he probably had somebody who supported him at the head office."

[rishig]

I think you miss the point. What if the cagr ex-china, ex-china derivatives was half that number?

 

On one of the slides, I have revenue growth data for the last 20 years. Here is rolling 5/10/15 year CAGR during this time. I don't assume anything heroic in my fair value assumptions if you look at the data below:

https://goo.gl/photos/rAtYPr5cxsEPFRfr5

 

Is there a reason to think that any kind of pricing and modest volume growth is permanently impaired in the long-term in China/HK?

 

Thomas Russo at Value Investor Conference in 2011 said the following:

"I met with Johann Rupert who runs Richemont (NYSE:CFR) in June of 08 when I was on that safari trip – he’s based in South Africa – and we were talking about Richemont, he said, the beauty of Richemont is we don’t have to make investments anywhere, we can just make them where the best returns arise. And he said, for example, then he was putting absolutely no more money into Japan, which had been 15% of their profits, because it was so badly ex growth, with the declining population, no immigration, problem economy. And it’s a beautiful response because he as a multinational, global franchise can put the money just where it has its highest prospective returns. He’s pouring money into China now. But sometime the returns in our lifetime may even go down in China. I’m not sure it will ever happen. It’s a big country and it’s a growing prosperity one. But the beauty for Richemont is that they can move the money all around."

 

 

[ZenaidaMacroura]

Actually don't take my word for it.... ask Mr. Cartier himself.

 

http://www.bloomberg.com/news/articles/2015-06-08/billionaire-cartier-owner-sees-wealth-gap-fueling-social-unrest

 

 

The article is a summary of his talk here (which I highly recommend):

 

Not a bad talk, but you may have posted a link to the wrong talk. The talk is from 2010 and I don't think it's related to 2015 Bloomberg article. :)

 

Oops sorry. Here's the 2015 one:

 

The part about "Cartier never being thrown away" and that they once considered a mobile device is interesting to me.  It's sort of a tangent but I see a lot of luxury brands making forays into tablet/phone cases.  I've seen Coach and other lower tier brands do it (which isn't surprising) but I've also seen Hermes, LVMH do it (which is very surprising given the Cartier throwaway litmus test).

 

If phones and tablets are not enduring due to technological obsolscence then neither is their form factor?  So why put the LV Monogram on phone cases that will be collecting dust when the underlying device is shelved?  Or use superior leathers in Hermes' case?  Is it a profit grab for the folks who are already decked-out in the brand and want to have a 'cohesive' look?  It's probably not material to the thesis at all with regards to Richemont but I found it interesting... 

 

 

[topofeaturellc]

All of those things he says are true, except that a very meaningful slug of his China sales don't represent real demand. There is also the capital they spent on stores that may be out of the money.

 

Once you deal with that everything else you say is correct.

 

I'm not Mr. Market.  I am quite seriously a contrarian deep value guy and I think this is an interesting idea.  The problem is your see's mental model is wrong. 

[rishig]

All of those things he says are true, except that a very meaningful slug of his China sales don't represent real demand. There is also the capital they spent on stores that may be out of the money.

 

Once you deal with that everything else you say is correct.

 

I'm not Mr. Market.  I am quite seriously a contrarian deep value guy and I think this is an interesting idea.  The problem is your see's mental model is wrong.

 

This is year three since crackdown in corruption in China. It is a well known fact that luxury watch sales spike up when China is going through a transition in leadership. See http://cn.ckgsb.com/userfiles/doc/lan_watch_jmp1.pdf

 

If you look at data from Federation of Swiss Watch Industry, the exports for luxury watches in 3000+ CHF category has started to stabilize. http://www.fhs.ch/file/59/comm_160202_a.pdf

 

Lastly, I don't read too much into geographical sales, as long as overall sales are stabilizing. Rupert in 2008 said "Europe, .., those sales include travelers. So, don’t stare yourselves blind at the geographic split." Besides, the watch business is 25% of the profit, jewelry is 75% of the profit.

 

On your point about they are out of the money on the capex they spent in China / HK, again here is a snippet from Rupert on this topic:

 

"Rest assured we will err on the side of caution in terms of assuming further fixed costs. The key is to try and change as much fixed costs into variable costs. So if we do leases the goal will always be to share with the landlord. Yes, if we do incredibly well, give them their share, but the turnover clauses, where it can be negotiated, are preferable to lower fixed, with the potential downside. And Norbert and Richard and I are identical on this. We obviously face constant demands from the heads of the Maisons because everybody would like to have their own store on every major street in every major capital in the world. And when things go well, obviously the three of us are wrong, when things go well. When things go badly, the shareholders suffer. So I think we act as a bit of a shock absorber. And believe me, half of that proves what my poor CEO’s got to face. These phone calls from, I mean, everybody wants a store on every major street in every major city in the world and they have rational reasons why they’ll make money and we agree they’ll all make money. However, when things go wrong, the landlords still make money and we don’t."

 

On your comment that China / HK sales are never coming back, I encourage you to talk to people who live in HK and Japan or read the book "Cult of the Luxury Brand: Inside's Asia Love Affair with Luxury" by Radha Chadha.

 

On your comment on my mental model of See's is wrong - I am assuming you mean that Cartier doesn't really have pricing power. It has just grown because of a fad in China / HK. I disagree. Quoting Rupert again:

 

"To grow 15% dividends and earnings, you need to have a sustainable competitive advantage and the only way that we know how to maintain a sustainable competitive advantage is to grow the brand equity of the various Maisons, because that brand equity will give you, will create demand and will result in pricing power."

 

On whether I could be wrong in the short-term. I totally could be. The stock may go down due to more pain. Is the long-term value of the business impaired. I don't think so. I would buy more if this were to go down by 50% i.e. EV/EBIT of 5x, where EBIT is possibly peak in his cycle.

 

On your point that you are a contrarian deep value guy, thanks for challenging the thesis. I am looking for ways my thesis could be broken. If you have evidence that shows that the above points I make are incorrect in the *long-term* I would love to know.

 

I am not a bottom fisher. I don't know where the bottom of any stock is. I just protect against more pain in the short-term by buying small positions and then growing it as the valuation gets cheaper. At current valuation, this is a small position. I like Rupert as a partner. Here is one final quote:

 

"We will maintain enough liquidity and fire power inside Richemont to make sure that if things go badly, and real opportunities present themselves within the Luxury Goods sector, that we do have the fire power to act immediately. Unfortunately, life is like that, that when you really need fire power, the banks are not there and the funds are gone. When you don’t need money you have an avalanche of cash coming your way. So, we will be cautious."

[Guest Schwab711]

On your comment on my mental model of See's is wrong - I am assuming you mean that Cartier doesn't really have pricing power. It has just grown because of a fad in China / HK. I disagree.

 

I think the See's mental model is wrong because See's had untapped pricing power while Cartier is very aware of the value of their brand. This could still be an excellent investment opportunity even though it doesn't resemble See's.

 

 

This is year three since crackdown in corruption in China. It is a well known fact that luxury watch sales spike up when China is going through a transition in leadership. See http://cn.ckgsb.com/userfiles/doc/lan_watch_jmp1.pdf

 

Awesome research, very interesting.

[topofeaturellc]

The reason why Rupert is saying don't look at geography is because the China impact is everywhere.  Let me give you my favorite example - look at the pounds wagered at UK Casinos in Bacarrat over the the last five years. Huge run up, now a collapse - why - chinese players playing bacarrat in non-destination casinos there.

 

Schwab has 1 part of why I think the See's mental model is off, the second part is that when buffett bought those kinds of businesses they weren't massively overearning the way Richemont might have overearned over the last five years.

 

Rupert can say what ever he wants. The fact is that the tangible capital in his business has actually grown faster than sales over the last five years.  Given his manufacturing ops shouldn't really require that kind of incremental capital the lions share of that must be relatied to the boutiques. You can also see it in his rental expense line - which was flat for decade and has basically doubled in the last five years.

 

That paper you cite is actually making my case that a larger proportion of sales than you think will be linked to corruption and capital flight. At some point that will end.

 

Again - I have absolutely no question about the value of the true luxe brands they have. I'm not questioning that AT ALL.  It should be a very high return on capital business that requires little investment to grow the top line and throws off lots of cash and should have a valuation that reflects that. 

 

What may be incorrect about your thesis in the long-term is that the base that business will sustainably grow off of is much smaller than you think it is. Whether that is an EBIT number or an IC number. Real normalized values for those numbers may be much lower than today. Because not only have you had a massive amount of topline that may be going away, but also you've gotten 1000 bps of margin expansion over the last ten years - in a business that shouldn't have much operating leverage and has shown basically flat gross margins.

 

I mean maybe 8 billion top line growing at five% with 20% operating margins for the next five-ten years years gets you to a cash flow numbers in 2021 or 2026 that on the multiple you think its worth, makes it an attractive investment. But that's for you to decide.

 

I only said that about being a deeo value guy because you were basically saying my concerns were all short term in nature. 

 

Again - I think this is an interesting idea.  I just think maybe its not cheap enough for me yet.  I'm also quite content with it never getting cheap enough for me.

[rishig]

The reason why Rupert is saying don't look at geography is because the China impact is everywhere.  Let me give you my favorite example - look at the pounds wagered at UK Casinos in Bacarrat over the the last five years. Huge run up, now a collapse - why - chinese players playing bacarrat in non-destination casinos there.

 

Schwab has 1 part of why I think the See's mental model is off, the second part is that when buffett bought those kinds of businesses they weren't massively overearning the way Richemont might have overearned over the last five years.

 

Rupert can say what ever he wants. The fact is that the tangible capital in his business has actually grown faster than sales over the last five years.  Given his manufacturing ops shouldn't really require that kind of incremental capital the lions share of that must be relatied to the boutiques. You can also see it in his rental expense line - which was flat for decade and has basically doubled in the last five years.

 

That paper you cite is actually making my case that a larger proportion of sales than you think will be linked to corruption and capital flight. At some point that will end.

 

Again - I have absolutely no question about the value of the true luxe brands they have. I'm not questioning that AT ALL.  It should be a very high return on capital business that requires little investment to grow the top line and throws off lots of cash and should have a valuation that reflects that. 

 

What may be incorrect about your thesis in the long-term is that the base that business will sustainably grow off of is much smaller than you think it is. Whether that is an EBIT number or an IC number. Real normalized values for those numbers may be much lower than today. Because not only have you had a massive amount of topline that may be going away, but also you've gotten 1000 bps of margin expansion over the last ten years - in a business that shouldn't have much operating leverage and has shown basically flat gross margins.

 

I mean maybe 8 billion top line growing at five% with 20% operating margins for the next five-ten years years gets you to a cash flow numbers in 2021 or 2026 that on the multiple you think its worth, makes it an attractive investment. But that's for you to decide.

 

I only said that about being a deeo value guy because you were basically saying my concerns were all short term in nature. 

 

Again - I think this is an interesting idea.  I just think maybe its not cheap enough for me yet.  I'm also quite content with it never getting cheap enough for me.

 

If I were to believe what the paper suggests, then the spike in sales was due to corruption. Well, this is year three in corruption crackdown. Yet the current base will be 20% lower after three years in crackdown?

[topofeaturellc]

There is corruption related to bribery and then there is corruption related to capital flight. And you have a lot less capital to flee in an economic downturn.

[rishig]

There is corruption related to bribery and then there is corruption related to capital flight. And you have a lot less capital to flee in an economic downturn.

 

All of the operating leverage has come from Jewelry Maisons, Cartier and Van Cleef. Operating margins at Specialist Watchmakers has been flat.

 

As of Sept 15, number of boutiques for Jewelry Maisons are shown below:

       

	Total	Internal	External
Cartier	284	200	84
Van Cleef & Arpels	109	73	36

 

In 2010, number of boutiques for the two are shown below:

	Total	Internal	External
Cartier	283	171	112
Van Cleef & Arpels	79	49	30

 

In 2010, operating margin for Jewelry Maisons was 27%. Today, it is at 35%. Despite three years of China crackdown, Jewelry Maisons has continued to perform well. Most of the boutique expansion has been in Van Cleef. Van Cleef mostly makes of its profit from jewelry. My family is in the jewelry business. I asked my brother who lives in Dubai if he has seen an oversupply of jewelry competitors for Cartier and Van Cleef. He laughed on me.

 

On your comment on tangible capital invested has grown, I encourage you to dig deeper. A large part of fixed capital investments have gone into manufacturing. They have been vertically integrating their Maisons. This is super important for the long-term brand equity. Rupert often says: "You cannot build Ferraris in Fiat factories."

 

So, my point being that taking a 20% lower base to grow off from for the Jewelry Maisons seems quite drastic. Is it possible? Sure. It didn't happen in 2009 when world was coming to an end. Were the Jewelry Maisons driven up by corruption. Could be. But three years later, it continues to hold ground on profitability. Having said that, I hear you. The next global recession could be a lot worse. The base may be 20-30-40% lower. I don't know that. I am willing to take my chances with my tiny position. It keeps me informed.

 

Also, you are completely ignoring the possibility that if there is indeed a 20-30% reduction in base then it isn't just Richemont specific but all luxury good companies will be affected. With Richemont's fortress balance sheet, they can make some really good acquisitions at a decent price. Rupert has avoided doing all kinds of crazy things when the industry was (is) booming by acquiring companies at a high price. He is disciplined and I think they will make a Van Cleef type acquisition if things go sound industry wide. I am going to add a few quotes related to M&A:

 

"Our single most profitable venture is probably Panerai, where we paid less than $1m, we found 43 [war] Rolex movements,

which we cleaned and oiled and we put into platinum watches that we sold for more than the purchase price."

 

"Van Cleef would be a good example of how our business model works where -- actually it was a Mr. Corrado Fratini of Italy who put the Company together, we had had an interest, I then bought the Company from him over the phone. Eloy was with him but we shook hands over the phone, and one of our large competitors based in Paris, offered him 25% more than what we'd agreed upon over the phone without asking what we'd agreed upon. And Mr. Fratini said sorry, I'm a gentleman, I've agreed. And that's how we got Van Cleef & Arpels and that's more than a decade ago. But slowly doing all the right things, pulling the licenses back, getting the leases, getting the products, going into the archives, getting the artisans back.Today it is a very profitable company, but I remember coming year after year and not only you folks but colleagues of mine at the Board level, say so when exactly are we going to make money? You remember how often. I said when we're ready for it to make money, Board members. Alan, you remember how many years? Finally I took it off the Board table, I said it will make money and we'll let you know. Today it is a very precious part of our Group."

 

"They all think they're worth 20 times what they are, okay. I get two a week, household names, but a lot of these were bought by financial institutions who are now wishing to exit and they came in the other way around. I went into Italy and actually spoke to the supplier, five, six years ago, and I looked at it from the supplier up and I did and this one very big acquisition I got to realistic price being 40%, four zero percent, of the eventual price."

 

"I think every manager's goal really is to make a company idiot-proof because sooner or later an idiot will run the company, you've got to know that okay, it doesn't matter what company in the world. So if you had like Mr. Buffett said, you build moats, you build brand equity, you can withstand quite a lot of stupid things that we ourselves do. I'm not worried that somebody who is in another luxury goods company is going to think of something and that's going to kill our business."

[topofeaturellc]

If they are vertically integrating why is GM flat?

[topofeaturellc]

And I agree with you that the quality of the balance sheet could allow them to make some great deals if the market blows up.

[DanielGMask]

All of those things he says are true, except that a very meaningful slug of his China sales don't represent real demand. There is also the capital they spent on stores that may be out of the money.

 

Once you deal with that everything else you say is correct.

 

I'm not Mr. Market.  I am quite seriously a contrarian deep value guy and I think this is an interesting idea.  The problem is your see's mental model is wrong.

 

This is year three since crackdown in corruption in China. It is a well known fact that luxury watch sales spike up when China is going through a transition in leadership. See http://cn.ckgsb.com/userfiles/doc/lan_watch_jmp1.pdf

 

If you look at data from Federation of Swiss Watch Industry, the exports for luxury watches in 3000+ CHF category has started to stabilize. http://www.fhs.ch/file/59/comm_160202_a.pdf

 

Lastly, I don't read too much into geographical sales, as long as overall sales are stabilizing. Rupert in 2008 said "Europe, .., those sales include travelers. So, don’t stare yourselves blind at the geographic split." Besides, the watch business is 25% of the profit, jewelry is 75% of the profit.

 

On your point about they are out of the money on the capex they spent in China / HK, again here is a snippet from Rupert on this topic:

 

"Rest assured we will err on the side of caution in terms of assuming further fixed costs. The key is to try and change as much fixed costs into variable costs. So if we do leases the goal will always be to share with the landlord. Yes, if we do incredibly well, give them their share, but the turnover clauses, where it can be negotiated, are preferable to lower fixed, with the potential downside. And Norbert and Richard and I are identical on this. We obviously face constant demands from the heads of the Maisons because everybody would like to have their own store on every major street in every major capital in the world. And when things go well, obviously the three of us are wrong, when things go well. When things go badly, the shareholders suffer. So I think we act as a bit of a shock absorber. And believe me, half of that proves what my poor CEO’s got to face. These phone calls from, I mean, everybody wants a store on every major street in every major city in the world and they have rational reasons why they’ll make money and we agree they’ll all make money. However, when things go wrong, the landlords still make money and we don’t."

 

On your comment that China / HK sales are never coming back, I encourage you to talk to people who live in HK and Japan or read the book "Cult of the Luxury Brand: Inside's Asia Love Affair with Luxury" by Radha Chadha.

 

On your comment on my mental model of See's is wrong - I am assuming you mean that Cartier doesn't really have pricing power. It has just grown because of a fad in China / HK. I disagree. Quoting Rupert again:

 

"To grow 15% dividends and earnings, you need to have a sustainable competitive advantage and the only way that we know how to maintain a sustainable competitive advantage is to grow the brand equity of the various Maisons, because that brand equity will give you, will create demand and will result in pricing power."

 

On whether I could be wrong in the short-term. I totally could be. The stock may go down due to more pain. Is the long-term value of the business impaired. I don't think so. I would buy more if this were to go down by 50% i.e. EV/EBIT of 5x, where EBIT is possibly peak in his cycle.

 

On your point that you are a contrarian deep value guy, thanks for challenging the thesis. I am looking for ways my thesis could be broken. If you have evidence that shows that the above points I make are incorrect in the *long-term* I would love to know.

 

I am not a bottom fisher. I don't know where the bottom of any stock is. I just protect against more pain in the short-term by buying small positions and then growing it as the valuation gets cheaper. At current valuation, this is a small position. I like Rupert as a partner. Here is one final quote:

 

"We will maintain enough liquidity and fire power inside Richemont to make sure that if things go badly, and real opportunities present themselves within the Luxury Goods sector, that we do have the fire power to act immediately. Unfortunately, life is like that, that when you really need fire power, the banks are not there and the funds are gone. When you don’t need money you have an avalanche of cash coming your way. So, we will be cautious."

 

I'm not against investing in the company - I'm actually considering initiating a position, but this is incorrect: "" Besides, the watch business is 25% of the profit, jewelry is 75% of the profit."

 

Page 35 of the annual report states that specialist watchmakers account for 3,123M in sales and jewelry maisons for 5,657M, with its corresponding operating profit for each segment, 23% for watches and 35% for jewelry, which I guess was the place where you got to the conclusion of watches accounting only for 25% of profit.

 

But on page 79 (note 5 of financial statements) you can find a sales break down by product category and watches account for 5,168M and jewelry for 3,325M, which means that Cartier watches are a very important part of the business but since they are accounted as a jewelry maison, it looks like it's not because of the watches!