CFRUY - Richemont

[DanielGMask]

What do you think about the capital structure? Rupert controls 50% of the votes with only 9.1% of the equity. And also related, the board of directors and senior executive committee had a total compensation of about 50M per year in 2014 and 2015. Is that a reasonable amount for a company like this or too much?

 

I'm interested in the company. I think there's a real moat in many of the brands and specially in Cartier, which is by far the biggest contributor to sales.

[rishig]

If they are vertically integrating why is GM flat?

 

Good question, some context is needed to answer this question. Sorry for the long reply.

 

The Swatch Group's subsidiary, ETA, historically supplied movements not just to brands within the group, but also to dozens of others, including brands like Rolex and Cartier. Another subsidiary, Nivarox, virtually monopolizes the production of vital hairsprings and other regulating mechanisms.

 

In 2008, ETA decided it was going to phase out movements to companies outside the Swatch Group. ETA was at full capacity making movements for the Swatch Group and increasing productivity to supply would result in lower quality. In addition, the company argued that selling loose parts made it hard to track supplies and help counterfeiters. It also reasoned that reducing kit supplies would encourage other watch brands to invest in manufacturing, to the the good of entire Swiss watch industry. Switzerland's Competition Commission (ComCo) after a lengthy investigation gave green light to ETA's multi-year phase out plan. Nick Hayek, Swatch's chief executive, likened his company to a "supermarket", where others demand high supplies - requiring big investments by Swatch - in good times, and then cancel orders overnight when times turn hard.

 

Developing an in-house movement is by no means a small accomplishment, requiring millions of dollars of investment. A chronograph ramps up in complexity and cost by several folds. Richemont for years has been investing in manufacturing and vertical integration. It started with Richemont acquiring "LMH" in 2000. From 2011 transcript:

 

"We started verticalizing our watch production. I'd say in the late 90s and it accelerated with the acquisition of

LMH. So today, we have some 21 factories, employing nearly 7,000 people in Switzerland. Clients are too intelligent. They don't want to buy a Ferrari made in a Fiat factory. That was our like motive, and why we accentuated verticalization, and I would say before the great number of our competitors."

 

In 2008, Cartier introduced its first ever Geneva Seal watch with all in-house movements. See here:

http://www.watchtime.com/featured/cartier-complicated/

 

It's a long answer to why GM has not gone up, but the point of vertical integration was to control their own destiny and to make an authentic product that can command the price premium of being a "Swiss Made" watch. The "Swiss Made" label requires that 50% of components be made in Switzerland, and there are many so called Swiss Made watches that have components being made in China and then the assembly happening in Switzerland. Clients today are not stupid. Doing such a thing can definitely raise GM, but it would erode the brand value.

 

That gets me to the second question asked by someone on what do I think of 50% voting control in the hands of Rupert. I like it. Without it, I am sure a manager would have outsourced movements production to China when ETA announced its phase out plan killing the long-term value of the brand.

 

Here's another example why local production is so important (unrelated to Richemont but important to illustrate the pricing power of a luxury brand by producing locally). Coach makes leather bags in China, and it has pretty much no pricing power. Once a Coach leather bag goes out of fashion, it can be found in off price stores at 50-75% discount. On the other hand, Hermes' Birkin leather bags are sold at $10,000 - $200,000. Why? Because of the authenticity of the product - it is hand made in workshops in Paris.

 

See here how a Hermes Birkin is made:

http://houston.culturemap.com/news/fashion/06-04-12-exclusive-photos-inside-the-hermes-factory-where-birkin-made/#slide=22

 

See here how Cartier makes its jewelry in workshops in Paris:

http://www.telegraph.co.uk/luxury/jewellery/58123/cartier-jewellery-behind-the-scenes.html

See here how Cartier Tank's are made:

http://www.acontinuouslean.com/2013/11/13/cartier-tank-mc/

 

[rishig]

"1MDB Probe Shows Malaysian Leader Najib Spent Millions on Luxury Goods"

http://www.wsj.com/articles/malaysian-leader-spent-millions-on-luxury-goods-1459383835

[HJ]

 

http://www.bloomberg.com/news/articles/2016-04-07/jewel-heist-geriatrics-crave-diamonds-spurned-by-ipad-generation

 

[rishig]

 

http://www.bloomberg.com/news/articles/2016-04-07/jewel-heist-geriatrics-crave-diamonds-spurned-by-ipad-generation

 

The article is about the fall in desirability and prices of diamonds. Richemont's jewelry brands - Cartier, Van Cleef & Arpels (VCA) are in the branded jewelry business i.e. they purchase commodities (diamonds, precious metals) and transform them into branded goods.

 

Branded jewelry accounts for less than 20% of all the jewelry sold globally. Both Cartier and VCA are in the design and creativity business and have been consistently ranked in the top 3 jewelry brands in the world for a long time (the other one in the top 3 being Harry Winston owned by the Swatch Group). Richemont's jewelry business has been extremely robust despite all the headline news. Customers that purchase branded "high" jewelry are very different from the ones buying non-branded diamond jewelry. If you look at auctions for branded high jewelry, these items retain (and often appreciate in) value over the decades. On the other hand, when one sells unbranded jewelry, all one gets back is the metal weight. Take a look at this article: http://www.nytimes.com/1993/07/03/your-money/03iht-mranty.html

[HJ]

Let me preface by saying that I'm not that knowledgeable about the industry or Richemont specifically, but I'm curious what percent of their businesses could really be classified as sort of this "super high end" collectible types.  After all, they produce revenue of 5-6 billion euro annually in watches, and call it 4 billion euro annually in jewelry.  If you say average watch cost 20,000 euro, you are still talking about hundreds of thousands of pieces annually, and maybe also hundreds of thousands of pieces of jewelry each year.  Are most of these "collectibles" and worth double or triple their replacement cost over time?  Is there any source to get to the ASP break down of their products?  I'm guessing anything selling for below 10k a piece doesn't really attach much "Cartier" / "VCA" premium, but just a generic jewelry premium, i.e. also impacted by the ebb's and flows of the generic jewelry business?  In the statement "Branded jewelry accounts for less than 20% of all jewelry sold", how is that 20% calculated?  Is all Cartier business and Tiffany business counted as branded, and, say a $50,000 wedding ring at Costco not branded? Just curious. 

 

I think these companies do a great job marketing themselves by focusing people's attention to their heritage, attaching a "cultural premium" to their brands.  But at 10's of billions of revenue run rate each year, a chunk of it has gotta be more generic businesses? 

 

 

[rishig]

Let me preface by saying that I'm not that knowledgeable about the industry or Richemont specifically, but I'm curious what percent of their businesses could really be classified as sort of this "super high end" collectible types.  After all, they produce revenue of 5-6 billion euro annually in watches, and call it 4 billion euro annually in jewelry.  If you say average watch cost 20,000 euro, you are still talking about hundreds of thousands of pieces annually, and maybe also hundreds of thousands of pieces of jewelry each year.  Are most of these "collectibles" and worth double or triple their replacement cost over time?  Is there any source to get to the ASP break down of their products?  I'm guessing anything selling for below 10k a piece doesn't really attach much "Cartier" / "VCA" premium, but just a generic jewelry premium, i.e. also impacted by the ebb's and flows of the generic jewelry business?  In the statement "Branded jewelry accounts for less than 20% of all jewelry sold", how is that 20% calculated?  Is all Cartier business and Tiffany business counted as branded, and, say a $50,000 wedding ring at Costco not branded? Just curious. 

 

I think these companies do a great job marketing themselves by focusing people's attention to their heritage, attaching a "cultural premium" to their brands.  But at 10's of billions of revenue run rate each year, a chunk of it has gotta be more generic businesses?

 

All jewelry that Cartier / VCA sells is branded. Firstly, if you were in the market to buy a $50,000 ring, you would think hard about the craftsmanship of the product and not just to go to Costco / Zales. Secondly, the "bridal" segment is a very small portion of what Cartier / VCA sells. VCA's top selling high jewelry last year was the seven seas collection: http://www.vancleefarpels.com/us/en/nanosites/seven-seas.html. One doesn't go to Cartier / VCA to buy generic diamond rings.

 

The Cartier love bracelets cost about $6000 and in my estimatation about 5x the cost of making the product in India, including the cost of metal (my family is in the Jewelry business). A Cartier Love Bracelet has ~30 grams of gold. At current cost, that is about $1200. Add a 5% cost of making the product in India, the total cost is under $1500. Cartier makes these in their Paris workshop and they have been selling Love bracelets at a 4-5x premium since the 1970s.

 

VCA's Perlee branded gold bracelets are hand made and the ones studded with diamonds (1.8 carrots) start at $25,000. See here: http://www.vancleefarpels.com/eu/en/collections/jewelry/perlee/perlee-clover/vcarn5b200-perlee-clover-bracelet-medium-model.html. The metal weight in grams is about 30, so the metal costs the same as Cartier Love bracelet - ~$1200. It has 80 round diamonds weighing about 1.8 ctw (D-F color and VVS in clarity). The diamond costs is under ~$3000. The total cost excluding labor is under $5000. The VCA bracelets are beautifully handmade but I doubt the labor cost is more than 20% of the metal. So, they are selling these also at about 4x-5x the cost.

 

Lastly, not being a buyer of luxury goods, I have done a lot of work to understand who buys luxury products and why. Bain & Company is the leading consultant in the luxury goods sector. Here is a report on luxury consumer's buying behavior that I highly recommend:

https://drive.google.com/file/d/0BxOXaczTEJajdkRjc1pvalh5b2c/view?usp=sharing

 

The conclusion from the report is that consumers in China is the largest group of customers for luxury goods. This is not unexpected given this informal survey: https://www.youtube.com/watch?v=3SETM2ZJTrY. This set of customers is not very different from the one that buys Apple iPhones with gold faces (See here: http://fortune.com/2014/07/26/apples-iphone-is-golden-in-china/) and the same that has driven Starbucks to have the largest store base in a country outside the US (in a nation that is a tea drinking nation). There was a comment earlier in the thread that Chinese luxury consumption is a fad. It's natural to draw a conclusion like this when one lives in a western country and views purchasing of luxury branded goods as superfluous. But note that more than 40% of women in Japan own a Louis Vuitton handbag that costs over $1500. I highly recommend this video by the author of the book "What Chinese Want": https://www.youtube.com/watch?v=nxHXTQUE6qo.

 

One really has to dig deeper to understand why luxury good companies have sold off recently. For the last 10 years, Hong Kong had been booming due to shoppers from mainland China. In 2003, China passed the individual visit scheme that allowed individuals from mainland China to visit Hong Kong and Macau. Prior to this, individuals could only visit for business visits or in group tours. Visitors to Hong Kong grew from 12 million a year in 2003 to 47 million a year in 2014. This is in a city that is tiny - Hong Kong has only 7 million people. One can imagine the resource constraints that this led to. Protests broke out in Hong Kong against mainland Chinese visitors in Q4 2014. See here: https://www.youtube.com/watch?v=83wzQpzOEVk. This really scared away visitors and in 2015, visitors dropped below 40m. Also, China is considering limiting number of visas issued to mainland Chinese visitors to Hong Kong. See here: https://www.youtube.com/watch?v=wwpZWGvqXBc.

 

Hong Kong Disney had its first loss in last 4 years for the same reason - visitors from mainland China are down. Another proof that this is what has dented the sales is that while Hong Kong sales has come down, sales in other regions have done well. China mainlanders have skipped Hong Kong and gone elsewhere. The weak euro attracted them to Europe and sales in Europe made up for the fall in sales in Hong Kong. I view all of this as a temporary issue that will take a few years to resolve.

 

On the other hand, this brings to another possible opportunity. The stock prices for Hong Kong mall operators have started to come down. Wharf Holdings (0004) owns the two largest malls in Hong Kong, Harbour City and Times Square. The two together account for 10% of retail sales in Hong Kong. NAV for Wharf Holdings is 100 HKD and the stock is trading at 40 HKD. Even though this looks cheap, remember NAV is based on IFRS accounting and the real estate is valued annually based on ongoing cap rates. The cap rate used by the "indepedent" valuation people is 5%. Also, rents in these malls are at peak - they have gone up from 50 HKD in 2005 to 250 HKD today per sq.ft. per month. These two malls are among the top 5 in the world in terms of per sq. ft. sales, annual foot traffic and per sq. ft. rent. Occupancy in the two malls has consistently been at 99% for the last decade. If the bad news continues, I expect occupancy to go down, rents to come down and the stock to come down, but in the long-run, these would be wonderful assets to own. Wharf at 25-30 HKD would be a great opportunity in my opinion.

[Moht]

Pretty brutal March '16 numbers out from Swiss Watch Federation: http://www.fhs.ch/file/59/comm_160303_a.pdf

 

Worldwide sales down 16%.  HK, US and China especially hard hit, with declines of 38%, 33% and 14% compared to the same period last year.

 

Think it's probably baked into the stock, though.  Your thoughts, Rishi?

[rishig]

Pretty brutal March '16 numbers out from Swiss Watch Federation: http://www.fhs.ch/file/59/comm_160303_a.pdf

 

Worldwide sales down 16%.  HK, US and China especially hard hit, with declines of 38%, 33% and 14% compared to the same period last year.

 

Think it's probably baked into the stock, though.  Your thoughts, Rishi?

 

I am not surprised by HK numbers - there are lots of things going against HK currently. HKD is pegged to USD, so mainland China visitors have been flocking to Europe in general. Visitors to HK from mainland China is down by 26%. See: http://partnernet.hktb.com/en/research_statistics/index.html. HK is a shopping destination. With Euro weakening, the mainland China visitors have been traveling to places where they can get experiences beyond shopping (and can shop as well). However, I expect this quarter the numbers from Europe to be pretty horrible as well, because of the Brussel attacks. There are other reasons why mainland China visitors to HK have been dropping - for the last one year, the anti mainland sentiment in HK has been quite severe. (Search YouTube).

 

I would be interested in seeing where Richemont's overall numbers across geographies end up. I don't have very high expectations and much is baked into the price. If the stock drops 10%-20%, I will be adding.

[fareastwarriors]

http://www.wsj.com/articles/cartier-parent-richemont-warns-of-tough-months-ahead-1463724224

Cartier Parent Richemont Warns of Tough Months Ahead

Swiss companies have struggled in recent years due to the strong Swiss franc

 

 

http://www.wsj.com/articles/richemont-why-the-its-shares-arent-ticking-1463754078

Richemont: Why Its Shares Aren’t Ticking

The Swiss luxury group has unrivalled brands, but the luxury watch market continues to decline

[Mr Pink]

Probably not going to do anything in this but want to thank Rishig for the interesting discussion and sharing great links

[rishig]

I presented Richemont at ValueX. My presentation: http://bit.ly/richemont-valuex

 

I also added to my position this morning.

[valuefinder0525]

I presented Richemont at ValueX. My presentation: http://bit.ly/richemont-valuex

 

I also added to my position this morning.

 

Have you done a brand by brand analysis in terms of the returns on the invested capital? Curious to see how many of the brands were good investments.

 

Also any idea what Rupert could do with all the cash?

[rishig]

I presented Richemont at ValueX. My presentation: http://bit.ly/richemont-valuex

 

I also added to my position this morning.

 

Have you done a brand by brand analysis in terms of the returns on the invested capital? Curious to see how many of the brands were good investments.

 

Also any idea what Rupert could do with all the cash?

 

A brand by brand analysis of ROIC is not possible since the they do not break out capital deployed on a brand basis. Overall ROIC has been north of 25% consistently.

 

From reading the transcripts, my best guess is return of capital via dividends. Rupert wants to continue growing dividends at 15%. If the industry continues to be ugly, they may do an acquisition.

[fareastwarriors]

Who Needs a CEO? Not Swiss Watch Giant Richemont

 

Luxury company unveils management overhaul as it reports sharp fall in first-half profit

 

 

http://www.wsj.com/articles/richemont-to-eliminate-ceo-post-in-management-reshuffle-as-profit-falls-1478247354

[fareastwarriors]

Richemont, Swatch Rally on Optimism Worst Is Over in Watches

 

https://www.bloomberg.com/news/articles/2017-01-12/richemont-christmas-sales-beat-estimates-as-china-u-s-rebound

[walkie518]

did this thread die? 

 

updated thoughts?  my sense is it's cheap, something w/a 6x CHF of course even better, but the stock has gone no where on the 5 yr chart... might be on back of yoox acquisition? 

 

not sure how they underwrote that but owning the funnel shd add a lot of value?

 

watches return to growth can't be a negative: http://www.fhs.swiss/file/59/comm_190909_a.pdf though not where it was just a few years ago...

 

I would think Hong Kong underlines the negativity? 

[Okonomen]

did this thread die? 

 

updated thoughts?  my sense is it's cheap, something w/a 6x CHF of course even better, but the stock has gone no where on the 5 yr chart... might be on back of yoox acquisition? 

 

not sure how they underwrote that but owning the funnel shd add a lot of value?

 

watches return to growth can't be a negative: http://www.fhs.swiss/file/59/comm_190909_a.pdf though not where it was just a few years ago...

 

I would think Hong Kong underlines the negativity?

 

It trades around 4% FCF yield. I disagree that a company may be cheap due to the price not moving for several years. It also traded at a crazy valuation back then, so like with KO, an expensive price equals many many years of inferior returns for buyers.

[John Hjorth]

did this thread die? 

 

updated thoughts?  my sense is it's cheap, something w/a 6x CHF of course even better, but the stock has gone no where on the 5 yr chart... might be on back of yoox acquisition? 

 

not sure how they underwrote that but owning the funnel shd add a lot of value?

 

watches return to growth can't be a negative: http://www.fhs.swiss/file/59/comm_190909_a.pdf though not where it was just a few years ago...

 

I would think Hong Kong underlines the negativity?

 

It trades around 4% FCF yield. I disagree that a company may be cheap due to the price not moving for several years. It also traded at a crazy valuation back then, so like with KO, an expensive price equals many many years of inferior returns for buyers.

 

Personally, I would substitute the "equals" above in Okonomens post above with "may equal". It's - as always - about personal assessment of the investment thesis and time horizon - here, very long. [ Joel Stevens, Austin Value Capital [December 31^st 2015] : Price and Returns].

 

Not for everybody, and I may be wrong in this space at the moment.

[walkie518]

did this thread die? 

 

updated thoughts?  my sense is it's cheap, something w/a 6x CHF of course even better, but the stock has gone no where on the 5 yr chart... might be on back of yoox acquisition? 

 

not sure how they underwrote that but owning the funnel shd add a lot of value?

 

watches return to growth can't be a negative: http://www.fhs.swiss/file/59/comm_190909_a.pdf though not where it was just a few years ago...

 

I would think Hong Kong underlines the negativity?

 

It trades around 4% FCF yield. I disagree that a company may be cheap due to the price not moving for several years. It also traded at a crazy valuation back then, so like with KO, an expensive price equals many many years of inferior returns for buyers.

 

Multiple compression from lofty heights is not the story here ... there was a decline in profitability per dollar of sales due to investment activities

 

2019 sales were nearly €14B and 2015 sales were €10B so +7% annual sales growth is not nothing but no super interesting either... more pointedly, in FY2015 Richemont had a 25% operating margin and the last annual showed 14% so what happened?

 

Most of the increase in sales occurred between 2018 and 2019 on the back of the Yoox and Watchfinder acquisitions.  The value of adding these distributors to the group has yet to be realized but I think this is what makes the investment case and obfuscates the statements leading to comments on 4% FCF yield that no one wants.

 

Surely, both are different businesses, but Watchfinder is a gem.  Not only does Richemont make money on the initial sale, but they can make money trading the assets over time in the secondary market.  Moreover, because they create a network of watch traders, they get not only repeat customers but a center of mass for both markets.  This also gives Richement an outlet to buy broken and resell fixed w/NOS parts ... huge upside in a fragmented market if addressed effectively. 

 

I wouldn't downplay the value of Yoox either though the model might have less synergy with existing businesses?  Others who know more can correct but I thought they got Yoox at a reasonable valuation considering site traffic and sales?

 

Taking all of that into account, FY19 only shows a 5% improvement in operating profitability over FY18 with a 27% increase in sales (mostly Watchfinder and Yoox).  I don't think taking the piece of Yoox they didn't own was about a 5% improvement but an update to logistics and omnichannel sales for all brands in the group.  I also think it's likely that mgmt will find ways to return to historical profit margins once the dust settles (even if it takes a few years).

 

My point is that under the hood there is a lot going on... we'll hear more on Nov 15 ...

[clutch]

CFRUY down 10% while SWX: CFR is steady. What is going on?!?

[clutch]

CFRUY down 10% while SWX: CFR is steady. What is going on?!?

 

Actually, it seems like CFRUY had a run-up for the past few days that diverged from SWX:CFR.