Kering (OTCPK:PPRUF) (OTCPK:PPRUY) announced its H1-23 results, reporting an underwhelming 2% growth Y/Y, an operating margin decrease, and close to zero free cash flow. The luxury group continues to lag behind industry leaders in LVMH (OTCPK:LVMHF) and Hermès (OTCPK:HESAF), with no clear sign of change approaching, but the management transformation could be a step in the right direction.
I reiterate a Hold rating, with a price target of €526 per share, which equals $564 per share of the company’s ADR.
A month ago, I initiated coverage on Kering claiming its ‘Ugly Duckling Tale Continues‘. I urge you to read that article, in which I described my investment thesis in detail, as well as the group’s operating segments, and the main reasons for its underperformance compared to the industry leaders.
In short, I find the company’s management inferior to its closest rival LVMH, as the latter continues to win the marketing battle hugely and constantly improve new brands, whereas Kering’s operations outside Gucci and YSL are deflated. Furthermore, there are clear inefficiencies reflected in the group’s cash cycle, which require a turnaround.
Now, let’s focus on the company’s results, see if it’s still underperforming, and discuss the governance reorganization.
Kering reported consolidated revenues of €10.1 billion, a lackluster 2.0% increase from the prior year. Based on its historical seasonality, the French conglomerate is on pace to deliver 3.6% growth for the entire year. For comparison, LVMH grew by 15.0%, and Hermès grew by 22.0%.
Geographically, Japan grew by 18%, Asia Pacific excluding Japan grew by 11%, Western Europe grew by 5%, RoW grew by 5%, and North America declined by 16%.
Gucci remained the largest segment in terms of sales, responsible for over 50% of the group’s total sales. It is also the most profitable segment, with 35.3% EBIT margins. Saint Laurent is second, with 15.6% attributed to the brand, and 30.5% EBIT margins. Third is Bottega Veneta, with 8.2% of sales and a much lower 20.3% margin.
The Gucci segment includes the results of Gucci branded products which are distributed through 536 operated stores worldwide (8 openings in the period), as well as through wholesale channels.
Gucci is the crown jewel of the group, growing at a 14.6% CAGR between 2016-2022, maintaining 35% and above operating margins. Between 2019 and 2022, Gucci went through a reorganization of the brand’s distribution chain, which culminated in the company surpassing the 90% threshold for sales generated in directly operated stores.
In H1-23, Gucci generated 91.0% of its sales from operated stores, reflecting €17.7 million in annual sales per operated location, a decrease from the prior year. Revenues decreased by 0.9%, and margins decreased by 20 bps.
The Saint Laurent segment includes the results of YSL branded products which are distributed through 288 operated stores worldwide (8 openings in the period), as well as through wholesale channels.
Saint Laurent is the fastest-growing brand within the group, with a 15.3% CAGR between 2016-2022. The segment achieved all-time high operating margins in 2022, at 30.9%.
In H1-23, Saint Laurent generated 80% of its sales from operated stores, reflecting €9.8 million in annual sales per operated location, an improvement from the prior year. Revenues increased by 6.4%, and margins decreased by 40 bps.
The Bottega segment includes the results of Bottega Veneta branded products which are distributed through 279 operated stores worldwide (8 openings in the period), as well as through wholesale channels.
Bottega is clearly the laggard among the company’s three largest brands, growing at an unimpressive 6.8% CAGR between 2016-2022. Furthermore, the brand operates at a lower margin, achieving 21.0% in 2022, still significantly below its 2016 highs.
In H1-2023, Bottega Veneta generated 80.0% of its sales from operated stores, reflecting €5.0 million in annual sales per operated location, in line with the prior year. Revenues remained flat, and margins improved by 200 bps.
The Other Houses segment aggregates the results of the Alexander McQueen, Balenciaga, Brioni, Boucheron, Pomellato & Dodo, and Queelin brands. Their products are distributed through 591 operated stores worldwide (11 openings in the period), as well as through wholesale channels.
Other Houses are growing at an impressive pace, with a 14.7% CAGR between 2016-2022, while significantly improving margins along the way. It seems like it’s only a matter of time before some of the brands aggregated under the segment will be awarded a segment of their own.
In H1-23, 68.0% of the segment’s sales were generated in operated stores, reflecting €4.2 million in annual sales per operated location, a decrease from the prior year. Revenues decreased by 5.1%, and margins declined by 230 bps.
Kering Eyewear & Corporate
This segment is quite weird, as it aggregates the results of the company’s eyewear and beauty businesses with fragmented corporate expenses.
The group recently announced the acquisition of Creed, which is a high-end luxury fragrance house established in 1760. Creed’s results should be aggregated into the Eyewear & Corporate segment, which will probably go through some kind of restructuring in the near future.
We can’t learn too much from the segment’s results, aside from the fact that it turned to profitability in the first half and revenues grew by 50%. We’ll have to wait for restructuring until we get a better understanding.
Overall, Kering’s underperformance remained apparent in the first half of 2023. As LVMH and Hermès continued to widen the gap with double-digit performance.
As I discussed in my previous article, the biggest problem with Kering is its cash cycle, a problem that continued in the first half. The company shows adjusted FCF in its presentation, but in reality, FCF came in at €287 million. Excluding its non-recurring investments in buildings, free cash flows were €1.6 billion which is still a material decrease from the prior year.
Important Notes From The Call
The most important update, I think, is that Kering is shuffling its management structure.
Francesca Bellettini, President and CEO of Yves Saint Laurent since 2013, in addition to her current role, is appointed Kering Deputy CEO, in charge of Brand Development.
Marco Bizzarri, President and CEO of Gucci since 2015 and a member of Kering’s executive committee since 2012, will leave the company effective September 23, 2023.
Jean-François Palus, currently Kering Group Managing Director, is appointed President and CEO of Gucci for a transitional period. He is tasked with strengthening Gucci’s teams and operations as the House rebuilds influence and momentum, and readying its leadership and organization for the future.
Lastly, Jean-Marc Duplaix, Chief Financial Officer since 2012, is appointed Kering Deputy CEO, in charge of Operations and Finance. Jean-Marc Duplaix will head all Group corporate functions and be responsible for enhancing efficiency and accountability.
According to François-Henri Pinault, Chairman and CEO of the group (and the majority owner representative), the rationale for the reorganization is as follows:
In a nutshell, the rationale of our organization is the following: It is to elevate the operational expertise at the group level. It’s about enhancing our stewardship of our Houses. And it is to empower them to focus on their core knowhow. And I’m certain that this reorganization is a decisive step, not only in getting our performance back on track in the short-term, but more importantly, to capture the growth of the luxury world for the next decade.
Personally, I like this quote. To me, it’s a sign that the group is acknowledging its failure over the past decade, and that’s a first step towards fixing that. However, the new change seems quite stretch, with two deputy CEOs working under a CEO and having other C-level responsibilities. It remains to be seen just how effective and transformative will this shakeup end up being.
Regarding Gucci, the group expects a transition period in 2023, which combined with overall weakness in the fashion luxury industry, will probably result in a very low year.
2023 is a transition year with soft revenue trends so far for Gucci. H1 margin may be, in a way, a good proxy for the full year. But I want to be clear that we will support all initiatives that the new management and the new design team at Gucci, we would like to launch in H2 and going forward to reignite the brand for the long run. So I don’t know if it’s per se a reset, but we will support all the investments needed. And as already stated, the potential of the brand in terms of revenues and EBIT margin is immense and intact compared to what we had the occasion to present, but the trajectory to reach that objective might not be linear and comprise some phase of investments.
— Jean-Marc Duplaix, CFO & Deputy CEO, H1-23 Earnings Call
Another significant update is the acquisition of a 30% stake in Valentino from Mayhoola, an investment fund based in Qatar. The agreement will enable Kering to progress towards a 100% stake in Valentino in 2028. The deal values Valentino at €5.7 billion. Today, Valentino has 211 directly operated stores in more than 25 countries and has recorded revenues of €1.4 billion and recurring EBITDA of €350 million in 2022.
Kering and Mayhoola also said that as part of the broader partnership, Kering and Mayhoola will explore potential joint opportunities in line with their respective development strategies. We don’t really know what this means and we don’t have too much information about Mayhoola, but François-Henri Pinault mentioned Mayhoola showed inclination to buy shares of Kering in the open market to strengthen the relationship.
I used a discounted cash flow methodology to evaluate Kering’s fair value. I forecast the group will grow revenues at a 5.4% CAGR between 2023-2030 at the pace of the luxury market.
I project FCF margins will increase gradually up to 17.6% in 2030, as the company realigns its operations and returns to a normal cash cycle.
Taking a WACC of 8.9% and adding its net debt position, I estimate Kering’s fair value at €526 per share, which amounts to $564 per PPRUF ADR based on the current USD/EUR ratio.
Kering has a long way to go before its ugly duckling story ends, however, the management change is a positive step towards recovery. The stock has significantly underperformed its peers in the last decade, primarily due to stagnant free cash flows and trailing the industry’s growth.
Luxury is all about brand value, and Kering clearly suffers from inferior marketing. We’ve received more evidence in H1, as the company’s sales grew by a miserable 2.0%, while LVMH has grown by 15.0%.
Despite activist headlines causing a short-term upswing, the Pinault family still holds significant control over the company and most activist attempts will likely be blocked.
While Kering owns a high-quality portfolio of brands, I find its operations fundamentally worse than its peers, and thus view its discount justified. Therefore, I rate the stock a Hold, but plan to monitor its performance closely, and if we get a sign that the management transformation is working, I would probably upgrade the stock to a Buy.
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