Beloved brands, a unique distribution network and a conservative balance sheet are the main ingredients in LVMH. In addition, the luxury conglomerate has an experienced management team that continually succeeds in taking advantage of the group’s strengths. In general, we prefer organic growth, but if LVMH is the one pulling the trigger on an acquisition, we are less concerned. The group’s historical track record has demonstrated to us that we need not to be.
The luxury conglomerate LVMH manufactures and distributes over 70 of the world’s most luxurious brands. The group has more than 4,500 stores around the world, from where the majority of the prestigious products are sold. The European market represents around 30 percent of LVMH’s sales while the US market represents around a quarter. The group’s largest market is Asia, where almost 40 percent of the sales are made. The different categories under the umbrella of this luxury giant include everything from fashion and leather goods to wines and spirits, perfumes and cosmetics, watches and jewellery and specialist stores.
The roots of LVMH trace back to 1593, when the Group’s oldest house, the Château d’Yquem vineyard, was founded. However, the group did not become LVMH as we know it today until 1987, when the fashion company Louis Vuitton (LV) and the wine and spirits company Moët Hennessy (MH) merged. While Louis Vuitton is one of the world’s most luxurious and desirable brands in the market for fashion and leather products, Moët Hennessy is best known for its exclusive champagnes and cognac of which the two most famous form the company’s name.
Moët Hennessy represents the LVMH conglomerate’s wine and spirits division. The division has a natural restriction on supply, as the products must be made in certain specific regions. For example, the grapes must be from the Champagne region in France before the sparkling wine can be called champagne, and the cognac must be from the area around the French city of the same name. Consumers, however, love these prestigious products, so LVMH has ample opportunities to increase prices in line with inflation, and perhaps even more – and the level of earnings from the wine and spirit division is, as a result, the second highest in LVMH. While LVMH owns two thirds of Möet Hennessy, Diageo (which we are also co-owners of) owns the remaining third.
The fashion and leather division is in the lead when it comes to earnings
The strong brand of the group is reflected in its multi-year success. Sales have grown by double digits the last few years, most recently by 10 percent in the last financial year, and the operating margin has also improved.
Last year, the operation margin was 21 percent which was an increase of almost 2 percentage points compared to the year before. This reflects the group’s scalability and potential to create value. In 2013 and 2014, LVMH experienced stalling growth rates in its sales of luxury products, and this was mainly attributed
to a lower level of demand from Chinese consumers. However, it seems like the Chinese are back in business, and today they represent almost a third of the sales of luxury products in a global context. Over the course of last year, LVMH’s share price was periodically negatively impacted by the stock market’s concerns about a potential slowdown in the growth rate of the Chinese economy and how this would negatively impact LVMH’s growth rates. However, this fear has so far proven to be unfounded. When management presented the results for the year, they illustrated a strong Asian market that contributed to accelerating growth, and China stood out as the strongest contributor to this growth.
Even though LVMH operates in many categories, there is one in particular that we see as highly valuable – and that is the fashion and leather category. This category represents almost 40 percent of the group’s total sales but as much as 60 percent of its earnings. Thus, the division is the largest and most profitable in the group with an operating margin of 32 percent.
The leather and fashion division consists of several exclusive fashion houses, including well-known names such as Marc Jacobs, Celine, Kenzo and Givenchy. The crown jewel of the division – and the group – however, is Louis Vuitton. This is confirmed by the fact that this fashion house has been named as the most valuable luxury brand in the world for many consecutive years. At the same time, it is estimated that Louis Vuitton is also the world’s most profitable luxury brand with an operating margin of more than 40 percent.
Louis Vuitton’s story began almost 200 years ago when a young lad called Louis Vuitton in 1835 made the long 400-kilometre trek on foot to the French capital, Paris. The 14-year-old apprenticed as a trunk maker and became so good at his craft that the Emperor, Napoleon III, eventually appointed him as court trunk-maker for Empress Eugénie. Almost 20 years after he arrived in Paris, in 1854, Louis Vuitton opened his own boutique.
The luxury brand, however, would come to be famous for much more than just its suitcases. Today, Louis Vuitton sells luxury handbags and many other kinds of fashion and leather goods. It has succeeded in creating a brand that is so exclusive that consumers are happy to buy its products even though it is the only brand in the world that is never sold in outlets or on sale. Not even the financial crisis could deter fashion-conscious consumers from buying Louis Vuitton bags and other items. In fact, sales grew during this period, even if it was at a bit slower pace than usually. This testifies to a high degree of wealth among a faithful customer base in addition to a great intangible value in owning the products.
Christian Dior is off to a great start under the banner of LVMH
Louis Vuitton would rather burn its inventory than put the products on sale. This helps to retain the aura of exclusivity surrounding the brand, and it also ensures that the brand value is not diminished by selling the products at a discount. Furthermore, the prestigious Louis Vuitton products are only sold from the company’s own stores. This is a necessity as it is the only way of ensuring that the products are never put on sale. Exclusivity and quality are thus part of what characterises Louis Vuitton, just as it does many of LVMH’s other products.
Louis Vuitton’s products are made in France only. This contributes to keeping the quality at its peak and also preserves the brand’s identity and historical roots in France. The majority of Louis Vuitton’s sales to Chinese consumers are also from stores not located in China. If there is one thing that the Chinese find even more glamorous than a Louis Vuitton bag, it is a Louis Vuitton bag that has been bought at the flagship store on the Champs-Elysées in Paris – and there are still long lines of eager customers waiting in front of the store (which is also the largest Louis Vuitton store in the world).
LVMH’s frontman is the Frenchman Bernard Arnault, and he found his way into the group when he purchased a stake in the company in 1988. The year after, he became the principal shareholder, CEO and Chairman of the Board – positions he still holds. Arnault and the remaining management team have a long-term focus on strengthening the company’s core business. The last few years, resources have increasingly been allocated to areas with the greatest potential for value creation – and areas that are less value creating and too far from the company’s core business have been sold off. In addition, management has been focusing on commemorating every individual brand’s unique characteristics and strengths so that all the fashion houses would be regarded as their own valuable brand and not merely as part of one unified conglomerate.
In 2017, LVMH acquired Christian Dior Couture, which, among other things, produces fashion and leather goods, shoes and jewellery. LVMH has owned the perfume part of Christian Dior for a long time, whereas Christian Dior owned more than 40 percent of LVMH before the acquisition – and Arnault owned a large part of Christian Dior. Thus, the acquisition of Christian Dior Couture took place in the process of simplifying the group structure of Arnault’s companies.
This past year has thus been the first full calendar year in which the whole of the iconic brand, Christian Dior, has been part of LVMH. The year has been successful with high sales growth, and Christian Dior Couture has – just like Louis Vuitton – had a very high proportion of sales from its own stores.
LVMH’s returns on invested capital are over 15 percent – and almost 44 percent if goodwill from the company’s ongoing acquisitions is excluded. As the group has relatively low ongoing investments in the business, a high proportion of the earnings are converted to free cash flows, and these currently amount to approximately five percent of the market capitalisation. At the same time, LVMH does not have much debt, and this allows the group to pay a little under half of these cash flows to shareholders – mainly through dividends, which are increasing each year. The significant potential for dividends that we see in LVMH was most recently confirmed in 2018, where the group’s dividend payments to shareholders rose by 20 percent compared to the year before.
Low debt, combined with low interest rates in the Eurozone, has led to a number of market participants strongly arguing that LVMH should return more capital to the owners. As co-owners, however, we appreciate a conservatively financed balance sheet, since this creates flexibility and room to act – even during times where access to debt and other sources of capital is more limited.
Many speculators do not regard financial conservatism as valuable in times with plenty of cash flowing in the streets. However, the value of flexibility is demonstrated when access to capital is limited. In such periods, strong companies can take full advantage of their conservative balance sheets. Companies burdened with more debt will not have the same flexibility and freedom to manoeuvre if their interest payments suddenly consume a large part of their free cash flows. With the Group’s many prior acquisitions, LVMH has demonstrated that they have both the will and the ability to strike a deal when the right value-creating opportunities present themselves. One example of this is when the group acquired the supremely attractive champagne brand, Krug, in 1999 after the then owner, Remy Contreau, found himself in financial difficulties.
Krug is far from the only value-creating acquisition that LVMH has made. Through the company’s solid worldwide distribution network, when acquiring smaller brands the group can disperse these to all the company’s existing stores at a lower cost than a small family-owned business could manage on its own. So even though we generally view acquisitions as a dubious use of co-owner capital when compared to organic growth, we are very confident that it does make a lot of sense in this case.
Therefore, it is no surprise to us when LVMH makes minor acquisitions on an ongoing basis; rather, we have faith that the management team is making the right acquisitions at the right times when the underlying value of a company can be purchased at a good price. This long-term approach has been the historical norm, and it is expected to remain that way in the future.
In our view, the combination of good, solid brands and strong senior management focused on the long term is hard to find. These are two of the many qualities that we believe LVMH possesses – and they are what we, as long-term co-owners, are looking for. We are pleased by the fact that consumers wear exclusive clothing from Céline, carry luxury handbags from Louis Vuitton and drink champagne from Möet et Chandon. This creates value for us as co-owners – and we believe that these habits have come to stay.