Richemont

The company behind some of the world’s most prestigious watch and jewellery brands has been facing headwinds in the last few years. However, we believe that the company’s experienced management team on several occasions has demonstrated that they have a long-term view and are highly competent. This, combined with a strong balance sheet, makes us believe that the company can once again regain its footing and re-establish its strong brands.

Richemont owns several of the world’s leading luxury goods companies – mainly those selling watches and jewellery. The group’s exclusive jewellery houses consist of Cartier and Van Cleef & Arpels. Cartier is the world’s most valuable jewellery brand and, in our opinion, also Richemont’s most valuable company. The group’s high-end Swiss watches include well-known brands such as IWC, A. Lange & Söhne, Jaeger-LeCoultre and Piaget. In addition, Richemont’s umbrella also encompasses Chloé’s exclusive handbags and Montblanc’s sophisticated pens.

This luxury giant has existed in its current form since 1988, but many of its well-known brands have been around for hundreds of years. For example, the watch brand, Vacheron Constantin, was founded in 1755 by the watchmaker Jean-Marc Vacheron. It is thus one of the world’s oldest watch brands still in production and the brand is also the oldest “house” in Richemont’s portfolio. The French company, Cartier, is almost just as old as the doors to its jewellery shop in Paris in 1847.

Richemont has previously also been highly diversified owning companies from many different business areas including TV stations, liquor making, and a large ownership share in British American Tobacco. In 2008, the conglomerate was split in two. The luxury brand side of the business continued under the name Richemont, while the other activities were transferred to a company called Reinet. Had this split not occurred, it is unlikely that we would be co-owners of the company today.

When Richemont’s customers, for example, buy jewellery from Cartier, it is all about being able to radiate wealth and elegance. Increasing levels of prosperity, especially in Asia, thus form the framework for what we expect will result in long-lasting attractive growth in the company’s earnings and cash flows. Richemont sells luxury products for 11 billion euro annually, and around half of these sales are on the Asian market. Europe is the group’s second largest market and represents just over a quarter of sales while the United States represents just over 15 percent. Asia is an important market for the group – and especially China (including Hong Kong and Macau) and Korea are the main contributors to the growth. Last year, sales on the Asian market grew by over 15 percent (excluding Japan), while the sales growth in the rest of the world was significantly lower – and negative in Europe.

Today, even luxury goods are sold online

In the last few years, Richemont has increased the focus on its online business. In 2010, the luxury conglomerate bought part of Net-A-Porter, which is an online market place for luxury goods. Last year, the group bought the remaining share of the exclusive online department store and thus became full owners of Yoox-Net-A-Porter as the platform is called today. Online shopping does not have to mean lower prices or discounts, and today, some consumers buy even the most luxurious goods online. This was one of the reasons why Richemont wanted to own the platform. The acquisition of the portal demonstrates that Richemont’s management team is visionary and capable of keeping up with time. In addition, it provides the group with the opportunity to control distribution, marketing and pricing of the products sold online.

In 2018, Richemont announced a strategic partnership with the Chinese e-commerce platform, Alibaba, as part of a strategy to have significant online presence on the important Chinese market. The collaboration reflects the large potential that the group sees in China. Chinese consumers are assessed to represent a third of the global demand for luxury goods, and the Chinese market is also Richemont’s second largest (and represents the majority of the group’s growth in Asia).

The glamorous jewellery from Cartier and Van Cleef & Arpels currently amounts to just under 60 percent of Richemont’s total sales – but an entire 90 percent of the group’s earnings. Jewellery sales grew last year by almost 10 percent and is the most profitable segment for the company with operating margins of 30 percent. This is almost twice as high as the group’s total operating margin – and three times higher than the watch division, which represents a quarter of the group’s sales. The watch division has an operating margin of 10 percent, which is significantly lower than previously and also significantly lower than what we expect the general level to be in the future.

While jewellery sales have been strong, the sales growth for watches used to be higher than it currently is – and in the last few years, it has been negative. In our view, this is partly because watches are not just sold through company owned stores but also – to a great extent – through a number of external watch retailers. Back in 2012/2013, growth rates on the Asian market were high which made watchmakers stock up on inventory. When the Chinese central government launched a comprehensive anti-corruption campaign in 2014, this had a strong negative impact on watch sales in China as many of the watches were being bought as gifts.

Selling through own stores is the way forward

In the last few years, Richemont’s management has bought back large parts of these inventories in order to prevent the products from being put on sale. Even though this has negatively impacted the group’s reported financial results, we think it may be value creating in the long run as it reduces the risk of ruining brand value. Even though the group’s stock repurchases were reduced in the latest financial year, the group is still buying back watches from inventories. This is a testimony to the fact that these inventories have been far too large – something which was a surprise to us as well as, presumably, Richemont’s management.

An essential component of Richemont’s business is the value of its brands. The most valuable jewellery is today sold only through own stores, but previously over half of the group’s sales were through external distributors. However, the group’s management team has become more aware of the value of being in control of the distribution. Thus, as part of ensuring future value creation, a few years ago the company began a process of moving more sales from wholesale to retail.

Since 2010, retail sales have consequently increased. It has gone from representing 46 percent of the sales to almost two thirds, and we view this as a very value-creating development for the company. By getting more and more control of the distribution, marketing and pricing of their products, they can ensure that brand value is not ruined. For example, putting an IWC watch on sale may help increase growth rates in a certain year, but it can end up wrecking the customers’ long-term perception of the brand.

The South African businessman Johann Rupert has been the group’s frontman since the foundation in 1988 – except for a single year, in which he took a sabbatical in 2014. Rupert founded Richemont, where he was CEO right from the beginning. He became Chairman in 2002 and remains so today. As he owns 10 percent of the company’s capital and the majority of voting rights through an unlisted class of shares, he runs the group based on a long-term view. He does not attempt to optimise the group’s short-term profits, and the initiatives towards taking control of the distribution and the repurchase of inventory are excellent examples of this.

Large cash holdings and high dividends are significant assets

This long-term and conservative approach to strategy and operations is also reflected in the company’s financing. Richemont’s coffers are bursting with cash, and in the last financial statements it amounted to a whole 3.5 billion swiss franc – equivalent to more than 5 percent of the company’s market capitalisation. Having high cash reserves is not always appreciated by the stock market, particularly not in periods where interest rates are low. However, we view it as a strength providing flexibility and opportunity to act as one sees fit – for example, as Richemont has done in their acquisition of the entire Yoox-Net-A-Porter. It is also a valuable asset when the access to capital is restricted and the interest rates start increasing again someday. We are glad to see, however, that last year Richemont was able to take advantage of the low interest rates to issue bonds worth 3.75 euro million (mainly to finance the acquisition of Yoox-Net-A-Porter).

As co-owners, we also benefit from the large cash reserves via the group’s annual dividend payments which amount to just under three percent of the market capitalization. The dividend payments have grown by more than 20 percent per year since the company was split up in 2008. Considering the company’s significant cash position, it is our assessment that there is a potential for dividends to continue to increase in the future.

Even though the growth in revenue and earnings has been challenged in Richemont, it is important to keep in mind that the earnings have been at a high level – in 2018 operating margin was 17 percent. However, the operating margin have been higher previously. In 2015, it was 25 percent, and we expect that this level can be regained. The lower earnings have also resulted in a temporarily lower return on invested capital. This was at 16 percent in the last financial year. Due to the operating margin being at a low level and lower than our long-term expectations, the company’s return on invested capital is also under pressure.

The last few years have seen changes to Richemont’s management team, and in this context, the structure has been changed. From 2013 to 2017, the group had two CEOs while today it only has one. The group’s top management team consists of Group CEO Jérôme Lambert, Group CFO Burkhart Grund and CEOs of Cartier and Van Cleef & Arpels, who all report to the Chairman of the Board, Johann Rupert.

Jérôme Lambert became CEO in 2018 after having been COO the foregoing year. He has had an extensive career in Richemont where he has worked for more than two decades. He has headed several of the group’s houses, including Jaeger LeCoultre and Montblanc. Burkhart Grund became CFO in 2017 but joined Richemont in the year 2000. Thus, even if the top management team in Richemont is relatively new, they have a long history with the company.

Despite facing headwinds for the last few years, we expect that Richemont – with their range of desired brands and the increased focus on ensuring future value creation – will make a strong comeback. Growth seems to be back, and we have faith that the long-term thinking and visionary management will restore the prior values in Richemont.