As Luxury Revives, Richemont Should Shine
The maker of watches and jewelry, like its sector, has suffered from softness in Asia and terrorism in Europe. Better times are coming.
Swiss luxury watch and jewelry maker Richemont could soon recover some of its sparkle after being battered in recent quarters by sluggish Asia demand, volatile currencies, and weakening tourism in Europe.
The grandly named Compagnie Financiere Richemont (ticker: CFR.Switzerland), which counts Cartier, Piaget, Lancel, and Montblanc among its many brands, issued a profit warning last month after sales in the five months through August plunged 14%. It reckons that operating profit in its fiscal first half to the end of September, due to be reported Nov. 4, will be 45% below the level in the same period last year.
The problems afflicting Richemont are occurring across the sector. Few luxury businesses have been spared by slowing economic growth in Asia, where much of their clientele is based, or an anticorruption crackdown in China that targeted gift-giving. Struggling economies across Europe have also taken a toll, and a recent spate of terror attacks has deterred many tourists, particularly in the key French luxury market.
U.K.-based Polar Capital fund manager Nick Davis says Richemont has most of the characteristics he looks for in a stock. “We like to buy good companies when they’re out of favor, and that’s certainly true of Richemont,” he observes.
Richemont’s only homegrown problem is the Swiss franc, which remains strong after the country removed a cap on its value against the euro last year. As a result, Swiss companies’ repatriated international earnings have come under pressure.
THERE WERE SOME BRIGHT spots in Richemont’s September update. The company boosted sales in China and South Korea, while Britain’s decision to leave the European Union and the consequent weakening of the pound helped lift its revenue there. Richemont’s management held its nerve during the worst of the market downturn and didn’t succumb to the temptation to pursue short-term profit, either by cutting back on advertising and promotion spending or slashing prices. In fact it did the opposite, even to the extent of buying back excess inventory.
Richemont was helped in this by shareholders who support its long-term strategy. “You can damage these brands very quickly and it takes a long, long time to recover,” Davis comments.
Davis also makes a distinction between so-called hard luxury goods, which include watches and jewelry, and soft luxury, such as fashion. Hard luxury has more sustainable earnings and is protected by very high barriers to entry.
Within this group, Davis believes Richemont is well positioned to benefit from a recovery, despite current soft market conditions. He describes the company as “one of Europe’s true global champions,” with China counting for more than 20% of its overall sales and
“Richemont has very strong brands, a very good management team, strong balance sheet, very high barriers to entry, so that you know when head winds turn to tail winds in terms of this industry’s trends, they’ll be very well placed to benefit from the recovery,” he says.
DAVIS CAUTIONS AGAINST making investment decisions based on short-term data, but says there are indications that the luxury sector is finally bottoming. “It does feel as though you’re a long way into the downswing in terms of reported sales,” he says.
He believes that the longer-term backdrop remains positive in Asian markets, with the continuing expansion of middle class consumers, and that Richemont is particularly able to take advantage of that.
“When a company has a very strong capital allocation, it can generate good cash and you can be confident it’ll do sensible things with that,” he says. “Our process is about identifying companies that can give double-digit shareholder returns, and we’re very comfortable that this one can do that over the medium term.”
Bryan, Garnier analyst Loïc Morvan is upbeat about prospects for the luxury sector generally and Richemont specifically, which he upgraded to Buy from Neutral last week, raising his target price to 73 Swiss francs ($73.43) from CHF60. “Following several quarters of negative trends in Greater China, it seems that momentum is beginning to improve in Mainland China and even in Hong Kong, although to a lesser extent,” he says.
He says that 2016 will still be tough on the profitability of hard-luxury groups but that this has at least been priced into the market. “We bet that momentum will gradually improve in the coming quarters and that the worst is behind us, particularly in APAC, and therefore we begin to be more positive for 2017.”
Morvan estimates that Richemont’s organic sales will fall 7% this year but rise 5% in 2017. Ahead of last week’s upgrade, he expected only 2% organic sales growth next year.
Richemont shares closed Friday at CHF64.80.