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As a high quality investor myself, i value quality than quantity and therefore, number of subscribers will not affect my decisions. I will always stand true to my philosophy that is to share my best ideas and hopefully, more investors would appreciate the art of investing in high quality companies.
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Company: LVMH
Ticker: LVMHF, listed in France
Industry: Luxury goods
Investment thesis
Recently, I picked up a book named “Future Luxe: What's Ahead for the Business of Luxury” by Erwan Rambourg. As a prudent investor myself, investing in the luxury industry seems to be contradicting as the principles practiced by them are counterintuitive. (ie: selling things at high price with limited value created, limited quantity, low optimization's, etc) However, the book does convince me otherwise.
Naturally, when it comes to luxury, the first brand that comes to my mind first will be LVMH. Thus, it piqued my interest to research further on LVMH as it is known as the king of the luxury industry.
On top of that, the company seems to be trading at reasonable valuation due to temporary headwinds such as weakness of the Chinese consumer buying power, slowdown in the global economy, reversion of revenge spending due to Covid-19, etc. This research will be revolving around its moat, management, risk & competition and what lies ahead for the luxury industry.
Introduction
The LVMH group was formed from the merger of Moët Hennessy and Louis Vuitton in 1987. Bernard Arnault became the leading shareholder and Chairman and CEO in 1989, with the ambition of making LVMH the world leader in luxury. Click here to read more about its fascinating stories on how Bernard Arnault built up his empire.
Sources: Quartr_app
Business model
Today, the LVMH group has built its leading position through a unique portfolio of 75 exceptional Maison’s, operating in five business segments:
Sources: 2022 LVMH snapshot
Fashion and leather goods remain the biggest segment (49%) for the groups and contribute 71% of its group profitability. It is followed by selective retailing & others (19%), watches & Jewellery (13%), Perfumes & cosmetics (10%) and Wines & spirit. (9%) LVMH has been actively expanding both its jewellery segment and experience segment (hotel and vacation, shipyards, etc)
Total addressable market
The general consensus is that luxury is a very niche market and it is usually targeting high net worth individuals. It is true to a certain extent. Based on Bain estimation, the market size for personal luxury goods is around $374bil and if you include others like luxury cars ($500bil), hospitality ($200bil),etc, it has reached a stunning $1.5 trillions.
It is definitely bigger than my expectation and it is expected to grow bigger (to around $600bil/3-8% for personal luxury goods by 2030). As per Erwan, he believes that luxury goods will do well for this decade as there are 3 key trends that will propel the growth of the industry.
#1 The rise of asian consumer
Asian consumers are aging into prime consumers, especially China (expected to be 50% of the total market). As per his argument, the middle class population should be made up to 3.5bil by 2030 from 1.4bil in 2015. Higher income will likely encourage consumers to shift their spendings habits from necessity to high end products.
Take china as example, in 2018, LVMH is targeting 13 mil customers but they are selling to 1.3mil people with many of them are first time buyers. (The penetration remains low-10%). A more important question is how large is the target and Erwan estimated that it can be as high as 24mil. Even with low penetration, LVMH china sales will double in the next 5 years.
#2 The rise of female purchasing power
Women employment rates are going up (to 50% of the total workforce) and the median earnings are increasing at a faster rate than male (still about 20% less than male). Besides, the share of women who are married has been failing leading to higher discretionary spending. (spend less on children)
For example, the median age for women has increased from 20 to 28 years in the US from 1948 to 2018 based on the US census Bureau. Luxury sector will be one of the major beneficiaries with the rise of female purchasing power as they are usually the key customers.
#3 Luxury customers are getting younger
With the rise of selfie and social media, youngsters are constantly comparing and trying to show the best side of themselves. Thus, the appeal for luxury goods is getting higher as it is one of the best ways to showcase yourself. For example, when Erwan visited Hong Kong in 2018, the executives told him that the average age of consumers in China comes down one year every year.
Of course, there is a limit on age but it does show that the luxury brands are getting younger audiences and they have to innovate to be more appealing to them. Ie: selling through online/e-commerce like farfetch.
Competitive advantage
The power of brands/desirability
“Here lies the difference between luxury and premium. People buying premium or even super-premium like to justify every dollar by a return on investment. Premium means pay more, get more in functional benefits. Luxury is elsewhere: it signals the capacity of the buyer to transcend needs, functions, or objective benefits. The Luxury Strategy”
Bernard Arnault understood this principle better than most people when he first stepped into the luxury industry. As a result, desirability of a brand has been his obsession. "What I have in mind every morning is that the desirability of a brand should be as strong in ten years. It’s really the key to our success. Bernard Arnault”
However, it is a challenging task to create truly luxury brands. Besides, It is also tough to balance between scarcity and growth once it has reached a certain scale. Even he himself said that it is a tough thing to do in one of his interview:
"A star brand is timeless, modern, fast growing, and highly profitable. Can a brand be all four at once? It is rare. In my opinion, there are fewer than ten star brands in the luxury world. It is very hard to balance all four characteristics at once—after all, fast growth is often at odds with high profitability—but that is what makes them stars. If you have a star brand, then basically you can be sure you have mastered a paradox. Bernard Arnault”
How does LVMH create desirability?
The company has various strategies in place to increase desirability through their products, distribution, pricing, marketing,etc.
Vertical integration - Top quality products
"If you control your factories, you control your quality. If you control your distribution, you control your image, Bernard Arnault”
Under Arnault, LVMH has been the pioneer in vertical integration for the industry as he valued highly on complete control over the supply chain. It is not only to ensure the highest quality products but also to keep the identity of their products. (remain the production at the brand origin despite higher cost)
“When someone buys a luxury item, they are buying a product steeped in a culture or in a country. Having local roots increases the perceived value of the luxury item. The Luxury Strategy”
As a result, most of its workshop remains in France and they train their own artisans through its University of LVMH to produce their own products. (many of their key products are hand made and take up to 1,000 steps to complete)
Distribution and inventory management
LVMH is also known for their strong retail presence (direct to customer) instead of relying on distribution channels like wholesaler or distributor. This is because they want to have full control on their customer experience from entering to selecting and finally to purchase.
Other brands have been following their footsteps and based on Erwan, he is betting that high end brands will still be mostly physical stores and the future distribution breakdown will be likely to be 80% physical, 20% online.
Besides, with their own distribution network, they can manage their inventory and it is not a secret that they will always plan the availability of certain products so that their customers have to wait to receive the product to increase “desirability”. Rolex is the master at this and their customers generally have to queue for at least a year to buy the classic watch - The submariner. In the resale market, it can easily fetch up to 2x the retail price.
Famously, LVMH would rather incinerate unsold items than discount them, all for the purpose of maintaining long-term brand equity rather than maximising short-term profits. This definitely sounds like going the extra mile to protect brand value at cost.
Pricing
Pricing is another important element in increasing desirability. Purely pricing their products at the highest among its competitors is not going to do the work. LVMH strategy is to price their products high enough to create a barrier that is not accessible to the general population. Thereby, creating exclusivity as well as reflecting on owner identity.
Although Bernard Arnault has been strongly against the idea that their products are being bought for showing off, I bet that a majority of their sales are to satisfy this type of demand. It is human nature to showcase their shiny objects (ie: for mating, sense of achievement,etc) and it has been embedded in us since our ancestors.
Then, they will consistently increase the average selling price to reinforce their luxury brands status. Take the example below, LVMH has increased their price for LV speedy handbags by 5% for the past 40 years and it is moving its assortment to higher price ranges over time.
Sources: Bernstein analysis
Marketing
This is the last piece of the puzzle to create desirability. Theoretically, if the brands have so much desirability, marketing seems to be a waste of money as the brands itself will be good enough to attract customers, This is true to a certain extent.
The way LVMH sees it is different. For them, marketing is not merely about exposure. It is also about delivering a message and a story behind the brands. Thus, the way LVMH markets itself is by sponsoring events that are closely related to them. For example, LVMH sponsors the Louis Vuitton Cup, a sailing event, not any specific boat or striking a deal with the Olympic games that is scheduled to be held in Paris in 2024.
Besides, LVMH is also skillfully selecting ambassadors (mostly celebrities with international fans) that share their values. Some great examples are Lionel Messi and Christian ronaldo (LVMH), Black pink (Jisoo with Dior, Rose with Tiffany & Co, Lisa with Celine) and BTS, etc.
It sort of reminds me of Nike where they basically dominate the top notch athletics segment by signing exclusive deals with them. Usually, the top will get the most attention and it is easier to convert the hardcore fans into their customers. These celebrities will also want to associate with industry leaders thereby creating a strong network effect.
Economy of scale
LVMH probably is the first conglomerate for luxury houses and realizes that with all the brands collected under one roof, it gives them enormous bargaining power on the supply sides.
Imagine when LVMH bargaining for leases with its owners, it is undoubtedly going to be beneficial to LVMH as they will be leasing a few stores instead of one at the same time. It gives them a chip to request for the best location, cheapest rent, most exposures,etc. It is a win-win for both as the owners win by LVMH ability to draw foot traffic and LVMH securing the lowest cost to operate.
Same goes for their advertising expenses (shared among the group of portfolio), raw materials (used similar leather,wools,fur), etc. Besides, they also benefited when it comes to hiring talents such as designers, managers, etc as it helps to build their resume. It becomes a magnet for talents as they usually look for industry leaders. (more opportunities as well)
LVMH high margin can be attributable to both its exceptional pricing power as well as lowest cost to operate. It is something that is tough to replicate by its competitor.
Management
There are two things that I would like to highlight on how Bernard Arnault built his empire and why it is important going forward.
Long term thinking
We tend to benefit in life, says Russo, “when we sacrifice something today to gain something tomorrow. When it comes to the capacity to suffer, LVMH certainly is one of the top in the lists. The mindset of long term thinking has been deeply embedded within its family members. Take for example, he mentioned that he is willing to take decades to nurture a brand.
“Take some of the small makeup companies we have acquired recently, like Bliss and Urban Decay. When we bought them, they were little start-ups run by their founders—very simple businesses, but with a lot of originality in the products. So now we know we must nurture them until they have some history. But even if it takes ten or 15 years for them to become stars, that has been an amazing investment, right?” Bernard Arnault, Interview with HBR.
Here is another view on how he thinks differently from some US companies:
However, it is difficult, for a business like ours, to be permanently focused on the current quarter while we are building a brand for the next twenty years. In the US this sometimes leads to short-sighted decisions taken to the detriment of the long-term interest of the company. Bernard Arnault”
Decentralise
Every great business shares this characteristic of decentralization. There is no difference for LVMH. I would argue that it is much more important for them as fashion requires creativity and centralization will only stifle it.
“Our philosophy is quite simple, really. If you look over a creative person’s shoulder, he will stop doing great work. Wouldn’t you, if some manager were watching your every move, clutching a calculator in his hand? So that is why LVMH is so decentralized. Each brand very much runs itself, headed by its own artistic director.
Central headquarters in Paris is very small, especially for a company with 54,000 employees and 1,300 stores around the world. There are only 250 of us, and I assure you, we do not lurk around every corner, questioning every creative decision. Bernard Arnault, Interview with HBR”
However, he keeps a fine balance and protects the downside risks of freedom.
“We do not put the entire company at risk by introducing all new products all the time. In any given year, in fact, only 15% of our business comes from the new; the rest comes from traditional, proven products—the classics. Bernard Arnault, CEO of LVMH”
Ownership and succession
The Arnault family is likely to remain in control for the foreseeable future due to how they structure their shareholding. Despite having a 48% of economic interest, the family has around 64% of voting rights which give them absolute control on how to run their business.
Currently, all his children are running a part of the business. Below is a table summarizing their roles:
Sources: Compile by TQI capital
With Bernard Arnault approaching retirement age, there are many questions on succession. Bernard Arnault is not going to leave succession to chance. It is because he understands the importance of it since he often makes use of family friction to his own advantage. It is something that he would want to avoid at all costs.
For example, he has been training his children since young and most of them started running the business at an early age. (usually mentored by experienced executives) Besides, he also focuses on meritocracy and most of his children attended difficult schools to prove their worthiness.
In addition, he also transformed the holding company into a limited joint-stock partnership that gives them control despite small holdings. Lastly, he created a second entity, Agache Commandite SAS, that is owned by his five children, each with a 20% stake.
It is to empower his children and to make important decisions such as dissolving the company or selling their shares (can’t sell for 30 years) will require unanimous board approval. Once that period lapses, only direct descendants of the elder Mr. Arnault will be able to hold the shares.
However, I believe that Bernard Arnault is still going to run the business for a while as LVMH has extended the retirement age from 75 to 80 years old (He is 74 years old now).
Capital allocation
Sources: Compile by TQI capital
Bernard Arnault is considered one of the best capital allocators due to the value he has created throughout his entire career in LVMH. With only $15mil of investment, he managed to turn it into $190 billions of wealth. His strategy is simply acquiring brands with heritage, investing heavily to grow organically (direct retail, innovation, etc) with the remaining returning to shareholders.
On acquisition
He is very particular about the company that he acquired. This is because he understands that desirability is hard to replicate even with talents and money. Heritage as well as the longevity of a brand plays a big part when LVMH makes its acquisition.
“Okay, we have a genius here with Christian Lacroix,” but we learned that genius is not enough to succeed. It was something of a shock, to be honest, to discover that even great talent could not launch a brand from zero. A brand must have a heritage; there are no shortcuts. BA, Interview with HBR”
“When he talks about potential acquisitions, he’s not looking for the brand that’s hot right now. He’s looking for a brand that he thinks can be here 100 years from now,” said Anish Melwani, chairman and CEO of LVMH for the US.
As a result, most of its brands have a long history of operations.
Sources: Compile by TQI capital
That being said, there are some poor acquisitions as well. Some of its fashion brands like Celine and Marc Jacobs have been nowhere near as successful over the last decade.
The true test will be their biggest acquisition ($15.8bil) - Tiffany & co in 2021 at 4x P/S or 30x P/E. Currently, LVMH has appointed some of his most trusted lieutenants (Michael Burke, CEO of LV, Alexandre, his 3rd son, Anthony Ledru, Ex cartier executive, etc) to run the company in hope that it can be a star brand for LVMH.
Can they replicate the success of Bulgari? (3x sales and 6x profitability since acquisition in 2010). It remains to be seen but it will be another major pillar for its business. (LVMH is pretty late in the jewellery space and Richemont (owner of Cartier, IWC, Montblanc, etc) could be the next acquisitions target if they are opened for acquisition as it is known for lacking successors and constantly being attacked by activists).
Other smaller acquisitions ($3.2bil) like Belmond in 2018 show their commitment to expand into upscale hospitality. LVMH’s belief that “the future of luxury is in luxury goods and in luxury experiences”. It is a small segment for now but it will be another growth pillar for LVMH.
Competition and risk
The rise of affordable luxury
After researching the industry, I totally agree with the statement by Kapferer, “luxury is superlative, not comparative”. The beauty of luxury is that a consumer can own both Hermes and Louis Vuitton at the same time. This is because they are serving different markets and identity. This is why luxury stores usually open next to each other and it only strengthens their brand image overtime.
Bear argues that their real risks are coming from the change of consumer taste such as youngsters are looking for something fresh and differentiated or even sustainability. As a result, it has created a new trend - affordable luxury.
These players are more aggressive with innovation and mainly sell through online at an affordable price. A good example is Allbirds who claim to be the most sustainable shoes and clothing. They constantly talked about the legacy players being cruel and using unsustainable materials such as animal skins or furs.
Or Blue Nile, one of the top companies ruling the online market for lab-grown diamonds. It is priced substantially lower than real diamonds and it is responsibly produced unlike the legacy players who use forced labourers in Africa. Although most of them claim to source ethically, it is tough to verify.
Counterfeiting
Another business risk for them will be counterfeiting and it is relatively hard to eliminate as the market is so big and different countries have different stances on it. LVMH spent $100mil alone to fight against counterfeit and it will be a continuous effort going forward.
This is because counterfeiting not only affects their sales, but it is also diluting their brand desirability. Most consumers will not be able to differentiate between real or fake and their brands will likely take a hit when something wrong happens to them.
Conclusion
There are a few concluding thoughts to wrap up on the research:
1) The luxury market is huge and it is expected to grow by 3-8% annually by 2030. (estimated $2.1 trillion dollar if assuming 5% CAGR) It is due to a few key trends like the rise of China consumer wealth, females are getting richer and their customers are getting younger.
2) The company has mastered the paradox of luxury brands and looking to replicate more star brands (Louis Vuitton, Christian Dior, etc)
3) LVMH economy of scale has helped to improve both their profitability and barriers to entry
4) It is growing its hard luxury (jewellery and watches) and experiential segment (usually through acquisitions)
4) It is headed by one of the best capital allocators (Bernard Arnault). Besides, It is also a family owned company with significant stake and control (48% economic interest and 64% voting rights). Lastly, the management possess some of the high quality traits like long term thinking and decentralisation
5) The company balance sheet is also solid with reasonable leverage (1.1x Net debt/CFO) and high cash conversion rate (prudent in accounting)
However, there are a few things to take into consideration such as the rise of affordable luxury and counterfeiting. Besides, the company is also going to be affected by the cyclical nature of the industry as luxury goods are highly dependent on consumer discretionary income. For example, their sales are adversely affected during major crises such as the 2008 financial crisis or 2020 pandemic. That being said, they do rebound quickly once the economy stabilizes.
Lastly, regulations like the luxury tax might be a threat to their consumer buying powers as countries are looking for more sources of revenue. For example, Malaysia has implemented a luxury tax at around 5-10%. Of course, it will affect the industry as a whole but LVMH, being the largest player, will have the most exposure. (could be cushion if they bought it from overseas but will affect local demand)
In conclusion, there are hardly any companies in the industry that are as dominant as LVMH. If I am going to make a bet on who is going to be the winner for the decade, LVMH will certainly be my top pick. As for other monobrands, it is likely that they will be consolidated by the bigger players except only a few truly exceptional brands like Rolex, Hermes, etc will remain independent. (as per Erwan prediction)
Based on the current valuation, I do believe that it is fairly reasonable. It is a buy for me but I do hope for more margin of safety. (Average down will be my strategy going forward)
Disclaimer: I have position in the company and receive no fees for writing the post. I am not affiliated or have any role with the company. This post is just for educational purpose and it is not an advice to buy or sell the stocks. Invest at your own discretion.
Resources
The Complete History & Strategy of LVMH by Acquired
LVMH: The Civil Savage by The Generalist
Edelweiss Capital on luxury brands: Part 1, Part 2 & Part 3
LVMH and The Luxury Strategy by Punch Card investor
Learning from LVMH's Bernard Arnault by Masterclass
Sources: Erwan Rambourg
Sources: LVMH website on collaboration
Sources: Luxe digital
Sources: Erwan Rambourg