Topic: An investment in LVMH
Conclusion: Just say no
Until today, I’ve never looked twice at the LVMH share, but that’s about to change.
It’s now 5:55 p.m. Swedish time on Saturday, February 17, 2018 and I’m about to google the company for the first time, and form an opinion on its shares.
To be clear, it’s almost completely irrelevant whether LVMH makes telecom equipment or champagne and leather bags.
The two things that do matter are:
- What profits and cash flows LVMH can reasonably be expected to produce
- How much of those will be distributed to shareholders, and how the market will value those profits and cash flows (or otherwise decide on the share price)
Everything else is “assistance fluff” used to determine 1 and 2.
Don’t get me wrong though, it is important to know what business LVMH is in, in order to assess the company’s sustainability. What’s not important, however, is my view on the design or quality of their bags, the value for money I get from LVMH’s champagne or cognac, or attractiveness of their accessories, watches (did you notice my LVMH watch in the after ski picture above?), perfumes, cosmetics and… magazines (?).
Any single product or brand in this vast conglomerate is all but insignificant, no matter your subjective perception of its importance
But I trust you already understand as much.
By the way, it’s now already 6:05 p.m., so I’d better get started.
Valuation vs. financials and market position
My first observation is that with a market cap of 126bn EUR at a P/E ratio of 24.5 and a P/Book ratio of 4.3 they sure need to have a plausible plan for how to grow strongly and consistently for me to be interested. Alternatively, the numbers have to be fudged in some way (NB: fudging usually takes place in the opposite direction).
I have no interest in a deep dive in LVMH’s financial statements, so instead I just googled “LVMH financials” and found this on Reuters.
The 5-year sales growth has been 8.8%, and the 5-year EPS growth 8.3%. The numbers unfortunately are all over the place for other time periods, but 8.8% seems plausible as both a historical gauge and an estimate for the future. I mean, why wouldn’t a leading luxury goods house take some market share from the general economy, also known as customer “wallet share”, and thus grow a few points faster than average?
Another consideration is whether LVMH has a wide moat (sustainable competitive advantage) that warrants a higher than average long term growth forecast? Maybe, maybe not, but for now that’s probably the safest bet (that they do have an advantage that will allow for continued growth outperformance). My hunch is that consumers want to be mislead, and LVMH has a position and cash flow that permit outspending competitors in terms of marketing. Did you know that most of the advertising for luxury products is directed toward those who have already bought from the company – it’s there to alleviate post-purchase disappointment and cognitive dissonance.
The consensus forecast for 2019 is 12 EUR per share, which is +9% up from 2018, and the long term projected growth rate is 10%. I think that is a little too high, considering the 5-year historical average of less than 9% growth during a global stock market boom and immense central bank liquidity injections. I have nothing to add regarding the company’s historical numbers for leverage, margins, tax rates etc., other than that LVMH strikes me as a streamlined and efficient company – a mature category leader. The “mature” part makes me think I can simply extrapolate all numbers into the future. In real life forecasting is never that easy, but for now I’m painting this picture in broad strokes.
There’s just one thing that bothers me a bit: the ROE, Return On Equity, is “just” 17-18% for a P/Book of 4.3. That implies a required rate of return for investors of just 4% Sure, there is growth on top of that, and there is compound interest if you let the years pile up, but for every single year, the implied return for an investor is actually just 4% – unless the P/B valuation multiple increases over time. On the other hand the implied return is 4.4 per cent year two…
6:30 p.m. Here I had to take a short break for overseeing dinner, not to mention having a re-fill of champagne
Pros and cons with an investment in LVMH
There are upsides: great market position, proven growth model, proven investor interest in the stock, great cash conversion (cash flow is higher than profits), they already have a normal to high tax rate of 30 per cent, and a future proof product (vanity never dies).
But there are downsides too: a lowly 4% implied return on an equity investment, a P/CF of 17x and a P/E of 24x, not to mention the risk of an unprecedented era of easy money and widespread conspicuous consumption coming to an end.
TINA: There Are No Alternatives?
Sure, I get that in today’s low interest rate environment there aren’t many good alternatives, and a 4% real return, although with operational risk, is much better than 0% or negative real return.
Nevertheless, remember that the LVMH share has occasionally traded at much lover multiples in the past, and my best guess is they’ll do it again when the economic cycle turns. Actually, the LVMH share lost 50% in both of the most recent down cycles. I’m betting they’ll do even worse this time round. Notwithstanding that, I think the minimum return requirement for any equity investment should be 8-10%.
Please keep in mind that interest rates and inflation are cyclical phenomena and equity investments have extreme duration. Hence the current ZIRP/NIRP paradigm shouldn’t affect your tolerance for high multiples.
I know I’m getting out on a limb here. Some will say the growth rate of 9% should be added to the ROE for a total of 13% de facto ROE. I don’t agree, although there is of course some growth effect to consider. Anyway, I’m used to critique regarding my valuation methods. I still, e.g., remember the ridicule I faced when the Swedish retailer H&M traded at 350+ two years ago, and I said I wouldn’t touch it above 200 (it’s now at 135-140).
The LVMH case smacks of the same situation all over again. Although this is not a recommendation in any way, shape or form, I would hold off buying any LVMH shares above 150. Personally, I doubt I’ll buy any until it hits two digits at 99 EUR/share. Why not check at my P/E=1 idea in this post instead?
Cheers (6:50 p.m., I spent almost an hour on this! I hope you’re happy!!)