Compagnie Financière Richemont is one of the largest luxury companies in the world. Richemont's largest business segment is jewelry, and archeologists have found that humans have been wearing jewelry for more than 150.000 years. Thus, it seems unlikely that jewelry will fall out of favor anytime soon. Richemont owns some of the most well-known jewelry and watch brands in the world, but does this make it a good investment? This is what I am going to investigate in this analysis.
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The Business
Compagnie Financière Richemont is a Swiss holding company and the fifth largest luxury company in the world. Established in 1988 and headquartered in Bellevue, Switzerland, Richemont operates through three segments: Jewellery Maisons, Specialist Watchmakers, and Other. The company is involved in the design, manufacture, and distribution of jewelry products, precision timepieces, watches, writing instruments, clothing, leather goods, and accessories. Richemont's products are offered under several renowned brands, including Cartier, Van Cleef & Arpels, Buccellati, A. Lange & Söhne, Baume & Mercier, IWC Schaffhausen, Jaeger-LeCoultre, Panerai, Piaget, Roger Dubuis, Vacheron Constantin, Alaïa, Chloé, Delvaux, dunhill, Gianvito Rossi, Montblanc, Peter Millar, Purdey, Serapian, AZ Factory, Watchfinder & Co., TIMEVALLEE, MR PORTER, The Outnet, and YOOX NET-A-PORTER. However, the company is planning to sell the majority of its shares in MR PORTER, The Outnet, and YOOX NET-A-PORTER. Richemont's largest segment is Jewelry, which contributes 69% of sales, followed by Specialist Watchmakers at 18% of sales, and Fashion & Accessories/Other at 13% of sales. Its largest market is Asia Pacific (34% of sales), followed by the Americas (23% of sales), Europe (22% of sales), Japan (11% of sales), and the Middle East & Africa (10% of sales). Richemont has a moat through its brands, many of which are over a century old and have built brand recognition over time. This means that customers trust these brands and are willing to pay a premium price for them.
Management
The CEO of Richemont is Nicolas Bos. He joined the company in 1992 and became the CEO in June 2024. Nicolas Bos, a distinguished graduate of ESSEC Business School, brings a wealth of experience to his new position at Richemont. His journey within Richemont has been marked by significant contributions. In 2000, he transitioned to Van Cleef & Arpels, eventually rising to the position of Global President and CEO in 2013. Notably, since September 2019, Bos has also overseen Buccellati, showcasing his versatility and adeptness in the luxury goods industry. According to Chairman and founder of Richemont, Johann Rupert, he asked Nicolas Bos to become the CEO 18 months before he eventually accepted the role. Initially, Bos was hesitant, stating, "I'm going to have to disappoint you because I'm having far too much fun with what I'm doing right now. And I don't need the hassles and the politics and everything of a CEO role." Rupert responded, "That's exactly why we want you. We don't want a unification power thing. We want somebody who doesn't want the job." Eventually, Bos took the job. While he is new in his position, he will be supported by Chairman and founder Johann Rupert, which I believe is beneficial. Johann Rupert has expressed his reluctance to be persuaded by investment bankers to do buybacks when shares are trading at a high valuation and to raise prices excessively during good economic times because if the economy turns, lowering prices would hurt the brand value. Overall, I believe that Nicolas Bos has the experience to lead Richemont moving forward, and I like that Johann Rupert is still the Chairman. Thus, I have great faith in the management.
The Numbers
The first metric we will investigate is the return on invested capital (ROIC). We require a 10-year history with all figures exceeding 10% for each year. Richemont has delivered some underwhelming ROIC, as it has only been above 10% in three out of the past ten years. There are several reasons for the low ROIC. One is that Richemont has made several acquisitions during this period. Another reason is that Swiss watchmakers were flooding the market with Swiss-made watches in 2015, 2016, and 2017, where all companies sold as many watches as they could, which hurt margins. In 2018, the largest watch market in the world, Hong Kong, froze up due to protests, which hurt all companies. Finally, there has been the pandemic, which affected the company as well. Nonetheless, the overall numbers are still underwhelming, but it is encouraging that Richemont has managed to deliver a ROIC above 10% in the past two years, and hopefully, it is a trend that will continue.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. I don't have the growth rate from 2013 to 2014 as Finbox only provides data for the past ten years. Richemont has made several acquisitions over the past ten years, which has affected the numbers. However, it is encouraging to see that Richemont has managed to increase its equity year over year in most years. Richemont delivered its highest equity in 2022 and almost reached that peak in fiscal 2024, which is encouraging.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising that Richemont has delivered positive free cash flow every year over the past ten years. It is encouraging to see that Richemont has achieved its highest free cash flow in the past four years. The levered free cash flow margin has also increased over the past five years, and while it hasn't reached the heights of 2022 again, it is encouraging that it increased from fiscal 2023 to fiscal 2024. The current free cash flow yield is slightly higher than the ten-year average, indicating that Richemont is trading at an attractive valuation, but we will revisit that later in the analysis.
Debt
Another important aspect to consider is debt. It is crucial to assess whether a business has a manageable level of debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings. After analyzing Richemont's financial statements, I have concluded that the company has 1,54 years of earnings in debt. This is well below the three-year threshold, indicating that debt is not a concern when considering an investment in Richemont.
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Risks
Based on my findings so far, I believe that Richemont is an intriguing company. However, no investment is without risk, and Richemont also has its fair share of risks. Macroeconomics. The luxury sector is sensitive to economic cycles, and a downturn can significantly impact consumer spending on high-end goods. Furthermore, geopolitical tensions and currency fluctuations can adversely affect the company's international revenues. Management has mentioned that continued macroeconomic and geopolitical uncertainty, as well as unfavorable foreign exchange movements, have affected the results recently. This trend is expected to continue, as Chairman Johann Rupert has mentioned that he suspects we are going to have high inflation for longer than Central Banks think. Foreign exchange rates have also impacted the company, which is evident when looking at Richemont's operating profit. In fiscal 2024, operating profit was 5% lower than the previous year, resulting in an operating margin of 23,3%. However, the currency impact was quite significant. At constant exchange rates, operating profit increased by 13%. The gross profit margin included a 200 basis point negative foreign exchange impact, while at constant exchange rates, the gross margin was up 130 basis points.
Competition. Richemont faces stiff competition from other large luxury conglomerates such as LVMH, which possess substantial resources, strong brand portfolios, and significant market influence. For instance, in an earnings call, LVMH's CEO Bernard Arnault mentioned that Richemont owns two brands (Cartier and Van Cleef & Arpels) that are considered among the top eight luxury brands, while LVMH owns four of these eight brands (the last two being Hermès and Chanel). Furthermore, the luxury market continually sees new entrants that bring fresh designs, innovative marketing strategies, and a strong digital presence. These new entrants have the potential to attract younger, fashion-forward consumers.
Counterfeiting goods. One of the biggest threats to the luxury sector today is counterfeit goods. Preserving the creativity and rights of designers, artists, and brands is crucial for the long-term survival of luxury companies. All companies in the luxury sector have experienced counterfeiting since the earliest days of their success, and it is an ongoing risk. Chairman Johann Rupert has mentioned that "when people buy a fake watch, fake Cartier or fake Rolex, and their friends said to them, ah, beautiful watch." They either lie to their friend, but they're a little bit embarrassed. And then guess what, they eventually buy the real one". However, the risk from counterfeits has increased with the emergence of social media platforms such as TikTok, which target the younger generation of shoppers who do not mind owning counterfeit products. Counterfeiting goods may negatively impact Richemont in various ways. Every counterfeit sale represents a lost opportunity for the brand to sell authentic products (at least initially). Additionally, counterfeit goods saturating the market may diminish the demand for genuine products.
Reasons to invest
There are also numerous reasons to invest in Richemont. One reason is the favorable market conditions for the luxury sector. Several factors support the sector's growth. One key factor is that customers start buying luxury goods at a younger age. Data from the U.S. indicates that Millennials earn similar incomes to their parents at ages 25 to 34 but have significantly less savings than previous generations, suggesting a "you-only-live-once" mentality. Additionally, data suggests that the youngest generation (Generation Z) starts buying luxury items three to five years earlier than Millennials did. These generational factors could significantly contribute to the industry's growth over the next decade. We don't have numbers from Europe, but it likely follows the same pattern. Another tailwind for the luxury sector is the global growth of the middle class. By 2030, another 700 million people are expected to join the global middle class, which will comprise more than half of the world's total population. The middle class is already the largest spending group in the world. In 2020, the global middle class spent $44 trillion, which accounted for 68% of the world's consumer spending. By 2030, middle-class households are expected to spend even more, an estimated $62 trillion, which is 50% higher than in 2020. Thus, a growing middle class and the trend of purchasing luxury goods at a younger age are favorable conditions for the luxury sector.
The jewelry segment is Richemont's highest-margin segment, with an operating margin of 33,1%. It is encouraging that Richemont's jewelry sales have more than doubled in the last five years, reflecting a 16% compound annual growth rate (CAGR). Management believes several trends will continue to drive growth in the jewelry segment at these rates. One is the durable nature of jewelry, which can be worn for decades and passed down to future generations. As the world adopts a more sustainable attitude, focusing on using more and wasting less, this will benefit the jewelry market. Another factor is the increasing attractiveness of jewelry for men as a means of self-identity, a trend that management observes growing globally. Finally, compared to other luxury segments, the market share of unbranded jewelry remains very high. However, branded jewelry continues to gain market share, and management believes there is significant potential for branded jewelry in the years to come.
The speciality watchmaker segment at Richemont has lower margins compared to its jewelry segment, with an operating margin of 15,2%. However, this margin has significantly improved by 550 basis points from 9,7% in fiscal year 2018, indicating that Richemont has successfully increased the profitability of this division. Management has stated that its Specialist Watchmakers brands have evolved towards a sustainable business model focused on client centricity and true demand. Many of the eight brands have reached a new scale, collectively generating incremental sales of more than CHF 1 billion since 2018, an absolute 39% sales increase. Management has also noted that it is unlikely the market will see a repeat of the 2015 to 2018 period, when Swiss watchmakers flooded the market, putting pressure on margins. This is because Richemont and other Swiss watchmakers now understand that flooding the market does not benefit the industry.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 6,43, which is from 2023. I have selected a projected future EPS growth rate of 11%. Finbox expects EPS to grow by 10,6% in the next five years. Additionally, I have selected a projected future P/E ratio of 22, which is twice the growth rate. This decision is based on Richemont's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be CHF 99,29. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Richemont at a price of CHF 49,64 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 4.570, and capital expenditures were 850. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 595 in our calculations. The tax provision was 815. We have 587,7 outstanding shares. Hence, the calculation will be as follows: (4.570 – 595 + 815) / 587,7 x 10 = CHF 81,50 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Richemont's Free Cash Flow Per Share at CHF 6,33 and a growth rate of 11%, if you want to recoup your investment in 8 years, the Payback Time price is CHF 83,33.
Conclusion
I find Richemont to be an intriguing company, and I also have great faith in the management despite the CEO being new. I believe that Richemont has a strong moat, as some of its brands have been around for more than a century, meaning these brands have been trusted by consumers for generations. While Richemont has delivered underwhelming ROIC in most years, it is encouraging that ROIC has improved in the past two years. Macroeconomic factors pose a short-term risk for Richemont, especially due to foreign exchange rates, which have affected the company because of the high Swiss franc. Furthermore, management believes that high inflation will stick around for a longer time, which may also impact Richemont. Competition is a risk as Richemont competes with some great companies in both jewelry and watches. However, Richemont has some of the strongest brands in the industry, and the CEO and founder of LVMH owns shares in Richemont, indicating he is not overly concerned about competition. Counterfeits could affect the industry, and while some of Richemont's competitors have mentioned that counterfeit goods are one of the biggest risks for the industry, Richemont doesn't seem to be overly concerned about it. Personally, I believe it is something that needs to be monitored. Long-term, Richemont should benefit from favorable market conditions for the industry, with people buying luxury at a younger age and a growing middle class around the world. Richemont has delivered high growth in its jewelry segment, and management believes this growth is sustainable for years to come. Richemont has also managed to make its specialty watches segment more profitable and believes the industry has learned from previous mistakes, which should benefit this segment moving forward. Overall, I like Richemont, but due to the low ROIC, I would prefer a discount before acquiring shares. Thus, I will buy shares at the intrinsic value of the Margin of Safety price at CHF 99.00.
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