Hermes Stock: Consensus Estimates For 2024 Are Too Low (Upgrade) (OTCMKTS:HESAF)

Hermes (OTCPK:HESAF) is truly a one-of-a-kind asset in the public markets. This family-owned 200-year-old business attracts the world’s richest and top-tier celebs, without huge investments in brand ambassadors or marketing.

For quite some time, I stayed on the sidelines, as I viewed the company as too big to continue to grow its mono-brand at a similar pace while sustaining this level of desirability. Not anymore.

I’m upgrading Hermes from Hold to Buy, expecting the company’s Q1 revenue update, due in April, to be the next positive catalyst.

Introduction

I’ve been covering Hermes on Seeking Alpha since July of last year, as part of my overall interest in the luxury sector. In short, I think the sector’s characteristics are extremely attractive for investment, due to its general disconnect from the overall economy, its exposure to companies based outside the U.S., and the companies’ long-term-minded yet highly efficient management teams.

2023 taught us that not every high-end brand is in fact luxury, and even true luxury brands don’t necessarily provide the advantages the sector supposedly has to offer. That being said, Hermes is the cream of the crop of the sector and unquestionably does provide such advantages.

The company consistently outgrows its competitors while staying true to its core values and maintaining industry-leading margins. Still, I refrained from investing in Hermes, as I viewed its premium over LVMH unjustified, despite Hermes’ significantly better performance, primarily because I expect LVMH to narrow the gap as we approach a more stable economic environment.

And, while I still estimate that Hermes’ fundamental outperformance will slow down in the upcoming quarters, it does not detract from the fact that I believe Hermes is an attractive investment at its current valuation.

Let’s dig in.

Declining Valuation Premium Over LVMH

If you’ve been following my coverage of the sector for a while, you already know I believe that in luxury fashion, there are only two companies that are truly top quality – LVMH (OTCPK:LVMHF) and Hermes.

The rest of the pack cannot keep up with these two powerhouses, which are led by irreplicable strong leaders in Bernard Arnault and Axel Dumas. Between LVMH and Hermes, however, there’s a huge difference.

The first is a serial acquirer and a huge conglomerate, which caters to several levels of wealthy individuals and participates in lines of business that Hermes doesn’t, namely, wines & spirits, and retailing.

On the contrary, Hermes is a monobrand. Its customer profile does partially overlap with LVMH, but there’s a significant population that Hermes isn’t exposed to.

Those differences result in Hermes being more resilient as well as more efficient and lean as a company. And those differences are exactly why Hermes should undoubtedly trade at a premium over LVMH.

The question was always at what premium, and if in my last article, it stood at over 2.2x, today it is below 2x, and that’s based on 2023 earnings, which doesn’t show the complete picture as we’ll see later in the article.

Entering New Categories

Aside from the premium, another reason I was reluctant to invest in Hermes was my fear that as the economic environment normalizes, its peers will benefit from the return of the aspirational consumer, whereas Hermes will see growth decelerate to more normalized levels, eventually resulting in reduced outperformance.

While that remains a concern, I have more conviction in Hermes’ growth path for the near-to-mid-term, as the business becomes more robust and diversified.

Prior to the pandemic (2013-2019), Hermes grew sales at a 10.6% CAGR. Coming out of the pandemic, growth accelerated due to several factors, primarily pent-up demand, a larger footprint, increased production capacity, and much higher levels of global wealth.

But there’s another factor for the acceleration and strength in Hermes’ results that I believe doesn’t get enough attention. That is Hermes’ success in the non-leather categories.

Interestingly, between 2013-2019, the Leather Goods & Saddlery segment led the company’s growth, outgrowing the rest of the segments by a significant margin with a CAGR of 13%, and reaching 50% of total sales in 2019.

Coming out of the pandemic, we’re witnessing the opposite trend. Growth is being led by the non-leather segments, and that’s despite leather still growing at a similar 13% rate. We are seeing astounding acceleration across the rest of the sectors, including Ready-to-wear, Jewellery, Silk, Watches, and Beauty.

Looking at the graph above, we can see each segment’s CAGR across three time periods. Notice that the only segment that’s stable across all three periods is Leather Goods & Saddlery, whereas the rest of the segments are showcasing a material improvement in the ’19-’23 period.

The important point is that the non-leather segments are still relatively small, combining for less than 60% of the company’s €13.4 billion in revenues for the year. They all have a huge runway for outsized growth, and over the last call, management acknowledged the strength and importance of these categories, providing more assurance that they’re indeed pressing the gas pedal on these fronts.

To me, this is a game-changer.

Digging Into 2023 Numbers

In 2023, Hermes generated revenues of €13.4 billion, growing 16% Y/Y, driven by improvements in all segments, as we discussed earlier. Importantly, the gross margin improved by 150 bps to 72.3%, and the operating margin improved by 160 bps, reaching 42.1%.

While every margin expansion is a welcomed development, in this case, it’s even more impressive, because margins expanded despite Hermes’ most profitable segment in Leather becoming a smaller portion of sales.

If Hermes will be able to sustain operating margins in the 40% range while growing at its usual low-to-mid-double-digit rate, I think it’s safe to say it will remain a market-beating investment for the foreseeable future.

An important factor to consider with Hermes is that it has an overwhelming exposure to Asia Pacific, where it generates almost 50% of its sales. For comparison, LVMH generates approximately 30% of its sales in the region.

This could be viewed as a risk but also as an opportunity, as the Americas region is only 11% the size of LVMH’s, compared to their respective Asia businesses, where LVMH is only ~3x bigger.

Valuation & Growth Trajectory

I fully expect Hermes will continue to grow at a double-digit rate. While refraining from providing quantifiable guidance is a common theme in the sector, management did say that they’ve started 2024 at a similar pace, with the support of a high-single-digit price increase and strong demand.

Fundamentally, the company is highly likely to continue to perform. All that’s left for us to determine is does the current price provides upside.

Currently, consensus estimates for 2024 stand at €15.0 billion in revenues and €43.38 EPS, or growth of 11.7% and 5.3%, respectively. Consensus estimates imply a 170 bps margin contraction, and continued FX headwinds.

In my view, those estimates are too low. Even if revenue growth decelerates to 11.7%, I see no reason for this significant for margin contraction, considering that FX was a headwind in 2023 as well, and that management clearly said they increased prices to cover for increased costs.

Looking at these estimates, Hermes is currently trading at a 50x P/E over 2024, yet if we apply a steady margin, the multiple is slightly above 47x. Additionally, Hermes exited the year with 12.5% revenue growth, and the lower estimates might be too conservative as well.

So yes, no matter how we look at it, Hermes is seemingly trading at a high valuation, somewhere in the high forties. However, this is surprisingly slightly below its 5-year average, and Hermes currently has a company-record net cash position to the amount of €8.5 billion. Furthermore, this reflects an even lower premium over LVMH.

To me, Hermes has room to surprise to the upside fundamentally, and it trades slightly below its fair multiple, considering the net cash position. With the company entering an accelerated growth phase in its non-leather segments, I find this an attractive entry point for long-term investors.

Conclusion

Hermes is a unique asset in the public markets, being arguably the most successful family-owned brand in the world.

The company continues to beat expectations and leave dust to its competition, as its high-quality management drives operational excellence and leads the company to succeed in new categories.

While the valuation seems prohibitive on a shallow look, Hermes is actually trading slightly below its historical levels considering its net cash position.

I believe the company is going to continue to grow EPS at a mid-teens pace, which is materially higher than current estimates.

For those reasons, I upgrade Hermes to a Buy.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.