Kering: Revival Underway But Impact Yet To Be Seen (Rating Upgrade) (OTCMKTS:PPRUY)

Gucci owner Kering (OTCPK:PPRUY)(OTCPK:PPRUF) might be the fourth largest luxury company by market capitalisation, but its fortunes have branched off from its counterparts in recent times. This shows up in its negative price returns of 25.4% over the past year, even as stocks like LVMH (OTCPK:LVMUY), Hermès (OTCPK:HESAY) and Richemont (OTCPK:CFRUY) managed to show varying degrees of gains (see chart below).

There was a high probability of Kering’s weak returns even when I wrote about it back in July last year on slowing sales and management changes. This prompted a Sell rating on the stock, and it has indeed lost over 21% of its value since. With a 4% decline in reported sales for the full year 2023, it’s clear that the company’s fortunes continue to wane.

However, Kering already had a plan underway in 2023 for a revival, that saw its net debt jump by 3.7x on increased investments. Here I take a closer look at what the plan entailed and whether any impact has shown up so far.

The muted Gucci revival

As Kering’s flagship brand, which brought in half the revenues and 69% of the operating income in 2023, Gucci’s revival is key for Kering. This is particularly so after the brand saw a bigger drop of 6% in revenues in 2023 compared to 4% for total revenues. Its comparable change (on scope and exchange rate basis) was no better, at negative 2%, the same as that for total revenues.

Further, with a 15% drop in operating income, Gucci also saw its operating margin soften. While it’s still strong at 33.1%, it has dropped compared to 35.6% in 2022. This is significant because up to 2022, Kering’s operating margin was at 27.5%, second only to Hermès among its peers, which set it apart. However, after having dropped to 24.5% in 2023, it’s now comparable to both LVMH and Richemont as well.

So far, however, the changes made have seen at best mixed for Gucci. Here’s how:

• New creative director: The appointment of Sabato De Sarno, who has worked with Valentino and Prada in the past, as the new creative director last year was a fundamental change to re-energise Gucci. His collection, which debuted in September 2023, hasn’t exactly led to runaway sales for the brand, though. In Q4 2023, Gucci’s revenues declined by 8% in reported terms and 4% in comparable terms. Still, there’s some hope here, considering that at least the far more challenging results in Q3 2023 (see table below) have been arrested to some extent.

• Market focus: In its capital markets day presentation of 2022, Kering targeted an increased share for Gucci in the US, Europe and China markets. It has succeeded in doing so for Europe, which reported a 31% share in Gucci’s revenues in 2023 compared to 22% in 2022. But the share of North America has declined by 2 percentage points to 27%. Whether this is a reflection of Gucci’s popularity in the market is, however, debatable considering that the US market has been a drag in 2023 for other luxury brands too. LVMH, for example, saw just a 1% increase in revenues from the US in 2023 compared with an 8.8% rise in total revenues.

Inorganic expansion underway

Besides a focus on Gucci, Kering is also expanding inorganically. The highlight in this regard was its acquisition of a 30% stake in Valentino last year, with the possibility of buying out the entire brand by 2028. If Kering does acquire the brand in full, it may well turn out to be a good addition to the company’s roster of brands.

In 2022 (the latest year for which numbers are available), Valentino saw 10% revenue growth at constant exchange rates, slightly higher than Kering’s 9%. However, its revenue for the year at EUR 1.42 billion isn’t big. For context, it was less than that for Bottega Veneta, which was at EUR 1.7 billion, which is Kering’s third largest stand-alone brand after Gucci and Saint Laurent. To put it another way, Valentino’s revenues were less than 7% of Kering’s total revenues, indicating that at least initially it might not provide the biggest growth impetus if fully acquired.

Its newly formed division Kering Beauté also bought the high-end luxury fragrance brand Creed last year. With its 10% share in the EUR 5 billion luxury fragrance market (see chart below), the brand’s revenue would be equivalent to 2.5% of Kering’s 2023 sales. It’s hard to say how far it contributed to the Kering Eyewear and corporate segment, of which it’s part, however. While the segment showed a continued strong 38% revenue growth in 2023, it was nevertheless slower than the 55% seen in 2022.

The outlook and market multiples

Based on the limited results for Gucci so far and the relatively small acquisitions in the past year, it would be a stretch to think that Kering can bounce back with a bang anytime soon. Not with the US and European markets expected to be weak this year along with China’s uncertain recovery.

In line with this, the company expects recurring operating income to contract in 2024 from the year before. Commensurately, analysts’ estimates available on Seeking Alpha show expectations of further decline in earnings per share [EPS] in 2024, after an 18% decline in 2023.

Despite the EPS drag, however, Kering’s forward GAAP price-to-earnings (P/E) ratio to 21.85x, is lower than all its peers’ P/Es, with LVMH at 26x and Richemont at 22.2x, while Hermès, as always trades, at a much higher premium with its ratio at 51.9x. Similarly, Kering also trades at a trailing twelve months [TTM] ratio of 17.1x compared to LVMH and Richemont at 27.5x and 21.5x respectively.

What next?

However, the market multiples don’t alone make Kering a good buy among luxury stocks right now. Especially not considering its falling revenues and earnings even while its peers have seen positive growth in the past year.

Still, there’s something to be said for its efforts at reviving Gucci, growing its market in focus and geographies and expanding through the inorganic route. The results of these steps might not have shown up so far, and going by Kering’s forecast, are unlikely to do so in 2024 either. But they can reap benefits in the medium to long term. I’m upgrading Kering to Hold based on this, though a further downslide in its price can’t be ruled out in the next months if its numbers are even worse than expected.

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.