Description

Richemont is a Swiss company that owns iconic brands such as Cartier, Van Cleef & Arpels, Montblanc, Vacheron Constantin, Piaget, Peter Millar and others. The company has two main divisions: Jewellery and Watchmakers.

The focus of this writeup will be the Jewellery segment as it accounts for most of the value.

Cartier might be one of the strongest brands in the world and Richemont’s Jewellery segment one of the best durable businesses that I know. This statement is backed by numbers: over the last decade, sales have grown from $5.2bn to $14bn; 10% CAGR. This has been accomplished mostly organically, investing behind their 2 most important brands Cartier and Van Cleef & Arpels complemented with a small acquisition of Buccellati. The segment generates significant operating margins of ~35%. In terms of durability, think there are few brands as timeless and iconic as those under this portfolio. For example, the Cartier Tank watches have been roughly the same for 100 years, while remaining in high demand and retaining value. The Love Bracelet has not really changed in 50 years.

Going forward, Jewellery should continue as an attractive category and Richemont should remain the leader. Only 20% of sales are “branded”, the rest is through independent smaller jewelers. Branded is taking share and that explains some of the growth of the last decade, coupled with pricing and some volume as the appeal of luxury goes global. These factors provide a big tailwind for sales going forward.

There are significant barriers to entry, and there are some industry characteristics that protect the company from new entrants. For example, training jewellers takes years before they are ready to build some of the most complex pieces. These pieces are done by hand so there are no easy shortcuts. There is another layer of protection as the business requires significant amounts of capital that keeps some of the competition at bay. Jewellers need to buy high value raw materials and keep inventory as the process of gathering materials, building the pieces and selling takes time. For example, Richemont has over $7bn in inventory. On top of that, they have invested and keep investing large dollars behind their brands through advertisement, stores, etc. Richemont as a whole will probably spend close to $2bn in communications annual. This is a tough ask for independent players and larger players should keep benefitting from scale. This is all on top of years building brand equity, gaining the trust of a small but valuable customer base, controlling some of the best real estate, etc.

Think high end jewellery, where Richemont plays and leads, has some of the characteristics of great businesses. These few true luxury brands have the ability to raise prices, without impacting demand and that is exactly what they have done. If done orderly, it can even raise the appeal of the product. Richemont has been quite strategic with this, as year after year they have increased prices. The lack of change is also great, as they don´t rely on fashion and hitting it with a new concept. It is just relying on the value of timeless design and pieces that appreciate through generations. Their customer base has significant purchasing power, so these relationships over time can be extremely valuable. The business has been shifting towards DTC over time, so they will know more about the end customer and reduce the amount of accounts receivable.

Why this opportunity exists?

Shares are down close to 30% over the last 6 months.

Some of it can be attributed to industry wide slowdown. Luxury was a big beneficiary during Covid as customers accelerated spending on these items. For example, Richemont Jewellery increased sales 80% over last 3 years. The expectation is for sales to moderate going forward. In the last quarter, we started to see some of this in the numbers. My guess is there will be some moderation and digestion over the next few years, but should be manageable. Would not be surprised if there is no sales growth over new 2 years as demand normalizes.

A positive is that close to 75% of sales are DTC so there is not a huge glut of inventory at wholesalers. In the past they have had to even buy inventory from resellers as to avoid them dumping it to the grey market. Now they have been paying attention to end market demand instead of stuffing the distributors.

Another area of concern is management. Johan Rupert owns 9% of the company but has control via the B shares, that have higher voting power. He is a polemic figure, as he has no filters and is willing to go against the crowd. For example, the company has +$5bn of net cash and has resisted pressure from activists to return it to shareholders. Also, Rupert is not an aggressive acquirer and has resisted pressure to use the cash for acquisitions. He constantly says that they are in the business of creating goodwill and not buying it. He also says that great assets are not for sale and what is for sale normally has problems. I actually like his non-conventional style but it´s not for everyone.

Finally Farfetch. A few years ago, Richemont invested in the JV Farfetch China. In 2022, they agreed to sell YNP to Farfetch. This deal now is close to collapsing, as the buyer has run into trouble. Richemont probably just wanted to get rid of YNP but now they will probably retain the asset. A positive is that it seems like Richemont is not willing to put additional capital into Farfetch. This situation is ongoing but hope they keep a distance from this company.

A rough overview of YNP, as it seems we will have to keep the asset. YNP is a luxury ecommerce platform. The company has been investing behind it under the theory that the industry needs a neutral online marketplace and an ecommerce solution. They have been trying to bring other players into the fold but with little success. As of now, YNP is still money losing and has been a huge distraction for Richemont. My guess is investors would probably be happy if they just shut it down. If Farfetch deal collapses, then we will have to manage through the uncertainty. The asset is not significant in terms of value, and if retained will probably lose $200mm/year. My guess is that they will try to dispose or reduce the negative impact, as previously intended under the Farfetch deal.

Valuation

Think most of the company´s value is in the Jewellery segment. As previously mentioned, this segment has grown sales at 10%/yr over last decade. I expect over the next decade, sales should grow +5%/yr as branded jewellery takes share, wealthy population increases with GDP, price increases, etc. Margins should remain close to the current 35% level. How much is a durable global brand, that can grow and increase prices over time worth? I would be willing to pay 20x FCF of 5% earnings yield for this asset. My guess is that it´s probably worth more than that. The Jewellery segment should generate close to $4bn in FCF this year. At 20x, the segment would be worth $80bn. That is close to $135/share.

On top of that, the company has $10/share in net cash. So we have $145/share in value vs a market price of $113. Seems like a good value for such a high quality asset.

I am assigning no value to the Watch or Other segments. The watchmaker segment last year did $3.9bn in sales and 19% EBT margin. The Other segment which includes brands such as Peter Millar, Montblanc, Chloe, etc has been basically break even over the last few years. Some of these brands are still not large enough to move the needle and other are just not good businesses.

Corporate costs are roughly $400mm. For simplicity, I assign no value to these two segments and assume they just cover the unallocated corporate costs. This is quite conservative as some of these brands have a ton of value.

The importance of the Jewellery segment has increased over time. Over the last decade, Jewellery as % of total sales has increased from 50% to 70%. Also, as % of total EBT has increased from 75% to +90%. Richemont has become a higher quality company through this transition.

*Company reports in Euro but is listed in Switzerland so Share Price is CHF. I do the same in this writeup.

Catalyst

-Farfetch situation clears up

-Succesion is announced

-Investors get a sense of demand bottoming out

-LVMH takes aim at Cartier