Hold Hermes International, But Do Not Buy (OTCMKTS:HESAY)

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Hermès International (OTCPK:HESAY) is an excellent luxury goods business, and one which current shareholders should continue to hold. That said, it is not one that I believe should be bought at this time, and I will explain why in the following paragraphs.

That the Paris, France-based Hermès International is a powerhouse in the global luxury goods sector is incontestable – only Louis Vuitton Moët Hennessy, or LVMH (OTCPK:LVMHF) and the privately-held Chanel S.A. (both French companies as well) command greater brand value.

Luxury Brand Global Brand Value ($)
LVMH 47.214 billion
Chanel 37.006 billion
Hermès 30.966 billion
Gucci 25.274 billion
Rolex 8.389 billion
Cartier 5.998 billion
Burberry (OTCPK:BURBY) 4.698 billion
Christian Dior 4.658 billion
Yves Saint Laurent 3.572 billion
Prada (OTCPK:PRDSY) 3.504 billion

Figures for brand value of the top ten most valuable luxury brands worldwide in 2019. Figures collated from Statista.

This brand strength is augmented by the preference Hermès has for eschewing regional brands in favor of globally uniform brand recognition. The highly-prized Birkin bag, which retails for up to six figures, is one such globally known product. Product diversification is another strength that Hermès possesses, as the revenue breakdown by product for 2019 illustrates. Interesting to note is how dominant the saddlery segment is in terms of revenue, as that is the core business which Hermès began life with nearly two centuries ago.

Product 2019 Revenue (€) 2019 Revenue ($)
Leather goods – saddlery 3.414 billion 3.79 billion
Ready-to-wear/accessories 1.574 billion 1.75 billion
Silk and textiles 592 million 657.49 million
Other Hermès Métiers 525 million 583.08 million
Perfumes 326 million 362.06 million
Watchmaking 193 million 214.35 million
Other products 258 million 286.54 million
Consolidated revenue 6.88 billion 7.64 billion

Figures collated from Hermès 2019 activity report available on Hermès International’s investor relations page.

Geographic diversification is yet another strength, as demonstrated by the geographic breakdown of 2019 revenue and reinforces the global recognition of the Hermès brand.

Geographic Area Revenue (€) Revenue ($)
France 867 million 962.91 million
Europe (excluding France) 1.202 billion 1.33 billion
Japan 864 million 959.58 million
Asia-Pacific (excluding Japan) 2.590 billion 2.88 billion
Americas 1.241 billion 1.38 billion
Other 120 million 133.27 billion
Consolidated revenue 6.88 billion 7.64 billion

Figures collated from Hermès 2019 activity report available on Hermès International’s investor relations page.

This combination of brand recognition, product diversification, and geographic scale accounts for the firm’s profitability, given the 34.39% operating margin and the healthy revenue and net income figures that Hermès International has reported over the past five years.

Year Revenue (€) Revenue ($) Net Income (€) Net Income ($)
2015 4.84 billion 5.38 billion 972.6 million 1.08 billion
2016 5.2 billion 5.78 billion 1.1 billion 1.22 billion
2017 5.55 billion 6.16 billion 1.22 billion 1.35 billion
2018 5.97 billion 6.63 billion 1.41 billion 1.57 billion
2019 6.88 billion 7.64 billion 1.53 billion 1.7 billion

Figures collated from annual reports available on Hermès International’s investor relations page.

That profitability also accounts for the fifteen-year record of consecutively rising dividends that Hermès has distributed to its shareholders, and it seems at this time that Hermès will continue to be able to do so given the 31.27% payout ratio and reported free cash flow of €969.6 million ($1.08 billion). Overall, the 25.32% return on equity shows how shareholders have benefited from this holding hitherto.

It has been questioned whether shareholders will continue to benefit going forward. The consultancy firms Bain and McKinsey have both forecast that the luxury goods sector will see a huge decline in the coming year due to COVID-19. Bain sees sales falling by 50-60% in Q2 2020, while McKinsey sees the market contracting by 35-39% this year. This will, of course, affect Hermès as well.

Hermès is profitable enough, and well-capitalized enough, to withstand the forecasted luxury goods market downturn. Image provided by Forbes.

The firm is well-positioned to weather the coronavirus storm, as its long-term debt of €925.6 million ($1.03 billion) is offset by a net worth of €6.57 billion ($7.3 billion), and its total current liabilities of €2.02 billion ($2.24 billion) are offset by total current assets of €6.09 billion ($6.76 billion), cash-on-hand worth €4.38 billion, and total accounts receivable of €537.2 million ($596.63 million). Furthermore, Hermès is projected to see 12.17% earnings-per-share growth over the next five years. However, the projected market downturn raises the question of whether one should invest in Hermès now.

Prospective investors considering Hermès International as a holding in their own portfolio should look to the shares trading on the Euronext exchange under the ticker RMS as these shares are sponsored by the company – conversely, the shares trading on the over-the-counter markets under HESAY and (OTCPK:HESAF) are not sponsored.

At close of the Euronext market on 06/08/2020, Hermès International traded at a share price of €770.00 ($869.35) with a price-to-earnings ratio of 54.01 and a dividend yield of 0.58%. The current P/E is higher than the five-year average P/E of 42.02, and the current dividend yield is lower than the five-year average dividend yield of 0.81%. This suggests that while the stock is rarely cheap, it is considerably overvalued at this time – is that the case?

To determine fair value, I will first divide the current P/E by the historical market average of 15 to get a valuation ratio of 3.60 (54.01 / 15 = 3.60) and divide the current share price by this valuation ratio to get a first estimate for fair value of €226.47 (770.00 / 3.60 = 226.47). Then, I will divide the current P/E by the five-year average P/E to get a valuation ratio of 1.29 (54.01 / 42.02 = 1.29) and divide the current share price by this valuation ratio to get a second estimate for fair value of €596.90 (770.00 / 1.29 = 596.90).

Next, I will divide the five-year average dividend yield by the current dividend yield to get a valuation ratio of 1.40 (0.81 / 0.58 = 1.40) and divide the current share price by this valuation ratio to get a third estimate of €550.00 (770.00 / 1.40 = 550.00). Finally, I will average out these three estimates to get a final estimate for fair value of €457.79, or $516.86 (226.47 + 596.90 + 550.00 / 3 = 457.79). On the basis of this estimate, the stock is overvalued by 33% at this time.

The quality of Hermès International as a business is indisputable – it is the third-most valuable luxury brand in the world, is a profitable dividend contender, and is financially strong enough to withstand the forecasted luxury market downturn caused by COVID-19. However, its share price will likely fall as a consequence, and for that reason I would prefer to wait for a pullback before parking money here. In short, Hermès is a hold at present, but not a buy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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.

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