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Morningstar | Richemont Set to Benefit From Strength of Its Brands and Operating Leverage in Watchmaking Unit

Wide-moat Richemont is the number-two global luxury goods conglomerate by revenue. Over the years, the group has amassed and developed a portfolio of very successful global brands, mostly in the hard luxury segment. Despite more pronounced cyclicality, hard luxury goods benefit from much longer product cycles and lower fashion risk. Most of the group’s brands are at least a century old, have iconic collections lasting 40-80 years, and have historically commanded significant pricing power. Prices of more than $5,000 for most of Richemont’s watch brands and the prestige value attached to them protect the group’s watch business from the emerging technological disruption. Additionally, control over distribution and higher entry barriers in the jewellery business, along with diversification by brand, give us confidence that the company will be able to generate economic profits well into the future, despite cyclicality. Returns on capital averaged 16% over the past decade, ranging from 12% to 22%, above the cost of capital of 8.6%. We expect the company's core business (excluding YNAP) to grow at about 5%, driven by an increasing number of high-net-worth individuals globally, some upside from existing client demand for jewellery, and increased growth for smaller brands (notably Van Cleef & Arpels, which has north of 100 stores versus 300 for Cartier and about 200 for Bulgari). This compares with our long-term forecast of 4% growth for the luxury goods industry and incorporates Richemont's brands' higher sustainable pricing power. We believe this more moderate growth should be less investment-intensive than the prior decade, as manufacturing capacity and global retail networks have largely been built out and the boom-time rent inflation is cooling. As a result, we expect free cash flow to be boosted by operating leverage and lower capital expenditures once demand picks up. The YNAP acquisition should help increase control over distribution for the company's brands and add top-line growth, but it adds uncertainty to the overall business.