EUR 850.00 For Business Accounts Only

Morningstar | Hermes' Results in Line, With No Major Change in 2019 Demand Trends Expected; FVE Maintained

We are maintaining our EUR 347 fair value estimate for wide-moat Hermes shares as the company reported full-year sales and profits in line with our expectations and previously communicated guidance. Gross margin was just a little lower versus the prior year, as nonrecurrence of last year’s hedging gains was offset by strong capacity utilization. Hermes benefitted from operating leverage on its selling expenses, as sales were primarily driven by volume and less by perimeter (selling expenses declined to 24.7% of sales versus 24.9% in 2017), and communication expenses were stable as percentage of sales (5%). Other operating expenses were slightly higher than we expected at 6% of sales (versus 5.6% in the prior year and the 5.5% we anticipated).

Hermes confirmed its intention to increase prices in 2019 by 3%-3.5%, which is higher than the previous year’s 1% lift. The company highlighted increasing worker compensation and raw material prices as a reason for price increases. We note that pricing has been muted over the last couple of years and is now moving closer to historical levels. We incorporate 2% net pricing contribution to growth in our models over the next 10 years.

Diversification within the company’s product categories and product ranges is increasing. Ready-to-wear and fashion accessories as well as other Hermes sectors (jewellery, furniture, and home goods) were the strongest-performing categories last year, growing 14.1% and 19.6% at constant currencies, respectively. The company noted especially strong performance with shoes. Further, store expansion gives the company the ability to present those items to its loyal customers for the first time. Leather goods decreased somewhat as a percentage of sales to just below 50% and remains subject to capacity constraints. Both reinvented classics and new products continue to be successful in the segment, catering to new and existing consumers.

Hermes is further planning to diversify its product range through entry into the beauty category, which would complement its existing fragrance business in 2020. Makeup would be the first area of interest and in line with its business model spirit, not done through licenses but internally and initially distributed in its own stores. Supplies would come from Italy and France, given that Hermes itself lacks capabilities in this field. We expect the build-out of the category to be gradual and initially have a low contribution to sales.

Management noticed no changes in buying patterns in the beginning of the year and said Chinese demand remains solid, driven by existing loyal customers, young consumers, and increasingly women. The Chinese luxury market was initially male-dominated, but now women are gaining share.