EUR 850.00 For Business Accounts Only

Morningstar | We Lift Our FVE for LVMH to EUR 231 on Back of Higher Expectations for W&J Division Profitability. See Updated Analyst Note from 25 Jul 2018

We are increasing our fair value estimate for LVMH to EUR 231 from EUR 201 per share as the company reported a strong first half. Our fair value increase mainly reflects our revised long-term assumptions about profitability in the watch and jewellery division, which we increase to 16% from 14%, driven by a strong improvement in profitability for Bulgari, which we model to exceed 20% over the next decade, in line with peer Tiffany. We also lift our current-year revenue and margin expectations and adjust our second-stage growth rate slightly upward to reflect superior long-term growth for the firm, enabled by its diversification and pricing power.

Organic growth remained strong in the second quarter at 11% (versus 13% in the first quarter), with most segments growing at a double-digit pace. Improvement in profitability has been a bigger surprise, though. Operating profit came in ahead of our annual expectations and consensus estimates, with margin improvement across all segments. Gross margins increased by over 200 basis points from last year’s level, supported by currency (one third of improvement) and operating leverage excluding currency (two thirds of improvement). While the positive currency impact on profits (together with the negative impact on sales) is expected to moderate over the coming quarters, we expect operating leverage to remain in place.

Most remarkable were margin improvements in watches and jewellery (from 12.7% in the first half of 2017 to 17% in 2018, with Bulgari's operating margin above 20%); selective retailing (thanks to discontinuation of an unprofitable concession); and wines and spirits (thanks to especially positive hedging impacts). Fashion and leather goods margins improved by 0.5%, negatively affected by dilution from the Christian Dior acquisition and Rimowa restructuring but supported by profitability improvement at Louis Vuitton and better results for some underperforming brands.

Like several of its peers, LVMH has not seen any weakening of Chinese demand after the stock market turbulence and currency depreciation. Sales to Chinese consumers improved by 20% over the period, while sales to Americans also grew by 20%, with strength continuing in the second quarter. Store expansion across brand portfolio remains cautious compared with the prior expansion cycle, limiting any adverse margin impact in case of eventual weakening in demand.

The bulk of Louis Vuitton's growth remains volume-driven, with low-single-digit contribution of perimeter and pricing. Sales remain strong across newness and classic ranges, with strong performance at the very top of the market (for example, precious skins). Despite increasing visibility of the brand in ready-to-wear (which helps attract new consumers and create buzz around the brand), we expect Louis Vuitton to remain predominantly a leather goods company (where the bulk of profits is created). Although the brand’s recent growth is remarkable given its size, we believe it to be partially cyclical and partially driven by successful product newness introduction. Thus, we expect gradual moderation of LV brand growth to luxury industry growth averages.