Kering SA: The Management’s Focus On ‘La Luxe’ Could Make Investor Returns Go Through The Roof

Kering SA (OTCPK: OTCPK:PPRUY, OTCPK:PPRUF) is best known as the parent company of brands like Gucci, Saint Laurent, Bottega Veneta, Puma, and many other luxury brands and sports brands all over the world. Over the past few years, the management of the company has started an initiative to divest all the non-luxury brands within the company and become a pure luxury player. The change of the company name from PPR to Kering was the first step towards the implementation of this new strategy.

The positive outcome of the company’s new strategy is slowly becoming visible in the financials and the quarterly results. Our evaluation of the company’s strategy, our financial forecasts, and our valuation indicate that the stock price of PPRUY has an excellent scope for appreciation assuming that the management continues its good work.

Company Overview

PPRUY is one of the largest luxury goods conglomerates in the world. The company engages itself in designing, manufacturing, marketing and retailing of apparel and accessories. The company has essentially operated through two segments – Luxury and Sports & Lifestyle. Some of its key luxury brands are Gucci, Saint Laurent, Ulysse Nardin, Sergio Rossi, Stella McCartney, Alexander McQueen, Bottega Veneta, and so on. Gucci is the company’s flagship brand which accounts for more than a third of its revenues and more than half of its total profitability. The company was founded in 1881 and is headquartered in Paris, France.

Complete Focus On The Luxury Houses

Over the past couple of years, the management has started working towards a strategic change initiative by steadily divesting all the brands owned within the Sports & Lifestyle segment such as Puma, Volcom, Cobra, and so on. This attempt by the management is to make sure that the company has a clear strategic focus on the Luxury segment. The most recent attempt by the management is to divest its popular sports skatewear label, Volcom. Incidentally, Volcom happens to be its last remaining non-luxury brand which the company had acquired in 2011 for a price of $608 million. The company is also preparing to carry out a spin-off of Puma, its sportswear brand in order to adhere to its luxury-focused strategy. It is likely that the management had been aggressively trying to find a strategic buyer for Puma. A possible failure in this attempt would have resulted in the spin-off where the management is planning to offer 1 share of the new Puma entity for shareholders owning 12 shares in PPRUY.

Divestment Of Stella McCartney

PPRUY faced a minor setback in its Luxury segment when it was required to end its 17-year-long partnership with Stella McCartney. The British fashion designer went ahead and bought back the 50% stake owned by PPRUY with the objective of building the business independently. While the brand was not a major contributor to PPRUY’s total revenues, it was unique in its own way as it is one of the few global brands that is strictly against the use of fur and leather and markets itself as a cruelty-free brand. Stella also has a unique positioning in the industry as a leading female designer in a male-dominated industry.

A Strong Q1 Backed By Excellent Numbers For Gucci

2018 has begun on a fantastic note for PPRUY as the results of the first quarter have beaten all expectations. As we can see in the image below, the company’s revenues grew by 27.5% with a comparable growth of 36.8% that can be attributed to its largest brand, Gucci. The like-for-like growth of 48.7% in Gucci sales as against the first quarter of 2017 is phenomenal. Not just Gucci, the other key luxury houses of the company have all grown well indicating that the management’s strategy of focusing on the Luxury segment is working wonderfully well.

Description: C:UsersDellDesktopNew DriveSeeking AlphaWorkingKeringQ1.JPG

Source: Kering Q1 Results

Projected Income Statement & Cash Flows

Annual P&L ($ mn)

2015

2016

2017

2018E

2019E

2020E

Revenues

1657

1728

1922

2123

2338

2567

% Growth

4.3%

11.2%

10.5%

10.1%

9.8%

EBITDA

373

428

437

488

542

603

% of Revenues

22.5%

24.8%

22.7%

23.0%

23.2%

23.5%

EBIT (incl. extraordinary exp)

187

357

394

393

434

485

% of Revenues

11.3%

20.7%

20.5%

18.5%

18.6%

18.9%

Net Income (Adj)

291

244

277

311

344

379

% of Revenues

17.6%

14.1%

14.4%

14.7%

14.7%

14.8%

Source: Historical Data from PPRUY; Estimates based on calculations by Baptista Research

Cash Flow Statement ($ mn)

2015

2016

2017

2018E

2019E

2020E

Net Income (Adj)

291

244

277

311

344

379

+ Depreciation & Amortization

71

80

83

91

100

110

+/- Change in Working Capital

-120

-183

-75

-85

-103

-98

+/- Deferred Taxes and Others

-63

19

7

1

26

-3

Cash Flow from Operations

180

160

291

317

367

388

Net Capex

-276

-67

-109

-144

-208

-234

Net Financial Investments

-2

0

0

0

0

0

Cash Flow after Investments

-278

-67

-109

-144

-208

-234

Free Cash Flow

-98

94

182

173

159

155

Source: Historical Data from PPRUY; Estimates based on calculations by Baptista Research

Dividend and Earnings Ratios

2015

2016

2017

2018E

2019E

2020E

Dividend Per Share ($)

3.1

2.0

1.4

1.4

1.4

1.5

Dividend Yield

17.8%

8.8%

3.0%

1.6%

1.4%

1.4%

Dividend Growth

-36.8%

-28.3%

-3.4%

2.8%

8.0%

Dividend Payout

133.9%

100.9%

63.9%

55.0%

51.1%

50.0%

Earnings Per Share ($)

2.3

1.9

2.2

2.5

2.7

3.0

EPS Growth

-16.1%

13.1%

12.3%

10.7%

10.4%

Source: Based on calculations by Baptista Research

The company’s revenue growth story has been excellent as a result of the double-digit growth by Gucci and Saint Laurent, the two largest contributors to the top-line. The Puma spin-off and the divestment of Volcom and Stella McCartney are not expected to have a significant impact on the total revenues. It is reasonable to assume that the double-digit growth will continue for the coming three years, especially after seeing the fantastic Q1 results. Historically, the company has sustained its EBITDA margin between 22-25% and its Net Income margin at around 14.5%. While a complete focus on Luxury could push this margin upwards, we have been conservative in our assumption and maintained the same level of margin for the company.

There is no significant deviation expected in the working capital largely due to the fact that the management has been handling it well over the past few years. However, the management is expected to increase its capex over the coming years for the organic expansion of its brands. Despite this expenditure, the company will continue to generate a decent level of free cash flows.

While the earnings of the company have grown well, the management has reduced the dividend payouts over the past three years and re-invested the profits back into the business. It is expected that they will stabilize the payout ratio at 50% of the earnings during the course of the coming three years. Even with the lower payout, the company is still paying about $1.4 per share of dividend which is reasonably good for long-term investors.

Valuation: If The Gucci Growth Continues Then The Valuation Upside Is Phenomenal

We have made use of our projections of PPRUY’s revenues and profitability along with the valuation multiples in the table below in order to forecast the stock price for the coming three years. The company is currently trading at a price to earnings of over 40 as a result of the fantastic quarterly results. Based on our analysis of PPRUY’s peer group, we believe that there might be a certain amount of multiples contraction with respect to the price to earnings and the EV/Sales. However, despite the contraction, if the company continues to maintain its top-line growth with Gucci and Saint Laurent and keeps its margins stable, the stock price could go as high as $86.3 by the end of 2018. Currently, the stock trades around $59 which implies that there is an upside of more than 30% for investors during the year. As per the table below, we have kept our valuation multiples steady over the coming three years and our three-year price target for the stock is $109.9. The expected appreciation in the stock price coupled with the decent dividend payouts makes this stock an interesting pick for long-term investors.

Price and Valuation Ratios 2015 2016 2017 2018E 2019E 2020E
Price ($) 17.4 22.3 46.7 86.3 98.2 109.9
Outstanding Number of shares (million) 126.0 126.0 126.0 126.0 126.0 126.0
EV/ Sales 4.1 5.7 6.2 5.3 5.5 5.6
EV/ EBITDA 12.7 15.3 19.1 23.2 23.6 23.7
EV/ EBIT 15.6 19.0 23.1 28.8 29.4 29.5
Price/Earnings 22.3 38.8 41.8 35.0 36.0 36.5

Source: Historical Data from PPRUY/ Morningstar; Estimates based on calculations by Baptista Research

Risks

The valuation of PPRUY in this article is specific to the date of the analysis i.e. 30th April 2018. A valuation of this nature is necessarily based on the prevailing stock market, financial, economic and other conditions and industry trends. Valuation is not a precise science and is subjective in nature and dependent on the exercise of individual judgment. Therefore, it can be concluded that there is no indisputable, single valuation.

We must emphasize that the projected valuation and the share price of PPRUY are dependent on a number of factors – the continued revenue growth of Gucci, Saint Laurent and the other key luxury brands, the realization of the profitability and other assumptions taken into account. Our analysis cannot be directed to providing any assurance about the achievability of these financial forecasts. There is a possibility that the actual results of the company are different from the projected results as a result of unexpected events and circumstances e.g. failure of key brands, change in the quality of management, changed investor perception regarding PPRUY and the luxury goods sector, trade recession, war and so on. It is also likely that these differences between the actual financials and the projected financials may be material in nature.

We had no interaction with the management of the company and they did not comment on the achievability or the reasonableness of the assumptions underlying the financial forecasts. Our projections are based purely on the belief in the management’s ability to continue its revenue growth and sustain its current level of margins.

Conclusion

PPRUY is the kind of stock that every value investor would want in their portfolio. It has a solid management and strong fundamentals. In terms of strategy, the management has been divesting all the non-luxury businesses and focusing on the core luxury goods business. They have already demonstrated the success of this strategy by producing double-digit growth for Gucci, Saint Laurent, and all its top brands. Our price target for 2018 is $86.3 and our valuation suggests that the stock price could go as high as $109.9 by the end of 2020. It is an excellent value pick within the luxury sector.

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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