Hermes' outstanding 2023 earnings
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Hi reader and welcome to another article of the Best Anchor Stocks blog,
It’s the first time I am bringing an earnings article to the blog (these are typically paywalled) but I thought it would be a good idea to bring Hermes’ earnings digest. The main reason is that I have written before about the company. You can read my first article below, where I tried to explain what guides the company’s capital allocation decisions:
As you’ll see throughout this article, these capital allocation decisions remain intact.
The company reported strong earnings last week, as expected. I did not know if these earnings would be up to the market’s standards, but I was pretty sure they would be good because the company is in (almost) complete control of its growth and profitability. Few companies know in January what they will be reporting in December, but Hermes is one such company.
It turns out they not only were up to the market’s standards, they exceeded them. Hermes’ stock climbed significantly after reporting earnings and was up almost 6% by Monday:
The summary table and some comments
I have somewhat tweaked my earnings articles to make them more digestible. They now go straight to the point and only share relevant information. I feel this format is much more in line with the types of companies I invest in at Best Anchor Stocks. These rarely change every year and thus not going to in-depth in their earnings helps me reduce the noise.
Here’s a summary table with Hermes’ financials, KPIs, and qualitative guidance. Note that I included price and volume growth in KPIs just so you get an idea, but I don’t consider these to be KPIs per se. I honestly think Hermes has no relevant KPIs worth mentioning besides its financial figures:
I also decided to focus solely on the yearly numbers because I don’t think quarterly numbers mean much. In fact, I’d go as far as saying that annual numbers are not really relevant for the company either. The reason is that what matters for the company’s thesis is its terminal value, as its CFO rightly points out:
We are putting us at a place to have a perpetual growth higher than the model, which has more impact than knowing what I’m going to do in 2023 in terms of growth. We have a perpetual growth, which for the moment is quite high. And that is what I try to preserve.
Let me give some brief comments on these numbers…
This year's price realization was significant at 7%, but this didn’t stop the company from growing significantly in volume. This is a unique luxury trait: high prices make genuine luxury goods more desirable (i.e., they are Veblen goods).
The strength was broad-based across geographies (all grew around 20%) and metiers (all grew double-digits). The strength of Hermes is not found in any particular product but in its brand.
Similarly to Nintendo and despite being widely different companies, Hermes took advantage of its cash position and generated significant interest income. This explains why the net income margin expanded more than the company’s operating margin. The goal of the high cash position is the same as Nintendo’s: independence and survival (“The group, whilst growing strongly, has consolidated its solid financial foundations to remain independent and deploy its long-term strategy.”)
The company suffered a working capital hit this year, seeing an outflow of €794 million. I’ve checked the last 7 years or so and the company tends to enjoy a marginally positive working capital inflow. Management only commented the following: “A €794 million increase in working capital requirements consistent with the strong rise in activity.” I honestly don’t know where it comes from because there’s no detail, but I highly doubt it’s something worrying. The only thing I can think about is inventory associated with several store reopenings this year.
Qualitative highlights and lowlights
Hermes continues growing its production capacity across all divisions, especially in leather goods, silk, and textiles. The company will open 4 leather workshops in the coming 4 years, and the best thing about these investments is that they enjoy excellent visibility. The reason is that true luxury companies tend to be capacity-constrained, so they know that pretty much all capacity will be used in the future and will translate into revenue.
I don’t think the current growth rate is sustainable over the very long term, and I highly doubt management thinks it either. Next year, growth will likely be strong, with management passing through an 8-9% price increase to cover increasing costs and currency exchange headwinds. We must not forget that Hermes has a somewhat particular pricing strategy: “There is no desire for us to be more profitable in this price increase.”
The discussion around store openings was interesting. Management claimed that they only open stores in emerging countries when the rise of the middle class justifies it. They argued that domestic high net work individuals tend to shop in other countries and thus don’t justify a store opening.
Investments in communication, renewals, real estate, and IT are accelerating, and management “took a shot” at the aspirational luxury players: “We don’t have to invest a lot of money in media and press to drive up our revenue, unlike others.”
Management gave a great sign of good capital allocation by announcing a special dividend of €15. Issuing special dividends signals that management understands capital allocation.
Another great management trait is evident in sharing the company's gains with employees. Hermes announced an annual bonus of €4,000 to all employees and a new free share plan. Hermes has an 80% employee-shareholder base.
The company continued its vertical integration. First, it took majority ownership of its retail operations in the Middle East, which the law previously did not allow. Secondly, it acquired ownership of some suppliers in the shoe and jewelry metiers.
Management also announced the opening of its eCommerce site in Brazil. This should not be taken for granted, as Brazil (and South America in general) might become one of the company's future growth drivers.
There was also a good indicator of true luxury in the call: “We are not in areas where there are necessarily a lot of potential clients, but we seem to be able to draw them.” This speaks greatly about the company’s brand equity and loyal customer base.
This is the end of the article. I hoped it helped you understand Hermes’ earnings better, although what really matters is the preservation of its terminal growth rate.
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