Burberry & LVMH

Steve Clayton - Fund Manager

28 September 2018

Checking Out

We have sold the bulk of our position in Burberry, realising significant profits for the fund. We originally bought in to Burberry when the fund launched back in December 2016 and our recent sales have been made at a gain of over 50%, plus dividends received along the way.

Travelling and arriving

Burberry are currently undertaking a major revamp, aimed at elevating the brand ever higher into the luxury spectrum. When the strategy was launched the shares reacted badly because the market expected it to hold sales and profit growth back in the near term. We said at the time that we were holding on, because if successful, the strategy could bring big rewards.

Burberry CEO, Marco Gobbetti, hired a new design chief, Riccardo Tisci, who he had worked successfully with at Givenchy. Mr Tisci has just unveiled his first new ranges, created with the move upmarket in mind.

Having initially fretted over the new approach at Burberry, the market has now become an enthusiastic cheerleader for it and the shares have moved sharply higher. Gucci has had a very successful revamp in recent years and perhaps investors are reading across, but failing to recognise the different starting points for the two luxury brands.

We think that risk and reward are no longer attractive. At the levels where we were selling, Burberry was trading on around 28x next year’s consensus earnings. That is above its average valuation of recent years and it looks to be pricing in a great deal of success for Messrs Tisci and Gobbetti’s efforts.

That may come, but we felt there was little margin for error left for the stock, so we have taken some profits and moved on.

Foreign Travels

Burberry may seem fully priced, but the luxury goods industry as a whole has much to recommend it. Customers are well-heeled and are typically purchasing with wealth, not income, which can make the luxury consumer resilient to economic ill winds.

The products are desirable and exclusive and their price points allow efficient producers to make attractive margins and generate strong cash flows. Their retail outlets tend to be in prime locations and while online sales of luxury goods are rising, we feel there will always be demand for physical stores because the service element is a big part of the luxury shopping experience.

So we have taken advantage of the flexibility in the fund’s mandate to invest in LVMH. This is the first time the fund has bought an overseas stock and such holdings will always be a minority exposure, limited to no more than 20% of the fund’s value.

Although listed in France, LVMH earns its profits in many different currencies around the world. In the long run we expect the performance of the business itself to be the most important driver of returns, but owning overseas stocks does create the potential for currency gains or losses, on top of the underlying movement in the share price.

High Flyer

LVMH stands for Moët Hennessy Louis Vuitton. While the initials may be mixed up, the group’s focus on luxury brands is not. It owns an unparalleled stable of labels stretching from Christian Dior to Givenchy, Tag Heuer to Bulgari, in categories from fashion through leather goods and into jewellery, fine champagnes and cognacs.

Valued at around €150bn, LVMH dominates the luxury sector. The group has been built up over more than forty years by Bernard Arnault, whose family own just over half of the group. The business operates globally and many of its brands have over a century of tradition behind them. Fashion and Leather Goods is the biggest earner within the group.

Despite being the biggest player, LVMH has been outgrowing its smaller rivals and organic growth has averaged over 8% p.a. since 2010. The virtuous circle of strong margins delivering buoyant cash flow to reinvest back into growing the business has been playing out well at LVMH and we think this can continue for some time to come.

Financially the group is strong. Leverage is less than 1x earnings before interest, tax, depreciation and amortisation and even if we treat their store leases as debts and recalculate the ratio accordingly, it doesn’t reach 2x.

We like the group’s strategy of controlling its own distribution globally for key brands. This allows it to keep control over where its brands are seen, vital to retaining cachet and maintaining price discipline.

Ticket price

Best of all, LVMH is currently trading on a significantly lower valuation than Burberry, at 23x forward earnings. Still not in the bargain basement, but given the group’s strength and diversity we think it looks the better way to invest in the luxury sector currently.

We still have a residual position left in Burberry, for the stock dipped back away from our selling levels before we had sold out completely. At this stage we view the position as an option. If it retreats too much, we could rebuild, or reduce it further into any renewed rally. We are in the territory where we feel agnostic towards it.

As regular readers of these blogs will know, our basic setting is a reluctance to trade for trading’s sake, since this incurs costs for uncertain rewards. So we may be left with a little dash of Burberry check in the fund for a while longer.

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