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When I think of solid investments, I look for high quality business models with a great management team at an attractive valuation. Over the past three years, luxury fashion house LVMH (OTCPK: LVMHF) has gained 84%, turning its CEO, Bernard Arnault, into a centi-billionaire and, very briefly, the richest person in the world. It is a quality brand and unlike Tapestry (TRP) and Ralph Lauren (RL), its brands only target the high-end luxury market as a more diversified conglomerate. The company has about 75 brands, including Christian Dior, Louis Vuitton, Bvlgari, Sephora, etc. and covers several geographical areas (866 stores in the United States; 512 in France; 428 in Japan; etc.) and several product categories. While arguably best known for its fashion line, 53% of revenue comes from other categories, including wines and spirits, fragrances and cosmetics; watches and jewelry; and selective distribution / others. It enjoys gross profit margins of around 68% with EBITDA margins hovering around around 35%; the strong profitability and recession-proof customer base therefore make it a relatively safe bet. And at 16.2x EBITDA, I think the stock has room for multiple expansion given its strong portfolio and industry-leading position.

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Data by YCharts

That said, 3 of the last Seeking Alpha articles dating back to May last year were outstanding; 1 was a “sale”; and only 1 was a “buy”. Although it rebounded well from a weak 2020 and saw double-digit annual growth, the stock still faces a lot of skepticism. In an article on Seeking Alpha, it was pointed out that Chinese President Xi Jinping’s intention was “to adjust excessive income”. Yes, Asia represents a dominant luxury market, but, in my opinion, it is a bit of a stretch for investors to extrapolate from political commentary to the sector’s long-term outlook. Socialism is not new in China; even if it were to become more socialist, it is hard to imagine that LVMH, with its diversified brands, could not adapt to changes in consumption, not to mention the emerging opportunity of the “mass affluent”.

DCF analysis indicates a significant advantage

To get an idea of ​​the intrinsic value of the company, I performed a DCF analysis. No DCF analysis can provide a perfect picture of future shareholder returns; however, they can provide an illustrative “story” of the likelihood of different scenarios. I expect 10% revenue growth in 2026. For a company that has consistently generated double-digit growth, that’s reasonable. I assumed EBIT margins would increase to 28%. Capital expenditures, increase in net working capital, depreciation and taxes have been stabilized for simplicity. By 2026, I will have an EBITDA of 36 billion euros.

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Source: created by the author using data from Yahoo! Finance

Assuming a terminal EBITDA multiple of 14x and a discount rate of 7%, the stock shows an increase of almost 20%. Given that the broader market is heavily overvalued, that makes the stock a steal at today’s price which has eroded nearly 11% year-to-date. Over the past ten years, the stock has generally traded in the 13-16x range, so I think my valuation is pretty conservative.

dcf

Source: created by the author using data from Yahoo! Finance

Looking at the sensitivity analysis, you can see that there are a lot more ways up than down. If the multiple remains at around 16x, there is 33% upside here. It would take the multiple to contract below the lower end of the historical 12x range and growth to fall below 9% to move the stock into overvalued territory. Above all, my model reveals that the stock is not so sensitive to variations in margins; a 1% change in margin produces less than a 4% change in expected returns. Given the company’s favorable perception of the brand, I also don’t see margins under pressure to begin with.

Top Catalysts

Several catalysts will enable LVMH to outperform over the next few years. The first is the pursuit of acquisitions. LVMH operates in a highly fragmented industry and has the marketing capabilities to significantly accelerate brands. The recent acquisition of Tiffany’s back in early 2021 illustrates that management is serious about diversifying its brand exposure beyond ultra-affluent, as well as having confidence in the underlying business at the most strong from a pandemic. Importantly, the Tiffany acquisition was largely hedged due to over €13.5 billion of operating free cash flow, so the company is well positioned to acquire other brands. .

We also need to see continued organic growth. Management achieved organic growth of 14% in 2021 compared to 2019 (2020 was an atypical year), reflecting the momentum of the Fashion category which recorded growth of 42%. Going forward, investors will focus on excluding Asia. Japan, which saw organic revenue growth of 31% compared to 2019 in 2021. Wines and spirits, which saw 57% year-on-year growth, is also another key category to which investors are looking. will rotate to possibly correct the discount to intrinsic value. With the opening and reopening of branded stores in New York and other major cities, LVMH is ready for a new wave of growth. Because it owns the retail side of the equation, LVMH can even take advantage of competing products and has the analytics to see which brands are popular to acquire or invest more organically.

Risks

There are several reasons why one might be hesitant about LVMH. First of all, the Arnault family controls 47.3% of the title, which makes it risk having a lack of “outside view”. Also, even though I say the stock is undervalued, Ralph Lauren and Tapestry are both trading at just 8.2-8.4x EBITDA, almost half of LVMH’s situation. Given the industry-leading position and historical track record of double-digit growth, I think LVMH justifies it, but the fashion and luxury industry is notoriously unpredictable. It is impossible to say with certainty which trends may come and go; while LVMH’s brands have shone in the past, one wonders how much of a role luck played in this success. In the future, LVMH will have to continue to demonstrate the attractiveness of its brand. Given that luxury consumers are often focused on the “next big thing,” it’s not hard to imagine a world where Christian Dior is no longer considered high-end.

Conclusion

LVMH is a high quality, low cost company. Although luxury is unpredictable, LVMH’s degree of vertical integration and its position as the leader in its category allow it to pivot better than some of its competitors. The double-digit growth record is expected to continue as foot traffic picks up and vertical expansion continues. Add a few other deals like Tiffany’s, and you have a very diversified portfolio led by an excellent management team with enormous pricing power. At a time when companies are struggling with congested supply chains and labor shortages, LVMH has an impeccable balance sheet and high margins to capitalize on a return of the pandemic. Accordingly, I strongly recommend investing in LVMH.