Hermès stock: bucking Asia’s weak trend (OTCMKTS: HESAF)

Luxury goods producer Hermes (OTCPK:HESAY), best known for its leather bags, looks like a much-loved company at first glance. With a price-to-earnings (P/E) ratio of 41.7x, it seems logical that its stock price has fallen almost 30% since the start of the year. And by extension, it is logical to believe that there are quite a few downsides in the near future, especially given the current state of the stock markets. In this article, I explore why Hermes has such high market multiples when it comes to performance and peer comparisons. He concludes that there may indeed be a downside in the short term, but there are still plenty of reasons to buy it in the medium to long term.

Sustained Asian demand

China is a huge market for luxury goods, and its recent slowdown has affected the performance of these companies to some extent. But there is a difference when it comes to Hermès. While other companies in the segment like Burberry (OTCPK:BURBY) and LVMH (OTCPK:LVMUY) have warned of the impact of the uncertain Chinese situation, Hermès seems less worried about it. A look at its strong financial results for the first half of 2022 (H1 2022) explains why. Asia excluding Japan, like its peers, is also a big market for the company, accounting for nearly half of its turnover. But unlike the other cases, for example LVMH, the growth of this region was 15% year-on-year. That’s lower than the overall revenue growth of 23%, as other regions showed much faster growth, of course, but that’s not bad either.

He explains this as being due to…

… a high level of activity throughout the region and by sustained sales in Singapore, Australia and Korea. Greater China rebounded strongly in June after being penalized by health restrictions and store closures in April and May….

Moreover, it should be noted that this growth was achieved on a very solid basis. In H1 2021, the region increased by 70% on 2019, the last pre-COVID-19 year. In 2023, growth in these economies is expected to slow according to the latest IMF estimates (see chart below), however, there may be some support from the recovery in China that it has already started to witness. As I pointed out recently in the case of LVMH, this could continue to support revenue growth.

Expanding margins despite high inflation

Its rising margins at a time of high inflation are also noteworthy. At 42.1% at the end of June 2022, HESAY’s operating margin is the highest in at least 10 years, even though its operating costs have increased by double digits over the past year. Ditto for its net margins at 30.5%, which have rebounded impressively after falling to 13.5% during the pandemic.

Moreover, its margins are also higher than other luxury companies, which sets it apart from the segment. Regardless, the luxury segment tends to have higher margins in all cases compared to, for example, the consumer discretionary sector as a whole, which has a much lower operating margin of 8.1%. So we are then looking at a company in a high-margin segment, whose margins are even higher than those of its peers and they are also growing.

Long term gains

It’s no wonder, then, that the company has made great gains for investors over the years. An investor who bought the stock 10 years ago would have realized capital gains of almost 315%. Even if it had been bought 5 years ago, the gains would be around 120%. Even its dividend yield, quite modest at 0.7%, is starting to improve slightly in the context of an investment made in Hermès ADRs 5 and 10 years ago at 1.6% and 2.4% respectively. .

A consistently high rate of pay

The only apparent downside to HESAY ​​is its high P/E ratio of 41.7x at the time of writing. This is the highest among its peers, with Estee Lauder (EL) far behind at 33x and it is well above the ratio of the owner of Gucci Kering (OTCPK:PPRUY), at 14x. This can be taken to imply that Hermès is overvalued. But this has to be seen both in terms of revenue and in historical context.

For the last financial year, its net profit grew by 64.5% in USD, which is faster than all its peers except LVMH, which recorded a whopping 138.5% growth. Its cost/income ratio at 40% is unmatched, with Kering trailing far behind at 28.4%. Moreover, its P/E is currently a bit below the median value of 41.9x over the past 13 years. It went to 126.8x. Seen in this light, its P/E is more an indication of the premium that investors are regularly willing to pay to hold a broadly reliable stock.

Valuation risk

At the same time, it is essential to note that the P/E of HESAY ​​has bottomed around 30x historically. Given that we are currently going through a particularly unpredictable period, with huge downside risks, it is probably a good idea to prepare for the worst. China’s recovery could well be thwarted if new coronavirus variants emerge and send it back into lockdowns. The slowdown in Europe and the United States is also expected to continue into 2023, which could slow the business. If its P/E were to fall to its historical lows, this would translate to a potential 28% drop in price from current levels, indicating that there may be a better price to buy HESAY.

Consider the investment time frame

Considering only the short term, HESAY ​​would be a wait-and-see. However, it’s hard to ignore the gains he’s made for investors over the past five or ten years. These indicate that for the medium to long-term investor, it continues to be a buy given its current strong performance, expanding margins and China’s recovery.