Hermes International: Short trading stock - expect unjustified take over premium to deflate AGAIN
Posted by PG on Saturday, July 4, 2009
Under: European Event-Driven Situations
With Hermes (RMS FP) trading at a 100%+ premium to the luxury goods sector, mainly supported by the largely unsubstantiated takeover speculation, Hermes stock is again highly vulnerable to a re-rating which could be driven by the speculative appeal to vanish. Similar to what happened mid-07 and early-09, we expect the unjustified take over premium to phase out and the large premium to sector average to compress in the short term. Ideally to start shorting around EUR 105-110 levels, and take profit around 75-85 levels.
Although probably one of most resilient business models in luxury goods sector, valuation is extremely stretched for a low-double digit earnings/sales growth profile:
o Hermes trades at an excessive 100%+ P/E premium to the luxury goods sector
o This compares with a long-term historical forward P/E premium of 30-40% to luxury peers
o Although Hermes’ profile proves to be late-cyclical and its products’ price points are within the highest of the luxury, recent observations start pointing to a slow-down in top- end luxury sales’ growth: RMS has lowest exposure to emerging markets’ customers from Russia/Middle East/ China (24% of sales vs sector average of 29%), the main current luxury sales’ growth driver. RMS exposure to more slowing markets as Japan (29% vs 23% sector) is among the highest in the sector.
Current pricing and 50% rise since early March-09 (compared to CAC40 rise of 20% since early Mar-09) is mainly driven by renewed take over speculation which seems very unrealistic to materialize in the short/mid term:
o Family partnership (72% of voting rights/capital) publicly stated it was not willing to sell anytime soon and is well decided to keep its investment
o Presence of poison pill (“Loi Breton”): Articles of Association delegate special powers to Executive Management to issue share purchase warrants and carry out capital increase
o The emphasis of the company’s control has been put on the transition to the next generation with the appointment of 6 members from the 6th generation to the management board, replacing the 5th generation members, who now number 5 on the board. This is in addition to the appointment of 3 members of the 6th generation to the supervisory board.
o The company is structured as “Societe en Commandite par Actions” (limited partnership): a structure which concentrates most operating decisions within the hands of the families and whereby the CEO can only be appointed by the families.
o “Loi Dutreil”: shareholder agreement whereby the families can benefit from a rebate on wealth tax if they keep the stocks for a minimum of 6 years (i.e. until 2011)
o Any shareholder who reaches 0.5% (and subsequent 0.5% increments) of Hermès’ capital or voting rights must reveal its position to the management, or lose their voting rights. So far, nobody has disclosed any such positions.
o If families would need the cash, they could easily re-leverage to raise special dividend, as currently the company has net cash position of €0.5bn. If they would leverage up to 2* Net Debt/EBITDA (cfr PPR at 2.8x), they could distribute up to €1.6bn to all shareholders (about €1.2bn to the family alone).
o Financials do not work for the 3 parties (LVMH, Richemont and PPR) who have been rumoured in the last 18 months to be building stakes and/or looking at Hermes. Luxury sector has become more rigorous since early 2000, with transaction multiples coming down: early 2000 transactions were typical at 2.5-3.5x sales, while recent transactions have been done at average 2x sales (RMS currently at 6.4x sales), displaying the higher (capital return) discipline of the sector.
At 34x ’08 guidance earnings and 22x EBIT, any premium over current price offered is dilutive for both LVMH and Richemont. After its Apr-07 PUMA acquisition, PPR is highly leveraged at 2.8x with BBB- credit rating. A cash acquisition of Hermes would increase PPR’s net leverage to 5.5-6x, making such an acquisition highly improbable.
o At a road show with Merrill Lynch, Hermes’ CFO reinstated even if LVMH would offer double of current share price, they wouldn’t sell (highlighting deeper conflict between Hermes and LVMH).
Up to end-May, we were uncomfortable to put Hermes as a consensus short call because of the possible short squeeze (understood that currently 20% of float is on borrow) on possible CAC40 index inclusion, given limited FF of the company: however with the 28-May-09 Euronext Expert Committee ruling against RMS inclusion, we feel that risk is temporarily gone and with Hermes further market outperformance, we feel comfortable now to put on the Hermes short.
Find here a full Panta Capital Analysis on the Hermes short idea.
Although probably one of most resilient business models in luxury goods sector, valuation is extremely stretched for a low-double digit earnings/sales growth profile:
o Hermes trades at an excessive 100%+ P/E premium to the luxury goods sector
o This compares with a long-term historical forward P/E premium of 30-40% to luxury peers
o Although Hermes’ profile proves to be late-cyclical and its products’ price points are within the highest of the luxury, recent observations start pointing to a slow-down in top- end luxury sales’ growth: RMS has lowest exposure to emerging markets’ customers from Russia/Middle East/ China (24% of sales vs sector average of 29%), the main current luxury sales’ growth driver. RMS exposure to more slowing markets as Japan (29% vs 23% sector) is among the highest in the sector.
Current pricing and 50% rise since early March-09 (compared to CAC40 rise of 20% since early Mar-09) is mainly driven by renewed take over speculation which seems very unrealistic to materialize in the short/mid term:
o Family partnership (72% of voting rights/capital) publicly stated it was not willing to sell anytime soon and is well decided to keep its investment
o Presence of poison pill (“Loi Breton”): Articles of Association delegate special powers to Executive Management to issue share purchase warrants and carry out capital increase
o The emphasis of the company’s control has been put on the transition to the next generation with the appointment of 6 members from the 6th generation to the management board, replacing the 5th generation members, who now number 5 on the board. This is in addition to the appointment of 3 members of the 6th generation to the supervisory board.
o The company is structured as “Societe en Commandite par Actions” (limited partnership): a structure which concentrates most operating decisions within the hands of the families and whereby the CEO can only be appointed by the families.
o “Loi Dutreil”: shareholder agreement whereby the families can benefit from a rebate on wealth tax if they keep the stocks for a minimum of 6 years (i.e. until 2011)
o Any shareholder who reaches 0.5% (and subsequent 0.5% increments) of Hermès’ capital or voting rights must reveal its position to the management, or lose their voting rights. So far, nobody has disclosed any such positions.
o If families would need the cash, they could easily re-leverage to raise special dividend, as currently the company has net cash position of €0.5bn. If they would leverage up to 2* Net Debt/EBITDA (cfr PPR at 2.8x), they could distribute up to €1.6bn to all shareholders (about €1.2bn to the family alone).
o Financials do not work for the 3 parties (LVMH, Richemont and PPR) who have been rumoured in the last 18 months to be building stakes and/or looking at Hermes. Luxury sector has become more rigorous since early 2000, with transaction multiples coming down: early 2000 transactions were typical at 2.5-3.5x sales, while recent transactions have been done at average 2x sales (RMS currently at 6.4x sales), displaying the higher (capital return) discipline of the sector.
At 34x ’08 guidance earnings and 22x EBIT, any premium over current price offered is dilutive for both LVMH and Richemont. After its Apr-07 PUMA acquisition, PPR is highly leveraged at 2.8x with BBB- credit rating. A cash acquisition of Hermes would increase PPR’s net leverage to 5.5-6x, making such an acquisition highly improbable.
o At a road show with Merrill Lynch, Hermes’ CFO reinstated even if LVMH would offer double of current share price, they wouldn’t sell (highlighting deeper conflict between Hermes and LVMH).
Up to end-May, we were uncomfortable to put Hermes as a consensus short call because of the possible short squeeze (understood that currently 20% of float is on borrow) on possible CAC40 index inclusion, given limited FF of the company: however with the 28-May-09 Euronext Expert Committee ruling against RMS inclusion, we feel that risk is temporarily gone and with Hermes further market outperformance, we feel comfortable now to put on the Hermes short.
Find here a full Panta Capital Analysis on the Hermes short idea.
In : European Event-Driven Situations
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