The numbers are staggering. When you look at the financial performance of Hermes versus its luxury peers, the numbers are simply staggering.
One year return?
Hermes returned 29%.
Its luxury peers (Richemont, Moncler, Kering, LVMH, Prada) averaged -5%.
The S&P 500 did 22%.
5 Year CAGR Total Return?
Hermes did a whopping 33%.
Its peers managed 14%.
So did the S&P.
LVMH? They did 24%.
A $10,000 investment in Hermes 5 years ago would have grown to $41,500. 4.2X your money.
That same investment in the peers would not have even doubled.
Putting it into LVMH instead of Hermes would have you missing out on $12,000.
So what does Hermes do that its peers don’t?
Let’s start with just how much they have outperformed their peers.
As you see in the tables above, the market has rewarded Hermes with a hefty EBITDA multiple and P/E ratio. Enterprise Value to Last Twelve Months EBITDA is 2.6X its peers and more than 2X the S&P average. It’s P/E ratio is more than double LVMH. A hidden, undervalued sleeper Hermes is definitely not. The market loves this stock. Why?
Well, it’s not revenue growth.
Revenue is right in line with the pack.
Management’s job is to optimize the machine for the long term using their two big levers: (1) improving returns and (2) improving capital cycling. In other words, find the optimal balance of returns for capital.
No one in luxury comes close to Hermes on both counts. Let’s look first at returns.
Once you get past the eye popping margins, you will see that Hermes’ Gross Profit Margin % is middle of the pack for its peers. In fact, it’s slightly below their average. Prada jumps out on the high end at 80% and Richemont on the low end at 68%.
But look at EBITDA Margin % and Net Income Margin %. Hermes is exceptional at controlling these costs and moving dollars to the bottom line. A 48% EBITDA Margin % is super impressive. But a 32% Net Income Margin %? Come on. It’s more than double the peer average and 1.8X greater than LVMH.
Free Cash Flow is what counts when it comes to returns and here again Hermes impresses by being able to turn 26% of Revenue into FCF. The peer average is 16%. Moncler is the only company that comes close to Hermes on this metric at 21%.
So when it comes to returns, Hermes is unequalled in turning sales into cash. Let’s look at capital cycling.
Interestingly, Moncler gets into Hermes’ class when it comes to Days Outstanding Inventory, Inventory Turnover and Cash Conversion Cycles. For a luxury brand to be at 206 Days Outstanding Inventory is impressive. Richemont is at a whopping 416 days while Kering comes in close to a year (355) and Prada at 303. These levels of inventory are reflected in the Inventory Turnover. Cash Conversion Cycles yield a surprise with Moncler at just 81 days. Learning how they pull that off is worth a post itself. Hermes has a CCC of 152 days which is 30% below the peer average.
I love the next column because it illustrates what might be the single most important metric for the leaders of scaling brands looking to glean insights from the best in class.
The peer average is 16%. Richemont is at 34%, 8.5X more than Hermes. Kering, Prada and LVMH huddle around 15%. And pesky Moncler challenges at an also impressive 5%.
The lesson here for founders is that your cash is tied up in Net Working Capital. If you want more money to grow or more money to flow to the bottom line or more money to distribute into your own bank account, focus on reducing Net Working Capital and achieving percentages similar to Hermes and Moncler.
ROC (Return on Capital) is where capital cycling comes together and here Hermes yet again sets a high standard. Their ROC of 22% is 1.8X better than the peer average and the next best companies are Moncler and LVMH which both come in at 15% or 700 basis points below Hermes.
Maybe you’re a little cynical about all this.
“These are public companies and I am private. Hermes does $15 billion in sales, I do $15 million. These guys are luxury, I’m not. They can sell bags for $100,000 and my AOV more like $100. Hermes has been at it for 187 years, I’ve been at it for 3. What lessons really apply here?”
In a future post I am going to write about the importance of time horizon. For now, let me say that Hermes once started small too, knocking out saddles for French riders. Despite the difference in time, geography, segments and revenues between your business and Hermes, one thing that is just as true today as it was then is that companies are machines to deliver returns based on inputted capital. Focusing relentlessly on improving your machine through the levers of returns (best judged by Free Cash Flow as a percentage of Revenue) and capital efficiency (best judged by Net Working Capital as a percentage of Revenue) will improve your Return on Capital which in turn will attract investors and superior valuations.