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3 reasons to buy Hermès International and 1 to sell

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Hermes International‘s (HE SAYS 0.83%) Stocks have lost about 40% of their market value this year as inflation, rising interest rates and other macroeconomic headwinds drove investors from growth stocks to value stocks.

Yet shares of the French luxury house have still more than doubled in the past five years. It has also weathered several downturns since its public debut in 1993 and remains one of the world’s best-known luxury brands. Let’s review three reasons to buy Hermès, and one reason to sell it, to see if this turbulent market is worth investing in.

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An Hermès scarf. Image source: Hermès International.

1. It is well insulated from current macro headwinds

Hermès and his rival LVMH Moët Hennessy LV (LVVERY 0.92%) both target wealthy buyers, who are generally much better protected from economic downturns than other consumers. Both companies can pass on higher costs to their customers more efficiently than lower-end brands.

Hermès also makes most of its products in small workshops in France rather than mass-producing them abroad, like LVMH. That localized approach underpins the Hermès brand’s luxury appeal and gives it significant pricing power vis-à-vis industry peers.

Hermès hasn’t aggressively expanded beyond its core brand with big acquisitions like LVMH, which currently owns 75 luxury houses in five different product categories. Hermès’s tighter focus on its flagship brand and less reliance on foreign manufacturers insulates it from many of the supply chain headwinds currently hurting LVMH and other multinational companies.

2. Your healthy post-lockdown recovery

Hermès’ growth slowed in fiscal 2020 when the pandemic forced it to temporarily close its physical stores. The decline in global travel and tourism has exacerbated that pain. But in fiscal 2021, it returned to growth with a healthy 42% increase in revenue in constant currency.

Period

Fiscal year 2019

Fiscal year 2020

Fiscal year 2021

Income

€6.88 billion ($7.2 billion)

€6.39 billion

€8.98 billion

YOY* Growth (Decrease)

12.4%

(6%)

41.8%

Data source: Hermes. *Constant currency terms. YOY = year over year.

That growth was fueled by double-digit increases in its six main categories: leather goods and saddlery, ready-to-wear and accessories, silk and textiles, other sectors, perfume and beauty, and watches.

In the first quarter of 2022, Hermès revenue increased another 27% year over year in constant currency terms with double-digit growth in all six categories. Analysts expect its revenue to rise 17% for the full year and then grow another 10% to €11.6 billion ($12.1 billion) in fiscal 2023.

3. Widening margins and increasing profits

Hermès’s margins and net profit shrank in fiscal 2020 as it grappled with higher expenses from COVID-19. However, its margins expanded rapidly in fiscal 2021 and actually exceeded their pre-pandemic levels.

Period

Fiscal year 2019

Fiscal year 2020

Fiscal year 2021

Operating margin

3. 4%

32.4%

39.3%

Net profit margin

22.2%

21.7%

27.2%

Year-over-year net income growth (decrease)

8.8%

(9.4%)

76.5%

Data source: Hermes.

That expansion can be attributed to its pricing power (particularly in high-growth markets like China), its operational efficiencies, and its improved scale. Hermès also increased its headcount by 8% in 2020 and 6% in 2021, indicating that it is still confident in its long-term prospects.

Analysts expect Hermès’ operating and net margins to decline slightly in fiscal 2022 (but remain well above their 2019 levels) before expanding again in fiscal 2023. They also expect its net income to rise 12 percent. % this year and grow another 11% to 3.03 billion euros ($3.16 billion) in fiscal 2023.

We should take all such forecasts with a grain of salt as the market faces many unpredictable headwinds, but Hermès’ resiliency during previous economic downturns suggests it can hit those targets.

The only reason to sell Hermès: its valuation

The biggest problem with Hermès is that many investors have already flocked to it as a recession-resistant play. As a result, his shares are now trading at about 38 times this year’s earnings.

By comparison, analysts expect LVMH’s revenue and earnings per share to rise 16% and 14%, respectively, this year. However, LVMH is trading at just 20 times this year’s earnings, which arguably makes it look much more attractive than Hermès.

Is it worth investing in Hermès?

I own shares in both Hermès and LVMH. But at these valuations, I think Hermès has less upside potential than LVMH or other higher-growth apparel retailers. Hermès remains a solid long-term investment, but investors should expect the stock to hold its own for at least a few more quarters in this challenging market before it rises again.

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