Interactive Investor

Stockwatch: two stocks for tough times?

28th October 2022 13:06

Edmond Jackson from interactive investor

How defensive are luxury brands through a recession? Analyst Edmond Jackson considers two firms in the sector.

Is it worth switching into premium goods’ company equities, along a rationale that affluent people maintain spending during a recession? How reliable is this claim? 

LVMH (EURONEXT:MC) with champagne served first in its formal title of Moet Hennessy Louis Vuitton is the bellwether luxury goods stock.  

My tactical question coincides with DZ Bank – Germany’s second-largest, with one of the largest research units – upgrading its stance from “hold” to “buy” - targeting €725.  

That implies around 10% upside from a current price of around €663 but quite whether there could also be 10% medium-term downside – or more - if a global recession does ensue. 

LVMH halved during the great financial crisis 

From 2007, it dropped from an €80 range to the €40’s but did swiftly recover and by end-2009, testing €70 then €130 by mid-2011. 

According to a simple historical chart, you would therefore wait for the current glowing consensus to get a reality check.  

Its 2009 results saw revenue ease 1% and continuing operations’ profit slip 8% with net profit down 13%. At least that affirms revenue resilience, hence the question shifts to how well LVMH can manage costs amid inflation, and pass rises on. 

2010 then saw a 19% jump in revenue, exceeding €20 billion for the first time, with all business areas and geographies doing well. Continuing operations’ profit soared 29% on a 21.3% operating margin. Such a margin is going to mean some extent of premium rating for this stock. 

But it then traded sideways for five years before commencing a strong bull run from €150 in 2016. Covid appeared to enhance treat-buying of luxury items as spending was diverted from travel and restaurants.  

Growth rating with a big premium to net assets 

Currently around €650, the trailing price/earnings (PE) is 25x and the yield close to 2.0%. While still broadly a “growth” rating, LVMH is down from €840 last January, so has not been immune to higher interest rates. A drop below €600 last May probably also related to the Ukraine crisis. 

A current market value near €330 billion (£285 billion) compares with net asset value around €50 billion, hence there is already a substantial premium for brand values.  

The first nine months of 2022 remain impressive: total revenue growth of 28% versus 20% organically. Not surprisingly, acquisitions characterise the late stage of the business cycle, yet LVMH was also able to cut its net debt by 28% over 12 months to last June, to €11.1 billion. 

Against a historic trend of Asia-Pacific being a strong market for Western luxury goods, lower growth in China and Covid restrictions there, have reduced Asian demand. Europe, the US and Japan are LVMH’s drivers this year. 

Wines and spirits up are up 23% as demand for champagne, fine wines and cognac continue. Fashion and leather goods remain the largest component at 48%: 

As of this month, management is “confident in the continuation of current growth...counting on the dynamic nature of its brands and the talent of its teams to further strengthen its global leadership position once again in 2022”. 

The crux is what extent of global downturn materialises. If it is anything on the scale of 2008-09 then LVMH’s growth rates will at least be compromised; however, greater wealth disparities nowadays may mean comparatively less so. 

All-considered, I regard LVMH as a “hold” if fairly priced and hard to justify switching into – at least while we appear to be heading into a downturn. With fresh money, it looks one to reconsider in 2023. 

Sanderson Design Group had quite similar resilience in 2009 

A relatively tiny, yet still comparable, stock is £87 million Sanderson Design Group (LSE:SDG) ,which bills itself as “luxury interior furnishings”, making wallpapers, fabrics and paints. 

Quite whether trying to mimic LVMH, it declared interim results similarly on 11 October, albeit with revenue barely improved around £58 million. Profit measures rose 10% to 13%, however, cost efficiencies helped the gross margin rise from 62.5% to 65.8% and at the operating level from 8.6% to 9.3%. Otherwise, marketing costs resumed pre-Covid levels and more staff have been recruited. 

Management is cautious, but says it continues to cope with headwinds. 

The big issue I find with Sanderson is liability for the housing market to slow. Another boost from lower stamp duty may be more than offset by higher mortgage costs.  

While it’s possible, people spend instead on improving their existing homes. I think a key driver of furnishings’ demand is people putting their own mark on a house after moving. 

Even so, when the group was known as Walker Greenbank plc, its year to 31 January 2009 was resilient. Revenue edged up 2% to £63.7 million “supported by the continued progress of the Sanderson brand”. Profit measures slipped only 10%. 

The stock still fell during this period, from around 50p in September 2007, as low as 8p in March 2009, essentially in line with macro events and the wider market. 

The January 2010 year saw a weak first half, but 2% like-for-like growth in the second limited the annual revenue drop to 5%. Profit measures plunged 30% to 40%, yet the board was confident enough to return to the dividend list after nine years. 

Sanderson Design Group - financial summary
Year end 31 Jan

 2016201720182019202020212022
Turnover (£ million)87.892.411211311293.8112
Operating margin (%)9.38.311.85.24.35.49.2
Operating profit (£m)8.27.713.25.94.85.110.3
Net profit (£m)5.95.411.94.43.83.87.8
Reported earnings/share (p)9.58.116.86.25.25.310.8
Normalised earnings/share (p)13.825.021.610.19.47.913.8
Operating cashflow/share (p)10.315.06.416.311.625.717.9
Capex/share (p)4.110.24.94.23.41.43.0
Free cashflow/share (p)6.24.81.512.18.224.314.9
Dividend per share (p)2.93.64.43.20.50.03.5
Covered by earnings (x)3.32.23.91.918.80.03.9
Return on Total Capital (%)20.611.918.78.26.25.112.4
Return on Equity (%) 12.421.17.15.95.79.7
Cash (£m)2.91.51.32.43.115.519.1
Net debt (£m)-2.35.35.3-0.4-1.3-9.3-15.1
Net assets per share (p)58.673.787.285.891.394.1112

Source: historic company REFS and company accounts

‘Luxury’ was not, however, the prop   

The group’s mid-market brands - Harlequin and Sanderson - performed well, but interestingly for this piece of analysis, “in a price-conscious market, our premium-end brand, Zoffany, has experienced a significant decline in revenues”.  

That was a particularly tough time for property sales. 

Overseas’ business was mixed: continental Europe and the US down 20% and 25% respectively yet - showing its long-term vibrancy - the Far East and Australasia supported 14% rest-of-world growth. 

Despite the chairman saying in the 2010 annual report: “We remain focused on international expansion where we see significant opportunity” the UK’s share of total group brand revenue has slipped from 59% to 52%. 

The all-time stock chart is a roller coaster, quite inevitable when this is a small-cap significantly at the mercy of the UK property market.

After Covid re-directed spending towards home improvement, it enjoyed a rally back near 2017 highs, then a sharp fall from September 2021, like so many small-caps, as investors de-risked. 

Likewise, in line with many UK domestic-driven equities, the stock is enjoying a reprieve – up around 20% this month, from a recent low. 

Around 123p and if forecasts are fair, the 12-months’ forward PE is around 9x and the yield just over 3%. There is intrinsic support by way of 117p a share, net asset value, where intangibles represent 32%, but is probably justified given significant brands’ value.  

The medium to longer-term financial summary does not, however, show LVMH’s strength of operating margin – instead, high-single-digit percentages. Free cash flow is also a bit erratic. 

I tend to think home furnishings are possibly more sensitive to recession than luxury drinks and clothing. Affluent people broadly sustain their socialising, regarding this as a priority. People are apt also to prioritise appearance and fitness, and treat themselves when they can, which supports luxury fashion. 

At 120p currently, the stock is on a forward PE of 9x and yields just over 3% - assuming forecasts for around 10% earnings growth, which may ease slightly in the January 2024 year. 

I apply a “hold” stance similarly as for LVMH – but again, wait first for downturn to manifest before buying.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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