Chit Chat Stocks - Hermes International (Ticker: HESAY) Not So Deep Dive

Episode Date: December 26, 2023

Hermès International S.A. (HESAY) is a prestigious French luxury goods manufacturer renowned for its high-quality fashion and accessories, maintaining an aura of exclusivity while addressing challenges in the luxury retail sector and evolving consumer demands. Listen as Brett and Ryan break down the company and its industry. Enjoy the show! ****************************** Chit Chat Money is presented by Interactive Brokers. Switch to the best brokerage in investing today: ⁠⁠⁠⁠⁠⁠⁠⁠⁠ibkr.com/info⁠⁠⁠⁠⁠⁠⁠⁠⁠ ***************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: ⁠⁠⁠⁠⁠⁠⁠⁠⁠https://chitchatmoney.substack.com/⁠⁠⁠⁠⁠⁠⁠⁠⁠ Want updates on future shows and projects? Follow us on Twitter: ⁠⁠⁠⁠⁠⁠⁠⁠⁠https://twitter.com/chitchatmoney⁠⁠⁠⁠⁠⁠⁠⁠⁠ Contact us: ⁠⁠⁠⁠⁠⁠⁠⁠⁠[e-mail]⁠⁠⁠⁠⁠⁠⁠⁠⁠ Timestamps Company Background | (3:49) Industry | (17:42) Management & Ownership | (23:51) Earnings | (26:49) Balance Sheet | (28:51) Valuation | (32:00) Our Analysis | (32:48) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Learn more about your ad choices. Visit megaphone.fm/adchoices

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episode. Welcome into Chitchat Money. My name is Brett Schaefer and I'm joined by my co-host Ryan Henderson. Today is our Tuesday not so deep dive episode where we analyze one stock covering its business model, financials, ownership, future growth opportunities, and much more. After listening to this episode, we hope you get a better perspective on the company we are covering today. I think we have a fantastic one to close out 2023, and that is Hermes International. I think after listening to this, and maybe Ryan will disagree with me, but we'll see what happens. You can probably understand why this is one of the best businesses in the world that consistently trades at 40 times earnings. Now, before we get into things, I have a few

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Okay. Ryan, anything else to add before getting into Hermes International for any of our European listeners? I hope I'm saying that correctly, but do not be insulted by our American, especially West Coast accents, talking about this thing. Yeah, let's get right into it. Last week, we looked at Ferrari. Two weeks ago, we looked at Moet Hennessy Louis Vuitton. I think I'm saying that right. LVMH. And this week, we're looking at Hermes. And I think it's kind of an interesting way to go about it because Hermes, in my view, kind of sits right in between LVMH and Ferrari, where it's the purposeful limited supply of Ferrari with the actual kind of product type of Louis Vuitton for the most part. So I don't know, just kind of, kind of a combination of the two, but for general purposes, for anyone that doesn't know Hermes, Hermes is a designer and manufacturer of really a variety of luxury products, primarily bags. That is probably what they're best known for. And it's the largest revenue driver for their business. So they've got a number of products. The biggest one is what they call leather goods and saddlery, like think saddles.

And this segment's 43% of their revenue. it's primarily men's and women's handbags, also travel bags, but there are also like horse saddles, other equestrian products. That's kind of where they got their start, but really the business is driven by handbags today. So the big ones here, the ones I think most people think of when they think of the Hermes brand is the Birkin bag or the Kelly bag. I looked this up and a new Birkin bag can cost anywhere between $10,000 and $2 million. Now, for Brett and I, I've got to be honest, I don't think we would recognize one. Before having done this research, if I just saw someone carrying a bag, I don't think I would have been able to say, oh, that's a Birkin bag.

But these are apparently iconic. Obviously, they're quite expensive. So it's kind of this if you know you know thing where people it's social signaling and kind of a status symbol but it's also so sort of prestigious that not everyone would recognize it so it's kind of just interesting but very expensive bags they are hand-finished it's not like Louis Vuitton where they are in some sense mass-produced these are all hand-finished goods they have artisans, I believe it was around, I'm going to mistake the number, so I'm not going to say it, they have a number of artisans and hand crafting employees that are designed for these roles specifically. And this is an important part of the business model. Typically these bags hold

and even increase their value. So the resale value of these bags tends to be pretty high. So So that also allows them, if you're Hermes, to push the price considerably because this is kind of an interesting model or an interesting point of Hermes' model in general. That if the bag is more expensive, it's even more of a status symbol and also it holds its resale value. So it's almost like when someone carries around a Birkin bag, it's not because they think it is so superior functionally to a typical handbag. It's because they want to, frankly, flaunt their wealth. So the more expensive the bag, the more wealth they're flaunting. So I just think it's kind of a unique model there and allows Hermes to really push the prices up on their Birkin bags and Kelly bags. other parts of the business they've got ready to wear basically this is just clothes very expensive

clothes for both men and women i was looking at it it's like i saw a very yellow belts a very normal looking hoodie for eighteen hundred dollars just i yeah i love it we should disclose now that this style of consumerism makes absolutely zero sense to brett or i but uh to to their respective customers they love it and it's it's like i said the story yeah it's the heritage with france everything's made in france everything's handmade and then you have the exclusivity of the availability which i think all three of those are what make them very similar to ferrari even though the products are more similar to louis vuitton and chanel all those other ones yeah so leather goods basically think bags biggest revenue driver for them second biggest

revenue driver clothes the ready to wear brand category that that's what they call it and then basically everything below that is fairly equal in terms of revenue share so they've got jewelry they've got silk scarves are actually pretty big for them perfume colognes watches i think there's some other stuff as well. The colognes really aren't, I was looking, I mean, it's expensive, but it's not Hermes Birkenbag style expensive. It's a hundred dollars for a bottle of cologne. Those are meant to be sort of introductory products to the brand. So it's meant to get people to whatever, uh, kind of love the Hermes brand, feel like they're a part of it. And then hopefully trade up over time. I think the biggest difference to call out here between Hermes and

Louis Vuitton is that, or maybe LVMH, Hermes is a single brand. It's not a house of brands, the perfume, the bags, the saddles, the watches, they are all Hermes branded. So unlike Louis Vuitton, Moet Hennessy, LVMH, where it's, I want to say like almost a hundred different companies now, this is all under the Hermes house and they don't really do any acquisitions i looked through and i think there's basically been three acquisitions in their history two or three where it was buying out like a niche supplier maybe it was meant to maybe they valued that supplier they used them a lot and they were going out of business i don't know but it was really not not meaningful to the investment whatsoever and so really just a single unified

brand last thing i'll mention though and this is maybe important when we're looking into the future for Hermes, there isn't really an online presence. Like you can buy some stuff online, but when we think about the high end stuff, Birkin bags, Kelly bags, I think there's some other stuff as well. They really want that transaction to be done in their stores. Their stores are part of the buying experience. They have 300 locations around the globe and each location is like this, you know very extravagant looking building it's a flex to walk in there and so they want customers coming in and then hopefully probably cross-selling other stuff as well while they're in the store so i think you can customize orders online but you can't actually buy a birkin bag

through the hermes or hermes website so yeah one thing to add on the dis or distribution there sorry i'll after you finish after you finish no no go ahead i was going to say on the distribution the online store is similar to their legacy retail distribution where they're not going to sell on a third party. And you're not going to be able to just buy, pick up and buy their most expensive products, their most sought after stuff, similar to Ferrari. But you will be able to get introduced to the brand. And it's almost like a marketing play. It's almost like the shopping experience on the online store is almost a browsing experience. Oh, that looks super nice. oh okay i can maybe afford that one it's they want to control that distribution

as much as possible um so yeah i think that's a key point as well yeah i mean it's you know you think about shopping at hermes you're not buying these things i don't think most people are buying these things on a regular basis so making them come out to the store and go through that experience i don't think that's asking too much and frankly people probably love that uh they probably like enjoy going to the store but let's talk through the history here i think that touches generally on the business model i'll also say that hermes is quite discreet they are not unlike louis vuitton where i think lvmh has been pretty public about their aspirations and bernard arnault has done a ton of public interviews hermes can tends to keep things close

to the vest and they had 588 pages in their annual report which was an absolute slog and I gotta say they gotta condense that I mean I do not know why they're wasting their time I don't know

I don't think there's not a single person on this planet that has read that entire thing I bet the people that put it together don't even read it all I bet they just stitch it together based on different departments anyway let's go through the history as with basically all of the luxury companies we've spoken about this month

hermes was founded by a passionate artisan who built a high quality product that's where you know today we talk about the heritage and yeah it's still a high quality product but a lot of it is just the brand like with louis vuitton a lot of it's just the brand recognition the pricing power comes from the fact that it's such a status symbol ferrari i mean they're still quite good engineering feats but back in the day a lot of the reason that it attracts value or attracts high-end buyers is because of that quality and so the same thing happened here with in hermes's case they were founded in 1837 by thierry hermes he established a harness workshop in paris this was initially designed for european noblemen um and basically they stuck with the harness

business for, I'd say, almost 40 or 50 years. And Thierry Hermès' son took over the business and they started shifting to saddles for wealthy people. It was internationally, but mostly done in Europe. And then it's been literally the exact same formula, I want to say, for the last 150 years. They passed the business down from generation to generation of the Hermes family, and they've done a pretty good job, actually a fantastic job stewarding this business. They introduced new products all under the Hermes brand, and they continue to increase prices slowly. The only other big moments that I would call out is the Birkin bag was introduced in 1984. I think they started getting into bags around the late 1800s, kind of

turn of the century. The Kelly bag was, it was renamed the Kelly bag. It was already a bag that was in their production line, but not production line, but something they were selling. It was renamed the Kelly bag after Grace Kelly. And then those bags really took off because celebrities would wear them. And at a time when there's so much media coverage over celebrities, it really drew attention to those bags. I guess other parts that are important here, Bernard Arnault tried to take an activist stake in Hermes, I think around the 2000s. And it was kind of progressive. He had a 5% stake through some subsidiaries, and then he started to try to push it. But he really couldn't get any sort of influence. He wasn't able to buy enough shares

because the family is basically unwilling to sell. And we are now on the sixth generation of Hermes management and the family has been able to hold a lot of their ownership and basically get paid, I believe purely through dividends. So it's really important to understand that this is almost a family business still because they are very long-term focused. There's kind of this famous story now where Hermes had a bag that was selling so well, they actually discontinued it because they were afraid that it would tarnish the brand, that it would become too mainstream. So they discontinued selling a really profitable bag just to kind of nurture the brand. So it's a very long-term focused management team.

I know every company says their management team always says they're long-term. But if you think about it, the incentives are really well aligned here because they get paid on the dividends over the long run. They don't really seem to have any interest in selling. So I'll leave it at that. If you want to talk through the industry and competition. Okay, we want to take another pause today to talk about our friends, Interactive Brokers, otherwise known as IBKR. We love Interactive Brokers. Ryan and I both use Interactive Brokers on a regular basis for our investment accounts. And the reason we love them is because they have

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there today. Yeah. And I will say as a little tidbit, it is reported and it's a little bit confusing and they're a bit secretive, but it's reported that there are over a hundred family members within this kind of structural organization that owns the company and it's worth their stake is worth over $100 billion now. So quite wealthy and long-term oriented indeed. Let's go industry and competition. I think there's three important points here, industry size along with the growth and then geographical distribution and competition. First, the luxury handbag market estimated to be about $23 billion. It has consistently grown for many years. It's projected to grow at about 6% as probably just through pricing power from the same amount of customers worldwide with a little

bit more unit volumes throughout the rest of this decade. And then about half of Hermes' revenue, this sector is going to drive the bus generally. The overall fashion luxury goods market is much, much larger, but Hermes is a smaller player here. I mean, they sell a good amount, as Ryan mentioned earlier, 23% of the business of ready-to-wear accessories and clothing items, belts, shirts, whatever but not nearly as much as other brands which is on purpose do you believe that this is a smart move for them to retain the quality basically their moat their brand out over the long term because i i think it's probably quite smart yeah 100 i mean it's with with louis vuitton I mean, they are at this point, like everyone knows they're expensive, but they are they feel accessible with Hermes.

It's like a different tier. I mean, I mean, it's literally a different pricing tier, but also it's like a next level status symbol. Yeah. And you don't want five people on a flight from New York to London to have, you know, a bunch of Hermes quality Hermes stuff on that flight. And you might see some LV and Chanel stuff there. I think the Ferrari CEO kind of put it best, which is, he said, we could increase supply, but it doesn't make any sense. We would, what did he say? We would insult our clients. They have a lot of existing customers who spent up to kind of be a part of this wealth club, essentially.

Or worked really hard over, you know, to build their own wealth. yeah yeah the last thing you want to do is increase supply so much that they feel devalued and they stop spending with you because i imagine a lot of the purses come from existing customers yep yep and it's a good point as we try to compare i think listeners should think about that as we compare hermes to lvmh maybe or just specifically louis vuitton and chanel and stuff like that as we go through the competition but first i want to hit geography they have heavy exposure to East Asia. I'll have a graphic in the newsletter on this that shows us pretty easily. 59% of sales are in Asia and then 10% of those, like 10% of sales are in Japan. So we have about

50% from Asia that's non-Japan. And I think a large chunk of that is going to be China, which is important for investors to consider. And then the Americas are much less important for them or maybe a growth opportunity. I don't know. You know, there's one in the Seattle area where we live in an area that basically triangulates Google, Microsoft and Amazon's campuses.

So maybe there's a lot of potential there, but that's only 18% of the business. And that includes not just the United States. So they have more exposure to Europe and Asia than I think the other companies we've looked at. Importantly though, just like LV, there is likely even more exposure from a nationality perspective to Asia

because who is buying the bags in Europe? A lot of tourists from America, the Middle East, and Asia. So there's a lot of exposure to this market. It's the most important market to them, not just geographically, but also the people visiting other areas. Think of the famous, not famous, the amount of Japanese tourists that visit Hawaii, right?

That's an important one as well, stuff like that. Now, if we look at competition, people I think are generally aware some of these but there's louis vuitton chanel dior gucci plenty of other ones but i think the question i think we maybe already answered this but to hit on it again do we think that air mess has transcended the competition similar to ferrari and doesn't actually have much of a competitive set anymore okay when i sell my business i want the best tax and investment advice i want to help my kids and i want to give back to the community oh then it's the vacation of a lifetime i wonder

if my head of office has a forever setting an ig private wealth advisor creates the clarity you need with plans that harmonize your business your family and your dreams get financial advice that puts you at the center find your advisor at igprivatewealth.com yeah i think it is similar to ferrari and i can't remember if it was sleepo capital or leandro who said it but just because you have a high price doesn't make you luxury it doesn't make you a luxury brand people could try to outprice them and brands have they've tried to be more expensive they tried to be slightly less expensive with the same quality and it just they don't make any headway against Hermes because a lot of the value comes from the heritage and the brand recognition

among wealthy people and and really the world at large because it's like we said it's a status symbol so yeah and then to answer your question no I don't think they compete with most handbag manufacturers yeah all right and then the last note I'd say is they have about 300 stores worldwide It's an important KPI to track as they try to enter a space. This is the most important distribution point for them. So, for example, I remember reading one of the older conference calls to get some more context on what their long-term plans were back then. And they were talking about launching something in Brazil and stuff like that.

And some of these markets might be smaller, but it's the most important point for them. And they'll talk about renovating, introducing new ones. I believe they just put one in Aspen in that ski resort area. So stuff like that, that's going to be the key way they grow. But let's move to management ownership. Key takeaway, most important thing is the family dynasty controls this business. There are a lot of complications, structure, strange things they have done. But, you know, there's all this stuff you can read in the 500 page annual report.

And if they wanted to hide something in there, fine, that's they hid it from me. I'm not reading that. But at the end of the day, the family controls what is going to happen with Hermes going forward. the current ceo who they call they love calling things not actually what they are doing which is quite hilarious i think they're very particular they call they have two executive chairman who's really there's one that's the ceo and they call it something else but his name is axel dumas the great grandson of emil hermes he has been leading this business since 2013 he's been there for quite a long time seems to have done a fantastic job this basically says the same

thing every conference call uh in 2022 dumas was paid 2.2 million euros in fixed compensation and 3.6 million euros in variable compensation very efficient here for a company of this size and i think an advantage of getting run by a luxury dynasty because he doesn't need to get paid a lot and i think it's a good sign that they actually care about you know their shareholders which are a stakeholder in this business uh i have some quotes in the newsletter they have varying rules on executive compensation, one, they, and I believe it is very hard to find, but I think I understand it correctly where since the IPO in 1993, compensation from a variable perspective for executives is capped at 0.2% of consolidated net income in the previous year. I like that a

lot. I think it's quite, it makes sense. You know, it's good incentives and it's not paying your management team too much. And then I have some other varying quotes about how they don't like partnerships you know the apple watch thing has been a i guess a notorious exception they give a lot of shares out to their employees worldwide which i think is also a good thing you know the people hand making the stuff in france um they talk about not having a marketing division but a quote communications division i thought it was funny on the conference call the executive said that the analyst hurt his feelings by saying they have a marketing team and then they also have um let's see what was oh yeah they're talking about the internet they said quote and this is

back in 2017 in other words we're trying to have the best possible platform on the internet and we're trying to build it it's not we do not want to be too fast because we don't want to lose control of our products so that's the thing they want control at every step and that philosophy hasn't changed for a long time there's not now not just doing it in paris but in every major city around the world all right let's hit the financials quick ryan important takeaways from the numbers here that any listeners should know about yeah and let me just say i love that part of the compensation where it's capped at 0.2 percent of consolidated consolidated net income because for one as a shareholder. It limits how much of your earnings an executive can grab, but also it incentivizes

them to raise the net income. Because if they're raising the earnings of the business, their cap is potentially higher. And I don't think they really managed for that, but at least if they did, their incentive would be in the right place. When we look at the financials, earnings, let's go through some of the numbers, 13 billion euros in revenue over the last 12 months it's growing 25 year over year actually coming out of covid they've been growing really quickly uh i've had an accelerated pace relative to their history so i i don't know if i'd say whether they're over earning or not but i wouldn't expect them to keep up the current growth rate probably going to be more in line with their historical average part of this is definitely

the growth um excuse me the reopening of china right and here's what kind of blows my mind And I heard someone else talking about this as well, but if I just read the unit economics to you, I don't think I would ever be able to guess what kind of a business this is. 71% gross margins, 42% operating margin. That is, I mean, that's insane for a retailer. I'm pretty sure I've never seen anything that high for a retailing business. Smokeless tobacco products. True. True. Actually, yes, that is true.

The free cash flow margin lags a little bit. We talked about this with LVMH where inventories grow in line with the business and it kind of leads to a cash flow lag, but still inventories aren't really that, they don't keep that much inventory on the balance sheet. I mean, it's $2 billion in inventory on the balance sheet from what I saw. They have $9 billion in cash and no corporate debt. i don't know if you took a look at that unless i'm missing anything it's a very clean balance

sheet and frankly it seemed a little weird that they're just kind of storing the cash in their balance sheet but they do pay out a lot in dividends so maybe it's just to kind of make sure they can continue to pay that out yeah so i read from our friend that ryan mentioned we had the combo discussion on to do an overview of these this entire industry which again if you haven't listen to, I highly recommend you go do it. It's Leandro from Best Anchor Stocks. He wrote a little quick blurb, not too quick, but not extremely long, on Hermes, on his public sub stack. This is not for his paid thing, so it's free for anyone to view. And he talked about how their philosophy is very similar to, well, I don't know if he made this direct comparison, but it's similar to

Berkshire Hathaway, where they're going to be typically more conservative than they need to be. So, for example, people always talk about how Berkshire Hathaway can run with more leverage, could run with way less net cash. Hermes, people talk about that all the time as well. The analysts are like, hey, look, your business is super durable. Why don't you put two times leverage here and buy back some shares? They don't really care about that. They want to be the most. Oh, and another example here would be Nintendo, where they're not worried about optimizing shareholder returns over a three, four, five year period.

They're worried about business durability over a multi-decade period, which I think the takeaway for myself is you can't have a different understanding as an investor. You're just going to get frustrated if you hope they're going to change this, which is most likely they're not going to be. Yeah. And just going back to some of the numbers to kind of put context around growth of the business over the last two decades. So over the last 20 years, revenue has grown at 12% a year, pretty astounding. And now part of that's being pulled up by the recent growth, but still it's probably 10% plus, even if they weren't growing the last two years. Earnings before taxes has slightly outpaced it at 14.5% annually, and it's been fairly

steady. There was a slight hiccup just looking at the numbers right here between kind of 2013, 2014 but they grew pretty much all throughout the great financial crisis and i guess it's kind of a testament to the business fairly recession proof they've gone from a billion in revenue to 14 billion in revenue in the last 12 last 20 years so it's i think at any point i probably would of looked at Hermes and said, how much more can they grow? Just because it feels like it's saturated in terms of the amount of wealthy people. But for one number of wealthy people continues to grow. And two, they have basically, uh, this baked in pricing power every year.

Yeah. It has been not a bad business whatsoever. All right. Earnings, multiple market cap, 205 billion euros. So this is one of the largest companies not only in Europe, but the entire world. Subtract out some of the net cash, let's just say roughly on an even trading day, they're at a 200 billion dollar, excuse me, 200 billion euro market cap. And then over the last 12 months, operating income using Ryan's two numbers there is about 5.46 billion euros. Taxes will obviously bring this down. So the true earnings multiple is going to be slightly higher than this but i just wanted to even it out because sometimes taxes get a little funky from year to year the enterprise value to operating income is 36.6 so not too much you know them and ferrari

they're very similar i think uh getting viewed from public market investors okay anecdotal evidence ryan talked a little bit about this already clearly value investor types we're not the ones buying these things but I don't know thoughts here yeah going to the Hermes website just makes me think how absolutely insane it is that anyone is paying for this but there are people out there that do and hey they have a hell of a brand so kudos to them I don't know if I've really ever maybe I've seen some in person but I don't think I've noticed and maybe i'm not really the people they're trying to appeal to but when you say hermes when anyone brings it up i think even if you don't know you think luxury

just because there's the kind of iconic age yeah there's that a little bit and what's weird is i knew what it was without caring about before this month like i knew what it was without caring about the products at all which is kind of weird how they're they're good with their quote-unquote not marketing, but communications. And for me, I would say, you know, Hermes, as Brian mentioned, is subtle. These other ones, like Louis Vuitton especially, are flashy. And I think it makes a big difference in preserving brand quality over the long term. Because every time you go to an airport, you are going to see someone, a big one, you're going to see someone with an LV bag of some sort. You're probably going to see some sort of maybe Chanel bag or some of these others.

And honestly, I can't remember ever seeing an AirMaz bag. Like you mentioned, it's more of a you-know-you-know type of thing. But I think those ones are not really at the commercial flights. They might be flying private. All right. Future growth opportunities. Anything else there, Ryan? And then move on to yours.

No. There's no future growth opportunity that's unique here at all. And I know I feel like I've been getting lazy with this. but they have been doing the same thing for since 1837 so i think it's unlikely that there's going to be any big shift it's not like lvmh where there might be a new acquisition or maybe they dispose of some business armez they're just going to keep launching new products that they feel like fits in their portfolio and i just say keep with it and then add some some slow subtle volume increases over the years and continue to raise prices that is a recipe for revenue growth and

margin expansion yep now i think with the luxury ones the whole point is that there's not very many future growth opportunities except for sticking to what you're doing i mean in fact i think like you got to stick with the heritage you got to keep it as an exclusive club you know you got to have it so people that want to spend ten thousand dollars to join the club quote unquote and then in 20 years 25 years the introductory price will probably 20 be 20 000 to join and that you know if management starts talking efficiencies i'd say watch out ryan some dad yeah i mean if they started doing something new it would be concerning especially for hermes where it's like the the simplicity is what's made the investment so attractive that they're able to grow at will

without acquiring any companies and basically just all organic initiatives that they do. I mean, it's so simple, but it's perfect for them. And I would be concerned if they started to try to drive growth some other way. Yeah, and the funny thing is, earnings would probably double pretty quickly, but it would actually be a terrible sign.

But I'd say more an actual future growth opportunity I have think investors should consider at thinking about whether this company is over-earning and there's a lot of variables but the emergence of you know the chinese korean and japanese tourists around the world this year and in 2024 definitely will help them remember these markets were much more strict and careful about the pandemic in general compared to some of the western areas so they were i mean really didn't reopen i mean we talked about with those airline companies. I think that was a big eye opener. The Japanese tourist has not gone outbound as much as

possible. They're still on a recovery trajectory, whereas the United States is almost in a back to normal state in 2023. And then conversely, you know, a headwind would be a more closed off China, which I think we'll talk about the low lights here. But Ryan, let's go through what we like and dislike about this business. Pretty simple. I think it's even more simple than Ferrari because Ferrari has some of that innovation, R&D, and then the transition to electric vehicles. But this one it's much much more elegant yeah i think some of the highlights for me is it's the ultimate signal of wealth buying one of these bags and people signaling their wealth has been a trend since forever i don't think it'll ever end so i think it's a trend that'll continue to propel

them to grow revenue. The economics are really strong. I mean, 70% plus gross margins, 40% operating margins. And I think I would not be surprised if they were generating 50% operating margins in 10 years. It feels like they can steadily grow that over time because they can just incrementally raise prices above their cost to fulfill orders, which is pretty much just the artisans and it feels like that's what they've done for the last decade i would not be surprised if they continue to do so they've had success introducing new product lines i think that's big if they were just a bags business or just saddles i mean they still have done quite well but the fact that they've been able to roll out new products with the aramez brand and see so

much success i think points to potentially faster revenue growth the culture of creativity now we don't really get this stuff it's not our foray but it's been it's obviously been incredibly strong the culture of creativity i think is also a not as big you know it's part of the advantage here i guess last thing it's just along with the other luxury companies we looked at the brand is very hard to replicate because of the heritage and we talked about it i mean there's been some competitors that have tried to outprice them but high prices do not make you a luxury brand it's it's the heritage and the image that you give to customers and hermes certainly possesses that so highlights across the board really strong business i mean

frankly it's certainly one of the best businesses i've looked at i mean the whole luxury theme we've been doing. They're all incredible businesses, but this feels very hard to disrupt. Lowlights for me, I don't have a lot of flaws related to the actual operations of the brand or anything like that. They do generate a lot of revenue from China. We were talking about it before the show, I guess a quarter of their sales come from China, but it's hard to know because they don't break it explicitly but obviously if anything were to happen there and it kind of people's opinions around china seems to ebb and flow but we hear news all the time about events going on over there that might uh close china off from the global economy apparently at the two leaders meetings

with the united states xi jinping told biden that they're gonna take back taiwan like in his own words so it's like look that that stuff could get sticky yeah and it just might end up closing them off from the global economy so if you're hermes i mean that's potentially a quarter of your sales gone that's i mean that's a huge hit to the investment here the other thing is that's probably been a huge growth vector for them as well is the increase in wealthy people in china especially over the last two decades so if that starts to slow yeah yeah but if i mean if that starts to slow maybe you begin to see kind of revenue growth taper off a bit but the only other thing is there was some news that came out this week that one of the heirs

to the Hermes fortune is like thinking about gifting his inheritance to his gardener. So I don't know. I also saw that maybe that's not fake, but like misleading.

So I'll leave it at this. If there's some sort of a feud between the sixth generation of Hermes family, like that's a recipe for disaster. You know, you could certainly see some sort of a demise and potentially the brand or have this end up being sold off to someone else which maybe that's good you know maybe bernard arno steps back in yeah maybe it just all rolls

to lvmh although that would be crazy if they actually acquired them i don't think they would be allowed to do that but it seems like the european union just focuses on regulating the united states tech market and that seems to be what their entire focus is but here's a quote from a bloomberg article about the family and the uh just about them in general says once vulnerable to predators as complacent family members got involved in other endeavors hermes is success has provided the group its best defense now they talk about how right now things are running smoothly dumas seems to be quite good really strong reasonable rational person but this type of stuff could happen again and we've all watched succession like that's not obviously it was a bit

of a caricature of this type of stuff but that type of thing could ruin things here i think i have similar highlights i would reiterate the elusive club feel as similar to ferrari where you join the club that owns these bags and then you can be a reseller down the line they earn value they retain their value or even grow in value if they're a collector's item over time and they have different types each year they have their like theme of the year where one of them was i i don't i can't even remember it was like a light you know our theme this year is light and i don't know they just change it up all the time and they're quite i mean they look good honestly like they're they're great looking products and that's probably because they have the hand makes

but then i think the other important one to reiterate is the more disciplined nature on expanding their presence because this is what retains the true luxury strategies i talked about with ferrari it's very similar a billion people know about your brand like 10 20 million can afford it but only a certain amount can buy it every year all right bull case bear case let's wrap things up ryan you got the numbers here so why don't you kind of go through what could happen financially sure and some of these are rough so don't it might be some of these numbers might be slightly off but i think it paints a general picture of what the valuation looks like today so over the last 20 years hermes has grown its revenue at a 12 compounded annual growth rate

earnings before taxes have grown at 14 and a half percent so i was trying to think through the puts and takes in terms of what could drive growth. I think for a bull case, just saying 14.5% earnings before taxes growth from here makes sense.

It's a little bit of margin expansion. Yeah. I think that's reasonable. Especially following two years of 25% plus revenue growth, I think there's

the chance that things kind of revert but let's say that my my only input here is that earnings before taxes grows at 14 well 15 for the next five years which i think is reasonable if they do that they'd be earning 11 billion euros in annual earnings before taxes if we apply a 25 times multiple to that in year five so the market values them at 25 times ebt which i think is right about their last 10 year average um in terms of multiple they would have a market cap of 275 billion euros it's roughly 210 billion euros today so you'd be looking at a six percent annual return minus including dividends add plus the cash you get back or the cash that they they retain over the years things could obviously go better than this but

hopefully that paints a picture if if you get 15 percent earnings growth here you're probably going to get six to seven percent returns annually so the market is expecting a continuation of what they've done over the last two decades for sure yeah and i think i have similar stuff here where you're either having a very extended time horizon i think where you're betting on the durable, uh, pricing power for over 10 more years and beyond, uh, you know, in the long term, multiple decades. And then you're also betting that the multiple stays high, I think at these levels, uh, or excuse me, like if you buy at this price, you're betting that, you know, that earnings

multiple, they keep getting valid at 35 times, 40 times earnings. All right, Ryan, what do you think could go wrong here? so well i do think the business is quite bulletproof minus the china risk so i don't have concerns about them being able to grow revenue by a solid amount call it 10 plus but obviously there's multiple compression risk and it feels like lately i mean if you just look at the multiples of the luxury companies since 2020 a lot of them have performed quite well But it also feels like there's maybe been a flight to safety among investors where these businesses have not been disrupted by COVID. They have been, frankly, resilient over the last 10 years, but specifically over the last three years.

And their multiples have expanded, which for me, I mean, kudos to the people that have been shareholders over this time, but that doesn't feel like a good entry point for me. So I think kind of the big bear case here is that there's the multiple reverts to its historical average, which seems like a safe bet. And if that happens, you're probably getting about about treasury level returns right now. Yeah. As I said in my bear case, the brand is bulletproof, as you wrote there for years. But that doesn't mean revenue growth is inevitable. something that's getting priced in a little bit right now they've had years where they don't grow that much they're not afraid to be slow so yeah and then obviously there's the family stuff where

families and they seem to be quite good but there's always that risk all right let's wrap things up more or less interested ryan yeah i mean wonderful business i'm just not gonna buy at this price i'd love to say i'm gonna put this on my watch list but i'll maybe revisit it if there's if it gets below 25 times earnings maybe even below that i mean in the 2010 to 2013 period it was below 25 times ebit so it's not that's when revenue was stagnating right yeah it's not abnormal for that to happen to a good business like this and maybe if you get a scenario like i don't know if something happens to the brand if there's some sort of terrible news where people start to think that it's it's affected the brand like i'm trying to trying

to recall one that's that's relatable maybe amex in the 60s because if i remember that correctly there was like a whole bunch of concerns around the business from the management side but there was everyone thought it was affecting the customers and it wasn't maybe there's something that happens like that and armez gets cheap again then i'd revisit it but yeah right now i mean this just great business but it's not really my cup of tea yeah it's not going to get optically cheap unless they make some mistakes and it's going to look like people there's going to be some huge negative stuff if the earnings get cheap specifically specifically the geopolitical stuff or management mistakes and i wouldn't note you said 2013 there at the end of that time period

dumas took over 2013 so i think he's part of the story here the last decade if something happens to china the china business especially for hermes i got a feeling that could potentially be a good entry point because this is a brand that's going to be it's going to withstand the test of time no doubt about it i could certainly see an overreaction there on the flip side though if that happens i think a lot of businesses are going to sell off unsurprisingly because so much of supply chains are uh located there but whatever yeah well good thing for them is they sell there but all the stuff is purposefully made in an expensive fashion in in france okay let's i'm more interested clearly i think it's very similar to ferrari now i would put and i'll put you on the

spot here i would put ferrari and hermes as two of the best businesses in the world i'm going to revise my list who goes up there for you i would put visa and mastercard there anything else come to mind as the business quality of maybe the ratings agencies although i don't know them very well but for you ryan anything else come to mind is being in that same stratosphere of business quality yeah i came across a couple companies going through like this wide moat list recently there's this australian toll road business that seems quite good uh no no that regularities can get ready come on come on go on i think costco's up there for me costco yeah good one good one some of these ones with just like

ultimate scale economies you could maybe even throw Home Depot in there just if you kind of have to X out the cyclicality of the housing space but I think there are some retailers that fit in there like Home Depot and Costco

but yeah Ferraris for sure some people would tell us Apple but I think it's a touch lower potentially Amazon for Amazon would be up there

for me yeah the logistics advantage you know it's quite good okay well that was a fun exercise and for anyone

we're going to do a special show to start the next year for the New Year's predictions we a lot of people do predictions we're going to probably do

something more catered to our show so focused on like ranking some sort of stock thing or whatever or like making like a fake long short portfolio.

These are just coming to mind right now. We're probably not going to actually do that, but we're going to try to do it, make it fun, not just the boring, hey, we think the AI bubble is going to continue. Okay.

Before we close out, we just finished our luxury month. Three companies we did were LVMH, Ferrari, and Hermes. If you had to rank them in terms of investment returns from here, who do you think is going to do the best? Who do you think would do the worst?

What time horizon? Five years? Five years. LVMH, five years. That's fair. Cheaper earnings, multiple. I think people value Hermes and Ferrari at the higher multiple because they understand the durability over a 20- to 30-year period.

And it's almost impenetrable. I also think with Ferrari and Hermes, it kind of feels like they have a shareholder base who aren't really inclined to sell. With Ferrari, it seems like... We know some bigger Ferrari shareholders, and they get invited to events. And with Hermes, I mean, a lot of it's family ownership.

So it's kind of one of those things where it's like people feel like they're a part of the club as a shareholder. And I don't think you get that sense with LVMH. but yeah I would say LVMH well you get the A there's like a free liquor thing right if you're a LVMH shareholder do you remember seeing that thing

I think you get like a magazine subscription too or something like that with LVMH the I would say LVMH is probably highest for me as well what about Ferrari vs Hermes 5 years that's a tough one I think

I'd imagine there's some Hermes. Some customer overlap there. Well, it's the dudes and women and men. You know what I mean? Some marriages, potentially. Yeah, 100%.

100%. All right. Well, that's going to do it for this episode. Remember, special one next week. AMA show or Ask Us Anything show. Also, that's going to be the next Power Hour that'll come out in two days after we record after this gets released. Let's hit the disclosure. We are not financial advisors.

Anything we say on the show is not formal advice or recommendation. Ryan and I may hold securities discussed in this podcast. We may have owned them in the past and we may buy, sell or hold them in the future. Thank you, everyone, for tuning in and we'll see you next time.