Hermes: You Won’t Believe How Much Revenue Their Stores Generate (OTCMKTS:HESAF)

Hermes (OTCPK:HESAF) (OTCPK:HESAY) released its first-quarter sales figures, which once again handily beat expectations.

As the company continues to gravitate above the rest of the industry, it appears Hermes can shrug off any macroeconomic concern or a luxury slowdown.

Let’s dive into Hermes’ counter-positioning and show where consensus estimates have it wrong.

Introduction

I’ve been covering Hermes on Seeking Alpha for almost a year. I initiated coverage with a Hold rating, as I viewed Hermes’ premium over other leading names in the sector as too high.

However, as macroeconomic uncertainty persists, and Hermes’ competitors are showing signs of weakness, the maker of the Birkin bag continues to grow at a rapid pace, demonstrating unparalleled strength and resiliency.

This, combined with the company’s new strategic focus on non-leather categories, has led me to upgrade Hermes to a Buy.

Cleaning Up The High Multiple Argument

Hermes is trading at a 51x P/E multiple over 2024 consensus estimates. We’ll get into whether those estimates are beatable or not in the following sections of the article, but for the sake of this conversation, let’s take them as they are.

A 51x multiple is objectively and unquestionably high. There aren’t too many companies in public markets that trade at such multiples, and if there are, the majority of them are growing faster than Hermes or on the brink of becoming profitable.

Hermes is different. While it is growing rather fast, somewhere in the mid-teens, it is certainly not a young company, being founded almost 200 years ago.

And yet, the stock has been hovering in the 45x and above levels of multiples post-pandemic (around 2.5x the S&P 500’s average):

And even prior to the pandemic, it traded in the 40s range, reflecting a similar premium:

Without getting too deep into theoretical stuff, it’s important to understand that in Hermes’ case, the high multiple primarily reflects a high terminal value.

In simple words, the market places a high probability for Hermes to continue to grow EPS at a mid-teens pace well into the future, and in my view, there’s nothing to suggest the market is wrong.

After all, the company is 200 years old, and it’s still growing at a rapid pace.

Another caveat to take in mind is that Hermes currently has an all-time-high net cash position. When neutralized, the multiple seems more aligned with historical levels, at 48x.

Counter-positioning & A Jaw-Dropping Sales Per Store Figure

Hermes has less than 300 stores worldwide. 294 to be exact. Hermes generated €13.4 billion in revenues in 2023, reflecting an average annual turnover of over €45 million per store.

I think the above graph is a great capture of Hermes’ counter positioning in the luxury landscape. The company continues to operate as a “humble” mono-brand, or what the industry likes to call quiet luxury. There are no huge celebrity deals and brand ambassador arrangements, no eye-popping fashion shows that cost billions of dollars, and many of its items are barely recognizable to the untrained eye.

All Hermes has done, for the last 200 years, is to drive desirability through scarcity, exceptional quality, and an extremely unique and inspiring manufacturing process, which I encourage everyone to learn about.

While Hermes did not grow its store count over the last decade, the company’s unit economics provide high certainty that if and when the current growth strategy reaches a certain limit, there are multiple strategic levers they can pull to maintain the mid-teens growth pace.

Again, I see absolutely nothing stopping the company from growing at a double-digit pace in the foreseeable future. I think the company’s ability to maintain these growth levels, despite the extraordinary growth numbers post-pandemic, and despite the unfavorable macro backdrop, especially in key geographies like China and Japan, clearly proves this claim.

Consensus Estimates Are Way Off

So, if there’s no evidence to suggest a material slowdown, what are current consensus estimates based upon?

In the first quarter of 2024, Hermes generated €3.8 billion in sales, reflecting 12.8% growth Y/Y, which would have been 17% on a constant currency basis.

Q1’24 was also the toughest on a comparable basis for the year (together with Q2), as they grew by 22.5% in both quarters last year, compared to 7.3% and 12.4% in the third and fourth quarters.

Based on historical seasonality, Hermes is on pace to reach sales of €15.5 billion for the year, which is 3.5% higher than consensus estimates.

In addition, EPS estimates of €44.9 reflect a margin contraction of 80 basis points, which, in case it happens, will mark the first contraction since 2020.

While there are valid arguments for a margin contraction, which primarily includes FX headwinds, I think it’s reasonable to expect Hermes could overcome those and at least maintain last year’s levels, as operational leverage and price increases offset high costs.

All in all, I expect Hermes to beat EPS estimates by around 5%, which is meaningful as it will support the resiliency thesis of the company even more.

Updated DCF Valuation

From 2013 to 2019, Hermes grew revenues at an 11% CAGR, growing from €3.8 billion in sales to €6.9 billion. During that period, net margins improved from 21.0% to 22.2%, resulting in a net income CAGR of 12%.

Then, came the pandemic. From 2020 to 2023, Hermes’ revenues grew at a whopping 20%, while profit margins improved from 21.6% to 32.1%, resulting in an astounding 33% CAGR.

While many attribute the post-pandemic growth to fiscal stimulus, it’s important to understand that Hermes’ customers are presumably the richest customer cohort in the world. I see no reasonable way to argue these people gained any material benefit from the favorable monetary environment during the pandemic, and the best evidence for that is that the company is maintaining very high growth levels in a much worse environment.

The reason for the acceleration, in my view, is primarily a result of management’s willingness to raise prices, as well as continued capacity enhancements (at the historical 7% pace), and increased focus on new categories outside of leather.

Looking ahead, my baseline assumptions are low-double-digit revenue growth, with stable margins.

Taking a 7.0% WACC, I estimate the company’s fair value at €2,335 a share. I find it highly likely Hermes will beat my assumptions rather than miss them, and I expect that as early as next quarter, I’ll have to raise my forecasts for this year and beyond.

Conclusion

Given all that we discussed, I believe Hermes’ fair multiple in the current market environment is somewhere in the 50x range. I expect the company will continue to trade at this level for the foreseeable future, albeit with occasional fluctuations, which would become optimal buying opportunities.

Having said that, the company’s mid-teens growth trajectory is simple and clear, and therefore, getting in at a fair multiple should still provide significant market-beating returns.

Therefore, I reiterate Hermes as a Buy, with a price target of €2,335 a share, reflecting a 50x multiple on my 2024 EPS estimate.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.