Hermès Q1 Financial Outlook: Anticipated Revenue Growth to Slow, Early Signs of Luxury Market Chill Emerge

Hermès, a top luxury brand originating from France and established in 1837, is globally celebrated for its exceptional craftsmanship, supreme quality, distinctive designs, and prestigious image. Starting with high-end horse harness production, the brand successfully transitioned to leather goods, with the Birkin and Kelly bags being the most renowned. Its product lines include leather goods and accessories, ready-to-wear and accessories, silk scarves, perfumes and beauty products, as well as watches and jewelry. Hermès consistently adheres to handmade production and the use of top-tier materials, which has made it a favorite amongst affluent consumers worldwide. In the generally cool luxury market of 2023, Hermès achieved double-digit growth in both revenue and net profit, a testament to its brand recognition.

As a top-tier luxury brand known for its handcrafted leather products, Hermès' main product lines include ready-to-wear, silk, leather goods, and perfumes. Financial data indicates that the company's core operations include ready-to-wear and accessories, silk and textiles, leather and saddlery, watches, and beauty products. As of Q4 2023, leather and saddlery accounted for over 40% of total revenue, while ready-to-wear and accessories accounted for more than 20%; these segments form the foundation of Hermès' revenue.

Chart: Hermès Core Business Revenue Structure (%)

For expectations on sales of various Hermès product lines in the first quarter, we can analyze from the following aspects:

(1) In the 2023 Hermès earnings call, it was stated that Hermès plans to implement a comprehensive price increase across its products in 2024, with increases between 8%-9%.

(2) High inflation and reduced purchasing power have had a certain impact on high-income or high-wealth customer groups, potentially slowing product sales growth.

(3) Hermès also plans to advance the construction of four leather workshop projects in France over the next four years, continuing to increase leather production capacity.

Overall, we expect sales for all Hermès product lines to continue to grow in the first quarter of 2024, albeit at a potentially slower pace. Additionally, thanks to the ongoing expansion of Hermès' leather workshop facilities resulting in increased production, we expect the sales growth of leather and saddlery in the first quarter to exceed that of other products.

By segment, leather and saddlery are expected to see the fastest sales growth, projected to reach $1.68 billion, an 11% increase year-over-year and a 13% increase sequentially; ready-to-wear and accessories are also expected to grow rapidly, with sales projected at $1.12 billion, a year-over-year increase of 10%, but this segment's growth rate is anticipated to be 10% lower than the previous quarter. So it should be noted that although Hermès' revenue is still in a phase of steady growth, the rate of increase has slowed compared to the previous quarter.

Chart: Hermès Total Revenue Change (Millions of USD)

Historical financial data indicates that in 2023, nearly all of Hermès' regional sales experienced growth around 20%, suggesting that the luxury brand was seemingly unaffected by the broader industry downturn. As we enter 2024, Hermès' regional business development still warrants our attention. Here are several factors that may impact regional sales revenue:

(1) The Asia-Pacific region, including China, is Hermès' largest market, accounting for 51% of the total sales last quarter. For example, Hermès plans to open a new store in Shenzhen in 2024. Additionally, the group is combining product design with its exclusive distribution network, aiming to drive growth in store and wholesale volumes in the Asia-Pacific region.

However, it should be noted that several consumer goods companies have stated that a continued decline in housing prices in 2024 could significantly deplete the assets of the wealthy and affluent middle class, affecting luxury goods consumer confidence. Institutions predict a significant decline in China's luxury goods market in the first quarter. An early sign was Dior's announcement at the end of February this year to cancel its men's show in Hong Kong at the end of March. Subsequently, Gucci's parent company Kering SA issued a warning, expecting Gucci sales to plummet by 20% in the first quarter, with the Chinese market being a major factor. Therefore, the decline in Gucci's Chinese market in the first quarter could exceed 30%.

(2) In the American market, while the sales of luxury companies like Kering Group significantly dropped in North America last year, Hermès' performance remained strong. The high-end trend in both supply and demand in the luxury market was confirmed in 2023 (the unit price of a Hermès bag is nearly ten times that of Gucci), and this trend is expected to be further highlighted in 2024.

(3) In terms of sales channels, thanks to the push from travel retail business, the demand for Hermès products in various regional markets has further increased, and the sales revenue from wholesale business has also continued to grow.

According to Bloomberg consensus expectations, Hermès' sales in the Asia-Pacific region for Q1 2024 are expected to rise further to $2.4 billion, a 7.8% increase year-over-year. The growth rate of revenue in the Asia-Pacific region has slowed down, with the region's revenue expected to account for about 60% of the group's total revenue, further expanding its impact on total revenue. In the U.S. market, revenue for the first quarter is expected to reach $660 million, a 10% increase year-over-year, with great potential for future growth.

Chart: Hermès Sales by Region (%)

Hermès Group stated that since its handbags and other leather goods are purely handcrafted and use top-grade raw materials, the production costs have always been high. Since 2022, the labor costs for the group's artisans have been rising, and an increase is expected in 2024 as well; additionally, the prices of high-quality leather and other raw materials have been increasing, leading to rising costs for other raw materials.

As Hermès is a luxury goods manufacturer, its production costs are sensitive internal information not disclosed publicly, so we cannot obtain specific figures at this time. However, according to information disclosed during Hermès' financial conference call in 2023, the group's production costs rose by 6% last year, including increases in raw materials and labor costs.

Furthermore, due to the ongoing global inflation, expenses related to marketing, advertising, rent, logistics, and after-sales services have also risen, leading to increased sales costs. Historical data indicates that Hermès' sales expenses have maintained high growth for six consecutive quarters, and we expect the sales and administrative expenses for the first quarter to reach $860 million, with an estimated sales and administrative expense rate of about 24%, a slight increase of 1% compared to the previous quarter.

According to forecasts from major banks such as JPMorgan Chase, Hermès' gross margin for the first quarter is expected to be 69%, lower than the previous quarter; net profit is expected to be $1.16 billion, a 10% increase sequentially. At the same time, EPS is estimated to be $9.93, a 10% increase year-over-year and stable sequentially.

Thanks to Hermès' steadily growing sales revenue and turnover, we anticipate the group's profits will continue to rise. However, due to the impact of rising costs on profits, we further estimate that the profit growth rate for Hermès in the first quarter may slow down, and the gross margin growth rate might also decelerate compared to the previous quarter.

Chart: Hermès Historical Gross Margin Change (%)

In recent years, Hermès has witnessed continuous sales growth, and this robust momentum indicates that Hermès has performed exceptionally in the competitive luxury market, maintaining its position among the top luxury brands in the world.

At the end of 2023, Deloitte released its "Global Powers of Luxury Goods 2023" report, where LVMH (Louis Vuitton Moët Hennessy) and Kering Group remained in the top two positions, with Hermès ranking eighth, asserting its industry-leading status.

Chart: Global Luxury Brand Ranking (Based on 2022 Performance)

Similar to domestic Chinese baijiu, the luxury handbag industry that Hermès focuses on has also begun to diverge significantly. Like Moutai, Hermès has shown stable growth irrespective of the cycle, while Kering, similar to other baijiu performances, has experienced fluctuations and even downturns.

As of the end of 2023, Hermès handbags have led the industry in sales for the fourth consecutive year, with the average retention value rising to around 110%. Additionally, the passing of Birkin bag muse Jane Birkin has made the already sought-after Birkin bags even more in demand. Overall, Hermès' position in the luxury goods industry remains unshakeable, with very stable market competitiveness.

Considering the likelihood of Hermès Group achieving an increase in revenue and profits in the first quarter, we expect Hermès' performance to continue to grow, albeit at a slower pace. Since the beginning of 2024, Hermès' stock price has significantly outperformed the broader market index.

From a valuation perspective, due to several potential growth factors, major banks have given Hermès an estimated P/E ratio of 51.2 times for the first quarter, maintaining a leading position compared to its industry peers. Considering the expected slowdown in Hermès' revenue and profit growth rate for the quarter, we believe the current market valuation for the company is high.

In terms of shareholder returns, in 2023, the company's total shareholder return was approximately 96 million euros. Since Hermès' current total market capitalization has exceeded 258 billion dollars, the company's historical shareholder returns are less than 1%. With the current risk-free rate in the United States exceeding 5%, the shareholder return for Hermès in the first quarter is still expected to be low.

Looking at stock price fluctuations, Hermès' stock price has risen by 18% since the year began. We believe the positive expectations for the first quarter's performance have been adequately reflected in the stock price. Also, due to the high market valuation for the first quarter and the low expected shareholder return, we further estimate that there is a limited likelihood of a significant stock price increase following the earnings announcement.

(1) If holding the underlying stock, adopt a covered call strategy, which allows enjoying the benefits of a stock price increase while retaining the option premium collected if the stock price does not exceed the strike price before the option's expiration, thus avoiding potential losses from selling the stock.

(2) If investors have a higher risk appetite, they can also consider shorting the company's stock. By selling high and buying low, they can profit from the anticipated decline in stock price, but this approach carries greater risk.