Hermes Continues Delivering Stellar Results; FVE Increased, but Shares Still Expensive

We increase our fair value estimate for wide-moat Hermes RMS to EUR 990 per share from EUR 700 per share, following another set of stellar annual results. Our fair value increase stems from higher than previously expected growth in 2023 thanks to strong price increases (5%-10% globally with 7% on average, compared with low- to mid-single-digit increases annually over the past few years). We also expect higher long-term sustainable profitability for the firm, with an operating margin around 40% (similar to that delivered in 2022 thanks to exceptionally strong capacity utilization and fixed-cost leverage even as gross margin came under pressure a bit). Further, we increase our phase II growth rate to 8% from 7% and our phase II return on new invested capital from 60% to 70% to reflect our confidence in the superior longevity of Hermes’ brand appeal, strength of execution, and pricing power. Despite the fair value increase, Hermes shares still trade in overvalued territory in our view.

In the fourth quarter Hermes delivered 22.9% constant-currency revenue growth, consistent over the year (23.6% annual increase) and easily outpacing peers such as LVMH’s fashion and leather division (10% growth in the quarter), Kering (negative 7% in the quarter), and Richemont (5% in the quarter). Hermes benefited from a rather easy comparison base in its main leather division (43% of annual sales), which was down 4.8% in fourth-quarter 2021 due to capacity constraints. Still, with 15.6% annual growth, sales were ahead of the company’s targets of 6%-7% capacity growth and 3.5% price effect, with strong productivity. Despite being significantly less aggressive with price increases than fashion and leather peers, Hermes was one of the few that saw its operating margin expand in 2022 from already record levels in 2021, to 40.5%, a 120-basis-point improvement. Hiring, investment, and salary increases will weigh on costs in 2023, but should be offset by price increases in our view.