Business Breakdowns
· Matt Reustle
[00:00:00] S0: I love hearing about the experience examples, those are just always so interesting to me. You covered the financial overview quite well previously, but on that point of something like the down supply and the cost associated with that, is there anything that they do to manage the risk of having an undersupply of materials or anything else that would be a risk from the cost side of the spectrum?
· Chris Davies
[00:00:00] S1: Yeah. So I think with a lot of luxury brands in Italy and also in France as well, you've seen Hermès do this over time, you've seen them vertically integrate. They started to buy up local supply to ensure that they've got that access when they need it. So, I mean, Moncler does have a very strong relationship with its suppliers. I don't think they're quite as vertically integrated as some of these other Italian brands. As it stands today, they have got very strict rules about the supply side, particularly on quality. But in terms of access, they haven't actually had any problems to date with any luxury brand. You've got to manage the demand side of the equation very carefully. So, I don't know, let's think of an example. Think of Ferrari. The founder of Ferrari used to talk about the idea of providing one less car than demand. So you're never quite meeting that demand. If you look at the number of units that Ferrari have sold, in 2019, it was just over 10,000. Last year it was just under 14,000. They've grown a bit, but not that much. They found other ways to grow. It's been through price and mix and selling special editions and the like. So I think for Moncler, you're never going to get this situation where they are really going to flood the market with lots and lots of inventory. They're really carefully trying to manage how much they're selling. So the whole commercial strategy is based on the principle of scarcity. That's basically how they think.
· Matt Reustle
[00:00:00] S0: It's such a fun economic equation for the luxury market to think about in terms of just being appropriate about the amount of scarcity that you have within the business. And I guess that answers my other question, just thinking through the financial model and where risks might exist from the inventory management side, I think when you're managing to demand, you probably have a limitation on that. But are there other things like inventory management, turnover, things that get cash caught up inside the business that you would point to as either a risk or something that they manage particularly well?
· Chris Davies
[00:00:00] S1: The management on the inventory, the working capital side of things, has actually been really very impressive over time. 2020 was a tough year for pretty much everyone, but not many people saw the pandemic coming. So, I mean, if you look over the long term, these guys have been making free cash flow margins in the mid-20s, and if you look at free cash flow to EBITDA conversion over the past five years, they've averaged about 61%, which is pretty impressive. So there haven't really been any signs that they've been struggling to manage all of this. This comes back to the whole commercial strategy of really carefully managing supply so that you're not overstocking the market. Because for luxury companies, volume can be a driver of growth, and it is in lots of cases. But price is also really, really important. If you're putting prices up or you're changing the mix of your collection slightly so it favors slightly higher price-point products, that is just free money from a profit perspective. It doesn't require any more fiddling around with the inventory or anything like that. But companies can be quite extreme when it comes to managing those rare situations where you do find that you end up with too much inventory. So I remember going back to Richemont, which owns Cartier, it owns Van Cleef, so two of the most famous jewelry brands in the world, but also has all these watches of the traditional variety. We're not talking Apple Watches here, we're talking the timeless pieces that get passed on from one generation to the next. They went through a bit of trouble in their watches business back in 2016, 2017, and between 2016 and 2018, they basically went out and bought back, I think it was half a billion euros worth of inventory from the retail channel and destroyed or recycled it. Moncler hasn't had to do that at all yet. I like to think that these days, with all the software that you can get that helps you manage what is really an omnichannel business, that it's much easier to figure out what needs to be in each location in order to satisfy demand, rather than sitting on huge piles of inventory all over the place. But you're right, it's a risk and you can never completely rule it out.
· Chris Davies, Matt Reustle
I think back to Adidas and Kanye West and how that relationship completely fell apart and how Adidas was left with an enormous pile of unsold inventory, which ended up looking pretty toxic because Kanye West had these increasingly strange moments and it was damaging the brand and so on and so forth. So yeah, it can be a risk. [00:00:00] S0: It's an interesting dynamic. And then Richemont proving the extreme of how you can manage that dynamic in the case that something does go wrong. Having that all in mind, impressive management of the cash flow conversion. When you think about capital allocation broadly, you have an example of acquiring Stone Island. Maybe there's an opportunity to be a luxury house over time with multiple more brands versus reinvesting back into the business or allocating to shareholders. How do you think about their capital allocation framework based on what they've said and your own interpretation?
· Chris Davies
[00:00:00] S1: The priority at the moment really is investing in the business they have today. So it's so early on still, there's so much left to do and maybe we'll get on to talk about some of those growth opportunities that they've got in the future. But there are still lots of them and they're still generating very attractive returns on capital. So if you're sitting there with a business that's able to do that and the runway is long, it's absolutely right. Your top priority is really reinvesting into the business. What does that mean? That means opening new stores. It means you are cultivating your brand. It means you're investing in marketing. It means you're investing in these crazy off-the-wall events that Ruffini is trying to bring in all over the place to make sure that Moncler and Stone Island are right at the cutting edge. So I think they're going to keep doing that for years and years and years to come. I don't think we're anywhere near the end of that reinvestment story. And I think for any company, really, if you're a long-term investor, the best ones to find are the ones that can just keep reinvesting capital at high rates of return well above your cost of capital for a long, long time. And Baillie Gifford has been very fortunate to find a few of these companies that we've already talked about. Hermès a few times. I mean, that's been owned by some of my colleagues for over 20 years and it's been an incredible success story. The acquisition side of things—I tend to see Stone Island as a bit of a one-off now. I'm not going to say that they'll never do another acquisition ever again. They've played it down somewhat. I don't think Ruffini is hugely keen on the idea of building a big Italian luxury conglomerate to stare down the French, the likes of Kering and LVMH. Never say never. Though I think for now his priority really is going to be reinvesting in the business. They pay dividends as well. They're pretty modest. I wouldn't say it's a big part of the story. Maybe acquisitions at some point in the future. I mean, Stone Island, remember, was the only deal they've ever done. It was the only acquisition.