Business Breakdowns
· 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.
· Matt Reustle
[00:00:00] S0: And you mentioned growth opportunities from here. What would you point to as those main levers of growth?
· Chris Davies
[00:00:00] S1: I mentioned earlier that you've got these strands of the Moncler brand. You've got Grenoble Collection and Genius. So I think the opportunity there is more of the same. Grenoble, however, I think is a bit earlier on. I think there's a really interesting opportunity there to start building out more and more of these stores. For example, this big show in Courchevel back in March. So this is a luxury ski resort town. It was the second big showcase of the Grenoble brand. I think that's got legs. So I suspect they're probably going to be doing more of the Grenoble stuff. Genius is that really powerful flywheel again—they'll keep on collaborating, keep coming up with these new and innovative ways of reimagining the Moncler brand and that will drive lots of interest in the collection. And it's interesting, actually, when you look at some of those periods where Genius has been a bit quieter, actually the core business has grown a little bit slower. So you can see that it is an important thing to keep pressing on with. There's a big opportunity in the US. Moncler is really under-indexed there. So roughly 14% of sales come from the US—that is quite a bit lower than most of the other big luxury houses, which tend to be north of 20%. So they're actually working on this right now. Various things going on here. They've probably been a bit slow to move to the direct-to-consumer retail model. I think they're trying to speed up that reduction in reliance on wholesale partners like Nordstrom and Saks and so on, which have tended to dominate the US business. So there's a shift definitely going on there. They're opening more stores. They've got this really big flagship store that's about to open on New York's Fifth Avenue, which is home to lots of other famous flagship stores—Armani, Cartier, Harry Winston, Louis Vuitton. Again, they'll be in very good company there. That's going to be their biggest flagship store, I think, in the world, and that's going to open in the US. But I think if you look at the east coast and the west coast, they're probably more penetrated, I would say, than everything in the middle. So it's interesting to me that they only recently, a couple of years ago, opened their first dedicated boutique in Dallas. There is a big gap I think they need to address in terms of growing brand awareness in a lot of these states in the middle of the US.