Chief Investment Strategist
Hermès was founded in 1837 by Thierry Hermès in Paris focusing on creating high-quality harnesses and bridles for carriage trade. In 1879, the sone Charles-Émile Hermès took over and moved the workshop to 24 Rue du Faubourg Saint-Honoré where the company’s headquarter is located today.
In the first half of the 20th century the company expanded into leather bags designed for horse riders to carry their saddles. It also expanded its leather goods into handbags and luggage in addition to securing the rights for using the zipper in leather goods and clothing, which was quite revolutionary around the 1920s. In 1937, Hermès celebrated its 100th anniversary introducing a silk carf known as Carré which quickly became an iconic product for the brand.
After WWII, the luxury-maker expanded geographically and into new product categories such as clothing, accessories, and perfumes. In 1984, it introduced the Birkin bag, names after the actress Jane Birkin, which became one of the most sought-after luxury items in the world.
Since 2000, Hermès has expanded further into ready-to-wear clothing, jewellery, watches, and even home goods with Jean-Paul Gaultier as the head designer for its women’s ready-to-wear. Throughout its history Hermès has been known for its high quality, craftsmanship, and timeless design.
Hermès is today a significant luxury-maker with revenue of €13.9bn in the past 12 months up 13% YoY defying the trend of other luxury brands seeing declining demand with LVMH revenue growth only at 4% YoY in Q1 2024 based on 12-month trailing figures. Hermès delivered EBITDA of €6.5bn in FY23 translating into an insane EBITDA margin of 48.6%.
The biggest product category is leather goods and saddlery accounting for 41% of revenue in 2023 following by the ready-to-wear and accessories segment accounting for 29%. The remaining 30% of revenue is split across silk and textiles (7%), other Hermès sectors (12%), perfume and beauty (4%), watches (5%), and other products (2%).
It is also clear from the geographical split of revenue that Asia-Pacific excl. Japan is the most important region accounting for 47% of revenue followed by the Americas at 19% of revenue. While the Chinese market is not separated out we expect it to be a large part of the Asia-Pacific revenue and thus the recent revenue growth is even more impressive given the Chinese economy is the weakness since 2015 when we exclude the first period of the Covid-19 pandemic.
Hermès has embraced an integrated and omnichannel (physical and digital) distribution network with exclusive stores as the brand enhancer and dominate distribution channel. Despite digital channels are playing a big role in today’s retail sector, Hermès has doubled down on its store network with opening of new stores in 2023. Real estate investments are still the single biggest investment category for Hermès at €392mn in 2023.
Helmer’s 7 Powers framework, developed by Hamilton Helmer in his book "7 Powers: The Foundations of Business Strategy", provides a structured approach to evaluating a company's strategic positioning. It can help investors understand why a company has a high ROIC and whether it has endurability. Below we analyse Hermès in each of the seven powers.
1. Scale economies - Large-scale production allows Hermès to spread its fixed costs over a greater number of units, reducing the average cost per unit. As a global brand, Hermès can leverage its extensive marketing campaigns across multiple regions, maximizing its reach and impact while minimizing the per-unit marketing cost.
2. Network economies - While network effects are more pronounced in tech companies, Hermès experiences a form of network economy through its loyal customer base and brand community. Owning Hermès products often serves as a social status symbol, encouraging more customers to buy its products to be part of an elite group.
3. Counter positioning - Unlike competitors who may pursue broader market segments, Hermès focuses on maintaining high prices and limited availability, which reinforces its luxury image. Hermès emphasizes traditional craftsmanship and high-quality materials, distinguishing itself from brands that may adopt more industrialized production methods.
4. Switching costs - Many Hermès products, such as the Birkin bag, are personalized and have a heritage value, making customers less likely to switch to other brands. Hermès products often retain or even appreciate in value over time, making them attractive investments for customers who are less likely to switch to other brands that do not offer similar value retention.
5. Branding - With a history dating back to 1837, Hermès is synonymous with luxury and exclusivity. Its brand is built on a legacy of quality and craftsmanship. Items like the Birkin and Kelly bags have achieved iconic status, reinforcing the brand's allure and desirability.
6. Cornered resource - The company employs highly skilled artisans whose expertise in leather craftsmanship is a key differentiator. Hermès has access to rare and high-quality materials, such as their specific leather types and silk, which are not easily available to competitors.
7. Process power - Hermès maintains rigorous quality control processes to ensure that every product meets its exacting standards. Unlike many luxury brands, Hermès produces a significant portion of its products in-house, allowing for greater control over the manufacturing process and maintaining high standards of craftsmanship.
It is clear that the company's competitive advantage lies in its strong brand identity, high switching costs, exclusive resources, and control over its production processes. These factors collectively enable Hermès to maintain its position as a leading luxury brand with sustained profitability and market dominance.
It is without doubt that Hermès is a high quality company. Not only because of its high quality products, but also the way the company is managed. Revenue has grown from €1.8bn in 2008 to €13.4bn in 2023 translating into 14.5% annualised revenue growth over 15 years. This growth rate is significantly above the average growth rate observed in the equity market and is the first beacon of growth. It all starts with revenue.
The next marker of high quality is not only the high EBITA (earnings before interest tax and amortisations) margin but the expansion over the past 15 years. In 2008, the EBITA margin was 27.5% and whopping 42.9% in 2023. This is simply outstanding. One might wonder why we focus on EBITA and not EBITDA. This is because EBITA gives a more realistic view of a company’s recurring revenue operational profitability and because it includes depreciation it takes into account the costs tied to maintaining long-term operational assets.
The final quality characteristic is the combination of high ROIC (return on invested capital) at around 35% compared to only 10% cost of capital and the growth rate of the invested capital. Sometimes the problem for a ROIC company is that it is difficult to reinvest into the business at high levels, but in the case of Hermès the company has been able to grow the invested capital by 17% annualised while maintaining a very high ROIC.
It should be clear by now, that Hermès brand is one of its key competitive advantages against the competition. The impressive part is that Hermès has invested around 4.5-5% of revenue into its brand every year since 2008. Even without meaningfully increasing spending on the brand the company has been able to grow revenue at a faster pace and maintaining a solid position.
It is the combination of all of the above that has ensured a remarkable share price performance including reinvestment of dividends. Hermès shares have delivered a total return of 795% over the past 10 years compared to only 135% for the MSCI World Index. This translates into 20.9% annualised growth rate for shareholders. Key risks: It is all about the brand
Luxury goods are typically very sensitive to the economic cycle but the 2008-2009 cycle showed that Hermès was able to grow through economic stagnation. The business is larger and more diversified, so the sensitivity to a recession might be bigger next time. As Asia-Pacific is the biggest revenue source the economic growth in Asia is the most important driver of Hermès’ future revenue.
The brand's value is closely tied to its reputation. Any scandal, quality issue, or negative publicity can harm the brand's prestige and customer loyalty. This is probably the biggest risk facing investors in Hermès shares.
Hermès' emphasis on artisanal craftsmanship, while a key strength, also poses a risk. Any disruptions in the availability of skilled labour or key materials can impact production capabilities and timelines. The reliance on rare and high-quality materials can lead to supply chain challenges. Any disruption in the supply of these materials can affect production and profitability.
Changes in trade policies, tariffs, and international relations can impact Hermès' ability to operate smoothly across different markets. For example, heightened trade tensions between major economies can affect costs and supply chains. Another risk is shifts in consumer preferences, especially among younger demographics, can affect demand for luxury goods. Trends towards sustainability and ethical consumption may require Hermès to adapt its practices and product offerings.
Quality companies can be defined in many different ways just like value. MSCI, which is world’s largest equity index provider, has defined it using three fundamental variables return on equity, debt to equity, and earnings variability. This definition makes sense because it can be applied to all companies regardless of which sector they are part of. The definition puts emphasis on profitability relative to the deployed equity, leverage ratio (less debt leverage relative to equity is good), and finally the predictability of the business with less variance in earnings being a good thing. In our past equity research we have also found that the lower earnings variability a company has the higher its valuation becomes, so this is a quality marker.
In our equity research note Top quality companies and how to decode their traits we focused on return on invested capital (ROIC) relative to the cost of capital (WACC) as the key measure to identify quality. Next we explained, that around half of those companies with the highest ROIC see their ROIC falling from the top to outside the top over three years due to competition or changing technologies. This is the quality trap that investors need to avoid. It is about finding enduring quality. The “7 Powers” framework is a good approach to analyse whether a company has enduring characteristics or not. Finally, a company can have a stable spread in ROIC minus WACC with a ROIC not in the absolute top and still be a phenomenal stock for shareholders. All it requires is that the business can invest a lot into the business. Historically, Walmart was exactly such a case.
The interesting thing about researching quality companies is that you cannot put it all into a formula. You must apply discretionary thinking about the business, its products, the company’s strategy, the industry drivers, technologies strengthening or weakening the business, because in the end the big returns about changes in expectations for the company.
The list below highlights our previous analyses of quality companies.
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