Last year has been quite controversial for Italian luxury brands. Nevertheless, revenues are in very good shape, and the strategies put in place by some of the most famous brands clearly show that the sector is at a historical turning point.
As Asian markets have experienced incredible growth, it is crucial for luxury companies to increase their footprint in order to be competitive at a global level, even if it requires huge capital expenditures in marketing and distribution channels. Italian companies would need a more structured industrial policy in order to maximize the huge potential of the luxury sector in Italy, but politicians have not yet addressed this. Furthermore, Italian companies are very small, as most of them started as popular artisan firms, and they prefer to retain full control of their company and not merge with one other.
Prada vs. Bulgari -- Two Different Stories
The need to raise capital explains why some of the most famous Italian companies, such as Prada, Bulgari, and Ferragamo, have been forced to decide between going public and being acquired by a big group. Gucci and Bottega Veneta were acquired years ago by the French company PPR. Brioni also joined PPR last year, and Bulgari was acquired by LVMH. Prada and Ferragamo, on the other hand, decided to raise capital by issuing shares in the market. The IPO of the Milan factory was a great success, and after just one month of being listed on the Hong Kong exchange its stock gained almost 30%, even though the shares now trade in line with the IPO price of HKD 39. Ferragamo has fared even better, gaining 30% since it was first listed on Borsa Italiana exchange on 29 June last year. However, in addition to strong stock returns, the two Italian companies also successfully met their expectations: Prada raised EUR 1 billion while Ferragamo collected EUR 350 million, which they are going to invest in their plan to establish a greater presence in the Asian market. This market is crucial for both companies: It represents 26% of Prada’s sales and an even bigger portion for Ferragamo, which derives 20% of its total sales from China alone.
Luxury Is Overvalued
Those IPOs were successful in terms of their market reception, but the question now is whether they will also reward investors. At the initial public offering, Prada was trading at a forward price/earnings multiple of 23 times 2011 earnings while Ferragamo had an even higher valuation, equal to 24.4 times. Those valuations are not actually so high in absolute terms, but if we take into account the EBIT margin for each company and compare the margin with that of LVMH, we realise that the IPO price for the Italian companies was too high. LVMH, the worldwide luxury leader, has an EBIT margin of 20%, compared with 11% for Prada and 12% for Ferragamo, but LVMH is currently trading at a forward price/earnings of 18 times. Another good example is U.S. company Coach, which has the highest EBIT margin in the sector at 30% but its stock trades at a price/earnings multiple of 21 times. This means that investors who buy shares of the two Italian companies are paying a higher price to own a less profitable company.
Speaking in broad terms, during the 2010 the luxury sector has been a highly appreciated area of the stock market, as the sector index MSCI World Textiles Apparel & Luxury Goods outperformed the MSCI World by more than 10 percentage points. Luxury stocks were buoyed by strong expectations for emerging markets, as many analysts believe that the total sales coming from Asia will increase 90% by 2015 and that emerging markets will represent 50% of global sales for the sector within five years. The bad news for investors, however, is that analysts have already incorporated this scenario into their valuation estimates, and that's why luxury stocks are generally overvalued by the market.
Francesco Lavecchia, is Equity Data Analyst of Morningstar Italy
