LVMH company 4000 words

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Abstract This report presents an investment recommendation report for Compagnie Financière Richemont SA. The methodology deemed most appropriate to perform such analysis was the Discounted Cash Flow (DCF) model. The report also

through the use of multiples. The DCF provided an intrinsic value of Richemont, whilst the multiples approach revealed a more extrinsic value for Richemont, bringing together the investment case. The report analysed five years of historical financial data and forecasted the following five years. In order to execute the forecast, external value drivers for the luxury goods industry in which Richemont operates, were identified. Additionally, in geopolitical and the economic outlook were analysed, as it is a positively correlated

In consideration, the DCF variables were forecasted, revealing an equity value of

million and an implied share price of 0 per cent premium to the share price as of 29th June 2018. A sensitivity analysis was also performed to show how modifications in the weighted average cost of capital and growth would affect the enterprise value and equity value per share. The report also conducts a scenario analysis illustrating two cases; a bullish case and a bearish case, and their relative effects on enterprise value and equity value. Following this, a relative valuation was conducted through the use of the P/E, EV/EBIT, EV/EBITDA and EV/REV multiples, revealing that Richemont is undervalued relative to its competitors. The report concludes that the findings of the DCF approach and the relative valuation approach, indicate an investment recommendation of BUY.

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DCF Discounted Cash Flow CAGR Compound Annual Growth Rate Capex Capital Expenditures CHF Swiss Franc CAPM Capital Asset Pricing Model COGS Cost of Goods Sold

Euro EBIT Earnings Before Interest and Taxes EBITDA Earnings Before Interest, Taxes, Depreciation and Amortisation ERP Equity Risk Premium EV Enterprise Value FFCF Forecasted Free Cash Flow FCF Free Cash Flow FY Financial Year YNAP Yoox-Net-A-Porter

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Contents 1.0 Introduction ..................................................................................................................................... 6

1.1 Trajectory of the Valuation ............................................................................................................ 6 1.2 Company Overview ....................................................................................................................... 7 1.3 Capital Structure ........................................................................................................................... 7 1.4 Financials ...................................................................................................................................... 8 1.3 Regional Sales .............................................................................................................................. 8 1.4 Business Area ............................................................................................................................... 9 1.5 Industry Overview ......................................................................................................................... 9

2.0 Methodology .................................................................................................................................. 10 2.1 Introduction to Valuation ............................................................................................................. 10 2.2 Discounted Cash Flow Model (DCF) .......................................................................................... 10 2.3 Relative Valuation ....................................................................................................................... 11 2.4 Data sources ............................................................................................................................... 12

3.0 Empirical Analysis ........................................................................................................................ 13 3.1 Historical Financial Performance ................................................................................................ 13 3.1 Determining Key Performance Drivers ....................................................................................... 15 3.2 Free Cash Flow Projections ........................................................................................................ 15

3.2.1 Sales growth drivers applicable to Richemont in all regions................................................ 15 3.2.2 Sales growth factors affecting regions ................................................................................. 16 3.2.3 Cost of Goods ...................................................................................................................... 21 3.2.4 Operating Expenses ............................................................................................................. 21 3.2.5 Tax ....................................................................................................................................... 23 3.2.6 Depreciation ......................................................................................................................... 23 3.2.7 Capex ................................................................................................................................... 23 3.2.8 Working Capital .................................................................................................................... 24

3.3 Weighted Average Cost of Capital (WACC) ............................................................................... 25 3.3.1 Cost of Debt ......................................................................................................................... 26 3.3.2 Cost of Equity ....................................................................................................................... 26

3.4 Terminal Value ............................................................................................................................ 29 3.5 Enterprise Value .......................................................................................................................... 30 3.6 Equity Value ................................................................................................................................ 31 3.7 Sensitivity Analysis ...................................................................................................................... 32 3.8 Scenario Analysis ........................................................................................................................ 33 3.9 Relative Valuation ....................................................................................................................... 35

4.0 Conclusion ..................................................................................................................................... 38 5.0 References ..................................................................................................................................... 39 6.0 Appendices .................................................................................................................................... 42

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1.0 Introduction The aim of this chapter is to introduce; the purpose of the report, the company being valued and the sector in which it operates. 1.1 Trajectory of the Valuation The subject of this thesis is a valuation of Switzerland-based luxury goods company Compagnie Financière Richemont Richemont This will be achieved by using the Discounted Cash Flow (DCF) model for valuation which will reveal the perceived value of Richemont relative to the discounted expected future cash flows of the next 5 financial years for the Group. The forecasted free cash flows and the terminal value will then be discounted using the weighted average cost of capital. The sum of the discounted free cash flows and the terminal value will establish an enterprise value which serves as the basis for the DCF valuation. Following a construction of the DCF, a sensitivity analysis and a scenario analysis will be performed. The sensitivity analysis will show how changes in the growth rates and weighted average cost of capital (WACC) will affect both the equity share price and enterprise value of Richemont. The scenario analysis will present two alternative cases a bullish case and a bearish case and the relative effects on Richemont enterprise and equity value. Following this, a relative valuation will be performed, comparative to DCF valuation which seeks an intrinsic value. Relative valuation, through the use of multiples, will allow an alternative derivation of the value of Richemont using the pricing of comparable firms standardised using common variables. The amalgamation of these two different valuation methods can be then used to assess investment decisions obtained from either approach. Accordingly, the thesis will conclude by providing an investment recommendation of buy or sell.

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1.2 Company Overview Founded in 1988, Richemont in the field of luxury consumer goods sector. The Group operates in three segments: Jewellery Maisons; being Cartier, Van Cleef & Arpels and Giampiero Bodino; Specialist Watchmakers: A. Lange & Söhne, Baume & Mercier, IWC Schaffhausen, Jaeger- LeCoultre, Officine Panerai, Piaget, Roger Dubuis and Vacheron Constantin; and Others: Alfred Dunhill, Azzedine Alaïa, Chloé, Montblanc and Peter Millar in addition to watch component manufacturing activities. Since its formation, the Group has continuously expanded; making an acquisition almost every year since 1993. The most recent of which being in June 2018, where YOOX NET-A-PORTER GROUP

) was acquired through a voluntary public tender and delisted from the Milan Stock Exchange effective as of 20 June 2018 (Richemont, 2018). Richemont is listed in Switzerland, however reports in Euros and has a March year- end. The share price as of 29th 1.3 Capital Structure Richemont has 522 000 000 'A' registered shares, with a par value of CHF 1.00 each, and 522 000 000 'B' registered shares, with a par value of CHF 0.10 each, in issue (Richemont, 2018). The 'A' shares are listed and traded on the SIX Swiss Exchange and the 'B' shares, representing 9.1 per cent of Richemont equity and 50 per cent of voting rights, are not listed and are held by Compagnie Financière Rupert. Table 1 shows the number of shares calculated by means of their par value. Table 1: Capital Structure of Richemont (Richemont, 2018)

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1.4 Financials In FY2018, Richemont revenues totalled 10 979 million, a 3.12 per cent increase from FY2017. The Asia Pacific accounted for 40 per cent of Group Sales; with particular strength in its main markets, namely China, Hong Kong, Korea and Macau. In Europe, the second-largest region, Group sales decreased 2 per cent to 27 per cent as a result of the relative strength of the euro and inventory-buybacks. Across the Group, improved gross margin and tight operating expense control resulted in a 5 per cent increase i lion. Richemont has a strong balance sheet, with net cas s of 31st March 2018 market funds, short term bank deposits and short-duration bond funds primarily denominated in Swiss francs, euros and US dollars (Richemont, 2018) 1.3 Regional Sales Richemont operates on a worldwide basis. Figure 1 illustrates the evolution of sales by geographic region from FY2014 to FY2018. From the figure it is clear that the Asia Pacific has consistently dominated sales (in terms of revenue), followed by Europe. Figure 1: Richemont Sales by Region (Source: Richemont, 2018)

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1.4 Business Area The group operates in three segments; Jewellery Maisons, Specialist Watchmakers and Others. The largest revenue generating area of Richemont is the Jewellery Maisons, accounting for 6 447 million of revenue in 2018. Figure 2 demonstrates the historical progression of sales by business area. Figure 2: Richemont Sales by Business Area (Source: Richemont, 2018) 1.5 Industry Overview The luxury goods industry is continuously evolving; whether it being due to the digital transformation, economic cycles or changing customer preferences. Consequently, the industry is becoming increasingly competitive. Aggregate net luxury good sales of the top 100 global luxury good companies amounted to $217 billion in 2016. Compound annual growth rate in luxury goods sales for FY2014 to FY2016 was 3.9% (Deloitte, 2018). Bain estimates a 4 to 5 per cent compound annual growth rate in the luxury goods sector over the next three years, with total revenues between by 2020 2017). In general, the outlook for 2018 appears promising however economic volatility could intimidate market expansion.

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2.0 Methodology This chapter of the report will introduce the models utilised to conduct valuation. The section commences with a brief introduction as to what valuation is, followed by a description of the valuation models; DCF and Relative Valuation. The underlined determinants in this chapter will be defined and applied to Richemont in conjunction thus have been addressed in Chapter 3. 2.1 Introduction to Valuation Every asset has a value. Any preconceptions or biases an individual brings to the valuation process will be reflected in the valuation. A Valuation analysis focuses on cash generation and its sustainability throughout the lifetime of the asset. The role and relevance of valuation is reformed in different arenas; such as in portfolio management, acquisition analysis and corporate finance (Damodaran, 2012). 2.2 Discounted Cash Flow Model (DCF) In DCF valuation, the value of an asset is the value of the expected (future) cash flows of the asset, discounted back at a rate that reflects the risk associated with achieving these cash flows (Damodaran, 2012). A DCF valuation is a function of the expected cash flows of an asset. Assets with high and predictable cash flows should have greater values than assets with low and unpredictable cash flows. According to DCF, the value of an asset is estimated using the present value of the expected cash flow associated and can be calculated using Equation 1. Equation 1: DCF

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normally forecasted for a five year period, though it can vary amongst sectors and a stage of development. Given the characteristically difficult nature of accurately forecasting a firms financial performance over a lengthy period (due to reasons such as economic cycles), a terminal value is calculated to capture the remaining value of the firm beyond the forecasted five year period (Pearl and Rosenbaum, 2009) The forecasted free cash flows and the terminal value must be discounted using the weighted average cost of capital. The sum of the discounted present value and the terminal value establish an enterprise value which serves as the basis for the DCF valuation. It must be emphasised that there are limitations associated with DCF valuation, in particular its sensitivity towards assumptions related to perpetual growth rate and discount rate (Pearl and Rosenbaum, 2009). The sensitivity of changes in these assumptions can be measured using a sensitivity analysis. The use of a scenario analysis can also allow experimentation of cases other than the base case the report explores. The conducted scenario will present a base case, a bullish case and a bearish case and the relative effects it has on the enterprise and equity value will be concluded. 2.3 Relative Valuation A relative valuation approach, unlike a DCF valuation which seeks an intrinsic value, trusts the market to be right. Relative valuation refers to the derivation of the value of an asset using pricing of comparable assets, standardised using common variables such as revenues or book values (Damodaran, 2012). Multiples are a device enabling a relative valuation; the use of appropriate multiples will allow conclusions from the DCF to be cross checked. There are different types of multiple, i.e. sales multiples, earnings multiples, book

-book value ratio (PBV) is an example

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of a book value multiple; whereby assets selling at a discount on book value relative to comparable firms can be perceived as being undervalued. If the derived multiple for the company being valued is at a significant premium to its peers it is important to provide a strong justification as to why. It is also important to understand the fundamental variables driving the multiple, as they may result in inaccurate conclusions, for example a high Price to Earnings ratio could be a result of higher expected growth rate which is likely to have positive implications. The selected multiples for this valuation are; Price/Earnings Ratio (P/E), Enterprise Value/EBITDA (EV/EBITDA), Enterprise Value/EBIT (EV/EBIT) and Enterprise Value/Revenue (EV/Rev). 2.4 Data sources In order to perform this valuation, information from independent sources were utilised. Further, to support the analysis, historical financial data from Annual Reports and Bloomberg were used.

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3.0 Empirical Analysis The aim of this section is to perform the valuation models introduced in Chapter 2 and present the findings. Execution of this will allow the reveal the perceived value of Richemont, allowing an investment recommendation to be made. 3.1 Historical Financial Performance Before embarking upon valuation it is important to analyse historical financial reports from a valuation perspective. This should allow identification of key value drivers in the investment narrative and comprehend how Richemont is preparing for the future. The analysed historical period for Richemont was between FY2014 and FY2018. During this period the Groups sales grew at a CAGR of 1.84 per cent. Average capex as a percentage of sales was 5.03 per cent and this figure has been consistently higher than depreciation, indicating expansion of operations. Inventory turnover over the historical period proves to be improving (i.e. inventory turnover days are reducing); a positive indication of better inventory management. The evolution working capital levels and ratios are shown in Table 2.

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Table 2: Working Capital Schedule

A solid investment analysis must identify how risky the investment decisions Richemont has made over time and how much risk do equity investors face. Short term liquidity risk surfaces mainly from the need to fund current operations. The current ratio and the quick ratio are frequently used measurements of short-term liquidity risk. Gallo (2015) defines the current ratio as a measur pay off its short-term liabilities with its current asse equation 2. Equation 2: Current Ratio

Historic data for the past 3 years was computed to reveal the current ratio trend for Richemont. All 3 years had a current ratio above 3. This is a desirable outcome as a current ratio below 1 would indicate Richemont has financial obligations outstanding in the following year exceeding the assets it can expect to turn into cash. It must be

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noted however that current ratios can be manipulated around financial reporting times. S&P rating for default risk rating is A+ (Bloomberg, 2018). 3.1 Determining Key Performance Drivers The first step in performing a DCF is to understand the valued firm and the sector in which it operates, allowing one to identify value creating or destructing determinants. Richemont recognises its growth drivers as the following; geographic spread, the mix of sales by product type and distribution channel; acquisitions of businesses. The Group further reports a positive relationship between consumer confidence and consumer spending on its products. Research of independent sources identifies key growth drivers in the forthcoming years as; Chinese middle class rising, local consumption recovery in mature markets, increase of online sales and Generations Y and Z (Bain, 2017). 3.2 Free Cash Flow Projections Forecast for sales were made in consideration of internal, strategic measures taken by the Group and external factors such as the political and economic climate of regions; Europe, Middle East and Africa, Asia Pacific, Americas and Japan. 3.2.1 Sales growth drivers applicable to Richemont in all regions An annual study conducted by the BCG and Altgamma (2018) identifies an increasing trend of sales attributed to millennials thus emphasises the importance of attracting millennials in the forthcoming years. Bain (2017) also reported that in 2017, 85 per cent of growth in the luxury goods sector is attributable to Generations Y and Z, reaffirming the importance of charming millennials.

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Richemont has taken several measures to attract millennials. Firstly, Rupert launched a man

diverse board members. Richemont, recognising the importance capturing these millennials, launched a relatively cheaper new watch brand Baume in May 2018, aimed at younger consumers (Koltrowitz, 2018). Online sales of luxury goods are accelerating, rising 24 per cent year on year in 2017 (Sanderson, 2018). In response to the growing importance of online presence, Richemont acquired YNAP. (2018) study into key trends for the luxury goods sector emphasised the importance of luxury brands prioritising an omni- -channel experience is a multi-channel sales approach that provides the c Richemont acknowledged the importance of such strategy, describing its YNAP

accelerate their focus on omni-channel and digital marketing. 3.2.2 Sales growth factors affecting regions The group acknowledges positive correlation between consumer confidence and sales hence the economic and political climate of regions have been individually analysed to derive supported growth figures. Europe There are mounting fears about political instability in Italy and Spain (Johnson, Politi and Stothard, 2018). sales from Germany, Italy and Spain 2018 accounted for 854 million (28 per cent) of European Sales. In France, economic growth is anticipated close to 2 per cent due to strong external demand and healthy business confidence (OECD, 2018).

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France is an important market as it accounts for approximately a quarter of European sales. Other Europe (which includes the UK) accounts for a third of sales. The UK is set to leave the European Union at the end of March in 2019 hence the potentially crippling effects of the separation is incorporated into growth estimates in FY2019 and FY2020. Brexit is expected to cause higher inflation due to a weaker sterling, which will reflect onto consumer purchasing power hence its purchases of Richemont figures for FY2019 and FY2020 were forecasted shyly at -0.55 per cent and -2.67 per cent for FY2019 and FY2010 respectively. Remaining forecasts have been made

unforeseeable at present. Middle East and Africa Growth prospects for the Middle East and North Africa region will continue to be mostly determined by geopolitical tensions and conflicts. The MENA region accounts for approximately 29 per cent of sales, as of FY2017 and FY2018 figures. According to the World Bank (2018) growth among members of the Gulf Cooperation Council (GCC) is expected to rise to 2.7 per cent in 2019. Consequently an increase of 1.22 per cent and 1.14 per cent growth is forecasted in FY2019 and FY2020, respectively. In the following three years, growth rates are shying at 1 per cent due fluctuations in oil prices that may occur due to factors such as greater-than-expected U.S Shale oil production would result in a decrease of oil prices (World Bank, 2018) Asia Pacific 40 per cent of Richemont strength in China, Hong Kong, Korea and Macau. A McKinsey study found that Chinese customers will be accountable for over 40 per cent of the global luxury market by 2025 and be accountable for most of the industry growth (Bu et al., 2017). In consideration of the significance of Chinese demand for

goods now and its industry, China is identified as a key value driver in this valuation.

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The Q/A session transcript for the 2018 Annual Report presentation revealed Helen

Brand, questioned Richemont o which Richemont

anks and companies to start increasing debt to GDP ratio. rumours of an approaching Minksy Moment in China (Authers, 2017). A Minksy Moment is a term used to describe periods of stability that result in over-confidence causing banks to engage in speculative lending which will ultimately lead to a collapse of assets (Glenn and Yao, 2017)

second quarter of 2018 it increased 6.7 per cent, though this expansion was slowest pace since 2016 which is attributed to aggressive deleveraging efforts which curtailed investment in infrastructure. However, IMF forecasts for 2018 and 2019 do not report any expected cuts in economic growth in 2018 or 2019 (Liubing, 2018).

2018 survey however has since slightly dropped to a one year low point of 118.2 points (June 2018) but still remains reassuring. This is a key indicator of demand for luxury goods. The impact of the

economic data (Wildau, 2018). Also, at present the Renminbi is clearly strengthening and purchasing power is significant inside mainland China and outside. Morgan Stanley (2017) projects 6.1 per cent growth in average real GDP growth until 2020, falling to 4.6 per cent in 2021-25. In FY2019 and FY2020, growth in India is expected to rebound to 7.4 per cent, after temporary disruptions resulting from the currency exchange initiative and the Goods and Service Tax (IMF, 2018). Considering the aforementioned, growth in FY2019 is expected to prosper at 11.50 per cent, in line with FY2018 growth. In FY202 t causing an asset crisis is forecasted and therefore growth declines 4.50 per cent.

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In addition to a potential Minsky Moment, long term outlook for the APAC region are affected by aging demographics and slowing productivity growth. Consequently, growth forecasts diminish from 2.22 per cent to 1 per cent from FY2021 to FY2023. Nevertheless, even at the aforementioned shy growth rates, sales from the Asia Pacific will account for approximately 43 per cent sales in 2023). Americas The US accounts for approximately 81 per cent At present, US economic growth is fuelled by tax cuts, which is feeding through to consumer confidence. Additionally, the yield on the 10 year US Treasury note increasing, reflecting expectations of a stronger economy (Hunter, Platt and Samson, 2018). The US Federal Reserve, quantitative tightening programme is also expected to strengthen the dollar making Richemont products relatively cheaper, stimulating growth in the next couple of years (Anstey and Borghese, 2018). Accordingly, forecasts assume growth of 4 per cent in FY2020 and FY2021. Mexico, Central America and the Caribbean is formed largely by developments in the United States due to the cumulative effects of trade, financial and migration linkages (IMF, 2018). In the short term the region is expected to benefit from higher growth in the US. Due to the uncertainty of the outcome of the November 2020 US election, forecasts are shying as US policies will be largely affected from the outcome. Sales growth is projected to decrease to 3 per cent to in FY2020 and 0.61 per cent thereafter. Japan Japan alone accounts for approximately 9 per cent of total sales. In FY2018 Japan experienced a 3 per cent decline in growth of sales, however since then the economy is showing signs of rebound and consumer spending has improved (Kalish, 2018). The economy is expected to continue to strengthen in 2019, supported by stronger private consumption, external demand and investment (IMF, 2018). Subsequently, growth in FY2019 and FY2020 is expected to grow at 3.61 and 3.81 per cent respectively.

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Section 3.2.1 identified a key value driver as millennials, however approximately a , 2017). The looming

effects of an aging population and the deficient number of millennials stifling growth. YNAP Sales The BCG and Altgamma (2018) report found that 55 per cent of luxury consumers that purchase online use their mobile phones versus a computer, emphasising the need for brands to develop their mobile strategy. The report identified that the majority of those that purchase on their mobiles were younger generations and Chinese consumers. YNAP chief executive Mr Marchetti recently indicated interest in

Richemont , 2018). Such alliance could allow rapid

penetration of the Chinese market, which would supplement sales growth. In order to make relatively accurate assumptions it was deemed appropriate to analyse historical data from the past five years. The first step in the valuation process was to project out the income statement. Online sales are expected to account for a quarter of total luxury sales by 2025 therefore the rapid and dominant online presence accessed through the acquisition is believed to be a key sales driver for Richemont ( Arpizio, 2017). Considering this, it was forecasted that e-commerce sales will grow in all regions at an average of 10 per cent per year Concluding sales figures Due to the significance of size of YNAP takeover and different expected growth rates, sales projections were divided for Richemont and YNAP and then total sales were summed. Please see Appendix 1 to see the full projected sales for the forecasted period.

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3.2.3 Cost of Goods Costs of Goods (COGS) for Richemont was assumed to gradually decline as the group established company and it is expected that direct costs such as manufacturing will become increasingly streamlined. For YNAP microscopic variations in COGS is expected, as consumer expectations of omni-channels, research and development costs are likely to keep COGS constant. Total COGS for Richemont and YNAP was integrated from the historic annual reports and then used to benchmark against expected COGS calculations. The results are presented in Table 3. Table 3: Cost of Sales

3.2.4 Operating Expenses Operating expenses for Richemont and YNAP were also forecasted separately. Selling and distribution expenses are expected to average around 27.58 per cent of total sales. Communication expenses from FY2014 to FY2016 averaged around 9.06 per cent of sales figures with the exception of FY2017, where this figure rose to 10.51 per cent. As a result, Richemont ensured that communication expenses declined in FY2018 to 10.07 per cent. It has been identified that their desired level thus measures taken to achieve such level for communication expenses is approximately 10 per cent of sales (Richemont, 2018). Hence, forecasts have been conducted accordingly. Administrative expenses are forecasted to remain consistent with historic levels, averaging at 8 per cent.

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Table 4

Historic averages of YNAP operating expenses were averaged an extrapolated with slight deviations across the forecasted period. Total operating expenses for Richemont including YNAP are forecasted in line with theoretical figures of the Richemont takeover of YNAP and average at around 5 per cent of total sales. Table 5: operating expenses

After operating expenses for Richemont and YNAP were computed, the EBIT was derived as the following (see Table 6). Table 6: EBIT for Richemont (including YNAP)

.

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3.2.5 Tax Richemont states that taxation charge differ across the Group; therefore each annual report identifies an average effective tax rate that is calculated using profit before tax figures but excluding share of post-tax results of equity-accounted investments. The provided tax rates from FY2014 to FY2018 were averaged to 20.8 per cent yet Richemont explains that they apply an average rate of 21 per cent to reflect a rate applicable to the main Swiss-based operating companies (Richemont, 2018). The Group also reported that it anticipates their effective tax rate to remain in the 19-21 per cent range for FY19, always excluding exceptional items. For this reason an effective tax rate of 21 per cent was flat lined across the forecasted period. 3.2.6 Depreciation Historic depreciation for Richemont averages at 4.31 per cent however it is assumed that depreciation will increase to 5.4 per cent due to the significantly larger entities wear and tear implications. Depreciation eventually decrease slightly in the projected period 5 per cent in FY2023. YNAP depreciation is expected to remain consistent at historic figures and therefore is flat lined at 3.82 per cent. 3.2.7 Capex The historical average of capex averages at 5 per cent and has been consistently higher than depreciation and indicating expansion of operations thus forecasts have been made similarly. Capex for YNAP is largely attributable to investing in converging and upgrading technology (YNAP, 2016). In a 2016 press release YNAP states its aim of reducing capex to 4-5 per cent of net revenues by 2020. However, in (2018)

-180 million CAP 2 301 million we identify Capex to be

approximately 7.1 per cent of YNAP revenues (YNAP, 2016). Capex in FY2020 is

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expected to stay around 7 per cent, the following 3 years are projected around 6 to 6.5 per cent of YNAP sales.

year of the DCF calculation, Capex figures and Depreciation are set at the same value to ensure that Richemont in perpetuity is not overvalued. 3.2.8 Working Capital Working capital is often referred to as the difference between current assets and current liabilities. Depending on the purpose of the valuation the definition can be slightly modified. For the purpose of the DCF, operating working capital is required. Operating working capital excludes any non-operating items such as excess cash or dividends payable (Goedhart, Koller and Wessels, 2010). A working capital schedule was created by subtracting specific current liabilities; trade and other payables, current income tax liabilities and provisions, from specific current assets; Trade and other receivables, inventories and prepayments. The historical figures were averaged and flat lined across the forecasted period. Appendix 1 presents the full working capital schedule. Historic trends were analysed and forecasts were made accordingly. Inventory turnover over the historical period proves to be improving (i.e. inventory turnover days are reducing); a positive indication of better inventory management. A quicker inventory turnover decreases the cash conversion cycle (Tarver, n.d.) This means Richemont is able to collect cash from revenues relatively quicker thus Richemont is able to use its working capital more effectively. In the recent years, Richemont has launched series of excess inventory buybacks

unauthorised sellers. Such preventative measure have weighed on profit growth in the short term however in the long run protects, if not appreciates brand value. Richemont management appears confident that inventory levels are now relatively healthy (Richemont, 2018)

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Forecasts implemented in the valuation, anticipate this trend of strong inventory management to continue. Based upon the assumptions for the variables of the DCF the free cash flows are expected to be following (see Table 7) Table 7: Free Cash Flows

3.3 Weighted Average Cost of Capital (WACC) WACC is a widely accepted method used as a discount rate to calculate the present

The cost of capital represents the average rate of return equity holders and debt investors require to cover the opportunity cost of investing in the firm. As debt and equity have different tax implications and risk profiles, WACC is dependent on a

(Damodaran, 2010). The formula for the calculation of WACC is shown below. Equation 2: WACC

WACC = After Tax Cost of Debt % of Debt in Capital Structure + Cost of Equity % of Equity in Capital Structure

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3.3.1 Cost of Debt In March 2018, Richemont International Holding SA, a subsidiary of the Group issued the 4 types of corporate bonds. The Mid YTM and the Last Price of the bonds were extracted from Bloomberg (2018), the market values of each bond were then calculated by multiplying the Bond Par Value by the market value divided by 100. The calculations were then weighted and the before tax cost the bonds were derived as 1.40 per cent (as shown in Table 8). The before tax cost of debt was then multiplied by 1 minus the effective tax rate of 21 per cent (applicable to the entire forecasted period) to find a cost of debt of 1.11 per cent. Table 8: Before Tax Cost of Debt

3.3.2 Cost of Equity The cost of equity is determined by three variables; the risk-free rate of return, the market risk premium and a risk adjustment that echoes riskiness relative to the average company (Goedhart, Koller and Wessels, 2010). Cost of equity is commonly calculated using the Capital Asset Pricing Model (CAPM), equation 3. Equation 3: Cost of Equity

Risk Free Rate Damodaran (2010) define -free asset as one where the investor knows the

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expected return. This will occur only if there is no default risk which infers that the security must be issued by a government. It must be noted however that not all governments are default free, as seen recently with the Greek government. Another condition that an asset must fulfil to be classified as a risk-free is there being no uncertainty about reinvestment rates thus indicating there are no intermediary cash flows. In the case of Richemont the German bund was deemed the appropriate risk free rate as The Consistency Principle states, the currency in which the cash flows are estimated must determine the choice of the risk-free rate (Damodaran, 2010). Although headquartered in Switzerland, financial reports are domiciled in euros. Also German bonds have higher liquidity and lower credit risk than bonds of other European countries (Goedhart, Koller and Wessels, 2010). The German 10- year bund yield as of 29/06/2018 was 0.34 per cent however this is forecasted to rise to 0.8 per cent in the cost of equity calculation as the European Central Bank end their quantitative easing programme at the end of December 2018 (Martin, 2018) Equity Beta

and the overall market return (systematic risk). The market is described as having a beta of 1.0 therefore companies with a beta of 1.0 are expected to have the same return as the market, companies with a beta less than 1.0 have lower systematic risk than the market and those with a beta greater than one have higher systematic risk. Higher systematic risk stocks are captured in the CAPM calculation as the higher beta will result in a higher cost of equity. For Richemont the beta was calculated using the return of the market in which it is listed Swiss Market Index ('SMI') and the return of Richemont using the all the available data. The covariance between the market and Richemont was subsequently computed. The unlevered (asset beta) was then calculated using equation 4.

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Equation 4: Unlevered Beta

The unlevered beta does not consider the capital structure of Richemont therefore this calculation must then levered (equity beta) using equation 5. Equation 5: Levered Beta

Using a target capital structure of 80 per cent debt, 20 per cent equity and a tax rate of 21 per cent. The Modigliani-Miller (1958) theory believe that there are benefits to leverage (debt) until the optimal structure is reached. Firms operating within the luxury goods sector have similar debt-to-equity ratios thus a target ratio of 80:20 was deemed appropriate.The levered beta (equity beta) was calculated as 1.18. Equity Risk Premium The equity risk premium is the difference between the expected return of the market and the risk free rate (Goedhart, Koller and Wessels, 2010). It is the average return investors demand over the risk free rate that compensates them for the risk involved in investing in the market. A country risk premium can be added to the equity risk premium to include any additional risk associated with investing in that country/region. sales by region was weighted and multiplied by the equity risk premium for the corresponding region, sourced by Damodaran (2018). The weighted equity risk premiums were then summed to 7.11 per cent, a number believed to represent the equity risk premium for the operations

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globally. It must be noted ERP calculations are an estimation; where Richemont has not provided country data in its reports, regional estimations have been computed. Table 9: Weighted equity risk premium

Source: Damodaran, 2018

Upon identification of the equity risk premium (7.11 per cent), risk free rate (1.2 per cent) and the equity beta (7.11 per cent), the CAPM formula (see equation 3), was utilised to derive the cost of equity at 8.18 per cent. WACC was therefore calculated 6.8 per cent (see Figure 3). Figure 3: Components of WACC

3.4 Terminal Value The Terminal Value (TV) reflects the potential future growth of a company beyond the explicit forecast period (KPMG, 2015). The TV is computed by applying an expected continuous level of growth to the final cash flow forecasted in the last year

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of the forecasted period. This method of valuation assumes that growth can be achieved by the asset until perpetuity. TV can be calculated using equation 6. Equation 6: Terminal Value

TV was thus computed using the formula. The final free cash flow for Richemont is forecasted at 731 million, a modest growth rate of 1.84 per cent was presumed, in line with historical CAGR and WACC was determined as 6.8 per cent resulting in TV for Richemont at 3.5 Enterprise Value

enterprise value. The enterprise value of Richemont will be calculated summing the net present value of the discounted forecasted free cash flows and the discounted terminal value, illustrated in the equation 7. Equation 7: Enterprise Value

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Richemon net present value of the discounted future free cash flows in the DCF totalled 10 446 million and the discounte , resulting in an enterprise v million. 3.6 Equity Value Determination of the enterprise value allows the implied equity value to be further calculated. While enterprise value embodies the value of the entire company, equity value represents the portion owned by shareholders (Goedhart, Koller and Wessels, 2010). Equation 8: Equity Value

Using the aforementioned calculations, equity value was derived at 360 million (see Figure 4). Total debt was found by summing long-term borrowings of

lance sheet as of 31st March 2018 (Richemont, 2018). Figure 4: Equity Value

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Equity Value per Share Equity value per share can be computed using the formula below. Equation 9: Equity Value per Share

equity value of million was divided by 574 200 000 shares (See

section 1.2 Capital Structure) to find an implied share price of per cent premium to share price as of 29th June 2018. 3.7 Sensitivity Analysis Enterprise Sensitivity Analysis Figure 5 represents the ranges for the sensitivity analysis. An enterprise sensitivity analysis allows investors to determine how different values for the WACC and growth rates affect the enterprise value. The DCF was produced using a WACC of 6.83 per cent and a growth rate of 1.84 per cent at which enterprise value is million. If the growth rate was to increase to 2.34 per cent and WACC remained the same enterprise value would increase to 53 008 million. If WACC increased to 7.08 per cent and growth remained at 1.84 per cent, enterprise value would decrease to 311 million. Figure 5: Enterprise sensitivity Analysis

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Equity Share Price Sensitivity Analysis Figure 6 demonstrates how changes in WACC and growth rates will impact equity share price. The DCF was produced using a WACC of 6.83 per cent and a growth rate of 1.84 per cent at which implied equity share price was per share. If WACC was to decrease to 6.58 per cent and growth was to also decrease to 1.34 per cent, the sensitivity analysis shows that implied equity share price would fall to

86.71. If WACC was to remain at 6.83 per cent and growth was to increase 2.34 per cent, implied equity share price would increase to 97.21 per share. Figure 6: Equity Share Price Sensitivity Analysis

3.8 Scenario Analysis To use the scenario analysis, two cases were constructed, other than that of the base case presented in this report. The alternative two cases were a bullish case (an extremely aggressive scenario) and a bearish case (a very conservative scenario). Appendix 2 presents the growth rates in a bearish case. The smallest historical growth rates in the income statement were computed to find the effect on the enterprise value and equity value. Figure 7 illustrates the pessimistic/bearish case;

235. It must be emphasised that this figure was computed using the lowest historical average growth rate for all sales, and the highest historical growth of expenses.

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Figure 7: Bearish Case Scenario analysis The converse, bullish case was then tested. The bullish case selected the highest historical sales growth rates and the lowest expenses to test the implications on enterprise value and equity value then extrapolated the rates to forecast the next five free cash flows. Figure 8 presents the findings. In this case enterprise value at an inflated value of Appendix 3 presents the growth rates in a bullish case. Figure 8: Bullish Case Scenario analysis

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3.9 Relative Valuation P/E The P/E Multiple for Richemont for FY2019 was calculated as 23.42x. Compared to the average of 26.87x of its competitive peers suggests that Richemont is undervalued by 12.9 per cent. In FY2020 the multiple for Richemont is 21.31x compared to the 26.87x of its peers, suggesting that Richemont is undervalued by 20.7 per cent. See Figure 9. Figure 9: P/E Comps

EV/EBITDA The EV/EBITDA multiple does not consider the impact of different capital structures across companies and therefore is perceived as a primary reference for valuations (KPMG, 2015). The EV/EBITDA multiple for Richemont was 12.29x and 11.33x in FY2019 and FY2020 respectively, compared to 14.7x in FY2019 and FY2020. This means Richemont is undervalued by 13.9 per cent in FY2019 and 20.6 per cent in FY2020. Accounting standards between firms are different so it is possible that the some of the comparable overstating their earnings. See Figure 10.

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Figure 10: EV/EBITDA comps

EV/EBIT The EV/EBIT multiple for Richemont was 15.6 and 14.1 FY2019 and FY2020 respectively, compared to 17.5 in FY2019 and FY2020. Thus the multiple suggests that Richemont is undervalued by 11 per cent in FY2019 and 19.1 per cent in FY2020. See Figure 11. Figure 11: EV/EBIT comps

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EV/REV The enterprise value compared to Richemont priced low, this implies that the Group has good projects. The EV/Rev Multiple for Richemont in FY2019 was 2.9x compared to the multiple of 4.0x of its peers. See Figure 12. Figure 12: EV/REV comps

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4.0 Conclusion This thesis was aimed at performing an equity valuation of Switzerland-based luxury goods company, Compagnie Financière Richemont SA. Utilisation of an intrinsic valuation measure, namely the discounted cash flow model, and an extrinsic valuation measure, namely relative valuation comparables, the valuation was performed. The key value drivers for Richemont were identified as; growing demand from the Asia Pacific, more specifically China, online sales and millennials. Following identification of the value drivers forecasts were made and the DCF was created. The DCF revealed Richemont to have enterprise v million, an equity

premium to share price as of 29th June 2018. According to the calculated implied share price, Richemont is trading below its fundamental value. Considering this valuation in this report and some global research houses, Richemont s 12 month price target is between 70 and 111 per share (Bloomberg, 2018). A sensitivity and a scenario analysis was performed to test the forecasted assumptions. The sensitivity analysis showed how changes in growth and WACC

A scenario analysis was conducted presenting a base case, a bullish case and a bearish case and the effects it had on the enterprise value and equity value. The

Following this, a relative valuation was conducted through the use of the P/E, EV/EBIT, EV/EBITDA and EV/REV multiples, revealing that Richemont is undervalued relative to its competitors, reinforcing the findings of the DCF. Based upon the findings of the DCF approach to valuation and the relative valuation approach, the report concluded an investment recommendation of BUY.

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IMF, (2018). Word Economic Outlook. [Online] Available from: https://www.imf.org/en/Publications/WEO/Issues/2018/07/02/world-economic-outlook-update-july- 2018 [Accessed on 21 August 2018] Hunter, M., Platt, E & Samson, A. (2018). US 10-year Treasury yield touches three-year high. [Online] Available from: https://www.ft.com/content/837ee75e-fc3b-11e7-9b32-d7d59aace167 [Accessed on 7 August 2018] Liubing, C. (2018). Economic experts predict a positive outlook for China. [Online] Available from: https://www.telegraph.co.uk/news/world/china-watch/business/china-economy-forecast/ [Accessed on 3 August 2018] Johnson, M., Politi, J. & Stothard, M. (2018). Instability in Italy and Spain jolts European markets. [Online] Available from: https://www.ft.com/content/5aa1a252-602e-11e8-9334-2218e7146b04 [Accessed on 28 July 2018] Kalish, I. (2018). Japan: Economy shows signs of rebound. [Online] Available from: https://www2.deloitte.com/insights/us/en/economy/asia-pacific/japan-economic-outlook.html [Accessed on 7 August 2018] KPMG, (2015). Lightning Investors Limited: Valuation Report. [Online] Available from: https://www.colt.net/wp-content/uploads/2015/12/2015-12-16-KPMG-Independent-Valuation- Report.pdf [Accessed 7 August 2018] Koltrowitz, S. (2018). Swiss watchmaker Richemont launches lower priced brand to lure millennials. [Online] Available from: https://www.reuters.com/article/us-richemont-baume/swiss-watchmaker- richemont-launches-lower-priced-brand-to-lure-millennials-idUSKCN1IH2C2 [Accessed on 12 August 2018] Martin, W. (2018). The European Central Bank just called time on its $3 trillion stimulus program. [Online] Available from: http://uk.businessinsider.com/ecb-to-end-quantitative-easing-mario-draghi- 2018-6 [Accessed on 11 August 2018] Morgan Stanley, (2017). [Online] Available from: https://www.morganstanley.com/ideas/china-economic-market-transformation-bluepaper [Accessed on 6 August 2018] Reynold, R. (2017). [Online] Available from: https://www.bloomberg.com/quicktake/japan-s-shrinking-population [Accessed on 18 August 2018] Richemont, (2018). FY18 Annual Results. [Online] Available from: https://www.richemont.com/images/investor_relations/results/annual_results/2018/arp_transcript_fy20 18_18052018_d83jebhc6w1dc7.pdf [Accessed 2 August 2018] Richemont, (2017). FY17 Annual Results. [Online] Available from: https://www.richemont.com/images/investor_relations/reports/annual_report/2017/ar_fy2017_f73jdsf8 2s64r2.pdf [Accessed 2 August 2018] Richemont, (2016). FY16 Annual Results. [Online] Available from: https://www.richemont.com/images/investor_relations/reports/annual_report/2016/ar_fy2016_d92nb1v df73tb.pdf [Accessed 9 August 2018] Richemont, (2016). FY16 Annual Results. [Online] Available from: https://www.richemont.com/images/investor_relations/reports/annual_report/2016/ar_fy2016_d92nb1v df73tb.pdf [Accessed 12 August 2018] Richemont, (2015). FY16 Annual Results. [Online] Available from: https://www.richemont.com/images/investor_relations/reports/annual_report/2015/ar_fy2015_h68qw9 5aw9b.pdf [Accessed 12 August 2018]

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Rosenbaum, J. and Pearl, J. (2009). Investment Banking: Valuation, Leveraged Buyouts and Mergers & Acquisitions. United States: John Wiley & Sons, Inc. Tarver, E. (n.d). How does inventory turnover affect the cash conversion cycle? [Online] Available from: https://www.investopedia.com/ask/answers/031615/how-does-inventory-turnover-affect-cash- conversion-cycle-ccc.asp [Accessed on 7 August 2018] Thompson, J. (2018). How Richemont Plans to Survive in a Changing 21st Century Marketplace. [Online] Available from: https://www.bloomberg.com/news/articles/2018-07-16/how-richemont-plans- to-survive-in-a-changing-21st-century-marketplace [Accessed 10 August 2018] OECD, (2018). France- Economic forecast summary (May 2018). [Online] Available from: http://www.oecd.org/economy/france-economic-forecast-summary.htm [Accessed 7 August 2018] Wildau, G. (2018). China GDP growth slips to 6.7% in second quarter. [Online] Available from: https://www.ft.com/content/f17e67e4-8646-11e8-96dd-fa565ec55929 [Accessed on 3 August 2018] Worldbank, (2018). Global Economic Prospects: The Turning of the Tide? [Online] Available from: http://pubdocs.worldbank.org/en/314521526416522634/Global-Economic-Prospects-June-2018- Regional-Overview-MENA.pdf [Accessed 7 August 2018] YNAP, (2016). Press Release Capital Markets. [Online] Available from: http://cdn3.yoox.biz/cloud/ynap/uploads/doc/2016/Press-Release_Capital-Markets-Day_6-July- 2016.pdf [Accessed on 15 August 2018]

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6.0 Appendices Appendix 1: Sales Forecasts Please note that historical figures (FY 2014- FY2018) for YNAP and Richemont have been computed using both financial statement to show theoretical figures of if the takeover had taken place before (highlighted)

Appendix 2: Bearish Scenario Analysis

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Appendix 3: Bullish Scenario Analysis

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