LTGG Reflections: From handbags to outliers

Our approach to luxury brands 

The challenge we faced when examining these companies in the early 2000s was the same then as it is today: how to assess the long-term growth potential of a luxury brand? Standard models simply don’t work, as these businesses can seemingly defy gravity by generating unusually elevated returns on assets year after year, decade after decade. For reference, Hermès’ average return on assets over the past decade is 20 per cent – well over twice any cost of capital implied by any standard economic model. This should in theory be impossible to achieve, especially considering Hermès dates back over 180 years. Such businesses possess a certain je ne sais quoi – a powerful alchemy of authenticity, heritage and symbolism that is incredibly difficult for newcomers to replicate. The potential for such companies cannot therefore be assessed using solely traditional financial models and metrics.

For the fledgling LTGG strategy in 2004, this was a challenge that our team was well placed to accept. Our 10 Question Stock Research Framework was after all purposefully designed to marry the quantitative and qualitative aspects of long-term scenario analysis. Nonetheless, Hermès was not an obvious buy for us back then. The company was already a luxury powerhouse, its family ownership was already over a century old, the brand was already global, and the stock was already sitting on a price-to-earnings ratio that most sell-side brokers considered to be eye-wateringly expensive. Our investment case therefore seemed already baked into the valuation, so what edge could we in LTGG possibly have? The answer lay in our access to perhaps the greatest luxury of all: time.

The market often fails to recognise the power of compound growth. In contrast, we believed Hermès would go on to embody precisely what the nascent LTGG strategy was attempting to achieve – exceptional returns over long periods of time – so long as one remained patient. That said, even our LTGG team was divided on the durability of the psychological power of the brand, but (as our process dictates) they backed Mark’s enthusiasm.

So why did we not pursue LVMH? Unlike Hermès’ mono-brand, LVMH’s sprawling stable of different brands raised questions about management’s approach to capital allocation and so we preferred to monitor from the sidelines. While we eventually came to the view that LVMH was in fact an astute allocator of capital and possessed an admirable time horizon, it was no longer clear what it might add to the LTGG portfolio by that point. The reason was not simply our existing holding in Hermès, but also our 2008 purchase of another stable of brands: Kering.

Known back then as PPR, our central thesis was that the group would evolve from a motley collection of disparate non-luxury brands into pure luxury. Kering would in due course become synonymous with the likes of Gucci, YSL, Bottega Veneta, Balenciaga and others. Moreover, the multi-brand approach implied a degree of diversification, where the ebbing of one brand’s success in any particular period could in theory be offset by the rise of another.

While this case played out in the years that followed, latterly Kering’s valuation became ever more dependent on just one of its brands, Gucci, which had swollen to account for around half of total sales after enjoying rapacious growth for several years. Though the brand successfully leaned into the new generation of younger consumers, its styles veered more toward fashion than luxury, more cyclical than timeless. Gucci’s high net worth customers appeared increasingly alienated. Support from Kering’s other brands hasn’t come to bear, as they remain sub-scale and face headwinds of their own. Taking this together with the impending retirement of Chairman and CEO François-Henri Pinault, who has architected the group’s success over the past twenty years, we took the decision to sell our holding in August 2024 in favour of higher conviction names elsewhere.

Despite ‘only’ a circa 4x return during our 16-year holding period, Kering features among the top ten contributors to LTGG performance since inception in 2004 – ahead of Hermès (and NVIDIA!). This phenomenon is a function not just of its longevity in the portfolio, but also its position size. This serves as a reminder that our task in LTGG is threefold: first identify the outliers, second hold onto them over time, and third hold onto them at scale.

Embracing mistakes and seizing opportunities

This is easier said than done. We will of course make mistakes. In 2012, for example, we were drawn to the increasing luxury status of Burberry, but sold in 2016. It turned out that the brand was more susceptible to general consumption trends than we had anticipated, while the management culture appeared increasingly short-termist.

Our greatest mistake in LTGG, however, would be to miss investing in the next great opportunity. We only need a few of these to drive the majority of portfolio returns. This has been as true for the fast-growing names in the portfolio (the likes of Amazon, NVIDIA, Tesla, etc.) as it has been for the steady compounders such as Hermès. It explains why we have recently invested in Moncler, best-known for its luxury winter wear, and Kweichou Moutai, the Chinese premium liquor brand. We have conviction that both can compound mid-to-high teens revenues steadily over the coming decade and beyond (and returns at potentially even higher rates). Both have formidable competitive moats thanks to their established brand heritages. Both already enjoy remarkably high net margins: Moncler between 20-25 per cent and Moutai close to 50 per cent. Given the predictability of these businesses, and if we hold margins and multiples equal, we believe patience will lead us to see five-fold returns from here.

This leads us back to one final question on Hermès: why do we still own it? With a market capitalisation in excess of $250bn and a price-to-earnings ratio of 50x, many argue that it is overvalued. Yet we believe it is altogether possible that Hermès steadily grows its market share of the luxury goods industry from current low-single-digits to 10 per cent. This would represent mid-teens topline compound annual growth and earnings growth in the high teens or even low twenties. Increasing penetration in ready-to-wear could also drive part of the growth story, while Hermès’ strong pricing power shows no sign of abating. Last but not least, the family ownership ensures brand discipline is as fastidious as ever. In short, and with echoes of our Hermès stock discussion back in the early 2000s, we believe there is still much more runway (excuse the pun) from here for truly long-term investors.

The likes of Hermès, Moncler, Kweichou Moutai and other luxury names in the LTGG portfolio present not a story of pace, but of duration. And as illustrated by the historic examples in this commentary, their returns over time can be luxuriously extreme.

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