Too big

Back in 2006, LVMH was the 70th largest contributor in earnings terms (€1.8bn) to the AlphaValue coverage (464 stocks now, 340 then). Its market cap then was the 62nd at €34bn.

Today its market cap is the first of the AlphaValue coverage universe (€306bn) and it ranks 9th on 2021 estimated earnings (€8bn).

Any lasting Chinese love for expensive bags could see LVMH overtake BHP, Rio, Novartis, Royal Dutch Shell, BAT which are still bigger earners. Nestlé and VW would be harder targets but not out of reach. Presenting LVMH in that light underscores the amazing rebalancing of sectors which took place over the last 15 years and how a non-essential industry took the lead.

We repeatedly played with the concept of Khol (Kering, Hermès, l’Oreal and LVMH) being too big for the CAC40 index at c. 35% of total weighting. That means that nobody with risk diversification in mind can hope to match the index starting with a LVMH weighting of 15% of that index.

The CAC40 no longer being large enough for LVMH and its Khol peers, we matched them to the broader AlphaValue coverage which accounts for c. 85% of the Stoxx600 market cap.

The figures are striking as Khol’s market cap grew to 6% of the universe vs. 1.5% 15 years ago. That 4x increase is not matched by earnings which are up less than 3x to 3% of total earnings. These percentages are in relation to 2021 earnings seen at €555bn and a combined market cap at nearly €11,000bn.

The above chart is designed to highlight the growing weight in relative terms to European equities.

Another way to underline the eerily weight of Khol is to look at their contribution to earnings growth over the period. They added €12bn to their total earnings between 2006 and 2021 when the reference universe has been adding only €48bn. This 25% weight is obviously in relation to dismal 2020 and 2021 global earnings courtesy of COVID-19. Looking back at our pre-COVID-19 2021 expectations, total earnings would have grown by c.€195bn between 2006 and 2021 so that Khol would have contributed 6% of that increase. Not bad anyway for four stocks.

One can also match the combined 2021 Khol earnings (€17bn) to usual sectors’ results. That would be half that of Oils or Autos with none of their capital requirement. That is a relative statement as the acquired growth of LVMH is marring its recent and near-term ROCEs (without marring its multiples as it happens).

The unknown is how much of the Khol weight ends up into a self-propelled dynamic as most actively-managed ETFs will want those nearly whatever the focus (China, Luxury, ESG, Growth, etc.). The bigger those four names become, the more likely it is that they are building blocks of ETFs, which adds to their valuation. The tipping point is anybody’s guess. 

We also take the opportunity of this short review of Khol’s weight for a double check on their ESG credentials

ESG analytics will not spring surprises but are worth a comment. The S front is a natural win for these stocks as staff is as well paid as investment bankers and complains less as there is indeed more visibility in the luxury business model. The tricky bit might be with subcontractors as exemplified by the crisis that European fast fashion has had with China. This is difficult to price but one can assume that those companies are rich enough to invest in quality supply chains.

On the E front as well there is little in the way of these businesses that would put them at odd with environmental decency.

The sore point is really about governance. There is nothing intrinsically wrong with those groups but they leave little room to independent views as they are successful family controlled businesses. This goes against the AlphaValue default view that minority investors are best off with a vocal independent board. Obviously the success of the Khol groups over the last 3 decades points toward exceptional competence so that AlphaValue’s vision of what is ‘good governance’ wise is a bit shaken. Call Khol the exception to the rule

Sustainability metrics are hugely dependent on governance metrics so suffer as well as a result.

The following table provides a summary review of those firms on the ESG front. On those firms own definition of board independence, their sustainability metrics would be superior ones.

More research on www.alphavalue.com