Richemont reinvigorated: An opportunity?
By Ryk de Klerk
THE growth prospects for Richemont have improved dramatically and all South Africans are afforded the opportunity to share in the luxury goods firm’s growth due to Richemont’s equity-based shareholder loyalty scheme to capture further upside.
Over the past 10 years Richemont, owner of several of the most prestigious names in the luxury industry including Cartier, Van Cleef & Arpels, Montblanc, Dunhill and Chloé, has underperformed the European stock market as measured by Shares STOXX Europe 600 UCITS ETF (DE), a fund that seeks to track the performance of STOXX600, an index composed of the 600 largest companies from European developed countries.
Richemont’s past performance since 2011 indicates that it is a true value stock.
The stock outperformed the STOXX600 ETF when global economic activity, as measured by the average manufacturing Purchasing Managers’ Indexes of the US (ISM) and China (CFLP), rose and, conversely, underperformed when global economic activity eased and contracted.
Richemont also began to severely underperform the S&P Global Luxury Index since the third quarter of 2017.
Richemont’s share price has recovered by 56 percent in terms of US dollars since the end of March during the global financial crisis caused by COVID-19.
In comparison, the S&P Global Luxury Index is up by more than 88 percent over the same period.
Richemont and the well-known Alibaba, arguably China’s version of Amazon, on a 50:50 basis, partnered with Farfetch by investing $1.15 billion about (R17.5 billion) in the latter to provide luxury brands with enhanced access to the China market as well as accelerate the digitalisation of the global luxury industry.
Some see Farfetch as the Amazon of high fashion.
Richemont and Alibaba collectively invested $600m in private convertible notes issued by Farfetch Limited.
In addition, Richemont and Alibaba will invest $500m in Farfetch China for a combined 25 percent stake in a new joint venture that will include Farfetch’s marketplace operations in the China region. In addition, Alibaba and Richemont have an option to purchase a further combined 24 percent of Farfetch China after the third year of the joint venture’s formation.
At a Bank of America Consumer & Retail Virtual Conference in November, Elliot Jordan, CFO of Farfetch, alluded to the massive opportunity in the Chinese luxury market.
They estimate that by 2025 the Chinese luxury market will increase to more than $170bn dollars or nearly half of the global personal luxury goods market from 35 percent in 2019 or about $105bn.
The online personal luxury goods industry has grown by a compounded annualised growth rate of 28 percent from 2009 to 2019 compared to the overall industry’s 5 percent from 2008 to 2018.
2020 is a disastrous year with the overall market shrinking by nearly a third but a bounce-back to 2019 levels is possible by 2022.
While it is impossible to forecast future profit growth for Richemont, I think the reinvigoration of Richemont has vastly improved the prospects of above-average profit growth over the long run.
Although it will remain prone to the global economic cycle, long-term profit growth will be underscored by the company’s increasing presence in China and the Luxury New Retail or LNR initiative.
I am of the opinion that the stage is set for a re-rating of Richemont against its peer group and global equity markets, specifically against STOXX600.
That said, the coronavirus had and is still having a major impact on many peoples’ financial health.
The lockdowns and subsequent layoffs, furloughs and pay cuts led to the sales of assets to put bread on the table. Some of us, yours truly included, simply cannot afford to pay R130 per Richemont share and at the same time run the risk of losing more money should the stock market crash.
But Johan Rupert, Chairman of Richemont, and his board afforded me the opportunity to share in the upside of Richemont while limiting potential capital losses.
Earlier this year Richemont announced an equity-based shareholder loyalty scheme to capture further upside in the market price of A Shares and the JSE-listed Depositary Receipts where 10 Depositary Receipts equals one Richemont A Share.
This culminated in the issue of two A Warrant Receipts for each Richemont share held. The exercise price of the A Warrant Receipts, being the price at which holders will be entitled to purchase one Richemont Depositary Receipt at maturity in November 2023, has been set at 6.7 Swiss franc and 67 Warrant receipts are required to purchase one Depositary Receipt.
The exercise price of the A Warrant Receipts is 0.67 Swiss franc converted into South African rand at the rand to Swiss franc exchange rate at maturity in November 2023
The warrants were listed on the JSE at the end of November as Richemont Options. As they can only be exercised in November 2023 they are, as we call it, European call options.
If the price of Richemont A shares ends up to be below 6.7 Swiss francs at expiry date in November 2023, the options or warrants will be worthless and you will lose all the money you put up.
The theoretical values of the warrants and options are determined by sophisticated statistical models that inter alia take into account the time to expiry of the instruments, volatility of the Richemont’s share price in Swiss franc, Richemont’s dividend yield and risk-free interest rates in Switzerland.
The theoretical price of the JSE-listed Richemont options is also influenced by the prevailing exchange rate between the South African rand and the Swiss franc.
I use a fairly simple Black and Scholes model to get an idea of a fair price of the option.
The price at which the Richemont options trade on the JSE may deviate significantly from the theoretical prices as a result of liquidity, supply and demand. The option models used by market participants also differ resulting in different theoretical prices.
Arbitrage between the options and Richemont shares locally and internationally will from time to time lead to reasonably fair values at which the options will trade.
Richemont A shares on Friday closed at 76.5 Swiss franc. Based on the volatility of 20 percent and a risk-free rate of one percent my model indicates a fair value of 0.22 Swiss franc for the Richemont A Warrant.
As the JSE-listed Richemont option is equal to one tenth of the A warrant the fair value of one Richemont option amounts to 37 South African cent at an exchange rate of R17 to the Swiss franc. That compares to the option’s closing price of 36 cent on the JSE on Friday.
My capital outlay to buy to 100 Richemont share would cost me R13 000 rand while the same eventual exposure to Richemont via Richemont options will entail buying 6700 options at a price of 37 cent resulting in a capital outlay of R2 479 rand, excluding transaction costs.
With the options, the most I stand to lose is R2 479 if Richemont’s price falls significantly.
No wonder that non-executive members of Richemont’s board of directors bought 50 million Richemont A Warrants (equal to 500 million JSE-listed options) at a weighted price of 0.196 Swiss franc per Warrant in the first week of December. That is a sure sign of confidence.
Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. He has a direct interest in Richemont options. You should consult your broker and/or investment adviser for advice. Past performance is no guarantee of future results.