Monday, January 25, 1999

Gucci Group, N.V.
Phone: 212-815-2291
Website: http://www.gucci.com
Price (1/22/99): $72 7/8


Luxury goods are worth paying up for. Or so it seems. Having survived the Asian economic crisis in relatively fine form despite repeated fears to the contrary, Gucci Group (NYSE: GUC) has proven itself worthy of... a handsome suitor.

LVMH Moet Hennessy Louis Vuitton SA (Nasdaq: LVMHY), the world's top luxury goods maker, and a firm vying for the longest corporate name, has reportedly accumulated a 26.7% stake in Gucci. And it may have further designs on the company.

Gucci shares took a licking after being tossed about in the general Asian malaise like some plain-Jane Samsonite luggage. From a high around $80 per share just over two years ago, the stock plunged below $30 in the October 1997 panic. It began to perk up last July, but then the return of the global financial crisis dropped the stock back to the low $30s.

Gucci recovered with the market, but the stock really popped on January 6 when Moet & Chandon purveyor LVMH announced it had accumulated a better than 5% stake. Gucci rose 23% on the news, closing at $68 5/8. It inched higher on reports of LVMH's increasing interest, including its $398 million purchase of the 9.5% stake held by Italian fashion house Prada. Prada cozied up to Gucci last summer before being rebuffed.

LVMH claims it doesn't plan to make a buyout bid "under present conditions," and Gucci's board, led by Chairman and CEO Domenico De Sole, says it has no interest in ceding control. Still, some Gucci shareowners may be ready to splurge on some chic Gucci bags and maybe a world cruise after seeing the shares roar ahead 130% in just three months.


Based in Holland, Gucci is one of the world's top designers, producers, and distributors of luxury accessories, including leather goods, shoes, watches, ready-to-wear apparel, ties, and scarves.

For the first nine months of FY98, leather goods constituted 44% of total revenue, despite a 23% dollar decline in sales year-over-year. Shoes accounted for 15%, despite a 14% dollar decline. Watches soared to 22% of sales ($160 million), after representing just 3% of sales in the year-ago period. In the past year, Gucci brought that business back in-house.

For this year-to-date period, company-owned stores reported $451 million in sales (down 3%), while wholesale sales (to franchise stores, duty free shops, and department and specialty stores) increased 29% to $273 million. Royalty revenues plunged 57% to $16.9 million due to the shift in the watch business.

While Asia accounted for a disproportionate 45% of sales for the first nine months of FY97, Gucci's sales were much more balanced for the first nine months of FY98, as European revenue shot up 37%. Overall, the U.S. accounted for 28% of sales, Europe for 30%, and Asia for 39%, with the remainder coming from other regions.


Income Statement
12-month sales: $998.2 million
12-month income: $168.9 million
12-month EPS: $2.82
Profit Margin: 16.9%
Market Cap: $4,343.4 million

Balance Sheet
Cash: $89.4 million
Current Assets: $461.1 million
Current Liabilities: $287.6 million
Long-term Debt: $39.4 million

Price-to-earnings: 25.8
Price-to-sales: 4.4


In June, Gucci piqued the interest of fellow Fool Alex Schay, who noted that the company enjoys hefty margins and lots of free cash flow. Alex wondered whether it made sense for the stock, then at $52 per share, to be trading at a discount to other brand-name luxury firms.

As Alex pointed out, Gucci had been using its cash to get better control of its business by acquiring its Korean and Guam franchisees and taking a 51% stake in its Taiwan franchisee. It also regained control of Gucci Timepieces and repositioned this business.

The return of the Asian contagion soon left even brand-name companies reeling, but Alex's point was right on: Gucci was undervalued based on its profitability and the growing strength of its brand.

That strength was reflected in Q3 results announced December 10. Revenue rose 6% to $253 million, producing EPS of $0.76 versus $0.70 a year ago. Even amidst serious global financial turmoil that was dampening spending on luxury items both in Asia and in the U.S., Gucci came through just fine thanks to a 37% surge in European sales.

That's all the more surprising because sales of Gucci's core leather goods fell 20%, and leather sales depend partly on Asian tourists buying from duty-free shops while traveling in Europe. The strong European results, then, reflect management's smart decision to open new stores and renovate flagship stores in Europe to appeal more to local customers.

Sales for the first nine months of FY98 increased 3% despite a 11% decline in Gucci's huge Asian market. Earnings per share year-to-date were virtually flat, at $2.13 versus $2.17. While that news sent the stock soaring above $50 again, it was still worth a look.


Thinking about Gucci's future might best be done over a glass of champagne. As the owner of the Christian Dior fashion house, the Louis Vuitton brand of luggage, and duty-free retailer DFS Group, LVMH could probably expand Gucci's retail presence in a way that also would protect and enhance its brand.

LVMH's huge position should at least give it control of a few board members. That could lead to joint ventures or other arrangements that could prove mutually beneficial for the two companies.

Of course, it's not clear what will happen. Giorgio Armani of the Armani fashion house reportedly spoke to LVMH's CEO Bernard Arnault about a combined takeover of Gucci. Some analysts are convinced that Gucci won't remain independent for long.

However, De Sole can make a strong case that Gucci's board should do nothing. On January 8, the company reported that sales for the first two months of Q4 soared 23% to $200 million from $163 million thanks to solid sales at its retail stores. Gucci also enjoyed a pickup in demand in the U.S. and Japan and "signs of recovery" in its Hong Kong and Hawaii stores. He blessed a FY98 earnings estimate of $3.00 per share, above the consensus of $2.95 per share.

Moreover, De Sole and lead designer Tom Ford are widely credited with resuscitating the company after some difficult years in the early '90s. So, LVMH must proceed with care lest it destroy the very gem it seeks.

Gucci now trades at 24 times expected FY98 earnings, with analysts calling for $3.22 per share for FY99. That's certainly rich compared to the discounted price last fall. Yet if LVMH really wants to gain control of this top luxury brand, Gucci's stock may have to go higher. After all, Gucci works that retail space where buyers expect to pay up for quality.

-- Louis Corrigan

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