The biggest stock market story of early 2020 is easily the coronavirus, now officially known as COVID-19, and its implications for the global economy -- particularly in China.
The market's response has been to sell down many companies with sensitivity to the Chinese economy. Luxury retailer LVMH (OTC:LVMUY) is certainly one of them, having fallen about 9% from its recent high as of midday Thursday. However, long-term investors would be wise to use the pullback as a buying opportunity.
A big hit to a major market
It's easy to see why investors are concerned about LVMH's exposure to the coronavirus. Asia (excluding Japan) is the company's largest geographic market, and China is a major contributor.
|LVMH Geographic Segment||Percentage of Total Revenue|
The COVID-19 has shut down large parts of China's economy. Schools and offices are closed, factories are not running at capacity, and many people are choosing to stay home rather than go out to shop or meet with friends out of an abundance of caution. To make matters worse, the pandemic has coincided with the Chinese Lunar New Year celebrations, which is a time of elevated spending on gifts -- likely hitting LVMH's Chinese sales especially hard.
When LVMH reported earnings on Jan. 28, CEO Bernard Arnault addressed the issue by noting that the COVID-19 outbreak didn't appear to be as bad as the SARS outbreak that occurred in the early 2000s, and he said he doesn't see much of a disruption occurring if the pandemic is resolved within two to three months. Interestingly, the company hinted that the Hong Kong political protests may end up having a greater impact on financial results. Hong Kong is a large market for luxury items, and LVMH saw its sales in the city drop 40% in the fourth quarter of 2019.
It's possible that Arnault underestimated the impact; more recent information shows that COVID-19 may be more contagious than SARS (albeit less deadly). Truth be told, nobody knows how long the coronavirus will be a factor and what its impact will ultimately be. But the pandemic will (hopefully) be contained at some point, and it appears unlikely to cause damage to LVMH's long-term financial health or earnings power.
High-end financial performance
Fear of a large impact from the coronavirus has overshadowed LVMH's long-term outlook for earnings growth. The best evidence of LVMH's financial strength is its 2019 financial performance, where its sales and earnings both grew 15%. This was driven by continued strength in the global luxury market.
|Revenue||46.8 billion euros||53.7 billion euros||15%|
|Profit from recurring operations||10 billion euros||11.5 billion euros||15%|
Commenting on the outlook, Arnault stated: "So for 2020, as with previous years, the climate is buoyant. It will remain so, as I've said on several occasions today, in the coming years."
For LVMH's earnings growth to remain intact, you simply need to believe that LVMH will maintain relevant brands -- it has many, including namesakes Louis Vuitton, Moet & Chandon, and Hennessy -- and that the global middle class will continue to grow its desire for luxury goods. These feel like pretty safe bets to make over the next 10-plus years.
Tiffany should start paying off soon
Another reason to be bullish on LVMH stock is its recently announced acquisition of Tiffany, which it's buying for $16.2 billion in an all-cash deal.
Tiffany is an iconic global brand that will fit nicely within LVMH's stable of global brands that include other jewelry and watch companies such as Hublot and Bulgari. LVMH is an excellent operator and will likely find some synergies between its existing jewelry assets. There's also an opportunity to ramp up Tiffany's global presence by opening more stores in Europe, Asia, and Latin America. These are markets that LVMH knows well, where it already has a strong retail footprint.
The deal is being financed with cheap debt and is expected to be immediately accretive to earnings when it closes this year.
Focus on the long term
At this writing, there's still a great deal of uncertainty regarding COVID-19, so patience will be required to see the ultimate length and impact of the health crisis. But unless it results in an unprecedented global slowdown in consumer spending that lasts through the spring and summer, it's unlikely to damage LVMH's financial health.
Businesses derive their value from their ability to generate future cash flows. While 2020 may disappoint prior earnings expectations as a result of the coronavirus, LVMH's long-term earnings power is unlikely to be impaired. Therefore, to the extent the COVID-19 proves to be a temporary issue, long-term investors should consider using the lower stock price as a buying opportunity.