3 Reasons to Buy Hermès International, and 1 to Sell

Hermès International's (HESAY 1.00%) stock shed about 40% of its market value this year as inflation, rising interest rates, and other macro headwinds drove investors from growth stocks toward value stocks.

However, the French luxury house's stock has still more than doubled over the past five years. It has also withstood several recessions since its public debut in 1993, and it remains one of the world's best-known luxury brands. Let's review three reasons to buy Hermès -- and one reason to sell it -- to see if it's a worthwhile investment in this turbulent market.

A Hermès scarf. Image source: Hermès International.

1. It's well insulated from the current macro headwinds

Hermès and its rival LVMH Moët Hennessy L.V. (LVMUY 3.09%) both target affluent shoppers, who are generally much better insulated from economic downturns than other consumers are. Both companies are able to pass on higher costs to their customers more efficiently than lower-end brands.

Hermès also manufactures most of its products in small workshops in France instead of mass-producing them overseas, like LVMH. That localized approach supports the luxury appeal of Hermès' brand and gives it significant pricing power against its industry peers.

Hermès hasn't aggressively expanded beyond its core brand with big acquisitions as has LVMH, which currently owns 75 luxury houses across five different product categories. Hermès' tighter focus on its flagship brand and lower dependence on overseas manufacturers insulate it from many of the supply chain headwinds currently hurting LVMH and other multinational companies.

2. Its healthy post-lockdown recovery

Hermès' growth decelerated in fiscal 2020 as the pandemic forced it to temporarily close its brick-and-mortar stores. The decline of global travel and tourism exacerbated that pain. But in fiscal 2021, it returned to growth with a healthy 42% increase in its constant-currency revenue.

Data source: Hermès. *Constant currency terms. YOY = year-over-year.

That growth was driven by double-digit increases across all six of its main categories: leather goods and saddlery, ready-to-wear and accessories, silk and textiles, other sectors, perfume and beauty, and watches.

In the first quarter of 2022, Hermès' revenue rose another 27% year over year in constant currency terms with double-digit growth across all six categories. Analysts expect its revenue to rise 17% for the full year, then grow another 10% to 11.6 billion euros ($12.1 billion) in fiscal 2023.

3. Expanding margins and rising profits

Hermès' margins and net profit dipped in fiscal 2020 as it grappled with higher COVID-19 expenses. However, its margins expanded rapidly in fiscal 2021 and actually exceeded its pre-pandemic levels.

Data source: Hermès.

That expansion can be attributed to its pricing power (particularly in high-growth markets like China), its operating efficiencies, and its improving scale. Hermès also expanded its workforce by 8% in 2020 and 6% in 2021, which indicates it's still confident about its long-term prospects.

Analysts expect Hermès' operating and net margins to dip slightly in fiscal 2022 (but remain far above its 2019 levels) before expanding again in fiscal 2023. They also expect its net income to rise 12% this year and grow another 11% to 3.03 billion euros ($3.16 billion) in fiscal 2023.

We should take all those forecasts with a grain of salt, since the market faces a lot of unpredictable headwinds, but Hermès' resilience during previous economic downturns suggests it can hit those targets.

The one reason to sell Hermès: Its valuation

The biggest problem with Hermès is that many investors have already flocked to it as a recession-resistant play. As a result, its stock now trades at about 38 times this year's earnings.

By comparison, analysts expect LVMH's revenue and earnings per share to rise 16% and 14%, respectively, this year. Yet LVMH trades at just 20 times this year's earnings, which arguably makes it look a lot more attractive than Hermès.

Is Hermès a worthwhile investment?

I own shares of both Hermès and LVMH. But at these valuations, I believe Hermès has less upside potential than LVMH or other higher-growth apparel retailers. Hermès is still a solid long-term investment, but investors should expect the stock to tread water for at least a few more quarters in this challenging market before it swims forward again.