Greater Chinese Takeaways - Berenberg · Greater Chinese Takeaways John Guy Analyst +44 20 3465...

Greater Chinese Takeaways

John Guy

Analyst

+44 20 3465 2674

[email protected]

Bassel Choughari

Analyst

+44 20 3465 2675

[email protected]

Rupert Trotter

Specialist Sales

+44 20 3207 7815

[email protected]

20 June 2013

Luxury Goods

BERENBERG EQUITY RESEARCH

For our disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) and our disclaimer please see the end of this document. Please note that the use of this research report is subject to the conditions and restrictions set forth in the disclosures and the disclaimer at the end of this document.

Table of contents

Greater Chinese takeaways 5

Don’t fight the long-term demographics 6

Brand momentum as measured by Baidu searches 10

Projected Chinese city GDP evolution 14

Key company takeaways 15

Sporting, Fashion & Leather goods pricing comparison 21

Chinese watch distributor feedback 22

Watch price comparisons – Mainland China vs. local FX 28

China – macro and industry data 29

China – demographic data 30

Greater China – Macro indicators 31

Greater China – selected data 32

Commodities and exchange rates 33

Luxury goods performance 34

Swiss watch industry data 1/2 35

Swiss watch industry data 2/2 36

adidas - Mixing it up 38

adidas key assumptions and sensitivities (1) 39

adidas key assumptions and sensitivities (2) 40

Q2 2013 in focus 41

Cash machine could pay out more to investors 44

Valuation 46

Financials 53

Burberry Group - Smelling of roses? 56

Burberry assumptions and sensitivities 57

Beauty is an opportunity 58

Japanese licence termination may not dilute earnings 60

Financials 62

Luxottica Group - Slowly but surely 65

Financials 66

LVMH - Opportunity knocks 69

LVMH Group assumptions and sensitivities 70

H1 2013 focus 71

Gearing levels raise acquisition alert 78

Financials 80

Compagnie Financière Richemont - Catalytic converter 83

Richemont key assumptions and sensitivities 84

Diving into Net-a-Porter 85

Financials 94

The Swatch Group - Looking for a better entry point 97

Swatch key assumptions and sensitivities 98

Short-term risks 99

Medium to long-term opportunities 103

BaselWorld initial thoughts 106

Harry Winston assumptions and opportunities 107

Financials 113

Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) 116

Contacts: Investment Banking 120

Luxury & Branded Goods Luxury Goods

5

Greater Chinese takeaways

● We visited over 20 luxury and sporting goods brands in Shanghai, Hong Kong and Macau as well as meeting with senior management of all the major Chinese watch distributors and Samsonite.

Our key Greater Chinese takeaways are as follows.

● Do not fight the medium to long-term demographic of a growing middle class in China with an increasing appetite for aspirational luxury brands. Masstige continues to outperform prestige on the mainland.

● Do not expect a material bounce in mainland Chinese demand for luxury and prestige watches in the second half of 2013 despite a softer export comparison base. In our view, it could take at least until the first half of 2014 for demand to normalise. Prestige watch brands materially affected in Mainland China include Cartier and Rolex.

● In terms of Fashion & Leather goods brands, Hermès, Prada and Chanel sales momentum appears stronger than that of Louis Vuitton and Gucci in Greater China (ie Mainland China, Hong Kong and Macau).

● Other outperforming brands across Greater China include adidas, Burberry and Swatch Group mid to high-end brands Rado, Tissot and Longines. In the short term, we see downside risk to Swatch Watches & Jewellery and Production EBIT margins, driven by Harry Winston dilution, weaker organic H1 2013 W&J growth and an expected decline in Production sales and margin. The fundamental investment case is intact and we look for a more attractive entry point over the next 3-6 months, hence our downgrade of Swatch to Hold.

● Brand sales performance is volatile and mixed by region. Mainland China remains the weakest region where, on average, prestige luxury continues to trend down high-single digit to double digits from April.

● Hong Kong stores with high exposure to mainland Chinese consumers are more negatively affected; stores situated closer to Hong Kong residential areas are showing more resilient trading.

● Luxury goods demand remains the strongest in Macau with prestige watch brands experiencing double-digit sales growth, partially offsetting more volatile trading in Hong Kong.

● Rental and labour cost pressures in Mainland China and Hong Kong continue to weigh on profit generation. We expect cost pressures to ease from 2014.

● adidas: Trading is impressive across retail stores in Shanghai and Hong Kong. Sales conversion rates are up yoy, NEO is outperforming and price/mix evolution is positive with a higher weighting of Lifestyle than Sport Performance for the adidas brand in Asia. Rent and employee costs continue to pressure margins but we estimate the Hankow Road store (HK) will deliver a c30% EBIT margin in 2013.

● Burberry: Shanghai store conversions continue to drive double-digit growth in 2013. Shanghai is the focus this year with Beijing into 2014. We see material scope to drive up sales densities and conversion rates. Our mainland Chinese sales estimates may prove conservative through to FY 2017 (£481m). Moreover, we believe a concession rollout in Japan supported by mainline stores and improving Beauty sales could result in a neutral-to-positive EBIT outcome by FY 2016 (licence termination).

adidas

Buy Current price

EUR 83.40 Price target

EUR 98.00 20/06/2013 Frankfurt Close

Burberry

Buy Current price

GBp 1,399 Price target

GBp 1,600 20/06/2013 London Close

Luxottica

Buy Current price


EUR 41.00 20/06/2013 Milan Close

LVMH

Hold Current price


EUR 140.00 20/06/2013 Paris Close

Richemont

Hold Current price

CHF 84.35 Price target

CHF 86.00 (from 72.00)

20/06/2013 Zurich Close

Swatch

Hold (from Buy) Current price

CHF 536.00 Price target

CHF 575.00 (from 625.00)

20/06/2013 Zurich Close

Rating system: Absolute

20 June 2013 John Guy Analyst +44 20 3465 2674 [email protected]

Bassel Choughari Analyst +44 20 3465 2675 [email protected]


6

Don’t fight the long-term demographics

Recent macro economic data have been less supportive of sustained growth, with industrial output decelerating to 9.2% yoy in May from 9.3% in April. External trade data remain particularly weak with export growth of just 1%, the worst performance since last July, after 14.7% in April, and imports contracting by 0.3% yoy. The volatile trade data are distorted by the ebb and flow of over and under-invoicing in order to conceal capital flows through Hong Kong. Nevertheless, recent trade data have softened.

The decline in inflation to 2.1% in April shows in our view that China could easily provide credit stimulus without raising inflation concerns. With limited public debt, material currency reserves and some capital controls, China could pull all the levers of standard macro policy should the fledgling government decide to do so. The new government has already stressed that a key objective will be stimulating internal consumption, improving national standards of living and raising wages – all against the backdrop of having to transition to more balanced growth.

Chinese GDP evolution and 2013 forecast real GDP growth

Source: WTO, World Bank, Capgemini, Berenberg research

Chinese GDP evolution and 2013 forecast real GDP growth

Source: McKinsey, Bloomberg

If the rebalancing and transition to more balanced growth were to unravel, we would expect China within a few months to administer a new credit stimulus as it did after the collapse of Lehman Brothers.

GDP per capita 5,445

Population, m 1,344

High net worth population, 000 562

High net worth population, chg. yoy -17.40%

High net worth population, World, m 11

China high net worth pop. as a % of total 5.1%

+9.6%+9.1%

+10.4%

+9.2%

+7.8% +7.8%

+0.0%

+2.0%

+4.0%

+6.0%

+8.0%

+10.0%

+12.0%

2008 2009 2010 2011 2012 2013E


7

As for the ongoing strategy of bringing more Chinese people from the countryside to urban areas, while directional growth slowed to 7.8% in 2012, disposable income per capita for urban residents continues to rise (albeit from a low base).

Chinese urban growth

Source: McKinsey

Urban residential disposable income continues to rise slightly ahead of real GDP.

Urban residential disposable income per capita (RMB)

Source: McKinsey, Bloomberg

According to the National Bureau of Statistics, Frost & Sullivan and the Harvard Business Review, the number of urban residents ought to increase from 691m (2012) to 1,094m by 2030.

Moreover, the number of cities which will have 80% of the population categorised as “middle class” has increased from 60 in 2008 to 340 as of 2012 and is expected to reach 550 by 2020.

Aspirational, mass affluent and wealthy – future demographics

If sustained luxury goods demand is predicated on a more affluent middle class, then Mckinsey’s estimates of 28% of Chinese households attaining mass affluence status (RMB100,000-200,000) by 2015 from 6% in 2010 (implied 5-year CAGR of

9.6%9.1%

10.4%

9.2%

7.8%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

2008 2009 2010 2011 2012

15,78117,175

19,109

23,979 24,565

0

5,000

10,000

15,000

20,000

25,000

30,000

2008 2009 2010 2011 2012


8

42%) should support mid-single digit to low double digit sales growth (assisted by price/mix and space growth) for luxury goods over the medium-to-long-term.

Mass affluence household projections (2010-15E)

Source: McKinsey Global Institute

We appreciate there are no official statistics on gift-giving for party political and business-related affairs. Suffice to say that Chinese watch distributors expect the current anti-gifting trend to continue into the second half of the year with optimists forecasting a bounce back in demand from H1 2014.

We believe that this may weigh on consumer sentiment, predicated on the expectation of an H2 recovery in prestige and luxury watches consumption. Chinese and Hong Kong export value comparisons toughen from May to August (the trough is in August at +13.3% and the peak is in June at +21.7%) before softening in September (-2.1%); hence we expect the ongoing volatility in Greater China to continue over the next 3-6 months.

Quality consumption growth rates by demographic

Source: McKinsey Global Institute

In the long term, growth projections for quality goods consumption are encouraging as the current Chinese leadership under Xi Jinping aims to stimulate

92%

68%

6%

28%

2% 4%

0%

20%

40%

60%

80%

100%

2010 2015E

Aspirational/ lowermiddle class (<100,000)

Mass affluent/ uppermiddle class (100,000-200,000)

Wealthy(>200,000)

households,m: 223 273 10-15 CAGR

+20%+42%

-2%

12% 4%

12% 22%

76% 74%

0%

20%

40%

60%

80%

100%

2010 2015E

Aspirational/ lowermiddle class (<100,000)

Mass affluent/ uppermiddle class (100,000-200,000)

Wealthy(>200,000)

Consumption*: ~80 ~180 10-15 CAGR

+17%

+33-6%


9

internal consumption at a time when export data remain soft.

According to Mckinsey Global Institute estimates, the mass affluent/middle class is expected to grow at the fastest rate (five-year CAGR of 33% to 2015) compared with wealthy five-year quality consumption CAGR of 17%.

We believe there is growing outperformance potential for companies with diversified brand portfolios with greater exposure to the mass affluent/middle classes such as adidas, Burberry, Coach, Hugo Boss and Swatch’s mid to high-end brands of Tissot, Rado and Longines etc.

Masstige brand winners We highlight current and prospective masstige winners below. Based on our recent field trip to Greater China, we noted adidas, Burberry and Swatch Group’s mid to high-end brands as outperformers.

In addition, niche prestige fashion and leather goods brands such as Hermès and Chanel appeared to outperform, as shown by recent Baidu internet search momentum. The list below is not exhaustive.

Moreover, we appreciate that brands such as Burberry have consolidated their position as more of a diffusion brand, having successfully traded the consumer up to more bespoke/tailored fashion and leather goods over the past few years. Prorsum catwalk now accounts for 5% of sales compared with 1% in 2009.

We note that in selected Asian stores such as Avenue store in Shanghai, the Prorsum proportion of sales is as high as 20% while the new 5,000 sq/ft store in Kobe, Japan has 30% of store sales exposure to Prorsum collections. This is positive in terms of generating a higher cash margin as well as driving up group sales densities and attachment rates.

Masstige current and prospective winners

Source: Berenberg estimates

Apparel & accessories Leather goods & footwear Jewellery Watches

Armani adidas Georg Jensen Baume & Mercier

Burberry Coccinelle Mauboussin Bell & Ross

Chloe Dunhill Pandora Ebel

Coach Furla Pomellato Certina

Diesel Kate Spade Swarovski Frederique Constant

Hugo Boss Mandarina duck Tiffany Hamilton

Lacoste Mulberry Damiani Longines

Lancel Nike Chow Tai Fook Mido

Longchamp Puma Calvin Klein Rado

Michael Kors Timberland Omega Raymond Weil

Miu Miu Churches Links Tag Heuer

Ralph Lauren Hogan Bijou Brigitte Tissot

Tory Burch Fay


10

Brand momentum as measured by Baidu searches

Interbrand measures brand momentum and ranks the top 100 global brands every year using its matrix of financial, demand and competitive analysis.

Interbrand brand score matrix

Source: Interbrand

Within the top 100 global luxury brands in 2012, Burberry showed the fastest brand value growth (+16% yoy), ahead of Hermès, Cartier, Gucci and Louis Vuitton. Prada was featured as a new entry in 2012 (84th).

Interbrand top 100 global luxury brands evolution (2010-12)

Source: Interbrand

We believe a way to measure brand momentum in Greater China is via Baidu internet brand search momentum. As of 2012, of the top 59 searches, Louis Vuitton scored the highest hit ratio (8.8%), followed by Chanel (6.8%), Gucci and Coach (5.2% and 4.9% respectively). Hard luxury local brand Chow Tai Fook registered in fifth place (4.9%) while Swatch Group’s mid to high-end Longines brand beat prestige watch brands to register in sixth place.

As of 2012, we estimate the search weighting for watches and jewellery was 49.2% compared with 45.8% for fashion and leather goods brands. Others accounted for 5.1%.

2012 2011 2010

Position Brand Value (US$m) chg. Position Brand Value (US$m) chg. Position Brand Value (US$m) chg.

Louis Vuitton 17 23,577 2% 18 23,172 6% 16 21,860 4%

Gucci 38 9,446 8% 39 8,763 5% 44 8,346 2%

Hermes 63 6,182 15% 66 5,356 12% 69 4,782 4%

Cartier 68 5,495 15% 70 4,781 18% 77 4,052 2%

Tiffany 70 5,159 15% 73 4,498 9% 76 4,127 3%

Burberry 82 4,342 16% 95 3,732 20% 100 3,110 0%

Prada 84 4,271 New


11

Baidu internet search top 59 brands, 2012

Source: Baidu, Berenberg

1 Louis Vuitton Fashion & Leather Goods 8.8%

2 Chanel Fashion & Leather Goods 6.8%

3 Gucci Fashion & Leather Goods 5.2%

4 COACH Fashion & Leather Goods 4.9%

5 Chow Tai Fook Watches & Jewellery 4.9%

6 Longines Watches & Jewellery 4.1%

7 Hermes Fashion & Leather Goods 4.1%

8 Prada Fashion & Leather Goods 4.1%

9 Cartier Watches & Jewellery 3.8%

10 Armani Fashion & Leather Goods 3.7%

11 Tiffany Watches & Jewellery 3.4%

12 Omega Watches & Jewellery 3.0%

13 Dior Fashion & Leather Goods 2.9%

14 Patek Philippe Watches & Jewellery 2.3%

15 Rolex Watches & Jewellery 2.1%

16 Chow Sang Sang Watches & Jewellery 2.1%

17 Burberry Fashion & Leather Goods 2.0%

18 Versace Fashion & Leather Goods 1.8%

19 Vacheron Constantin Watches & Jewellery 1.8%

20 Montblanc Watches & Jewellery 1.3%

21 Celine Fashion & Leather Goods 1.3%

22 Bulgari Watches & Jewellery 1.3%

23 MiuMiu Fashion & Leather Goods 1.3%

24 Ferragamo Fashion & Leather Goods 1.2%

25 YSL Fashion & Leather Goods 1.2%

26 Marc Jacobs Fashion & Leather Goods 1.2%

27 Roger Dubuis Watches & Jewellery 1.2%

28 Rado Watches & Jewellery 1.1%

29 Chloe Fashion & Leather Goods 1.1%

30 DKNY Fashion & Leather Goods 1.0%

31 Piaget Watches & Jewellery 1.0%

32 IWC Watches & Jewellery 1.0%

33 Hugo Boss Fashion & Leather Goods 0.9%

34 Ralph Lauren Fashion & Leather Goods 0.9%

35 Parker Other 0.9%

36 Tag Heuer Watches & Jewellery 0.9%

37 Van Cleef & Arpels Watches & Jewellery 0.9%

38 Dunhill Fashion & Leather Goods 0.9%

39 Balenciaga Fashion & Leather Goods 0.9%

40 Jaeger-LeCoultre Watches & Jewellery 0.9%

41 Fendi Fashion & Leather Goods 0.7%

42 Panerai Watches & Jewellery 0.7%

43 Loewe Fashion & Leather Goods 0.7%

44 Zegna Fashion & Leather Goods 0.6%

45 Aurora Watches & Jewellery 0.6%

46 Dupont Other 0.5%

47 Paul Smith Fashion & Leather Goods 0.5%

48 Lancel Fashion & Leather Goods 0.4%

49 Breitling Watches & Jewellery 0.3%

50 Dolce & Gabbana Fashion & Leather Goods 0.2%

51 Breguet Watches & Jewellery 0.2%

52 Zenith Watches & Jewellery 0.2%

53 Harry Winston Watches & Jewellery 0.2%

54 Graff Watches & Jewellery 0.1%

55 Tudor Watches & Jewellery 0.0%

56 Audemars Piguet Watches & Jewellery 0.0%

57 de Beers Watches & Jewellery 0.0%

58 Forevermark Watches & Jewellery 0.0%

59 Chopin Watches & Jewellery 0.0%


12

Category splits as a percentage of total searches


We outline key brand movers so far in 2013 against the average number of luxury goods searches in order to evaluate which brands are gaining and which are losing search momentum.

We highlight the Louis Vuitton brand as having continued to decline relative to the total number of searches. We acknowledge that Louis Vuitton lost its first-mover advantage in the region years ago (it first moved into Greater China in 1992) and it has consistently ranked as the most sought-after/searched-for brand.

As the store strategy changes (fewer new openings in favour of improving conversion and productivity in existing stores), so we believe that the Louis Vuitton brand will lose some momentum over the short term.

However, as the brand gradually continues to change the price/mix offering, we believe that the ultimate result, assuming Louis Vuitton is successful, will be a more tightly managed, exclusive and cash-generative brand.

Louis Vuitton search momentum under pressure Prada continues to trend above average


49.2%

45.8%

5.1%

Watches & Jewellery Fashion & Leather Goods Other

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average number of searches LV search evolution

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13

Chanel trending above the average search rate Gucci is underperforming vs. average searches


Hermes trending above the average search rate Coach brand search rates have improved


Cartier trending below the average search rate Swatch’s Longines brand search momentum


Tiffany trending below the average search rate Chow Tai Fook brand search momentum


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average number of searches Gucci

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14

Projected Chinese city GDP evolution

Mainland China – key cities as of 2012

Source: Essilor presentation, November 2012

Mainland China – key cities as of 2020

Source: Essilor presentation, November 2012


15

Key company takeaways

Having visited retail operations for adidas, Burberry and Swatch among others we set out our key local findings in this section. We place these observations within a broader company context in the specific company sections. We appreciate that these are snapshots only and not necessarily reflective of the companies’ performance across all regions.

adidas Group

We note that retail sales as a percentage of Greater Chinese sales are low at 15.4% as of FY 2012. adidas distributed through 7,500 POS in the region (FY 2012) with the NEO brand now selling through 1,000 POS. Greater China is one of three “attack markets” for the group (Russia/CIS and North America being the other two).

We expect Greater Chinese retail sales to reach c20% of total Greater China sales over the next 12-18 months. Initial takeaways are that the adidas brand continues to take market share from key rivals such as Nike in the region. adidas brand footwear is priced very low compared with main competitors and relative to European pricing. We view this as a straightforward strategy to aggressively take market share in the short-to-medium term, while improving the price/mix steadily over time.

Interestingly, the Sport Performance versus Lifestyle split for the adidas brand in Shanghai and Hong Kong was 55/45 in FY 2012 compared with 72/28 on a group-wide basis. We flagged the opportunity to tweak down Performance to c65% over next few years, which could lead to at least 200-300bp incremental gross margin within the mix.

We acknowledge that diluting performance too much is a risk as sporting goods companies use performance product as a platform to launch more profitable lifestyle products. Moreover, consumers identify the brand more through performance than lifestyle so too heavy a weighting for lifestyle runs the risk of diluting brand identity and consumer loyalty (Puma is a case in point).

Shanghai SLT, Brand Centre, No 691 Middle Huaihau Road The store has selling space of 1,280m over five floors; 2012 was the first year of

trading with CNY51m of sales.

Sales so far in 2013 (up to 3 June) are trending 6% up against a budget of +10% although we note the 20% decline in footfall due to the recent opening of the K11 mall nearby.

The store’s sales performance since the opening of K11 is impressive on a relative basis (C&A -15%, H&M -10%, Nike down mid single digits).

The opening of the Nike store last August has not affected adidas sales as Nike is perceived as a pure sport brand in Shanghai whereas adidas is seen as offering sport performance and lifestyle products.

adidas brand Sport Performance and Lifestyle product weightings are currently 50/50. This points to a material regional mix uplift from Lifestyle compared to the group as a whole (72/28 split). This is clearly positive for gross margin/mix as we estimate that Sport Performance product gross margins are between 500bp and 1,500bp lower than Lifestyle’s.


16

The store takes deliveries on a daily basis with automatic replenishment coupled with some manual stock adjustments. A big project for the store manager this year is to renovate the stock room.

Decisions on local advertising and promotional activity are typically taken centrally although the store manager can raise manual requests and ask that specific products be marked down if they are not selling well after a month; we noted a keen emphasis on stock management.

The store manager meets with regional HQ staff several times a week.

NEO brand sales are very encouraging at +500% versus space growth of +450%; Chinese NEO products are seen locally as fashionable.

After three months, Lifestyle products can be discounted. NEO has higher margins and tend not to be discounted at the same pace as other Lifestyle products.

Stock levels were described as normal with stock turning c6x pa in store. This compares with adidas Group stock turn of above 3x in FY 2012.

Store staff attrition rates were 98% last year (new store), as is common in the retail sector. The store has 73 employees of whom c60% are not from Shanghai. adidas Group offers staff a complete training programme and sales people are paid on a fixed basis plus performance (70% of pay is discretionary); the average age of sales staff is 23. The average working week is just over 40 hours and staff scheduling is aligned with store traffic (2pm to 6pm is peak traffic time). Average pay is CNY40K pa.

The ASP in store has decreased by c10% yoy although this was planned as the NEO brand has replaced higher-ticket Porsche Design and Y3 brands on the fourth floor. Sales conversion rates have improved by over 25% yoy as the fourth floor now accounts for c12% of store sales compared with 8% previously.

Female-directed product launches and higher-margin Stella McCartney lines are selling very well, partly due to a softer comparison base but also due to the improved price mix.

The top three performance categories are football, basketball and training.

China adidas retail will be focusing more on football and basketball from late this year into 2014, which appears to us to be strategically sound given the World Cup finals in Brazil from July next year.

Hankow Road, Hong Kong The store opened in 2006. Net sales year to date are up 21%, which compares

favourably to the 10% increase budgeted for.

Space allocation in store is two thirds Sport Performance, one third Lifestyle; on a product-weighted basis, the sales split is 60/40;

Management is looking to build up the NEO and Stella McCartney brands in particular where adidas enjoys higher gross margin. The customer base is centred on mainland Chinese buyers but pricing is lower as there is no VAT and FX delta. Prices are invariably 30% lower in Hong Kong compared with the mainland.

Stock levels are well managed and running in line with the group average at around -2% yoy on a currency-neutral basis.

Average selling prices are up mid to high single digits yoy.


17

Conversion rates have improved yoy from 10% to 12%.

The store sold more than 170 pairs of Boost shoes in one week; we note that Hong Kong and Shanghai stores appear to have been receiving Boost stock since late February.

The store sells Stella McCartney apparel but does not stock the SM Boost, unlike the Shanghai store.

Average net sales for the first five months in store were HKD10.5m/month. May sales were strongly boosted by NEO (recently introduced to the store).

Hankow Road sales account for c40% of adidas and Reebok Hong Kong retail sales (Hong Kong is c30% of retail sales for Greater China).

The store’s annual sales target is HKD9.7m.

The store is seeing strong rent inflation this year (c500bp) as rental costs are more turnover-linked than fixed. Expectations are for rent inflation to continue in 2014 but at a lower pace (c200bp).

Despite the rent increase, we estimate that the Hankow Road store has an EBIT margin of over 30%.

We outline product and male/female sales splits below.

Sport Performance vs. Lifestyle sales weighting Male vs. female sales split


Performance, Lifestyle, NEO (%) Apparel vs. Footwear sales split


60%

40%

Performance Lifestyle

60%

40%

Male Female

20%

64%

16%

Performance Originals Neo

57%

43%

Apparel Footwear


18

Burberry

We spent time visiting Burberry mainline and flagship stores in Shanghai and Hong Kong. Our first impression was that our current sales estimates for Burberry Mainland China were too low. We have therefore revised up our estimates in order to factor double-digit reported sales growth every year for the next four years.

Burberry is in the process of right-sizing the Chinese operations it took back in September 2010 (50 stores) and in some cases relocating to malls with a higher average sales footprint in order to maximise the space with the appropriate mix. Shanghai is the focus for Burberry this year with a large flagship store due to open in late June on Nanjing Road (8,000-9,000 sq/ft). By the end of 2013, Burberry ought to be operating out of 8-9 stores in Shanghai (with three flagship stores).

As Burberry adjusts its Chinese store footprint, we expect average mainline store sizes to increase by more than 10% to just under 3,000 sq/ft.

Anecdotally, Prorsum sales as a percentage of total sales range from 20% at Shanghai to just over 30% in Kobe, which is a clear indication that Burberry is having success in trading consumers up through its price/mix architecture. We appreciate that Prorsum’s gross margin is lower than that for the London and Brit collections (Brit has the highest gross margin) but the cash margin is the highest given the materially higher ASP for Prorsum.

Our Mainland China sales estimates factor a three-year 22% sales CAGR to just under £400m by FY 2016 and assume a Chinese sales sq/ft CAGR of c9% over the same period to £1,831 sq/ft – ahead of our Retail Group estimates.

China sales, EBIT and sales sq/ft estimates

China Pre transfer

(2009) FY11E FY12E FY13E FY14E FY15E FY16E

Revenue 75 129 179 218 269 327 397

reported growth %

50.0% 38.7% 21.6% 23.4% 21.5% 21.6%

currency impact %

5.0% 2.0% 1.2% 0.0% 0.0% 0.0%

lfl sales %

30.0% 25.0% 11.0% 10.0% 10.0% 10.0%

space %

15.0% 11.7% 9.4% 13.4% 11.5% 11.6%

EBIT 14 25 35 43 53 65 83

EBIT margin 18.7% 19.0% 19.3% 19.5% 19.8% 20.0% 21.0%

Stores 50 57 63 69 75 83 93

Mainline 13 20 24 28 31 36 41

Concession 30 33 34 36 38 40 45

Space ('000 sq ft)

126 141 154 175 195 217

China sales sq/ft

1,027

1,275

1,417

1,542

1,680 1,831

Purchase price 65 Sales multiple 0.87x 0.50x 0.36x 0.30x 0.24x 0.20x 0.16x

EBIT multiple 4.64x 2.64x 1.88x 1.53x 1.22x 0.99x 0.78x



19

Chinese sales sq/ft vs. Hong Kong and Retail Group estimates

FY11E FY12E FY13E FY14E FY15E FY16E

Hong Kong sales sq/ft 2,139 2,593 2,950 3,237 3,387 3,544

China sales sq/ft 1,027 1,275 1,417 1,542 1,680 1,831

Group Retail sales sq/ft 962 1,270 1,417 1,551 1,675 1,809


On a group-wide basis, we estimate Burberry three-year sales and EPS CAGR of 8.7% and 9.3% respectively. This may prove conservative as we expect Burberry standalone/JV Japanese stores coupled with an improving Beauty business to more than offset the Japanese licence termination impact due by June 2015 – see our separate note Smelling of roses?.

Shanghai, L’ Avenue

The store size is 10,760 sq/ft with the lease to be renewed in a few years on a fixed cost plus turnover basis.

The store has a prime (corner) location inside the mall and Burberry pays rent to LVMH, which owns the mall.

Previously in the western part of Shanghai, there was little luxury accessibility for consumers.

Shanghai has the highest ATV (average transaction value) in Mainland China and sales sq/ft are running at well over £2,000 on our estimates.

Prorsum (less check, more refined products with “solid leather”) sales are c20% of store sales, well above the group average of 5%.

More women are starting to shop in the store with an estimated sales split of 60/40 female to male shoppers.

Monthly flow is fully utilised across the store to great effect as Chinese consumers enjoy newness in store on a regular basis. Chinese consumers understand the British heritage behind the brand, which provides a unique selling point compared with French and Italian competitors.

Solid leather sales are c60% of store sales compared with 35-40% for the group on average. Hence we see more scope to improve the mix over the short-to-medium term.

Replenishment is daily and replenishment rates are higher for bags/non-apparel at c50% compared with apparel at 35% (10ppt lower than the group average).

Online/global theatre is a draw for Chinese consumers. Roughly half of the collection offered online will be in store. While online stocks are still based in Europe, by the end of this year stocks will move to Hong Kong, which should reduce distribution-related costs.

The art of the trench has yet to be properly marketed and exploited in Shanghai.

The store manager believed that Burberry was taking market share from Louis Vuitton, Prada and Zegna. We note that Burberry’s market size is small in China at just over €200m compared with Louis Vuitton at c€1bn.

Across Mainland China, there is an expectation that store sizes will increase as Burberry focuses on upgrading Beijing stores next year. The initial focus is on eight cities although up to 20 cities in China have been alluded to for potential development.


20

Opportunities exist to increase the ATV in stores; it is currently approximately one third of Louis Vuitton’s. Burberry prices were estimated at c40% higher than London – our sample pricing comparison revealed an average price delta of 66%, albeit skewed by the mid-length metallic leather sleeve trench which was 103% more expensive in sterling terms in Shanghai.


21

Sporting, Fashion & Leather goods pricing comparison

Brand pricing in Mainland China vs. local prices

Brand Product Price diff.

Louis Vuitton Neverfull personalised small, monogram +36.2%

Louis Vuitton Neverfull* +25.4%

Louis Vuitton Speedy 40* +86.4%

Louis Vuitton Noe BB* +31.0%

Louis Vuitton Kepall 45 Bandouliere +30.9%

Hermes Etriviere, canvas bag +27.9%

Hermes Evelyne III +30.1%

Hermes Silk tie +34.9%

Hermes Mini chaine d'ancre cufflinks +29.8%

Hermes Ashtray +30.1%

Prada Zipped wallet +34.1%

adidas Boost -1.9%

adidas McCartney boost -12.9%

adidas ZX 750 -4.2%

adidas Logo tee flow shirt +12.1%

adidas Run Parka McCartney +17.8%

adidas neo T shirt +22.3%

adidas Trefoil tee +55.3%

Burberry Mid-length metallic leather sleeves trench* +102.5%

Burberry Small blaze in check and leather bag +39.1%

Burberry Textured patent detail trench coat * +85.6%

Burberry Python leather pumps * +54.2%

Burberry Medium metallic leather tote bag +50.4%

Nike free 4.0 +42.1%

Nike Mercurial Ronaldo +48.6%

Source: Berenberg estimates * FX adjusted


22

Chinese watch distributor feedback

Our feedback incorporates meetings with senior management (CFO or above) for Hengdeli, Oriental and Emperor Watch & Jewellery Limited and store manager feedback for specific brands where appropriate. Our key observations were as follows.

Mainland Chinese prestige watch demand remains under pressure with no bounce back in demand expected until at least H1 2014.

Watches priced at CHF50,000 and above are most adversely affected.

Mass affluent brands such as Rado, Tissot, Longines, Balmain and Certina continue to outperform peers.

The reduction of 60% over ten years in the import tax for luxury Swiss watches on the mainland is likely to result in a moderate price reduction of c1%. We do not expect watch manufacturers such as Swatch and Richemont to lower prices, which in our view, will most likely result in distributors having to absorb the majority (if not all) of the pricing impact.

Rental cost pressure remains a drag on profitability, most notably in Hong Kong. For example, incremental costs clearly affected Oriental H1 2013 rental and wage costs. Rent moved from 5.5% to 7.4% of sales with wages rising to 4.1% from 3.8%. In order to manage the rent and labour costs, Oriental cut its advertising and promotion budget to 0.5% of sales (H1 2013) compared with 0.7% of sales twelve months ago.

We highlight the theoretical price impact on the back of the 60% (progressive) reduction in Swiss made luxury watch import taxes for Mainland China (note Hong Kong is exempt and that on average, watch prices in Hong Kong are 25-30% cheaper than in Mainland China).

Price difference vs. HK listed price

China +25-30%

Singapore +5-10%

Japan +20-25%

Korea +10-15%

Taiwan +3-5%

Thailand +3-5%

Source: Emperor Watch & Jewellery Limited

Progressive tax reduction impact (year 1)

Taxes 1) Import tax* 11%

2) Luxury tax 20%

3) VAT 17%

Import tax chg. in Y1 -18%

Import tax in Y1 9.0%

Import tax chg. after Y1 -5%

Watch theoretical price Pre-tax 100

post tax 132.5

Import tax pre-change 5.5

Import tax post change 4.5

New post tax 131.5

Diff. retail price old vs. new tax -0.7% Source: Berenberg estimates * Import tax is calculated on the import value, we assume the import value is 50% of the retail price


23

Hengdeli

Chinese consumer sentiment and appetite for luxury and prestige watches were described by CFO Cathy Li as “very uncertain”. While prospects for increased quality goods consumption, mass affluence and urbanisation remain core underlying medium to long-term trends, the crackdown on gift-giving continues to weigh on consumer demand for prestige watches.

Hengdeli operates out of three different store types: Elegant stores, which distribute prestige brands with an average selling price (ASP) of CHF50,000; Prime Time stores, which are geared towards the growing affluent middle class and have an ASP of CHF15,000; and Time stores, which serve the entry market with an ASP of CHF5,000.

Swatch brand presence (as the key watch supplier and partner with Hengdeli) in Hong Kong is less than 25% as its more diversified portfolio with mid to high end (excluding luxury and prestige) brands such as Rado, Tissot and Longines are more suited to the Mainland Chinese market. We estimate that Swatch brands account for more than 50% of Hengdeli Mainland Chinese sales. Expectations are for the watch market priced below CHF3,000 to grow at a faster rate on the mainland.

Best-selling prestige brands such as Omega, Cartier and Rolex appear to be suffering in Mainland China. We understand that Cartier watch sales are trending down c30% compared with Rolex at -25% and Omega at -10% to -12% (we note that CEO Nick Hayek referred to Omega sales trending down c6% in the region during the first four months of 2013). Hengdeli’s management does not expect a recovery until midway through 2014.

Brands described as having the biggest bottlenecks were prestige brands while mid to high-end inventory remains well managed as brands such as Tissot record c30% growth yoy year to date. Hengdeli has deliberately built up stock commitments for Swatch Group mid to high-end brands as its growth strategy is centred around increasing its mid to high-end brand footprint in China and Hong Kong.

There appears to be a growing trend for Chinese consumers to opt for mechanical movement watches as opposed to quartz. Five years ago, CFO Li highlighted that up to 70% of Chinese consumers were “status purchasers” whereas today the weighting is c50%.


24

Management estimates that c30% of prestige watch related demand is tied to gift-giving, which remains subdued. As part of the decline in prestige demand, the channel is over-stocked currently with watch distributors being able to offer the upper-ends of watch supplier historical discounting bands (c10%).

Gross margin is expected to trend lower for Hengdeli in 2013, partly a result of an increased discounting strategy especially for prestige brands and a lack of price increases (watch manufacturers such as Richemont, LVMH and Swatch increased prices twice in 2011 followed by price rises of 8-12% in 2012). Now that the market is more subdued, price rises have been considerably more muted across brands.

Inventory turnover days were described as being manageable despite exceeding 2009 peak levels at 197. Moreover, Hengdeli management reiterated the view that it believed the company was in the best stock position relative to peers such as Emperor Watch & Jewellery and Oriental Watches.

Anecdotally, we note that Chow Tai Fook watch sales declined by 18% during the second half of 2012 coupled with an inventory rise of 17% (Chow Tai Fook recently signed a distribution agreement with Richemont’s brand, Baume & Mercier).

Oriental Watch Holdings Limited

We met with CFO Alain Lam at Oriental’s Hong Kong headquarters. He updated us in particular on Rolex sales trends in Greater China. Oriental remains Rolex’s largest Greater Chinese distributor (70% of Oriental sales are Rolex).

General comments were made on the regional volatility with Hong Kong and Macau faring better than Mainland China, where Mr Lam believed weak consumer confidence was the root cause for reduced spending rather than the slowdown in gift giving, which he expected to reverse in 2014.

The mid market, characterised by mid to high end watch consumption, continues to outperform while demand for prestige watches in Macau remains robust. We highlight regional same-store sales growth for Oriental to May 2013 below.

Oriental Watch Holdings Limited regional trading evolution to May 2013

Source: Oriental Watch Holdings Limited

-40%

-30%

-20%

-10%

+0%

+10%

+20%

+30%

Ap

r-1

2

May

-12

Jun

-12

Jul-

12

Au

g-1

2

Sep

-12

Oct

-12

No

v-1

2

Dec

-12

Jan

-13

Feb

-13

Mar

-13

Ap

r-1

3

May

-13

Hong Kong Macau China


25

The general trend appears one of slow recovery although we note Mainland Chinese same-store sales declined by 6% on a -6% comparison last year. In other words, there is no real sign of a rebound in consumption.

Macau and Hong Kong sales have improved but we note that the two-month average comparison base (April-May: -10%) toughens by 500bp to -5% for June-July. Similarly, for Macau, the two-month average comparison for April-May was -21% compared with June-July at -7%.

Anecdotally, when speaking with all major Chinese watch distributors, demand in Macau has remained relatively resilient. We noted during our visit to the Cotai gaming strip multiple local stores selling racks of differentiated prestige brands from Rolex to Patek Philippe.

New watches were displayed next to second-hand watches and colour coded to indicate to the prospective buyer whether the watch was new or second-hand. The style of distribution and flexibility around discounting is likely in our view to be disconcerting for Chinese watch distributors and watch manufacturers with directly owned stores aiming to control distribution, brand equity and – most important of all – pricing power.

On balance, mid to high-end brands such as Rado, Tissot and Longines continue to outperform compared with prestige brands. We note that the flagship Rolex store in Shanghai on the Bund is loss-making with rental costs of CNY1m per month exceeding monthly revenue. Oriental almost views the investment as an advertising and promotional cost aimed at driving traffic into Hong Kong stores.

Emperor Watch & Jewellery Limited

We met with Bryan Wong, the group’s managing director and Anna Luk, director of investor relations at Emperor’s Hong Kong headquarters. Emperor is the most exposed of the three watch distributors to prestige watches. Emperor also has its own jewellery business focused on jade and diamonds; this has a gross margin range of 35-40% compared with 2012 group gross margin of 26% (-280bp yoy). We estimate a 2012 watch gross margin of c22%. Internal expectations are for the jewellery operations to account for c22% of group sales in 2013 compared with 19% in 2012.

Emperor has an extensive watch brand mix (23 brands in Hong Kong and Macau, 34 brands in Mainland China and three brands in Singapore). We highlight below Emperor’s three-year watches and jewellery ASP evolution from 2010 to 2012 and note a three-year watch ASP CAGR of 8.1% to HKD70,963 (number of units increased by 6.8% over the same period). This compares with Emperor’s jewellery three-year ASP CAGR of -18.3%, although the number of goods sold has increased by c52% over the same period.

Emperor ASP evolution 2010-12 for watches and jewellery

ASP

FY10 FY11 FY12

Watches # of goods sold 61,584 74,373 74,969

ASP (HKD) 56,200 64,970 70,963

Jewellery # of goods sold 25,612 63,489 89,789

ASP (HKD) 24,754 16,223 13,487


Management remains bullish over medium to long-term trends including increased levels of tourism (inter-Asia and from overseas), which ought to continue to drive incremental footfall and sales. We highlight the growth in Mainland Chinese travellers visiting Hong Kong between 2008 and 2012.


26

Mainland Chinese visitor evolution to Hong Kong 2008-12


However, in the short term management does not anticipate an upturn in Mainland Chinese prestige watch consumption until the first half of 2014 at the earliest. Margins are likely to remain under pressure on the back of higher rental costs – in some cases rents have doubled or tripled over the past few years (rents consist of a fixed cost element but the variable element, being turnover-linked, can be as much as 70% of the overall rental uplift evaluation). Given weaker demand so far in 2013, expectations are for rent-related costs to stabilise in 2014.

We understand that four prestige brands raised prices in April in Hong Kong and Macau: Cartier, Panerai, J-LeCoultre and Lange & Sohne. All are Richemont brands.

In terms of regional performance, Mainland China remains weak with no sign of improvement. Hong Kong sales were described as “ok” although profitability continues to be affected by higher rent and salary-related costs.

Emperor is more insulated than other watch distributors as it owns the bulk of its real estate. However, in 2012, rental costs as a percentage of sales increased from 6.8% to 9.35%. In 2013, approximately one third of the store portfolio has experienced over a 20% increase – suggesting that Emperor requires a same-store-sales growth run rate of at least 6% in order to offset the rise in rental costs.

Macau trading appeared to be trending up high single digits year to date (c8%).

Watches inventory on average was estimated at 150 turnover days (120 turnover days for Cartier and Rolex) although the expectation is that stock levels for prestige brands will inevitably increase throughout 2013.

As regards demand elasticity on pricing, this remains a sensitive subject dating back from 2011 when watch manufactures raised prices by 100-200% in one year compared to the historical annual price increase of 5-8%. For Emperor, we understand that up to 75% of its watches business is exposed to the HKD300,000 and above price point, where demand has come to a halt in Mainland China and is moving slowly in Hong Kong.

Assessing inventory levels correlated with Swiss watch exports

There remains much debate and concern around stock builds in Asia and Europe. Below, we compare and contrast Swatch Group, Richemont, Hengdeli and Emperor inventory levels and breakdown. We compare the run rate of semi-finished, finished and work in progress stock versus Swiss watch export growth

16,862,003 17,956,731

22,684,388

28,100,129

34,911,395

57%61%

63%

67%

72%

55%

60%

65%

70%

75%

80%

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

2008 2009 2010 2011 2012

Visitors from mainland China

% of mainland visitors arrivals to HK


27

from 2008.

Interestingly, all watch players appear to be taking a firmer grip on inventory control judging by the downward moves to work in progress. This indicates future capacity levels based on real-time consumption.

Swatch has cut back its WIP but finished goods remain high vs. Swiss watch exports

Richemont inventory position appears worse than Swatch though we note the larger DOS mix

Source: Company data . Data are calendarised.

Hengdeli WIP reflects Swatch Emperor appears to be controlling its stock well

Source: Company data. Data are calendarised.

-80%

-60%

-40%

-20%

+0%

+20%

+40%

+60%

+80%

+100%

2006 2007 2008 2009 2010 2011 2012

Swiss watch exports Raw materials

Work in progress Semi-finished goods

Finished goods

-30%

-20%

-10%

0%

10%

20%

30%

40%

CY06 CY07 CY08 CY09 CY10 CY11 CY12

Raw materials and work in progress

Finished goods

Swiss watch exports

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

CY06 CY07 CY08 CY09 CY10 CY11 CY12

Raw materials Work in progress

Finished goods Swiss watch exports

-50%

0%

50%

100%

150%

200%

250%

FY06 FY07 FY08 FY09 FY10 FY11 FY12

Goods held for sale Raw materials Swiss watch exports


28

Watch price comparisons – Mainland China vs. local FX

Brand pricing in Mainland China vs. local prices (FX adjusted)

Brand Product Price diff.

Breguet Classique, 5207, yellow gold +22.0%

Breguet Classique, 5207, white gold +22.0%

Breguet Tourbillon Messidor +33.5%

Breguet Classique 3330, yellow gold +22.5%

Breguet Tradition 7037, yellow gold +21.7%

Breguet Tradition 7037, white gold +21.9%

Breguet Tradition 7027, white gold +19.0%

Breguet Marine Tourbillon +33.5%

Breguet Hora Mundi +22.2%

Blancpain 500 Fathoms GMT +24.7%

Blancpain Fifty Fathoms Automatic +24.3%

Blancpain Villeret perpetual calendar +24.6%

Blancpain Villeret running equation of time +22.4%

Blancpain L-evolution 8 day complete calendar +24.8%

Cartier Ronde Louis Cartier white gold/ diamonds +16.7%

Cartier Ronde Louis Cartier white gold/ diamonds +16.6%

Omega Speedmaster Moonwatch +24.4%

Omega Speedmaster red gold +20.7%

Rolex Daytona steel +22.9%

Rolex Daytona yellow gold +13.4%

Rolex Daytona white gold +20.5%



29

China – macro and industry data

Country profile – Mainland China

Source: Berenberg estimates, WTO, World Bank, Capgemini


Population, m 1,344


High net worth population, chg. yoy -17.40%



Country profile - Hong Kong


Population, m 7


High net worth population, chg. yoy 5.20%



Country profile - Macau


Population, m 1

Macau 2012 gaming revenue U$D38bn +13.5% yoy

2012 visitors 28m, +0.3% yoy

China, Hong Kong & Taiwan 2012 visitors 25m

Overnight visitors 2012 13m, +5% yoy


30

China – demographic data

China – Urban middle class residents China – Urban population by city tier

Source: 2011 Blue Book of Cities in China, Essilor, Berenberg research

China – Urban population vs. disposable income

Source: 2011 Blue Book of Cities in China, Essilor, Berenberg research

Asia – Projected population growth rates, 1950-2030

Source: UN, Berenberg research

37%

45%50% 52%

0%

10%

20%

30%

40%

50%

60%

2009 2019 2023 2025

Esitimated percentage of middle-class residents in China's urbanpopulation

City Tier City no. Urban population, m

Tier I 4 45

Tier II 23 97

Tier III 260 190

Tier IV 367 113

Tier V 1,636 162

Total 2,290 607

300

550

800

0

5,000

10,000

15,000

20,000

25,000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Urban population Per capita disposable income of urban households

19.7 19.319.9

24.723.0

19.6 19.5 19.316.6

14.212.2

11.2 10.28.8

7.36.0

5.0

10.0

15.0

20.0

25.0

30.0

195

0-1955

195

5-1960

196

0-1965

196

5-1970

197

0-1975

197

5-1980

198

0-1985

198

5-1990

199

0-1995

199

5-2000

200

0-2005

2005-2010

201

0-2015

201

5-2020

2020-2025

202

5-2030

ASIA


31

Greater China – Macro indicators

China – Cargo at major seaports, 2004-13 China – Chinese total trade, 2004-13

China – Chinese freight volumes, 2004-13 China – Macro composite lead indicator

China – NBS PMI manufacturing, 2008-13 China – Real estate floor space started, 2004-13

China – New loans 2007-13 China – Consumer expectation index, 2003-13

Source: Datastream, Berenberg research

-10.0%-5.0%0.0%5.0%

10.0%15.0%20.0%25.0%30.0%35.0%

May

-04

Sep

-04

Jan-0

5M

ay-0

5S

ep-0

5Jan

-06

May

-06

Sep

-06

Jan-07

May

-07

Sep

-07

Jan-0

8M

ay-0

8S

ep-0

8Jan

-09

May

-09

Sep

-09

Jan-1

0M

ay-1

0S

ep-1

0Jan

-11

May

-11

Sep

-11Jan

-12

May

-12

Sep

-12

Jan-1

3

Chinese cargo handled at major seaports (vol Y/Y)

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

May-0

4

Se

p-0

4

Ja

n-0

5

May-0

5

Se

p-0

5

Ja

n-0

6

May-0

6

Se

p-0

6

Ja

n-0

7

May-0

7

Se

p-0

7

Ja

n-0

8

May-0

8

Se

p-0

8

Ja

n-0

9

May-0

9

Se

p-0

9

Ja

n-1

0

May-1

0

Se

p-1

0

Ja

n-1

1

May-1

1

Se

p-1

1

Ja

n-1

2

May-1

2

Se

p-1

2

Ja

n-1

3

Chinese total trade Y/Y

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

May

-04

Sep

-04

Jan-0

5M

ay-0

5S

ep-0

5Jan

-06

May

-06

Sep

-06

Jan-0

7M

ay-0

7S

ep-0

7Jan

-08

May

-08

Sep

-08

Jan-0

9M

ay-0

9S

ep-0

9Jan

-10

May

-10

Sep

-10

Jan-1

1M

ay-1

1S

ep-1

1Jan

-12

May

-12

Sep

-12

Jan-1

3

Chinese freight vols Y/Y

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

No

v-03

May

-04

No

v-04

May

-05

No

v-05

May

-06

No

v-06

May

-07

No

v-07

May

-08

No

v-08

May

-09

No

v-09

May

-10

No

v-10

May

-11

No

v-11

May

-12

No

v-12

-60.0%

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

Ap

r-08

Au

g-0

8

Dec-0

8

Ap

r-09

Au

g-0

9

Dec-0

9

Ap

r-10

Au

g-10

Dec-1

0

Ap

r-11

Au

g-1

1

Dec-1

1

Ap

r-12

Au

g-1

2

Dec-1

2

Ap

r-13

-30.0%-20.0%-10.0%

0.0%10.0%20.0%30.0%40.0%50.0%60.0%70.0%80.0%

May

-04

Au

g-0

4N

ov

-04

Feb

-05

May

-05

Au

g-0

5N

ov

-05

Feb

-06

May

-06

Au

g-0

6N

ov

-06

Feb

-07

May

-07

Au

g-0

7N

ov

-07

Feb

-08

May

-08

Au

g-0

8N

ov

-08

Feb

-09

May

-09

Au

g-0

9N

ov

-09

Feb

-10

May

-10

Au

g-1

0N

ov

-10

Feb

-11

May

-11

Au

g-1

1N

ov

-11

Feb

-12

May

-12

Au

g-1

2N

ov

-12

Feb

-13

0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0

1,600.0

1,800.0

Dec

-07

Ap

r-0

8

Au

g-0

8

Dec

-08

Ap

r-0

9

Au

g-0

9

Dec

-09

Ap

r-1

0

Au

g-1

0

Dec

-10

Ap

r-1

1

Au

g-1

1

Dec

-11

Ap

r-1

2

Au

g-1

2

Dec

-12

Ap

r-1

3

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

No

v-0

3F

eb-0

4M

ay-0

4A

ug

-04

No

v-0

4F

eb-0

5M

ay-0

5A

ug

-05

No

v-0

5F

eb-0

6M

ay-0

6A

ug

-06

No

v-0

6F

eb-0

7M

ay-0

7A

ug

-07

No

v-0

7F

eb-0

8M

ay-0

8A

ug

-08

No

v-0

8F

eb-0

9M

ay-0

9A

ug

-09

No

v-0

9F

eb-1

0M

ay-1

0A

ug

-10

No

v-1

0F

eb-1

1M

ay-1

1A

ug

-11

No

v-1

1F

eb-1

2M

ay-1

2A

ug

-12

No

v-1

2F

eb-1

3


32

Greater China – selected data

China – Retail sales gold, silver & jewellery China – Retail sales gold, silver & jewel., value yoy change

HK – Retail sales gold, silver & jewellery, value HK – Retail sales gold, silver & jewellery, value yoy change

HK – Visitor arrivals from China (1000s) HK – Visitor arrivals from China, yoy change

Macau – Gross gaming revenues (USDm) Macau – Gross gaming revenues, yoy change

Source: Bloomberg, Berenberg research

0

5

10

15

20

25

30

35

Ap

r 00

No

v 0

0

Jun

01

Jan

02

Au

g 0

2

Mar

03

Oct

03

May

04

Dec

04

Jul

05

Feb

06

Sep

06

Ap

r 07

No

v 0

7

Jun

08

Jan

09

Au

g 0

9

Mar

10

Oct

10

May

11

Dec

11

Jul

12

Feb

13

China retail sales gold, silver & jewellery

-30

-20

-10

0

10

20

30

40

50

60

70

80

Ap

r 00

Oct

00

Ap

r 01

Oct

01

Ap

r 02

Oct

02

Ap

r 03

Oct

03

Ap

r 04

Oct

04

Ap

r 05

Oct

05

Ap

r 06

Oct

06

Ap

r 07

Oct

07

Ap

r 08

Oct

08

Ap

r 09

Oct

09

Ap

r 10

Oct

10

China retail sales gold, silver & jewellery

0

50

100

150

200

250

Oct

04

Mar

05

Au

g 0

5

Jan

06

Jun

06

No

v 0

6

Ap

r 07

Sep

07

Feb

08

Jul

08

Dec

08

May

09

Oct

09

Mar

10

Au

g 1

0

Jan

11

Jun

11

No

v 1

1

Ap

r 12

Sep

12

Feb

13

HK retail sales jewellery watches & clocks

-20

-10

0

10

20

30

40

50

60

70

Oct

04

Mar

05

Au

g 0

5

Jan

06

Jun

06

No

v 0

6

Ap

r 07

Sep

07

Feb

08

Jul

08

Dec

08

May

09

Oct

09

Mar

10

Au

g 1

0

Jan

11

Jun

11

No

v 1

1

Ap

r 12

Sep

12

Feb

13

HK retail sales jewellery watches & clocks, chg. Yoy

0

500

1000

1500

2000

2500

3000

3500

4000

Jan

02

Jul

02

Jan

03

Jul

03

Jan

04

Jul

04

Jan

05

Jul

05

Jan

06

Jul

06

Jan

07

Jul

07

Jan

08

Jul

08

Jan

09

Jul

09

Jan

10

Jul

10

Jan

11

Jul

11

Jan

12

Jul

12

HK visitor arrivals from China

-100

-50

0

50

100

150

200

250

Jan

02

Jul

02

Jan

03

Jul

03

Jan

04

Jul

04

Jan

05

Jul

05

Jan

06

Jul

06

Jan

07

Jul

07

Jan

08

Jul

08

Jan

09

Jul

09

Jan

10

Jul

10

Jan

11

Jul

11

Jan

12

Jul

12

HK visitor arrivals from China

0

5000

10000

15000

20000

25000

30000

35000

Jan

05

Jun

05

No

v 0

5

Ap

r 06

Sep

06

Feb

07

Jul

07

Dec

07

May

08

Oct

08

Mar

09

Au

g 0

9

Jan

10

Jun

10

No

v 1

0

Ap

r 11

Sep

11

Feb

12

Jul

12

Dec

12

Macau gross gaming revenues

-40

-20

0

20

40

60

80

100

Jan

06

May

06

Sep

06

Jan

07

May

07

Sep

07

Jan

08

May

08

Sep

08

Jan

09

May

09

Sep

09

Jan

10

May

10

Sep

10

Jan

11

May

11

Sep

11

Jan

12

May

12

Sep

12

Jan

13

Macau gross gaming revenues,chg. Yoy


33

Commodities and exchange rates

Euro vs. major currencies CHF vs. major currencies

Gold price evolution, 2003-13 USD/oz Silver price evolution, 2003-13 USD cents/oz

Copper price evolution, 2003-13 USD/tonne Polished diamonds (1ct) price evolution, 2003-13 USD

Rubber price evolution, 2003-13 MYR/kg Cotton price evolution, 2003-13 USD/lb

Source: Datastream, Berenberg research

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2008 2009 2010 2011 2012 2013-Ytd

USD CHF CNY JPY RUB GBP BRL

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

2008 2009 2010 2011 2012 2013

USD EUR CNY JPY RUB GBP BRL

0200400600800

100012001400160018002000

May

03

May

04

May

05

May

06

May

07

May

08

May

09

May

10

May

11

May

12

May

13

Gold

0

1000

2000

3000

4000

5000

6000

May

03

May

04

May

05

May

06

May

07

May

08

May

09

May

10

May

11

May

12

May

13

Silver

0

2000

4000

6000

8000

10000

12000

May

03

May

04

May

05

May

06

May

07

May

08

May

09

May

10

May

11

May

12

May

13

Copper

800

1000

1200

1400

1600

1800

2000

May

03

May

04

May

05

May

06

May

07

May

08

May

09

May

10

May

11

May

12

May

13

Diamond, 1ct

0200400600800

100012001400160018002000

May

03

May

04

May

05

May

06

May

07

May

08

May

09

May

10

May

11

May

12

May

13

Rubber

0

50

100

150

200

250

May

03

May

04

May

05

May

06

May

07

May

08

May

09

May

10

May

11

May

12

May

13

Cotton


34

Luxury goods performance

Luxury goods performance vs. Berenberg Luxury Goods Index 2012-13

Source: Berenberg research, Datastream Index constituents: Burberry, Chow Tai Fook, Christian Dior, Coach, Emperor Watch, Fossil, Hengdeli, Hermes, Hugo Boss, LVMH, Luk Fook, Luxottica, Salvatore Ferragamo, Pandora, PPR, Prada, Ralph Lauren, Richemont, Swatch Group, Tiffany, Tod’s, Brunello Cucinelli, Essilor, Geox, Laurent Perrier, Movado, Safilo, Oriental Watch, Mulberry, adidas, Puma and Nike.

Luxury goods performance vs. Berenberg Luxury Goods Index 2006-13

Source: Berenberg research, Datastream Index constituents: Burberry, Chow Tai Fook, Christian Dior, Coach, Emperor Watch, Fossil, Hengdeli, Hermes, Hugo Boss, LVMH, Luk Fook, Luxottica, Salvatore Ferragamo, Pandora, PPR, Prada, Ralph Lauren, Richemont, Swatch Group, Tiffany, Tod’s, Brunello Cucinelli, Essilor, Geox, Laurent Perrier, Movado, Safilo, Oriental Watch, Mulberry, adidas, Puma and Nike.

70

90

110

130

150

170

190

210

Dec

10

Jan

11

Feb

11

Mar

11

Ap

r 11

May

11

Jun

11

Jul

11

Au

g 1

1

Sep

11

Oct

11

No

v 1

1

Dec

11

Jan

12

Feb

12

Mar

12

Ap

r 12

May

12

Jun

12

Jul

12

Au

g 1

2

Sep

12

Oct

12

No

v 1

2

Dec

12

Jan

13

Feb

13

Mar

13

Ap

r 13

May

13

BRBG Luxury Goods Index LVMH Essilor

Luxottica Swatch Group Burberry

Richemont adidas Puma

30

80

130

180

230

280

330

380

430

Dec

05

Mar

06

Jun

06

Sep

06

Dec

06

Mar

07

Jun

07

Sep

07

Dec

07

Mar

08

Jun

08

Sep

08

Dec

08

Mar

09

Jun

09

Sep

09

Dec

09

Mar

10

Jun

10

Sep

10

Dec

10

Mar

11

Jun

11

Sep

11

Dec

11

Mar

12

Jun

12

Sep

12

Dec

12

Mar

13

BRBG Luxury Goods Index LVMH Essilor

Luxottica Swatch Group Burberry

Richemont adidas Puma


35

Swiss watch industry data 1/2

Swiss watch export value, CHFm Swiss watch export unit/volume, ‘000

Swiss watch export, price range value growth Swiss watch export, price range vol. growth

Swiss watch exports, China yoy change Swiss watch exports, Hong Kong yoy change

Swiss watch industry – Business climate Swiss watch industry – Order book level

Source: Bloomberg, Berenberg research

(10.0)%(5.0)%0.0 %5.0 %10.0 %15.0 %20.0 %25.0 %30.0 %35.0 %40.0 %

0.00

500.00

1000.00

1500.00

2000.00

2500.00

Dec

-10

Jan

-11

Feb

-11

Mar

-11

Ap

r-1

1M

ay-1

1Ju

n-1

1Ju

l-11

Au

g-1

1S

ep-1

1O

ct-1

1N

ov

-11

Dec

-11

Jan

-12

Feb

-12

Mar

-12

Ap

r-1

2M

ay-1

2Ju

n-1

2Ju

l-12

Au

g-1

2S

ep-1

2O

ct-1

2N

ov

-12

Dec

-12

Jan

-13

Feb

-13

Mar

-13

Ap

r-1

3

Value Growth

(20.0)%

(10.0)%

0.0 %

10.0 %

20.0 %

30.0 %

40.0 %

0.00

500.00

1000.00

1500.00

2000.00

2500.00

3000.00

3500.00

Dec

-10

Jan

-11

Feb

-11

Mar

-11

Ap

r-1

1M

ay-1

1Ju

n-1

1Ju

l-11

Au

g-1

1S

ep-1

1O

ct-1

1N

ov

-11

Dec

-11

Jan

-12

Feb

-12

Mar

-12

Ap

r-1

2M

ay-1

2Ju

n-1

2Ju

l-12

Au

g-1

2S

ep-1

2O

ct-1

2N

ov

-12

Dec

-12

Jan

-13

Feb

-13

Mar

-13

Ap

r-1

3

Units Growth

-20%

-10%

0%

10%

20%

30%

40%

Jan

-12

Feb

-12

Mar

-12

Ap

r-1

2

May

-12

Jun

-12

Jul-

12

Au

g-1

2

Sep

-12

Oct

-12

No

v-1

2

Dec

-12

Jan

-13

Feb

-13

Mar

-13

Ap

r-1

3

CHF 0-200 CHF 200-500 CHF 500-300 CHF >3000

-30%

-20%

-10%

0%

10%

20%

30%

40%

Jan

-12

Feb

-12

Mar

-12

Ap

r-12

May

-12

Jun

-12

Jul-

12

Au

g-1

2

Sep

-12

Oct

-12

No

v-1

2

Dec

-12

Jan

-13

Feb

-13

Mar

-13

Ap

r-1

3

CHF 0-200 CHF 200-500 CHF 500-300 CHF >3000

(50)%

0 %

50 %

100 %

150 %

200 %

Jun

09

Sep

09

Dec

09

Mar

10

Jun

10

Sep

10

Dec

10

Mar

11

Jun

11

Sep

11

Dec

11

Mar

12

Jun

12

Sep

12

Dec

12

Mar

13

China, yoy chg.

(60)%

(40)%

(20)%

0 %

20 %

40 %

60 %

80 %

Jun

09

Sep

09

Dec

09

Mar

10

Jun

10

Sep

10

Dec

10

Mar

11

Jun

11

Sep

11

Dec

11

Mar

12

Jun

12

Sep

12

Dec

12

Mar

13

Hong Kong, yoy chg.

-100

-80

-60

-40

-20

0

20

40

60

80

May-8

3

May-8

5

May-8

7

May-8

9

May-9

1

May-9

3

May-9

5

May-9

7

May-9

9

May-0

1

May-0

3

May-0

5

May-0

7

May-0

9

May-1

1

-60

-40

-20

0

20

40

60

80

May-8

3

May-8

5

May-8

7

May-8

9

May-9

1

May-9

3

May-9

5

May-9

7

May-9

9

May-0

1

May-0

3

May-0

5

May-0

7

May-0

9

May-1

1


36

Swiss watch industry data 2/2

Swiss watch industry – Order inflow Swiss watch industry – Order inflow

Swiss watch industry – Production Swiss watch industry – Capacity utilisation, %

Swiss watch industry – Raw materials purchases Swiss watch industry – Domestic selling prices

Source: Bloomberg, DataStream, Berenberg research

-60

-40

-20

0

20

40

60

80

May-8

3

May-8

5

May-8

7

May-8

9

May-9

1

May-9

3

May-9

5

May-9

7

May-9

9

May-0

1

May-0

3

May-0

5

May-0

7

May-0

9

May-1

1

-60

-40

-20

0

20

40

60

Ma

y-8

3

Ma

y-8

4

Ma

y-8

5

Ma

y-8

6

Ma

y-8

7

Ma

y-8

8

Ma

y-8

9

Ma

y-9

0

Ma

y-9

1

Ma

y-9

2

Ma

y-9

3

Ma

y-9

4

Ma

y-9

5

Ma

y-9

6

Ma

y-9

7

Ma

y-9

8

Ma

y-9

9

Ma

y-0

0

Ma

y-0

1

Ma

y-0

2

Ma

y-0

3

Ma

y-0

4

Ma

y-0

5

Ma

y-0

6

Ma

y-0

7

Ma

y-0

8

Ma

y-0

9

Ma

y-1

0

Ma

y-1

1

Ma

y-1

2

-40

-30

-20

-10

0

10

20

30

40

50

60

May-8

3

May-8

5

May-8

7

May-8

9

May-9

1

May-9

3

May-9

5

May-9

7

May-9

9

May-0

1

May-0

3

May-0

5

May-0

7

May-0

9

May-1

1

50

55

60

65

70

75

80

85

90

95

100

May-8

3

May-8

5

May-8

7

May-8

9

May-9

1

May-9

3

May-9

5

May-9

7

May-9

9

May-0

1

May-0

3

May-0

5

May-0

7

May-0

9

May-1

1

May-1

3

-60

-40

-20

0

20

40

60

80

May-8

3

May-8

5

May-8

7

May-8

9

May-9

1

May-9

3

May-9

5

May-9

7

May-9

9

May-0

1

May-0

3

May-0

5

May-0

7

May-0

9

May-1

1

May-1

3


37

LVMH – Seven-year historical PE Burberry – Seven-year historical PE

Richemont – Seven-year historical PE Swatch Group – Seven-year historical PE

Luxottica – Seven-year historical PE Essilor – Seven-year historical PE

adidas – Seven-year historical PE Puma – Seven-year historical PE

Source: Bloomberg, DataStream, Berenberg research

5.0x

7.0x

9.0x

11.0x

13.0x

15.0x

17.0x

19.0x

21.0x

23.0x

Jun

-06

Oct

-06

Feb

-07

Jun

-07

Oct

-07

Feb

-08

Jun

-08

Oct

-08

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

LVMH

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

Jun

-06

Oct

-06

Feb

-07

Jun

-07

Oct

-07

Feb

-08

Jun

-08

Oct

-08

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

Burberry

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

35.0x

Jun

-06

Oct

-06

Feb

-07

Jun

-07

Oct

-07

Feb

-08

Jun

-08

Oct

-08

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

Richemont

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

Jun

-06

Oct

-06

Feb

-07

Jun

-07

Oct

-07

Feb

-08

Jun

-08

Oct

-08

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

Swatch Group

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

Jun

-06

Oct

-06

Feb

-07

Jun

-07

Oct

-07

Feb

-08

Jun

-08

Oct

-08

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

Luxottica

10.0x12.0x14.0x16.0x18.0x20.0x22.0x24.0x26.0x28.0x30.0x

Jun

-06

Oct

-06

Feb

-07

Jun

-07

Oct

-07

Feb

-08

Jun

-08

Oct

-08

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

Essilor

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

16.0x

18.0x

20.0x

Jun

-06

Oct

-06

Feb

-07

Jun

-07

Oct

-07

Feb

-08

Jun

-08

Oct

-08

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

adidas

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

16.0x

18.0x

20.0x

Jun

-06

Oct

-06

Feb

-07

Jun

-07

Oct

-07

Feb

-08

Jun

-08

Oct

-08

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

Puma

adidas AG Sporting Goods

38

Mixing it up

• Having visited adidas retail/concept stores in Shanghai and Hong Kong with retail management, we are confident that the adidas brand has significant self-help margin drivers, primarily through ongoing price/mix development geared more towards Lifestyle than Sports Performance. In addition, hybrid style and performance products such as the Stella McCartney Boost shoe (sold at an 11% premium in China over the conventional Energy Boost running shoe) and the repositioning of the NEO brand in China ought to drive up conversion rates and brand ASP as well as market share and margins.

• In our view, adidas’ brand product pipeline for 2013 looking looks strong, having launched the Energy Boost as early as February in China and March across Europe and the United States as well as the basketball D-Rose 3.5 and Crazy Light 2 collections and the Nitrocharge football silo in May. adidas “SpringBlade” running shoe is expected to land in stores ahead of the back-to-school (BTS) period in August; hence we expect resilient footfall and gross margin upside risk to persist into Q2 2013.

• Q2 is seasonally a non-markdown quarter and Q2 2013 will also represent the first clean quarter for the group, having annualised the NFL lockout and Reebok’s fraudulent Indian activities in 2013. As a result, we believe that our Q2 2013 earnings forecast of €0.99 (6.5% ahead of Bloomberg consensus) may prove conservative. Commodity costs such as rubber, cotton and oil-based materials continue to work in adidas’s favour in 2013 as adidas pays suppliers a fixed cost on an annual basis while hedging FOB costs (negative this year).

• During our trip, we were encouraged to note store managers’ focus on inventory management, replenishment and staff motivation. We noted strong double-digit sales growth for high-margin Originals and NEO collections, situated on the top two floors of the stores. We also maintain our conviction that adidas Group can achieve an EBIT margin of 12.1% by 2015, ahead of internal guidance of 11%. Our FY 2015 earnings forecast of €7.10 is 12% ahead of Bloomberg consensus. We make no change to our P/E based price target of €98, which is supported by DCF.

Buy Rating system

Current price

EUR 81.23

Absolute

Price target

EUR 98.00 13/06/2013 XETRA Close Market cap EUR 16,633 m Reuters ADSGn.DE Bloomberg ADS GY

Changes made in this note Rating Buy (no change) Price target EUR 98.00 (no change) Chg 2013e 2014e 2015e

old Δ% old Δ% old Δ%

Sales 15194 - 16186 - 17231 -

EBIT 1441 - 1719 - 2090 -

EPS 4.75 - 5.76 - 7.10 -


Share data

Shares outstanding (m) 209 Enterprise value (EUR m) 17,671 Daily trading volume 900,926

Performance data

High 52 weeks (EUR) 87.70 Low 52 weeks (EUR) 56.30 Relative performance to SXXP DAX 1 month 1.6 % 0.6 % 3 months 6.0 % 5.4 % 12 months 20.0 % 16.3 %

Business activities: Sporting goods

Non-institutional shareholders: adidas management 2%

20 June 2013

John Guy Analyst +44 20 3465 2674 [email protected]

Bassel Choughari

Analyst +44 20 3465 2675 [email protected]

Rupert Trotter

Specialist Sales +44 20 3207 7815 [email protected]

Y/E 31.12., EUR m 2011 2012 2013E 2014E 2015E

Sales 13,322 14,883 15,194 16,186 17,231

EBITDA 1,199 1,195 1,722 2,017 2,408

EBIT 953 1,185 1,441 1,719 2,090

Net profit 613 791 995 1,204 1,484

Net debt (net cash) 91 448 886 1,389 2,084

EPS (reported) 2.93 2.52 4.75 5.76 7.10

EPS (recurring) 2.93 3.78 4.75 5.76 7.10

CPS 1.2 3.5 3.4 4.1 5.4

DPS 1.0 1.4 1.7 2.1 2.5

Gross margin 47.5% 47.7% 49.9% 50.6% 51.3%

EBITDA margin 9.0% 8.0% 11.3% 12.5% 14.0%

EBIT margin 7.2% 8.0% 9.5% 10.6% 12.1%

Dividend yield 1.3% 1.7% 2.1% 2.6% 3.2%

NOPAT/IC (Post tax ROIC) 8.1% 6.5% 10.8% 11.5% 12.5%

EV/sales 1.3 1.2 1.2 1.1 1.0

EV/EBITDA 14.7 14.8 10.3 8.8 7.3

EV/EBIT 18.5 14.9 12.3 10.3 8.5

P/E 29.2 22.6 18.0 14.9 12.1

ROIC/WACC % spread -0.9% -2.5% 1.8% 2.5% 3.5%

Source: Company data, Berenberg


39

adidas key assumptions and sensitivities (1)

Key financial and regional estimates

In €m FY11 FY12 FY13E FY14E FY15E

12-15E CAGR

Group sales 13,322 14,883 15,194 16,186 17,231

5.0%

chg. +11.1% +11.7% +2.1% +6.5% +6.5%

Group adj. EBIT 953 1,185 1,441 1,719 2,090

20.8%

chg. +6.6% +24.3% +21.6% +19.2% +21.6% margin 7.2% 8.0% 9.5% 10.6% 12.1%

Sales split by region Western Europe 3,922 4,076 4,035 4,237 4,449

3.0%

European Emerging Markets 1,597 1,947 1,996 2,175 2,328

6.1%

North America 3,102 3,410 3,478 3,687 3,871

4.3%

Greater China 1,229 1,562 1,671 1,822 2,004

8.7%

Other Asian Markets 2,103 2,407 2,503 2,679 2,866

6.0%

Latin America 1,369 1,481 1,511 1,586 1,713

5.0%

Total 13,322 14,883 15,194 16,186 17,231 Reported %

Western Europe +10.7% +3.9% -1.0% +5.0% +5.0% European Emerging Markets +15.3% +21.9% +2.5% +9.0% +7.0% North America +10.6% +9.9% +2.0% +6.0% +5.0% Greater China +22.9% +27.1% +7.0% +9.0% +10.0% Other Asian Markets +6.6% +14.5% +4.0% +7.0% +7.0% Latin America +6.5% +8.2% +2.0% +5.0% +8.0% Total +11.1% +11.7% +2.1% +6.5% +6.5% chg. currency neutral (cn) FY11 FY12 FY13E FY14E FY15E Western Europe +10.3% +3.0% -1.0% +5.0% +5.0% European Emerging Markets +22.3% +15.0% +2.5% +9.0% +7.0% North America +15.3% +2.0% +4.0% +6.0% +5.0% Greater China +23.4% +15.0% +10.0% +9.0% +10.0% Other Asian Markets +5.1% +7.0% +7.0% +7.0% +7.0% Latin America +9.7% +8.0% +5.0% +5.0% +8.0% Total +13.0% +6.0% +3.6% +6.5% +6.5%

EPS, diluted (€) 2.93 3.78 4.75 5.76 7.10

23.3%

DPS (€) 1.00 1.35 1.70 2.05 2.53

23.3%

Working capital 2,210 2,384 2,434 2,593 2,760 Stock turn 2.8x 3.1x 3.0x 3.0x 2.9x Creditors days 51.7 43.9 43.9 43.9 43.9 Debtor days 43.7 41.4 41.4 41.4 41.4

Net cash/ (debt) 91 448 886 1,389 2,084 Source: Berenberg estimates, Company data


40

adidas key assumptions and sensitivities (2)

Divisional estimates

In €m FY11 FY12 FY13E FY14E FY15E

12-15E CAGR

Sales by distribution channel Wholesale 8,949 9,533 9,581 10,060 10,462

3.1%

Retail 2,793 3,373 3,575 3,969 4,366

9.0%

Other Businesses 1,580 1,977 2,038 2,157 2,403

6.7%

Total 13,322 14,883 15,194 16,186 17,231

5.0%

chg. currency neutral (cn) Wholesale +11.0% +2.0% +2.5% +5.0% +4.0%

Retail +19.7% +14.0% +8.0% +11.0% +10.0% Other Businesses +12.7% +17.0% +1.8% +5.8% +11.4% Total +13.0% +6.0% +3.6% +6.5% +6.5%

Sales by brand adidas 9,867 11,344 11,508 12,343 13,228

5.3%

Reebok 1,962 1,667 1,687 1,738 1,807

2.7%

TaylorMade-adidas Golf 1,044 1,344 1,465 1,553 1,623

6.5%

Rockport 261 285 288 302 311

3.0%

Reebok-CCM Hockey 188 243 246 250 262

2.5%

Total 13,322 14,883 15,194 16,186 17,231

5.0%

chg. currency neutral (cn) FY11 FY12 FY13E FY14E FY15E adidas +14.5% +9.9% +3.0% +7.3% +7.2% Reebok +5.8% -17.9% +2.2% +3.0% +4.0% TaylorMade-adidas Golf +15.9% +19.5% +11.0% +6.0% +4.5% Rockport +6.3% +1.9% +3.0% +5.0% +3.0% Reebok-CCM Hockey +5.9% +8.9% +4.0% +1.6% +4.6% Total +13.0% +6.0% +3.6% +6.5% +6.5%

Sales by product category Footwear 6,242 6,922 7,268 7,850 8,478

7.0%

Apparel 5,733 6,290 6,542 6,934 7,315

5.2%

Hardware 1,347 1,671 1,385 1,402 1,438

-4.9%

Total 13,322 14,883 15,194 16,186 17,231

5.0%

chg. currency neutral (cn) Footwear +18.0% +6.0% +7.0% +8.0% +8.0%

Apparel +8.0% +4.0% +5.0% +6.0% +5.5% Hardware +10.0% +17.0% -15.3% +1.2% +2.5% Total +13.0% +6.0% +3.6% +6.5% +6.5% Source: Berenberg estimates, Company data


41

Q2 2013 in focus

adidas Group is due to report Q2 2013 earnings on 8 August. We forecast Q2 2013 earnings of €0.99, 6.5% ahead of Bloomberg consensus. The second quarter is not seasonally a markdown quarter (Q1 2013 was a clearance quarter where gross margin increased by 240bp yoy to 50.1% and EBIT margin rose by 110bp yoy to 11.8%) and the sales comparison is softer. Therefore, we see upside risk to both our Q2 2013 gross margin and top-line growth estimates of 190bp yoy to 50.2% and 4% currency-neutral sales (+2% on a reported basis to €3,591m).

Management may raise FY 2013 gross margin guidance

We believe management may raise its official FY 2013 gross margin guidance range of 48-48.5% should the first half of the year result in a group gross margin of over 50%. We highlight below our assumptions compared with management’s current annual guidance. Moreover, cotton, rubber and other oil-based raw material prices remain lower than in 2012. As adidas pays its suppliers a fixed price, we believe there is scope to raise margin forecasts and as a result, FY 2013 earnings guidance.

adidas management FY 2013 guidance versus Berenberg estimates (currency neutral)

Outlook 2013 Berenberg FY13E

adidas Group increase at mid-single-digit sales % 3.6%

Wholesale increase at low single-digit sales % 2.5%

Retail segment increase at high single-digit to low double-digit % 8.0%

Other businesses increase at mid-single-digit sales % 1.8%

Taylor-Made-adidas Golf increase at mid-single-digit sales % 11.0%

Rockport increase at mid- to high single-digit sales % 3.0%

Reebok-CCM hockey increase at mid- to high single-digit sales % 4.0%

Gross margin 48% to 48.5% 49.9%

Operating margin approaching 9% 9.5%

Average operating working capital (% sales) moderate increase expected In line

Capital expenditure €500m-550m €525m

Gross borrowings further reduction net cash €886m

Net borrowings/EBITDA maintained below 2.0x -0.50x

EPS to increase by 12% to 16% (€4.25 to €4.40) € 4.75

Shareholder value further increase DPS +26%, €1.70

Source: Berenberg estimates, Company data

We outline key commodity price moves over the past 18 months in both US dollars and euros. We estimate that raw materials make up 65% of adidas Group COGS though no single raw material makes up more than 5% of COGS. Standout price movements in euros are rubber (-27.2% yoy), aluminium (-8.2%), cotton (+6.6%), HDPE and ethylene (-5% and -2% respectively).


42

Price movement in US dollars (%)

Q1 2012 Q2 2012 Q3 2012 Q4 2012E Q1 2013E Q2 2013E

Crude Oil 12.1% -6.9% -2.9% 0.5% -4.6% -5.7%

Natural Gas -41.0% -47.8% -30.3% 2.5% 41.8% 77.8%

PET -12.7% -17.0% -20.3% -7.1% 2.4% 0.2%

Pulp -12.8% -15.9% -20.5% -11.3% -1.2% 0.3%

Aluminium -13.1% -24.0% -19.8% -4.5% -8.0% -6.7%

Rubber* -23.4% -9.5% -21.6% -12.7% -20.4% -28.4%

Caustic Soda 13.6% -4.5% 6.4% -1.1% 5.2% 14.6%

Soda Ash -4.0% -9.1% -9.1% -9.1% -5.1% 0.0%

Cotton -49.7% -52.3% -34.3% -24.9% -9.5% 8.4%

HDPE -2.2% -4.0% 0.3% 15.5% 5.3% -3.4%

Ethylene 30.1% -10.6% -13.2% 8.9% -0.1% -0.4%

USD/EUR 4.4% 12.2% 12.9% 3.8% -0.7% -1.6%

Source: Berenberg estimates, DataStream

Price movement in euros (%)

Q1 2012 Q2 2012 Q3 2012 Q4 2012E Q1 2013E Q2 2013E

Crude Oil 17.0% 4.4% 9.6% 4.3% -5.3% -7.3%

Natural Gas -38.4% -41.4% -21.3% 6.4% 40.8% 74.9%

PET -8.9% -6.9% -10.0% -3.5% 1.7% -1.4%

Pulp -8.9% -5.7% -10.3% -7.9% -1.9% -1.3%

Aluminium -9.3% -14.7% -9.5% -0.8% -8.7% -8.2%

Rubber -26.6% -19.3% -30.5% -15.9% -19.8% -27.2%

Caustic Soda 18.6% 7.1% 20.1% 2.7% 4.5% 12.8%

Soda Ash 0.2% 2.0% 2.6% -5.6% -5.7% -1.6%

Cotton -47.4% -46.5% -25.9% -22.0% -10.1% 6.6%

HDPE 2.1% 7.7% 13.2% 19.8% 4.5% -5.0%

Ethylene 35.8% 0.2% -2.1% 13.1% -0.8% -2.1%

Source: Berenberg estimates, DataStream

A short-term risk to oil-dependent materials may arise from tensions over how best to deal with the Syrian crisis. US crude oil rose to a nine-month high (Brent crude settled at $105.93 a barrel on Friday 14 June, a four-month high) as US President Obama pushed forward the agenda for the US to arm rebel forces in the region, contrary to Iranian and Russian moves to support the incumbent President Assad.

Nike reports before adidas In terms of catalysts, Nike is due to report its Q4 2013 earnings on Thursday 27 June. We believe Nike’s Chinese sales evolution and order book progress will be of significant interest.

Nike Q3 2013 Chinese sales declined by 10% on a currency-adjusted basis (Nike reported Q3 2013 trading on 21 March 2013) and the company commented that it expected the trimming of excess inventories in the region to take a few additional quarters.

However, we noted that the order book after Q3 2013 trading improved, which may suggest a small uptick in Q4 2013 sales. We note that local sporting goods players such as Li Ning have recently seen improving sales trends, resulting in more upbeat commentary as regards a cleaner stock channel in mainland China.

On our estimates, FX-neutral sales growth at adidas brand retail stores in mainland


43

China and Hong Kong are trending in high-single digits to low double digits. We note that footfall in Shanghai’s Huaihau Road is down by c20% yoy on the back of a new mall development (the K11 mall); hence mid to high single digit sales growth for the store is in our view a resilient performance.


44

Cash machine could pay out more to investors

In our view, the 2012 dividend increase of 35% to €1.35 may signal the start of an incremental rise in the payout ratio for shareholders as adidas Group generates materially higher cash-flows over the course of the next few years. This is assuming no major acquisition – we do not see such as likely as management remains sensitive over the performance of its Reebok brand since acquisition on 2006. In fact, until Q4 2012, Reebok-CCM-Hockey, which generated €243m of sales in 2012, was up for disposal. Should bidders reappear with more favourable offers, we would not rule out the possibility of adidas disposing of the brand.

We expect higher cash-flow yields to come from ongoing stringent working capital management; improved retail versus wholesale mix (23% to 26% by FY 2015) leading to higher group average margin; positive operating leverage as of H2 2013 and FY 2014 on the back of a more efficient sourcing, supply and logistics network; and ongoing market-leading innovation coupled with ASP improvements and gross margin gains via a steady increase of Lifestyle products over Sport Performance. We recognise the importance of Sport Performance within the adidas brand but maintain a 72% Sport Performance to 28% Lifestyle weighting is too high, especially within the context of mainland Chinese and Hong Kong stores working to a more balanced 50% Lifestyle, 50% Sport Performance mix.

Working capital profile and forecasts

We highlight the efficient working capital profile of the group below and note that adidas Group’s inventory position had improved on a sequential quarterly basis to -2% yoy as of Q1 2013.

Average working capital profile to Q1 2013


As of December 2012, reported working capital stood at 16% of net sales, down from 16.6% in 2011. Our model assumes reported working capital as a percentage of net sales remains at around 16% although we recognise inventory levels will rise in Q4 2013 as the group gears up for the World Cup in Brazil (this starts in Sao Paulo on 12 June 2014). We look for working capital to increase by 6.5%, in line with our FY 2014 net sales estimate (€16,186m).

24.3 22.9

21.7 20.9 20.8 20.5 20.7 20.9 20.4 20.2 20.0 19.9 20.0 20.3

Q409

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

Q112

Q212

Q312

Q412

Q113

Average operating working capital as a % of net sales, at quarter end


45

The payout ratio could move to 50%, assuming dividend cover of 2x As noted above, adidas Group increased its 2012 dividend by 35% yoy to €1.35. Assuming a constant 2012 payout ratio of 35.7%, dividend cover would increase from 1.9x to 2.8x by FY 2017; this reflects our current (conservative) assumptions.

Berenberg current assumptions

FY12 FY13E FY14E FY15E FY16E FY17E

Dividend 1.35 1.70 2.05 2.53 3.13 3.36 Dividend growth 35.0% 25.7% 21.1% 23.3% 23.5% 7.4% Pay-out ratio 35.7% 35.7% 35.7% 35.7% 35.7% 35.7% Dividend Yield 1.7% 2.1% 2.6% 3.2% 4.0% 4.2% Dividend Cover 1.9x 2.8x 2.8x 2.8x 2.8x 2.8x Cash flow yield 4.4% 4.3% 5.2% 6.8% 8.8% 9.8% Net cash/EBITDA (x) 0.4x 0.5x 0.7x 0.9x 1.0x 1.3x Adj net cash/EBITDAR (x) 0.8x 0.8x 1.1x 1.3x 1.5x 1.9x


Assuming dividend cover of 2.0x (roughly in line with 2012), the payout ratio could increase to a consistent 50% level, above that of peers.

Assuming a payout ratio of 50% from 2013 to 2017

FY12 FY13E FY14E FY15E FY16E FY17E

Dividend 1.35 2.38 2.87 3.53 4.36 4.67 Dividend growth 35.0% 76.1% 20.9% 23.0% 23.3% 7.1% Pay-out ratio 35.7% 50.0% 50.0% 50.0% 50.0% 50.0% Dividend Yield 1.7% 3.0% 3.6% 4.5% 5.5% 5.9% Dividend Cover 1.9x 2.0x 2.0x 2.0x 2.0x 2.0x Cash flow yield 4.4% 4.3% 5.2% 6.7% 8.7% 9.7% Net cash/EBITDA (x) 0.4x 0.5x 0.6x 0.7x 0.9x 1.0x Adj net cash/EBITDAR (x) 0.8x 0.8x 1.0x 1.1x 1.2x 1.5x



46

Valuation

As the second-largest sporting goods company in the world, we expect adidas’ sales growth to remain above the market average (2.2x global GDP versus the 1.5x market average) over the three years to 2015. In our view, adidas ought to improve its operational leverage through size and scale efficiencies in terms of production, increased retail penetration and improved mix. Distribution centre rationalisation and ongoing investments in R&D and innovation should also be key drivers of margin growth to FY 2015.

Cash-rich, market-share winner and attractive valuation

We forecast net cash to increase to €886m in FY 2013 from €448m in FY 2012 (FY 2011: €91m). We look for an improved sales mix and lower commodity/raw material cost pressure, partially offset by a negative impact on hedging and structurally higher Chinese labour costs to drive FY 2013 gross margin up by 220bp yoy to 49.9%. Moreover, we remain cautious on the 12-month evolution of operating expenses as a percentage of sales (+70bp to 42% including depreciation; excluding depreciation, our FY 2013 operating expenses forecast as a percentage of sales ratio is 40.2%) as new regional/centralised distribution centres are completed in Germany and Russia.

Our FY 2013 capital expenditure estimate is within management’s guidance of €500m-550m at €525m. We remain cautious in our working capital outflow assumptions for FY 2013 and outer years. We expect inventory to build as the adidas Group increases its exposure to directly owned stores (DOS) versus wholesale. We forecast retail as a percentage of sales to increase by 80bp to 23.5% in FY 2013, which may prove conservative, reaching 25.3% by FY 2015 – an implied increase of 260bp versus FY 2012 (22.7%).

On a non-cash-adjusted basis, (at €79.1), adidas trades on FY 2013E and FY 2014E P/Es of 16.6x and 13.7x respectively compared with its 10-year average P/E of more than 18x and seven-year historical average of c17.5x following the Reebok acquisition in 2006.

Adidas’ seven-year historical average P/E (FY 2006-12)

Source: DataStream, Berenberg Bank estimates

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

16.0x

18.0x

20.0x

Jun

-06

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-06

Feb

-07

Jun

-07

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-07

Feb

-08

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-08

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-08

Feb

-09

Jun

-09

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-09

Feb

-10

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-10

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-10

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-11

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-11

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-11

Feb

-12

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adidas


47

On a cash-adjusted basis, our current and one-year forward estimated multiples fall to 15.7x and 12.6x respectively. We believe our €98 price target is conservative given our forecast of double-digit three-year EPS and DPS CAGR (FY 2012-15E) of c23% respectively.

Furthermore, we expect the adidas Group’s post-tax ROIC to increase by 430bp to 10.8% in FY 2013 and to reach 12.5% by FY 2015.

Our price target, based on our P/E analysis and driven by earnings and cash flow forecasts, implies FY 2013 and FY 2014 P/Es of 20.6x and 17.0x respectively and is supported by our DCF (€98).

On a cash-adjusted basis, at our €98 price target, adidas would trade on FY 2013E and FY 2014E P/Es of 19.7x and 15.9x respectively. On a PEG basis, adidas at 0.5x (Bloomberg consensus) and 0.4x (Berenberg estimates) is attractive relative to VF Corp on 1.2x, Nike on1.5x, Lulu-Lemon on 1.7x, Asics on 1.7x.

adidas Bloomberg and Berenberg estimates versus peers

Source: Berenberg Bank estimates, Bloomberg

adidas Bloomberg and Berenberg estimates versus peers


2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E

Puma -2.6% 4.6% 4.3% 83.7% 12.2% 9.7% 154.0% 14.1% 10.3%

Nike 7.1% 7.9% 6.9% 11.0% 12.1% 8.2% 12.1% 11.9% NA

VF Corp 6.0% 8.1% 10.0% 15.6% 10.2% 13.4% 15.3% 10.7% 9.5%

Under Armour 22.2% 21.0% 20.5% 25.0% 24.3% 18.1% 28.1% 24.2% 21.0%

Lulu Lemon 22.4% 21.1% 21.9% 11.4% 27.4% 24.0% 10.9% 27.0% 26.3%

Anta Spots -17.2% 2.4% 9.4% -17.3% 5.1% 10.2% -17.7% 4.6% 10.8%

Asics 16.5% 9.5% 3.8% 18.6% 10.9% 7.8% 20.1% 14.4% 10.3%

Amer Sports 4.8% 5.1% 4.3% 35.3% 11.5% 7.9% 49.1% 15.1% 9.9%

Li Ning -10.8% 7.5% 13.2% n.m. 439.2% 65.1% n.m. n.m. 354.1%

Total sector weighted 8.3% 9.7% 9.5% 16.0% 16.8% 11.8% 20.1% 13.8% 9.3%

Total sector median 6.0% 7.9% 9.4% 17.1% 12.1% 10.2% 17.7% 14.2% 10.5%

adidas 3.8% 6.8% 6.2% 16.8% 16.9% 14.8% 17.4% 19.1% 15.9%

adidas vs peers (premium/ discount) -54.3% -29.8% -35.4% 4.8% 0.7% 25.1% -13.3% 38.4% 70.9%

adidas Berenberg estimates 2.1% 6.5% 6.5% 44.1% 17.2% 19.4% 21.6% 19.2% 21.6%

adidas vs peers (premium/ discount) -74.9% -32.5% -32.4% 175.6% 2.3% 64.1% 7.8% 39.6% 131.8%

Sales growth EBITDA growth EBIT growth

2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E

Puma -1.4x -1.6x -1.9x 10.8% 11.5% 12.1% 8.8% 9.6% 10.2%

Nike -1.0x -0.8x NA 14.9% 15.5% 15.7% 13.3% 13.8% NA

VF Corp 0.4x 0.2x 0.0x 16.7% 17.0% 17.5% 14.6% 15.0% 14.9%

Under Armour -1.0x -1.0x NA 14.0% 14.4% 14.1% 11.9% 12.2% 12.3%

Lulu Lemon -1.7x -1.9x -1.9x 27.9% 29.4% 29.9% 25.0% 26.2% 27.1%

Anta Spots -3.4x -3.4x -3.2x 19.7% 20.2% 20.4% 18.2% 18.6% 18.8%

Asics -0.2x -0.5x -0.8x 9.4% 9.6% 9.9% 7.6% 7.9% 8.4%

Amer Sports 1.9x 1.6x 1.2x 9.5% 10.1% 10.4% 7.7% 8.4% 8.9%

Li Ning 2.4x 0.4x 0.0x 1.2% 6.1% 9.0% -5.2% 1.5% 5.8%

Total sector weighted -0.7x -0.8x -0.8x 16.0% 16.6% 16.9% 14.1% 14.6% 9.4%

Total sector median -1.0x -0.8x -0.8x 14.0% 14.4% 14.1% 11.9% 12.2% 11.2%

adidas -0.4x -0.5x -0.6x 11.0% 12.0% 13.0% 9.0% 10.0% 11.0%

adidas vs peers (premium/ discount) -47.1% -28.5% -19.7% -31.0% -27.3% -22.9% -36.0% -31.4% 17.1%

adidas Berenberg estimates -0.5x -0.7x -0.9x 11.3% 12.5% 14.0% 9.5% 10.6% 12.1%

adidas vs peers (premium/ discount) -28.4% -10.0% 10.8% -29.0% -24.8% -17.2% -32.6% -27.5% 29.6%

Net debt/ EBITDA EBITDA margin EBIT margin


48

adidas – market price multiples Bloomberg and Berenberg estimates versus peers


adidas – target price multiples Bloomberg and Berenberg estimates versus peers


Stacking up against Nike adidas Group trades on FY 2013E and FY 2014E P/Es of 18.4x and 15.4x (Bloomberg consensus as of 17 June) compared with its seven-year average of 17.5x. According to our analysis, adidas has the lowest PEG in the sector at 0.5x (Bloomberg consensus and Berenberg estimate of 0.4x) versus our market capitalisation weighted average of 1.2x and Nike’s 1.5x.

In our view, the global sporting goods market is effectively dominated by two core players: Nike and adidas. There are specialty players such as Lulu-Lemon and Under Armour as well as smaller conglomerates such as VF Corp which have also emerged as market share winners.

Market share gains

We believe that the sporting goods market will continue to grow at a faster rate than global GDP, with market share winners such as adidas and Nike growing at above-average rates for the sporting goods market. Our global sporting goods average multiplier from 2012 to 2015 implies 1.5x growth versus global GDP, with adidas at 2.2x, Nike at 2.8x and Puma at 1.6x. Historically, Nike has dominated key sporting goods markets such as the US. We note that the Nike brand had more than a 30% larger sales base than adidas and a c380% higher sales base than Puma for respective FY 2011 reporting periods

PEG

2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2012-15E

Puma 18.3x 15.9x 14.2x 9.4x 8.4x 7.6x 11.5x 10.0x 9.1x 1.0x 1.0x 0.9x n.m.

Nike 21.4x 18.6x 16.4x 13.0x 11.6x 10.7x 14.5x 13.0x NA 1.9x 1.8x 1.7x 1.5

VF Corp 17.2x 15.3x 13.4x 11.6x 10.5x 9.3x 13.1x 11.9x 10.8x 1.9x 1.8x 1.6x 1.2

Under Armour 40.4x 32.3x 25.6x 19.1x 15.4x 13.0x 22.5x 18.1x 15.0x 2.7x 2.2x 1.8x 1.7

Lulu Lemon 33.2x 26.1x 21.2x 19.7x 15.5x 12.5x 22.1x 17.4x 13.8x 5.5x 4.6x 3.7x 1.7

Anta Spots 13.5x 13.3x 12.2x 7.3x 6.9x 6.3x 7.9x 7.5x 6.8x 1.4x 1.4x 1.3x n.m.

Asics 18.9x 17.1x 16.0x 10.8x 9.8x 9.1x 13.5x 11.8x 10.7x 1.0x 0.9x 0.9x 1.7

Amer Sports 15.6x 13.2x 11.9x 10.0x 9.0x 8.3x 12.3x 10.7x 9.7x 0.9x 0.9x 0.9x 0.8

Li Ning n.m. 110.2x 18.2x 77.9x 14.4x 8.7x -18.3x 61.0x 13.4x 1.0x 0.9x 0.8x n.m.

Total sector weighted 22.1x 19.7x 16.5x 13.8x 11.6x 10.4x 14.8x 13.5x 9.7x 2.2x 2.0x 1.8x 1.2

Total sector median 18.6x 17.1x 16.0x 11.6x 10.5x 9.1x 13.1x 11.9x 10.8x 1.4x 1.4x 1.3x 1.4

adidas 18.4x 15.4x 13.1x 10.3x 8.8x 7.7x 12.6x 10.6x 9.1x 1.1x 1.1x 1.0x 0.5

adidas vs peers (premium/ discount) -16.9% -22.0% -20.6% -25.1% -24.2% -26.0% -15.1% -21.7% -6.2% -48.5% -46.3% -43.8% -56.1%

adidas Berenberg estimates 17.5x 14.4x 11.7x 9.4x 8.0x 6.7x 11.2x 9.4x 7.7x 1.1x 1.0x 0.9x 0.4

adidas vs peers (premium/ discount) -21.1% -26.9% -29.2% -32.1% -31.4% -35.6% -24.7% -30.6% -20.8% -51.9% -49.7% -47.5% -63.7%

PE EV/ EBITDA EV/ EBIT EV/ sales

2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E

Puma 18.7x 16.3x 14.6x 9.6x 8.6x 7.8x 11.8x 10.3x 9.4x 1.0x 1.0x 1.0x

Nike 22.0x 19.1x 16.9x 13.4x 12.0x 11.1x 15.0x 13.4x NA 2.0x 1.9x 1.7x

VF Corp 18.0x 16.0x 14.0x 12.0x 10.9x 9.6x 13.7x 12.4x 11.3x 2.0x 1.9x 1.7x

Under Armour 42.8x 34.2x 27.1x 20.3x 16.3x 13.8x 23.9x 19.3x 15.9x 2.9x 2.4x 2.0x

Lulu Lemon 39.2x 30.8x 25.0x 23.5x 18.4x 14.9x 26.3x 20.7x 16.4x 6.6x 5.4x 4.4x

Anta Spots 13.6x 13.3x 12.3x 6.7x 6.3x 5.7x 7.2x 6.9x 6.2x 1.3x 1.3x 1.2x

Asics 23.1x 21.0x 19.6x 13.2x 11.9x 11.1x 16.5x 14.4x 13.1x 1.2x 1.1x 1.1x

Amer Sports 16.1x 13.5x 12.2x 10.2x 9.2x 8.5x 12.6x 11.0x 10.0x 1.0x 0.9x 0.9x

Li Ning n.m. 110.2x 18.2x 65.2x 12.1x 7.3x n.m. 51.0x 11.2x 0.8x 0.7x 0.7x

Total sector weighted 23.5x 20.9x 17.5x 14.5x 12.3x 11.0x 15.9x 14.2x 9.7x 2.4x 2.1x 1.9x

Total sector median 20.4x 19.1x 16.9x 13.2x 11.9x 9.6x 14.4x 13.4x 11.3x 1.3x 1.3x 1.2x

adidas 20.7x 17.4x 14.8x 11.6x 9.9x 8.7x 14.2x 11.9x 10.3x 1.3x 1.2x 1.1x

adidas vs peers (premium/ discount) -11.6% -16.7% -15.3% -19.8% -19.2% -21.0% -10.7% -16.1% 5.8% -45.9% -43.4% -40.6%

adidas Berenberg estimates 20.6x 17.0x 13.8x 11.2x 9.5x 8.0x 13.3x 11.2x 9.2x 1.3x 1.2x 1.1x

adidas vs peers (premium/ discount) -12.2% -18.4% -21.0% -22.9% -22.5% -27.1% -16.1% -21.2% -5.3% -46.5% -43.8% -41.2%

EV/ salesPE EV/ EBITDA EV/ EBIT


49

(Nike: May 2011; adidas: December 2011; and Puma: December 2011).

Of the top 10 players, Nike and adidas have been the two largest share winners over the past five years (2007-12) according to Euromonitor. Nike increased its global sporting goods market share by 200bp to 14.7% over this five-year period, with adidas gaining 140bp to 11.5%. Of the top 10 global players, Puma was one of only two companies to lose share, dropping 10bp to 2.1%.

Nike 2015 strategy

Nike expects to generate:

high single-digit revenue growth (average annual rate);

mid-teens earnings-per-share growth (average annual rate);

return on invested capital of 25% and;

an increase in dividends, within a target calendar year payout range of 25-35%.

Nike reiterated its goal of reaching $28bn-30bn of sales by 2015 during its Q3 2013 earnings call in March. Assuming Nike reaches the mid-point at $29bn, this would imply a three-year sales CAGR (FY 2012-15) of 6.3%, a higher growth rate than adidas at just over 5% and consistent with our market model assumptions, where we expect adidas and Nike to take the most incremental market share to FY 2015 (560bp and 960bp respectively).

Margin and costs metrics

We compare adidas’s, Puma’s and Nike’s COGS as a percentage of sales, and operating expenses (excluding depreciation) as a percentage of sales, EBIT and gross profit historical profiles in order to highlight relative deltas and/or future cost-saving opportunities.

adidas, Puma and Nike COGS as a percentage of sales (CY 2003-12)

Source: Company data, Berenberg estimates, Bloomberg consensus

adidas has historically had a higher COGS base than Puma. As raw material (65% of COGS) prices fall, we expect COGS pressure to ease. We estimate that sporting goods companies could benefit by 50-150bp from lower raw material costs in 2013 (for adidas, no single raw material accounts for more than 5% of COGS).

40%

45%

50%

55%

60%

65%

CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12

Puma adidas Nike


50

The net impact on gross margin is likely to be lower, assuming global consumption for sporting goods cools on weaker consumer confidence and increased cost of living.

Adidas’s, Puma’s and Nike’s opex as a percentage of sales (CY 2003-12E*)

Source: Company data, Berenberg estimates, *Bloomberg consensus (FY 2013 Nike)

Operating expenses as a percentage of sales evolution for adidas versus Nike highlight significant operating leverage opportunities for adidas in our view.

Within the sporting goods sector, we have noted inefficiencies linked with some of the largest companies as regards warehouse capacity management, order taking and distribution. Part of this, we believe, was due to the legacy “order book” model whereby sporting goods companies would look to fill almost an entirely wholesale order book up to 70-80% in advance and work on the basis of releasing two global collections a year (in summer and winter).

As part of the strategic investments adidas, Nike and Puma are taking to 2015, we believe that all three companies have varying opportunities to rationalise distribution capacity, reduce costs and improve working capital.

Both adidas and Puma are running major distribution centre rationalisation projects, which initially will increase execution risk and double running costs but ultimately ought to result in material cost savings and working capital improvements.

We note that adidas management believes it is “half-way” there in terms of reaching its 2015 infrastructure targets. adidas shipped 244m pairs of shoes, 314m units of apparel and 51m units of hardware in FY 2012, so the distribution base is robust enough to deal with global demand.

We expect a new NEO supply chain management system to be implemented in FY 2013 with a major SAP upgrade in Russia. E-commerce will also be consolidated on a global basis with one IT platform and one IT solution.

By comparison, Nike recorded CY 2011 operating expenses as a percentage of sales of 30.9% (adidas, 39.9% (CY 2012 39.5%) highlighting Nike’s superior operating efficiency and future cost opportunities for adidas group.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12

Puma adidas Nike


51

FX exposure

Dollar appreciation and impact vs. adidas, Puma and Nike – translation

adidas Puma Nike Appreciation of the USD vs. other currencies Positive Positive Negative

Depreciation of the USD vs. other currencies Negative Negative Positive


Company KPIs

We outline key KPIs for the adidas group, Puma and Nike in order to assess key management remuneration components.

Company specific KPIs

Company adidas Puma Nike KPI Operating cash flow as the most

important driver to increase shareholders value

By 2015: “Back on the Attack” metrics

2013: Successful implementation of the transformation and cost-reduction programme

Operating profit

Sales, EPS and share price performances

Metrics Operating profit

Change in operating working capital

Net investments (capex - D&A)

Sales, SG&A, operating margin, capex as a percentage of sales, FCF and ROCE

Profitability over the shorter term

Operating profit of individual segments

WKR and PP&E are regularly reviewed by management


adidas 12-month forward consensus EPS moves and re-rating versus peers

Source: DataStream

We believe that adidas Group has the potential to continue to increase its market share in the United States where it comes from a particularly low base and operates its lowest regional EBIT margin – we estimate just below 6%. In our view, the adidas High School Kids brand and sales strategy are having a positive impact not only in terms of increased conversion and brand engagement but also with US department stores allocating more space to the adidas brands in store (play zones in Dicks Sporting goods, for instance).

16% 16% 4%

-5%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

adidas Nike Puma Li Ning

12m fwd. Consensus EPS Δ Market Multiple Δ

Mkt. Relative Multiple Δ Share price movt


52

We believe there is greater potential for EBIT margin accretion at adidas (FY 2012 8% versus Nike Bloomberg consensus of 12.9% for FY 2013 as of May). A key reason for the higher EBIT margin at Nike is that in euros, Nike is c30% larger in terms of sales and therefore has stronger purchasing power with suppliers and historic negotiating firepower with US department stores. Any strengthening in the US dollar is positive for adidas and less favourable for Nike.

Nike’s operating expenses as a percentage of sales (excluding depreciation) are lower than adidas at c30%. We appreciate that Nike plays bigger in its home market and has greater proximity sourcing so is able to maintain a leaner operating cost structure. However, we do not believe that the delta (excluding depreciation) should be as high as almost 1,000bp.

As a result, we see material cost saving opportunities for adidas in distribution, sourcing and supply as well as improving stock management and replenishment rates as US and European city-based distribution centres are rationalised into regional hubs. We expect the positive operating leverage to take effect during 2014.

On our analysis, adidas Group post-tax ROIC is expected to increase 430bp in FY 2013 to 10.8% and by a further 170bp to 12.5% by FY 2015. This compares with Nike’s current mid teens post-tax ROIC profile.

We believe that adidas is taking share from Nike in key regions such as Mainland China and note during our recent field trip that Nike’s sizing for the local market was not tailored to suit the local demographic (too many large and extra large clothing sizes on racks). adidas appeared to have the right offering in the appropriate sizes in its retail stores in Shanghai and Hong Kong.

adidas vs. Nike forward P/E evolution

Source: DataStream

75.0

85.0

95.0

105.0

115.0

125.0

135.0

Jun

-11

Au

g-1

1

Oct

-11

Dec

-11

Feb

-12

Ap

r-1

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-12

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adidas Nike


53

Financials

Adidas profit and loss

In €m FY11 FY12 FY13E FY14E FY15E FY16E Sales 13,322 14,883 15,194 16,186 17,231 18,355

chg. +11.1% +11.7% +2.1% +6.5% +6.5% +6.5% CoGS (6,993) (7,780) (7,609) (7,989) (8,389) (8,766)

% of sales 52.5% 52.3% 50.1% 49.4% 48.7% 47.8% Gross profit 6,329 7,103 7,586 8,196 8,842 9,589

margin 47.5% 47.7% 49.9% 50.6% 51.3% 52.2% Royalty and commission 93 105 109 117 124 129 Other operating income 98 127 132 137 143 149 Operating expenses (5,321) (5,875) (6,105) (6,433) (6,700) (6,977)

% of sales 39.9% 39.5% 40.2% 39.7% 38.9% 38.0% EBITDA 1,199 1,195 1,722 2,017 2,408 2,889

margin 9.0% 8.0% 11.3% 12.5% 14.0% 15.7% Depreciation (246) (275) (281) (299) (318) (339) Impairment losses

(265)

% of sales 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% Operating income 953 920 1,441 1,719 2,090 2,550

margin 7.2% 6.2% 9.5% 10.6% 12.1% 13.9% Operating income, adjusted 953 1,185 1,441 1,719 2,090 2,550

chg. +6.6% +24.3% +21.6% +19.2% +21.6% +22.0% margin 7.2% 8.0% 9.5% 10.6% 12.1% 13.9%

Financial result (84) (69) (53) (37) (17) 11 chg. -4.5% -17.9% -22.5% -30.1% -54.8% -164.3%

Earnings before taxes 869 851 1,388 1,681 2,073 2,561 chg. +7.8% -2.1% +63.1% +21.1% +23.3% +23.5%

Earnings before taxes adjusted 869 1,116 1,388 1,681 2,073 2,561 chg. +7.8% +28.4% +24.4% +21.1% +23.3% +23.5%

Income taxes (261) (327) (396) (479) (591) (730) Tax rate 30.0% 38.4% 28.5% 28.5% 28.5% 28.5%

Income taxes, adjusted (327) (327) (396) (479) (591) (730) Tax rat, adjusted 37.6% 29.3% 28.5% 28.5% 28.5% 28.5%

Minority interest 5 2 2 2 2 2 Income from discontinued operations/ others

Net income 613 526 995 1,204 1,484 1,833 Net income adjusted 613 791 995 1,204 1,484 1,833 EPS adjusted 2.93 3.78 4.75 5.76 7.10 8.76

chg. +8.1% +29.1% +25.7% +21.1% +23.3% +23.5% EPS adjusted diluted 2.93 3.78 4.75 5.76 7.10 8.76

chg. +8.1% +29.1% +25.7% +21.1% +23.3% +23.5% Weighted average shares outstanding (mn) 209.216 209.216 209.216 209.216 209.216 209.216 Weighted average shares outstanding, diluted (mn) 209.216 209.216 209.216 209.216 209.216 209.216 DPS 1.00 1.35 1.70 2.05 2.53 3.13 DPS growth 25.0% 35.0% 25.7% 21.1% 23.3% 23.5% Pay out ratio 34.1% 35.7% 35.7% 35.7% 35.7% 35.7%



54

Balance sheet

In €m FY11 FY12 FY13E FY14E FY15E FY16E Cash and cash equivalents 906 1,670 2,108 2,611 3,306 4,234 Short-term financial assets 465 265 265 265 265 265 Accounts receivable 1,595 1,688 1,723 1,836 1,954 2,082 Other current financial assets 289 192 192 192 192 192 Inventories 2,502 2,486 2,538 2,704 2,878 3,066 Income tax receivables 77 76 78 83 88 94 Other current assets 469 489 499 532 566 603 Assets classified as held for sale 25 11 11 11 11 11 Total current assets 6,328 6,877 7,414 8,233 9,260 10,547 PPE 963 1,095 1,339 1,592 1,852 2,121 Goodwill 1,553 1,281 1,281 1,281 1,281 1,281 Trademarks 1,503 1,484 1,484 1,484 1,484 1,484 Other intangibles 160 167 167 167 167 167 Long-term financial assets 97 112 112 112 112 112 Other non-current financial assets 42 21 21 21 21 21 Deferred tax assets 484 528 528 528 528 528 Other non-current assets 107 86 86 86 86 86 Total non-current assets 4,909 4,774 5,018 5,271 5,531 5,800 Total assets 11,237 11,651 12,433 13,504 14,792 16,347 Short-term borrowings 289 280 280 280 280 280 Accounts payable 1,887 1,790 1,827 1,947 2,072 2,208 Other current financial liabilities 66 83 83 83 83 83 Income taxes 252 275 281 299 318 339 Other current provisions 549 563 575 612 652 694 Current accrued liabilities 992 1,084 1,084 1,084 1,084 1,084 Other current liabilities 303 299 305 325 346 369 Liabilities classified as held for sale 0 0 0 0 0 0 Total current liabilities 4,338 4,374 4,435 4,630 4,836 5,057 Long-term borrowings 991 1,207 1,207 1,207 1,207 1,207 Other non-current financial liabilities 9 17 17 17 17 17 Pensions and similar obligations 205 251 251 251 251 251 Deferred tax liabilities 430 368 376 400 426 454 Other non-current provisions 55 69 69 69 69 69 Non-current accrued liabilities 45 40 40 40 40 40 Other non-current liabilities 36 34 35 37 39 42 Total non-current liabilities 1,771 1,986 1,994 2,021 2,049 2,080 Total liabilities 6,109 6,360 6,430 6,651 6,885 7,137 Share capital 209 209 209 209 209 209 Reserves 791 641 641 641 641 641 Retained earnings 4,137 4,454 5,168 6,020 7,076 8,382 Shareholder's equity 5,137 5,304 6,018 6,870 7,926 9,232 Non-controlling interests -9 -13 -15 -17 -20 -22 Total equity 5,128 5,291 6,003 6,852 7,907 9,210 Total liabilities and equity 11,237 11,651 12,433 13,504 14,792 16,347



55

Cash flow

In €m FY11 FY12 FY13E FY14E FY15E FY16E Operating cash flow

PBT 869 851 1,388 1,681 2,073 2,561 D&A 253 536 281 299 318 339 Operating profit before wk 1,179 1,430 1,668 1,980 2,391 2,900 Increase in receivables (41) (135) (35) (112) (119) (127) Increase in inventories (353) 23 (52) (166) (175) (188) Increase in payables 449 94 37 119 126 135 Cash from operating activities 1,234 1,412 1,639 1,886 2,292 2,793 Interest paid (113) (90)

Income taxes paid (314) (380) (396) (479) (591) (730) Net cash from operating activities 807 942 1,243 1,407 1,701 2,064 Investing activities

Purchase of intangibles (58) (58) Proceeds from intangibles 0 1 Purchase of PPE (318) (376) (525) (551) (579) (608)

Proceeds from sale of PPE 2 19 Net cash used in investing activities (566) (217) (525) (551) (579) (608)

Free Cash flow 241 725 718 856 1,123 1,456 Financing activities

Dividend paid to shareholders (167) (209) (282) (355) (430) (530) Dividend paid to non-controlling interest (3) (3) 2 2 2 2 Net cash used in financing activities (500) 42 (280) (353) (428) (528) FX 15 (3) Change in cash and cash equivalents (244) 764 438 503 695 928 Cash and cash equivalents, beginning of the year 1,156 912 1,676 2,114 2,617 3,312 Cash and cash equivalents at year-end 912 1,676 2,114 2,617 3,312 4,240 Bank overdraft 6 6 6 6 6 6 Cash & cash equivalents BS 906 1,670 2,108 2,611 3,306 4,234 Debt from BS (1,280) (1,487) (1,487) (1,487) (1,487) (1,487) Interest calculation Average cash/ (debt) 1,034 1,294 1,895 2,366 2,965 3,776 Interest rate (debit) 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% Interest rate (credit) 3.4% 3.4% 3.4% 3.4% 3.4% 3.4% Interest (expense)/ income (80) (66) (53) (37) (17) 11 Net cash/(debt) 91 448 886 1,389 2,084 3,012


Burberry Group plc Luxury Goods

56

Smelling of roses?

• In our view, FY 2014 will be another volatile year for Burberry. Management has guided to H1 2014 adjusted PBT lower than last year (£173m) as the company reinstates the bonus accrual (£12m impact last year) and absorbs a greater proportion of Beauty integration costs during the first half of the year. Moreover, Interparfums has guided to Burberry 2013 sales of c$98m (c£62m) with the bulk of sales, if not all, to be registered during the first half of the year. Hence we expect Burberry’s Beauty sales to be 25%/75% weighted in FY 2014.

• After the FY 2013 results, we met with CEO Angela Ahrendts and the broader management team. Key takeaways included a) the company’s belief that there is a sustainable long-term opportunity to drive Beauty sales and gain market share in fragrance and notably skincare; b) an ongoing commitment to digital investment with increased focus on consumer connectivity through the initiative Burberry 360; and c) no change on the timing of the termination of the Japanese licence by June 2015 (FY 2016). We expect Burberry to “right-size” the operations and focus on a concession model within key Japanese department stores. This could result in a neutral EBIT impact by FY 2016, assuming Beauty sales grow above the group average, which we believe is a realistic expectation.

• We also spent time with Paul Price, chief merchandising officer. We were impressed with the A/W collections that started going into stores this June. Burberry product offerings will change every month in line with the monthly flow strategy to ensure ongoing freshness in-store and online. We expect greater emphasis will be placed on small leather goods where Burberry has a lower attachment rate compared with peers, “solid” leather bags over house check, menswear (tailoring and accessories), and a canvas bag launch within the Brit collection coupled with initiatives to drive up sales productivity.

• We make minor changes to our earnings estimates and appreciate upside risk to Burberry’s mainland Chinese outer sales, having visited stores in Shanghai and Hong Kong. We make no change to our P/E based 1,600p price target, supported by our NPV takeout analysis (£8bn), DCF (1,676p) and SOTP (1,696p).

Buy Rating system

Current price

GBp 1,350

Absolute

Price target

GBp 1,600 13/06/2013 London Close Market cap GBP 5,998 m Reuters BRBY.L Bloomberg BRBY LN

Changes made in this note Rating Buy (no change) Price target GBp 1,600 (no change) Chg 2014e 2015e 2016e


Sales 2211 0.5 2364 1.8 2523 1.7

EBIT 464 1.8 509 0.6 550 0.1

EPS 77.52 0.3 85.18 -0.6 92.24 -0.9


Share data

Shares outstanding (m) 447 Enterprise value (GBP m) 5,779 Daily trading volume 1,959,016

Performance data

High 52 weeks (GBp) 1,541 Low 52 weeks (GBp) 1,000 Relative performance to SXXP FTSE 100 1 month 1.6 % 2.5 % 3 months -4.2 % -3.8 % 12 months -19.9 % -11.3 %

Business activities: Burberry designs, sources, manufactures and distributes luxury men's, women's and children's clothing and non-apparel accessories globally through its own retail stores, concessions, online and to wholesale customers and franchisees. Burberry also licenses third parties to manufacture and distribute products using the "Burberry" trademarks.

20 June 2013


Bassel Choughari


Rupert Trotter


Y/E 31.03., GBP m 2012 2013 2014E 2015E 2016E

Sales 1,857 1,999 2,222 2,405 2,566

EBITDA 465 539 613 663 711

EBIT 377 428 472 511 550

Net profit 274 312 347 378 408

Y/E net debt (net cash) -338 -297 -482 -639 -785

EPS (reported) 62.8 71.6 79.6 86.7 93.6

EPS (recurring) 61.6 70.0 77.8 84.7 91.4

CPS 45.2 23.8 77.9 76.5 79.8

DPS 25.0 29.0 33.4 38.4 44.1

Gross margin 69.9% 72.1% 71.8% 71.2% 71.5%

EBITDA margin 25.0% 27.0% 27.6% 27.6% 27.7%

EBIT margin 20.3% 21.4% 21.2% 21.3% 21.4%

Dividend yield 1.8% 2.1% 2.4% 2.8% 3.2%


EV/sales 3.1 2.9 2.6 2.4 2.3

EV/EBITDA 12.4 10.7 9.4 8.7 8.1

EV/EBIT 15.3 13.5 12.2 11.3 10.5

P/E 22.2 19.6 17.6 16.2 15.0

ROIC/WACC % spread 21.3% 17.1% 15.5% 14.4% 13.1%



57

Burberry assumptions and sensitivities

Divisional assumptions

FY12 FY13 FY14E FY15E FY16E

3yr CAGR (%)

Group Sales (£m) 1,857.2 1,998.7 2,221.9 2,405.5 2,566.4

8.7%

Y/Y growth -2.3% 7.6% 11.2% 8.3% 6.7%

Operating Profit (£m) 376.9 428.1 471.9 511.5 550.3

8.7%

Y/Y growth 25.2% 13.6% 10.2% 8.4% 7.6% Operating margin (%) 20.3% 21.4% 21.2% 21.3% 21.4%

EBIT Driver Retail/wholesale margin % 16.4% 17.8% 19.0% 19.2% 19.5%

Gross margin % 68.1% 72.1% 71.8% 71.2% 71.5% Operating expenses as % of sales -51.7% -52.8% -52.8% -52.0% -52.0% Licensing margin % 82.9% 84.6% 84.0% 84.0% 84.0%

Retail/Wholesale Retail sales (£m) 1,270.3 1,416.6 1,551.2 1,675.3 1,809.3

8.5%

Y/Y growth 32.0% 11.5% 9.5% 8.0% 8.0% Underlying growth 31.0% 12.0% 7.5% 8.0% 8.0% FX impact 1.0% -0.5% 2.0% 0.0% 0.0% New space growth 17.0% 7.0% 4.0% 5.0% 5.0% LFL growth 14.0% 5.0% 3.5% 3.0% 3.0%

Wholesale sales (£m) 478.3 472.7 594.2 653.6 679.7

12.9%

Y/Y growth 8.6% -1.2% 25.7% 10.0% 4.0% Underlying growth 8.0% 1.0% 25.0% 10.0% 4.0% FX impact 0.6% -2.2% 0.7% 0.0% 0.0%

Retail/wholesale EBIT (£m) 286.9 335.6 407.6 447.1 485.4

13.1%

EBIT margin 16.4% 17.8% 19.0% 19.2% 19.5%

Licence Total sales (£m) 108.6 109.4 76.6 76.6 77.3

-10.9%

Y/Y growth 10.4% 0.7% -30.0% 0.0% 1.0% Underlying growth 5.0% -1.0% -27.0% 0.0% 1.0% FX impact 5.4% 1.7% -3.0% 0.0% 0.0%

EBIT (£m) 90.0 92.5 64.3 64.3 65.0 EBIT margin 82.9% 84.6% 84.0% 84.0% 84.0%

Benchmark EPS (p) 61.6 70.0 77.8 84.7 91.4

9.3%

Y/Y growth 26.1% 13.5% 11.1% 8.9% 8.0%

DPS (p) 25.0 29.0 33.4 38.4 44.1

15.0%

Y/Y growth 25% 16% 15% 15% 15%



58

Beauty is an opportunity

Burberry had a busy and successful FY 2013 from a financial, brand and consumer engagement perspective. Group sales reached c£2bn while adjusted PBT of £428m was ahead of consensus expectations.

FY 2014 marks the first full year that Burberry will operate its Beauty business, its fifth pillar of sales/brand growth, directly in-house. Management has guided to FY 2014 Beauty sales and EBIT of £140m and £25m respectively. This implies a FY 2014 EBIT margin of 17.8%, which in our view and relative to premium peers appears conservative.

2012/2013 momentum

Key highlights include:

Burberry Britain watch launch;

focus on flagship stores – Chicago, Regent’s Street, Hong Kong and Shanghai;

chat live launched;

global gift drive;

spring/summer campaign with record consumer engagement in store and online;

Burberry “Splash” eyewear launch;

Burberry first to live-stream catwalk show on Twitter;

smartphone personalisation introduced;

nail colours introduced; and

trench kisses campaign launched.

Burberry Beauty operations are underpenetrated According to Burberry management, the size of the overall global beauty market is estimated at $100bn, with the premium market estimated at €20bn. The US and Europe are estimated to have c60% premium market share while Chinese demand has doubled over the past five years.

Burberry is clearly underpenetrated across all markets with the exception of China, where it has a more established product foothold.

Burberry Beauty market share dynamics versus the number-one brand Underpenetrated in large markets US France UK Italy China Market share of no 1 brand 11% 11% 11% 11% 21% Burberry

2% 1% 1% 1% 12%

Source: Company data

The aim of the Burberry Beauty division is to break into the top 10 across all key major categories of fragrance, cosmetics and skincare. We appreciate that Burberry’s skincare business is very small today (less than £20m of sales); hence there is a great opportunity to grow the Beauty segments from a low base.

Stepping into Interparfums’ shoes

As of 1 April 2013, Burberry officially took its Beauty operations in-house and guided to FY 2014 revenues of £140m and EBIT of £25m. We appreciate there will be start-up costs and an overhang of old Burberry fragrance stock at Interparfums; we expect this to be cleared in the next 3-6 months. As a result, Burberry’s £140m FY 2014 revenues are likely to be H2 weighted with the bulk of


59

profit also falling into the second half of the year.

The front-end loaded integration costs, coupled with the reinstatement of the bonus accrual and non-Beauty wholesale underlying H1 2014 sales guidance of -10%, are sufficient to explain why management has guided to H1 2014 PBT below that of H1 2013 (£173m).

By terminating the Beauty licence, there has been a reallocation of staff to the division (a third of Burberry’s staff have moved internally) while key industry hires from Dior, Chanel and P&G have been made for product, sourcing and distribution.

Advantages of one company, one brand and broad consumer appeal We highlight the advantages below:

leveraging group capabilities such as media and A&P spend;

cross-selling products (Burberry Body and the “nude” trench coat collection); and

building on a brand with broad consumer appeal coupled with differentiated and authentic British heritage.

Burberry management is working on product development, sourcing, inventory management, sales and distributor management, all of which would have been taken care of by Interparfums previously. We find it reassuring that Burberry has an effective fragrance and make-up supply chain in place with just over 80 suppliers and 500 SKUs today with a prospective 1,500 SKU range under development.

The supplier base has been “engaged and proactive”, according to management as Burberry launched its inaugural Beauty conference in February 2013. SAP is live and integrated and the global distribution hub is fully operational. Burberry expects that more than 70% of its volume will come via suppliers and that more than 95% of Beauty distribution will take place via points of sales (POS).

We believe there is significant scope to increase the product range across the three key brand collections – Prorsum, London and Brit. Management expects four exclusive colognes to be introduced at the Prorsum level and London to enjoy continued success with Body as well as with a new, younger/fresher fragrance called Tender. Another product offering will sit alongside the current Brit fragrance; hence there is plenty in the pipeline to drive the top line.

Our current estimates assume that Beauty sales will more than double by FY 2017 to above £300m, assuming an EBIT margin of 18% (£55.4m). We view the EBIT margin assumption as conservative, especially given that the mix of intended new products are geared towards the high end of the Burberry pricing pyramid. Moreover, we note that our sales estimates imply that Wholesale underlying (excluding Beauty) sales decline by mid-to-high single digits in FY 2014 with a small recovery in FY 2015 (+3.8%).


60

Japanese licence termination may not dilute earnings

There appears to be a growing consensus that Burberry could suffer from an EBIT decline of up to 10% in FY 2016 as management is terminating the Japanese licence in June 2015. Contrary to consensus expectations, we believe the impact may be neutral to potentially positive by FY 2016 and clearly positive for the long term as Burberry not only right-sizes the Burberry business in Japan but retains full control of the brand.

We do not expect Burberry’s Japanese joint venture to make up the anticipated profit shortfall in FY 2016. But, together with an increased proportion of sales coming from retail (higher margin) coupled with resilient sales and an above-group EBIT margin performance from the Beauty business, the anticipated FY 2016 EBIT impact may not be as negative as current expectations suggest.

As of FY 2013, global licence revenue accounted for just over 5% of group sales and c21.6% of group profit. Slightly more than 60% of the licence business is exposed to Japanese consumers.

Approximately two-thirds of Burberry’s Japanese licence business is apparel and one-third residual non-apparel. We understand that c50% of Japan licence apparel is exposed to premium local collections (“Japan London”), which do not reflect/align with Burberry’s global collections. In our view, as long as these sub-collections continue to run, Burberry is likely to suffer further brand equity dilution. Non-apparel licences have been coming to an end.

We believe management has a clear vision for the Burberry brand in Japan as it rolls out its non-apparel JV retail network with Sanyo, Shokhai and Mitsui. The Japanese non-apparel JV comprises three mainline stores (Ginza, Omotesando and Kobe) and nine concessions (based in department stores). Some legacy issues have already been cleaned up (£6m cost related to non-apparel licence terminations, such as leather goods, shoes and belts) with the non-apparel JV currently accounting for just under 2% of global sales.

Management coordinated the launch of global fragrance (Burberry Body), eyewear and timepieces during 2011, which reinforced Burberry’s global offering and strengthened regional brand equity. As the Beauty business is now operating in-house and reports through the Wholesale division, we expect the licence sales and EBIT contribution to represent 3.4% of sales and 13.6% of EBIT in FY 2014 and 3.2% of sales and 12.6% of group EBIT by FY 2015 (note this includes the watch licence with Fossil and eyewear licence with Luxottica, due for renewal in December 2013 and 2015 respectively as well as childrenswear licences in Europe and the Middle East).

We appreciate the Japanese licence termination is different from the Spanish restructuring of FY 2010 (there are no liabilities/write-downs), as we estimate there are 750 POS (fragrance, kiosks in department stores; including eyewear with the Sunglass Hut, the number of POS is likely to exceed 1,000).

Initial estimates imply £2,000 sq/ft, increasing to £3,000 by FY 2017

Burberry is due to update the market on its termination plans in 2014. We outline our initial estimates to take into account CEO Angela Ahrendts’ desire to right-size the Japanese operations, aiming for 50-75 doors over the medium to long term. We envisage the bulk of these being run via a concession model in Japanese department stores in better locations than the current Burberry licence stores (some are on the seventh floor of Japanese department stores and do not share the same footfall advantages as competitors such as Gucci and Prada, which are typically located on the ground/first floor alongside anchor tenants such as Louis Vuitton).


61

Assuming Burberry has a total of 42 stores by FY 2016 (12 mainline and 30 concessions) with average mainline stores at 4,500 sq/ft and concessions at 1,000 sq/ft.

Should Japanese stores reach £3,000 sq/ft at an EBIT margin of 19% (conservative in our view as Hong Kong stores already convert over £4,000 sq/ft and have EBIT margins of over 25% in some cases, according to our estimates), the Japanese operations would generate £51m of EBIT against a normalised run rate of £51m (we assume 80% Japanese EBIT contribution out of a forecasted £63.4m for FY16 assuming no termination).

Japan working assumptions

Japan FY13E licence FY13E FY14E FY15E FY16E

Revenue 725 51 99 167 269

reported growth %

93.7% 69.4% 60.6%

currency impact %

0.0% 0.0% 0.0%

lfl sales %

15.0% 15.0% 10.0%

space %

58.8% 50.6% 37.7%

EBIT £m 74 10 19 32 51

EBIT margin 10.2% 19.0% 19.0% 19.0% 19.0%

Stores 750 15 23 33 42

Mainline 0 3 5 8 12

Concession 0 12 18 25 30

0.5 Space ('000 sq ft) 375 26 41 61 84

Space growth

59% 51% 38%

Japan sales sq/ft 1,933 2,000 2,250 2,500 3,000


Moreover, we note that the new Kobe mainline store has c30% sales exposure to its Prorsum collection compared with a group average sales exposure of c5%. As a result, our revenue estimates may prove conservative – assuming the Japanese consumer is more willing to purchase Prorsum in a higher concentration compared with other regions.


62

Financials

Profit and loss GBPm, y/e March FY12 FY13 FY14E FY15E FY16E

Group Revenue £m 1,857.2 1,998.7 2,221.9 2,405.5 2,566.4 Revenue growth 23.7 % 7.6 % 11.2 % 8.3 % 6.7 % Cost of sales (558.3) (556.7) (626.6) (692.8) (731.4) Gross profit 1,298.9 1,442.0 1,595.4 1,712.7 1,835.0 Gross margin % 69.9 % 72.1 % 71.8 % 71.2 % 71.5 % Memo: Distribution costs (510.5) (604.2) (584.6) (624.8) (669.1) % of sales 27.5% 30.2% 26.3% 26.0% 26.1% Memo: Admin expenses (412.3) (410.3) (397.0) (424.3) (454.4) % of sales 22.2% 20.5% 17.9% 17.6% 17.7% Net operating expenses (922.1) (1,015.1) (982.1) (1,049.7) (1,124.1) % of sales 49.7% 50.8% 44.2% 43.6% 43.8% Memo: Operating leases included above (182.9) (216.3) (209.3) (223.7) (239.5) Adjusted EBITDA 464.5 539.3 613.3 663.0 710.8 Memo: Depreciation (74.3) (94.5) (105.1) (113.7) (121.3) Adjusted EBITA 390.2 444.8 508.2 549.3 589.5 Memo: Amortisation (13.3) (16.7) (36.3) (37.8) (39.1) Adjusted EBIT 376.9 428.1 471.9 511.5 550.3 Adjusted EBIT margin % 20.3 % 21.4 % 21.2 % 21.3 % 21.4 % Treochy costs / other 0.0 (82.3) 0.0 0.0 0.0 Reported EBIT 376.9 345.8 471.9 511.5 550.3 Reported EBIT margin % 20.3 % 17.3 % 21.2 % 21.3 % 21.4 % Net finance (expenses)/income (10.9) 4.9 (2.1) (0.6) 0.9 Profit before taxation 366.0 350.7 469.8 510.9 551.2 Put option charge 10.2 (5.2) (5.2) (5.2) (5.2) Adjusted profit before taxation 376.2 427.8 464.6 505.7 546.0 Taxation (100.6) (91.5) (117.5) (127.7) (137.8) % tax rate 27.5 % 26.1 % 25.0 % 25.0 % 25.0 % Taxation attributable to adjusted PBT (102.4) (115.4) (117.5) (127.7) (137.8) Attributable profit for the year 263.3 254.3 352.4 383.2 413.4 Adjusted attributable profit for year 273.8 312.4 347.2 378.0 408.2

Dividends (95.9) (113.5) (145.5) (167.3) (192.4) Dividend cover 2.9x 2.8x 2.4x 2.3x 2.1x Payout ratio 35.0 % 36.3 % 41.9 % 44.3 % 47.1 % Retained profit 167.4 140.8 206.9 215.9 221.0 Basic DPS 25.0 29.0 33.4 38.4 44.1 % growth 25.0 % 16.0 % 15.0 % 15.0 % 15.0 %

Diluted EPS Diluted adjusted EPS 61.6 70.0 77.8 84.7 91.4

% growth 26.1 % 13.5 % 11.1 % 8.9 % 8.0 % Diluted EPS 59.3 57.0 78.9 85.8 92.6

Av. No of Ordinary Shares Outstanding (m) 435.9 436.2 436.2 436.2 436.2 Av. No of Diluted Ordinary Outstanding (m) 444.3 446.5 446.5 446.5 446.5



63

Cash flow GBPm, y/e March FY12 FY13 FY14E FY15E FY16E Cash from operating activities (reported EBIT) 376.9 345.8 471.9 511.5 550.3 Add back: Depreciation

74.3 94.5 105.1 113.7 121.3

Add back: Amortisation

13.3 16.7 36.3 37.8 39.1 (Increase)/decrease in inventories

(61.8) (39.2) (22.0) (34.5) (22.7)

(Increase)/decrease in receivables

(17.6) (32.0) (17.8) (14.7) (12.9) Increase/(decrease) in payables

60.0 27.6 42.7 40.4 23.6

Changes in working capital (19.4) (43.6) 2.9 (8.8) (12.0) Stock turn

1.8x 1.6x 1.7x 1.7x 1.7x

Receivables days

28.5 29.1 29.1 29.1 29.1 Payables days

212.1 222.8 222.8 222.8 222.8

Other non cash movements 37.4 109.6 0.0 0.0 0.0 Cash from operations 482.5 523.0 616.1 654.2 698.8 Interest received

2.7 3.5 5.1 6.5 7.7

Interest paid

(3.3) (2.6) 2.8 3.0 3.1 Taxation paid

(108.2) (99.0) (90.8) (117.2) (127.5)

Exceptional Net cash inflow from operations 373.7 424.9 533.2 546.4 582.2

Cash flows from investing activities Capex

(153.1) (175.9) (193.5) (212.8) (234.1) Net cash used in investing activities (176.6) (320.9) (193.5) (212.8) (234.1) Free cash flow 197.1 104.0 339.7 333.6 348.1 Cash flows from financing activities

Dividends paid in year

(99.2) (113.5) (145.5) (167.3) (192.4) Net cash from financing activities (154.3) (159.8) (145.5) (167.3) (192.4) Net increase in cash and cash equivalents 42.8 (55.8) 194.2 166.3 155.7 Movement on overdraft 40.2 (77.5) 0.0 0.0 0.0 Increase in cash and cash equivalents 83.0 (133.3) 194.2 166.3 155.7

Net debt calculation Closing cash balance

546.9 426.4 620.6 786.9 942.6 Loans and borrowings

(208.6) (129.8) (139.0) (148.2) (157.4)

Net (debt) / cash (excl. leases) 338.3 296.6 481.6 638.7 785.2



64

Balance sheet GBPm, y/e March FY12 FY13 FY14E FY15E FY16E ASSETS

Non-current assets Intangible assets

133.1 210.2 167.9 124.1 79.0

Property, plant and equipment

331.6 411.8 500.2 599.3 712.1 Deferred tax assets

84.1 117.6 117.6 117.6 117.6

Trade and other receivables

22.3 39.9 39.9 39.9 39.9 Derivatives

14.7 0.2 0.2 0.2 0.2

Total non-current assets 585.8 779.7 825.9 881.2 948.8 Current assets

Inventory

311.1 351.0 373.0 407.5 430.2 Trade and other receivables

145.2 159.6 177.4 192.1 204.9

Derivative financial assets

3.2 20.1 20.1 20.1 20.1 Income tax receivable

10.1 9.4 14.6 19.8 25.0

Cash and cash equivalents

555.2 426.4 620.6 786.9 942.6 Total current assets 1,024.8 966.5 1,205.7 1,426.4 1,622.9 Total assets 1,610.6 1,746.2 2,031.6 2,307.6 2,571.7 LIABILITIES

Non-current liabilities Long-term liabilities

(104.9) (108.0) (108.0) (108.0) (108.0) Deferred tax liabilities & Derivative liabilities

(1.6) (1.5) (1.5) (1.5) (1.5)

Retirement benefit obligations

(0.8) (0.6) (0.6) (0.6) (0.6) Long term provisions

(15.1) (19.8) (19.8) (19.8) (19.8)

Total non-current liabilities (122.4) (129.9) (129.9) (129.9) (129.9) Current liabilities

Bank overdrafts and borrowings

(208.6) (129.8) (139.0) (148.2) (157.4) Derivative financial liabilities

(1.9) (0.1) (0.1) (0.1) (0.1)

Trade and other payables

(324.4) (339.8) (382.5) (422.9) (446.4) Income tax liabilities

(61.9) (93.8) (120.4) (130.9) (141.3)

Total current liabilities (596.8) (563.5) (642.0) (702.1) (745.2) Total liabilities (719.2) (693.4) (771.9) (832.0) (875.1) Net assets 891.4 1,052.8 1,259.7 1,475.6 1,696.6 EQUITY

Ordinary share capital

0.2 0.2 0.2 0.2 0.2 Share premium account

202.6 203.6 203.6 203.6 203.6

Other reserves

181.5 233.1 233.1 233.1 233.1 Retained earnings

507.1 615.9 822.8 1,038.7 1,259.7

Total equity 891.4 1,052.8 1,259.7 1,475.6 1,696.6


Luxottica Group SpA Luxury Goods

65

Slowly but surely

• During our China trip, we visited LensCrafters (LC) stores in Shanghai. China is the world’s largest ophthalmic market by volume. However, we believe that value growth and profit conversion remain a medium to long-term story and see no major upside risk to our FY 2013 and FY 2014 estimates.

• According to our channel checks, the top three selling brands in Shanghai stores are Ray-Ban, Prada and Tiffany. We estimate that on average, Ray-Ban products are sold at a 10% discount compared to Europe while luxury products (Oliver Peoples, Burberry and MiuMiu) are sold at a 30-60% premium.

• We also estimate that within the visited stores, sales of sun products account for c50% of sales (c10% for LC in mainland China), driven by a younger and more fashion-oriented customer demographic.

• We also note that LC’s opticians have relatively high education standards (they have studied for several years) in a country where education levels are lower (we understand that anyone can become an optician after a month of training). Nevertheless, we were surprised to see that in order to drive footfall, LensCrafters offers free eye testing.

• Although emerging markets offer very attractive medium- to long-term prospects, short-term sales densities remain lower than in mature markets. We believe that markets such as China and Brazil offer long-term growth prospects, although ultimately we view the Latin American market (complemented by the Tecnol acquisition) as having more upside risk.

• We note that during our recent road show with management, CEO Guerra highlighted that China was the most challenging emerging market, notably for sun products. Our understanding is that in China, it took LensCrafters 3-4 years to become profitable.

• Our €41 price target, based on a P/E analysis and driven by earnings and cash flow forecasts, implies FY14E and FY15E P/Es of 24.3x and 21.2x respectively, versus a three-year historical average of 25.5x. It is supported by our DCF model (€41).

Buy Rating system

Current price

EUR 39.65

Absolute

Price target

EUR 41.00 17/06/2013 Milan Close Market cap EUR - m Reuters LUX.MI Bloomberg LUX IM

Changes made in this note Rating Buy (no change) Price target EUR 41.00 (no change) Chg 2013e 2014e 2015e


Sales 7732 - 8344 - 8965 -

EBIT 1156 - 1310 - 1478 -

EPS 1.45 - 1.67 - 1.90 -


Share data

Shares outstanding (m) 465 Enterprise value (EUR m) 18,856 Daily trading volume 1,133,247

Performance data

High 52 weeks (EUR) 42.70 Low 52 weeks (EUR) 26.60 Relative performance to SXXP FTSE MIB 1 month 0.0 % 3.9 % 3 months 2.1 % 0.3 % 12 months 22.0 % 22.9 %

Business activities: Manufacturing and Wholesale distribution (39.5% of FY11 sales) Retail Distribution (60.5% of FY11 sales)

Non-institutional shareholders: L. Del Vecchio 61.2%

20 June 2013


John Guy


Rupert Trotter


Y/E 31.12., EUR m 2011 2012 2013E 2014E 2015E

Sales 6,222 7,086 7,732 8,344 8,965

EBITDA 1,136 1,362 1,542 1,718 1,918

EBIT 821 1,004 1,156 1,310 1,478

Net profit 456 567 681 782 894

Net cash (net debt) 2,078 1,263 1,026 645 187

EPS (reported) 0.98 1.17 1.46 1.68 1.92

EPS (recurring) 0.98 1.21 1.45 1.67 1.90

CPS 1.3 1.2 1.4 1.5 1.8

DPS 0.5 0.6 0.7 0.8 1.0

Gross margin 65.2% 66.4% 66.9% 67.3% 67.9%

EBITDA margin 18.3% 19.2% 19.9% 20.6% 21.4%

EBIT margin 13.2% 14.2% 14.9% 15.7% 16.5%

Dividend yield 1.6% 2.0% 2.3% 2.7% 3.0%


EV/sales 3.0 2.7 2.4 2.3 2.1

EV/EBITDA 16.6 13.8 12.2 11.0 9.8

EV/EBIT 23.0 18.8 16.3 14.4 12.8

P/E 36.4 29.2 24.3 21.2 18.5

ROIC/WACC % spread -1.4% -0.5% 0.7% 1.3% 1.8%



66

Financials

Profit and loss

in €m 2011 2012 2013 2014 2015

Net sales 6,222 7,086 7,732 8,344 8,965

chg. +7.3% +13.9% +9.1% +7.9% +7.4%

CoGS (2,168) (2,379) (2,558) (2,731) (2,873)

chg. +8.9% +9.7% +7.5% +6.8% +5.2%

as a % of sales 35% 34% 33% 33% 32%

Gross profit 4,054 4,707 5,175 5,613 6,092

margin 65.2% 66.4% 66.9% 67.3% 67.9%

chg. +6.5% +16.1% +9.9% +8.5% +8.5%

Operating expenses (2,923) (3,345) (3,632) (3,894) (4,174)

chg. +4.6% +14.4% +8.6% +7.2% +7.2%

as a % of sales 47% 47% 47% 47% 47%

EBITDA 1,131 1,362 1,542 1,719 1,918

margin 18.2% 19.2% 19.9% 20.6% 21.4%

chg. +11.6% +20.4% +13.2% +11.4% +11.6%

EBITDA, adjusted 1,136 1,362 1,542 1,719 1,918

margin 18.3% 19.2% 19.9% 20.6% 21.4%

chg. +9.8% +19.9% +13.2% +11.4% +11.6%

Operating income 807 982 1,156 1,310 1,478

margin 13.0% 13.9% 14.9% 15.7% 16.5%

Exceptionals, operating income -8.9 -22 Operating income, adjusted 821 1,004 1,156 1,310 1,478

chg. +12.1% +22.3% +15.1% +13.3% +12.9%

margin 13.2% 14.2% 14.9% 15.7% 16.5%

Interest income/ (expense) (109) (119) (94) (91) (87)

Other - net -3 -6 -3 -3 -3

Other income expenses, net (112) (126) (97) (94) (90)

Pre-tax profit 695 856 1,059 1,216 1,389

Pre-tax profit, adjusted 712 885 1,062 1,219 1,392

Tax (237) (310) (376) (432) (493)

Tax rate 34.1% 36.3% 35.5% 35.5% 35.5%

Minority interest 6 4 4 4 4

Net income 452 542 679 780 891

chg. +12.5% +19.8% +25.3% +14.9% +14.3%

Net income, adjusted 456 567 682 783 894

chg. +13.1% +24.5% +20.2% +14.8% +14.3%

EPS, ajdusted 0.99 1.22 1.47 1.68 1.93

chg. +12.7% +23.3% +20.2% +14.8% +14.3%

EPS, adjusted fully diluted 0.98 1.21 1.45 1.67 1.90

chg. +12.5% +22.8% +20.2% +14.8% +14.3%

Dividend per share 0.49 0.58 0.73 0.84 0.96

chg. +11.4% +18.7% +25.3% +14.9% +14.3%

Pay out ratio 50% 50% 50% 50% 50%

# shares, weighted avg. 460.4 464.6 464.6 464.6 464.6

Fully diluted # shares, weighted avg. 463.3 469.6 469.6 469.6 469.6



67

Balance sheet

in €m 2011 2012 2013 2014 2015

Current assets Cash & cash equivalents 905 790 1,027 1,409 1,867

Account receivable, net 668 699 887 951 1,004

Inventories, net 650 729 654 701 740

Other assets 231 209 209 209 209

Total current assets 2,454 2,427 2,778 3,270 3,820

Non-current assets

PP&E, net 1,159 1,192 1,192 1,192 1,192

Goodwill 3,091 3,149 3,149 3,149 3,149

Intangible assets, net 1,351 1,346 1,346 1,346 1,346

Investments 9 12 12 12 12

Other assets 157 147 284 284 284

Deferred tax assets 154 170 170 170 170

Total non-current assets 5,921 6,015 6,152 6,152 6,152

Total Assets 8,374 8,442 8,930 9,422 9,972

Current liabilities

Bank overdrafts 194 90 90 90 90

Current portion of LT debt 498 310 310 310 310

Accounts payable 608 683 756 801 843

Income taxes payable 40 66 72 78 84 Short term provisions for other risks & charges 53 66 66 66 66

Other liabilities 534 590 590 590 590

Total current liabilities 1,927 1,805 1,884 1,935 1,983

Non current liabilities

Long-term debt 2,245 2,052 2,052 2,052 2,052

Employee benefits 198 192 192 192 192

Deferred tax liabilities 232 228 228 228 228 Other provisions for other risks & charges 80 120 120 120 120

Other liabilities 67 53 53 53 53

Total non current liabilities 2,822 2,644 2,644 2,644 2,644

Total liabilities 4,749 4,449 4,528 4,579 4,627

Shareholder's equity Group shareholder's equity 3,613 3,981 4,390 4,831 5,334

Non-controlling interest 12 12 12 12 12

Total shareholder's equity 3,625 3,993 4,402 4,843 5,346



68

Cash flow statement

in €m 2011 2012 2013 2014 2015

Net income 458 542 679 780 891

Stock-based compensation 44 41 Depreciation & amortisation 324 358 387 409 439

Net loss on disposals of fixed assets & other 17 33

Other-non cash items (5) 14 Changes in accounts receivable (36) (31) (189) (64) (53)

Changes in inventories (31) (79) 75 (47) (39)

Changes in accounts payable 51 74 73 45 42

Change in other assets/ liabilities 18 26 6 6 6

Changes in income taxes payable (20) Total adjustments 363 438 353 349 395

Operating cash flow 821 979 1,031 1,128 1,287

PP&E, net (229) (354) (387) (409) (439)

FCF 592 625 645 720 847

Investing cash flow (460) (354) (524) (409) (439)

Cash flow before financing 361 625 508 720 847

Dividends (207) (227) (270) (339) (389)

Financing cash flow (175) (227) (270) (339) (389)

Foreign exchange impact 28 Chg. in cash & cash equivalents 214 398 237 381 458


LVMH SA Luxury Goods

69

Opportunity knocks

• LVMH is due to report H1 2013 results at the end of July (last year, results were released on 26 July). We believe management may use H1 2013 results as an opportunity to temper FY 2013 and FY 2014 EBIT margin expectations as Louis Vuitton’s product mix evolves coupled with ongoing investments in Wines & Spirits and Selective Retail divisions. We forecast FY 2013 group EBIT margin of 20.4% versus Bloomberg consensus of 20.8% and expect group EBIT margin to recover to 21.0% by FY 2015 (Bloomberg consensus: 21.8%).

• In our view, relative share price underperformance (-16% compared to the SXXP and -17% versus the CAC) over the past 12 months reflects Vuitton brand concern. Short term, we see downside risk to Louis Vuitton margins on sustained A&P investment and higher raw material costs/COGS. However, we maintain that Moët Hennessy is undervalued by the market (as highlighted in our Deal or no deal note) and forecast sales and margin upside for Selective Retail and Perfume & Cosmetics operations. We do not expect Louis Vuitton to go ex-growth on a reported basis and view low/mid-single digit sales growth with a greater focus on store productivity as a more realistic scenario.

• We forecast H1 2013 sales of €13,845m and EBIT of €2,735m (c4% below Bloomberg consensus). We factor margin dilution within Wines & Sprits on the back of continued investment in Eaux de Vie (cognac) and Chandon brands at Mont Aigu. In addition, we do not expect Fashion & Leather goods’ EBIT margin to improve in H1 given sustained A&P investment in the Louis Vuitton Balloon campaign; this annualises towards the end of the year.

• We have raised our FY 2013 and FY 2014 earnings forecasts by 1% and 1.6% to €7.08 and €7.87 (5% and 6% respectively below Bloomberg consensus) in order to account for Hermès associate income (partially offset by the €10m AMF fine). Our €140 price target is based on a blended average of our SOTP, P/E and DCF analysis, driven by cash flow and earnings forecasts. We maintain that Moët Hennessy is undervalued although lower growth at Louis Vuitton and pressure on post-tax ROIC during FY 2013 need to be considered.

Hold Rating system

Current price

EUR 125.80

Absolute

Price target

EUR 140.00 14/06/2013 Paris Close Market cap EUR 63,181 m Reuters LVMH.PA Bloomberg MC FP

Changes made in this note Rating Hold (no change) Price target EUR 140.00 (no change) Chg 2013e 2014e 2015e


Sales 29863 1.8 32093 1.9 34319 1.9

EBIT 6196 0.1 6762 0.5 7328 0.4

EPS 7.01 1.0 7.75 1.6 8.48 1.3


Share data


Performance data

High 52 weeks (EUR) 143 Low 52 weeks (EUR) 114 Relative performance to SXXP CAC 40 1 month -5.8 % -6.3 % 3 months -4.1 % -5.2 % 12 months -15.9 % -16.9 %

Business activities: Multinational luxury goods conglomerate, with operations in Fashion & Leather Goods, Perfumes & Cosmetics, Watches & Jewellery and Wines & Spirits.

Non-institutional shareholders: Arnault Group - 46.6% Trapani Family - 2.7% Treasury Shares - 1.9%

20 June 2013


Bassel Choughari


Rupert Trotter


Y/E 31.12., EUR m 2011 2012 2013E 2014E 2015E

Sales 23,659 28,103 30,411 32,692 34,960

EBITDA 6,302 7,244 7,637 8,337 9,002

EBIT 5,263 5,921 6,205 6,798 7,356

Net profit 3,065 3,424 3,555 3,953 4,314

Net debt (net cash) 4,660 4,616 3,049 1,124 -1,122

EPS (reported) 6.3 6.9 7.1 7.9 8.6

EPS (recurring) 6.2 6.8 7.1 7.9 8.6

CPS 1.8 4.7 6.0 7.2 8.2

DPS 2.6 2.9 3.2 3.5 3.9

Gross margin 65.8% 64.7% 65.0% 64.5% 64.5%

EBITDA margin 26.6% 25.8% 25.1% 25.5% 25.7%

EBIT margin 22.2% 21.1% 20.4% 20.8% 21.0%

Dividend yield 2.1% 2.3% 2.5% 2.8% 3.1%


EV/sales 2.9 2.4 2.2 2.1 1.9

EV/EBITDA 10.8 9.4 8.9 8.2 7.6

EV/EBIT 13.0 11.5 11.0 10.0 9.3

P/E 20.3 18.5 17.9 16.1 14.7

ROIC/WACC % spread 2.6% 2.7% 2.5% 2.9% 3.1%


http://www.berenberg.de/cgi-bin/content/content.cgi?rm=show_doc&session_id=b649d6d20d6b2489294c4cdc73d2c981&sb_userid=0&sb_eventid=0


70

LVMH Group assumptions and sensitivities

Divisional estimates (2013E to 2016E)


FY11 FY12 FY13E FY14E FY15E FY16E 3y CAGR 5y CAGR

Group Sales (€m) 23,659.0 28,103.0 30,411.0 32,692.1 34,959.9 37,384.1 7.5% 9.6%

Y/Y growth 16.4% 18.8% 8.2% 7.5% 6.9% 6.9%

Operating Profit (€m) 5,263.0 5,921.0 6,205.3 6,797.8 7,356.1 7,951.1 7.5% 8.6%

Operating margin (%) 22.2% 21.1% 20.4% 20.8% 21.0% 21.3%

Wines & Spirits €m 3,524.0 4,137.0 4,496.9 4,811.7 5,148.5 5,508.9 7.6% 9.3%

Total growth 8.1% 17.4% 8.7% 7.0% 7.0% 7.0%

Organic growth 10.0% 11.0% 10.0% 7.0% 7.0% 7.0%

Forex and acquisitions -1.9% 6.4% -1.3% 0.0% 0.0% 0.0%

EBIT (€m) 1,101.0 1,260.0 1,376.1 1,491.6 1,596.0 1,707.8 8.2% 9.2%

Margin 31.2% 30.5% 30.6% 31.0% 31.0% 31.0%

Growth 18.4% 14.4% 9.2% 8.4% 7.0% 7.0%

Fashion & Leather goods €m 8,712.0 9,926.0 10,263.5 10,981.9 11,750.7 12,573.2 5.8% 7.6%

Total growth 14.9% 13.9% 3.4% 7.0% 7.0% 7.0%

Organic growth 16.0% 7.0% 6.0% 7.0% 7.0% 7.0%


EBIT (€m) 3,075.0 3,264.0 3,263.8 3,492.3 3,736.7 3,998.3 4.6% 5.4%

Margin 35.3% 32.9% 31.8% 31.8% 31.8% 31.8%

Growth 20.4% 6.1% 0.0% 7.0% 7.0% 7.0%

Perfumes & Cosmetics €m 3,195.0 3,613.0 3,818.9 4,086.3 4,331.4 4,591.3 6.2% 7.5%

Total growth 3.9% 13.1% 5.7% 7.0% 6.0% 6.0%

Organic growth 9.0% 8.0% 7.0% 7.0% 6.0% 6.0%


EBIT (€m) 348.0 408.0 446.8 490.4 519.8 551.0 8.4% 9.6%

Margin 10.9% 11.3% 11.7% 12.0% 12.0% 12.0%

Growth 4.8% 17.2% 9.5% 9.7% 6.0% 6.0%

Watches & Jewellery €m 1,949.0 2,836.0 2,921.1 3,154.8 3,375.6 3,611.9 6.0% 13.1%

Total growth 97.9% 45.5% 3.0% 8.0% 7.0% 7.0%

Organic growth 23.0% 6.0% 6.5% 8.0% 7.0% 7.0%

Forex and acquisitions 74.9% 39.5% -3.5% 0.0% 0.0% 0.0%

EBIT (€m) 265.0 334.0 350.5 378.6 425.3 469.5 8.4% 12.1%

Margin 13.6% 11.8% 12.0% 12.0% 12.6% 13.0%

Growth 107.0% 26.0% 4.9% 8.0% 12.4% 10.4%

Selective Retail €m 6,436.0 7,879.0 9,210.6 9,947.4 10,643.7 11,388.8 10.5% 12.1%

Total growth 19.7% 22.4% 16.9% 8.0% 7.0% 7.0%

Organic growth 19.0% 14.0% 17.5% 8.0% 7.0% 7.0%

Forex and acquisitions 0.7% 8.4% -0.6% 0.0% 0.0% 0.0%

EBIT (€m) 716.0 854.0 967.1 1,144.0 1,277.2 1,423.6 14.4% 14.7%

Margin 11.1% 10.8% 10.5% 11.5% 12.0% 12.5%

Growth 33.6% 19.3% 13.2% 18.3% 11.7% 11.5%

Benchmark diluted EPS (c) 6.23 6.82 7.08 7.87 8.59 9.3 8.0% 8.4%


71

H1 2013 focus

We highlight our H1 2013 sales estimates below. Standout assumptions include soft Fashion and Leather goods organic sales growth of 4% (Q2 2013 implied organic growth is 5% compared with 3% in Q1 2013 although we note a 400bp easier comparison base during the second quarter).

H1 2013 divisional sales estimates

Sales €m Berenberg H1 2013E

Wines & Spirits 1,859

Actual 5.7%

Organic 7.0%

Currency & structure -1.3%

Fashion & Leather Goods 4,721

Actual 1.4%

Organic 4.0%


Perfumes & Cosmetics 1,808

Actual 4.7%

Organic 6.0%


Selective Distribution 4,215

Actual 17.4%

Organic 18.0%


Watches & Jewellery 1,377

Actual 2.5%

Organic 6.0%


Other -135

Total 13,845

Actual 6.8%

Organic 9.1%



After a lacklustre performance by the Fashion & Leather goods division during the first quarter where we understand that the Louis Vuitton brand slightly underperformed divisional organic growth of 3%, we expect a similarly muted performance during Q2 2013 with Louis Vuitton organic growth rates of 4%, one percentage point below the divisional estimate.

According to Chinese internet search engine Baidu, Louis Vuitton brand search momentum appears to have deteriorated over the past few months relative to the total average number of luxury goods searches.


72

Louis Vuitton brand search momentum (Baidu) vs. average no. of searches

Source: Baidu, Berenberg estimates

Fashion and leather goods peers showing improved/above-average search momentum include Prada, Chanel and Hermès.

Prada momentum vs. average Chanel momentum vs. average


Another “mega-brand” which appears to be losing search momentum is Gucci.

Gucci brand search momentum (Baidu) vs. average no of searches


We expect similar Wines & Spirits organic growth for Q2 2013 of 7% in spite of a 200bp easier organic sales comparison. According to Nielsen US spirits data,

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Hennessy US spirits volume growth tailed off after a very strong March (the month was linked to high promotions as a percentage of sales).

US Moët Hennessy spirits volume growth evolution to May 2013

Source: Nielsen data

US Moët Hennessy spirits price mix growth picked up in May after two relatively tough months in March and April. Rémy stands out as the strongest performer.

US Moët Hennessy spirits price/mix growth to May 2013


We note that Moët Hennessy brands reduced the percentage of products sold on promotion in April and May after a strong promotional period in February and March. The reduction will clearly support the improvement in price/mix into May.

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US Moët Hennessy spirits percentage sold on promotion to May 2013


In terms of cognac export data on a global value basis, we note declining trends across all regions. By volume, the Americas experienced a sharp improvement while Europe and Asia remain relatively subdued.

Cognac exports evolution by value

Source: Berenberg estimates, Nielsen data

We believe that the volume uptick in the Americas in April and May was primarily driven by increased demand for VS and VSOP over XO and XO+ brands. Furthermore, promotional activity in March may have accelerated volume growth, leading to stronger-than-expected restocking in key off-trade regions such as the United States.

On our estimates, Hennessy VS, VSOP and XO fall within the top five Moët Hennessy brands in terms of share of sales, with Moët et Chandon taking the largest share followed by Hennessy VS.

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April and May volume exports improve in the United States


Mainland Chinese volume and value cognac export evolution remain sluggish and point to particular demand weakness for XO and XO+ brands.

Chinese cognac export momentum by volume and value


Cognac vol. exports by price/mix Cognac volume exports XO+


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Cognac value export evolution by price/mix


Other divisions

We expect Selective Retail to deliver the strongest organic sales momentum although we acknowledge that turnover at DFS should be flattered this year by the inclusion of three Hong Kong airport concessions, forecast to add c€600m in incremental divisional sales (+670bp) albeit on a margin-dilutive basis. Anecdotally, we recently travelled to Hong Kong and saw the new DFS concessions in operation. Not only are the concessions situated in prime locations, footfall and spending appeared brisk.

We forecast an organic sales improvement for Perfume & Cosmetics in Q2 2013 of 7% (from 5% in Q1 2013) as momentum for the Dior brand has accelerated from the first quarter in Hong Kong and Shanghai, according to our airport and mall channel checks.

In spite of the softer organic sales comparison for Watches & Jewellery, there may be downside risk to our Q2 2013 organic estimate of 10% (H1 2013E: +6%) on the back of softer mainland Chinese demand for luxury and prestige watches.

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Profit expectations by division

We highlight our H1 2013 divisional profit and EBIT margin assumptions below. The standout division is Fashion & Leather Goods, where we factor a small decline in profitability yoy during the first half of the year based on our Louis Vuitton sales and EBIT margin forecasts.

Short term, we do not expect H1 2013 yoy profit growth within the Watches & Jewellery division despite currency hedging.

1H 2013 EBIT & EBIT margin assumptions

EBIT €m Berenberg H1 2013E

Wines & Spirits 521

Margin 28.0%

Growth 5.0%

Fashion & Leather Goods 1,501

Margin 31.8%

Growth -1.0%

Perfumes & Cosmetics 215

Margin 11.9%

Growth 9.2%

Selective Distribution 421

Margin 10.0%

Growth 13.0%

Watches & Jewellery 158

Margin 11.5%

Growth -0.4%

Activities & eliminations -82

Total 2,735

Margin 19.8%

Growth 2.9%



78

Gearing levels raise acquisition alert

LVMH FY 2012 net debt to equity fell by 300bp yoy to 17% with net debt/EBITDA of 0.6x and net debt/EBITDAR (including FY 2012 lease costs of €1,944m capitalised at 8.0x) of 2.2x. We expect net debt/EBITDAR to fall to 1.8x (FY 2014 net debt/EBITDA to 0.1x); hence LVMH has material balance sheet firepower at its disposal, which we believe will be targeted on future acquisitions as opposed to a share buyback.

Besides Burberry, we believe that LVMH could look at Dior Couture as a viable takeout alternative, thereby indirectly increasing CEO Bernard Arnault’s shareholding in LVMH and collapsing the current structure. We believe the brand must be big enough to dilute Louis Vuitton sales and EBIT contribution while offering margin opportunities/synergies. For more information on takeout candidates, please refer to our acquisition wish list in our cornerstone research note, Deal or no deal dated 7 December 2012.

LVMH net debt/EBITDA and net debt/EBITDAR 2005-16E


LVMH changes in working capital 2005-16E (€m)


(1.0x)

(0.5x)

0.0x

0.5x

1.0x

1.5x

2.0x

2.5x

3.0x

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13E

FY

14E

FY

15E

FY

16E

Net debt/EBITDA (x) Adj net debt/EBITDAR (x)

(1,000.0)

(500.0)

-

500.0

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13E

FY

14E

FY

15E

FY

16E

Increase/(decrease) in other recs and payables

Increase/(decrease) in accounts payable

Decrease/(increase) in receivables

Decrease/(increase) in inventory

http://www.berenberg.de/cgi-bin/content/content.cgi?rm=show_doc&session_id=22b1469c3e6d7e1eb0c4b1e11d3344c5&sb_userid=0&sb_eventid=0


79

LVMH free cash flow evolution 2005-16E (€m)


LVMH net (debt)/cash evolution 2005-16E (€m)


500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

4,500.0F

Y08

FY

09

FY

10

FY

11

FY

12

FY

13E

FY

14E

FY

15E

FY

16E

Free cash flow

(5,000.0)

(4,000.0)

(3,000.0)

(2,000.0)

(1,000.0)

-

1,000.0

2,000.0

3,000.0

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13E

FY

14E

FY

15E

FY

16E

Net (debt) / cash


80

Financials

Profit and loss

EUR'm y/e December FY11 FY12 FY13E FY14E FY15E

Turnover 23,659.0 28,103.0 30,411.0 32,692.1 34,959.9

Growth 16.4% 18.8% 8.2% 7.5% 6.9%

Cost of Sales (8,092.0) (9,917.0) (10,643.8) (11,605.7) (12,410.8)

Gross Profit 15,567.0 18,186.0 19,767.1 21,086.4 22,549.2

Gross Margin 65.8% 64.7% 65.0% 64.5% 64.5%

EBITDA 6,302.0 7,244.0 7,637.0 8,336.8 9,001.9 Depreciation, amortisation and impairment (1,039.0) (1,323.0) (1,431.7) (1,539.0) (1,645.8) Note: Amortisation (73.0) (139.0) (139.0) (139.0) (139.0)

EBIT Recurring Operations 5,263.0 5,921.0 6,205.3 6,797.8 7,356.1

Recurring Operations EBIT Margin % 22.2% 21.1% 20.4% 20.8% 21.0%

Other income or expenses (109.0) (182.0) (190.7) (208.9) (226.1)

as % of recurring operations 2.1% 3.1% 3.1% 3.1% 3.1%

EBIT as reported 5,154.0 5,739.0 6,014.6 6,588.8 7,130.0

EBIT Margin As Reported 21.8% 20.4% 19.8% 20.2% 20.4%

Note: cost of financial debt (151.0) (140.0) (91.5) (33.7) 11.2

Financial expense (242.0) (14.0) 59.0 69.0 69.0

Profit before tax 4,912.0 5,725.0 5,982.1 6,624.1 7,210.2

Income Tax (1,453.0) (1,820.0) (1,902.3) (2,106.5) (2,292.8) Income tax rate 29.6% 31.8% 31.8% 31.8% 31.8%

Income from investments/associates 6.0 4.0 0.0 0.0 0.0

Profit after tax 3,465.0 3,909.0 4,079.8 4,517.6 4,917.4

Minority interests (400.0) (485.0) (524.8) (564.2) (603.3)

Net income 3,065.0 3,424.0 3,555.0 3,953.4 4,314.0

Net income (pre g/w) 3,065.0 3,424.0 3,555.0 3,953.4 4,314.0

Dividends (1,270.8) (1,447.5) (1,592.2) (1,751.5) (1,926.6) EPS (ex. GW & EI) 6.27 6.86 7.12 7.92 8.64

DPS

2.60

2.90

3.19

3.51

3.86 Diluted EPS 6.23 6.82 7.08 7.87 8.59

Growth 23.8% 11.5% 10.0% 10.0% 10.0%

Payout ratio 41% 42% 45% 44% 45%

Dividend cover 2.4x 2.4x 2.2x 2.3x 2.2x

Av. No. of Ord Shares Outstanding (m) 488.8 499.1 499.1 499.1 499.1

Av. No. of Diluted Ord Outstanding (m) 492.2 502.2 502.2 502.2 502.2



81

Cash flow EUR'm y/e December FY11 FY12 FY13E FY14E FY15E

Operating profit 5,154.0 5,739.0 6,014.6 6,588.8 7,130.0 Add back: Depreciation, amortisation, impairment 1,039.0 1,323.0 1,431.7 1,539.0 1,645.8

Interest paid (152.0) (154.0) (91.5) (33.7) 11.2

Tax paid (1,544.0) (1,970.0) (1,882.3) (2,056.9) (2,247.6) Net operating profit before working capital 4,441.0 4,989.0 5,472.4 6,037.3 6,539.4

Decrease/(increase) in inventory (768.0) (829.0) (789.9) (801.5) (670.9)

Decrease/(increase) in receivables (65.0) (147.0) (163.0) (161.1) (160.2)

Increase/(decrease) in accounts payable 331.0 173.0 229.7 304.0 254.4

Increase/(decrease) in other recs and payables (32.0) (10.0) - - -

Change in working capital (534.0) (813.0) (723.2) (658.7) (576.7)

Net cash from operations 3,907.0 4,176.0 4,749.2 5,378.6 5,962.8

Purchase of tangible and intangible fixed assets (1,749.0) (1,710.0) (1,736.0) (1,770.8) (1,859.3) Proceeds from sales of tangible & intang assets 31.0 44.0 0.0 0.0 0.0 Guarantee deposits paid and other op investments (12.0) (36.0) 0.0 0.0 0.0

Capital expenditure (1,730.0) (1,702.0) (1,736.0) (1,770.8) (1,859.3)

capex growth % 77% -2% 2% 2% 5%

Free cash flow 891.0 2,334.0 3,013.2 3,607.8 4,103.5

FCF Growth % (34.4)% 162.0 % 29.1 % 19.7 % 13.7 %

(Purchase) / proceeds from treasury shares 2.0 5.0 0.0 0.0 0.0

Equity dividends paid (2,671.0) (1,967.0) (1,592.2) (1,751.5) (1,926.6)

Cash flow before financing (1,778.0) 372.0 1,421.0 1,856.3 2,176.9

Financing activities

Net increase / (decrease) in cash 39.0 (93.0) 1,480.0 1,925.3 2,245.9

Check

Opening cash balance 2,042.0 2,081.0 1,988.0 3,468.0 5,393.3

Closing net cash balance 2,081.0 1,988.0 3,468.0 5,393.3 7,639.2

Net movement in cash 39.0 (93.0) 1,480.0 1,925.3 2,245.9

Overdraft for cash balance in balance sheet 295.0 295.0 295.0 295.0 295.0

Cash per balance sheet 2,376.0 2,283.0 3,763.0 5,688.3 7,934.2

Net debt calculation

Short term borrowings (3,134.0) (2,976.0) (2,976.0) (2,976.0) (2,976.0)

Long term borrowings (4,132.0) (3,836.0) (3,836.0) (3,836.0) (3,836.0)

Cash 2,303.0 2,196.0 3,763.0 5,688.3 7,934.2

Other 303.0 -

- -

Net (debt) / cash (4,660.0) (4,616.0) (3,049.0) (1,123.7) 1,122.2



82

Balance sheet EUR'm y/e December FY11 FY12 FY13E FY14E FY15E

Cash 2,303.0 2,196.0 3,763.0 5,688.3 7,934.2

Trade receivables 1,878.0 1,985.0 2,148.0 2,309.1 2,469.3

Inventories 7,510.0 8,080.0 8,869.9 9,671.4 10,342.3

Other current assets 1,576.0 2,012.0 2,012.0 2,012.0 2,012.0

Current Assets 13,267.0 14,273.0 16,792.8 19,680.8 22,757.8

Goodwill 6,957.0 7,806.0 7,806.0 7,806.0 7,806.0

Brands and other intangibles 11,482.0 11,510.0 11,510.0 11,510.0 11,510.0

Property, plant and equipment 8,017.0 8,769.0 9,073.4 9,305.1 9,518.6

Other assets 7,346.0 7,572.0 7,572.0 7,572.0 7,572.0

Fixed assets 33,802.0 35,657.0 35,961.4 36,193.1 36,406.6

Short term borrowings (3,134.0) (2,976.0) (2,976.0) (2,976.0) (2,976.0)

Accounts payable (2,952.0) (3,134.0) (3,363.7) (3,667.7) (3,922.1)

Income Taxes (443.0) (442.0) (462.0) (511.6) (556.8)

Provisions (349.0) (335.0) (335.0) (335.0) (335.0)

Other creditors (2,716.0) (2,595.0) (2,595.0) (2,595.0) (2,595.0)

Current liabilities (9,594.0) (9,482.0) (9,731.7) (10,085.2) (10,384.9)

Long term debt (4,132.0) (3,836.0) (3,836.0) (3,836.0) (3,836.0)

Provisions (1,400.0) (1,530.0) (1,530.0) (1,530.0) (1,530.0)

Other liabilities (4,506.0) (5,456.0) (5,456.0) (5,456.0) (5,456.0)

Deferred income tax (3,925.0) (3,960.0) (3,960.0) (3,960.0) (3,960.0)

Long term liabilities (13,963.0) (14,782.0) (14,782.0) (14,782.0) (14,782.0)

Minority interests (1,061.0) (1,102.0) (1,018.4) (947.3) (885.9) Net Assets 23,512.0 25,666.0 28,240.5 31,006.7 33,997.5 Share capital 152.0 152.0 152.0 152.0 152.0 Share premium 3,801.0 3,848.0 3,848.0 3,848.0 3,848.0 Treasury shares (485.0) (414.0) (414.0) (414.0) (414.0) Revaluation reserve 2,689.0 2,819.0 2,819.0 2,819.0 2,819.0 Other reserves 12,798.0 14,393.0 14,480.0 14,480.0 14,480.0 Translation adjustment 431.0 342.0 342.0 342.0 342.0 Retained profit 3,065.0 3,424.0 5,386.7 7,588.7 9,976.1 Group share of equity 22,451.0 24,564.0 26,613.7 28,815.7 31,203.1 Minority interest 1,061.0 1,102.0 1,626.8 2,191.0 2,794.4 Total equity 23,512.0 25,666.0 28,240.5 31,006.7 33,997.5 Check 0.0 0.0 0.0 0.0 0.0

Group share of Equity 22,451.0 24,564.0 27,222.2 30,059.4 33,111.6 Total Shareholders Equity 23,512.0 25,666.0 28,240.5 31,006.7 33,997.5


Compagnie Financière Richemont SA Luxury Goods

83

Catalytic converter

• Should management decide to exit the Fashion & Leather goods division (excluding Net-a-Porter), we believe that the collective proceeds of individual brand disposals (Alfred Dunhill, Lance, Chloe, Shanghai-Tang, Alaiai) could generate €2.5bn-3bn on top of the €3.2bn net cash generated in FY 2013. In addition, we maintain that management could float 49% of Net-a-Porter over the next few years, which could generate c€1.5bn (EV paid in April 2010 was €420m).

• While management remains reluctant to pay a goodwill premium for brands, we see the strategic rationale in trading the goodwill premium Richemont could generate through its own disposals. In our view, a strategic bid for Audemars Piguet even above 6x sales (CHF3.6bn-4bn) would make sense given the high level of vertical integration Audemars brings. Moreover, excess cash could be used to accelerate the development of the jewellery offering in well-established brands such as Piaget and support Specialist Watchmakers’ expansion.

• Other opportunities include narrowing the EBIT margin gap between Van Cleef & Arpels and Cartier, the expansion of Cartier online across Europe and Asia and driving higher NAP sales growth through the new Asian distribution platform.

• We remain cautious on Cartier watches after our recent trip to Greater China and maintain that Cartier’s exposure to quartz movements remains too high given its non-weighted average selling price relative to peers. We expect investment in this area to weigh on the opex line in the short term but we acknowledge that the relative size and scale of the jewellery operations ought to mitigate the incremental investment.

• We revise up our FY 2014 and FY 2015 earnings forecasts by 8% and 7% to €3.93 and €4.42 respectively and our P/E based (SOTP and DCF supported) price target increases to CHF86. In the short term, we acknowledge weaker Mainland Chinese demand, rental cost pressure, lower gross margin guidance and forecast capital expenditure of €850m (excluding acquisitions for the next two years).

Y/E 31.03., EUR m 2012 2013 2014E 2015E 2016E

Sales 8,868 10,150 11,193 12,147 13,175

EBITDA 2,382 2,809 3,083 3,410 3,734

EBIT 2,048 2,426 2,661 2,951 3,237

Net profit 1,544 2,013 2,199 2,476 2,740

Y/E net debt (net cash) -3,182 -3,215 -3,914 -4,748 -5,617

EPS (reported) 2.8 3.7 4.0 4.5 5.0

EPS (recurring) 2.8 3.6 3.9 4.4 4.9

CPS 1.2 0.2 1.6 2.1 2.4

DPS 0.6 1.0 1.2 1.4 1.7

Gross margin 63.7% 64.2% 64.2% 64.2% 64.2%

EBITDA margin 26.9% 27.7% 27.5% 28.1% 28.3%

EBIT margin 23.1% 23.9% 23.8% 24.3% 24.6%

Dividend yield 0.7% 1.2% 1.5% 1.8% 2.1%


EV/sales 3.8 3.4 3.0 2.8 2.6

EV/EBITDA 14.3 12.1 11.0 10.0 9.1

EV/EBIT 16.6 14.0 12.8 11.5 10.5

P/E 24.1 18.5 16.9 15.0 13.6

ROIC/WACC % spread 16.6% 15.4% 13.2% 13.0% 12.5%


Hold Rating system Current price

CHF 85.10

Absolute Price target

CHF 86.00

19/06/2013 SIX Swiss Close Market cap CHF 38,545 m Reuters CFR.VX Bloomberg CFR VX

Changes made in this note Rating Hold (no change) Price target CHF 86.00 (72.00)

Chg 2014e 2015e 2016e


Sales 10921 2.5 11803 2.9 12564 4.9

EBIT 2612 1.9 2897 1.9 3135 3.3

EPS 3.63 8.2 4.13 7.1 4.54 7.7


Share data


Performance data

High 52 weeks (CHF) 92.80 Low 52 weeks (CHF) 48.40 Relative performance to SXXP SMI 1 month -0.6 % 1.1 % 3 months 12.2 % 12.8 % 12 months 36.0 % 29.1 %

Business activities: Richemont is the second largest global luxury goods company in the world by revenue and the largest player within hard luxury goods (Watches and Jewellery). The Group operates out of four core divisions; Jewellery Maisons; Specialists Watchmakers; Montblanc and Other (leather, fashion, accessories and Net-a-Porter). Each business unit composes a number of Maisons. Each Maison enjoys a high degree of operational autonomy.

Non-institutional shareholders: Rupert Family - (100% of B registered

shares, 9.1% of total capital, 50% of the Company's voting rights) Public Investment Corp - 3.13%

20 June 2013



Rupert Trotter Specialist Sales +44 20 3207 7815 [email protected]


84

Richemont key assumptions and sensitivities

Divisional forecasts

FY12 FY13 FY14E FY15E FY16E FY13-16E CAGR

Group Sales 8,867.5 10,150.0 11,193.0 12,147.1 13,174.8 9.1% Y/Y growth % 28.7% 14.5% 10.3% 8.5% 8.5%

Group Operating Profit (€m) 2,047.5 2,426.0 2,661.1 2,951.3 3,237.1 10.1% Y/Y growth % 51.0% 18.5% 9.7% 10.9% 9.7%

Operating margin 23.1% 23.9% 23.8% 24.3% 24.6%

Jewellery Sales (€m) 4,590.0 5,206.0 5,778.7 6,298.7 6,928.6 10.0%

Y/Y growth % 31.9% 13.4% 11.0% 9.0% 10.0% Jewellery constant 34.0% 8.0% 12.0% 9.0% 10.0% Currency -2.1% 5.4% -1.0% 0.0% 0.0% EBIT (€m) 1,510.0 1,818.0 1,964.7 2,110.1 2,286.4 7.9%

EBIT margin 32.9% 34.9% 34.0% 33.5% 33.0%

Specialist watchmakers Sales (€m) 2,323.0 2,752.0 2,999.7 3,239.7 3,434.0 7.7%

Y/Y growth % 30.9% 18.5% 9.0% 8.0% 6.0% Watchmakers constant 32.0% 13.0% 10.0% 8.0% 6.0% Currency -1.1% 5.5% -1.0% 0.0% 0.0% EBIT (€m) 539.0 733.0 779.9 826.1 875.7 6.1%

EBIT margin 23.2% 26.6% 26.0% 25.5% 25.5%

Montblanc Sales (€m) 723.0 766.0 789.0 845.2 820.5 2.3%

Y/Y growth % 7.6% 5.9% 3.0% 4.0% 3.0% Writing constant 9.0% 2.0% 4.0% 4.0% 3.0% Currency -1.4% 3.9% -1.0% 0.0% 0.0% EBIT (€m) 119.0 120.0 118.3 123.1 126.8 1.8%

EBIT margin 16.5% 15.7% 15.0% 15.0% 15.0%

Leather & NAP Sales (€m) 1,231.0 1,426.0 1,625.6 1,788.2 1,967.0 11.3%

Y/Y growth % 27.2% 15.8% 14.0% 10.0% 10.0% Leather & NAP constant 28.0% 11.0% 15.0% 10.0% 10.0% Currency -0.8% 4.8% -1.0% 0.0% 0.0% EBIT (€m) (27.0) (38.0) (11.9) 82.0 138.2 EBIT margin -2.2% -2.7% -0.7% 4.6% 7.0%

Diluted EPS (€) 2.76 3.59 3.93 4.42 4.89 10.8% DPS (€) 0.55 1.00 1.20 1.44 1.73 20.0%

Working capital (€m) (573.0) (916.0) (367.1) (336.7) (362.7) Stock turn (x) 0.9 0.8 0.8 0.8 0.8 Creditor days 148.5 133.1 133.1 133.1 133.1 Debtor days 19.6 20.9 20.9 20.9 20.9

Net cash/(debt) (€m) 3,182.0 3,215.0 3,914.0 4,747.8 5,617.4 Source: Berenberg estimates, Company data


85

Diving into Net-a-Porter

Net-a-Porter (NAP) is the UK’s largest online fashion store and the world’s premier online luxury retailer. The e-luxury retailer operates in more than 170 countries selling c350 brands. According to our research, NAP’s average order value is c£500/€590, having been relatively constant since the business was established in 2000.

Richemont acquired 67% of NAP on 1 April 2010 for £234.5m ($355.3m), valuing the equity of the business at £350m (EV of €420m), taking its stake to 100%. Ms Nathalie Massenet, founder of NAP, remains Executive Chairman having sold her stake for an estimated £50m. We understand Ms Massenet has since reinvested £15m back into the business. On 1 April 2010, Richemont obtained effective control of 93% of the voting rights of NAP Limited.

“Besides all the great designer names it stocks, one of the best things about Net-a-Porter.com is the next-day delivery service. That, coupled with beautiful packaging, makes the site an ideal stop…” (Vogue UK).

During the FY 2012 analyst presentation in Bellevue, Geneva, CEO and Chairman Johann Rupert described the acquisition as a defensive one as Richemont chose to exercise its pre-emptive option with the right of first refusal should NAP be approached by a third party (as was the case).

We forecast NAP’s sales to reach c€1bn by FY 2016, accounting for 8% of group sales, generating €119m of EBIT (4% of group EBIT). We appreciate that our estimates could be conservative as NAP is in the process of developing its Asian distribution platform, although according to our research it already has a c10% Asian consumer base.

We view two major downside risks: a) increased competition within the space (from Yoox.com and Amazon.com); and b) the risk of brand withdrawal by luxury goods companies looking to protect brand equity/pricing power and sales distribution.

NAP company description

NAP is an online seller of designer clothing and accessories. The company markets seasonal clothing, shoes and accessories for fashion-orientated consumers worldwide. Its product line includes belts, boots, coats, day and evening dresses, jackets, jeans, knitwear, pants, pumps, sandals, shoulder bags, skirts, tops, totes and wedges.

The company also offers a wide range of accessories such as bracelets, brooches, earrings, necklaces, rings, hairclips, hats, scarves, gloves, hosiery items and bags. NAP also provides national and international shipping services. In February 2011, Mr Porter, a male website dedicated to men’s fashion, events and lifestyle, was established. In addition, NAP runs a sister e-outlet site, the Outnet.com, which we estimate accounts for over 20% of NAP sales.

According to our estimates, NAP gross margin was 49.5% in FY 2011, falling to 45% in FY 2012 (in line with management’s FY 2012 presentation comments that NAP has a gross margin “in the high 40s”). We attribute the decline to an increase in cost of goods sold, which we estimate accounted for 55% of sales in FY 2012. NAP stopped disclosing financial statements (at Companies House in the UK) after its FY 2011 statement following the acquisition by Richemont. During the FY 2013 presentation, there was little disclosure on NAP’s sales and profit evolution suffice to add that business halved losses yoy to €19m and continued to


86

generate positive operating cash-flow. We estimate NAP sales reached €550m in FY 2013 (actual sales were not disclosed).

We estimate that NAP achieved an underlying EBIT margin of 14.5% in FY 2011, before share-based payments to directors of NAP in excess of €35m. As of FY 2013, NAP losses were €19m (down from €85m in FY 2012); the bulk of costs over the past two years have been associated with additional investment in IT, sourcing, distribution and logistics in the UK, US and more recently in Greater China.

NAP sales split (FY 2013 estimated sales €550m)


We estimate NAP generated >€9 per customer click in FY 2012

We estimate that NAP and affiliate sites (Mr Porter.com and the Outnet.com) receive approximately 4m monthly site visits, attracting 10,000 new customers a month. We estimate that NAP generates an average order value of £500/€590 (which is high relative to peers), on estimated FY 2012 sales of €438m. NAP and affiliate sites received 740,000 annual customer orders, up from 480,000 in FY 2011 (assuming a €590 average order on annual revenues of €281m).

Assuming NAP and affiliate sites received 48m site visits (4m/month) in FY 2012, this equates to €9.1 per click, a very cash-generative model in our view. We note that NAP acquired Koodos.com to complement its sister site, the Outnet.com, in October 2010, adding 200,000 members; the deal price was undisclosed.

We highlight below a snapshot of competitors’ historic average order values (AOV) comparing NAP’s click per visitor against brands such as Burberry, Ralph Lauren and Coach. NAP revenues are reported in GBP and comparator companies’ online revenues have been adjusted for currency. Within the table below, we use the following assumptions to provide a snapshot of how we think NAP AOV compared with key competitors during 2010/11.

Burberry’s FY 2011 visitor numbers are based on management commentary of having c33m users.

We note that Coach’s FY 2008-10 online visitors increased from 55m to 59m visitors, a 7.2% increase.

According to Ralph Lauren’s 2010 annual report, the company’s website had 3.5m monthly visitors.

60.0%20.0%

20.0%

RTW Shoes Bags


87

Our conclusion is that NAP’s AOV (in GBP) materially outperformed competitors by more than five times (in Coach’s case), while Ralph Lauren drove a higher AOV relative to Burberry.

NAP versus peers

Visitors (m) Revenue (£m) £ per view Conv. rate AOV (£)

NAP 48 238 5.0 1.0% 500

Visitors (m) Revenue (£m) £ per view (£500 AOV) (1% conv. rate)

Burberry 33 59 1.8 0.4% 182

Ralph Lauren* 42 129 3.1 0.6% 307

Coach* 59 53 0.9 0.2% 90

Source: Berenberg estimates * currency adjusted

NAP operations

In 2010, NAP operated a 50,000sq/ft distribution centre in New York, which handled about c30% of NAP business. More recently, NAP invested in a 250,000sq/ft distribution centre in Mahwah in New Jersey.

In 2013, Richemont intends to invest in its first distribution platform in Hong Kong with a second distribution centre to follow in mainland China (currently Asian consumers make up just over 10% of NAP sales with no distribution platform; hence we see this as a very significant sales growth driver, provided that NAP does not suffer from key brand withdrawal – our key concern over the medium-to-long term). NAP also has one main distribution centre in Charlton, UK, which services its European consumer base.

We highlight delivery timing and costs below.

UK shopping (London postcode):

Premier daytime: delivery between 10am and 5pm, seven days a week. If customers place their orders before 10am, they receive same-day delivery service (cost £12.00).

Premier evening: delivery between 6pm and 9pm (Monday to Friday). If customers place their orders by 2pm, they receive same-day delivery. Customers are allocated two-hour delivery windows and can also select a nominated date for delivery up to seven days in advance (cost £12.00).

Express: delivery between 9am and 5pm (Monday to Friday). Customers receive purchases 2-3 working days after the order has been placed (cost £5.00).

We note that for cities outside London (such as Bristol), NAP provides the Express delivery service only for £5.00. As for US shipping from the UK, delivery times are between 9am and 5pm (Monday to Friday) at a cost of $46.50. Customers receive purchases 3-4 days after the order has been received. From time to time, NAP will run free shipping promotions. Customers can sign up to fashion news in order to receive these notifications. NAP also insures each purchase during the time it is in transit until it is delivered (signature required upon receipt). Taxes and duties are calculated according to shipping destination and itemised on the order summary page. Local VAT/duties/taxes will be applied to other and EU destinations.

Returns and exchanges

Once a customer has requested a Returns Merchandise Authorisation number (RMA), he or she can send the product back within 28 days of receipt. If the size is incorrect, customers can select a different size and the garment will be delivered at no extra charge. Customers can also arrange a free collection with DHL. NAP


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premier customers will be contacted within 48 hours to arrange a collection. Orders sent back from a different destination may incur additional charges and/or be delayed by customs.

Running the numbers

We detail NAP financial statements to FY 2011 including our assumptions for FY 2012 and FY 2013. On an underlying basis, it would appear that NAP is capable of achieving at least a mid-teens EBIT margin. At present, NAP’s profitability is being affected by a material investment phase (IT, sourcing, distribution, logistics and advertising and promotion) as the luxury goods e-commerce player looks to expand its virtual footprint into Asia.

NAP P&L assumptions (£m)

Year Ended FY08 FY09 FY10 FY11 FY12E FY13E

£000's Income Statement key items: Total sales 55,158 81,546 130,009 238,072 371,392 464,240

YoY% total sales 48% 48% 59% 83% 56% 25%

Cost of Sales 28,162 42,148 63,589 120,241 204,266 241,405

YoY% COS 47% 50% 51% 89% 55% 52%

Gross profit 26,996 39,398 66,420 117,831 167,127 222,835

YoY% Gross Profit 150% 146% 69% 77% 42% 33%

Gross profit margin 48.9% 48.3% 51.1% 49.5% 45.0% 48.0%

Distribution costs 3,090 4,193 5,787 10,573 108,818 92,848

Administrative expenses 20,942 26,421 40,122 72,808 129,987 148,557

Administrative costs as % of all total costs 40% 36% 37% 36% 29% 31%

Other Operating Income 89 23 16 13 0 0

Share-Based payment charge

-29,280 0 0

Operating profit (w/o SB-payment charge) 3,053 8,807 20,527 34,463 -71,679 -18,570

Operating Margin 5.5% 10.8% 15.8% 14.5% -19.3% -4.0%

Depreciation & Amortisation 1,151 1,346 1,960 3,156 4,923 6,154

EBITDA (w/o SB-payment charge) 4,204 10,153 22,487 37,619 -66,755 -12,415

YoY% EBITDA 59% 141% 121% 67% -277% -81%

EBITDA margin 7.6% 12.5% 17.3% 15.8% -18.0% -2.7%


NAP sales and profit estimates may be conservative

The number of brands sold through NAP has increased materially from FY 2004 and is part of the reason why NAP’s seven-year sales CAGR to FY 2011 is 68%. As of FY 2004, NAP sold 80 brands through its website. This number increased to 391 brands in FY 2011 according to our research, resulting in a seven-year brand CAGR of 25%.

A simplistic way of trying to evaluate LFL sales growth at NAP would be to strip out the number of new brand additions on an annual basis. However, we note that it would also be necessary to ensure that no additional websites/regions had been added (virtual space) and that any sales number is adjusted for currency in order to reach a truer representation of like-for-like sales.

While the Outnet.com is supposed to target the younger, more cost-conscious consumer, we calculated that NAP and the Outnet.com had 193 overlapping brands out of a total of 348 brands for NAP and 304 brands for the Outnet.com (August 2012 yoy survey).


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As a result, when the number of brand additions starts to decline, we would expect to see virtual cannibalisation increase. A clear risk for NAP and its affiliates remains whether key luxury goods retailers such as PPR Group and Burberry continue to use/treat NAP and affiliates as an effective e-wholesaler, or whether the retailers look to take greater control over their e-brand equity and subsequent pricing power.

NAP sales growth (£m), estimated brand growth vs. sales growth

FY11 FY12 FY13E FY14E FY15E FY16E FY17E

NAP number of brands 391 348 348 348 348 348 348

NAP revenue (£m) 238 371 464 580 725 834 918

NAP CAGR in brands 25% -11% 0% 0% 0% 0% 0%

NAP yoy % revenue growth 83% 56% 25% 25% 25% 15% 10%

LFL NAP yoy % revenue growth 58% 67% 25% 25% 25% 15% 10%

Brand growth as a % of total growth 30% -20% 0% 0% 0% 0% 0%

Online luxury market size (£m) 3,360 4,032 4,838 5,806 6,967 8,361 10,033

Online luxury market yoy % growth 17% 20% 20% 20% 20% 20% 20%

NAP market share (%) 7% 9% 10% 10% 10% 10% 9%

NAP market share yoy % growth 57% 30% 4% 4% 4% -4% -8%

Source: Berenberg estimates, Company data, Bain & Co

Our NAP sales estimates (in GBP) may prove conservative as Bain & Co expects online sales will account for 5% of the global luxury goods market by 2014, worth £8.4bn or €10.4bn. The online luxury goods market CAGR (CY08-11) was c.20% while NAP’s market share CAGR over the same period was 37%, according to our estimates.

We expect NAP sales to continue to grow ahead of the online market and to account for 10.4% of the total online luxury goods market, up from 7% in FY11 by 2014.

NAP sales forecast based on online luxury goods market share growth

Normal timeline 2010 2011 2012E 2013E 2014E 2015E 2016E

NAP timeline FY11 FY12 FY13E FY14E FY15E FY16E FY17E

Total luxury market size (€m) 175,000 197,750 210,999 225,136 240,220 256,315 273,488

Total luxury market size (£m) 140,000 158,240 168,842 180,154 192,225 205,104 218,846

Total luxury market yoy % growth 14.4% 13.0% 6.7% 6.7% 6.7% 6.7% 6.7%

Online luxury market size (€m) 4,200 5,040 6,048 7,258 8,709 10,451 12,541

Online luxury market size (£m) 3,360 4,032 4,838 5,806 6,967 8,361 10,033

Online luxury market yoy % growth 17% 20% 20% 20% 20% 20% 20%

Online market as a % of luxury market 2.4% 2.5% 2.9% 3.2% 3.6% 4.1% 4.6%

NAP revenue (£m) 238 371 464 580 725 834 918

NAP yoy % revenue growth 83% 56% 25% 25% 25% 15% 10%

NAP market share (%) 7% 9% 10% 10% 10% 10% 9%

NAP market share yoy % growth 57% 30% 4% 4% 4% -4% -8%

Source: Berenberg estimates, Company data, Bain & Co

Our revenue growth forecasts for FY 2015 and FY 2016 of 15% and 10%, respectively, may prove conservative given the CAGR NAP has shown over the past seven years (68%).


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Key risks – increased competition and brand withdrawal

We have noticed a trend of luxury goods companies looking for greater control over their virtual distribution, pricing and brand messaging. Kering (formerly PPR) created a joint venture with Yoox.com to manage mono-brand luxury goods online stores for YSL (Yves Saint Laurent), Bottega Veneta, McQueen, Balenciaga and Sergio Rossi, announcing the deal on 3 August 2012.

Kering has subsequently indicated that Gucci (the number-one selling brand for NAP) may also move exclusively to Yoox.com. In our view, this kind of move is a clear indication that online mono-brand e-tailing is accelerating. We estimate that Gucci Group accounts for 25% of NAP sales. We would expect Gucci to join Yoox.com as this is about luxury goods retailers asserting more control over their brands in terms of product flow, pricing and brand messaging.

We list NAP’s top 14 brands by owning company. We appreciate that the number of products (by brand) on the NAP website will fluctuate and this sample represents a snapshot only.

NAP top 14 brands

Brand Owning Company Products on NAP website

Alexander McQueen Kering (Gucci Group) 111

Alexander Wang Alexander Wang Inc. 77

Bottega Veneta Kering (Gucci Group) 78

Burberry Burberry 120

Chloe Richemont 118

Donna Karan LVMH 86

Gucci Kering (Gucci Group) 142

Isabel Marant I.M. Production S.A 48

Jimmy Choo Labelux 124

Lanvin Jeanne Lanvin 159

Miu Miu Prada 184

Roberto Cavalli Roberto Cavalli S.p.A. 67

Stella McCartney KERING (Gucci Group) 114

Yves Saint Laurent KERING (Gucci Group) 137


Assuming NAP’s top 14 brands (including Kering brands) outsell other brands by two to one (which we believe is a fair assumption), the top 14 brands account for more than 60% of NAP total sales. Should luxury retailers look to withdraw brands from the NAP site, the revenue impact would be material. According to our research, Kering Group brands account for less than 30% of NAP sales.

At present, there has been no indication by Kering that it might stop selling its brands via NAP, although the press release detailing the joint venture with Yoox.com indicated that the latter would manage mono-brand luxury goods stores.


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NAP top 14 and Kering brand exposure (US NAP website prices)

TOP 14 Kering

Weighted average price of a product, $ 1,226 1,284

No. of products 1,565 641

Number of times KERING and top 14 outsell other brands 1 2

Top 14 total product value online 1,918,057 3,836,114

Kering total product value online 822,765 1,645,530

Rest brands (ex top14) product value online 5,492,597 5,492,597

Total product value online 7,511,194 9,529,791

Top 14 as % of total product value online 26% 40%

Kering as % of total product value online 11% 17%

Top 14 brands as a % of www.net-a-porter.com sales (ex TheOutnet) 40% 63%

Kering as a % of www.net-a-porter.com sales (ex TheOutnet) 17% 27%


The table above provides some sensitivity analysis should top 14 and/or Kering brands withdraw from NAP.

To conclude, there are pros and cons to using the NAP site. On the one hand, NAP is a strong innovator and user of social media with best-in-class brand exposure, and a distribution and logistics platform with plenty of growth potential as it looks to expand its virtual footprint in Asia in 2013.

June 2011: NAP “Live” was launched, which allows consumers to track what other shoppers are buying.

May 2011: NAP was the first to launch its own channel (fashion shows and interviews on Google television).

July 2009: NAP launched its first transactional iPhone application.

NAP has been voted one of the Sunday Times 100 best companies for three consecutive years.

Our forecasts to FY 2017 of over €1bn of revenues may prove conservative. However, should brands withdraw, NAP’s top-line forecasts could be materially affected, as the table below highlights – we assume that brands withdraw after FY 2013.

Top 14 brand and/or KERING brand withdrawal sensitivity analysis

As % of NAP sales: Top 14: 63%, Kering: 27% FY11 FY12E FY13E FY14E FY15E FY16E FY17E

NAP revenues, no withdrawal (£m) 238 371 464 580 725 834 918

NAP share of online luxury market, no withdrawals 7% 9% 10% 10% 10% 10% 9%

NAP revenue forecasts, Top 14 withdraw by FY12 238 371 241 283 332 366 391

NAP share of online luxury market, Top 14 withdraw 7% 9% 5% 5% 5% 4% 4%

NAP revenue forecasts, Kering withdraws by FY12 238 371 367 450 552 627 684

NAP share of online luxury market, Kering withdraws 7% 9% 8% 8% 8% 7% 7%


We note current/potential competitors to NAP:

Barneys (US) with revenues of more than $400m;

Bergdorf Goodman (US) with revenues of c$500m;

Ventesprivees.com (France) with FY 2011 revenues of €1.2bn;

Luisaviaroma (Italy);


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Colette (France);

Mytheresa (expanding German-based online player with tens of millions of euros of revenue);

Aloha Rag (US) with revenues of c$7m;

Matches Fashion (UK);

Atelier-Mayer (UK);

Tessabit (UK);

Biondin (France);

Diabro (Japan);

Boutique 1 (Middle East); and

Aishti (Middle East).

Our end-game for NAP

As regards the possibility of future acquisitions given Richemont’s net cash position of €3.2bn as of FY 2013, Mr Rupert has historically reiterated that Richemont would continue to “build goodwill rather than acquire goodwill”. This reiteration might suggest that all acquisitions (bar small manufacturing/strategic acquisitions) are off the table for the short-to-medium term.

However, we believe the end-game for NAP could lead to Richemont realising the goodwill/EV uplift in NAP over the next few years. NAP’s EV was €420m on the date of the 67% acquisition (April 2010).

We believe that NAP could be worth as much as 3x sales to either a trade buyer or the market, should Richemont look to part-float the business and exchange the goodwill premium built up over a 2-3 year period for another hard luxury complementary brand such as Audemars Piguet.

Assuming Richemont retained control of NAP and looked to float 49% of the business by FY 2016, on our sales estimates, Richemont would gain €1,512m from an IPO of 49% of the business, as highlighted in our IPO value release table below. We assume the following:

3x sales multiple for NAP; and

an implied EBIT multiple by FY 2016 is 25x.

We believe a sensible medium to long-term strategy for Richemont to mitigate downside sales and earnings risk to NAP would be to explore the possibility of an IPO when market conditions improve – should increased competition and brand withdrawal start to affect future sales and profitability of the business.


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Implied value release assuming 49% IPO of NAP Euro/m, Y/E March FY11 FY12E FY13E FY14E FY15E FY16E FY17E Leather & Accessories, Other 968 1,231 1,426 1,626 1,788 1,967 2,124 NAP sales (€m) 282 440 550 688 860 989 1,087 NAP as % of Other Businesses 29% 36% 39% 42% 48% 50% 51% NAP growth % 109% 56% 25% 25% 25% 15% 10% NAP as % of Group sales 4% 5% 5% 6% 7% 8% 8%

Leather & Accessories & NAP -34 -27 -38 -12 82 138 173 Ex NAP Division profit (€m) -40 58 -19 -19 5 20 21 NAP Estimates 6 -85 -19 7 77 119 152

3x sales (€m)

2,063 2,579 2,966 3,262 Implied EBIT multiple

300.0x 33.3x 25.0x 21.4x

Richemont retained value (€m)

1,052 1,315 1,512 1,664 Richemont realised value (€m)

1,011 1,264 1,453 1,598



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Financials

profit and loss

Euro/m y/e March 31st FY12 FY13 FY14E FY15E

Group turnover 8,867.5 10,150.0 11,193.0 12,147.1

Reported sales growth % 28.7% 14.5% 10.3% 8.5%

Cost of Sales (3,217.0) (3,631.0) (4,002.8) (4,344.0)

Gross Profit 5,650.5 6,519.0 7,190.2 7,803.1

Gross Margin 63.7% 64.2% 64.2% 64.2%

Selling, distribution and store expenses (1,961.0) (2,265.0) (2,529.6) (2,745.3)

% sales 22.1% 22.3% 22.6% 22.6%

Communication expenses (854.0) (939.0) (1,063.3) (1,166.1)

% of sales 9.6% 9.3% 9.5% 9.6%

Administration expenses (745.0) (876.0) (962.6) (1,044.7)

% of sales 8.4% 8.6% 8.6% 8.6%

Other operating income (43.0) (13.0) Total Net Operating Expenses (3,603.0) (4,093.0) (4,555.5) (4,956.0)

% of sales 40.6% 40.3% 40.7% 40.8%

Total Net Opex % growth 18.6% 13.6% 11.3% 8.8% Memo: property rents (578.0) (701.0) (773.0) (838.9) EBITDA 2,381.5 2,809.0 3,083.5 3,409.6 Memo: Depreciation (249.0) (295.0) (325.3) (353.0) EBITA 2,132.5 2,514.0 2,758.2 3,056.6

Memo: amortisation (85.0) (88.0) (97.0) (105.3)

Luxury EBIT 2,047.5 2,426.0 2,661.1 2,951.3

Margin % 23.1% 23.9% 23.8% 24.3%

Reported EBIT as per company 2,047.5 2,426.0 2,661.1 2,951.3

Reported Margin % 23.1% 23.9% 23.8% 24.3%

Net interest receivable (235.0) (47.0) (11.4) 32.0

as % net (debt)/cash -7.4% -1.5% -0.3% 0.7% Share of post tax profit of associated undertakings (9.0) (4.0) 0.0 0.0 Profit before tax as reported (ex post tax BAT) 1,812.5 2,379.0 2,649.8 2,983.2 Profit before tax (pre-excp, pre-g/w) ex BAT 1,803.5 2,375.0 2,649.8 2,983.2

Income Tax (264.0) (370.0) (450.5) (507.1) Income tax rate 14.6% 15.6% 17.0% 17.0%

Profit after tax as reported by company 1,539.5 2,005.0 2,199.3 2,476.1

Minority Interests 4.0 8.0 0.0 0.0

Net income (reported) 1,539.5 2,005.0 2,199.3 2,476.1 Underlying Net Income Luxury 1,543.5 2,013.0 2,199.3 2,476.1

Share of post tax profit associated undertakings 0.0 0.0 0.0 0.0 Diluted EPS (pre g/w, pre excp - Euro) 2.76 3.59 3.93 4.42 Source: Berenberg estimates, Company data


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Balance sheet

Euro/m y/e March FY12 FY13 FY14E FY15E

Inventories 3,669.0 4,326.0 4,769.0 5,175.5

Trade Receivables Net 476.0 581.0 640.7 695.3

Loan and receivables 217.0 239.0 239.0 239.0

Other Receivables 48.0 102.0 102.0 102.0

Derivative financial instruments 27.0 50.0 50.0 50.0

Prepayment and accrued income 116.0 100.0 100.0 100.0 Financial assets held at fair value through profit or loss 2,400.0 2,712.0 2,712.0 2,712.0

Cash at bank and in hand 1,634.0 2,443.0 2,655.0 3,488.8

Current Assets 8,587.0 10,553.0 11,267.7 12,562.6

Intangible assets 795.0 952.0 855.0 749.6

PP&E 1,529.0 1,787.0 2,357.1 2,975.9

Investments in associated undertaking 10.0 11.0 11.0 11.0

Deferred tax assets 461.0 441.0 441.0 441.0 Financial assets held at fair value through profit or loss 69.0 59.0 59.0 59.0

Other long term assets & Debtors >1yr 319.0 694.0 694.0 694.0

Fixed Assets 3,183.0 3,944.0 4,417.1 4,930.5

Total Assets 11,770.0 14,497.0 15,684.8 17,493.1

Borrowings (66.0) (142.0) 0.0 0.0

Current tax liabilities (299.0) (282.0) (282.0) (282.0)

Provisions (163.0) (172.0) (172.0) (172.0)

Trade payables (1,309.0) (1,324.0) (1,459.6) (1,584.0)

Bank overdrafts (764.0) (1,453.0) (1,453.0) (1,453.0)

Derivative financial instruments (124.0) (83.0) (83.0) (83.0)

Creditors <1yr (2,725.0) (3,456.0) (3,449.6) (3,574.0)

Borrowings (22.0) (345.0) 0.0 0.0

Post retirement & other benefit obligations (110.0) (99.0) (99.0) (99.0)

Deferred tax liabilities (24.0) (39.0) (39.0) (39.0)

Provisions for liabs and charges (325.0) (343.0) (343.0) (343.0)

Creditors >1yr (481.0) (826.0) (481.0) (481.0) Net Assets 8,564.0 10,215.0 11,754.2 13,438.1

Shareholder funds

Share capital 334.0 334.0 334.0 334.0

Treasury shares (515.0) (556.0) (556.0) (556.0)

Hedge and share option reserve 255.0 288.0 288.0 288.0

Cumulative translation reserve 1,410.0 1,324.0 1,324.0 1,324.0

Retained earnings 7,071.0 8,826.0 10,365.2 12,049.1

Total equity 8,555.0 10,216.0 11,755.2 13,439.1

MI 9.0 (1.0) (1.0) (1.0)

Total equity 8,564.0 10,215.0 11,754.2 13,438.1



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Cash flow statement

Euro/m y/e March FY12 FY13 FY14E FY15E

Operating profit pre exceptionals 2,047.5 2,426.0 2,661.1 2,951.3 Depreciation ppe impairment & amortisation of intangibles 334.0 383.0 422.4 458.4

Increase in inventories (687.0) (582.0) (443.0) (406.5)

(Increase)/Decrease in Receivables (72.0) (91.0) (59.7) (54.6)

(Increase)/Decrease in other Receivables (65.0) (56.0) 0.0 0.0

Increase in payables 251.0 (187.0) 135.6 124.4

Change in working capital (573.0) (916.0) (367.1) (336.7)

Other non-cash (13.0) 51.0 0.0 0.0

Cash from Operations 1,795.5 1,944.0 2,716.4 3,072.9

Net interest 7.0 (18.0) (11.4) 32.0

Taxation paid (317.0) (361.0) (450.5) (507.1)

Net Cash inflow from operating activities 1,488.5 1,568.0 2,254.6 2,597.7

Net Capital expenditure (398.0) (524.0) (895.4) (971.8) Net Cash generated from/used in investing activities (785.0) (1,441.0) (895.4) (971.8)

Free Cash Flow 675.5 121.0 897.3 1,150.7

Net repayment of borrowings (146.0) 308.0 0.0 0.0

Dividends paid (204.0) (250.0) (660.1) (792.1)

Net Cash used in financing activities (530.0) 3.0 (660.1) (792.1)

Effects of Currency Movements 42.0 (10.0) 0.0 0.0

Opening Net (Debt)/Cash 2,589.0 3,182.0 3,215.0 3,914.0

Net increase 173.5 130.0 699.0 833.8

Other non-cash 377.5 (87.0) 0.0 0.0 Closing net (debt)/Cash - EURO 3,182.0 3,215.0 3,914.0 4,747.8


The Swatch Group AG Luxury Goods

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Looking for a better entry point

• Swatch Group has an impressive sales and earnings track record (26-year sales and EPS CAGR of 7% and 14% respectively) and remains one of our most preferred medium- to long-term investment cases, driven by sustainable pricing power across a diversified brand portfolio. We expect Swatch to continue to gain share in key markets and appreciate the opportunities to upscale the recently acquired Harry Winston brand in terms of product and distribution.

• Short term, we expect sales and earnings volatility to present investors with attractive entry points over the next six months. We believe that Swatch’s reduction of its work in progress by 13% yoy in 2012 may be the single most important forward-looking indicator with regard to management’s proactive stance on future manufacturing capacity and stock management against the backdrop of weak mainland Chinese consumer demand, which we do not expect to improve until H1 2014.

• We expect FY 2013 total inventory to exceed CHF5.2bn in 2013, up from CHF4.4bn in 2012. While justified by the increase in directly owned stores as a percentage of sales coupled with Harry Winston stock allocation, we expect the market to weigh the working capital risk less favourably until tangible improvements in demand in key regions are noted without incremental markdown activity driving volume.

• For the first time in five years, our FY 2013 and FY 2014 earning forecasts of CHF30.8 and CHF34.0 are below consensus (by 6.7% and 8.1% respectively). We factor Watches and Jewellery EBIT margin dilution after the Harry Winston acquisition, weaker Production volumes and no profit within the Electronic Systems division for a second consecutive year in 2013. As a result, we downgrade Swatch to Hold and reduce our price target to CHF575 (from CHF625).

• Our CHF575 price target, based on our P/E analysis and driven by earnings and cash-flow forecasts, implies CY 2013 and CY 2014 P/Es of 18.7x and 16.9x (non-cash adjusted) and 17.6x and 15.8x (cash-adjusted), supported by our DCF (CHF580) and SOTP (CHF576).

Hold Rating system

Current price

CHF 540.50

Absolute

Price target

CHF 575.00 11/06/2013 SIX Swiss Close Market cap CHF 20,144 m Reuters UHR.VX Bloomberg UHR VX

Changes made in this note Rating Hold (Buy) Price target CHF 575.00 (625.00) Chg 2013e 2014e 2015e


Sales 8910 -2.6 10213 -7.6 11660 -12.2

EBIT 2315 -9.0 2692 -13.6 3082 -16.5

EPS 33.61 -8.3 39.07 -13.0 44.72 -15.9


Share data

Shares outstanding (m) 54 Enterprise value (CHF m) 27,501 Daily trading volume 174,610

Performance data

High 52 weeks (CHF) 598.00 Low 52 weeks (CHF) 346.60 Relative performance to SXXP SMI 1 month 1.2 % 3.7 % 3 months 0.2 % 0.8 % 12 months 23.1 % 18.7 %

Business activities: Manufacturer and retailer of Watches & Jewellery. Supplier of watch components and movements via its Production business unit and supplier of electronic components and semi-conductors via its Electronic Systems business unit

Non-institutional shareholders: Hayek family and associates 48.0%

20 June 2013


Bassel Choughari


Rupert Trotter


Y/E 31.12., CHF m 2011 2012 2013E 2014E 2015E

Sales 6,764 7,796 8,681 9,442 10,236

EBITDA 1,843 2,245 2,398 2,640 2,915

EBIT 1,614 1,984 2,107 2,324 2,572

Net profit 1,276 1,608 1,663 1,835 2,030

Net cash (net debt) 2,078 1,832 1,302 2,159 3,308

EPS (reported) 23.5 29.6 30.8 34.0 37.6

EPS (recurring) 23.5 29.6 30.8 34.0 37.6

CPS 2.7 3.0 -3.1 23.6 30.2

DPS 5.8 6.8 7.8 8.9 10.3

Gross margin 79.0% 79.0% 79.5% 80.0% 80.5%

EBITDA margin 27.2% 28.8% 27.6% 28.0% 28.5%

EBIT margin 23.9% 25.4% 24.3% 24.6% 25.1%

Dividend yield 1.1% 1.2% 1.4% 1.6% 1.9%


EV/sales 4.1 3.5 3.2 2.9 2.7

EV/EBITDA 14.9 12.2 11.5 10.4 9.4

EV/EBIT 17.0 13.9 13.1 11.8 10.7

P/E 23.1 18.3 17.6 16.0 14.4

ROIC/WACC % spread 5.3% 5.8% 4.3% 4.1% 4.7%



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Swatch key assumptions and sensitivities

Divisional estimates

FY12 FY13E FY14E FY15E 3y CAGR (%) 12-15E

Group net sales (CHF m) 7,796 8,681 9,442 10,236 9.5%

Y/Y growth 15.3% 11.4% 8.8% 8.4%

Operating Profit (CHF m) 1,984 2,107 2,324 2,572 9.0%

Y/Y growth 22.9% 6.2% 10.3% 10.7% Operating margin 25.4% 24.3% 24.6% 25.1%

Watches & Jewellery Sales (CHF m) 6,955 7,846 8,550 9,302 10.2%

Y/Y growth 16.8% 12.8% 9.0% 8.8% Constant currency 13.4% 8.0% 8.0% 8.0% Currency impact 3.4% 0.5% 0.0% 0.0% EBIT (CHF m) 1,633 1,761 1,922 2,138 9.4%

EBIT margin 23.5% 23.0% 23.0% 23.5%

Production Sales (CHF m) 2,215 2,248 2,473 2,621 5.8%

Y/Y growth 12.3% 1.5% 10.0% 6.0% Constant currency 12.4% 1.0% 10.0% 6.0% Currency impact -0.1% 0.5% 0.0% 0.0% EBIT (CHF m) 442 438 482 511 5.0%

EBIT margin 20.0% 19.5% 19.5% 19.5%

Electronic Systems Sales (CHF m) 308 291 291 297

Y/Y growth -7.8% -5.5% 0.0% 2.0% Constant currency -9.4% -6.0% 0.0% 2.0% Currency impact 1.6% 0.5% 0.0% 0.0% EBIT (CHF m) 1 0 12 15 EBIT margin 0.3% 0.0% 4.0% 5.0%

Corporate Sales (CHF m) (1,682) (1,704) (1,872) (1,984)

EBIT (CHF m) (92) (92) (92) (92)

Diluted EPS (CHF) 29.6 30.8 34.0 37.6 8.3%

Y/Y growth 26.2% 4.0% 10.3% 10.6%

DPS (CHF) 6.8 7.8 8.9 10.3 15.0%

Y/Y growth 17.4% 15.0% 15.0% 15.0%

Net cash/(debt) (CHF m) 1,832 1,302 2,159 3,308



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Short-term risks

H1 2013 Watches & Jewellery underlying sales and margin pressure

We forecast H1 2013 group EBIT of CHF882.5m, a 2.3% decrease yoy as Swatch Group absorbs the Harry Winston brand. We expect Watches & Jewellery divisional EBIT margin to fall by 35bp on the back of the acquisition, partially offset by steady pricing power at Omega and resilient trading within mid to high-end brands such as Longines, Tissot and Rado.

However, prestige trading in mainland China and tourist-exposed Hong Kong destinations such as Breguet’s boutique at 1881 Heritage, Tsim Sha Tsui remains challenging. Weak trading has been exacerbated by rental and wage inflation, most notably in Hong Kong. We estimate that prestige and luxury brands (including Harry Winston, FY 2013 forecast revenues of CHF300m) will account for 52% of Watches & Jewellery sales for Swatch in 2013.

As a result of weak underlying prestige volumes, rental and wage inflation and first-half weighted advertising and promotion investments, we expect H1 2013 Watches & Jewellery EBIT margin to contract by 100bp to 21.1%. We note that collective first-half investments in advertising and promotion (most prominent around the Omega and Longines brands) coupled with a higher rate of investment during this year’s BaselWorld exhibition are likely to weigh on H1 profitability.

The underlying Watches & Jewellery constant-currency comparison base is also tougher at 15.8% (H1 2012). We forecast H1 2013 underlying constant-currency growth of 3.0% and 8% for FY 2013 (excluding Harry Winston), which assumes an underlying volume contraction of 1%, value growth of 6%, FX support of 0.5% (we note USD/CHF has moved back from 0.98 to 0.92 recently so is less favourable) and a sales contribution from new space of c3%.

CHF versus major currencies, 2008 to 2013 year to date

Source: Datastream

Including Harry Winston, we estimate Watches & Jewellery H1 2013 reported sales growth of 6.3% to CHF3,438m. We also look for a 12.8% yoy reported sales increase in FY 2013 to CHF7,846m with a higher sales contribution during the second half of the year as the underlying comparison base (excluding Harry Winston) eases to c11% and a full half year of Harry Winston sales is recognised

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during the second half (Swatch Group recognises 9/12th of Harry Winston sales in 2013).

2013 Production estimates may be over-cooked by the market

We have been strong believers in Swatch being able to drive higher Production volumes through its own brands, resulting in Watches & Jewellery EBIT margin support and higher component and movement pricing as the Swiss Competition Commission looks to ratify a draft agreement allowing Swatch Group to steadily reduce supply to third parties.

Yet over the past two years, principal third-party clients such as Richemont Group and LVMH have added considerably to their own in-house manufacturing to a point where we believe that capacity constraints on hands, dials and movements have eased (assisted by weaker demand for prestige watches in Asia). For example, we note that Richemont brands such as Panerai now have c65% of its movements manufactured in-house while IWC is at c50%, having invested CHF100m in the past ten years of which CHF25m was in 2012. Cartier watches will also invest a further CHF30m in its Couvet manufacturing plant in 2013.

We recognise there was a sharp appreciation in component pricing in January and February this year (up to 25-30% yoy increases for selected components). This ought to support Swatch’s FY 2013 Production margin but not necessarily volumes; hence we forecast H1 2013 Production sales decline of c5%, which may prove conservative (+1% on a underlying basis given the soft H2 comparison of -4%). We expect FY 2013 Production EBIT margin to decline by 50bp to 19.5%, supported by robust first-half pricing.

Mind the Swiss GAAP We believe the return to Swiss GAAP is a retrograde step that will make it harder to compare and contrast Swatch and Richemont performance. Swatch will be the largest non-financial company to use Swiss GAAP.

Fortunately, we understand that there will be no change to the way that Swatch accounts for its inventory as, under Swiss GAAP, companies can choose to adopt either FIFO or LIFO accounting. Under IFRS, LIFO accounting is prohibited (hypothetically, a switch to LIFO for Swatch could result in a lower inventory value allowing Swatch to drive a more positive working capital profile and cash-flow). This is a key point for us as we continue to analyse Swatch, Richemont, Hengdeli, Oriental and Emperor watches inventory divisional split performance correlated with Swiss watch exports to assess capacity constraints and evaluate the likelihood of incremental markdown on overstocking in the future.

Swatch Group implemented the return to Swiss GAAP as of 1 January 2013, describing the move as one that was justified and resulted in a reasonable “cost/benefit ratio” and that, by making the move, Swatch would “return to a more practical and less theoretical accounting practice”. At the time of the announcement, we noted the following.

Swatch’s optionality on whether or not to capitalise development and borrowing costs – we expect Swatch to capitalise as this allows for more effective margin recognition.

Swiss GAAP allows for no effectiveness tests, documentation or restrictions regarding hedging – Swatch is exposed to small amounts of yen hedging so we expect more opaqueness here.

On non-financial assets and goodwill, Swatch can amortise over a 20-


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year period as opposed to five years under IFRS. Should Swatch ultimately take a more concentrated position in Hengdeli (likely under distressed circumstances), the extended amortisation period would be advantageous for Swatch.

No actuarial valuation of Swatch’s collective pension funds is required under Swiss GAAP as pension accounting is based on the financial statements of the pension fund so there is no marking to market. We would expect Swatch to adopt a less actuarial pension accounting methodology, which we think is less conservative than accounting for the actuarial deficit in our DCF- and SOTP-based calculations (supportive valuation measures).

We note that Swatch adopted IAS (predecessor to IFRS) in 2001 voluntarily. When the company first switched and restated the 2000 figures, EBIT and net earnings decreased by 4% and 16% respectively as income from treasury shares and unrealised financial income on other investments were no longer included in the P&L but rather were reflected within changes in equity. Hence we expect to see some volatility within the restated numbers. Furthermore, as we hinted above, acquired intangible assets are not amortised under Swiss GAAP (goodwill is not tested annually for impairment) and can be set off against equity on acquisition, thereby avoiding a negative impact on profits and reducing capital employed – in turn driving up ROCE.

We wonder whether the move back to Swiss GAAP is a) a pre-cursor to collapsing the Production and Watches & Jewellery divisions as in our view Swatch will inevitably increase its component and movement allocation for directly owned brands or b), on a long-term basis whether the move is a pre-emptive accounting step to taking a larger position in its key Asian supplier, Hengdeli. We do not envisage Swatch investing more to acquire a larger stake although we note that Swatch has taken more than 10% of Hengdeli shares as collateral against a $100m loan to Hengdeli’s chairman Mr Yuping; this will expire in July 2014. Should a default occur and/or Greater China markets remain subdued, Hengdeli could come under financial distress. Currently, Swatch Group and LVMH hold 9.06% and 6.33% of Hengdeli shares respectively.

Mitigating opportunities – a softer cost base in 2013 versus 2012 2013 is not a summer Olympics year. As a result, Swatch Group ought to benefit from lower sales, marketing and advertising costs. On our estimates, the Omega/Olympic-related investment in 2012 was under CHF200m; this is unlikely to be replicated in 2013.

However, part of the annualised effect is expected to be offset by incremental investments made during BaselWorld 2013 for all Swatch brand (exhibition) stands in addition to concentrated advertising campaigns for Omega (co-axial chronometer) and Longines’ “Conquest” collection, having secured a 10-year advertising/sponsorship contract with the International Equestrian Federation.

In the medium-to-long term, we expect marketing campaigns to assist with Swatch brands’ steady improvement in collective brand pricing power and mix. For example, the Longines Saint Imier collection had an average selling price of just over CHF3,000 in 2012 compared with Omega at more than CHF16,800.

We believe the opportunity to improve the price/mix for mid to high-end brands such as Longines through strengthened associations such as the International Equestrian Federation could result in Longines doubling its brand ASP over a 3-5 year period. Swatch management highlighted Longines sales and EBIT margin


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performance in 2012 (CHF1.2bn sales with a 33% EBIT margin). We forecast Longines sales to increase by c22% in 2013 albeit at a lower margin due to higher marketing and contractual costs associated with the Equestrian Federation advertising and sponsorship deal.

Brand reference numbers and commodity weighting by brand

Source: BaselWorld 2012, Company data, Berenberg estimates (Longines Saint Imier collection)

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Platinum Gold Mix Titanium Steel


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Medium to long-term opportunities

In our view, the fundamental long-term earnings and market share drivers have not changed for the Swatch Group. If anything, they may have strengthened through the acquisition of Harry Winston as well as Swatch’s decision to progressively roll out more directly owned stores for prestige brands and run a more tightly controlled distribution strategy for mid to high-end brands (Hour Passion store format).

Long-term investment case intact

The fundamental drivers for Swatch long-term outperformance are intact.

Investor reliance on a proven track record: Swatch’s 26-year sales and EPS CAGR of 7% and 14% are impressive.

Swatch has manufacturing and innovation class: Swatch is less exposed to supply shortages and forced R&D investment given its world-class component manufacturing operations, ETA. To date, we estimate that just under 80% of all Swiss watches (volume weighted) are made with ETA movements.

High barriers to entry, strong pricing power and heritage: Manufacturing expertise, heritage, innovation, design and pricing power are all Swatch Group hallmarks.

While BaselWorld 2012 focused on James Bond 007 Omega and Cera Gold collections, BaselWorld 2013 introduced some very strong Swatch innovations such as anti-magnetic components made from “Nivagauss” material used in the movements’ staffs and pivots, which complement the Nivarox anti-magnetic hairspring (introduced in 2008).

Swatch estimates that 80% of watches in Japan are currently magnetised. The effect of a magnetised watch results in inaccurate and/or total loss of time-keeping. The introduction of movements that can withstand magnets of up to 15,000 gauss will ultimately reduce Swatch’s after-sales service-related costs and provide Swatch brands with a unique selling point compared with external competitors. We note that the AcquaTerra is capable of withstanding 15,000 gauss and by 2017 Swatch Group anti-magnetic materials ought to be available across prestige and luxury brands with in-house movements.

“Sedna gold” is a new rose gold alloy created by Swatch Group. It is patented for twenty years. Traditional rose gold is prone to oxidation after long periods as the combination of gold, copper and silver breaks down. Swatch has created a formula with gold, copper and palladium which does not oxidise. The new rose gold standard will be rolled out across prestige brands such as Breguet, Blancpain, Glasshute and Jaquet Droz.

Product diversity targets the broadest demographics: In our China sector piece, we highlight the demographic opportunities for the growing aspirational Chinese middle class. In our view, Swatch has the strongest mid to high-end brand collection which ought to directly appeal to the growing aspirational luxury consumer. According to Baidu, the Chinese internet search engine, the Longines brand remains the most sought-after watch brand in Mainland China so far in 2013.


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Geographic diversity ought to drive market share gains: We expect Swatch to increase its Americas sales penetration by 80bp to 9% by FY 2016 and Switzerland to continue to grow as a percentage of group sales on the back of Asian tourism and tax rebates (+40bp to 14.3% by FY 2016). We forecast Asian regional sales exposure (excluding European and US tourism) to be flat at 53.4%, primarily due to the current weakness in domestic Chinese consumption for prestige and luxury watches. CEO Hayek mentioned that Omega mainland China sales were down 6% from January to April while Hengdeli estimated Omega mainland Chinese sales had decreased by 10-12% year to date, outperforming prestige brands such as Cartier watches where sales are down more than 30% ytd.

Conversely, Swatch’s mid to high-end brands such as Tissot and Longines continue to outperform with Hengdeli reporting robust double-digit sales growth (in the region of 20-30%).

Cost control and margin management: We refer to the annualised Olympics and Omega spending last year while acknowledging that the softer cost comparison base is likely to be hit by incremental brand advertising and promotional spend (Omega, Blancpain and Longines) coupled with above-average investments during the BaselWorld 2013 brand exhibitions.

Swatch has a historically high operating expense ratio as a percentage of sales (FY 2012: 53.3% versus Richemont’s record low of 40.3% in FY 2013). Should demand weaken further for prestige brands, Swatch is able to reduce sales, marketing and administration-related costs in order to manage group EBIT margin. We note FY 2009 group EBIT margin represented the trough at 17.6%, a better-than-expected performance given the negative operating leverage of 4.5x (FY 2012 operational gearing was 3.1x).

Vertical integration and production margin opportunities: The high level of vertical integration across the manufacturing process and assembly line continues to appeal. Swatch is able to leverage its innovation and intellectual property across brands and enjoy the benefits of its relative size and scale in terms of Swiss-made components and movements (volume weighted).

In the medium-to-long term, we expect to see incremental Production margin increases through improved price/mix dynamics coupled with additive margin contributions to the Watches & Jewellery division as a higher percentage of in-house movements are allocated to Swatch-owned brands. In the short term, we believe that production volumes will decline as both the wholesale and retail market look to trim current inventory levels and manage working capital/cash-flow effectively.

Strategic alliances: Swatch in 2012 increased its stake in the Middle Eastern watch distributor Rivoli from 15% to 40% while maintaining a 33% stake in Alzouman General Trading Co. Ltd in Saudi Arabia. As of December 2012, Swatch’s associate income increased to CHF18m (CHF6m in 2011), mostly reflecting the increased stake in Rivoli. The net financial gain was CHF33m in 2012 compared with a loss of CHF3m in 2011.

In our view, working more closely with fewer partners makes sense as Swatch negotiates narrower discount bands on specific watches, cuts out 2-3% discounts for distributors that pay for product within 30 days and


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has more influence in controlling brand pricing and distribution.

Over the medium term, we are concerned as to how the working relationship will evolve with Hengdeli should Swatch Group proactively increase its own mid to high-end, luxury and prestige networks given Hengdeli’s reliance on Swatch brand ranges.

Strong balance sheet in spite of recent acquisitions: In spite of the $1bn EV paid for Harry Winston and an anticipated working capital outflow of cCHF930m in FY 2013 (FY 2012: CHF845m), we expect Swatch to generate net cash of CHF1.3bn (Bloomberg consensus: CHF1.5bn), supportive on a cash-adjusted P/E basis.

Opportunities for 2013 and beyond We highlight operating and brand opportunities for the future, as follows:

improved manufacturing automation – investment in ETA, machinery hubs, Guillocharge for dials, stamping, polishing and digital printing;

new product ranges at Rado, Omega, Longines and Swatch including the widely anticipated Section 51 plastic automatic watch. We understand Chinese stores will stock the watch from July while European stores should receive the product from August to September. We estimate the retail price will be the equivalent of CHF150-200 in Paris, well above the Swatch brand ASP.

We highlight our mid to high-end brand sales expectations from 2005 to 2016 below.

Estimated mid to high-end sales evolution for Swatch brands (CHFm)


expanding the multi-brand distribution concept via “Hour Passion” in Europe and overseas stores. If we include the basic range of brands in our mix calculations as well as factoring in our Harry Winston FY 2016 sales forecast of CHF650m, basic, mid to high-end watches ought to account for just under 50% of Watches & Jewellery sales; and

taking greater control of the distribution channel – the Breguet DOS network is expected to represent 30-35% of sales, Blancpain 20-30%, Omega 20-30% and the Swatch brand 60-70% (via small kiosk stores in prime travel locations) over the next 3-5 years, positive in terms of pricing power and mix, though fixed costs will rise.

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BaselWorld initial thoughts

As we literally have thousands of data points to crunch through after BaselWorld 2013, we make initial observations at this stage; these have nonetheless been corroborated by Swatch Group and Asian distributors alike.

Key takeaways

In our view, BaselWorld 2013 was the softest by way of retail order book demand in the past four years. Across the prestige and luxury sectors, order books were slightly down or flat to slightly up yoy with Swatch brands broadly outperforming peers. Distributors remain conscious of their order backlog and current inventory levels – cash-flow generation and stock turn remain the priorities of the day.

The overriding need to manage working capital and drive cash-flow while reducing overstocked brands has been a core theme for us this year and one we believe is in tune with Swatch Group’s proactive management of its work in progress (reduced by 13% yoy to CHF458m). Semi-finished and finished goods increased by 18% and 38% to CHF1,663m and CHF1,658m, respectively. As a result, we believe there ought to be more than enough inventory to fulfil Swatch’s DOS rollout strategy over the next 24 months.

Initial industry estimates appear to support up to 25-30% fewer new product launches yoy after a strong product pipeline in 2012.

Price positioning looks lower than in 2012. For example, Omega core 2012 launches included the James Bond 007 limited edition and Cera gold Chronograph with a retail price range of CHF7,000-28,000. In 2013, the emphasis was on Omega’s speedmaster (“dark side of the moon”), and the Aquaterra with anti-magnetic Nivagauss materials where the price ranges were CHF7,000-10,000.

An emphasis on mid to high-end range products by Swatch Group with the Swatch Section 51, as discussed above. Rado ceramic digital touch products were also aimed at the female market (no crown on the watch, thereby eliminating the risk of chipping one’s nails).

A lot of money has been spent on new BaselWorld stands with LVMH group taking big stand positions for Hublot, TAG and Bulgari.

The BaselWorld rumour involved Kering (formerly PPR) bidding for Richard Mille (2011 sales of CHF84m – we estimate closer to CHF100m in 2012, which could be sold for 3-5x sales). However, as the brand is very niche, we are unsure how Kering would scale the business should it acquire the brand. Acquiring Mille’s in-house manufacturing is clearly desirable and could be leveraged into other Kering watch brands such as Girard Perregaux.

Omega references nudged up from 258 in 2012 to 263 in 2013 although in our view this reflects more variations than differentiated models – the core range of new references in 2013 is closer to 160. Swatch Group innovations such as anti-magnetic materials and sedna gold ought to assist with product differentiation and future market share gains.


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Harry Winston assumptions and opportunities

CEO Hayek said that Harry Winston could become a CHF1bn brand with an EBIT margin of c25% within 4-5 years. This implies a five-year sales CAGR of more than 16% (FY 2013E-18E), which may be achievable given the relatively low sales base (2012E: $468m).

We note that the implied Bloomberg consensus two-year sales CAGR forecast to 2014 was more than 22% prior to Swatch’s acquisition. Here, we see material upside risk from scaling up the watches operations, which currently accounts for less than 20% of Harry Winston sales (c4,000 units manufactured compared with c18,000 units at Blancpain and c25,000 units at Breguet).

Our three-year Harry Winston sales CAGR estimate (2013-16) is 29.4% and implies FY 2016 sales of CHF650m with an EBIT margin of 16%.

In terms of incremental margin opportunities, we believe low-hanging fruit exists such as cutting out interest-related payments on debt-funded expansion. Swatch CEO Hayek highlighted on a conference call with analysts that he estimated debt-related funding currently costs Harry Winston 500-600bp of net income margin. As Swatch is debt-free, the debt-funded investment-related costs ought to cease given Swatch’s positive operating cash-flow/net cash balance sheet. In addition, we see margin opportunities from limited headcount rationalisation, greater leverage on sourcing, centralised advertising, supply and improved mix.

Why the confidence in driving the margin higher at Harry Winston?

We highlight below Harry Winston’s management team’s EBIT margin forecasts to January 2016 relative to luxury peers prior to the announced deal. According to the current management team, Harry Winston’s luxury EBIT margin ought to more than double from an estimated 5.7% in 2012 to 16% in FY 2016.

Harry Winston pre-deal luxury EBIT margin forecasts

Source: Harry Winston

In our view, the opportunity to stretch the Harry Winston brand is high. The brand has limited visibility through directly owned stores (DOS) of which it currently has 20 (equivalent to 9% of the total distribution network), which can be raised via Swatch’s Tourbillon store network.

FY20114.3%$345

FY20124.7%$412

TargetF2013

Fiscal 2016

Bulgari5.7%

$1,502

GRAFF21.2%$756

TIF19.4%$3,643

SWATCH23.9%$7,429

RICHEMONT25.5%

$11,553LVMH22.2%

$32,432

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Harry Winston Luxury Brand Benchmark – FY2012


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The historical management team at Harry Winston expected DOS to increase to c35 by FY 2016. We expect The Swatch Group to increase the number of DOS while at the same time managing wholesale brand distribution via larger and more controllable channels such as the Rivoli Group in the Middle East and Alzouman & Sons in Saudi Arabia.

Too great a focus on DOS expansion alone would result in slower EBIT margin increase, although this may well be the right action to take for a brand like Harry Winston.

Harry Winston pre-deal distribution network forecasts


Is Harry Winston the next Breguet, VCA or Cartier?

We believe that The Swatch Group has strong expertise in jewellery design and manufacture, although it lacks sourcing and distribution scale. Following the Harry Winston deal, we expect slight incremental jewellery weightings for brands such as Breguet and Leon Hatot, although we expect Swatch to remain first and foremost a watches and jewellery company as opposed to a jewellery and watches company. Hayek has estimated that in 10-15 years’ time, The Swatch Group sales could reach CHF20bn, of which no more than 20% of watches and jewellery sales would be standalone/purely jewellery-related.

To date, we note that brands such as Leon Hatot, Breguet and Omega have their own standalone jewellery offering and/or a meaningful percentage of intra-brand sales related to bejewelled timepieces.

For example, Breguet’s Crazy Flower bejewelled diamond timepieces are perceived by consumers as works of (jewellery) art that incorporate sophisticated timepieces. The bejewelled timepieces are decorative and innovative high jewellery, which command high barriers to entry and are positioned at the pinnacle of prestige pricing (more than CHF1.5m).

We note that the late Mr Hayek (senior) acquired Breguet in 1999 from Investcorp with annual turnover of over CHF20m. At the time, the business was loss-making. Mr Hayek took the brand back to its roots with collections such as the Tradition, reminding consumers of the brand’s rich heritage and innovation (Breguet was not only a watchmaker to members of European royalty, he introduced the world-renowned Tourbillon movement).

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20 c.35

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2012 2016

Wholesale (watches only) Licensed Salons DOS


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Having slightly revised our 2012 Breguet reported sales estimates, we believe Breguet delivered a 13-year reported sales CAGR of c35% from 1999-2012 to just under CHF1bn. Furthermore, we forecast Breguet sales CAGR of at least 6% to FY 2016, which may prove conservative as the DOS network increases to c30% of sales within the next 3-5 years.

Breguet 13-year reported sales* CAGR (1999E-2012E)

Source: Berenberg estimates (*CHFm)

Breguet’s sales and margin evolution over the past 13 years is supportive of Swatch’s track record of nurturing and building a star brand’s equity over a measured timeframe.

Other brands that stand out as having successfully improved sales and EBIT margins over time are Richemont brands; Cartier and VCA. Not only have the brands been blurring the distinction between prestige/bejewelled watches and jewellery for some time, on our analysis both brands enjoyed record sales and EBIT margins in FY 2013.

Increasing the Americas sales footprint

We compare Swatch Group and Harry Winston sales exposure (December 2012 versus January 2013). While both companies have a relatively strong sales presence in Asia, we note Harry Winston is bigger in Japan and as a result ought to have a greater sales growth opportunity in other Asian markets (China, Hong Kong, Macau and Singapore).

We anticipate that Swatch will be able to drive the Harry Winston brand to underpenetrated markets such as the Middle East through its retail and influential third-party distributor network (eg the Rivoli Group).

Importantly, Harry Winston has strong sales and brand presence in the Americas and the US, where the brand has in-house jewellery production capabilities. By comparison (on a percentage of sales basis), Swatch Group lacks size and scale in one of the largest luxury goods regions in spite of an estimated two-year sales CAGR of more than 25% for brands such as Omega, Breguet and Blancpain.

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Harry Winston FY 2013 regional sales split


Swatch Group FY 2012 regional sales split

Source: The Swatch Group

Production margin opportunities

In our view, the holy grail of luxury goods companies is to effectively control both brand and distribution with as much vertical integration as possible. While Swiss watch industry players continue to reduce inventory levels in key Asian regions such as Hong Kong and China, we believe that the mid to long-term future for Swatch’s Production division is healthy. Short-term, we see downside risk to volume and margin expectations on lower production volumes as retailers and manufacturers continue to manage working capital and capacity respectively.

The Harry Winston deal provides another potential dimension to Swatch’s Production efficiency. In terms of watch production, The Swatch Group is already the market leader with 75-80% of Swiss watch production market share (on a volume basis). We believe Swatch will be able to realise further synergies with Harry Winston’s production plant based in Geneva.

However, a potentially more interesting angle relates to comments from Harry Winston chairman and CEO Robert Gannicott: “The company (Harry Winston

United states32%

Europe23%

Asia ex. Japan25%

Japan20%

Switzerland, 13.9%

Other Europe, 22.7%

Total Europe, 36.6%

America, 8.2%

Greater China, 36.8%

Other Asia, 16.6%

Total Asia, 53.4%

Oceania, 1.0% Africa, 0.7%


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mining) will retain an ongoing relationship with The Swatch Group, one of the world’s largest buyers of polished diamonds, in sourcing polished diamonds for them. The two companies will also explore the opportunities for a joint diamond polishing venture bringing together the manufacturing and diamond expertise of the two companies.”

This view was echoed by Swatch CEO Hayek during the analyst conference call. He said that a diamond polishing joint venture would clearly be in the best interests of The Swatch Group from an ethical sourcing, supply and price standpoint.

The largest added value is created in retail ($bn)

Source: Bain & Co; IDEX, Tacy Limited, Chaim Even-Zohar, Diamond value chain

The highest EBIT margin is at source (Production) followed by Retail

Source: Bain & Co, IDEX, Tacy Limited, Chaim Even-Zohar, Diamond value chain

What needs to be fixed at Harry Winston?

In our view and notwithstanding scaling up watches production, which we take for granted, Swatch Group has a few “easy wins” to make.

The existing store formats need to change, in our view. The Beverly Hills store for example looks like Fort Knox and does not appear welcoming from a customer standpoint. The majority of the DOS network appears too “elite” and not “prestige” enough, thereby deterring a high number of potential customers.

12.0 12.3 12.517.5 18.2

35.0

60.2

Productionvalue

Production salesincl. stocks

rough- diamondsales by

sightholders/dealers

Cutting andpoloshing sales

Polished-diamond sales

by dealers

Jewelerymanufacturer

sales

Retail sales

+0.3 +0.2+5.0 +0.7

+16.8

+25.2

Production Production sales Rough-diamond Cutting and Polished- Jewellery Retail salesvalue incl. stocks sales by polishing sales diamond sales manufacturer

sightholders/ by dealers salesdealers

22-26%

1-3%2-5%

1-4%3-5%

8-10%

0%

5%

10%

15%

20%

25%

30%

Production(US$11bn)

Rough-diamondsales (US$13bn)

Cutting andpolishing(US$18bn)

Polished-diamonds sales

(US$18bn)

Jewellerymanufacturing

(US$35bn)

Retail (US$60bn)


112

The selling space in stores is too low. Currently the selling space in stores averages 25-30% with very little space dedicated to product display. We believe Swatch should adopt a more consumer-facing layout, similar to those found in Cartier stores which successfully display watches and jewellery under one roof.

Swatch has the opportunity to refocus its attention on the female watch customer. It has moved away from being c90% female orientated to c50/50 today. For example, we see opportunities to develop the high-margin Feathers collection.

Harry Winston stores need more traffic. According to our analysis, on average 16 customers visit a Harry Winston store each day. Footfall is therefore low, partly due to the intimidating store frontages but also due to the historical nature of the sales teams. The latter are very well connected and have in the past focused on a very small client base; store visits are predominantly arranged by appointment. While this has resulted in high conversion rates of up to 70-75% in some stores, footfall rates have not increased.

Harry Winston needs to leverage more from its diamond/jewellery heritage when expanding future watch and jewellery collections. For example, we believe Harry Winston could create a “Hope” watch collection given its association with the world famous Hope diamond or an “Opus” bijou jewellery collection to complement the existing high-end watch line.

Production control: Harry Winston manufactures very high-end pieces of jewellery upstairs in its 5th Avenue store but the bulk of the jewellery is outsourced across Manhattan. We believe that a tighter rein on in-house production ought to result in improved margin on increased verticality.

Valuation

Our CHF575 price target, based on our P/E analysis and driven by earnings and cash-flow forecasts, implies CY 2013 and CY 2014 P/Es of 18.7x and 16.9x (non-cash adjusted) and 17.6x and 15.8x (cash-adjusted), supported by our DCF (CHF580) and sum of the parts (CHF576).

Swatch SOTP

FY13E EBIT Tax

rate: PAT Implied 2013

Multiple Value (CHFm) Value per

share

21.0 %

Watches & Jewellery 1,760.6 (369.7) 1,390.9 18.2x 25,314.2 468.6

Production 438.4 (92.1) 346.3 15.0x 5,195.1 96.2

Electronic systems 1.0 (0.2) 0.8 12.0x 9.5 0.2

Corporate (92.0) Total implied value 2,108.0 (462.0) 1,646.0

30,518.8 565.0

Number of shares

54.0

Pension deficit + net cash

621.1 11.5

Total implied value

31,139.9 576.4



113

Financials

Profit and loss CHFm, y/e 31 December 2011 2012 2013E 2014E 2015E

Gross sales

7,143.0 8,143.0 8,756.5 9,446.6 10,173.5 Sales reductions

(379.0) (347.0) (75.2) (5.0) 62.7

Net sales 6,764.0 7,796.0 8,681.3 9,441.6 10,236.2 growth

10.7 % 15.3 % 11.4 % 8.8 % 8.4 %

Cost of sales

(1,422.0) (1,634.0) (1,779.7) (1,888.3) (1,996.1) Gross profit 5,342.0 6,162.0 6,901.6 7,553.3 8,240.1 Gross margin %

79.0 % 79.0 % 79.5 % 80.0 % 80.5 %

Net operating expenses

(3,499.0) (3,917.0) (4,503.9) (4,912.8) (5,325.0) Memo: Operating lease charges

(225.0) (309.0) (344.1) (374.2) (405.7)

EBITDA 1,843.0 2,245.0 2,397.7 2,640.4 2,915.2 EBITDA margin %

27.2 % 28.8 % 27.6 % 28.0 % 28.5 %

Depreciation

(213.0) (239.0) (266.1) (289.4) (313.8) EBITA 1,630.0 2,006.0 2,131.5 2,351.0 2,601.3 Amortisation

(16.0) (22.0) (24.5) (26.6) (28.9)

Operating profit 1,614.0 1,984.0 2,107.0 2,324.4 2,572.5 Operating margin %

23.9 % 25.4 % 24.3 % 24.6 % 25.1 %

Net financial result

(3.0) 33.0 (1.6) (1.7) (2.7) as % of net debt

(0.1)% 1.7 % (0.1)% (0.1)% (0.1)%

Profit before tax 1,611.0 2,017.0 2,105.5 2,322.6 2,569.7 Income taxes

(335.0) (409.0) (442.1) (487.8) (539.6)

% effective tax rate

20.8 % 20.3 % 21.0 % 21.0 % 21.0 % Net income 1,276.0 1,608.0 1,663.3 1,834.9 2,030.1 Net income margin %

18.9 % 20.6 % 19.2 % 19.4 % 19.8 %

Attributable: Minority interests

7.0 8.0 - - - Attributable: Equity holders

1,269.0 1,600.0 1,663.3 1,834.9 2,030.1

Dividends

(310.6) (364.3) (419.0) (481.8) (554.1)

Key data per bearer share (CHF 2.25) Basic EPS 23.5 29.6 30.8 34.0 37.6

% growth

15.9 % 26.1 % 4.0 % 10.3 % 10.6 % Diluted EPS 23.5 29.6 30.8 34.0 37.6 % growth

18.5 % 26.2 % 4.0 % 10.3 % 10.6 %

DPS 5.75 6.75 7.76 8.93 10.27 % growth

15.0 % 17.4 % 15.0 % 15.0 % 15.0 %

Av. No of bearer shares outstanding (m) 30.3 30.3 30.3 30.3 30.3 Av. No of diluted bearer shares outstanding (m) 30.3 30.3 30.3 30.3 30.3 % of share capital in bearer shares

56.2 % 56.2 % 56.2 % 56.2 % 56.2 %

% of diluted share capital in bearer shares 56.1 % 56.2 % 56.2 % 56.2 % 56.2 %



114

Cash flow CHFm, y/e 31 December 2011 2012 2013E 2014E 2015E Operating profit

1,614.0 1,984.0 2,107.0 2,324.4 2,572.5

Add back: Depreciation and amortisation

229.0 261.0 290.6 316.1 342.7

(Increase)/decrease in inventory

(800.0) (725.0) (827.3) (319.6) (149.2) (Increase)/decrease in receivables

(233.0) (200.0) (130.6) (93.8) (98.8)

Increase/(decrease) in payables

188.0 (39.0) 28.5 21.3 21.1 Changes in working capital (845.0) (964.0) (929.4) (392.1) (226.9) Stock turn

0.39x 0.37x 0.34x 0.34x 0.35x

Receivables days

48.2 49.6 49.6 49.6 49.6 Payables days

102.7 71.5 71.5 71.5 71.5

Other items 21.0 9.0 0.0 0.0 0.0 Operating activities 1,019.0 1,290.0 1,468.3 2,248.3 2,688.3 Net interest received / (paid)

11.0 25.0 (1.6) (1.7) (2.7)

Tax paid

(325.0) (316.0) (428.6) (469.1) (518.5) Cash flow from operations 705.0 999.0 1,038.1 1,777.4 2,167.1 Cash flow from Investing activities

Investments in tangible assets

(365.0) (438.0) (468.7) (501.5) (536.6) Net capital expenditure (376.0) (470.0) (1,203.7) (501.5) (536.6) Net cash flow from investing activities (561.0) (836.0) (1,203.7) (501.5) (536.6) Free cash flow 144.0 163.0 (165.5) 1,276.0 1,630.5 Financing activities

Dividends paid

(274.0) (316.0) (364.3) (419.0) (481.8) Cash flow from financing activities (350.0) (255.0) (609.3) (419.0) (481.8) Net impact of foreign exchange

(3.0) (4.0) - - -

Net increase in cash and cash equivalents (209.0) (96.0) (774.9) 857.0 1,148.7 Cash and cash equivalents at beginning of period 1,825.0 1,616.0 1,520.0 745.1 1,602.1 Cash and cash equivalents at end of period 1,616.0 1,520.0 745.1 1,602.1 2,750.8

Net debt calculations Closing cash balance

1,616.0 1,520.0 745.1 1,602.1 2,750.8 Loans and borrowings

(91.0) (135.0) 110.0 110.0 110.0

Closing net (debt) 2,078.0 1,832.0 1,302.1 2,159.1 3,307.8



115

Balance sheet CHFm, y/e 31 December 2011 2012 2013E 2014E 2015E ASSETS

Non-current assets Property, plant and equipment

1,665.0 1,889.0 2,091.5 2,303.5 2,526.3 Investment property

31.0 33.0 33.0 33.0 33.0

Intangible assets

328.0 615.0 1,325.5 1,298.9 1,270.0 Investments in associates

191.0 330.0 330.0 330.0 330.0

Financial long-term assets

253.0 256.0 256.0 256.0 256.0 Deferred income tax assets

241.0 272.0 272.0 272.0 272.0

Total non-current assets 2,709.0 3,395.0 4,308.0 4,493.4 4,687.3 Current assets

Inventories

3,671.0 4,407.0 5,234.3 5,553.9 5,703.0 Trade receivables

894.0 1,060.0 1,190.6 1,284.4 1,383.3

Other receivables and prepayments

338.0 376.0 376.0 376.0 376.0 Current income tax assets

24.0 17.0 17.0 17.0 17.0

Marketable securities

553.0 447.0 447.0 447.0 447.0 Cash and cash equivalents

1,616.0 1,520.0 747.1 1,604.1 2,752.8

Total current assets 7,096.0 7,827.0 8,012.0 9,282.5 10,679.1 Total assets 9,805.0 11,222.0 12,320.0 13,775.8 15,366.4 LIABILITIES

Non-current assets Borrowings

(73.0) (60.0) 185.0 185.0 185.0 Deferred income tax liabilities

(450.0) (550.0) (550.0) (550.0) (550.0)

Retirement benefit obligations

(23.0) (24.0) (24.0) (24.0) (24.0) Provisions

(37.0) (40.0) (40.0) (40.0) (40.0)

Total non-current liabilities (583.0) (674.0) (429.0) (429.0) (429.0) Current liabilities

Trade payables

(400.0) (320.0) (348.5) (369.8) (390.9) Other payables and accrued expenses

(545.0) (577.0) (577.0) (577.0) (577.0)

Borrowings

(18.0) (75.0) (75.0) (75.0) (75.0) Current income tax liabilities

(122.0) (167.0) (180.5) (199.2) (220.3)

Provisions

(66.0) (65.0) (65.0) (65.0) (65.0) Total current liabilities (1,151.0) (1,204.0) (1,246.1) (1,286.0) (1,328.2) Total liabilities (1,734.0) (1,878.0) (1,675.1) (1,715.0) (1,757.2) Net assets 8,071.0 9,344.0 10,645.0 12,060.9 13,609.2 EQUITY

Capital and reserves attributable to Group 8,054.0 9,325.0 10,624.0 12,039.9 13,588.2 Minority interests

17.0 19.0 21.0 21.0 21.0

Total Equity and liabilities 8,071.0 9,344.0 10,645.0 12,060.9 13,609.2



116

Please note that the use of this research report is subject to the conditions and restrictions set forth in the “General investment-related disclosures” and the “Legal disclaimer” at the end of this document.

For analyst certification and remarks regarding foreign investors and country-specific disclosures, please refer to the respective paragraph at the end of this document.

Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG)

Company Disclosures LVMH SA 5 The Swatch Group AG no disclosures Luxottica Group SpA no disclosures adidas AG no disclosures Burberry Group plc no disclosures Compagnie Financière Richemont SA no disclosures (1) Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as “the Bank”) and/or its affiliate(s) was Lead

Manager or Co-Lead Manager over the previous 12 months of a public offering of this company. (2) The Bank acts as Designated Sponsor for this company. (3) Over the previous 12 months, the Bank and/or its affiliate(s) has effected an agreement with this company

for investment banking services or received compensation or a promise to pay from this company for investment banking services.

(4) The Bank and/or its affiliate(s) holds 5% or more of the share capital of this company. (5) The Bank holds a trading position in shares of this company. Historical price target and rating changes for LVMH SA in the last 12 months (full coverage)

Date Price target - EUR Rating Initiation of coverage

21 June 12 - Under review 05 October 11

11 July 12 160.00 Buy

30 July 12 150.00 Buy

15 February 13 140.00 Hold

Historical price target and rating changes for The Swatch Group AG in the last 12 months (full coverage)

Date Price target - CHF Rating Initiation of coverage

15 August 12 500.00 Buy 15 June 12

04 January 13 575.00 Buy

15 February 13 625.00 Buy

20 June 13 575.00 Hold

Historical price target and rating changes for Luxottica Group SpA in the last 12 months (full coverage)


18 September 12 31.00 Buy 18 September 12


05 March 13 41.00 Buy

Historical price target and rating changes for adidas AG in the last 12 months (full coverage)


25 April 13 95.00 Buy 25 April 13

07 May 13 98.00 Buy


117

Historical price target and rating changes for Burberry Group plc in the last 12 months (full coverage)

Date Price target - GBp Rating Initiation of coverage

12 September 12 1300.00 Buy 16 May 12

08 November 12 1400.00 Buy


Historical price target and rating changes for Compagnie Financière Richemont SA in the last 12 months (full coverage)

Date Price target - CHF Rating Initiation of coverage

21 June 12 - Under review 21 April 10

17 October 12 63.00 Hold

04 January 13 72.00 Hold

20 June 13 86.00 Hold

Berenberg distribution of ratings and in proportion to investment banking services

Buy 41.28 % 46.88 % Sell 19.57 % 12.50 % Hold 39.15 % 40.63 %

Valuation basis/rating key

The recommendations for companies analysed by the Bank’s equity research department are either made on an absolute basis (“absolute rating system”) or relative to the sector (“relative rating system“), which is clearly stated in the financial analysis. For both absolute and relative rating system, the three-step rating key “Buy”, “Hold” and “Sell” is applied. For a detailed explanation of our rating system, please refer to our website at

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Bundesanstalt für Finanzdienstleistungsaufsicht -BaFin- (Federal Financial Supervisory Authority), Graurheindorfer Straße 108, 53117 Bonn and Marie-Curie-Str. 24-28, 60439 Frankfurt am Main, Germany.

General investment-related disclosures Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as „the Bank“) has made every effort to carefully research all information contained in this financial analysis. The information on which the financial analysis is based has been obtained from sources which we believe to be reliable such as, for example, Thomson Reuters, Bloomberg and the relevant specialised press as well as the company which is the subject of this financial analysis. Only that part of the research note is made available to the issuer (who is the subject of this analysis) which is necessary to properly reconcile with the facts. Should this result in considerable changes a reference is made in the research note.

Opinions expressed in this financial analysis are our current opinions as of the issuing date indicated on this document. The companies analysed by the Bank are divided into two groups: those under “full coverage” (regular updates provided); and those under “screening coverage” (updates provided as and when required at irregular intervals).

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Legal disclaimer This document has been prepared by Joh. Berenberg, Gossler & Co. KG (hereinafter referred to as „the Bank“). This document does not claim completeness regarding all the information on the stocks, stock markets or developments referred to in it. On no account should the document be regarded as a substitute for the recipient procuring information for himself/herself or exercising his/her own judgements. The document has been produced for information purposes for institutional clients or market professionals. Private customers, into whose possession this document comes, should discuss possible investment decisions with their customer service officer as differing views and opinions may exist with regard to the stocks referred to in this document.

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Analyst certification I, John Guy, hereby certify that all of the views expressed in this report accurately reflect my personal views about any and all of the subject securities or issuers discussed herein.

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I, Bassel Choughari, hereby certify that all of the views expressed in this report accurately reflect my personal views about any and all of the subject securities or issuers discussed herein.

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119

Third-party research disclosures

Company Disclosures LVMH SA no disclosures The Swatch Group AG no disclosures Luxottica Group SpA no disclosures adidas AG no disclosures Burberry Group plc no disclosures Compagnie Financière Richemont SA no disclosures (1) Berenberg Capital Markets LLC owned 1% or more of the outstanding shares of any class of the subject

company by the end of the prior month.* (2) Over the previous 12 months, Berenberg Capital Markets LLC has managed or co-managed any public

offering for the subject company.* (3) Berenberg Capital Markets LLC is making a market in the subject securities at the time of the report. (4) Berenberg Capital Markets LLC received compensation for investment banking services in the past 12

months, or expects to receive such compensation in the next 3 months.* (5) There is another potential conflict of interest of the analyst or Berenberg Capital Markets LLC, of which

the analyst knows or has reason to know at the time of publication of this research report.

* For disclosures regarding affiliates of Berenberg Capital Markets LLC please refer to the ‘Disclosures in respect of section 34b of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG)’ section above.

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120

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TOBACCO

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Matt Chawner +44 (0) 20 3207 7847 Alexander Heinz +49 (0) 40 350 60 359

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Rupert Trotter +44 (0) 20 3207 7815 Karl Hancock +44 (0) 20 3207 7803 Chris McKeand +49 (0) 40 350 60 798

Sean Heath +44 (0) 20 3465 2742 Fin Schaffer +49 (0) 40 350 60 596

INSURANCE David Hogg +44 (0) 20 3465 2628 Lars Schwartau +49 (0) 40 350 60 450

Trevor Moss +44 (0) 20 3207 7893 Zubin Hubner +44 (0) 20 3207 7885 Marvin Schweden +49 (0) 40 350 60 576

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MEDIA

Julia Thannheiser +44 (0) 20 3465 2676 PARIS PARIS

Christophe Choquart +33 (0) 1 5844 9508 Sylvain Granjoux +33 (0) 1 5844 9509

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Jean Beaubois +44 (0) 20 3207 7835 Clémence La Clavière-Peyraud +33 (0) 1 5844 9521 SOVEREIGN WEALTH FUNDS

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André Grosskurth +49 (0) 69 91 30 90 734 Alexander Wace (London) +44 (0) 20 3465 2670 CRM

Boris Koegel +49 (0) 69 91 30 90 740 Greg Swallow +44 (0) 20 3207 7833

Joerg Wenzel +49 (0) 69 91 30 90 743 SCANDINAVIA Laura Cooper +44 (0) 20 3207 7806

Ronald Bernette (London) +44 (0) 20 3207 7828

Marco Weiss (Hamburg) +49 (0) 40 350 60 719

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Greater Chinese Takeaways - Berenberg · Greater Chinese Takeaways John Guy Analyst +44 20 3465...

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