Kering: It’s Gucci - [Business Breakdowns, EP.199]

Summary

• The central valuation case: Gucci — nearly 50% of Kering’s revenue and over 50% of profit — is materially under-earning. Over 20 years Gucci ran 30–40% operating margins (40% at €10B revenue under Alessandro Michele); today it’s a €7.5B business at just over 20%. Plug a normalized 30% margin in and the headline 18x forward P/E drops below 10x — “we all know that’s the wrong multiple in a market that’s at least 12 to 13, 14 times earnings.”
• Gucci has more fashion and less leather than Louis Vuitton, contributing to Kering’s historical discount to LVMH. Only about half of Gucci is leather versus ready-to-wear and shoes, so its fortunes swing with designers — up 8x under Tom Ford (1994–2004), 2.5x under Michele — while LV’s leather-heavy mix is “a little more stable.” The last two years showed the reverse gear: “when revenues decline 25%, profits are down 50%, and that’s basically what’s happened to Gucci.”
• Eng’s cyclical framing: luxury is “great for about eight out of 10 years and two out of 10 they’re pretty tough” — and 2024 is the sixth-worst year in luxury of the last 20. The steady-state algorithm is ~3–4% price plus 3–4% volume plus mix for roughly 9% organic growth, but COVID-era hikes of 10–20% a year — Chanel and Dior up 50% in three to four years — are “starting to catch up with the industry,” especially in soft leather.
• The tradeable bet is the designer change, and it’s unproven: Sabato De Sarno from Valentino has designs only three months in market, leather bags arriving in September, and so far customer acceptance is “not yet.” Eng’s meta-lesson from Michele’s rise and fall: “management change, designer change takes time… it’s almost two years later” before new product fills stores — “be patient.”
• Valuation triangulates cheap three ways: <10x normalized earnings, EV/sales near 2.5x (a 50–60% discount versus LVMH’s 4x), and private-market value — luxury deals have occurred at 4–5x sales, so Gucci alone at 4x roughly covers today’s market cap. The other brands, almost 50% of revenue, “you get those for free pretty much.” Stock is down from €800 to almost €200; margin compression historically lasts only two to three years.
• Balance sheet is the constraint: 3x net debt/EBITDA is “hitting the limits,” so Eng sees little M&A beyond the possible Valentino put/call on the remaining 70%, plus possible disposals — he floated minority stakes, perhaps around 49.9% but explicitly said the exact figure was uncertain, in €1B+ retail sites he believed were in New York, Italy and Paris. Family control (Pinault, via Artémis, which holds Christie’s outside Kering) means Eng expects dividends to remain a priority, with a 40–50% payout ratio.
• Buying at the bottom means hunting for good news in the dark: “it’s like picking up a newspaper in the crash of 1929 trying to find good news.” Eng’s toolkit is Instagram followings and likes, Lyst-type indicators, credit-card data, store conversations — and shareholder engagement with management to “protect the income statement… you’re not a 10 billion euro business anymore at Gucci.”

Deep dive

1. From timber and electronics retail to luxury: the Pinault scaling machine

• Eng’s history: Kering in the ’80s–’90s was “an eclectic set of businesses” — timber, electronics, furniture and construction-goods retailing, ~40–50% of €22B revenue Europe-tied — until François-Henri Pinault concluded the local distribution assets had maxed out. The pivot came in 1999 when LVMH attempted a Gucci takeover; Gucci’s CEO and family sought a white knight, Kering took a stake and won full control by 2001, then bought Bottega Veneta, Balenciaga and YSL within three to five years while shedding Conforama, Rexel and finally Puma.
• The house’s real strength, per Eng, is scaling: Bottega Veneta went from €56M to €1.7B in 25 years. A multi-brand parent supplies “what type of store, what size store, how many pieces you need, all the back-end stuff, all the logistics, all the IT” — plus getting a CEO and creative director “on the same page strategically.” He’s careful not to dismiss the rival: “LV is really good too, by the way.”
• The Puma disposal crystallized the luxury focus: Puma ran 10% margins versus Gucci’s 30–40% over 20 years; luxury overall is a ~70% gross-margin, ~30% operating-margin industry.

2. Gucci is half the company — and half fashion

• Gucci is almost 50% of revenue and over 50% of profit, but unlike LV it’s only about half leather; the rest is ready-to-wear and shoes, so “its popularity comes in and out depending on how well its fashion does.” When a Michele-type designer clicks, the multiple re-rates toward LV; when fashion struggles, it looks like today.
• The current reset: designers changed, the brief is quieter — the “quiet luxury” theme — with Sabato De Sarno hired from Valentino now updating bags and shoes. Peak-cycle math: at €8–10B revenue Gucci ran 35–40% margins, touching 40% one year; today it’s €7.5B at just over 20% — “that’s why we’re talking about it, it’s so interesting where it is.”

3. The cycle and the pricing catechism

• Luxury tracks global wealth: 2003 and 2009 were the deratings — Eng remembers buying Richemont (Cartier, Van Cleef) at one times book during that period, “a great buying opportunity.” When asset prices rise, these businesses grow 9% organically with operating leverage on top; but 2024 is the sixth-worst luxury year of the last 20.
• The growth equation is ~3–4% price, 3–4% volume, plus mix from discontinuations and higher-priced introductions. COVID was unusual — 10, 15, 20% annual increases; Chanel and Dior up 50% over three to four years — “and consumers are starting to notice,” particularly in soft leather where competition is thickest.
• The pricing psychology, as Eng tells it: scarcity plus one-way prices train the consumer that a bag is “a store of value — hey, if I don’t buy it this year it’s going to be more expensive next year… this is not going to 50% off.”

4. Operational gearing in reverse — and diligencing a designer like a CEO

• The mechanism behind the collapse: cost base kept, brand reinvestment maintained, some wholesale cut — so a 25% revenue decline became a 50% profit decline. Aspirational Gucci customers, squeezed by higher rates, pulled back to “the brands that I really really love.” Eng’s closing risk flag is operational gearing, which “is misunderstood by a lot of investors… it’s one where I’m always in disbelief when it occurs. This time was a big one.”
• On the creative director as the key non-CEO role: Causeway diligences a designer like a management change — what did De Sarno’s Valentino sales and margins look like, and “is the customer base willing to change and go in that direction? So far the answer has been not yet” — though his designs are only three months old, with leather bags arriving in September.
• The bottom-fishing epistemology: “It’s always dark at the bottom… it’s like picking up a newspaper in the crash of 1929 trying to find good news.” The modern toolkit — Instagram likes, Lyst indicators, credit card data, store conversations — changed the analytical process, not the decisions.

5. Wholesale-to-retail, shared infrastructure, and who’s buying

• The lifecycle pattern: small brands run 70–80% wholesale; as they get bigger — at the scale of the brands discussed, over €1B — Eng says they think about ~80% retail. It’s a heavy capital switch, but retail buys control of pricing, inventory and the consumer relationship, versus wholesale where “when things are not selling well there will be some degradation” and no firsthand read on demand. Kering’s European development centers for leather and ready-to-wear — one of which Eng believes is in Italy — let brands “take a design concept and make it a reality a lot faster,” while product decisions stay decentralized with each brand’s CEO-designer pair.
• Store strategy is a corporate science: co-locating brands, such as Dior near LVMH stores, negotiating rents together, and sizing correctly — “if we rent 3,000 [square feet] and we only have product for 1,500, we’re in big trouble.”
• Demand geography: Chinese consumers probably drove ~50% of luxury growth over the last 10–15 years, now down to 10%; they probably represent ~25% of global wealth, though that wealth has declined recently, but spend 35% of luxury, while Americans — a third of global wealth — underspend at 20–25%. Eng’s preference is simply balance: “revenue is revenue at the end of the day… you wouldn’t want to have it 90-10.”

6. Balenciaga, the Valentino option, and a stretched balance sheet

• On the Balenciaga ad scandal: the multi-brand structure kept the damage concentrated in the brand — Eng compares it with Volkswagen’s portfolio, including Audi and Porsche — but the damage is durable, particularly in the US, where some owners “are reluctant to wear those products sometimes because of the message it may send.” Eng does not see a divestiture: “they will trade through it.” Edgier messaging is associated with fashion-forward brands, versus LV’s safer bag-on-a-boat conservatism.
• Eng sees few acquisitions for now: net debt at 3x EBITDA is “hitting the limits” after Creed, eyewear and the 30% Valentino stake (with a put/call on the rest). He floated possible disposals instead — minority stakes, perhaps around 49.9% but with the exact percentage uncertain, in €1B+ retail sites he believed were in New York, Italy and Paris.
• The staged-stake pattern in luxury, Eng’s framing: at four-to-five times sales, “it’s almost like a dating process before you get married.”
• Christie’s sits in family holding Artémis, not Kering — a service with no synergy with development centers or retail sites. Artémis owns Christie’s and just bought CAA; Eng says family-controlled companies typically focus on dividends, contextualizing his view that Kering should have a 40–50% payout.

7. Valuation triangulation and the patience lesson

• Three methods converge: 18x forward earnings falls below 10x on a normalized 30% Gucci margin; EV/sales near 2.5x is a 50–60% discount (LVMH at 4x, itself low; Hermès holds the sector multiple higher); and private-market math — deals at 4–5x sales mean Gucci alone roughly equals today’s market cap, so the other brands at ~50% of revenue come “for free pretty much.” With the stock down from €800 to almost €200, “when you come to the same answer… then you get more comfort as an investor.”
• Is the margin compression secular? Eng’s answer: historically it lasts “a couple years — two, three years, that would be the most.” Meanwhile Causeway is engaging management as a shareholder to push: protect the income statement, cut costs, shutter stores, “cool it on the M&A for a little while.”
• His closing lesson from studying Kering: “change takes time” — Eng thinks Michele’s product may have become “a bit too narrow,” and getting a new designer’s product into stores can take almost two years. “That would be the big lesson for me: be patient.”