With the businesses PPR intends to divest (Fnac and Redcats) now in discontinued operations, and agreements or plans in place to sell them, PPR’s full-year 2012 results reflect the company that management has been striving for since CEO Pinault took the reins from his father in 2005.
PPR’s revenue growth and profitability reflect that of a luxury company, as 64% of revenue and 84% of operating income are generated from the segment (the remainder is derived from sport & lifestyle, primarily Puma). With these results, we expect to see PPR’s returns on invested capital to improve to just over 10% (or likely higher once we reassess our discounted cash flow assumptions) from 8% currently, justifying our assessment that PPR may have an emerging economic moat.
With just over EUR 3 billion in annual revenue, the brand is a distant number three to competitors, Nike ($24 billion, or roughly EUR 18 billion) and Adidas (EUR 13 billion). Puma lacks the scale and distribution efficiencies of its peers. It will be difficult for Puma to earn share in many important athletic categories such as basketball and soccer, as Nike and Adidas have formidable footholds in each of those sports, respectively. Wide-moat Nike earns returns on invested capital in excess of 20% and narrow-moat Adidas’ returns are in the low teens, relative to PPR’s high-single-digit returns on invested capital.
PPR is now a retailer of brands with global appeal such as Gucci and Puma. Revenue growth and profitability reflect more that of a luxury company, given that 64% of revenue and 84% of operating income are generated from the segment (the remainder is derived from sport & lifestyle, primarily Puma). With these results, PPR’s returns on invested capital expect to improve to just over 10% (or likely higher once we reassess our discounted cash flow assumptions) from 8% currently, justifying our assessment that PPR may have an emerging economic moat.
The sport & lifestyle segment also grew 11.9% (3.3% on a comparable basis). Puma’s weakness in Europe was mitigated by the United States, each roughly a third of revenue. Management reiterated its commitment to improve the sport & lifestyle segment, and over the past year has made a number of management changes and a new CEO for the segment will be announced shortly.
PPR is adding products to the sport & lifestyle line such as Volcom sneakers, leveraging off its relationship with Puma, tapping more into the outdoor segment of business, and revamping its marketing message. Overall, the firm intends to grow the smaller brands in the segment that is dominated by Puma at nearly all of sales. More notable was that recurring operating margin was now 18.4%. While down a modest 20 basis points from the prior year, this represents a marked increase from the low-double-digit profitability PPR posted when Fnac, Redcats, and Conforama were a part of the business mix. Also, PPR announced that it increased the dividend by 7% to EUR 3.75 annually.
There was no update to the outlook for 2013 beyond expectations that 2013 would be another strong year. The luxury segment has been the primary growth driver for PPR and we expect this to continue. PPR’s luxury brands will remain popular and will be able to hold their ground with competing brands. However, it’s not likely that the magnitude of the top-line growth will continue. Luxury revenue has increased roughly 20% for each of the past four years, primarily driven by Chinese demand. For example, Gucci’s sales to Asia (excluding Japan) have grown from 18% of revenue in 2007 to over 30% currently.
Luxury brands are reaching maturation in China, and growth has begun to decelerate. Accordingly, over the next 10 years, analysts expect top-line growth in the luxury segment will slow to the low-double digits. The competitive environment is difficult and Puma (nearly all of the segment’s sales) is a distant number three to competitors Nike and Adidas.
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