Thane Duff: Industrial Analyst

MONEYWEB, BY BRUCE WHITFIELD, 26 OCTOBER 2001

BROADCAST TRANSCRIPT: Thane Duff: Industrial Analyst, Barnard Jacobs Mellet. The massive slowdown in consumer spending over the past six weeks has been noticed across a number of sectors, and today’s profit warning from diversified industrial group Richemont should really have come as no surprise, or should it, is the big question, I guess. The market didn’t seem to be too taken aback. Richemont was off just under 4% on the day. Thane Duff is the industrial analyst at Barnard Jacobs Mellet. Thane, did this warning take you by surprise?

THANE DUFF: The extent of the warning actually did. They warned us in their September trading statement that operating profit was likely to be down. For us the biggest worry out of this one is the actual extent of the decline at the operating profit level.

MONEYWEB: Because they are warning that it’s a 20% decline at operating profit level. What does that tell you?

THANE DUFF: If you look at the margins, the margins are declining 510 basis points. Which is fairly severe and actually quite a bit larger than a lot of their peer group. What they did warn us in September was that there were certain once-off costs. But really the extent of the slowdown in September would certainly seem to indicate quite a large level of leverage at the operating profit level. I think it actually raises more questions rather than offers answers at this point.

MONEYWEB: Are you satisfied with what you’ve read in the statement, or are there things from the company that you would really like answered?

THANE DUFF: I think probably the biggest thing that came out of this announcement. It probably has been a long-held viewpoint, that Richemont is one of your most defensive luxury goods plays. For us what has come out of both this statement and the previous one is that, looking at LVMH which is your biggest luxury group worldwide, Richemont has substantially underperformed both on its sales growth and at the operating profit growth level. And given the fact that something like LVMH has big exposure to duty-free stores, which are obviously going to suffer from the falling travel patterns, and they also have quite a bit larger exposure to the US, for us this does raise some rather disturbing questions. The extent of the actual operating profit decline, we believe, can’t be simply attributed to certain once-offs. They would account for a portion of it. There does appear to be structural difficulty that is being indicated from this particular margin decline.

MONEYWEB: Do you think then that this warning should perhaps have come a little bit earlier, maybe in last month’s profit statement?

THANE DUFF: Last month’s profit statement came out just after September 11.

And I think to be fair to them, along with a lot of the industry, they were saying that they were in the process of evaluating how severe the 11 September impact could be. And in fact something like LVMH has actually seen a reasonable pickup in the last month of September. My concern would actually go further back … in that in their June presentations to us there was actually no indication of the extent of these once-offs and, in fact, the first time that we actually heard about the once-offs was in the trading statement of 13 September. In fact, they actually reiterated a margin target by the end of March 2003 of 20%. As I said, given that margins are likely to fall to around about the 14% level for the interim results in November, that clearly indicates quite a large gap for them to actually get to their targeted level. So I would actually raise the question going back even further.

MONEYWEB: In terms of revenues we know the company is in the luxury goods sector as well, but it’s also big on tobacco. The world’s second biggest tobacco company. Are there any other interests other than luxury goods and tobacco interests?

THANE DUFF: They’ve got a 48% investment in a company called Hanover Direct which is listed on the American Stock Exchange. Traditionally a cataloguing company, they then ventured off at the height of the tech boom into e-commerce platforms which, unsurprisingly, did not work, along with probably quite a few other IT ventures. In terms of value in Richemont’s life, it’s absolutely tiny. It makes up roughly 0.2% of net asset value, and given the fact they’ve actually written off the investment, they don’t account for any losses. So it is largely luxury goods and the cigarette side, as you said.

MONEYWEB: The luxury goods side … is that the side that’s been impacted mostly, because one would assume cigarette sales would not have been affected by the events of September 11?

THANE DUFF: You have seen some form of downtrading, but given the fact that BAT sells products across 180 countries worldwide, and also sells in some of the more mature markets that are not subject to downtrading, we don’t expect to see much impact and, in fact, we’re looking for BAT to be up around 7.5% in sterling terms for the year. So, yes, your impact is solely on the luxury goods side.

MONEYWEB: In the third quarter of this year we saw South African unit trusts selling something like 1.5m shares in Richemont. They do still hold 5m shares. Do you think that they sensed that things were perhaps not as rosy as we might have thought?

THANE DUFF: I think so. If anything, there has been quite a large dichotomy of action on the part of foreign investors and South African investors. And with the greatest of respect to foreign investors, I think that South African investors have probably grasped the severity of the economic downturn probably a lot quicker than some of the European investors. What has maybe provided a bit of an underpin to the share price has been the imminent inclusion of Richemont in the MSCI index. I think you’ve seen a bit of foreign buying in anticipation of that inclusion, which is just a couple of weeks away. Whereas obviously South African investors don’t have any such considerations in terms of tracking and, I think quite rightly, have been selling.

MONEYWEB: Arthur Buchner, who’s our market commentator this evening, did point out that about 90% of the trade in Richemont today seemed to come out of Switzerland. Then also today Warburg putting out a statement that they are reducing Richemont from an accumulate to a reduce. And saying it’s down to R150, seeming to put that as a more realistic value for the share than the R187 it was trading at today.

THANE DUFF: I can’t disagree with that. If anything, we’ve probably been stale bears on this stock for the last eight months. We’ve had it as an underperform since January this year when Gucci came out with a fourth quarter trading statement. We thought, looking at what sort of expectations there were for GDP growth and the weakness in the US, that luxury stocks were not where you wanted to be. What has saved Richemont locally has been the very high rand hedge quality. You’re looking at roughly a 25% performance disparity between what it’s done in Switzerland and what it’s done in South Africa. And that has been solely attributable to the weakness of the rand against most major currencies.

MONEYWEB: At what level would you recommend buying Richemont now, following today’s statement?

THANE DUFF: We’d be comfortable below levels of around about R160. Obviously there is going to be some technical support with the run-up to the MSCI inclusion, but we think there is still negative news to come out of the whole luxury sector for the next three to six months, and things like travel patterns are not going to re-establish themselves tomorrow. While you’ve still got the war, you’ve got worries about anthrax and all those other sort of macro-factors. So we think that you might see stability for the next couple of weeks. Maybe a creeping decline. Thereafter, hopefully, fundamentals would rear their head and we’d look at levels below R160.

MONEYWEB: Thane Duff, industrial analyst at Barnard Jacobs Mellet.

Interesting there, Arthur, that he comes pretty close to the Warburg assessment. Warburg putting a price of R150 on it, saying reduce up until that point. And Thane saying they’ve been stale bears, he calls themselves, and saying they’d be comfortable buying below R160.

ARTHUR BUCHNER: It’s been an amazing bear trap stock, because on 21 September it traded at R140. And had this huge rally up to R190. Squeezed all the bears out. I don’t think there are too many bears that could hold their positions on margin calls, etc., and so I think they’re actually really sitting on the edge of their seats, wanting to short it, but really don’t want to get burnt again.

MONEYWEB: If you were a reader of Tradingweb.co.za, which is the venture at Moneyweb which Byron Kennedy is heading up, you would have bought put warrants on Richemont last week, and you could have made yourself a nice pile of cash.

ARTHUR BUCHNER: Oh, I think you could have made a lot of cash on a lot of warrants if you’d bought them only last week. But if you bought them about four weeks ago when volatility was at huge levels, because volatility after that September 11 crash really went ballistic. They almost doubled in value and suddenly over the last two weeks volatility has fallen and those warrant prices, even though you would have been directionally correct … your actual volatility would have wiped out those gains, and now suddenly volatility is getting to a level where it’s sustainable and people are happy to buy. I would advise purchasing warrants now at these levels of volatility.

MONEYWEB: Arthur Buchner, he is the head of derivatives at BOE Securities, and before that Thane Duff, industrial analyst at Barnard Jacobs Mellet.

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