TIVP058: Hermes: The Most Prestigious Luxury Brand in the World w/ Daniel Mahncke & Shawn O’Malley

25:11To begin getting smarter about investing, just visit theinvestorspodcast.com slash get started with stocks. That's theinvestorspodcast.com slash get started with stocks. And for a limited time, you can use code STOCKS15 for a 15 % discount at checkout. It's one part of why I said it's so important that it's still a family business, because if you would sell this and I just see a consultant coming in, the first thing they would do is take manufacturing and put it into some Asian country where it costs significantly less money than it is right now. One more thing about the names. In this case, the MS name didn't make it because at At some point, there were only three daughters and no son.

25:53And since many, many decades ago, it was still tradition that in a marriage, the wife has to take the husband's name, the MS name was abandoned. On the manufacturing point, another crucial part is that it's done almost exclusively in France. Like I said, that's not the case for most other luxury brands, even if the tags say made in Italy, made in France. That doesn't necessarily mean the bag was actually manufactured. there. It's often enough to just perform the final assembling in those countries, but the individual parts, they were still manufactured in Asian countries like China or Vietnam, for example.

26:25So that's definitely not the case for MS. 80 % of products are fully manufactured and assembled in France and the other 20 % of goods like watches, which come from Switzerland or footwear from Italy. So it's still about ensuring just the highest quality of product. And obviously everybody who knows watches know the highest quality of watches. They will come from Switzerland, footwear, some form of clothing. They're just the best in Italy. So that's why you move this manufacturing outside of your home country. Everything else is still being done in France. I want to double down on the idea that it's just so hard to even get these bags.

27:00Even if I were to just walk into a store with more than enough money to buy them, I wouldn't get one. And so, I mean, if you think about how we normally approach things as consumers, If I walk into an Apple store, the best case scenario for Apple is that I'd probably leave with a few Apple devices, some sort of subscription to Apple Music and iCloud and Apple TV. That would be a dream sales day. And so it's just crazy for me to think about, based on how we understand businesses to work, that companies like Hermes will straight up just tell a customer who is willing to spend money that they can't.

27:35and that clearly shows that I'm just not immersed enough into the luxury world to wrap my head around this fully but I mean I just imagine what is the process like when I go into a store like that what actually happens if they're not going to sell me the product I want why am I going there you know let's say I do want to buy a Birkin bag what would they tell me how would I actually go about eventually getting one first of all I think a Birkin bag would suit you Sean maybe you should go for one and at least give it a try. But no, honestly, it's just a completely different world. So if you walk into the store and you never purchased anything from MS, they will not sell you a bag.

28:13And we're not even talking about selling you a Birkenberg. They will likely not sell you any bag. Of course, they won't blatantly tell you that. They likely just say they don't stock those bags right now, at least in the store or something similar. What you can buy are scarves, bracelets, watches, essentially accessories that show your commitment to the brand. And it kind of feels like a leveling system. You have to start with the basic products, then you level up and eventually they might give you a call saying that a bag has come in and they invite you to the store. And then it's really some sort of ceremony.

28:46So you will sit there in a private room, the employee will showcase the bag, you drink some champagne, perhaps eat some cake, and then you have the chance to buy the bag that's offered. So that's crazy to me because you can't even decide which one you exactly want, right? So if I want a blue one and they only have an orange bag, let's say, is that truly the only one I can get? Yeah, you can't say I want a specific color or a specific feature. Either you buy the one that they have there or you don't. And this is basically what happens in the high-end watch boutique too. Sometimes they have more than one, then it's your lucky day.

29:23And I say it's luck because obviously it's not pure luck because they know and can decide whether they want to offer you a bag or even multiple of that because let's be honest here, we know they have them there, but you have no influence over it. And honestly, I totally get the frustration of customers. I would honestly feel somewhat disrespected if that happens to me. And to be brutally honest, 90 % of the people who feel disrespected, well, they are simply not the target audience of MS, me included, obviously. And this is pretty much the difference between an LVMH bag and an MS bag. You can save money.

29:54You can go to the LVMH store and then you can buy that bag. You know that you will leave the store with the bag that you want. That's where you see thousands of them in every big city in the world. You don't look at people with an LVMH bag and think, gosh, they must have a ton of money. At least for me, I know that I think when I look at them, yeah, they likely spend their monthly salary on that bag, which just for context, it's totally fine. It's an aspirational product and you buy it for yourself, for example, as a reward for something or you achieved something and you thought, okay, I want to buy this just for me.

30:24But that's not how an MS bag works. An MS bag is supposed to signal that this person really has money. Not only because he or she could afford one of those bags, but also because they were allowed to buy one of those bags. By the time you're considered for one, you likely spend five to ten times the amount of money on other MS products. And add to that, you know, Hermes makes money from repeat customers. So if someone has a Birken bag at home, chances are pretty high that they have 10 other Hermes bags too. And that's sales strategy. I think it also protects them from the secondary market, right?

31:01I could imagine Hermes keeps a really close eye on where these bags show up. And if someone is clearly buying them just to flip them for a higher price, then I presume that person basically just gets cut off. They're cut out of the system. There's no second chance to buy another one probably. Because from Hermes' perspective, the resale market is a double-edged sword. It reinforces the desirability and value for sure, but it also bypasses their ability to gatekeep access to the product. And so it gives people access to a bag that Hermes deliberately chose not to allocate to them in the first place.

31:40And so the more that happens, the more that dilutes the whole relationship-based distribution model that this is premised on. So the fact that hasn't unraveled after decades and centuries now at this point, I think it's really impressive how they've maintained that. That's another tricky balance that you as MS just get a strike. On one hand, you still have to treat your customers well. And on the other hand, you have to keep some of these very strict rules in place because you might risk diluting your brand otherwise. And that's really the worst thing that could happen to a luxury brand. And as you just said, if you are basically existing for as long as MS is existing and they still have the same reputation, that just means you do an incredible job of balancing those two things.

32:24And if you just look at the retail price, for example, for a Birkenberg, it's hard to speak about dilution at all. Birkenbergs have outperformed the S &P 500 over the last three to four decades with an average annual return of 14%. So they sell for hundreds of thousands of dollars online, which is just, it's insane. And whenever that's the case, it obviously helps with the reputation of a brand. If you can sell that bag for$300 ,000 and you bought it for 20K, that's obviously an immensely good thing for your reputation. However, to keep that reputation in place, you have to have these strict rules because if it's seen as an investment vehicle, it opens up yet another customer base that would buy from MS.

33:06Me, for example, I'd probably not buy a Birkenberg, if I could even buy one, to then, you know, go out with it. But if I know this outperforms the S &P over four decades, I might do it. And if we're being honest, those are not the type of customers that MS wants to attract. So yes, it's good for reputation, but only if supply on the secondary market is probably even more limited than coming directly from MS. And you can see all the sales practices as both sales strategy, but also as kind of a self-defense mechanism for the brand. And yeah, it makes a lot of sense for MS to just stick with this, even when 90 % of people think this is beyond ridiculous.

33:46I think this also comes down to knowing who your customer is. One of our largest portfolio holding companies is Adobe. And there are some viral tweets you'll see from time to time and threads online about these marketing and sales strategies that Adobe has where basically they just make it harder for people to cancel and even charge high fees for doing so. And so as a consumer, that's super annoying. And I don't think a company with a quality product like Adobe necessarily has to do that to keep their customers. But my point really is that even if that's true and it costs them some individual customers on the margins who may be churned to Figma or Canva, that's not the target group for Adobe.

34:29That's not what they're optimizing for. And so that doesn't actually invalidate the underlying argument or thesis for the business in the sense of what matters for the investment case. Their primary customers are these large corporations and Hollywood movie studios and large marketing agencies. And so it's very different than optimizing what the individual retail consumer would appreciate the most from a customer service perspective. And so I think it's similar for Hermes in a way. The average consumer might think these are just outrageous sales techniques, but these techniques don't matter to the main customer base.

35:07And in fact, in Hermes's case, they're actually important to the main customer base in keeping them attracted to and interested in the products. I think there's basically a 0 % chance that MS will ever change these tactics. This is what makes MS so attractive, just as you said, to the people that are actually the customer base, that actually want to differentiate by owning MS products. And all of that said, I watched some videos of how people basically prepare to go to MS. And preparing means here that they put on all this stuff they own by MS, and they basically create this strategy on what to say and how to act to get offered a bag when they go to the store.

35:47So for example, you don't want to immediately ask for a bag apparently because otherwise the employee will just go to the bag. They will say they don't have any in stock and then that's it. Instead, you ask about some other products before, then you get into a conversation, then you slowly mention the bags. And I couldn't help but feel some kind of secondhand embarrassment when I went through all of that. I mean, just to hope an employee decides to grant them the privilege of buying the product, all of that just doesn't seem too worth it to you. Think about what do I wear? What do I say? I don't know.

36:21It kind of seems insane. And by the way, we only focus so much on this process because I fear that from a brand and a cultural standpoint, this is probably one of the bigger risks for MS. I don't think there are a lot of risks with this company at all. But if you want to pinpoint one, perhaps it's this one. I mean, at the end of the day, it's a$200 billion company. And ultimately, such a big company needs volume too. And you can't just sell to long-established customers who have been buying NMS for basically generations. You got to have new customers as well who are first-time buyers. And I know from the watch sector that there are a lot of people who could afford these watches.

36:59And they still don't want to buy them because they feel they're not being treated well enough. And when they enter these stores and, you know, they have to buy stuff that they don't actually want, it's just such a bad experience for them. They just don't buy a watch at all. And if this happens on the margin, it doesn't really matter. If it becomes more of a bigger thing, it could actually hurt a brand. Yeah, I think it's gone beyond just customer dissatisfaction. In 2024, Hermes got hit with a U.S. class action lawsuit that basically targeted the exact sales dynamic we've been talking about. The plaintiffs argued that getting a Birkin is not just about paying the sticker price.

37:38It's more like a pay-to-play system where you're nudged to buy other Hermes products first to build a purchase history with no guarantee you'll ever then be offered a bag. And so they tried to frame that as an illegal tying arrangement under antitrust law. And Hermes, though, denied wrongdoing, of course, and argued that Perkins are handmade and scarce and allocations to loyal clients is a selective retail practice, not just a antitrust violation. And so in September 2025, we saw a federal judge in San Francisco dismiss the case with prejudice, though the plaintiffs filed an appeal afterward. word.

38:18I can see how the argument saying that Hermes uses tying arrangements in this case, and really that why that would be illegal. But on the other hand, I do think it's a common practice in luxury fashion. And as a brand, I think to some extent, you do have the right to decide who you actually sell your products to. That kind of gives me flashbacks to my law lectures back in the day. This should be about, I think the term was, invitatio ad offerendum, which is Latin. So basically goods displayed in a shop or a store, even with a price tag, are basically treated as invitations for customers to make offers, but not as binding offers by the seller.

38:57So that basically means the shop or the store can refuse the sale before a contract is concluded. And if that's correct, I hope my law professor would be proud of me for still remembering this. But it is generally just an interesting point. I don't want to open a cultural debate here, but I also think that, I don't know, social media has made people think that they are maybe entitled to something. So when they see their favorite influencer with an AirMass bag, they want one as well. So they save to get one. And then you're suddenly confronted with this totally different sales strategy. And of course it feels kind of unfair and maybe also weird, but for the brand, they just want to make sure that the same group of people as before get access to their product store.

39:37The question is somewhat redundant, but I assume that Hermes will then sell exclusively through its own stores, right? And then how does online shopping work in this scenario? Will they only offer products that you could also buy directly in the store? And then how important is it to appear in person to build a relationship and be noticed that maybe enables online shopping down the road? I mean, I would love to hear how any of that works. Usually, retail brands They either sell DTC, so direct to consumer, or in wholesale stores. And that just means that there's a store which offers multiple brands.

40:13So luxury brands, usually, as we said before, they go for DTC because it gives them way more control over the brand image and also the checkout process. So you get all the data, which is important, especially if you work with wait lists. Unsurprisingly, as I just said, for companies like MS, this is basically what they need to do. So we're talking about almost 100 % of their stores, of their sales being DTC. There are some exceptions. So for example, sometimes you might go to an airport and then you see a wholesale store. And if you go in there, you may find a couple of, let's say, MS products like perfumes or watches, but there's no signature MS product.

40:49And the online store is interesting as well, because by the way, you should check it out. The website looks really great at a time when most companies try to save money or just, you know, get some quote unquote cool new generated AI websites or ads. MS really doubled down on its basically image of craftsmanship and art. And they actually hired an artist to redesign the entire website with hand-painted visuals and illustrations. And it's a detail, but I guess, you know, this is luxury. So details matter and it looks great. I just like to see it. And in terms of sales volume, the online shop is not that relevant.

41:23I think it's about 10 % of revenue. So considering that about 75 % of people who buy something on the website are first-time customers. I think of it more as maybe an introduction to the brand. So MS is very much about the physical experience. The flagship stores also look incredibly good. So it's just an experience to go in there. And then if you're offered a bag in, let's say, 10 years time, maybe if you want a Birkenberg still, you can get to one of these private rooms, get the full experience of buying something from MS. And I must say, I never set foot into one. Usually what Sean and I like to do, especially when we talk about retail brands, is going to the stores, maybe talk to some people in there or to the staff in there.

42:02But I went to the store here in Hamburg and there weren't a lot of people in there. So I stood in front of it and I felt like, gosh, you know you couldn't buy anything in there. And just going in there to annoy employees who usually even turn down people that are willing to spend$20 ,000 on a bag, I thought it's probably enough if I just look at it from the outside. And so I didn't go in. I'd probably do the same, Daniel. And actually, as you're talking, I was thinking, they must have had a lot of internal debate about just if and when they would ever open an online shopping place, whether they'd ever have a website.

42:35And I'm actually kind of surprised that they do. But anyways, given the brand's strong focus on this French heritage that they're very proud of, is there still a major focus from a business perspective on the French market specifically? I'm not sure I know what the exact brand perception is in the U.S. beyond that just being a symbol of extreme, maybe extravagance. I know my wife probably dreams of owning one. And I guess I would need to change my social circles a bit to actually find more folks who are seriously talking about buying these products. But I mean, I did want to ask about China because most brands, including luxury brands in particular, have pivoted to the Asian markets and especially the Chinese market in the last maybe 15 years.

43:21And I would imagine Hermes has had to do the same to stay competitive. The last few decades have definitely brought quite significant differences in both product mix and also the geographic distribution of sales. So back in the 80s, over 50 % of sales were driven by the silk and textile section. So ties, scarves, shirts, all of that stuff. Today, obviously, leather goods are by far the biggest category. And within leather goods, obviously, we're talking about the bags. That change was mostly started by longtime CEO Jean-Louis Dumas, and he led the company from 1978 to 2006, so pretty long tenure.

43:59And under his watch, the famous Birkenberg was introduced. And this was not only a huge hit in France, where in the 70s and early 80s, still almost all of the company sales came from. This has also been a huge hit in international markets as well. So first and foremost, we are talking about the Asian market. So today, as you just alluded to, as with almost any other brand, about 50 % of sales come from the Asian market and mostly just China. And we sometimes talk about how growth in Asia has to be judged by whether it comes with the same margins as in Europe and the US. And in Hermes' case, the Asia-Pacific region, which again is mostly China, is actually the most profitable market they operate in.

44:41So margins in Europe and the US are in the low to high 30s. China is closer to 50%. And the main reason for that is probably just the store economics. So when you look at a retail business, usually you look for metrics like revenue per store, revenue per square meter, revenue per employee, and maybe product turnover. And Asia is the market where MS has the greatest demand relative to your supply. So that essentially means that every incremental unit or store you allocate to that region has a very high probability of selling through quickly and at full price. So unfortunately, MS doesn't report exact store accounts by region, store sizes or revenue.

45:21But I've played around with the numbers that we do know. And I made some assumptions here and there about the store size and revenue. And I think it's not unreasonable to assume that MS generates something between 60 and 80 ,000 euros per square meter of their stores globally. And that's a ridiculously high number. So just to give you some perspective, brands like Lululemon, which is a company we also covered here on the show, and it's one of the companies in our portfolio, they actually generate about$16 ,000 per square meter. And if you look at luxury fashion market, it's close to$30 ,000 to$40 ,000.

45:55And if you look at Apple, which is often crowned the king of store economics, it's somewhere in the 50s to 60s. So realistically, that's the level where MS is too, at a minimum. Maybe it's even beyond that. To a much lesser extent. It does remind me of my experience at a store when I was in Tampa the other day in the Hyde Park area, which is actually a very, very nice part of town there. And so anyways, I'm sitting there with my wife and her cousins peruse the jewelry thinking, man, they have like maybe a dozen items, a couple dozen items that are actually out for display across this entire store.

46:28And it wasn't like a super small store in an area where I'm sure rent is definitely not cheap. And I just remember thinking, man, unless they're charging some crazy prices for this jewelry, I'm not sure how this makes any sense. And as you can imagine, That was exactly what they were doing. I went to look at just a single necklace and it was like$10 ,000. I didn't think it looked like anything special. But yeah, that was the price they were charging. So if they can even just do a few sales a week, they can clearly sustain that kind of business. But it's just very, very different from how we're used to thinking about retail.

47:03And so changing the subject a little bit, looking at the last few quarters, it does seem like growth in China is slowing a bit. And so my question for you, Daniel, is do you think that's just a normal seasonality and maybe some tougher comps or does it feel more structural to you? And related to that, China has obviously been the big growth engine for luxury over the past decade. And if that tailwind is moderating, where do you see new incremental growth coming from? I mean, is there a China-like opportunity on the horizon? You could imagine India or parts of Latin America or Africa boasting much more robust future spending on luxury.

47:45But yeah, I don't know. How do you think about it? Well, before we get to the geography part of the growth equation, I would first like to just take a chance and talk about the AMS store count, because this is yet another thing that makes no sense based on what you learn in Business 101. a massive store count has actually declined from a peak of 311 in 2019 to 293 last year. And yet revenue is still compounded at roughly 17 % over that period. So when we talk about companies like Lululemon or Nike, we can often use store counts as a rough proxy for market maturity. And it also correlates with how much revenue obviously they can generate.

48:26With MS, that logic kind of breaks down. So it kind of reminds me of what you said about Ferrari in your episode. So most luxury car brands want the prime, the easy to access location in a city. Ferrari doesn't really care. They know customers will come to them anyway. And I think MS feels the same way. They think about it in terms of they don't need lots of stores for the big ticket purchases, aka the bags, they will just call you and you will literally come to them often at one of their flagship stores. So they don't need all of these different small ones in tier two cities, basically. I think that was my favorite tidbit that I came across about Ferrari.

49:05And it was something Guy Spear shared in an interview. That's why I remember it. But I can't imagine stronger proof of a brand mode than being able to literally pull customers to you in that way. Yeah, it's pretty amazing, especially if you talk about purchases that are still very high priced, but we're not talking about a Ferrari. I mean, technically, you know, I could buy their car, get in and then drive back home. Within a mass bag, you can get called to just a different city and you will still make that trip because you know, that's one of your few chances to actually buy one of their bags.

49:37And it's just incredible. And in terms of slowing growth in China, there are basically three things that affected the numbers in the last year or two. The first is what demand in just greater China looks specifically for MS. The second is simply the mathematical effect of comparison basis after a very strong period in 2022 and 2023, basically after the pandemic, where growth rates were in the high 20s to even the high 40s. And the third is whether what's happening is macro softness or more of a permanent change in how Chinese consumers engage with luxury as a whole. And I think the only one that would actually hurt MS in the long run would be a genuine perception shift, meaning the brand loses relevance at the very top end of the Chinese luxury consumer.

50:24And there isn't much evidence, if any, that this is what's going on. What MS has highlighted is more a change in traffic, store traffic, especially in greater China, which matters because MS, as we said before, is still unusually dependent on the in-store relationship for converting demand into sales. So, you know, if less people visit the stores, you cannot just sell more online. That's not what they do. Again, only 10 % of sales are generated from the website. So the store is where clienteling happens, where you build purchase history and where basically the allocation of scarce leather goods is managed.

51:01So when traffic softens, obviously the growth rate will also slow down. And just on that comparison point again, it's important to remember how distorted the last few years were, especially in China, more so than in any other country in the world. At the end of 2022, you had these closures and the restrictions were largely gone. And that's when you see an immediate spike in growth reaching over 40%. MS was actually the company that recovered most from all luxury companies in China. And then when you move into 2024, you're comparing against a year that was just unusually strong. So just mathematically, the growth rate should normalize even if the underlying business remains as strong as basically ever.

51:41But that explains, to be honest, only part of why the numbers slow. Because if you look at the numbers in 2025, you would expect them to re-accelerate, but they didn't do that. And I guess the simplest explanation is that the Chinese consumer environment has been weaker overall. And luxury demand in China has been softer across the board, not only for MS, not only for fashion, but just across the entire luxury industry. And it's also worth separating, at least to some extent, that China demand is not necessarily Chinese demand. So what matters is not really where you buy, but only if people that are from China originally stop buying MS products.

52:19And if spending migrates to, for example, overseas markets due to travel patterns, because as I said, the economies open up again, you can travel again, and especially the wealthy people will do that. Well, then you can just get some more sales in other parts of the world. I mean, Japan, for example, has been very strong. And likely some of that is probably due to Chinese tourists buying a mess product, simply not in China, but, you know, in Japan. And I suspect this effect is probably smaller than you would imagine for brands like LVMH. Because again, you can't just go into a store, we say it for the 10 times today, when you're, for example, on a vacation, and then you buy a Birkenberg.

52:56And it's probably also why you don't see the Daigou phenomenon. I think we talked about this with Estee Lauder and LVMH and obviously this is not as much a part of MS. And just for our listeners who don't remember or didn't listen to those episodes, first of all, you should. But if you didn't, here's what Diagro is. I mean, it's basically a gray market personal shopper model. So someone buys luxury goods in lower price or just more accessible markets, oftentimes abroad, and then they resold them back home in China. And with MS, that's just harder to scale because the products people want, most of them you cannot get.

53:32And actually, if you look at LVMH, this business model has been a huge driver for them in terms of China sales and basically Asia as a whole. And when that practice was basically broken down by regulators, it was a huge hit for LVMH. Once again, because MS is much more exclusive and this practice, just because of how they operate, couldn't really bear fruit with that brand. You also didn't get the hit when the Daegu was basically regulated away. I feel like we have a few companies where such a big part of the thesis is based on success in China from Nike to Lululemon. And gosh, it just makes me realize how much more homework we need to be doing on the Chinese market.

54:14But on that note, how has competition performed in China? We know from many fashion brands that China has been just a really tough place to be for the last few years. But how did it look for the broader luxury sector? sector. And in the end, you pay these premiums for luxury companies because they are supposed to not get caught up in the same economic cycles that affect everybody else. And yet here we are talking about economic cycles. Well, especially in the highest tier of luxury, where MS certainly sits, you would expect this. When we look at Kering, for example, which is essentially a Gucci-centric story, we saw a very sharp decline in the region in the last year because Gucci is both more exposed to aspirational luxury and also more dependent on just the fashion cycle and the momentum in fashion in general.

55:00So when traffic slows and the consumer turns maybe just more cautious, those brands tend to feel it much harder. LVMH was more or less flat. And in theory, I would rate most of LVMH's brands to be aspirational too and therefore see a more significant reaction to lower consumer spending. However, LVMH owns just so many different brands that you obviously have this additional diversification effect where some categories hold up better than others and they basically balance the downturn. So I think for those companies, it definitely showed how hard business has been in China for the last couple of years.

55:34If you look at a company like Brunelli Cittinelli, which is an interesting reference because it's closer in positioning to the ultra luxury, not very shiny, but high quality bucket that you probably can also put MS in. Well, Brunelli was able to keep growing in Asia. However, I would say that these numbers are not only for China, but for Asia in general and overall. And we also can't ignore the fact that they started from a much lower base of just 350 million euros in sales. And obviously, Hermes is just significantly larger and it's easier to grow the pie when it's significantly smaller in the beginning.

56:08So I think the important point is that you don't see the lack of growth in recent quarters as a structural problem for Hermes and more so as part of a weaker macro environment. And usually what you would expect to see from a brand that's losing ground are signs that it's losing pricing power or that it increases product volume to keep sales stable or growing. And here, it seems like more than one of those normal luxury down markets, which by the way, industry experts have also been highlighting. So just coming back to the question of the next incremental growth markets for them, Jenna feels relatively mature.

56:46at this point. So are there other geographies that could become that next major demand engine for Hermes? I know I kind of asked you about that earlier. And related to that, for someone who is not naturally drawn to ultra luxury fashion, especially me of the both of us, I'm curious whether Hermes is seeing the same kind of demand from younger generations or whether the brand tends to just attract older customers where then there's a question of like, hey, is this a kind of a melting ice cube that they're holding on to? But now we've looked at, I would say quite a lot of brands that have used China as the major growth engine in the last few decades.

57:26And when I compare that to other economies that we've looked at, so for example, South America, I feel like China had a very unique combination of scale, speed of wealth creation, a retail infrastructure build-up that just allowed brands to put down an enormous footprint in a relatively short period of time. And also just a cultural adoption of luxury as a status language, which probably not a lot of people expected from the quote-unquote communist China. So if you combine all of that, at least to me personally, it seems very difficult to find any other place that can offer all of these circumstances.

58:03Perhaps the closest one, although in earlier stages obviously would be India. I mean India is growing very fast and there's a very wealthy segment of the population and more than other luxury brands MS doesn't necessarily need a wealthy middle class. So they cater to the top 1 % arguably especially in emerging markets probably the top 0.1 % and I know that sounds kind of bad but just judged by the business model, that's how it is. So LVMH, Gucci, Prada, they all sell to large parts of the upper middle class as well. And MS is doing so to a much less extent. And another thing that I think about, and maybe some luxury experts here will disagree with me on that, is that I don't believe MS actually needs a single geography to basically replace China in order to keep compounding.

58:53Because the business is fundamentally supply constrained. So it's more about allocating resources than opening up completely new markets. So if one market is cooling down, MS would simply reallocate the bags that they have to pockets of the market where demand is still high. So let's say you imagine you have a full waitlist in a dozen countries and then in one country, for example, in China, the waitlist is shrinking. Well, then you would just sell your products to the more crowded waitlist and then wait for the slower market to pick up speed again. And that's basically what you can do by just reallocating the product that you have.

59:27And I'm not saying that MS doesn't care about opening up new markets. If India becomes a significant part of MS's business over, let's say, the next 10 years, that would definitely be great. But MS doesn't need that to happen to just continue growing in, let's say, the low double digits. And we often speak about call options. And I think expanding into new markets would be such a call option for me. so you'd expect double digit growth driven by mostly price increases obviously and then slight increases in volume potentially and should any market turn out to be the new china then that would be like you said this kind of call option on future growth that could maybe support another decade of high teen or low 20s growth is that really how you think about it that's how i'm thinking about it i mean price increases have historically been mid to high single digits depending on the year.

1:00:18And you can still expect mid-single-digit increase in volume too. So that's how you would get to that growth rate, yeah. All right. Based on that, I assume you also don't expect any headwinds from younger generations being less interested in high-end fashion and bringing down volume over time? Actually, younger generations are very interested in fashion and also high-end luxury brands. I mentioned earlier that I suspect social media is part of the reason why some of these high-end brands have really doubled down on the waitlist approach and building a history with the brand. Because of course, that has always existed to some extent.

1:00:54But when I think about my parents' generation, especially my grandparents, I think they just wouldn't have had even the idea of buying something at MS if they couldn't afford it or if they just wouldn't be part of a social group or circle that usually goes their shopping basically. And I believe that has changed, at least to some extent. So when you open social media, you see many influences that at first glance, and this is basically what they do, look just like you, but they were these high fashion brands. And because of that, a lot of people want that too. So I think that was a bit different in the, I don't know, 70s.

1:01:29I mean, back then Hollywood actors wore those brands and you knew you were not like them. That has changed to a large extent. So I actually think demand for these products outside of the traditional customer base is growing too and probably more so than it has ever been in the past. That's a really interesting point. I mean, I think it's not just a gut feeling. I've seen studies that show something similar. Bain & Company, for example, found that Gen Z has the highest purchase intent for luxury brands right now of any generation. And so you also discussed the long-term trends among aspirational buyers versus truly wealthy people.

1:02:08And so I think that's also really interesting. And I would love if you could put more insight into that. So short term, you have clearly seen that trend in 2025. Aspirational customer spend on luxury goods was basically down 35%. And they were not spending nothing at all. They were just spending it on different goods, not necessarily on luxury fashion. But there's a much larger underlying trend behind this that actually shows once again how difficult it was for MS to stay the course. but also how it's exactly why it is untouchable today as a brand. And when all the other luxury brands went down, MS basically is still trading at 50 times earnings.

1:02:46So most luxury brands have, I would say, doubled down on democratizing luxury goods. So they advertise to customers in the upper middle class. And in the short term, that obviously boosts your numbers enormously. It's a much bigger market than just the top 1%. And you didn't necessarily have to discount because people, especially after COVID, they just had a lot of savings. So at first glance, everything would look great. Basically what we talked about before, more sales, more profits, no discounts. But even then, you are diluting your brand just by giving too many people access. And exclusivity not only means you sell your goods without a discount or at high prices, it also means to just seriously limit supply and not go for the extra dollars, although they look attractive.

1:03:32And a while ago, as I said before, we discussed Montclair here on the podcast, and they are basically taking, I would say, an entirely opposite approach to MS. They do a lot of promotion with celebrities, which is something that MS doesn't do at all. And they want to appeal to customers with these flashy designs and even public appearances as marketing. And many of the luxury fashion brands, even the ones with longstanding and traditional history, have also followed the, I would say, streetwear hype. So basically, they are following the customers. And I know that a lot of people here, especially working for TIP, they know and they love the book Luxury Strategy.

1:04:10And you would know that luxury brands, if you've read that book, they shouldn't do that. They shouldn't follow the customer. Again, MS doesn't even sell you bags when you're in the store with the money, willing to spend it. And maybe that's where another misconception is coming from. Perhaps some people think that MS isn't maybe popular with Gen Z because they don't follow these brands. But such trends have always been there. And usually they come and they go. MS customers, I would say, they appreciate it for not taking part in them. And to some extent, I would also call it natural selection. So even in the upcoming generations, the people who make real money, they will likely appreciate exactly that about MS as basically all other generations have before.

1:04:54I think there's a timeless component to luxury. You're tapping into some aspect of human nature that is just enduring, and that is to want to be at the top of the social hierarchy. And then these symbols we use to signal that can be extremely lucrative businesses. And so Hermes is really positioned as the ultimate symbol, I think, which from a shareholder perspective is very, very compelling. And that brings me to ask about their financials and capital allocation as managers of this incredible business, right? There's no doubt that they've managed the brand tremendously well. But I want to really zoom in more on the capital allocations and the financial profile.

1:05:35You know, you can imagine that, unsurprisingly, the margins at least look outstanding, 70 % gross margins. And then at the same time, though, some of the kind of fundamental measures of health for the company, I think, are declining. and that is to say the store count is declining, which on the other hand does make supply more limited and maybe actually has this counter effect where it makes the product more desirable. I don't really know how to think about that, but they also don't do any marketing. And so it sounds like to me most of the line items that retailers usually spend money on are just really non-existent expenses or very small shares of overall revenues for Hermes.

1:06:15And I suspect that is really part of the reason cash has compounded at a K-Row 25 % over the last 10 years. And on the one hand, that's obviously great for a balance sheet that looks really good. But especially since Hermes has no long-term debt, meaning that cash is more than double the entire liabilities of the company. So you really don't have to worry about this company going to bankruptcy at all. But you could also argue that hoarding that much cash does seem like an ineffective use of capital, potentially due to really the lack of reinvestment opportunities that they have before them. MS definitely doesn't take the maybe typical fashion brand path, but it is investing quite a lot of money.

1:06:59I mean, the two main buckets are production capacity and then the controlled distribution network. And both of these are more capital intensive than one might imagine at first. So when there aren't many new stores built, you would think that they don't spend a lot of money on that line item. But the renovation of existing stores alone costs more than 600 million euros in 2024. And that's about double the amount for any given year. So usually this position would be closer to 300 million euros. But then you also spend another 200 million euros on building new workshops and training new artisans.

1:07:32And when you have some overhead costs too, I would say you can quickly reach about 800 million to a billion euros a year in investments on that end. And obviously that doesn't sound much when you have a 200 billion euro company, but you shouldn't forget the 50x multiple. So free cash flow is about 4 billion euros. And compared to that number, I think a billion a year doesn't look like a small reinvestment anymore. And besides that, MS also pays a dividend. But similarly to Ferrari at these multiples, it's not a game changer. despite spending I think 1.6 billion euros on the normal dividend last year and then adding another billion on a special dividend the yield was still below one percent and at the end of the day I think I even like the fact that they just keep more cash instead of buying back shares or paying out dividends when the yield is just very low so in case you ever get a pushback on the stock you actually have a lot of cash that you can then use or deploy at significantly higher returns than spending billions of US now to buy back shares at a multiple of 50.

1:08:34Well, we've seen this problem before and it's absolutely not the company's fault. But if you think just intuitively that a company is paying out, let's say$1 per share in profits, well, if you can buy a share in that company for$10, then you'd be getting this excellent 10 % dividend yield. But if the market values those shares at$1 ,000, something kind of ludicrous, maybe akin to how Hermes is being valued, maybe not quite that extreme, but still, you're getting only a 0.1 % dividend yield. And either way, what I'm trying to say is the company is trying to return the same amount of dollars to shareholders.

1:09:12But the more extreme the valuation, the less impactful those capital returns actually are on shareholder returns, which is usually a sign that the stock is too expensive for us. It's pretty good heuristic to use. And the logic also is the same with buybacks too. Buybacks made at higher valuations are not going to go as far when the shares are trading at such pricey valuations. But speaking about valuation, I think it's time we get into your model. You always do such a good job building models for us to look at, Daniel. And yeah, I'd be very surprised, I think, if you told me Hermes looks cheap.

1:09:46But I would say it's a stock that's not meant to look cheap. And it hasn't had to look cheap to still be a great investment. And its multiple actually has been relatively stable for decades now. And that is a very premium multiple, by the way. So I think it's fair to value it with some assumption that the market will continue to pay a premium for this business. And then the question is, what is a reasonable multiple to bet on from a fair value sense? And at what point do we have any kind of margin of safety where we feel like even if we're paying a premium to the market average, we're getting access to the stock.

1:10:23It may be a discount to real quality it deserves. One of the most impressive things about MS is the fact that you could have bought this company basically 20 years ago at the same very large multiple and you still outperform the market. So I think what stock, if not MS, earned its rate to trade at a high multiple and you think it will likely stay that way for a long time. Having said that, we basically sat here a couple of months ago talking about Ferrari and just two months after we covered it, if even, the stock dropped 30%. So it can happen to any company. Although I must say that I think MS is probably even more durable than Ferrari, but Ferrari, you can still at least paint a bearish scenario where many, many years into the future, cars that are not self-driving might lose significant relevance.

1:11:10And in your episode, you talked about how driving a Ferrari might become what horse riding has become more of a fun luxury hobby. And even in the short term, you have the EV threats hanging over Ferrari. So that's basically why the stock has gone down. One of the reasons, at least basically 30 % since October last year. And I don't see similar risks for MS. ESG is obviously a constant concern. But if anything, MS is at the forefront of sustainable manufacturing. and just considering the lack of overall risks, I think there's an argument to make that most of MS's value lies in the terminal value of the company, meaning that it is very likely to perform at rates higher than, for example, GDP growth for a very, very long time, much longer than most other companies.

1:11:57And what we usually do to value companies is we forecast five years of revenue and earnings or free cash flow because that's a reasonable timeframe frame for us to forecast. Everything beyond that feels basically more like a gamble. And we then use a multiple, an exit multiple at the end of the forecasted period to come up with the valuation. And I usually prefer that approach over a terminal growth rate because it feels more tangible to me. I have a long track record of multiples that the market was willing to pay for a company at any given time and any given scenario. And I have a much harder time assessing when a company will just stop growing faster than GDP?

1:12:35Will it be in five years, in 10 years, in 20 years? I just have no idea. And if you take a company growing at 10 % per year and expect that in five years from now, that will go to, let's say, 2 % forever, you might underestimate the potential quite significantly, at least for the next 10 or 15 years. And with MS, it's a bit different because I would bet on MS still being around and growing at high single digits, even in 20 years from now. And it's difficult to capture that in a model. When I just go through our usual approach, I expect a revenue cago of, let's say, 9 % to 10 % and net income margin of about 34 % in the base case.

1:13:13And in my valuation, you will see that I model out each business segment, but I don't think we need to go through all of that. Those are the key numbers, the most important ones. If you're interested in all the details and even changing my assumptions, you can download the model in our free weekly newsletter, which is also out today. And yeah, I would say at high single digit top line growth, a 34 % net income margin and an exit multiple of 40, which is slightly below the historic leverage. And then we still use our 8 % discount rate. And I know it's a lot of numbers. At 20 % margin of safety, you would get a fair value of about 18 to 1900 euros per share.

1:13:52So at the time of recording, the price is about€2 ,200 per share, which looks like it would imply a mid-single-digit return, which does not meet our hurdle rate. But I think you're not done, though. Tell me more about the rest of the valuation before we make a conclusion. Yeah, the base case is a mid-single-digit return not coming close to our 12 % hurdle rate. I mean, in a bull case, I kept the multiple and the margin of safety that we use somewhat the same. So it's not really a highly unlikely bull case. It's more so maybe it's somewhat optimistic based case. And then I calculated with just mid-teens sales category and a 38 % net income margin, which is a margin that we already have seen with the business before.

1:14:35And at that point, you would get 2 ,700 euros per share. So that would imply a 13 % return. And this would basically only mean a re-acceleration to 2024 levels and then margin increases over time. So I think this is realistic, but even then it would just barely cover or maybe overcome our hurdle rate. And then for the bear case, I dropped the multiple to 30 times, which is still above the S &P and is still somewhat of a premium multiple. Sales growth to 6%, which is also not unlikely if you see a kind of sustaining slowdown, especially in the bigger markets. And then net income margins, they stay at today's level of 30%.

1:15:12And then you end up with the stock that is only a thousand euros per share. So that's quite a significant downturn from where you're standing today. So I guess long story short is that this is a multiples play. I don't expect a sudden 20 % growth rate. So it basically all depends on the multiple that the market is willing to give AMS. And if the market keeps valuing AMS at a low 40s multiple, I think you can expect easily single digit, high single digit returns, maybe low double digit returns. If the multiple drops, there's definitely some way to go to the downside. And I guess expecting that the multiple increases further is not likely or not something you want to bake into the types of assumptions we like to have in our model just out of the sake of conservatism, especially not looking at longer term.

1:15:59But how differently would the valuation look when using a DCF approach with a terminal growth rate? Have you really thought about that? Yeah, I did it. And I mean, using a terminal growth rate only makes sense when we work with a longer forecast period. So I forecasted the financials up until 2035. I revised the growth slightly to 8 % and I kept margins stable at basically 2030 level. So we're talking 34 % net income margins. And then I used the terminal growth rate of 3%. And after discounting, you would still, quote unquote, only get a fair value of 1800 euros. So the result is very close to the base case exit multiple approach, at least when you use the assumptions that I use.

1:16:44And again, you have the chance to download the model, play around with the numbers, and come up with whatever fair value you want, basically. I think Hermes is an incredible company. I actually think I like it more than LVMH, which is a company I pitched months ago, I think in the summer of 2025. Anyways, what I like more about it is just the singular brand focus. There's no distraction, right? LVMH is more like the Berkshire Hathaway of luxury, where it's this serial acquirer model of folding more and more brands into this massive conglomerate that just gets, I think it ultimately gets very messy and it's easy to lose track of some of the brands and allow them to be diluted.

1:17:28And there's also a huge alcohol component to that business. I mean, it's not like a majority of revenues or anything, but it's a significant part of the business. And there's all kinds of interesting data coming out about how alcohol consumption is very much changing worldwide and people are drinking less than they used to. So anyways, there's all these different kind of interrelated reasons that I feel less and less excited about LVMH over time. But I think I do feel really excited about Hermes and just this idea of a singular focus on craftsmanship, one brand, one identity around it. That is a really compelling sales pitch.

1:18:06And then, of course, there's a question of the multiple. And so you're not going to catch me buying Hermes at 50 times plus earnings. You know, this is the tricky thing about investing is like I have friends and family that will ask me about stock picks and like, hey, would you recommend should I buy Hermes? If I'm looking at a probability distribution, most likely buying Hermes at 50 times earnings, assuming you hold it for, let's say, a decade. I'm sure most people would do fine. The contingency there is did you actually hold it for a decade? And secondly, you're setting yourself up where there is a range of probabilities where you just get absolutely flattened.

1:18:47And that's really what we're trying to minimize on this show. That is our whole approach to investing is thinking about the range of probabilities and to what extent can we reduce the likelihood of us just absolutely getting destroyed on an investment. And if you buy it 30 times earnings, I could say with a very high degree of certainty, you're much less likely to get destroyed on an investment than if you're paying 50 times earnings, even for a company like Hermes, assuming everything else equal in those two comparisons. And so I am one who has never complained about paying up for quality. I'm happy to do it.

1:19:22And I would love to pay up for Hermes in this situation. I think the current valuation strikes me as just not as enticing as we would like relative to the other reinvestment opportunities in our portfolio. We've seen Adobe sell off a lot. That's a company I would probably love to add more to. And there's so many other exciting companies I know that we are thinking about covering. I'm not at a point where I feel like the best use of our capital, the best allocation of a spot in our portfolio would be to add Hermes at its current valuation. but just, you know, this is very non-technical analysis here, but just looking at the valuation multiple for the company since something like 2015, pretty much any time the stock dipped below a 40 times PE, and especially 35 in the earlier part of that decade, you had some instances where it fell toward like 33 times earnings.

1:20:17Those clearly look like setups to me where the stock is very attractively priced because you're paying something that is much closer to a normal market multiple for what is truly a one of a kind business. I don't know. I think at around like 40 times earnings, I could probably start to swallow like a tracking position in it. And then something, you know, on the lower end of 30s, I would get really, really excited about adding Hermes to the portfolio, knowing that they can very comfortably grow into that multiple and have a very high likelihood of sustaining an elevated multiple to the market for an extended period of time.

1:20:56But that's just my two thoughts. I totally agree with almost everything you said. I think if there's one point that I consider to be very underappreciated with MS, it's the management team and the culture. And it's hard to grasp and it's obviously intangible. But if you think about how many quarterly meetings there have been in which the management could have decided to just increase volume on how much they sell slightly more. And they've never done so. I think it's underappreciated how many good decisions the management team has made. And if you compare to almost all other luxury brands out there, basically all of them eventually start selling a bit more volume, getting a bit more dilutive.

1:21:35And you just talked about LVMH. And I think to me personally, it's a great company, but every single brand that they keep on acquiring will dilute the overall LVMH brand a slight tidbit more than they were before. And MS is just this one perfectly managed brand, which is probably just a one out of one, basically like all their bags. And I think it's a fantastic company. And over the long haul, I would just love to own the stock if it comes down from the current multiples. Because right now, as you have said, we just have no margin of safety on this. When we looked at Ferrari, it was trading at a similar multiple to MS now.

1:22:11And only a couple of weeks later, it dropped to low 30s in the multiple. And the stock is now closer to being 30 % down. And this happens to even the best companies. There are not a lot of times when you can buy MS at multiples in the low 30s, as you just said. In fact, the last time that happened was a decade ago. But still, I don't want to build, I think, a tracker position here now. And as you just said, for a full position, it's too expensive. I'm just missing the margin of safety. And this is not a stock that is expensive because it will grow a lot. It's really just about the reputation of the brand.

1:22:41And I know it was obvious before the pitch that MS is expensive, but the idea of this show is to build a portfolio, as everyone who's still listening to this podcast right now probably already knows. And for that, you'll need a lot of good companies on your watch list. And when you've done the work to then react when the prices drop, that's a very good situation to be in. And when that already happened, it might be too late to do the work. And you want to be prepared. We are now prepared on MS. That's why we look at these companies even when they trade at a premium. So I think we don't add it to the portfolio yet, and we both hope it will have the same fate as Ferrari, and we can buy it in the low 30s at some point.

1:23:20But that's it. Sean, now I think if you don't have anything to add, that would be the part where I ask you about your hints for next week's episode. Fingers crossed we get that low 30s Hermes multiple. I don't know if we'll get it, but gosh, that would be awesome. We'll send an emergency update in the newsletter if the day ever comes. but yeah no looking out to next week I always say this but it's one I'm really excited about otherwise I wouldn't be pitching it it's a company that I know really well as a consumer and I don't think I'm special for that I think most listeners will feel like it's a company they know very very well I know Daniel knows it very well too and yet we have managed not to cover the business yet and it's not a mag 7 company but I will say it did used to be in one of the market-defining acronyms, as you might put it.

1:24:14This is probably getting way too obvious, but it's a company that nearly every household uses, dominates their TV consumption, and then now the stock has fallen around 30 % in six months at the time of recording this episode. So it does feel appropriate to take a look, but I'm sure I've spoiled it. But yeah, that will be the pick for next week. I'm pretty excited for this one because there's so many people talking about it, but I haven't yet seen a valuation on it. So I'm just very excited if it actually is as cheap as the price drop in the last couple of months would suggest. And I think that's it.

1:24:51I would say I'll close it today with a quote by Carolina Herrera, who is a Venezuelan-American fashion designer. And she said, luxury will always be around no matter what happens in the world. And that might be true for an industry, but as investors, we need to find a luxury brand for which this holds true as well. I really do think it's a mess and probably there are not many others, but at 50 times earnings, I do not yet want to bet on it. That's why we made our decision. Next time we look at a company that's slightly more cheap than this. So stay tuned and see you all next week. Thanks for listening to TIP.

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1:26:29Thank you.