Compagnie Financiere Richemont SA Earnings Call Insights: Priorities, Deployment of Resources

On Wednesday, Compagnie Financiere Richemont SA ADR (OTC:CFRUY.PK) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Priorities

Johann Rupert – Executive Chairman and CEO: If you make the right guess this is not a bribe believe me….

Unidentified Analyst – Goldman Sachs: (Indiscernible)

Johann Rupert – Executive Chairman and CEO: No, you don’t. You know I have real problems with institutions where somebody can be bribed with a watch. You know €10 billion or €5 billion but when you can bribe somebody with a watch then there is a problem with the culture of the institution. I’m surprised because very few people had any idea. Okay, well done. So (Francesca) guessed correct and she is nice enough to auction for a charity. Bravo.

Unidentified Analyst – Goldman Sachs: Congratulations on a terrific set of numbers and the result of lots of hard work and assumes late a long time ago, but in here as to mention where do you have the highest returns on your cash flow – your capital expenditures going forward. Where will the investment returns be the greatest. Do you think about your Maisons, your flex of stores, whether it’s in China, generally. Whether it’s in travel retail, what are the areas. You’ve touched upon this question so often while you may not much left, but just your priority.

Johann Rupert – Executive Chairman and CEO: Well, it depends upon are you asking in which geographic area which company, which combination of company plus geographic area or where we overprice our product so ridiculously that the cash flow is superb, it’s…

Unidentified Analyst – Goldman Sachs: It’s sort of a broader question. You will be able to continue to redeploy capital and you’ve seen it go up and you’ve said already that you’re going to be increasing your capital spending. So rather than beat that drum, because eventually well let me switch the question, you once had a great observation about counterfeit and about what measures you take to try to increase it and go against it and also what did internally to your organization to help make it more urgent in its own production practices. So maybe just reflect on that for a moment.

Johann Rupert – Executive Chairman and CEO: It is really difficult because we generally find that this is a very long-term business. Currently because of currency movements, et cetera, Japan is still our most profitable market because of the pricing and how the yen has moved. And it has been one of our most profitable markets for very, very, very, very many years, Gary. But I guess our single most profitable venture is probably Panerai, where we paid less than $1 million and we found 40 pre-war Rolex movements which we cleaned and oiled. We have put into platinum watches and we sold for more than the purchase price. That don’t come that often. I would say Van Cleef would be a very good – Van Cleef would be a good example of how our business model works where – actually it was in Mr. (Kurier Frattini) of Italy who put the company together. We hadn’t had any interest. I then bought the company from him over the phone. No one was with him, but we shook hands over the phone. One of our large competitors based in Paris offered him 25% more than we had agreed upon over the phone. Without asking what we had agreed upon. Mr. Frattini said, ‘Sorry, I’m a gentlemen. I’ve agreed.’ That’s how we got Van Cleef & Arpels. That’s more than a decade ago. But slowly doing all the right things, getting – pulling the licenses back, getting the leases, getting the products, going into the archives, getting the (indiscernible) zones back. Today, it is a very profitable company, but I remember coming year after year and not only you folks but calling someone at the board level. So we (indiscernible) to make money. Do you remember, I said when we are ready for it to make money, Board members – Alan, you remember how many years? Finally (Indiscernible) off the Board table. I said it will make money and we’ll let you know. Today, it is a very precious part of our group. So (Tom) it’s a difficult to call it. You are correct. The real question is do companies redeploy their free cash flow accretively and do they waste it? If that’s your question, fully (angry). There are lot of companies who actually waste their free cash flow and they reinvest it suboptimally. If you find the companies that redeploy their free cash flow properly and at the higher rate, then you get that generational power. I haven’t worked out, which in the past, which ones in the past, I would say…

Richard Lepeu – Deputy CEO: You may add this so that you need a vision because when you bought LMH, we will never be there today should we have not bought LMH.

Johann Rupert – Executive Chairman and CEO: Yeah, that was not my vision. That was my paranoia of what would happen. I think if you want to be successful, you need a very healthy dose of paranoia that somewhere everyday someone is there that wants to eat your breakfast and if you’re not there they will do it so. So LMH, if we hadn’t done that what’s that’s 12 years ago, if we hadn’t done that we wouldn’t have had a business. But for that I have to thank my French friends, which if Jean-Marie Messier hadn’t that the grand vision of building Vivendi, you wouldn’t report us at 68 francs. The share went to 8. So if we hadn’t had that cash, we hadn’t exists out of Pay TV, we wouldn’t have the cash to buy LMH. If we hadn’t bought LMH, we wouldn’t have been in the business today, because it would have been like making Ferraris in Fiat factories, you cannot do it. Our clients are too sophisticated. They want authenticity and with the transparency, that the web brings I mean you can’t lie to clients. We have superior quality. I will say to people trademark is not so mysterious and all the trademark is (indiscernible) what you see is what you get. If I buy this, I’m not expecting (indiscernible), I’m expecting (cup), and it better be the same every time I buy it. If you buy a watch it’s not that you buy high or low or this, but it’s got to be consistent and what the client expects. The lady or the gentleman it must exceed their expectations. At least meet. So trademarks across the world, a trademark is not sufficient for anything and so we need that consistency and it’s a tension to detail. A paranoid and that’s why I love Ralph Lauren so much. We are actually not quite sure whose more paranoid him or me. When we sit down and we start talking about what could go wrong and this goes into the early morning. So a healthy (paranoid) is not bad. But the real question that he asked and I am afraid that’s the key question that 99% of all people miss, it is no good generating free cash flow of you reinvested at less than the rate that you are generating at that. As simple as that, than rather give all your cash to your shareholders. But I have to admit, quite often when we have calculated that it would be a more than optimal return it has turned into a bloody disaster and quite often it’s your gut feel that has led to (indiscernible). Very often a group of us sitting around and saying, we smell something. I don’t know how to define that; you know what I am saying. With Panerai my colleagues tell me that I am African or no with taste. So don’t buy it. What they wrote to me that I am unsophisticated. I didn’t write to them, but I have more shares. So we are buying it.

Jon Cox – Kepler Capital Markets: Jon Cox with Kepler Capital Markets. It is a question on the sort of whole watch production liberalization issue. How many years do you think it will be for you to be comfortable with your sort of manufacturing footprint. You talked about year one all the brands that have their own.

Johann Rupert – Executive Chairman and CEO: We are comfortable right now. Jon, we’re comfortable right now, I told you last year and the year before that we’re comfortable, we have empathy with Mr. (indiscernible) position and we comfortable and I saw yesterday was that (indiscernible) say that 2013 is the same as 2012. So we’re comfortable.

Jon Cox – Kepler Capital Markets: Well, as part of that question, I can see you’re obviously doing a lot of expansion in your manufacturing capacity, Cartier expansion and also Watchmakers. Would it be realistic to expect then there will be some margin pressure on the watch division as you expand your own production?

Johann Rupert – Executive Chairman and CEO: Yeah, we’ve said for the last five years. Obviously they would be but – there will be a blend between owned and others, and there is no headline in this or any story in this. It’s an evolving situation. We’ve don’t know where it’s going to lead because there are enough movements inside Switzerland, but when people export 800,000 Swiss made movements to Hong Kong, and then call those watches Swiss watches, then I have empathy with IX. It’s rubbish. It those 800,000 are to be, there wouldn’t be a problem. So it’s – I’m not going to go down there because every question leads to another headline and Rupert says this and then this is that. We are comfortable. We’re comfortable with our costing and we’re comfortable with a blend of costs. What’s more important, our clients are comfortable with it and we have a good relationship with the other manufacturers, with Rolex, with The Schwartz Group, we don’t really have enemies in the watch making universe here. I want to just keep it like that. Our plans are in place. They have been in place for a while and if I can put it to you like this, there is no story here. There might have been a story three or four years ago things have gone wrong and you’re 100% correct, we’re could have blown our cost under the water. As things stand now, I mean I’m comfortable, (indiscernible), but you should stay till the end of production.

Richard Lepeu – Deputy CEO: Yeah. Well, it is also important to note that the market has evolved towards higher price points. Meaning that the in-house movement which of course cost more than standard movement has just met the evolution of the demand, so – and you saw translated into fear. So here we are.

Deployment of Resources

Jon Cox – Kepler Capital Markets: Just a question on the deployment of you resources as it were. On M&A, it’s pretty clear you have a fantastic portfolio in the hard luxury segment with the Jewellery and the Specialist Watchmakers, but maybe potentially some of the soft leather accessories at suboptimal and maybe the problem with the profitability, is it trying to look around some businesses within the sort of soft leather and accessories side does roughly big bang acquisition but …

Johann Rupert – Executive Chairman and CEO: They all think they were 20 times what they are, okay. I mean I get two week. (Indiscernible) but a lot of these were bought by financial institutions are now wishing to exit and they came in the other way around. I went into Italy and actually we spot to the supplier five, six years ago and I look for it from the supplier up and I did and there is one very big acquisition, I got to a realistic price being 40% of the eventual price, you can’t competitive and then that person is ready to our business and then you got Zara and H&M. I’ve got news for Zara. In China they have been at Zara, yes. They want the same people want us into some of their big malls. Zara has always had the prep they will come in, they have no down payments, no minimums and the big Chinese mall operators they know. They have people that are quicker than you. So, now, it’s (dis-intermediations), it’s like Dell and then Gateway, if you’re selling other – sooner or later if you’re selling copies of other people’s products, which essentially is a business model. Then sooner or later somebody is going to do it quicker than you. Do I want to be in that business ready to go to runways, take pictures, send it to China, get the factories moving, ship them by the time your staff gets on the runway it’s too old and too expensive, seems to be like a bad business model. Accessories is a different business. But a lot of the companies that often serve today were bought by non-industry players at the height of the boom and they still haven’t realized that they lost their money three years ago. They lost their money when they paid it. It’s (this thing in the order) and we all do it. You make a dumb buy. I have done it a lot of times. When I was to sell it, I think, (indiscernible) lost a lot of money. I didn’t lose a lot of money when I’m trying to sell it. I lost the money when I was idiotic in the pursuit when I bought the bloody thing. That’s when you poke your money. It’s not when you try and find a bigger idiot than you take it off your ass. So, a lot of these things that are available were bought at the wrong prices. It’s – and I know, we all know the same companies and it is of no interest to us at this stage.

Jon Cox – Kepler Capital Markets: Then again on the capital, what do you want to do with your capital? I think the last time I heard you were talking about you wanted to be able to guarantee almost a 15% rise in the dividend.

Johann Rupert – Executive Chairman and CEO: No, there is a difference in the guarantee and what we’re trying to do. And we are looking, we’ve looked at that and I will tell you when I say we are not going to do it, then I’ll say Richard, I’m retiring, okay. He says he will retire with me. I think as we all know, we can do it for a few more years simply. I think every managers’ goal really is to make a company idiot-proof. Because soon or later an idiot will run the company. You’ve got to know that, okay. It doesn’t matter what company in the world. So if you have like Mr. Buffett said you if you build moats, you build brand equity, you can withstand quite a lot of stupid things. That we ourselves do. I’m not worried that somebody who isn’t a luxury goods company is going to think of something and that’s going to kill our business, whereas if you’re in the IT business or many, many businesses, it should keep awake.

Unidentified Analyst – Goldman Sachs: Patrick (Indiscernible). There was cost increase of 7% for the opening of new boutiques in the last year. What shall we expect here for the current financial year? Secondly, you will hate my second question, but I’m still asking it. You were mentioning that the current profit margins are not sustainable. What would you say in the longer term, is the sustainable profit margin level in terms of gross margin and EBIT margin? Bearing in mind that you do more manufacturing and bearing in mind you have a higher exposure in the (indiscernible) markets.

Johann Rupert – Executive Chairman and CEO: (Indiscernible) said 20% is his goal. In 2001 or 2000, you guys never won (indiscernible) for BAT in every meeting I got. So (indiscernible) said 20%. I’m not going to do it to my colleagues on my right, okay. I’ve no idea what’s its (indiscernible). 23 is pushing it. I can’t build your models. I can’t tell you what we are going to do.

Unidentified Analyst – Goldman Sachs: In terms of gross margin?

Johann Rupert – Executive Chairman and CEO: No idea.

Gary Saage – CFO: I mean as you’re getting, I think maybe just on the stores question. Mr. Rupert at the half year talked about our planning process and how we go through the strategic plans and how all the brands come and there is a different between want and need and we opened up 72 stores this year EEC the CapEx for the retail. The overall value of the retail would be down versus this year. That doesn’t mean that the store account will be down, because there is a change in the mix, there is a bit more allocated this year to the fashion and accessories model because they’ve doubled their profits as you’ve seen. The product pipeline seems to be good. So I can’t really equate a number for you, in terms of percentage, but because our watch and jewelry stores smaller than they (indiscernible) store or what having. I think on the value of CapEx, we use to get ranges. I don’t necessarily want to do that, I’d rather give you a number, including manufacturing from our bottom-up approach and that’s about 750 million, which is pretty consistent with what we talked in last year.