Reasons and motivations to buy certain stocks can be as different as Investors' personalities; some want to profit from a quick one, two-day move caused by pending news like quarterly results while others prefer investing in companies that offer stable businesses with predictable cash flows and solid financials. The stock and investment thesis I am about to present here definitely falls into the latter half, so if you prefer evaluating a stock by its prospects for the next three years rather than the next three quarters, this article might be for you.
The company in question is Inter Parfums (IPAR), a worldwide creator and distributor of branded perfumes and scents; so the chance of one of their products being a stocking stuffer under your Christmas tree is actually quite high.
IPAR in my view is a compelling long-term buy for the following reasons:
Zero debt and a constant operating cash flow in a stable and recession proof industry
A cash pile that covers nearly 30% of the enterprise value will have to be invested in new brands and/or returned to shareholders via buybacks or dividends
Good growth prospects through new product launches, acquisition of licenses and expansion in related segments
So let's go into details:
The Business
Global fragrance sales amount to about $27 billion with an estimated growth rate of between 3 and 5% annually. While Europe still represents the biggest piece of this pie (about 45%), the majority of future growth lies in the emerging markets; Latin America, the Middle East and especially Asia. Growth rates in the low to medium single digits certainly don't make for a sexy story, but the stability of sales even through the recession of '08/'09 make this business as robust as only a few other outside the food and beverage sector.
The perfume market is highly fragmented, with a multitude of luxury clothing, apparel and accessory brands competing with athletics companies and a growing number of pop and movie stars launching signature products. Bigger players use to keep the whole process of developing, producing, marketing and distributing in house, while smaller brands prefer to licence their products to companies like Inter Parfums and Coty (COTY) with established global presences.
One of the positive aspects of this business is that IPAR does not own or operate a single store and therefore skips the risks associated with maintaining physical locations. On the other hand they have a global distribution network set up which makes it easy to efficiently launch new products worldwide and scale up in size. Plus, I find that fragrances are less subject to swings in fashion and don't bare the risks of apparel companies that have to be spot on to capitalize on seasonal trends.
Fundamentals
Inter Parfums has licensing contracts with over 20 different brands, the majority of which are set to expire in the 2020s.
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IPAR's most successful brand ever was British luxury company Burberry (OTCPK:BURBY), which contributed about half of total sales. After the original 20-year licensing deal ran out in 2013, Burberry decided to do it on their own and bought out Inter Parfums side for $239 million. Due to the depart of such a huge partner and a only partial contribution to 2013 sales, IPAR's top line will be decreasing two years in a row; even though the "real" picture is not that bleak.
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As you can see, ex Burberry sales are actually increasing at a CAGR of 22.8% (2009 to 2014), with management's long-term goals set on a more modest 10-15% rate in coming years.
Beyond losing a big chunk of sales and profits, Burberry's exit can be seen as quite positive for Inter Parfums. First of all it de-concentrates the dependency on a single brand; the single biggest contributor to sales now is Lanvin with $77.6 million or 23% of 2012 sales and this licensing contract is only due in 2023. Second, thanks to the licensing termination payment, IPAR now sits on a cash pile of $288 million (over 26% of the current market cap) with zero long-term debt which leaves a lot of room to expand and/or return to shareholders.
This occasion shows how important it is to have an eye on expected termination dates and the acquisition of new licenses, which feels a little like examining product pipelines of pharmaceutical companies. So it comes as good news, that IPAR managed to gain a couple of very promising licenses, like the 20-year exclusive worldwide rights for Karl Lagerfeld fragrances, which could be a growth driver. In a recent conference call management mentioned this one to have the potential to reach $100 million in sales in 2015. Other potential "Blockbusters" include Alfred Dunhill (with 6+4 years left) and Anna Sui, which is expected to do very well in Asia and will be with the company until 2021.
Two other recently acquired licenses expected to drive future growth are Oscar de la Renta, an established brand best known for its bridal fashion and China's leading luxury brand Shanghai Tang, for both of which IPAR owns the exclusive worldwide rights for 12 years to come.
Shanghai Tang started out in Hong Kong in the 1920s and grew into China's first internationally recognized luxury label, before getting fully acquired by Swiss/South African luxury giant Richemont (OTCPK:CFRUY) between 1998 and 2008.
Fragrances are a completely new segment for Shanghai Tang and it is definitely good to see that another Richemont subsidiary puts trust in IPAR's expertise to create and distribute its scents.
Other brands owned by Richemont that are on IPAR's client list include Alfred Dunhill, Montblanc and Van Cleef & Arpel while only one of its brands (Chloe) is being serviced by IPAR competitor COTY. COTY's licence for Chloe came via acquiring Unilever Cosmetics in 2005, while all the other four Richemont brands "organically" chose Inter Parfums as their partner in 2007 (Van Cleef & Arpels), 2010 (Montblanc), 2012 (Alfred Dunhill) and 2013 (Shanghai Tang).
I am not completely sure to what degree the mother company Richemont has a say in who its subsidiaries chose to partner with, but it is very encouraging to see all of their recent decisions to fall in favor of Inter Parfums.
A completely new segment that Inter Parfums set its eyes on is the market of servicing hotels with merchandise (yes, those small sets of shampoos, soaps and fragrances), with five-star chain Sofitel being the first client in this category. Its 120 facilities around the world will now be supplied with Lanvin products and while the impact on IPAR's numbers will be minimal, it hopefully is the first step to grow this business into a meaningful contributor.
IPAR's geographic presence mirrors the worldwide fragrance market quite well, and a quick look on sales growth over the last two years clearly shows why the company is focused on strengthening its position in Asia. With the acquisition of Shanghai Tang and the upcoming launch of their first scents, I would not be surprised to see Asia grow into the largest sales contributor for Inter Parfums.
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On the other hand there also might be room for surprise in the European part of sales, as the old continent slowly moves out of its economical melancholy and shows signs of growth again. With a combined 45% of sales being generated in western and eastern Europe, the switch from drag to growth could be a huge positive for the company, given of course the European economy delivers.
Historic financial performance and projections
Inter Parfums has a record of extremely stable and constant growth in every relevant number; be it sales, earnings per share or even dividends per share.
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In the decade from 2002 to 2012, the company managed to grow sales by 17.5% (CAGR), earnings per share by 16% and its dividend per share more than ten-fold. Even in its worst year during the meltdown of '08/'09, sales only decreased by 8%, EPS by 5% and dividends were kept steady.
Of course, all those numbers include Burberry which represented about 50% of the company's business and with its departure, current results are heavily skewed and do not show the underlying growth in IPAR's business. But while it might take a year or two to make up for Burberry's 50% share, this table shows how capable management is in growing existing brands into blockbusters and at the same time acquire new licenses that fit into the company's portfolio to secure long-term growth opportunities.
For 2014, management guided $495 million in sales and $0.95 to $0.98 in earnings per diluted share. I expect the recent licence deals like Lagerfeld, Oscar de la Renta and Shanghai Tang to slowly grow towards their full potential in 2015 and therefore push sales growth a bit closer to 20% growth rates. Accordingly I expect the company to generate upwards of $580 million in sales and $1.20 EPS, as operating and net margins have been extremely constant over the past.
In case of a steeper European recovery and/or exceptional performance of some of the company's brands, I would leave room for another 5% on top of those estimates. Keep in mind that management gave Lagerfeld alone the potential to reach $100 million in sales in 2015, which would already lift sales into the mid-500 millions assuming two years of flat growth for the rest of its brands.
As most licenses run until 2020 or later, I expect the risk of losing another major sales driver to be very low; the first high-end brand to eventually not continue the partnership with Inter Parfums would be S.T. Dupont in 2016 and it is unlikely to be one of the top five sellers by that time; so even if faced with a departure, IPAR's numbers are unlikely to experience another shock like this year. Given that the world economy will stay out of trouble for some time being, I expect the around 15% CAGR in sales and EPS to continue way beyond 2015.
Cash and dividends
One remarkable feature of Inter Parfums is its over ten-year dividend paying history. The company started rewarding shareholders this way in the first quarter of 2002 with a quarterly distribution of 1 cent per share, which back then was around a 0.6% annual yield.
IPAR has paid and never cut a dividend ever since, increasing the payments up to 12 cents per share and quarter last year. Plus, shareholders were paid a bonus dividend of 48 cents per share last month. Dividend increases always took place in the first quarter, and last year's solid financial performance leaves me thinking that another raise to 15 or even 16 cents per share is due this march, resulting in a forward yield of 1.7 to 1.8%.
This consistency in dividend history lets me believe that management is trying to build a reputation for rewarding shareholders that is likely to continue in the future. With net margins constantly around 10% and a operating cash flow of $61 million (2012), IPAR's payout ratio lies somewhere between 20 and 25%.
Through the one-time termination payment from Burberry, the company now is in the very unique position of holding more than a quarter of its market cap in cash on its balance sheet, while at the same time carrying absolutely no long-term debt. Just a couple of weeks ago, management discussed the use of this $300+ million cash pile on a conference call.
Their first priority would be to invest this money back into the core business through the acquisition of licenses. But at the same time it shows that the company's leaders are not willing to overpay for new deals or acquire brands that do not fit into its existing portfolio: Miu Miu, one of Prada's (OTCPK:PRDSY) subsidiary signed with competitor COTY in November, a deal that IPAR could have easily overpaid for.
Even if Inter Parfums will enter a couple more partnerships over the next half a year, the sheer size of their cash balance would still allow for a generous return to shareholders, either via buybacks or dividends, which management signaled would be their second most favorite deployment of resources.
If we assume that one third ($100 million) of the company's cash would be more than enough to acquire another three licenses or so; Inter Parfums could easily buy back 10% of their float and still be left with a nice stash and zero debt. Just like everybody is waiting on Apple to come up with a plan for their giant cash pile, the use of Inter Parfums money would be the main catalyst for the stock over the next two or three quarters. I expect management to try to put this money to work in a couple of deals, but if nothing huge has come up by summer (in time for next year's Christmas season), the focus will likely be to return as much as possible to shareholders.
One has to keep in mind that the different scenarios would have a very different impact on IPAR's valuation: if most of the cash is used to acquire new licenses, those would only be accreditive to EPS in the years to come, speak 2015 and later; but if a majority would be spent on buybacks and/or dividends, the consequences would be immediate (a lower float means a higher EPS). Therefore one should have a long investment horizon to not be disappointed in the short run if the return to shareholders should end up being lower than expected.
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Valuation, Comparison and negatives
Inter Parfums' stock had a stellar year of 2013, gaining about 75% (plus around 5% in dividends) and boasting a market cap of $1.1 billion. At these levels, the company would be valuated at a 2015 P/E of just under 30 and a price/sales of just under 2 while yielding 1.7% and growing top- and bottom line by about 15% per year.
Due to its unique cash position, it is only fair to discount this factor and have a second look at the company's number and how they compare to COTY for example. The company reported cash equivalents to amount to $288 million by the end of the third quarter, so combined with its regular operating cash flow it would be fair to take some $300 million off the market cap, which lowers 2015 P/E to 22 and price/sales to under 1.5, while of course still yielding 1.7% and growing EPS by 15% annual. By conservative metrics, these numbers suggest that IPAR is definitely no bargain, but they are still competitive to its biggest rival.
COTY grew its sales by about 10% per year from 2010 to 2013, but is expected to flatline in 2014; EPS grew from $0.55 to $0.82 over the same period. The results for Q1 of 2014 are actually slightly lighter than the year before, indicating that EPS too, should be flatlining in 2014. If we assume growth of 10% in 2015 and account for the $2.6 billion in long-term debt the company is carrying around, COTY's 2015 P/E comes in at over 24 and price/sales at 1.7, while yielding 1.3% and growing at a lower rate than Inter Parfums.
Considering that IPAR has a stellar 10-year record of constantly growing sales, EPS and dividends and still offers more dynamic growth prospects for the future, it should be a clear choice to seek to find an entry into Inter Parfums, rather than COTY.
The only issue that every investor has to see as a negative, is the fact that insider selling has been a constant variable with IPAR. A total of 420,000 shares have been sold over the last 12 months, which represents close to 1.5% of the float and of which a big part is related to share based compensation. While I dislike the fact that the action is so one-sided, I do not see the amount of shares being sold as a reason to question the company's fundamentals and prospects.
One of the few risks I associate with Inter Parfums right now, is general market risk. The business itself is simple and profitable, the dependence on a single brand decreased dramatically and long contract terms secure sales for years and years to come. The financial health of the company is as good as it gets and a growing 2% dividend yield should provide support whenever the stock price should take a dive.
A 2015 P/E of 20 is no bargain, but the low operating risk and expected return to shareholders is something that investors have been paying up for in stocks like Procter & Gamble (PG) or Johnson & Johnson (JNJ), which both have P/Es not far away from IPAR's but are way behind on projected growth rates in sales, EPS and dividends.
I have not yet initiated a position in the stock, but I am looking to do so within a week or two. My approach to a stock like Inter Parfums would be to buy one portion now to have "a foot in the door" and fill up on dips toward $30 on overall market weakness. My investment horizon for a position in Inter Parfums would not be under three years, with the option to integrate that position into a Dividend Growth Portfolio. In a base scenario, I would see the stock having upside till $50 through 2015; but if either existing brands blow through expectations, the European economy catches fire or the cash gets deployed in a very shareholder rewarding way, the stock could reach this target already in 2014.
Conclusion
Inter Parfums is a perfect fit for investors who seek a solid long-term play with convincing growth prospects in a low-risk business. Its perfect balance sheet makes sure the company has all the resources it needs to capitalize on opportunities and still leaves plenty of room to reward shareholders directly. Especially on dips, investors should look to add aggressively.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in IPAR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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