Piquadro SpA follow up – Aspirational branding

After a first glance at Piquadro and many interesting comments from readers, I wanted to follow up un a couple of the points raised.

Return on Equity / Return on capital

One reader commented that Return on Equity (ROE) decreased significantly. This is correct. However, just looking at ROE ignores if the quality of the balance sheet has changed.

If we look at the 4 years we have currently one can clearly see the effect if we add return on capital and return on invested capital:

ROE RoC ROIC
2007 64.6% 29.5% 30.3%
2008 52.2% 28.1% 27.3%
2009 38.5% 22.3% 21.6%
2010 38.9% 25.9% 25.6%

ROE has indeed decreased, but including the reduction in debt, return on capital still looks pretty OK in the hiogh 20ties. In my opinion, ROE is not a very good indicator if the capital structure changes.

Increase in inventory

Another reader commented that inventory increased significantly in June 2011, which of course would not be a good sign. I quickly checked the half year report (September) for the latest figures:

30.06.2011 31.03.2011 30.09.2010
Trade receivables 25.3 21.4 22
Inventory 14.3 10.1 11.9
Payables -18.1 -16 -15.1
net Working Capital 21.5 15.5 18.8
Sales (6m) 30.1   27.1
Net WC in% of sales 71.4%   69.4%

If we look at the more meaningful net working capital, one can clearly see that working capital compared to 6m sales is still at a relatively high level, even after the increased payables. The increase is not dramatic (71.4% of 6m sales vs. 69.4%), but definitve something to watch. I am not sure if this is a side effect of increased store openings.

Business model / competitive advantages

I am not a business model expert, but in my opinion most of the “Branded fashion” companies do not really have a “hard” competitive advantage. The classical competitve advantages or moats are:

– barriers to entry
– economies of scale /cost advantages
– Switching costs
– network effects
– brand equity

I think for someone who produces relatively expensive branded bags, the first 4 factors do not really apply per se. I would also question number 5, “brand equity” in the classical meaning. The best example for brand equity is usually Coca Cola or other comparable “consumer brands”. Their concept is very simply spoken that the consumer “trusts” those brands and therefore both, prefers the product when she shops in the supermarket and is prepared to pay more.

In my opinion, for Piquadro and similar companies, the concept of an “Apirational brand” applies which is slightly different than mass market branding. If we look at the definition at Wiki,an aspirational brand can be described as follows:

In consumer marketing, an aspirational brand (or product) means a large segment of its exposure audience wishes to own it, but for economical reasons cannot. An aspirational product implies certain positive characteristics to the user, but the supply appears limited due to limited production quantities.

An important characteristic of an aspirational product is that the part of its exposure audience that is at present economically unable to purchase it, thinks of itself as having a fair probability of at a certain point in the future being able to do so.

Of course it is not easy to createan Aspirational Brand, otherwise everyone would do it. In its March 2011 company presentation, Piquadro explicitely states about their brand proposition:

Distinctive brand for “moving” people in leather goods industry
Aspirational brand: high quality, technological mood, innovation, design and ergonomic performance
Premium/performance positioning

Clear distinction from competitors at comparable price level through commitment to innovation, design, high quality and ergonomic performance.

Of course, those statements contain a lot of marketing bs, but pages 6-10 clearly show the strategy. Especially page 9 is quite interesting. Piquadro wants to position itself as a brand one wants to buy for oneself rather than to show off.

It remains to be analysed how succesful this approach is, but in my opnion, the currrent success in the very “fashionist” Italian market is a good foundation for further international expansion. And once a succesfull aspirational brand is established, a company is able to earn signifcant returns on capital.

However if one looks for example in an old Mediobanca research report, one could read the following quote:

This also takes into account Piquadro’s positioning in the accessible luxury market, which is showing itself to be highly vulnerable to market downturns, coupled with the company’s small size and limited stock liquidity.

So this might be one of the reasons for the low stock price: The expected downturn especially in its home market Italy will hit Piquadro harder than the even more “aspirational” luxury brands.

Luxury Leather goods industry

Some remarks about the bag / leather goods industry in general: What I find interesting is the fact, that this industrys seems to have some natural advantages compared to the luxury clothing industry or even the luxury shoe industry:

– “one size fits all”: for bags, one doesn’t have to carry different sizes like for clothes or shoes, so inventory should be considerably lower than for “size” products

– due to the relatively “compact” presentation, those companies don’t need huge flagship stores like Armani etc. If one looks for example at TUMI or Mandarina Duck stores, they are usually relatively small. One also doesn’t need changing rooms etc. This should lead in theory to relatively lower rental costs compared for example to Dolce etc.

– it is clear to see that the traditional fashion labels try to sell more bags. It is to be seen how “specialists” will perform, but one of the issues with the “general” labels is that they usually only offer a very limited variety of bags, the specialists offer a lot more choice.

– so far, Piquadro seems to have concentrated its efforts on male customers, especially briefcases. I find this quite interesting, as for example one analyst told me that Louis Vuitton makes most of its money in China with male handbags. So this segment of the market might be especiallyinteresting in growth markets and maybe less competitive than the female segment.

– also, the developement of a new class of gadgets like the Ipad and the Kindle offers additional potential for those companies.I am not sure how big this market will be but one should keep this in mind

Summary: So far no decision to buy or not to buy yet. Piquadro looks like an interesting company in an interesting segment, but I need to dig a little bit more into it, especially with regard to competitive analysis.

8 comments

  • Concerning the Margins in the DOS business, I have to row-back (at least) a bit. I just found the 2.half report 2011 on the confusing IR webside at voila:

    EBITDA margins in the DOS business fell from 12% to 6% (!), also Piquadro might well report a decrease in sales of up to 7% in the 3. quater. I guess there is also plenty of space on the downside…

  • Oskar,

    since I wrote my bachelor thesis about this topic (with respect to the European Airline sector) I can recommend this paper of Goodacre on the influnce of operating leases on retailers:

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=279030

    You consider operating lease obligations by simply discounting their minimum future lease obligations and then adding back the present value onto the balance sheet. For example, Air Berlins gearing ratio changes from ~96% to 550% when considering operating leases liabilites. There are even airlines which sold and leased-back virtually all of there aircraft, hence showing no aircraft in their balance sheet 😀 An airline without aircraft, this is only possible under todays international reporting standards 😀

  • I have read a few times, that lease payments are usually the factor that causes a retailer to file for bancruptcy. The fututre lease payments (obligation to pay those rents) do not appear on the balance sheet, but need to be taken into account somehow (how?). So the true “debt”-level of a retailer may be a lot higher than at first assumed. That is the risk of the DOS-concept. This is also the reason why many retailers have very low financial debt, because this leaves room for the rent-obligations.

    • Hi Oscar,

      you are absolutely right. One has to distinguish between fianncial leases which ar on-balamce sheet and operational leases which are currently still off balance sheet.

      Piquadro has ~5 mn leases on balance sheet and 7 mn EUR off balance sheet operating leases (nominal). This is not at a critical level, but should be incorporated into a EV analysis.

      mmi

  • @Stefan: You are right, I should have been a bit more precise on this one. It surely only works when margins rise considerably, but as many other retails show, this can be the case. (By the way, as long as the wholesale business manages to achieve growth too, also the overall margin will expand; I guess Gerry Weber is quiet a good proxy for this one)

    The main point I was trying to make (and failed :P) is that Piquadro has the opportunity to grow in a profitable way, however thereby increasing the risk because of higher fix cost.

  • hi stefan,

    you should not forget that Piquadro trades at 7x PE.

    Your traget price would imply you only want to inevst at a PE of 4-5 in a highly profitable firm with a proven “competitive advantage”.

    I am not sure if you find many companies which fit into this description.

    mmi

  • Stairway: when DOS margins are at 13% and wholesale margins at 30%, why should average margins improve with a higher DOS share in sales?

    I think that can only be the case, if DOS margins can rise dramatically. Maybe that will be the case, but I don’t really know.

    For me Piquadro looks attractice, but as long as I can’t explain their competetive advantage, it’s a no go to buy far above book value. As MMI noted, a possible competetive advantage of piquadro can only exist in form of a good brand image. And that’s hard to judge for me.

    At the moment I have passed on Piquadro, maybe I will invest some more hours, if the price drops another 30 or 40%.

  • What is really interesting ist the fact that the DOS business, which is growing a lot faster than the wholesale business, is increasing its margins at quiet a nice pace. EBITDA margins improved from 10 to 13% in 2010/11 while wholesale is more or less stable at 30%. Therefore, an increase in DOS revenues relative to wholesale revenues will also increase the total group margin. However, Piquadro achieved only 5% sales growth in the first nine months, which could put some pressure on margins, since the DOS business usually carries high fix costs which leads to margins being prone to sales slowdowns. I guess the 9th of February will tell more, when the whole 9M report is published.

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