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Farewell to the ‘Neglected Luxury’ Niche

The Niche was present at the launch of the Asian Niches fund in February 2019 and has always had a weighting within the fund of between 3 and 5%, with a maximum allocation set at 5%. Together with the Internet Victims Niche, it represents the least Asian of the Niches in the Asian Niches fund.

The Niche has been particularly volatile and has performed only decently since inception, returning 14%.

The Niche was composed of five sub-niches at the start:

1) Luxury Travel

2) Beauty and Personal care

3) Fashion&Watches

4) Luxury cars

5) Champagne and fine wines

Luxury Travel had a very mixed performance due to Covid and the war. The small position in the Carnival cruise line unfortunately lost money. However, the most heavily weighted stock here, the Mandarin Oriental Group, a name that spoilt readers will be familiar with, did well thanks to its brand and property assets.

Beauty&Personal care consisted of one stock, Nu Skin, a dynamic multi-level company with a very high and innovative product. We believe the company can still do well but took a modest profit, made a little less modest by the strength of the dollar.

In Fashion&Watches we made some money buying on Hugo Boss weakness and holding and adding to Swatch Group.

Luxury Cars, although very volatile, contributed much of the upside in the Niche. Companies such as Daimler, Volkswagen, Harley Davidson and BMW performed very well. We have taken profits here and maintain a small exposure to these companies through the Electric Mobility Niches fund. These stocks, although now out of momentum, remain extremely valuable. They also indirectly serve as a reminder that the growth bubble is still far from

over.

We would like to digress from this theme. In fact, the annual figures for China’s electric mobility darling, NIO (but we could say Xpeng or Lucid or others), coincided with those of BMW. The two stocks are trading at 70% and 20% respectively from their highs, reached for NIO in early 2021 and for BMW in early 2022. At the highs, NIO was worth around USD 100 bln and BMW USD 67 bln. Today the two companies are worth USD 35 bln and USD 54 bln respectively. For those who like to buy underperforming stocks Nio would seem to be the player to bet on… And indeed we find analyst studies with headlines like “NIO down 66% with supercharged growth, time to buy”. Wow!

Let’s look at the results of the two companies.

• Nio sold 92k vehicles (clearly all electric) in 2021, a 109% increase over 2020. BMW sold 328k electrified vehicles in 2021 (BEV+PHEV, of which BEV 108k), a 70% increase over 2020. Nio grows more, but BMW sells about 3x the number of electrified vehicles of NIO, and 1x pure electric ones. I’d say one point for BMW.
• BMW also sells non-electrified vehicles. It won’t last forever, but in the meantime it sells them and makes money from them. Including these, BMW sold over 2.5 million vehicles (+200k bikes) in 2021. Another point for BMW.
• Nio has sales of USD 5.2 bln in 2021, up 118.5% year-on-year. BMW’s growth is much lower, 12.4%, but with sales about 24 times higher (about 120 bln USD). Another point for BMW.
• Nio realised pre-tax losses for 2021 of about 630 mln USD, and for ordinary shareholders the loss was even 1.6 bln USD. BMW made a pre-tax profit of around USD 18 bln. Another point for BMW.
• Nio has net cash (industrial) at the end of 2021 of about USD 3 bln. BMW has net industrial cash of about 28 bln USD (almost 50% of market cap). I still think BMW is better.
• Nio invests a lot in R&D and by 2021 has invested 720 mln USD. BMW also invests a lot, and for 2021 has invested 8.5 bln USD, 11x what NIO has invested. Another point.
• Nio FCF 2021 should be negative 1 BLN USD, while BMW’s FCF should be positive 8 BLN USD (and in 2022 could exceed 10 BLN USD). One more point

If we value Nio as BMW’s EV division, despite it selling far fewer cars, and assume that BMW’s EV division does not make as much profit as Nio, it follows that the rest of BMW would be valued at 19 BLN USD, or a P/E of less than 1.5x. Either Nio is overvalued or you have to sell your house and pension fund to buy BMW shares!!!

We don’t want to push BMW (which is a very nice company), but we do want to focus on the valuation of NIO, Xpeng, Lucid etc, which are still short. For those who would like to go long, perhaps on the consideration that these stocks have lost 70% from their highs, we recommend that you leave it alone and rather think about investing in a product like champagne, yes champagne, both through shares of the major players and through the product itself. The ETF on champagne does not yet exist, however, a few hours drive away there are plenty of wineries… And it can be a much more joyful way to enjoy this spring which has already started badly, rather than hoping for improbable recoveries of Nio and company.

Moving from chicory to risotto, Tesla remains a beautiful carmaker and its products drive us crazy. The company will see its market share grow a lot more and the Model Y is a great car and will be a super success. There is no risk of bankruptcy here, but the risk of the stock derating is huge. In our view, the company would be expensive even if it were worth just 30% of its current valuation. We also recommend that Tesla shareholders consider spending at least part of their capital gains on champagne. But as is always the case, those who have been so good as to hold them so far hardly look at the fundamentals, and will not take profits except in a panic.

Fundamental analysis can do nothing against momentum and euphoria. These act like a spell that protects the fortress against seemingly insurmountable forces, such as common sense. However, when the spell dissolves, nothing more can be done to defend the fortress. At that point, reality relentlessly exacts its merciless revenge. Far beyond what can be imagined. There is no shelter. There will be no survivors. Goodbye Gamestop, goodbye meme stock, goodbye anything that doesn’t have a real underlying. The alarm clock has gone off. Time to get up, wash up, get dressed and get back to the real world. Fascinating though, especially if there is champagne on hand….

And so we come to the sub-niche that negatively weighed most heavily on the performance of the Neglected Luxury niche, namely Champagne. Let’s not hide the fact that this is the sub-niche we are most fond of. In this sub-niche, Masi performed well, which we hold as an exponent of prestige wines, particularly the cherry-coloured Amarone. In contrast, the three listed companies that are heavily exposed to champagne performed poorly (the biggest player is LVMH, but the company is almost entirely dependent on the “elegant” Louis Vuitton bags, while the champagne part is marginal). Remaining extremely positive on the subject, we now create the Champagne Niche, a Niche purely focused on these champagne companies, dedicating 2.5% of the fund to them. The remaining 2.5% freed up by the closure of the Neglected Luxury Niche will be added to the Japanese Orphan Companies Niche, the Japanese micro-corporations that have not been covered by analysts, have been listed for decades, are flush with cash and have profits and dividends worth a song. Waiting for the world to remember them. We already have about a hundred of them in the Asian Niches fund and we plan to increase the number. They are all companies with which we engage directly with management and for which we produce an ESG and SDG analysis.

Champagne, the elegant lithium

There is no doubt that champagne is elegant, sparkling and sometimes fruity. However, in recent years, it is not these qualities for which it is remembered by its poor investors, but rather the dry and acidic feeling it has left at the back of their palates, and in their wallets.

Champagne companies, as some of our readers know, have a peculiar balance sheet. Among their assets they have two fat items. The first is tangible assets, in particular land and vineyards. But also the equipment to process the grapes into wine and the huge (and ancient) cellars to age it. The second is the inventory, i.e. the bottles that are fermenting (semi-finished products) and those being aged. On the other side, among the liabilities, we have the debt, normally huge, which covers the stock.

The debt is a bank debt, with long-term financing at fixed and variable rates. This will only gradually be affected by rising rates. The stock inevitably benefits from inflation, as this was produced well before inflation emerged. Land, vineyards and buildings are real assets, a natural refuge against inflation.

20 years+ chart of Vranken Pommery

As we had the opportunity to explain, champagne has been paying for a diabolical alignment for 15 years now, which occurred in 2007. In that year, the economy was flying and champagne was flowing. However, the number of bottles that could be produced was then, as now, limited by two factors: the land on which the product (Champagne) is named and the yield per hectare. Both of these factors are determined by regulation and cannot be exceeded. In 2007, Champagne consumption seemed destined to rise astronomically and this consumption, meeting a finite number of producible bottles, dramatically inflated prices, risking depriving some transalpine people of the precious drink (the French consume about 50% of Champagne). This was without even taking into account the Asian markets that were gradually opening up to the product, which until then had been opposed because of its dryness (the Chinese love sweetish spirits). So the regulations were changed, the yield per hectare was raised and the designation area was enlarged. From a maximum of 300 million bottles, 340 million bottles of champagne could now be produced per year. Then came the crisis, champagne no longer flowed onto tables, but piled up in cellars. Champagne prices plummeted along with those of the producers’ stocks, and it was dark….

…until 2020.

In 2020 the collapse of champagne consumption was remarkable because of Covid. This led the government to protect the industry from Covid-related losses. The industry was therefore less stimulated to produce in 2021, and this was compounded by the very unfavourable weather in the 2019/2020 season and Covid-related restrictions on staffing. However, in 2021 demand rebounded to 322 million bottles, surpassing 2019 levels, but with a low level of production and the need to build up stocks. Despite the war in Ukraine, the recovery in tourism is now expected to add demand. Meanwhile, the process of champagne’s slow penetration in Asia continues, driven by investments in marketing by major maisons such as those held by LVMH (Moet&Chandon, Veuve Clicquot, Dom Perignon, Ruinart, Krug, Mercier).

To be highlighted as:

– Champagne has a staggering operating leverage. A 10% increase in price can triple profits, given that we are starting from a low margin. As we are not far from the maximum number of bottles that can be produced, we believe that there may be room for a significant price increase. The first step could be the elimination of the discount sales campaigns we are used to.

– Champagne companies trade at or below tangible net worth. However, if we adjust this equity for the selling price of the finished goods in the huge warehouses the price/tangible equity ratio is well below par.

– If we then consider that the value of land, vineyards and buildings after depreciation is equal to or greater than the tangible net worth, securities are a clear anti-inflationary asset.

Today it is possible to buy hard assets like champagne, at 10x earnings, with growing profits, and P/TBV below 0.5x, in times of inflation…

With a little patience, lithium, the asset of the moment, can be found in abundance. Champagne is limited, beyond a certain amount you can’t go. Moreover, unlike lithium, champagne is good, and the companies that produce it today are cheap.

The upside here is substantial. We accept that for many of our readers we have lost credibility since we have been waiting for champagne to recover for years. But we repeat that it is precisely because we have been following it for years that we can now better perceive that we are close to the inflection point. Wishful thinking? Maybe yes, I will see..

En attendant, sante’!