Part One

The first part of this composition aims to show to the reader some of the
most important issues affecting the comparability of three companies
balance sheets. Even though these three have similar businesses,
products (with all respect due to the artists) and customers there are
some corporate choices that can influence a financial analysts decision
confusing him or her. Hence, we not only spot what are the main areas of
confusion according to our standpoint but also we offer a way to fix the
problem. This last idea fixing the problem means that the
rearrangements that we propose are tailored to standardise some values
so as to be able to perform comparison among the big three namely
LVMH Mot Hennessy Louis Vuitton SE, Kering SA, Herms International
S.A.

Inventories

Moving on now to the first issue that we found, we would like to cover the
inventory area. These three companies all start with the same approach
as the values for their product are reported by choosing the lower
between the cost to realise the good itself (excluding the interest
expense) and the net realizable value. The issue here is related to a
particular feature of one of the holdings: LVMH also owns companies that
are into the food&drink business and these ones cannot apply the same
rules that are in force with all the others. Hence, even though jewellery
(Hermes and Lvmh) is far from clothing (Lvmh, Kering and Hermes) and
even more with furniture (Hermes) they can be gathered together and
put away from alcoholic drinks because it involves a product that has a
different approach. Wines are recorded by using the harvest market value
calculated in accordance with the average purchase price of equivalent
grapes (Lvmh, 2014). If wines are the finite product we have also to
consider the raw stage: grapes. These last have their value calculated
pro rata considering their estimated yield and market value. Looking now
at the other recordings they are performed by valuing at the weighted
average cost or the Fifo method by LVHM and Kering. On the other hand
inventory goods at Hermes are recorded by using the weighted average
cost or standard cost adjusted for variances. To make clear the problem is

opportune going deeper to First In First Out method and the Weighted
Average Cost approach.

Fifo
The first in first out method refers to the practice of selling and recording
among the sales the earliest goods available. This approach has different
interpretations that need to be taken in account (Accountingtools.com,
2015). The first, good, is that by applying the Fifo we reduce the risk of
obsolescence (at this point is necessary to shed light upon the nature of
the companies being analysed: fashion and trend producers. This tells us
that although their clothing are not comestible they have an expiration
date as well that coincides with the next year collection. The second less
positive is that the cost of the oldest goods are matched with the last
revenues generated, therefore it means that in inflationary environment
FIFO would link lower than real costs to actual revenues. The gross margin
would be then slightly unreliable.
This fact has to be taken in account because both the lifo companies
have business also in other areas than Us and Europe where inflation (still)
exists, namely Asia and Pacific excluding Japan. Moreover for Lvmh
revenues in this area are the biggest in value among the ones from other
areas of the world. Therefore is reasonable estimating the inflation impact
of the prices of the good sold on a YoY base and then applying this
percentage also to the costs.

Weighted Average Cost

This is a simplistic approach that starts from considering all together the
costs of the goods then it divides this value by the number of goods
produced
so
as
to
obtain
the
average
cost
value
(Principlesofaccounting.com, 2015). Clearly this methods yields to some
problems. At first Hermes outputs are different in cost and kind (perfumes
and jewellery can target at the same client although they have different
prices) therefore it is necessary to go deeper and make sure that this
method does not apply on a large basis of product rather on a strict one
more focused on similar products in kind and cost.

Conclusion

In a nutshell we are handling three big holdings that control several

companies each and two thirds (LVMH and Kering) of these ones rely on
Fifo method to estimate the cost at which the goods are reported in the
balance sheet while the other third (Hermes) uses the weighted average
cost. As a consequences the first two have a gross margin that could be
unprecise while last holding can mitigate the gross profit margin since the
cost of goods sold are a general average that takes in account purchases
done at different times in the year. Our suggestion is that a financial
analyst rather than considering all the fluctuations in each raw material
price occurred between purchase and sale should focus on the inflation
rate for that period in that area and then applying it on LVMH and Kerings
costs in accordance with the percentage of revenues generated.

Depreciation

At this point we would like to stress another point that deserves to be

taken in account as there may be issues in case of different approaches.
Depreciation, also known as the progressive reduction of a fixed asset
value, can be applied in several ways (Accounting, Financial, Tax, 2015).
Firstly we should briefly introduce these ones and later we will consider
the choice made by the three holdings. The first way is the straight line
depreciation that is performed by charging the same amount along the
useful life. This method is tailored on goods that are expected to be
evenly used along their lives. Another opportunity to perform the
depreciation is the reducing balance method which charges higher
amounts at the beginning and then progressively reduces during the
goods useful life.

Choices made
After this introduction we should move to consider what they chose as
depreciation method. Property plant and equipment at LVMH are
depreciated according to the straight line depreciation method. From the
2014 notes at the balance sheet we can find all the details of the amount
of time dedicated to each category: buildings including investment
property: 20 to 50 years; machinery and
equipment: 3 to 25 years;
leasehold improvements: 3 to 10 years. At Kering depreciation has been
performed by using a straight line depreciation method as well. It follows a
briefly description from their notes at the balance sheet: 10 to 40 years
for buildings and improvements to land and buildings, and 3 to 10 years

for equipment. Last but not least we have Hermes where the straight line
method is valid as well. Now please consider the data over the amounts of
time for each category of goods depreciation: buildings from 20 to 50
years; leasehold improvements from 10 to 20 years; machinery, plant and
equipment from 10 to 20 years;

Conclusion
At a glance one would say that there is no difference among them as they
all deploy the same method, however is necessary to underline the
different amount of time for depreciation of goods from the same
category. LVMH and Hermess buildings depreciation differs from
Kerings, machinery and equipment is different for everyone and
leasehold improvements (not provided by Kering) is different as well.
Here the problem lies in the fact that different timelines take to different
depreciations even if they were depreciating the same good, with the
same initial value and bought at the same time. Clearly different
timeframes are a consequences of the tax law of the country in which the
holdings are domiciled. A solution at this problem could be a
rearrangement of these depreciation according to a unique and fair
timeline for each category so as to see standardised effects on the
balance sheets.

Taxation

This point deserves particular attention because of the nature of these

three holdings. Not only are their customers scattered everywhere on the
globe but also the provenience of their businesses is multinational. With
this phrase we mean that many societies (Puma, Gucci, Balenciaga, Marc
Jacobs, Loro Piana, Faubourg Italia) fully or partially owned by the big
three are domiciled in other countries. This creates differences in the
overall amount of tax payed because even within the European Union
there are different tax percentage. Hence, we believe that it is unfair
considering taxes as homogenous. Through the consolidated balance
sheets notes we can figure out that the effective tax rate (therefore the
weighted average of all the different taxes payed in different countries) for
Hermes was 33.3 percent in 2013 and 33.2 percent in 2014, for Kering
was 21.5% in 2013 and 24% in 2014, finally for LVMH was 30.8 percent in
2013 and 27.1 percent in 2014.

Conclusion

We propose a rearrangement to find a balance between these different

values. Our idea is to gather all the different tax percentages and then
calculate the average weighting these ones with their respective pre-tax
incomes. By doing this we will find a percentage that we should apply to
each company to evaluate their performances even after tax. The
following is a chart created to simulate how it would be.
Hermes
Effective
Tax Rate
201
3
201
4

Pre Tax
Income
1,194.6
33.30%
0
1,274.6
33.20%
0

LVMH
Effective
Tax Rate

Pre Tax
Income

Kering
Effective
Tax Rate

Pre Tax
Income

30.80%

5700

21.50%

1540.7

27.10%

8378

24%

1466.6

43.80
%
37.42
%

Leasing (ebitdaRent)!!!

Part Second

Introduction

Moving now to the second part of this elaborate we will consider the Roe
index. Before getting into this matter we feel necessary to spend a little
time describing this important ratio and also the reason why we are going
to calculate it in a particular way.
Roe stands for return on equity and this ratio can be obtained by dividing
the net income generated by a company by the average amount of its
shares ( we tend to use the average between the current and previous
year of equity so as to smooth the phenomenon of issuing new shares in
the meanwhile) (Lexicon.ft.com, 2015). This measure has a basic
importance for shareholders to figure out how much does the company
generate with their money. Given the wide horizon of equities that can be
issued some also introduced the ROCE (return on common equity) in order
to match the ordinary income with the ordinary equity. We have been
underlying the importance of this ratio although we have not stressed so
far the risk that lies behind it. This value can be easily manipulated by a

management board that is pursuing its own goals (different from the
shareholders ones). Manipulation happens frequently if you consider that
in many cases the managements retribution is linked to the company
performances and the more the Roe the better it should be the company
performance. How do they manipulate? This question has an easy answer
if you look at the main ways a society has to raise funds: equity and debt.
Say that a manager is really close to a certain Roe threshold that will give
him or her an extra bonus but the company has a lack of funds that does
not let it go on with its business. It is at least likely that the manager will
be tempted to consider as more favourable to raise money by issuing new
debt in order to leave unchanged the Roe index. However it would be
unfair consider the company under the same light before the issuance
because now we have new debt that will cost both in terms of capital and
passive interest. In a nutshell, Roe portraits an interesting and useful
picture of companys situation but it is uselessly risky relying just on it.

The Formula

Roe
Calculati
on
2013
Hermes

Kering

Lvmh

2014
Hermes

Kering

Lvmh

EBIT/Sal
es
PBT/EBI
T
PAT/PBT
Sales/Av.Assets
Av.Assets/Av.Equit
y
ROE

32.4%

13.6%

20.3%

31.5%

15.5%

98.1%

83.9%

96.6%

98.1%

87.3%

66.2%

79.3%

60.3%

67.4%

74.4%

102.3%

40.2%

54.7%

94.6%

43.6%

141.2%

206.2%

198.5%

138.2%

205.1%

30.4%

7.5%

12.9%

27.3%
-10%

9.0%
20%

Delta

17.7
%
154.3
%
67.4
%
55.9
%
215.2
%
22.2
%
72%

Now please consider the calculations we made on Kering, Lvmh and Hermes
balance sheets on years 2013 and 2014 in accordance with the provided
formula. Given the importance of the intermediate steps we are about to focus
on each one.

Ebit / Sales
Colum
n1
Hermes

Colum
Colum
2013
n2
n3
Kering Lvmh
13.57
32.44%
% 20.33%

Colum
n4
Hermes

Colum
2014
n5
Kering Lvmh
15.46
31.55%
% 17.73%

EBIT/Sales helps us to asses companies profitability by stressing the

percentage of sales made up by operating income. Generally the higher
the value the more the company is profitable and investors appreciate the
ability of generating by itself enough money for running the business.
Moreover it has to be taken in account that a positive increase in value of
this ratio means that the company is improving its business (Soliman,
n.d.). Considering on now our companies we can stress the differences
among
them: as we have been telling before the fact that they target at
a quite similar class of customers does not mean that they go on same
patterns. With this sentence we meant that Hermes is just focused on its

own
brand
while
LVMH
and
Kering
2013
have diversified and
Kering
then purchased many
83.94
brands. The outcomes
98.08%
%
96.64%
show quite clear that
Hermes is doing better than the others with an ebit/sales ratio over 30
percent both the years and far from the competitors (although we also
noticed a slight decrease from 2013 to 2014). Following the first we have
LVMH again with a decrease among these years and last we have Kering,
at least it does not share the same decrease ratio as its peers with a
remarkable increase (+14% YoY). Having considered the definition of this
ratio and the outcomes we should now draw a conclusion: based on the
calculations it is likely that the reason why Kering is not performing as
much as its peers is due to the nature of its holdings. Kering has stakes
both in sportswear sector (Puma) and in the fashion one (Gucci, Bottega
Veneta, etc) this means that its business is split in different fields. A brand
like Hermes clearly buys much more raw material of a certain quality and
kind rather than Kering or LVMH (the last has also an arm in the spirits
business) than it may be able to achieve better prices that led it toward a
certain operational efficiency. Before switching to the next ratio we would
like also to spend few words over the denominator.

Colum
n1
Hermes

Colum
n2
Lvmh

Colum
n3

Colum
n4
Hermes

Colum
2014 n5
Kering Lvmh
87.28
154.26
98.10%
%
%

As we have been telling before Hermes is fully concentrated on its brand.

Hence its sales come from Hermes branded product. This shows us that,
firstly, this concentration is likely to positively contribute to operational
advantages, secondly it is very unlikely that the other companies could
have reached the same values in sales for a single brand.

Profit before Tax / Ebit

This ratio is meant to give an idea of how much do the interests account
in these companies. The difference between the numerator and the
denominator lies on this voice. Interests refer to both the positive and the
negative ones (Schmidt, 2015). It is therefore possible having a ratio over
100 percent in case of positive interests exceeding the passive ones. On
the other hand we can have values closer to the other excess (0 percent)
when we deal with company particularly exposed to debt.
After this briefly introduction it is time to consider the outcomes. The
outstanding competitor here is LVMH that improved itself between 2013
and 2014 till reaching a highly competitive position (profit before tax is
definitely bigger than ebit therefore we are encouraged to think that
interest are giving a positive boost to profit). Looking at the others we see
Hermes keeping itself close to one hundred, it means positive interests
are less than passive ones but this overall cost accounts for a reduced
amount (1.96%) on the total profit before tax. Kering is for the second
time (in a row) the last even if we see again an improvements between
the two years. This position should make us consider the different nature
of these company (holding) as they rely more on debt to develop their
business. This feature is quite typical in private equity business where
many firms rely on debt to carry on their business strategies. It looks quite
easy to compare Kering to an investor with just business in its mind rather
than a fashion oriented holding company.

Profit After Tax / Profit Before Tax

2
0
1
3
Column1

CCC2
ooo0
l l l 1
uuu4
mmm
nnn
234

C
o
l
u
m
n
5

Hermes

Kering Lvmh
79.32
66.16%
% 60.28%

Hermes

Kering Lvmh
74.40
67.38%
% 67.41%

For the third moment of this analysis we have this PAT/PBT ratio which is
easily understandable (Www2.fiu.edu, 2015). The results are going to tell
us about the tax impact on the profits made by these companies however
it is not a matter of a fast comparison as they all have (Hermes included)
stakes in other companies outside French whit different corporate tax
percentages. Now we feel appropriate to recall, for the sake of general
understanding, that fashion does not walk along with logic all the times:
some ideas, trends and patterns are generated in places that may not
have business friendly approach (aka higher tax rates) but the higher
costs might be worth if they turn into profitable ideas and stronger
position against the market. The comparisons here is completely different
from the past two: Kering is the least exposed to tax with its companies
(even if it deteriorates between 13 and 14) while Hermes and LVMH are
more hit by taxation. Now a word for LVMH is due as not only this
company is keeping clear its fashion and luxury oriented business even if
it does a similar activity to Kerings but also it has more than a foot in the
spirits field (always keeping that image of luxury in the choice of its
investments). In a nutshell what we are saying is that it is reasonable that
LVMH has a wider taxation as they are in more businesses and the fact
that Kering has the lowest taxation should be regarded as the action of a
company that looks mainly for profit and less for an identity as luxury
holding.

Sales / Average Assets

Colum
Colum
Colum
n1
2013
n2
n3
Hermes Kering Lvmh
102.26
40.18
%
% 54.73%

Colum
n4
Hermes

Colum
2014
n5
Kering Lvmh
43.58
94.62%
% 55.94%

This ratio has a particular relevance as many investors look at it since

they feel familiar with the outcome. This index describes the percentage
of sales covered by asset value: in a nutshell it tells us how much of the
assets value is generated by the company with its sales
(Accountingtools.com, 2015). Clearly the higher the percentage the better

the business is. Moreover this index does not have a limit at 100% since a
company can also make in one year sales the more thank the book value
of its assets. Before proceeding with our analysis we would stress that
average stands for the average value of assets held between the current
and the previous year so as to mitigate any particular phenomenon.
Hermes is here the outstanding one. Moreover this company had in 2013
that feature that we were describing few rows above: for each
euro/pound/dollar in assets they generated 1.023 times that currency
value in sales. This fact does not happen often and also it is witnessing
the goodness of this business. Even if it followed a drop for Hermes in
2014 at 94.6 this company remained well on top. The other two
companies have for both years values comprised between 40 and 60
percent with an improvement for both in 2014. It is quite remarkable the
distance between Kering and LVMH: Kerings is again the smallest in value.
This aspect about Kering might be referred to a strategy in progress
(recently made acquisition for instance), our suggestion is to widen the
amount of years considered so as to have a more complete picture.

Average Assets / Average Equity

Colum
n1
Hermes

Colum
Colum
2013
n2
n3
Kering Lvmh
206.2
141.2%
% 198.5%

Colum
n4
Hermes

Colum
2014
n5
Kering Lvmh
205.1
138.2%
% 215.2%

The fifth and last index is even more used than the fourth by investors as
they can understand by looking at the outcome how much asset value
they are going to own per each euro/pound/dollar spent in equity
(Wilkinson, 2013). This ratio apparently, as the others, works in a logic
the more the better it is and it can also go over one hundred percent in
that case in which for euro that I spent on equity I have more in asset
value. However this value can be interpreted in different ways. At first
glance one would say that the more he or she takes per each euro
invested the better it is but a deeper consideration made us think about
that it is not that advantageous a bigger than average value. This
conclusion is built on the idea that the market is efficient (in jargon we
would say that there are not free lunch out there) therefore being able to
hold more than the 100 percent means that there is not any spread
between the equity value and the asset value not in physical terms rather

in terms of what that agglomerate of goods can create. If we were to

invest in a successful company we would expect to pay a premium due to
the solidity and reliability of the business rather than taking at discount.
This was a general thought and we cannot establish a threshold for every
company regardless the business, the size and so on. However, what we
can do is trying to estimate a general average for companies in the same
sector and with similar feature. This approach is very close to the one
used with yields in the bond market: everybody wish the highest premium
on the investments made but this comes along with risk and therefore the
bigger the premium the higher the risk(s). Following this discussion we
introduce now the outcomes obtained for our three companies. The lowest
(and also the better) is Hermes, both the years. Moreover Hermes
improved in this considered period as this index decreased in value. Far
from the outperformer we have Kering and LVMH both around the 200%
threshold. Among these last two is necessary to spot the noticeable
deterioration witnessed at LVMH as the index increased by 8.4%. Kering
on the other hand improved slightly (0.5%).

Roe Conclusion
Colum
Colum
Colum
n1
2013
n2
n3
Hermes Kering
Lvmh
30.4%
7.5%
12.9%

Colum
Colum
n4
2014
n5
Hermes Kering
Lvmh
27.3%
9.0%
22.2%

We are now at the conclusion of the second part. This step is not intended
to propose again what we told before rather we want to draw our
conclusion on the basis of the data and the ratios that we have been
considering together. Having deeply looked into these companies it is not
a surprise that Hermes be at the top as we know at least from the fifth,
the fourth and the first in which we witnessed a big gap between Hermes
and its competitor. Moreover we could also dare a judgment over these
three business model based on the numbers. It looks clear to us that in

the fashion environment is more rewarding focusing on an identity also for

the holding, matching a business only strategy with fashion does not pay
back as much as it does using a brand strategy. We could also develop a
discussion whether it is better gathering under the same roof many
brands that have some feature in common (LVMH) or trying to seek for
growth in other areas keeping the same brand (Hermes, but also
companies never mentioned before as Giorgio Armani Casa, Roberto
Cavalli Arredamenti) but we would need more data and a wider amount of
time to see who is doing better. Our conclusion is that Kering can be
profitable but without an identity, a straight target they will never be able
to find out synergies among their investments.

Accounting, Financial, Tax, (2015). How To Calculate And Record Depreciation [of
Fixed Asset]. [online] Available at: http://accounting-financial-tax.com/2009/04/how-to-calculateand-record-depreciation-of-fixed-asset/
Accountingtools.com, (2015). FIFO Method - AccountingTools. [online] Available
at: http://www.accountingtools.com/fifo-method
Accountingtools.com, (2015). What is asset turnover? - Questions & Answers AccountingTools.
[online]
Available
at:
http://www.accountingtools.com/questions-andanswers/what-is-asset-turnover.html [Accessed 8 Dec. 2015].
Lexicon.ft.com, (2015). Return On Equity Roe Definition from Financial Times
Lexicon. [online] Available at: http://lexicon.ft.com/Term?term=return-on-equity--roe [Accessed 8
Dec. 2015].
Principlesofaccounting.com, (2015). Principles of Accounting. [online] Available
at: http://www.principlesofaccounting.com/chapter8/chapter8.html [Accessed 8 Dec. 2015].
Schmidt, M. (2015). Earnings Before Interest Taxes EBIT other Earnings Metrics
Calculated. [online] Business Case Web Site. Available at: https://www.business-caseanalysis.com/earnings-before-interest-and-taxes.html [Accessed 8 Dec. 2015].
Soliman, M. (n.d.). Using Industry-Adjusted DuPont Analysis to Predict Future
Profitability. SSRN Electronic Journal.
Wilkinson, J. (2013). Return on Equity Analysis The Strategic CFO. [online]
Strategiccfo.com. Available at: http://strategiccfo.com/wikicfo/return-on-equity-analysis/ [Accessed 8
Dec. 2015].
Www2.fiu.edu,
(2015).
[online]
Available
http://www2.fiu.edu/~keysj/Financial_Statements_Cash_Flow_Taxes_CH02.doc

at: