Section E8/ Group 10

Dimitrii Kolesnikov, Costa Mitri, Sophie Skajem, Pedro Coutinho, Vanshika Singh

LVHM & Warnaco: Strategy & Financial Statement Analysis

1) Calculate ROIC for both companies for fiscal 2011. Assume that the values of nonoperating assets are
zero. For calculations requiring a tax rate, assume 33.3% for LVHM (the French corporate rate), and 35%
for Warnaco (the US corporate rate). Based on this analysis alone, how do the companies compare in terms of
their performance?

Return on Invested Capital (ROIC) is an alternative approach to measuring profitability and looks at the firms from
an unlevered perspective to neutralise the influence of the financing choice (debt or equity). ROIC divides Net
Operating Profit After Taxes (NOPAT) by average invested capital.

The ROIC for LVMH is 16.3% while the ROIC for Warnaco is 12.6%, showing that for the fiscal 2011 year, LVMH
is outperforming Warnaco by 3.7% of invested capital.

LVMH – 2011 Warnaco – 2011

(EUR millions) (USD millions)
Net Income 3,465 127
Interest Income 0 3.3
Interest Expense 242 16.3
Other non-operating loss 0.6
Tax rate 0.33 0.35
After-tax net non-operating
161.4 8.8
expense
NOPAT 3,626 136

2) Recalculate ROIC for both companies in fiscal 2011 while deducting nonoperating assets from your
calculation IC. Note, this will require your judgement as to what constitutes a nonoperating asset.

A. LVMH (All numbers in EUR millions)

Year Non-Operating Assets Total Non-Current available for sale
financial assets
2011 5,982 5,982
2010 3,891 3,891

In our calculation here we take average Invested Capital to account for the resources available throughout the year
available to produce the NOPAT, using the below formula:

Adjusted Average Invested Capital = [(IC 2010- NOA2010) + (IC2011-NOA2011)]/2

Adjusted Invested Capital 17,251.00
ROIC without Non-operating expenses LVMH2011 0.21
*(See original IC calculation in appendix)

B. Warnaco (All numbers in USD ‘000)

Year Non-Operating Assets Total Assets of discontinued
operation
2011 0 0
2010 125 125

Adjusted Average Invested Capital = [(IC 2010- NOA2010) + (IC2011-NOA2011)]/2

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Dimitrii Kolesnikov, Costa Mitri, Sophie Skajem, Pedro Coutinho, Vanshika Singh

Adjusted Invested Capital 1,080,856.50

ROIC without Non-operating expenses Warnaco2011 0.13
*(See original IC calculation in appendix)

3) How do you interpret the differences for each company as you compare your answers to 1 and 2? That is,
what does the analysis tell you about LVMH if they have a significant difference between ROICs when
nonoperating assets are assumed to be zero vs. non-zero?

If there is a significant difference between the ROIC of a company when non-operating assets are assumed to be zero
versus non-zero, it can provide insight into the company's overall financial performance and the impact of its non-
operating assets on its return on investment.

When we compare this indicator between the two companies, the exclusion of non-operating assets in the ROIC
calculation generates a significant difference in the LMVH (from 0.163 to 0.21) while in the case of Warnaco the
difference is practically none (from 0.126 to 0.13). This means that LMVH has a significant part of its resources in
assets not directly related to its operation.

Furthermore, when non-operating assets are assumed to be nonzero, it is essential to consider the level of risk
associated with each company’s investments and the potential impact on overall financial performance. LVMH
having the higher ROIC compared to Warnaco due to investments in non-operating assets, connotes that LVMH
might be taking on more risk, and attempting to diversify via non-operating assets that can act as financial backup.
This also leaves LVMH with a higher liability exposure.

4) Review the description of each company above and think about the strategic positioning of their products.
How are the two companies similar, and how are they different?

Both LVMH and Warnaco are large companies that produce consumer goods for global facing brands.

LVMH’s strategic positioning is focused providing luxury goods and services to affluent consumers and
maintaining its position as a leader in the luxury market globally. Although product wise LVMH is diversified, it
has a broader scope in terms of manufacturing capabilities – from clothing to perfumes and spirits.

On the other hand, Warnaco’s strategic positioning is more focused on offering mid-priced, high-quality clothing
and accessories to a broader range of customers compared to LVMH. Warnaco is an American apparel company
that is known for its brands in the underwear, swimwear and sportswear markets, which is where Warnaco primarily
focuses its operations.

5) Breakdown ROIC (either from 1 or 2) into its components, NOPM and IC turnover.

LVMH: ROIC = 1.066 (IC Turnover) * 0.153 (NOPM) = 0.163

Warnaco: ROIC = 2.325 (IC Turnover) * 0.054 (NOPM) = 0.126

(These calculations are from Q1, i.e. pre-deduction of non-operating assets from IC.)

6) Based on your calculations in 5, and your analysis in 4, does the breakdown for ROIC into NOPM and IC
turnover align with your expectations regarding company strategy? What does this say about management’s
ability to deliver performance in accordance with their stated objectives?

Based on our calculations in 5., and our analysis in 4., the breakdown for ROIC into NOPM and IC turnover align
with our expectations regarding with LVMH and Warnaco’s company strategies respectively. As a premium brand
operating in the luxury segment producing exclusive goods, LVMH naturally captures higher profit margins (high
NOPM) than Warnaco by charging a premium. However, to that same extent, LVMH’s low turnover of invested
capital also makes sense because it reflects the slower demand cycle and asset inefficiency that tends to come with
the production of such goods – higher and less frequent inventory turnover in retail. Given that Warnaco is focused
on manufacturing high-quality albeit mid-priced goods, its portfolio of apparel is arguably more appealing to the
masses – as reflected in their significantly higher turnover of invested capital.

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Dimitrii Kolesnikov, Costa Mitri, Sophie Skajem, Pedro Coutinho, Vanshika Singh

7) Dig deeper into the drivers of NOPM and calculate the expenses as a percentage of revenues. Compare
across the companies. Do the differences here tell you anything about the execution of the strategy?

The NOPAT margin indicates how much of the value generated by the customers has been retained by the firm to
pass on to the investors. A lower NOPM means that firm’s suppliers take up more share of the value delivered to
customer than the investors. Here, LMVH (NOPM=0.153) does better compared to Warnaco (NOPM=0.054).

Below we compare the operating expense ratios (drivers of NOPM) of the 2 firms. Warnaco’s higher
COGS/Revenue indicates that it spends a larger chunk of its revenue in production (supplier costs etc). LVMH is
capturing a higher share of its revenue, this could be explained by the premium it is able to charge for its products.

On the other hand, LVMH has a higher Marketing and SG&A expense ratio, 43.5% as compared to Warnaco’s
33.61%, implying that LVMH relies more on marketing to brand itself as luxury.

Expenses vs Revenue Ratios for LVMH for 2011

COGS/Revenue 34.20%
Marketing and selling expenses/Revenue 35.34%
General and administrative expenses/Revenue 8.22%
Other operating income and expenses/Revenue 0.46%
Income Taxes/Revenue 6.14%
Sum of above operating expenses as share of revenue 84.36%

Expenses vs Revenue Ratios for Warnaco for 2011

COGS/Revenue 56.20%
SG&A/Revenue 33.61%
Pension Expense/Revenue 1.06%
Amortization/Revenue 1.91%
Sum of above operating expenses as share of revenue 92.78%

8) Dig deeper into the driver of IC Turnover and calculate the various ratios by specific balance sheet item.
Compare across the companies. Do the differences here tell you anything about the execution of the strategy?

Warnaco has a higher IC Turnover than LVMH, which reflects that it efficiently uses its invested capital to
generate revenue (possibly higher sales volumes). However, it is important to consider other factors such as industry
standards and the company's overall financial health to determine whether the higher ratio is a positive sign.
IC(Adjusted)
ROIC (from Q2) NOPM from Q2 IC Turnover
LVMH 0.21 15.30% 17,251 137.15
Warnaco 0.13 5.40% 1,080 232.54

To take a deeper dive into the drivers of IC Turnover we compare the below ratios across the two companies:
Ratios LVMH Warnaco
Accounts Receivable Turnover (ARTO) = Revenue / Average Accounts 14 8
Receivable
Inventory Turnover (ITO) = Cost of Goods Sold / Average Inventory 1 4
Accounts Payable Turnover (APTO) = Purchases of goods/ Average Accounts 4 10
Payable
Fixed Asset Turnover (FATO) = Revenue / Average Fixed Assets 3 19

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Dimitrii Kolesnikov, Costa Mitri, Sophie Skajem, Pedro Coutinho, Vanshika Singh

 LMVH has a high ARTO than Warnaco which reflects a relatively robust credit collection over Warnaco, possibly
from its credit worthy customers. LVMH account receivable period (27 days) < Warnaco’s (47 days).
 LVMH has a lower ITO than Warnaco, reflecting slower inventory movement or low sales. It more likely is to be
the former because of the nature of LVMH products such as wines and spirits, which have a longer production cycle.
Luxury products in general are slow moving as compared to budget products that have higher demand. This is
consistent with our comparison of the operating cycle for both the companies, LVMH’s cycle is 2.5 times longer
than Warnaco’s. Although, it’s important to look at industry standards to make further insights.

A. Accounts receivable B. Days inventory held C. Days payable Cash conversion

period (365/ARTO) days (365/ITO) days outstanding cycle (A+B-C)
(365/APTO) days

LVMH 27 304 100 231

Warnaco 47 85 37 95

 Warnaco’s fixed asset ratio is much higher than LVMH’s, implying Warnaco relatively generates more revenue for
every $ invested in PP&E. While this indicates capital efficiency, it could also reflect that Warnaco has low capital
investment in infrastructure (such as stores) and instead relies on renting spaces in supermarkets to shelf its products
(the rent for which is probably reflected in its higher operational costs). LVMH’s low fixed asset ratio on the other
hand could reflect inefficient capital use (esp. due to its long production cycles) but could also mean that the
company is making capital investments and believes in a long-term vision and
 Lastly, we see that Warnaco has a much shorter DPO which could mean that it is not fully utilising the credit period
offered or values maintaining credibility with suppliers to churn its quick production cycles. LVMH’s longer DPO,
given its positioning, could mean that it has better credit terms in the industry.

Appendix:

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Section E8/ Group 10
Dimitrii Kolesnikov, Costa Mitri, Sophie Skajem, Pedro Coutinho, Vanshika Singh