CASE 2

Kering SA: Probing the Performance Gap with LVMH

TEACHING NOTE

■ SYNOPSIS ■
Strategy is about creating the conditions for the success of an organization: for business enterprises
this means profitability. Hence, diagnosis of a firm’s financial performance is an essential foundation
for evaluating and developing its strategy.
Kering SA is a French luxury and sports apparel company formerly known as PPR, a diversified retailing
company. The acquisition of Gucci in 1999 marked the beginning of PPR’s transformation from a
retailer into a diversified fashion, luxury, and sports apparel company, modelled closely on LVMH
(Louis Vuitton Moet Hennessy).
Yet, despite the similarities between the two companies, Kering has lagged behind LVMH in growth,
profitability, and shareholder returns. The case challenges students to identify the sources of the
performance gap, thereby allowing an evaluation of Kering’s strategy and a basis for
recommendations as to how Kering might close this performance gap.

■ TEACHING OBJECTIVES ■

The purpose of the case is to give students practice and develop their expertise in diagnosing
company performance as a tool of strategic analysis. As a result of studying and discussing this case,
students will be better equipped to:
 Use a company’s financial statements to evaluate its financial performance
 Use financial information combined with information on a company’s operations and its
strategy to identify the sources of underperformance
 Utilize this financial analysis to appraise a company’s strategy and offer recommendations for
revising that strategy in order to address the sources of underperformance.
I view the integration of financial and strategic analysis as essential training for would-be strategy
consultants. Like good medical practice, sound strategy practice requires that diagnosis precedes
prescription. The probing of financial data is a core component of performance diagnosis.

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 ■ POSITION IN THE COURSE ■

I like to devote at least one session early in my strategy course to performance analysis—partly to
reinforce the message that strategy is not simply about “looking at the big picture”—it is also about
the detailed probing of financial data in order to diagnose a company’s current and recent
performance in order to establish a foundation both for evaluating the current strategy and providing
a basis for strategy recommendations.

■ ASSIGNMENT QUESTIONS ■

1. How well is Kering performing relative to LVMH?

2. From (a) the financial data and (b) what we know about Kering’s businesses, can we identify
the sources of Kering’s inferior performance?
3. What can Kering’s management do to close the gap with LVMH?

■ READING ■

R. M. Grant, Contemporary Strategy Analysis (10th edn.), Wiley, 2019, Chapter 2, especially the section
on “Putting Performance Analysis into Practice”.

■ CASE DISCUSSION AND ANALYSIS ■

How well is Kering performing relative to LVMH?

To assess a company’s financial performance, we need some benchmarks. These can be:
1) Comparisons over time, i.e. comparing recent performance with previous performance
2) Comparisons with absolute benchmarks, e.g. comparing return on capital with cost of capital,
or return on equity with cost of equity
3) Comparisons with other firms (either close competitors or other firms more generally, such as
companies that make up the S&P500, the FTSE 100, or the CAC40).

In the case of Kering, (1) is difficult: the transformation in Kering’s business means that comparisons
over time are not very meaningful, especially given the costs on transition in terms of “non-recurring
net expenses” and “net income from discontinued operations” (which comprised losses of over €1.2
billion during 2014 to 2017). However, what is clear from the recent financial data is that there has
been a major upswing in underlying profitability: operating profit grew by 74.4% between 2014 and
2017.
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In terms of absolute benchmarks (2): Kering’s ROE and ROCE for 2016-17 are almost certainly above
the cost of equity and weighted average cost of capital.
In terms of (3), compared to its close competitor LVMH, Kering had long underperformed on every
performance measure; however, during 2016 and 2017, there was a marked upswing in Kering’s
performance—especially in revenue growth and in stockmarket valuation:

Kering LVMH
Revenue growth (2014-17) 54.2% 39.2%
Operating margin (average 2016-17)* 14.7% 18.7%
ROE (average 2016-17)+ 10.8% 15.9%
ROA (average 2016-17)** 8.3% 11.1%
ROCE (average 2016-17)++ 9.4% 13.7%
Increase in share price (10 years) 315% 247%
Notes:
*Operating income/Total revenue
+Net income/Average shareholders’ equity
** Operating income/Average total assets
++(Net income + interest/Shareholders’ equity + Long-term debt)

Identifying the sources of Kering’s inferior performance

Focusing upon the comparison between Kering and LVMH allows for a detailed exploration of the
sources of Kering’s modest profit performance.
We follow the ratio disaggregation procedure outlined in Figure 2.2 (see below). This disaggregation
could also be undertaken for return on capital employed, i.e.
Profit Profit x Sales .
ROA = =
Total Assets Sales Total Assets

Or

Profit Profit x Sales .

ROCE = =
Capital Employed Sales Capital Employed

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Applying this analysis to Kering and LVMH gives the results shown below:

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The main observations are:

 Kering’s inferior ROA reflects both a lower operating margin and lower rate of asset turnover

 Kering’s lower operating margin is reflecting a higher cost of goods sold and a higher ratio of

“other operating costs”—however, the biggest single factor explaining Kering’s low margin is

its higher ratio of “non-recurring costs”. These are restructuring costs and brand impairment

costs that are primarily a result of write-downs resulting from Kering’s extensive restructuring

as it has sold retailing companies and acquired fashion and luxury companies

 Kering’s inferior asset productivity may be deceptive: if we disaggregate into the individual

components we see that Kering has higher fixed asset turnover and higher inventory turnover

than LVMH. The reason for Kering’s lower turnover of total assets can be attributed to the fact

that it has proportionately higher levels of intangibles—goodwill and brands—on its balance

sheet. This is indicated by Kering’s lower ratio of sales to brand value. Does this mean that

Kering’s brands are less effective in generating sales? Possibly, but a more likely explanation is

that it reflects different accounting approaches to brand valuation.

To delve deeper, we need to disaggregate Kering’s performance in a different way: by business sector
and by geographic region.
 Disaggregation by business. Kering has two divisions: Luxury and Sport and Lifestyle. The
breakdown of revenues and profits for these two reveals distinctly different performance, with
Luxury having almost five times the operating margin of Sport and Lifestyle
 In relation to Luxury alone, if we compare the operating margin of Kering’s Luxury division
with the weighted average for LVMH’s Fashion and Leather Goods, Perfumes and Cosmetics,
and Watches and Jewelry divisions, we find that Kering is more profitable than LVMH!
 A geographical breakdown of the revenue sources of the two companies indicates that
regional differences are minor and cannot account for any differences in performance. Kering
is slightly more European-focused, but this is explained primarily by the importance of Europe
to its sales of Sport and Lifestyle products.
 In terms of Kering’s Luxury division, the stand-out performer is Gucci: its operating income
increased by 69% between 2016 and 2107.

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What can Kering’s management do?
The financial analysis suggests that Kering is performing very well in the luxury and fashion sector.
Despite lacking the long experience of LVMH in this sector and having paid substantial acquisition
premiums to acquire leading brands, Kering’s performance in this sector has been even higher than
LVMH.
Kering’s inferior overall profitability as compared with LVMH can be attributed to three factors:
1) Higher non-recurring costs which are associated with Kering’s restructuring and accounting
items arising from acquisitions and divestments
2) What appears to be a more generous valuations of brands as compared to LVMH
3) The poor profitability of the Sport and Lifestyle Division, of which Puma constitutes the
dominant part.
Hence, in terms of historical performance, the decision to spin-off Puma seems sound. In the short-
term, this will result in a boost to Kering’s profitability. Moreover, the rise in Kering’s share price also
reflects investor’s beliefs that this is a sound decision.
What about longer term: are Puma and Kering better off as separate companies rather than a
combined entity? The extent to which there are synergies between fashion/luxury brands and
sport/lifestyle brands is an interesting topic of debate.
Proponents of divesting Puma argue that:
a) Managing luxury brands such as Gucci is fundamentally different from managing sports brands
such as Puma

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 b) Kering has owned Puma since 2007. Puma’s performance has lagged far behind that of Nike
and Adidas (see Table A3)
c) Puma is a poorly positioned firm that is at a distinct competitive disadvantage to Nike and
Adidas. In terms of sales, Puma is a distant number three behind Nike and Adidas. This is a
business where scale matters—major economies of scale in R&D, advertising and sponsorship.
Opponents of the divestiture argue:
a) There are considerable synergies between luxury and sportswear. As fashion clothing becomes
increasingly informal, the barrier between high fashion and sportswear is becoming
increasingly blurred
b) Sportswear offers better growth prospects than luxury and fashion—especially as China and
other Asian countries become increasingly obsessed with soccer
c) There are important technological synergies between the two—fashion can increasingly
benefit from the technology-intensive materials and designs deployed in sportswear.

■ KEY TAKE-AWAYS FROM THE CASE DISCUSSION ■

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