Prada’s new Fans could be Fashion Victims

The Italian brand has been the best performing luxury stock over the past three months

By guest author Carol Ryan from Wall Street Journal

Graph courtesy by Wall Street Journal

Prada is a surprise hit with investors this season. Only a takeover offer would justify their bullish expectations, which the brand is still a long way from meeting on its own.

The Milan-based company’s stock has been the luxury industry’s top performer over the past three months. It has gained 25%, compared with muted increases of roughly 4% each for the shares of peers LVMH Moët Hennessy Louis Vuitton and Hermès.

A new beauty partnership with L’Oréal was announced in December and Prada’s performance on social-media platforms is improving—but not enough to justify the enthusiasm. More likely the stock is benefiting from speculation about which luxury brand will be taken over next. After LVMH’s $16 billion purchase of U.S. jeweler Tiffany & Co. late last year, investors are betting that rivals Kering and Richemont will bulk up with their own acquisitions.

Prada is an attractive target, despite years of underperformance. The founding family still owns 80 % of the stock, and the remaining minority investors would probably welcome an exit. Since the company listed in Hong Kong in 2011, Prada has delivered annual shareholder returns of minus 3 %.

The label’s shares are now almost as expensive as those of ultra-luxurious Hermès as a multiple of projected earnings. That is in part because Prada’s earnings are depressed. Its enterprise value is a more reasonable 3.6 times revenue—cheaper than other potential takeover targets like Moncler, which fetches 5.4 times. There is plenty of scope for a buyer to improve Prada’s profitability. The brand made an operating margin of less than 10 % in the first half of 2019, down from a peak of 27 % in 2012.

The big unknown is whether, or not the Prada family cares to cash out. Recent succession planning suggests not— Lorenzo Bertelli, son of co-CEOs Miuccia Prada and Patrizio Bertelli, has become increasingly hands-on since joining the company in mid-2018.

But a sale of four important Milan boutiques from the family holding company to Prada itself for EUR 66 million (USD 72.8 million) late last year could be interpreted as a tidying up of the company’s structure before a possible sale. An alternative explanation is that Prada wanted revenue from these stores to show up in their retail channel, rather than wholesale, as it tweaks its distribution model.

There are early signs that Prada’s years long attempt to revive its fortunes is working. Sales increased by 2 % in the first half of 2019 compared with the same period of 2018. To sustain the current share price, though, the brand needs to dramatically improve sales growth or else succumb to a takeover offer. Neither scenario is a sure bet.