DESPITE SOLID 1ST HALF, GUCCI STOCK PLUNGES ON FEARS OF SLOWDOWN

Byline: Sara Gay Forden

MILAN — The new Gucci is growing up.
After the two years of exponential growth since the Florence-based luxury house made its debut on Wall Street, the Gucci steamroller is starting to feel the pressures of a competitive luxury goods market.
Gucci Group NV’s six-month earnings report Wednesday reflected continued growth in the first half — with increases that in many cases outpaced competitors. But with slower-than-expected growth in the second quarter, Gucci sounded a warning signal for the rest of the year.
In response, shares of Gucci stock plummeted 11 1/8 Wednesday on the New York Stock Exchange, closing at 47 1/8, a 19.1 percent decline.
Gucci reported that net income rose 29 percent in the first half to $90.3 million on revenues of $478 million, up 22.6 percent from the first half of 1996. Sales in directly operated stores were up 18.5 percent and represented 65 percent of revenues in the first six months, while wholesale volume — including franchise, duty free, department and specialty store sales — rose 27.7 percent and represented 30 percent of sales.
The warning bell came from a disappointing second quarter, when sales through directly owned stores grew 12.4 percent and wholesale volume grew by only 9 percent, which Gucci attributed to “a significant reduction in Japanese tourism to certain key locations, such as Hawaii and Hong Kong.”
More specific numbers for the second quarter were not available because European companies such as Gucci, even if they trade on a U.S. exchange, report figures every six months.
“Our performance in the first six months has been spectacular,” said a weary-sounding Domenico De Sole, Gucci’s chief executive officer, in a telephone interview from Amsterdam after a grueling hours-long session with more than 300 international financial analysts.
But De Sole cited three factors he said will slow sales in the second half.
The influence of exchange rates and the strong dollar — for its earnings reports, Gucci translates sales in local currencies around the world into dollars — which De Sole said could knock as much as 10 percentage points off yearend growth.
The slump in the lucrative Hawaiian and Hong Kong markets due to a decrease in Japanese travel and spending.
The impact of Gucci’s own efforts to pare distribution. “We are a very disciplined brand, and we really believe that overexpansion can kill us,” said De Sole. “We have cut some important locations, some big businesses with wholesalers, and that will impact us at the end of the year,” De Sole said. “It’s our long-term goal, and we’re going to stick with it,” added De Sole, saying that by the end of the year he expects 70 percent of sales to derive from directly controlled doors, close to his goal of 75 percent.
Ready-to-wear sales rose 12.1 percent in the first half to $36.5 million from $32.6 million, and De Sole said his goal is to see ready-to-wear reach 15 percent of total sales from around 8 percent currently.
“The fall collection is doing very well,” said De Sole, although he declined to release specific figures for the season.
The bulk of Gucci’s business still comes from its leather goods and handbags, which represent more than 60 percent of sales. Sales of leather goods rose 24.2 percent to $290.5 million, while shoes were up 22.1 percent to $84.5 million. Sales of ties and scarves slumped 20.9 percent to $15.5 million, though analysts attributed the drop to a cyclical slump in demand for women’s scarves.
“The company itself is very sound, and its strategy is sound,” said Cedric Magnelia, an equity analyst with CS First Boston in London. “It is certainly a larger and more mature company than it was two years ago and at this point is playing in the league of Hermes and Vuitton.
“Expectations are high,” added Magnelia, “and Gucci is a victim of a difficult trading environment in Southeast Asia.”
As a result of the first-half report, analysts were revising their second-half revenue forecasts significantly to less than 10 percent growth, with some even predicting a drop in sales.
“Gucci is far more exposed in Hong Kong and Hawaii than the other luxury goods companies,” said one London-based analyst. “The brand is still strong, and there is still growth in a lot of markets, but they are being hit by the Japanese tourists that are not traveling to Hawaii and Hong Kong.”
The gross margin in the first half was 63 percent, compared to 63.8 percent a year earlier. Operating profit was up 14.7 percent to $120 million, Gucci said in a statement. Basic earnings per share for the period rose to $1.51 from $1.19, while diluted earnings per share were $1.47 compared with $1.15. Gucci also said its tax rate in the half was down to 30.7 percent from 38.3 percent due to reorganization of logistics.
Following the release of the figures, Morgan Stanley downgraded Gucci to “neutral” from “buy.” Morgan Stanley apparel analyst Josephine Esquivel said in a research report that Gucci’s first half earnings of $1.47 a share were below Wall Street’s consensus estimates of $1.49 and Esquivel’s own estimate of $1.52.
Based on the shortfall in the period and the expectation of a difficult second half, she cut her estimate for the year to $3 from $3.38 and her 1998 estimate to $3.40 from $4.05 pending further discussion with Gucci.
“It is likely that we will lower 1997 forecasts even further,” she said.
“Based on the volatility of certain key markets, primarily Hawaii, which accounts for slightly more than 10 percent of total sales, and Hong Kong, which also accounts for 10 percent, and the expectations of further weakness of the Japanese yen, we do not foresee any near-term catalyst for the stock and would remain on the sidelines,” Esquivel said.
“While we still believe the brand has momentum, in our opinion, these growth opportunities are less robust than we anticipated in the current environment. Moreover, we believe management will need to rebuild credibility following this disappointing earnings release.”
Esquivel said that in the past, bullishness on Gucci was based on the brand’s momentum across a number of product lines, despite a weak yen and the devaluation of certain Asian currencies in late August.
“We now believe the yen’s 12 percent year-to-date decrease on top of last year’s 15 percent drop is having broader implications for the Japanese consumer. Moreover, many foreign currency experts now believe the yen may drop to 130 yen to the U.S. dollar, which may indeed affect the luxury-goods-hungry Japanese consumer.”
Stacy W. Pak, analyst with C.S. First Boston, disagreed with Morgan Stanley’s assessment, describing the plunge in Gucci’s stock price Wednesday as a “knee-jerk reaction.”
She had been expecting earnings of $1.45, and lowered her rating to “buy” from “strong buy” because she believes that the second half of 1997 will “most probably continue to be tough.”
Currently Pak expects Gucci to earn $2.90 in 1997 and $3.40 in 1998.
She said Gucci’s core business remains strong, pointing out that sales are being hurt by currency translations.
“On a constant currency basis, sales were up 33 percent in the first half, and the fall collection has been performing exceptionally well,” she said.
“Gucci is being conservative because management cannot predict the yen or what will happen in Hong Kong, following the changeover in political control to the Chinese from the British,” she added.
“Gucci remains an exceptional company that is underdistributed in product and location versus competitors and has substantial growth opportunities,” she concluded.
In other developments, Gucci’s strategy of expanding and refurbishing stores continues.
De Sole revealed that Gucci has signed a long-term lease for a new flagship store in Milan, which he expects to open during the spring or summer of 1998. The new space, which measures about 10,800 square feet, is at the opposite end of Milan’s chic Monte Napoleone shopping avenue from Gucci’s existing store.
The new space, which had included the former Galtrucco clothing boutique and the Capellini home furnishings store, covers two floors and will have three windows on Via Montenapoleone. It will effectively double Gucci’s Milan selling space and house the full range of Gucci ready-to-wear and accessories, while the existing store will concentrate on accessories, De Sole said.
Gucci is also expanding its store space in Paris, where it has signed on the former Lufthansa space on Rue Royal, he added. Gucci is also expanding its space in Florence, as reported.
De Sole said he was also in negotiations for three new locations in Tokyo, including one of more than 7,000 square feet, considered very large for the Japanese market.

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