Hugo Boss AG (ETR: BOS)

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Sean Hinton

Geoffrey Jordan

Hugo Boss AG (ETR: BOS) manufactures clothing and accessories for the mid-range luxury fashion market through its BOSS and HUGO brand lines. Though Hugo Boss was originally a men’s businesswear company, it has since expanded into women’s clothing and leisure and sportswear. As of 2009, the British private equity firm Permira Holdings owned 88% of Hugo Boss’s common shares and 55% of its preferred shares, bringing its total ownership stake to about 72% of the company’s total capital.^[1]

According to estimates by management consultancy firms, sales of luxury goods worldwide fell by 8% to €153 billion in 2008. In particular, the second and third quarters were marked by sharp falls, whereas the first signs of a recovery appeared towards the end of the year. With estimated drops in sales of 16% in America, 10% in Japan and 8% in Europe, sales of luxury goods were especially weak in sophisticated markets. In response to the sudden fall in demand and the resulting high inventories, Hugo Boss implemented price cuts. In 2010, the luxury fashion market has still not recovered, as Hugo Boss reported total sales for the first quarter of €444 million, an 8% decrease from the previous year.

Despite the financial crisis, however, Boss saw a sales increase of 10% in Asia, with aspiring consumers of luxury goods in Asia and other emerging countries largely responsible for industry sales.

Company Overview

Business and Financial Metrics

First Quarter 2010 Earnings^[2]

Hugo Boss's sales from directly operated retail stores increased by 25% to €83 million in the first quarter of 2010, compared to €67 million in the year-ago quarter. However, lower pre-order volumes from the recession-dominated year 2009 were still impacting sales in Boss's wholesale business. Boss generated total sales of EUR 444 million in the first three months of the current fiscal year, equivalent to a year-on-year decline of 8%.

Sales in Europe as a whole amounted to €305 million, down 12% on the previous year. Sales in the Americas increased by 5% in the local currency in the first three months of the current fiscal year. In the Asia/Pacific region, sales growth of 4% to €48 million was achieved. At €21 million, sales in the growth market China were considerably higher than in the previous year (Q1 2009: €17 million).

Operating profit before interest, depreciation and amortization and special items (EBITDA before special items) decreased by 12% in the first quarter to €92 million. The adjusted EBITDA margin decreased slightly year-on-year to 20.7% (previous year: 21.6%). Consolidated net income decreased from €64 million in the previous year to €56 million.

Brand Lines

• BOSS Black is the premium line for business, leisure and events and forms the heart of the Boss brand. High-end accessories and sophisticated licensed products such as watches, eyewear and fragrances round off the range.

• BOSS Selection is the company's high-end menswear line. Sophisticated design, exclusive materials and traditional tailoring characterize this high-class collection. Watches, accessories and luxury shoes complement the classic suits and outfits. Boss Selection clothing is manufactured in Germany and Italy.

• BOSS Orange is the company's primary line for casuals and leisurewear for men and women. Bags, shoes, as well as eyewear, watches and fragrances manufactured under license complete the brand’s product range.

• BOSS Green is the company's line of sporty menswear. Boss Green combines golf, fashion and lifestyle into a single look. Dynamic colors underline the brand‘s look, targeting both trend-conscious younger clientele and the classic sporting man who likes playing a round of golf.

• HUGO offers both men's and women's clothing. The company describes the line as having an "unconventional and avant garde fashion".^[3] The progressive HuGo brand is aimed at trendsetters. The avant-garde women’s and men’s collections are completed by shoes and accessories together with license

products such as eyewear, watches and fragrances.

Research and Development^[1]

In the Technology & Service Center at the Company’s headquarters in Metzingen, the Group uses its years of experience in industrial textile production to develop pioneering products in the core area of classic clothing for men and women. At the same time, the Competence Centers in Coldrerio (Switzerland), Morrovalle (Italy) and Scandicci (Italy) are home to development departments for additional textile product groups, shoes as well as leather accessories.

These development locations create prototypes for new clothing collections that were previously designed in the pattern Design department using technical development. At the same time, all the necessary data is collected for possible later use in series production through extensive tests. This intensive product development in collaboration with suppliers and technology partners not only ensures that the future production process at the production sites runs smoothly, but also secures HUGO BOSS its competitive advantage in manufacturing technology and quality. Expenses for Research and Development for the collection development process in the creative departments amounted to €44 million in 2009.

Trends and Forces

Expenses per employee down 13% between 1998-2008

Between 1998 and 2008, the number of employees at Hugo Boss increased from 2,195 to 9,728, an increase of 343%; during the same time period, total personnel expenses increased from €91.7 million to €353.5 million (285%).^[4] Dividing the two figures shows that total average expenses per employee fell from €41,776 in 1998 to €36,338 in 2008. One factor driving this trend has been the company's shifting of manufacturing to lower-cost regions. Hugo Boss manufactures most of its own products in factories located in the U.S., Poland, Italy, and Turkey (the company's single-largest production site).^[5] In 2006, the average hourly wage for Turkish workers in the textile and leather manufacturing sectors was $2.31 per hour, much less than comparable wages in Germany, Hugo Boss's home country.^[6] In addition, all of the company's handbags are manufactured in China, where the average wage for workers in the manufacturing sector was just $0.67 per hour in 2004.^[7] Hugo Boss also announced in September 2008 that it would be partnering with Indian firm Pokarna Ltd to manufacture high-end men's dress shirts.^[8]

Global recession hitting sales growth

Despite the relative historical insulation of luxury manufacturers and retailers from economic downturns, Hugo Boss and other luxury manufacturers have felt the effects of the 2008 global financial crisis. In 2008, Hugo Boss's total sales increased 3% from 2007, while net income actually fell 27%^[9] (compared with sales and net income growth of 9% and 20%, respectively, from 2006-2007).^[10] In the fourth quarter of 2008, sales actually fell 17% and the company posted a quarterly loss of $23.5 million, showing a worsening of conditions as 2008 progressed.^[11][12] Since 88% of Hugo Boss's 2008 sales were made in Europe and the Americas, two of the hardest-hit regions, lower consumer discretionary spending in these economies could continue to depress sales growth and hit earnings. One bright spot is the company's operations in Asian markets, which posted 2008 sales growth of 21% (25% in local currencies, before converting to the euro).^[13]

Strong euro hurts sales growth

Unfavorable exchange rates halved Hugo Boss's sales growth from 6% to 3% in 2008, significantly impacting both revenue and net income.^[14] Through mid-2008, the euro remained relatively strong compared to the U.S. dollar, British pound, and Hong Kong dollar, some of the most important currencies for Hugo Boss's sales. As a result, each dollar or pound spent on Hugo Boss products converted to a smaller number of euros, which is the currency the company uses to report earnings. For example, 2008 sales in the Americas region were up 10% in local currencies but only 3% after converting to euros, largely due to the weak U.S. dollar.^[15] The euro began weakening against major currencies in the second half of 2008, as the global financial crisis spread further throughout the European economies.

Directly Operated Store sales growing strong

Though most of Hugo Boss's sales are made through third-party retailers, sales at its directly operated stores (DOS) have been growing at double-digit rates since 2003. Overall DOS sales have more than tripled from 2003-2008, increasing from 8% to 16% of the company's total sales.^[16][17] While there are upfront costs associated with establishing new DOS locations, Hugo Boss estimates that they reach break-even profitability within two years and repay the initial costs within 4-5 years, making DOS a longer-term investment in earnings growth.^[18] Additionally, Hugo Boss cites better presentation of its brands and higher-quality customer feedback as advantages to the DOS model. As such, the company has been increasing the number of its DOS steadily since 2001, from 51 to 330 as of 2008.^[19]

Competition

Hugo Boss competes primarily with other firms in the so-called "affordable luxury" market, shying away from the ultra-high-end luxury market. The luxury apparel industry is highly fragmented, and many of the leading companies are privately owned, making a competitive analysis somewhat difficult. Additionally, the goods in this industry are not as easily substitutable as in some others; brand loyalty and consumer preferences play a significant role in determining demand for Hugo Boss's products and its sales figures.

Most closely related apparel competitors include:

• Burberry Group PLC (BRBY-LN) manufactures luxury clothing and accessories for both men and women. The company's line of suits competes with Hugo Boss's BOSS Black line.
• LVMH Moet Hennessy L.V. (OTC:LVMUY) is a luxury holding company whose apparel brands include Louis Vuitton, Marc Jacobs, Fendi, and Thomas Pink.
• Link Theory Holdings Co., LTD (3373-TO) produces the Theory apparel brand, which has a comparable price range and target demographc.
• Christian Dior SA (CDI-FR) manufactures a luxury lineup that includes both men's and women's apparel and accessories
• Adolfo Dominguez SA (ADZ-MD) is a Spanish designer whose clothing and accessories are sold throughout Europe and in parts of Asia and the U.S.

Most closely related accessories and leather goods competitors include:

• Coach (NYSE:COH) makes a line of luxury accessories and small leather goods for men and women
• Etienne Aigner AG (AIG-FF) is a German firm specializing in leather goods and (primarily women's) accessories

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4} Hugo Boss Annual Report 2009
2. ↑ "HUGO BOSS in the first quarter of 2010"
3. ↑ HUGO BOSS 2007 Annual Report, page 38
4. ↑ HUGO BOSS 2008 Annual Report, page 6-7
5. ↑ HUGO BOSS 2007 Annual Report, page 39
6. ↑ Calculated using data from the Turkish Statistical Institute and the 2006 exchange rate from the CIA World Factbook
7. ↑ Labor Costs of Manufacturing Employees in China - Bureau of Labor Statistics
8. ↑ Hugo Boss Ticino ties up with Pokarna for shirt manufacturing - Fashion News India
9. ↑ HUGO BOSS 2008 Annual Report, page 6
10. ↑ HUGO BOSS 2007 Annual Report, page 58
11. ↑ HUGO BOSS 2008 Annual Report, page 6
12. ↑ Hugo Boss AG (BOSG_p.DE) | Reuters.co.uk
13. ↑ HUGO BOSS 2008 Annual Report, page 82
14. ↑ HUGO BOSS 2008 Annual Report, page 69
15. ↑ HUGO BOSS 2008 Annual Report, page 82
16. ↑ Deutsche Bank Global Markets Research - Hugo Boss (November 5, 2007)
17. ↑ HUGO BOSS 2008 Annual Report, page 64
18. ↑ Deutsche Bank Global Markets Research - Hugo Boss (November 5, 2007)
19. ↑ HUGO BOSS 2008 Annual Report, page 64