On Monday, BofA Securities adjusted its stance on Ermenegildo Zegna Group (NYSE:ZGN), downgrading the stock from Buy to Neutral and reducing the price target to $9.80 from the previous $13.00.
The revision reflects a 20% discount to the firm's discounted cash flow (DCF) valuation, citing concerns that luxury stocks may not trade at fair value in the near term due to sluggish revenue and earnings momentum.
The analyst at BofA Securities outlined the rationale behind the downgrade, noting a decrease in the terminal EBIT margin assumption from 17.0% to 15.5%.
This change accounts for increased costs of doing business and is contrasted with an anticipated margin of 10% for the year 2024. The analyst pointed out that the price-to-earnings (P/E) ratio of luxury companies tends to follow closely with their revenue performance.
According to BofA Securities, the luxury sector is expected to face continued challenges in revenue growth, which is projected to remain subdued into the second half of 2024 and into 2025, with forecasts of a 1% decline in the second half of 2024 and a modest 3% increase in 2025. This anticipated trend is likely to exert pressure on margins and pose risks to earnings.
The report also mentioned that the recent slowdown in the growth of the luxury sector can be attributed to a decrease in spending by Chinese consumers, an issue that Zegna highlighted during its second-quarter results call last week. BofA Securities believes that the current downturn in sector revenues is cyclical rather than structural, driven by a synchronized consumption weakness across the United States, European Union, and China.
In other recent news, Ermenegildo Zegna Group reported a 6% revenue growth in the first half of 2024, reaching €960 million, with an 8% increase at constant currency. This includes a noteworthy second quarter revenue of €497 million, marking a 5% year-on-year increase.
The company has been focusing on expanding the TOM FORD brand and boosting the performance of Thom Browne. Despite facing challenges in the Greater China region, Zegna has seen growth in various markets and remains committed to cost control and maintaining brand desirability.
Thom Browne has seen a significant revenue increase, tripling since 2017, and direct-to-consumer sales grew by 10% in Q2, accounting for 70% of total revenues. However, the Greater China region's revenue declined by 10% in Q2, with a slight improvement from -13% in Q1. Thom Browne's wholesale decline is expected to continue into Q3 and Q4, with potential weakness into 2025.
Despite these challenges, Zegna is optimistic about meeting full-year consensus expectations. The company plans to focus more on direct retail and concession models over wholesale, with new store openings anticipated to improve H2 performance. These are the recent developments in the company's financial performance and strategic direction.
InvestingPro Insights
As Ermenegildo Zegna Group (NYSE:ZGN) navigates the challenges highlighted by BofA Securities, InvestingPro data provides additional context for investors. Zegna's market capitalization stands at $2.12 billion, with a P/E ratio of 22.47, suggesting a premium valuation compared to near-term earnings growth. This aligns with BofA's concerns about luxury stocks potentially not trading at fair value in the near term. Additionally, Zegna's revenue growth for the last twelve months as of Q2 2024 was 16.7%, indicating some positive momentum despite the broader sector challenges.
InvestingPro Tips highlight that Zegna has impressive gross profit margins, at 65.36% for the last twelve months as of Q2 2024, which could be a point of resilience in a tough economic environment. However, the stock has experienced significant price declines, with a total return of -27.78% over the last three months, reflecting the market's reaction to the luxury sector's headwinds. For investors considering Zegna's stock, these metrics and the additional 9 tips available on InvestingPro (https://www.investing.com/pro/ZGN) could provide a deeper understanding of the company's financial health and market position.
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