Ermenegildo Zegna N.V.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Zegna is a global luxury brand, renowned for its menswear, leather goods, and accessories, and is known for its meticulous craftsmanship, quality, and design innovation, as well as having its own manufacturing and textile expertise.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Zegna’s Business: A Blend of Luxury, Manufacturing, and Distribution

Ermenegildo Zegna N.V. (“Zegna” or “the Group”) operates at various levels of the value chain—from producing fabrics and high-quality garments to selling them through its retail and wholesale channels. Key business aspects of the company are:

  • Branded Products: Zegna’s main revenue driver comes from high-end menswear, leather goods, and accessories, sold under various brand names, including Zegna, Zegna Sport, and the Thom Browne brands, which also includes clothing, footwear, and accessories for women.

  • Textiles Manufacturing: The Group’s textile segment involves producing fabrics, including woolen and cotton fabrics. Zegna operates its own production facilities.
  • Direct-to-Consumer (DTC) Retail: The company operates a network of directly operated stores globally, allowing it to manage brand presentation and customer experience. Additionally, it sells merchandise through its online platform.
  • Wholesale Distribution: Zegna also distributes its products through a network of select partners.

Revenue Distribution

Geographically, Zegna’s revenues are diverse, with significant sales in the EMEA, North America, and the APAC region.

EMEA (Europe, Middle East, and Africa) consistently generates substantial revenue for Zegna. In the recent years, revenues from the Greater China region have decreased significantly, and sales in this region are only about 1/5 of the revenue from other parts of Asia. Sales in the Americas are around half of what is generated in EMEA, and tend to be fairly stable over time.

Looking at revenue by segment, for the year ended December 31, 2022, the Textile segment generated revenues of €337.7 million, the Zegna branded products segment earned €1,024.7 million, and the Thom Browne segment earned €320.6 million.

Trends and Margins The luxury goods market, although resilient, has been subject to a number of external shocks and trends in recent years. In particular, COVID-19 significantly disrupted retail operations and supply chains. Meanwhile, inflation and the cost-of-living crisis has hurt consumer spending. This is more notable for the discretionary, retail spending segments such as clothing and fashion.

Looking at margins for the Group, for the full year ended December 31, 2022, gross profit margins and operating margins have been relatively high for all of the segments. EBIT margin was about 12.4% for Zegna branded products, 17% for Thom Browne, and 6.6% for the Textiles segment. This was achieved even while supply costs increased by approximately 20-30%.

Competitive Landscape The luxury goods market, although concentrated by a few big names, is highly competitive, and the barriers to entry are not especially high. Companies compete through differentiation, brand prestige, and innovative designs, all while relying on a good supply chain and distribution network. Key competitors in the luxury goods market include well-known names such as LVMH, Kering, and Prada. Zegna operates in this environment along with numerous other specialty and small brands.

Zegna’s Competitive Advantage and What Makes it Different

While Zegna competes in the same space as competitors, it has a certain degree of differentiation from competitors as follows:

  1. Vertically Integrated Operations: Owning its own manufacturing plants gives Zegna more control over its quality, production costs and timelines. Vertical integration increases the complexity of Zegna operations, as well as its overall efficiency. However, this creates problems with supply chain disruptions, particularly during the Covid-19 pandemic. Additionally, it is not always clear whether Zegna benefits from these operations.
  2. Legacy Brand Recognition: Zegna is one of the most well known and prestigious brands in menswear, and this brand recognition creates some degree of pricing power and customer loyalty.
  3. High Craftsmanship and Materials: The Company is known to use highly skilled craftsmen in the process of garment design and manufacture, and uses quality materials, which also results in a unique brand experience, making the company a leader in its niche.
  4. Innovative Design: The company has invested in new designs, materials and technological improvements which helps keep it relevant and in line with current tastes.
  5. Distribution Network: Zegna has a global distribution network which ensures that the brand and its products are readily available and well managed.

Moat Rating Justification: 2 / 5

Zegna’s moat can be classified as narrow. Although the company has a history, established brand recognition, and a degree of control over its production, it’s not clear if these qualities translate into sustainable excess profitability over time. Many competitors have equally strong brands, and also have various forms of differentiation. Its textile business is likely more of a commodity, with no differentiated aspect. While the company’s vertical integration gives it some additional control over its operations, it is not necessarily a significant source of unique advantage.

Risk to Zegna’s Moat and Business Resilience

  1. Brand Reputation: Luxury brands are vulnerable to reputational damage. Negative brand associations, bad press, and product quality issues can drastically impact demand for its products. Management is keenly aware of the importance of brand and quality.
  2. Supply Chain: Supply chains are especially vulnerable in the modern environment. Zegna’s business and its textile unit can both be significantly impacted by problems in the procurement and manufacturing, due to labor costs, raw material prices, and other such factors. Zegna’s vertical integration of its supply chains may mean greater problems, if any part of the supply chain is disrupted.
  3. Changing Consumer Preferences: Consumer preferences in the luxury space are always changing. Failure to adapt to such shifts and offer compelling products can significantly affect Zegna’s competitiveness.
  4. Economic Downturn: While the luxury market is resilient, a significant slowdown in global economic growth can heavily hurt revenues for the company, particularly if the spending habits of its core customer base are impacted.
  5. Increased Competition: As a very competitive industry, Zegna must stay vigilant and on top of changing trends and innovative products. Any failures in these regards may result in a slow erosion of profitability.

While Zegna faces some of the challenges to its competitive position, the company has shown signs of solid financial health and long term investment decisions, and has had a rather strong and enduring history. All these qualities likely give it a decent base for resilience, but with limited signs of wide moats.

Financial Analysis

Recent Performance Zegna’s financial results for the year ended December 31, 2022, showcased impressive revenue growth. Consolidated revenue increased by 16.5% compared to 2021, primarily driven by strong performances in directly operated stores and through its own brand portfolio. Adjusted EBIT was €151.7 million, with a robust Adjusted EBITDA margin of 18.3%. A significant portion of the revenue was impacted by positive currency effects, especially with the appreciation of the US Dollar. But even after adjusting for currency volatility and acquisitions, revenue growth was over 10% year on year.

In the short term, Zegna expects sales growth to slow down in 2023 due to the macroeconomic climate. Supply chain disruptions and inflation will cause increased costs, and may pressure the bottom line.

Balance Sheet Analysis Zegna has a decent balance sheet position. Zegna is an Italian business, which tends to mean low debt, and this is visible in Zegna’s financials as well. In 2022, the company has €314.3 million of cash and cash equivalents, with total debt of €447.6 million, resulting in a net debt of €133.3 million. The Debt/equity ratio is 0.38, giving the company a stable financial structure. There is approximately €800 million in current assets, and €636 million in current liabilities. The current ratio is approximately 1.26 which is acceptable. The book value per share is around €25.5, which is relatively close to the market price. There has been a slight decrease in the book value per share since 2021, as a result of some dilution. Finally, inventory levels were around €330 million in 2022.

Other Financial Insights

  1. Acquisitions: Zegna has been actively pursuing acquisitions as a means of growth and geographic expansion. The most notable recent acquisition is that of Thom Browne, in which they acquired a further 25% stake in 2022 to take a majority 100% stake of the brand. Zegna is aiming to capture synergies from these acquisitions to help with its overall profitability.
  2. Dividends: The company has been paying dividends to shareholders for many years, but does not have an explicit dividend policy. The dividends have varied wildly over time, and are very difficult to predict. The dividend per share for 2022 was €0.14.

Management’s Perspective Zegna management has made clear that it is aiming for long term growth and value creation for its shareholders. Management continues to emphasize investments in its supply chain and brands, and is focused on growing its revenue and profitability. Management is realistic about the coming months, and is not shy about discussing its concerns with the supply chain, inflation, and other global effects on its business.

Understandability Rating: 3 / 5

The business is moderately complex to understand, which earns it a 3/5 rating.

  1. Brand and Products: Understanding that Zegna is a fashion brand is simple, however, the nuances of what gives it a competitive advantage can be harder to grasp. It is essential to analyze its operations and supply chain to truly understand how it operates.
  2. Manufacturing and Distribution: Given the nature of the business, its textile operations and its distribution model can make the company more challenging to analyse as it is intertwined with other parts of the supply chain.
  3. Geographical Complexity: Zegna’s global presence, particularly in Europe, Asia, and North America, can add further dimensions to analyze and consider for the business. Additionally, the nature of the luxury market means it operates in varied environments with varying taste and customer bases.
  4. Accounting Specifics: The company reports its financials under IFRS standards, which could be unfamiliar to many. Additionally, the treatment of acquired goodwill and other intangibles, while explicitly presented in their financial statements, requires more understanding.

Balance Sheet Health Rating: 4 / 5 Zegna’s balance sheet receives a rating of 4/5 for its relatively healthy position, including the following:

  1. Moderate Debt Load: The company does not have excessive debt and has a good ratio of debt to equity.
  2. Solid Liquidity: The company’s current assets are higher than its current liabilities.
  3. Good Capital Structure: The company appears to be conservatively financed.
  4. Clear Accounting: While IFRS can sometimes have a level of opacity, the accounting conventions are mostly understandable, and the company has been clear and concise about its reporting practices.

However, one could argue the relatively short duration of much of Zegna’s debt is not optimal, and also that the company’s high capital intensity makes some of its assets a lower quality. Additionally, the company has an ongoing acquisition program, which may increase debt and lead to goodwill-related impairments. For these reasons, the overall balance sheet rating is 4/5.