Ratio analysis

Profitability Ratios

• ROE= Net Income/ Equity

ROE 2005= 17,62%

ROE 2006= 18,85%

ROE is the most popular yardstick of financial performance among investors. It

expresses the annual percentage of return to shareholders on their investment equity.
Hermes has a high ROE, both in 2005 and 2006. For each dollar invested by the
shareholders, the shareholders return is 0,17 and almost 0,19. It is quite high compared
to the treasury bonds, for example. Taking into account, also, that Hermes is a
established, and consolidated company, we could say that for the risk of the company,
the return is considerable high. Net income in 2006 increased by 8.7% to €268.4
million. Net income growth though, was smaller in 2006 than 2005 (15%).
ROE, as said, is a ratio important for financial investors and don’t measure the real
profitability of the company’s core activity. As it takes into account non operative
assets, the return may be mislead by extraordinary items. If we want to measure the
profitability of the core business we need to analyse the ROI.

• ROI= EBIT/ Operating Assets

ROI 2005= 32,9%

ROI 2006= 31,81%

ROI expresses profitability of operating activity. Hermès 2005 and 2006 ROI are very
big for the industry. Normally the industry of accessories has a ROI of 23%. The
accessories average ROI is considerable high compared to the other clusters in the
fashion business, however, we can see that Hermes has an even bigger ROI. Hermès, in
terms of profitability, it’s one of the biggest winners on the industry. There are very few
players with such figures and very few players that can display both strong EBIT
margin and high asset turnover.
In order to understand why the ROI is so high and where it comes from we should
analyse the Asset Turnover and the EBIT Margin ( Return On Sales)

• Asset Turnover= Sales/Operating Assets

Asset Turnover 2005= 1,85

Asset turnover 2006= 1,82

Asset turnover is a measure on how efficient is the company on using it’s assets to
generate sales. It’s the number of times that the invested capital “turns over” during the
year to generate sales or what volume of sales the company is getting for every $
invested in operating assets.
We see that Hermes also has a very big asset turnover compared to the accessories
cluster which is 1,3. The turnover has decreased from 2005 to 2006. The main reason
might be the investment on operating assets ( renovating, restructuring and opening new
DOS) and in widening the production lines.

• EBIT Margin= EBIT/Sales

EBIT Margin 2005= 26,87%

EBIT Margin 2006= 26,48%

EBIT/Margin is a measure of the profitability of the products that company sale. In this
case, Hermès has, again, a higher ratio than the Accessories cluster (21%) both in 2005
and 2006. Hermès is able to maintain this high EBIT to sales ratio thanks to it’s
vertical integration strategy. The investment they do year after year on direct
distribution (accounting for 67% of it’s investment in 2006) on Direct Operating Stores
allow the company to get the retail mark-ups. Moreover, the fact that Hermès produce
all its products in house also contributes to control the margin.

• Net Cash Flow to Sales= Net Operating Cash Flow/ Sales

NCF to sales 2005= 20,02%

NCF to sales 2006= 19,06%

Net Cash Flow to sales measures how much cash a company has been able to generate
from my sales.
Net Cash Flow to sales has been quite high and not much distant from EBIT to sales
both in 2005 and 2006. Hermès has a much higher ratio than the average companies in
the accessories industry (13%). This is due to the strategy of Hermès of vertical
integration down-stream through DOS. Although the company is facing increases of
working capital due to it’s growth and expansion, it’s retail strategy guarantee the
minimizing of accounts receivable and a steady and actual cash flow at the moment of
the product’s purchase keeping the working capital quite low.

• Sales Growth= (Sales year 1- Sales year 0)/ Sales year 0

Sales Growth 2005= 7,21%

Sales Growth 2006= 6,13%

Hermès careful investment strategy is the cause of quite stable and moderated sales
growth. In 2006, sales increased came from all business sectors. Hermès growth is very
small compared to the average growth of the companies operating in the accessories
industry 15%.

Financing Analysis Ratios

• Leverage Ratio= Debt/Debt+Equity

Leverage ratio 2005= 7,17%

Leverage ratio 2006= 6,67%

Leverage ratio measures the proportion between financial debt and equity within the
company and provides information on the risk of a company’s capital structure. Hermès
is a very conservative company with an extremely small amount of debt. In 2006
financial liabilities don’t even represent 7% of total equity. Company’s investments in
2006 were mostly financed with cash. The company, has , therefore, very big margin to
ask for new debt, if needed in future expansion.

• Interest coverage ratio= EBIT/Financial Charges

Interest coverage 2005= 26,63

Interest coverage 2006= 32,35

Interest coverage shows us how big are the financial charges of the company from the
operating income. It states if a company will have problems to pay its financial
liabilities or not.
Due to its low level of debt Hermès has a huge coverage ratio. It is said that if the ratio
is higher than 3, companies shouldn’t face problems on paying the debt.