Despite facing a barrage of downward earnings revisions , Hermes (RMS FP) trades at its all time high and remains egregiously expensive, driven by baseless takeover speculation.

Hermes is a French luxury goods company, active in Japan (25% of sales), Europe (43% of sales), Asia Pac (18% of sales) and the US (14% of sales). The company is family owned and operated, and has historically generated steady growth without damaging the brand’s premium image / extortionate price range.

We believe that Hermes is a very attractive short at current levels:

1.       The company is facing meaningful earnings headwinds:

a.       Luxury goods sales in Japan have now gone ex growth. This market makes up 40% of Hermes sales (in Japan and to Japanese tourists abroad)

b.      The company has run out of large metropolises to sell into, and is now opening stores in second tier cities globally

c.       RMS faces meaningful comp headwind in H2 of this year given sales in last 12 months have been buoyed by a number of new store openings and expansions in Q2 – 07

2.       The stock’s meaningful takeover premium no longer makes sense. The controlling family a long term holder of stock and intimately involved with management. They have adamantly and publicly stated that the company is nor for sale. Furthermore, the family signed a pact with French tax authorities whereby they pay no dividend taxes as long as they continue to control the company.

3.       Limited sales growth potential: Hermes is able to maintain incomprehensible prices in its leather goods category (for example, $50,000 handbags) by maintaining a limited production capacity and holdings wait lists for clients. Faster production / sales growth would eliminate the illusion of exclusivity, and ultimately weigh on margins. Indeed, the company’s very existence depends on its limited growth.

4.       The stock is priced for perfection: Hermes trades at 33.5 times current, and 30.5 times forward earnings (assuming the company is able to maintain near peak margins). The peer group, however, trades at 13 times current, and 11.6 times forward, estimates. Our peer group consists of LVMH, Tod’s, Bulgari, Pinault Printemps, Burberry and Tiffany’s – the world’s leading luxury goods companies.

5.       Currency headwing: The Euro is up by approximately 20% vs. most of the company’s major export currencies, presenting further headwind

6.        EBIT margins have actually begun to decline due to mix deterioration, and lower margins in new stores opening in second tier cities.

7.       The super-luxury leather goods category, which was historically dominated by Hermes, has seen a slew of new competitors such as Bottega Venetta.

Assuming the company maintains its historical 50% premium to peers, we have a price target of €54, implying 50% downside potential from current levels. Note that we assume the company is able to maintain margins achieved in 07 (the best year on record) and continues to generate 2-3% comp store sales growth. Both of these assumptions are likely to be revised down in coming months.