Good day, ladies and gentlemen, and welcome to the Kering 2017 first half results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jean-Marc Duplaix, CFO. Please go ahead, sir.
Good evening to all of you, and welcome to Kering's 2017 half year results call. I will first review our sales and earnings, and then Jean-François Palus, the Group Managing Director, will share a few words of conclusion. We will then be available to answer your questions. On slides four, five, and six, we have summarized the performance of the group in the period. Starting with highlights on slide four, the group has delivered record H1 performances across the board. Revenue first, with Q2 sales up almost 25% comparable and slightly above that in reported terms, resulting in a very strong 26.5% comparable increase in H1. As you can see, revenue growth in H1 ranged from 21%-34% in our three main regions, Western Europe, North America, and Asia Pacific. H1 group revenue reached EUR 7.3 billion.
Second, recurring operating income, which grew by 57% to EUR 1.27 billion, an all-time high. The operating margin improved 330 basis points to 17.5%, a major achievement. Third, our free cash flow also jumped substantially. It more than doubled year-on-year to reach EUR 718 million in H1. Finally, our net debt level is typically higher at the midyear point than at year end due to the dividend payment. However, year-on-year, net debt is down significantly. Switching to slide five, more detail on revenue. At the top-line level, we achieved a remarkable first half with strong double-digit growth in both quarters in luxury and in sport and lifestyle. Luxury grew 25% comparable in Q2 against tougher comps, leading to 28% growth in H1. Sport and lifestyle showed a slight sequential acceleration, driving 14% comparable growth for H1.
A word on corporate and others, in which you know we account for Kering Eyewear since January. Jean-François will give you an update on the business, but it's worth noting here that it contributed 2.8 percentage points of the group's total comparable revenue growth. Overall, we generated EUR 1.6 billion of incremental revenue in H1, all organically. On slide six, some brief comments on recurring operating income, which rose sharply both in luxury, up 49%, and in sport and lifestyle, where it more than doubled. EBIT margins improved substantially, up 320 and 260 basis points respectively. You see on the right-hand chart the main contributors to this highly satisfactory performance. On slide seven, additional data for luxury. Reported revenue increased 30% in H1, with one percentage point positive FX impact and zero change in scope. Comparable revenue growth was 28%, clearly outpacing market trends.
Retail was the main driver, with material double-digit increases across all regions. E-commerce was up 60% and now represents 4% of retail sales. Wholesale grew a healthy 15%. Trends by distribution channel and by region were broadly consistent in both quarters. In retail, Western Europe led the Q2 increase up 46%, fueled by both locals and tourists. Growth was especially buoyant in key markets such as Italy, France, the U.K., but also Germany and Spain. Asia Pacific advanced 31%, all countries being up with the exception, once again, of Taiwan. Among best performing markets, Mainland China and Korea stand out, as well as Macau, while Hong Kong is faring better but still contrasted. In North America, retail was up a strong 22%, thanks to locals who represent the bulk of the clientele. Finally, trends in Japan further improved with some brands doing better than others.
Overall, the local clientele was supportive and some tourist spending seemed to gradually come back from Mainland China but also Korea. If we look at the sales of our top three brands by client nationality, we see that the most significant ones were all up double-digit. The Chinese cluster dynamic both at home and abroad, grew approximately 30% worldwide. The European cluster grew even faster, especially at Gucci. The American cluster, as well as other Asian nationalities, also contributed significantly to worldwide growth, both in their respective domestic markets and when traveling. Our luxury activities achieved a first half EBIT of EUR 1.25 billion, up 49%, our highest first half result ever. The EBIT margin improved 320 basis points to 24.9%, driven by strong increases at Gucci and YSL, but also stabilization at Bottega Veneta, mitigating the dilution coming from investments at some of our other luxury brands.
CapEx in the period at 3.7% of revenue was in line with the 2016 first half. We are pursuing selective investments and working to enhance the efficiency and productivity of our network and return on investment. I'm not going to comment on the store network brand by brand. You have details in the appendix. Let me just stress that the luxury store count is up 1% compared to year-end at 1,323 units. Let's now have a look at Gucci on slide eight. In the first half, Gucci posted outstanding top-line growth. Comparable revenue was up 43% with all channels and regions contributing to this performance. The trend in Q2 with revenue up 39% was again impressive, especially as growth in retail up 42% was exclusively fueled by like-for-like sales at full price.
As you know, Gucci stopped markdowns in stores in late 2016 and faced tougher comps in the quarter, mainly in Asia Pacific and North America. In this context, the performance is even more remarkable, the enthusiasm for the brand being very intense across all markets, channels, and categories. By region, retail was buoyant in Western Europe, up 66%, in line with Q1. This was driven by local demand and strong tourist flows, representing a balanced mix between progressive and conservative segments, testifying to the diversified range of customers for whom the brand is relevant today. North America confirmed its excellent trend, as did Asia Pacific, with a very strong momentum in Mainland China and solid growth in Korea, Macau, and other markets. Japan further reinforced the positive performance we've seen since Q4 2016, and customers are embracing the new aesthetic and direction of Gucci.
This strong trend reflects the continuing excitement around the products and collections and the highly positive in-store experience. Online sales in the quarter increased by 52%. This strong performance does not take into account the contribution of Gucci's mainland China e-commerce site, launched in early July. All product categories were up high double-digit, both in women's and men's, reflecting the fully-fledged transition to the new offer and brand repositioning in line with Alessandro Michele's creative vision. Leather goods posted high double-digit growth with particularly strong performance in handbags, confirming the success of both the designer's carryovers and new lines. Shoes and ready-to-wear for women and men saw outstanding double or even triple-digit growth in the quarter. Once again, the increase in wholesale was significant, up 28% in the quarter. Royalties resumed a positive trajectory thanks to the eyewear license now internalized.
In the first half, recurring operating income was EUR 907 million, up 69%, while margin rose 440 basis points to 32%. Like-for-like growth and higher store productivity triggered massive operating leverage, while Gucci kept investing to support current and future growth. Store expenses, communication initiatives, and omni-channel were among the key areas of OpEx reinvestment. Gucci has a particularly ambitious and innovative omni-channel approach aimed at further reinforcing its competitive advantage. CapEx was up only 9% in H1, the focus being to steadily roll out the new concept implemented in 23 additional stores in the period. At the same time, the directly operated stores count was down six net units. Moving to Slide nine, as it focuses on reinforcing brand value, Bottega Veneta had a satisfactory first half. Revenue was up 2% comparable, with Q2 retail trends confirming its gradual improvements since the beginning of the year.
Q2 retail was up 4%, especially encouraging as the brand, quarter after quarter, takes additional steps to raise the share of full price sales in stores. By region, the highest increase was in Western Europe, driven largely by locals, while also benefiting from tourism. North America and Japan both improved sequentially. In Asia Pacific, the performance was contrasted, still solid in mainland China and Korea, with some pressure remaining in Hong Kong. It's worth emphasizing that all product categories contributed to growth, with good success in shoes and ready-to-wear. The newness of the early fall collection was well-received by the clientele and is driving performance. As you know, Bottega Veneta is working on many fronts to strengthen its positioning, notably with ongoing action plans to tighten wholesale control and contain markdowns.
Reflecting strict cost discipline and the alignment of OpEx priorities to support its action plans, Bottega Veneta stabilized its operating margin at 25%. CapEx was up compared to the low point reached in H1 last year. The evolution of the store network is on track. Certain stores are undergoing refurbs in terms of concept and lighting, others are being relocated, and still, others are being opened, but only when and where it makes sense, notably to deepen penetration in travel retail. On Slide 10, some highlights regarding Saint Laurent. In H1, the brand continued to sustain its momentum, with comparable revenue up 29%, and once again, delivered substantial operating leverage. At plus 24%, Q2 was now the quarter of above 20% growth. This was driven by retail up 30%. All regions were up double-digit. By product categories, leather goods were the key engine.
The summer collection, the first one designed by Anthony Vaccarello, enjoyed great success in both ready-to-wear and shoes. After a very strong Q1, wholesale revenue was up mid-single digit with some timing of deliveries. In the first half, Saint Laurent posted another strong jump in operating profit up 50%, resulting in a 310 basis points expansion in margin. This stemmed from the substantial leverage the brand enjoys. CapEx was up in H1, but stood at slightly more than 4% of sales. It is consistent with the current expansion plans in terms of directly operated stores network with a combination of flagships to increase market penetration, shops in shops, and travel retail openings. Moving on to Slide 11. Our other luxury brands posted a double-digit revenue increase in the half year, with soft luxury brands up 13% and watches and jewelry brands up 6%.
In Q2, revenue was up 9%, driven by retail up 23%, dynamic across all regions and all brands. Balenciaga is the main highlight, with trends accelerating, thanks to the outstanding reception of Demna Gvasalia's collections. Brioni, Stella McCartney, and Alexander McQueen all delivered healthy retail performances. In jewelry, Q2 was up double digits in retail with good market response from the new launches at Boucheron and Pomellato. During the first half, the operating profit and margin of our other luxury portfolio were diluted by brand investments at Boucheron and Pomellato. As you know, we have important ambitions for these brands and have developed a two to three-year investment plan to unleash their potential. For the other brands, while Brioni's results were still under pressure, Balenciaga, McQueen, and McCartney maintained a good level of profitability, and our watch brand stabilized their contribution.
CapEx was up, driven by a handful of key expansion projects, notably at Balenciaga. With Slide 12, let's move on to our sport and lifestyle activities, which demonstrated sustained revenue trends in the first half, up 14% comparable and 16% reported. For the first time, they passed the EUR 2 billion mark in a single semester. Puma pre-announced its Q2 earlier this month and reported yesterday. In H1, the brand posted a robust top-line performance with sales up 16% comparable. In Q2, all products and regions grew with especially positive momentum in footwear, up 27%. The women's business showed continuing strength, while men's shoes benefited from the strong performance of Ignite Limitless. The new NetFit lacing technology was introduced successfully across performance and sport style, as was the new Tsugi footwear style.
By channel, Puma achieved good sell-through with key retailers, a further increase in sales in its own store, and fast e-commerce growth. Thanks to gross profit margin improvement and material leverage on the OpEx base, Puma more than doubled its recurring operating income to EUR 113 million and a margin of 5.7%, up 260 basis points. As you know, Puma has upgraded its revenue and EBIT guidance for the full year. Volcom posted a 7% comparable revenue decline in H1. Wholesale is still under pressure in North America, but retail sales grew double digits in the quarter. Volcom has taken initiatives to reinforce the quality of its distribution and to grow brand awareness with new customers. The brand is able to limit the impact of lower revenue on its results, its H1 recurring operating loss narrowing compared to last year.
Now moving on to the remaining lines of the P&L summarized on slide 13. Other non-recurring operating income and expenses were EUR 44 million negative as compared to last year. This item notably encompasses restructuring charges and asset depreciation. Net financial charges amounted to EUR 113 million, up slightly year-on-year. Within this, the cost of net financial debt was up EUR 5 million to EUR 67 million impacted by a negative mix. The group has lengthened its debt maturity and secured new bond financing under very attractive terms. In the process, we reimbursed short-term commercial paper that was bearing even lower interest rates. The reduction in average net debt doesn't fully offset this negative mix impact.
Other financial charges amounted to EUR 46 million, mainly driven by the adverse incidence of the cost of carrying our currency hedges due to the increased interest rate spread between the Eurozone and the rest of the world. Corporate tax amounted to EUR 250 million, an 18% increase corresponding to an effective tax rate of 22.4% and a recurring tax rate of 21.6% versus 22.1% and 23.6%, respectively in H1 last year. Consolidated net income group share reached EUR 826 million, up close to 80%. Adjusted for non-recurring items, group net income amounted to EUR 872 million compared to EUR 521 million last year. A few comments on free cash flow and net financial position on slides 14 and 15. Our free cash flow more than doubled year-on-year at EUR 718 million. It was, and remains, one of our key priorities.
The change in working capital requirements relates to the strong level of activity at both Puma and Gucci, and to the integration of Kering Eyewear. We maintain a selective CapEx approach and had a ratio to sales slightly below 4% in the first half. Comparable to last year, there will be a phasing effect in 2017 with higher CapEx in H2. For the full year, we foresee that CapEx should stand at around 5% of sales. In the first half, net financial debt increased slightly compared to December last year to EUR 4.6 billion. This is due to usual seasonality patterns, including increased dividend payments in the first half, which this year represented a cash outflow of more than EUR 600 million.
However, I would like to stress that compared to June a year ago, we reduced our net debt level by half a billion EUR, so we are well on track for a new year of deleveraging. This ends my remarks. Let me now pass on to Jean-François for a conclusion.
Thank you, Jean-Marc. The first half of the year has definitely been one for the record books, and we are all extremely proud of what we have achieved across pretty much every part of our group. The strategy we are implementing and that we have presented to you on many occasions is clearly paying off with tangible results. I don't think there are many organizations of our size that are able to generate incremental revenues of EUR 1.6 billion over a six-month period, and to do so on the basis of a platform and footprint whose expansion has been marginal and purely organic. Our multi-brand model once again demonstrated its validity. Not only is Gucci continuing to achieve strong growth in all categories and all geographies, with no contribution from in-store markdowns, but virtually all other houses and brands are growing.
In fact, about 45% of the incremental group revenues in the six months were not generated by Gucci. The spectacular revival of our largest house remains unparalleled in the world of luxury. Gucci is working on every driver and KPI that will allow for the full potential of all categories to be achieved, and thereby sustain momentum in the business. As you've seen, Gucci is not our only fast-growing brand. Yves Saint Laurent highlighted its medium to long-term revenue and margin objectives last month. Its current trajectory is fully consistent with these ambitions, Balenciaga is also on a roll. We are confident that we have taken the right steps to return Bottega Veneta to profitable growth and prepared the groundwork for H2 and beyond. We have a host of initiatives in place to address this great brand's key priorities.
Its communications are about to undergo a radical reset with a great digital component. In-store merchandising will also emphasize newness, and we will continue reinforcing the exclusivity of the brand and further reducing markdowns. We are already seeing promising signs, notably with local clients. As for Brioni, we are very pleased with the progress the brand is making in its core categories, notably formal wear and bespoke. With a new CEO and creative director in place, Brioni will make further headway. It is an unquestionable strength of our business model to give us not only the time to get things right, but also to have access to the best talent and experience, both in-house and outside the group, when new directions are needed.
We are continuing to innovate in our hard luxury segment and investing in Boucheron and Pomellato, notably to round out their offer, renovate their retail network with refreshed concepts and displays, and diversify their communications, including digital. Puma is doing well, having made all the right moves to reestablish itself as a leading innovator in its category and reinforce its profitability. We are absolutely convinced that our clear outperformance is tied to our multi-brand strategy. If our houses and brands deliver these results, it is thanks to the empowerment that the group provides, as well as to the constant emulation between them. Having the right strategy is one thing, delivering on it is what really makes the difference. As you know, our focus for the past years has been on getting our existing assets, and notably our retail footprint, to which their full potential.
The expansion and adaptation of our DOS networks was highly selective in the first half and has primarily focused on optimizing our existing coverage or filling gaps here and there. Continuously enhancing the desirability and exclusivity of our brands is one of our highest priorities, and we are pursuing our strategy of raising full price sales. That is not something we are doing just at Gucci. It is a central imperative across all our houses. We must provide an in-store experience that is fully supportive of the image of our brands, both to attract new customers, particularly younger ones, and to retain existing clients. Retail excellence has been a key focus of ours and will remain so, as we are pleased seeing its positive effects on the perception of our brands. Younger customers are also the primary audience for our digital efforts.
Our brands are being particularly innovative, each in its own way, adapted to its own segment in terms of social media presence, online visibility, and e-commerce platforms. Finally, Kering Eyewear is a prime example of our ability as a group to harness organic growth that had traditionally been outsourced. I'd like to give you an update on where we stand. We had the critical mass we needed to internalize our eyewear activities. We are further expanding that scale with the partnership we are building with Richemont to develop the Maison Cartier eyewear category. Kering Eyewear gives us the adequate vehicle to build eyewear as a core category, fully aligned with each brand's strategy. Already the cadence of the collections has been adapted to match those of the fashion houses, and glasses have acquired a strong presence in our brands' runway shows, campaigns or look books, as you've probably noticed.
Where do we stand? 15 brands active in the category have been onboarded. Our manufacturing organization is in place and about to be strengthened with the addition of Cartier's facility. Our distribution channels are secured. We are operational in about 100 countries, and the experience has been viewed favorably all around by customers, intermediaries and by our brands. At EUR 209 million, or EUR 162 after elimination of intragroup sales and royalties, our revenues are in line with targets, and the EBIT contribution was positive in H1. With the headcount nearing the 700 mark, Kering Eyewear has managed to preserve its startup spirit. Actually, the startup spirit is something we nurture throughout Kering, not just in eyewear. Our ability to create value largely relies on a culture emphasizing imagination and inventiveness.
We have strong teams of people at all levels with the flexibility to make the right decisions or implement the right initiatives in rapidly changing landscapes. The first half of the year illustrates the power of our strategy in delivering considerable operating leverage on a sharp increase in top line. We boosted free cash flow generation and are on track to further reduce our net debt to EBITDA ratio at year-end. Having reached this milestone, we are more than ever confident that we have the right strategy and execution capabilities to deliver dependable performances quarter after quarter, to realize our ambitions and to maximize shareholder return. This being said, we are very careful not to be complacent. We are working hard in each and every unit of the group to sustain growth and profitability. We know that we are coming against far tougher comps.
I'm sure you all remember that our comparable revenue growth rate last year nearly doubled between H1 and H2. In luxury, it was almost three times higher in the second half, fueled by Gucci in particular. We are also keenly aware that there are many sources of risk and volatility in the global environment. We are prepared and eager to continue competing. With a strong first half under our belt, we are confident that we will deliver another year of consistent growth and profitability improvement. Jean-Marc and I are now ready to take your questions.
Thank you, sir. If you would like to ask a question, please press star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press star one to ask a question. We'll pause for just a moment to allow everyone to signal. We'll take the first question from Helen Brand of UBS. Please go ahead.
Hi, good evening everyone. My first question, unsurprisingly, is on Gucci. Could you break down the ASP compared to the volume growth, in Q2, perhaps at retail and for the total brand? Secondly, as we're thinking about the second half, how do you see that ASP and price and mix, I guess, trending in H2? Secondly, if you could just help us a little bit on the EBIT margin expansion at Gucci. How much did gross margin contribute to EBIT margin expansion in H1? How do you expect this, as well as OpEx inflation to trend in the second half? If I can just squeeze in a third, we are almost at the end of July. We're probably starting to hit some tougher comps for Gucci.
Can you give us a feel as to what level of normalization of growth we're seeing at the moment at the brand? Thanks very much.
Good evening, Helen. Starting with your question about the average selling price. We have benefited at Gucci from still an improvement of the product mix, and also with the launch of some newness that helped to grow the average selling price. Second, you know that we have stopped completely markdown activities during the quarter, so that at the end of the day, for sure, if you look at the performance of Gucci as a whole, in retail, it's true that we had a significant driver coming from the ASP because of the end of the markdown activities. I would say that you may remember that during the first quarter, we had mentioned that it was two-thirds due to traffic and something like one-third from the product mix and the average selling price.
Let's say that during this quarter it was more half/half, but now if we consider only the full price sales, we are still in the same range and even with more traffic. I would say that if I consider only full price sales, the main driver is traffic and volumes, let's say something above the two-thirds of the first quarter. Regarding the trends for the second half, it's of course too early to comment about what could be the evolution of the ASP and what could be the impact due to the volumes and the traffic. Let's say that regarding the end of markdown activities, we are now on a more comparable basis since we had to completely stop or almost stop all the markdown activities during Q4.
We can imagine that considering that the traffic is still up in all the clusters of fashion and apparel, the bulk of the growth of revenues will rather derive from traffic as we don't anticipate major changes in terms of average selling price. Regarding the margin expansion we experienced at Gucci during this semester, it's true that as a first comment, I would say that we have enjoyed a quite significant drop-through, meaning that if we compare the gain in terms of gross margin to the gain of EBIT, it's above 50%. It means that it's a quite solid one. It's true that we have, as usual, and as already mentioned, reinvested part of it in some very specific lines of expenses. However, these lines represent something like 70%, still of the cost base. In store expenses also we have some variable expenses.
It's something like one-third of the store expenses are variable. Going forward, we believe that we continue to reinvest in these lines of expenses. I remind communication, marketing activities, store expenses, and information system and omni-channel at the same pace because we are convinced that because we want to deliver a very resilient performance at Gucci for the long run, that we need to sustain that performance and that growth through these activities. Let's say that we can anticipate some more margin expansion during H2, but at a slower pace considering that of course, as mentioned by Jean-François, the comp base on the top line starts to become tougher. In terms of approaching leverage, it should be not to the same extent as H1. Your last question is clearly about current trading. As you know, we don't comment generally the current trends.
Let's say that, without being more precise, it's still quite favorable.
Great. Just to follow up, are you giving any steer in terms of that gross margin expansion in H1, or was it mainly OpEx leverage that we saw in terms of the margin?
We have benefited from some gross margin expansion. Clearly, if you look at the contribution of the different items to the EBIT improvement, it's not the main driver. The end of the markdown activities had clearly a positive impact, probably slightly above our expectations. It's true that we have not yet transferred some items to the outer channel. Going forward, and as we have already said, the gross margin of Gucci is already quite high due to the very good job done by the team to optimize the cost of goods sold. We don't anticipate some additional major expansion on that side.
Great. Thank you very much.
Thank you, Elaine.
Thank you. We'll take the next question from John Guy of MainFirst. Please go ahead.
Good evening, gentlemen. Thanks for taking my questions. I've got three, please. Maybe starting with the free cash flow, great job in terms of more than doubling that. When I look at Gucci's CapEx as a percentage of sales to 2.7%, that was 100 basis points lighter than the total luxury CapEx as a percentage of sales in the first half of the year. I think, as Jean-Marc, you alluded to 5% of sales for total group CapEx. Can you give us an idea then, in terms of where Gucci's CapEx is going to run over the course of the year? Will it be 4% or slightly below? That's my first question. My second question, can you actually provide a number in terms of how much you spent during the first half on the Gucci store refurbishments, in millions of euros? My final question, just around Puma.
It looks like there's no change to your stake at the moment. Given Puma's market cap now above EUR 5 billion, I'm assuming it's harder to find a trade buyer willing to pay a 20%-30% premium if you're looking to dispose this brand. Would you now consider a dual track disposal or placing process going forward? Thank you.
Thank you, John, for your questions. Regarding CapEx of Gucci, it is true that we have here once again, a phasing impact. You use the months of the summer also to make some refurbishment and work in the store, so that there is now, in a way, in the group, some seasonality with more CapEx in H2. All in all, we believe that for the full year, it is true that we have an objective of 5% for the group as a whole. It does encompass some CapEx incurred at the corporate level, especially for the upgrade of the information system and some other investments in terms of logistics. At the Gucci level, we should be around 4%, probably, something around that, or probably slightly above. In that range, concerning also the expansion of the revenues, which is above our expectations.
Of course, we cannot recalibrate the CapEx compared to the initial budget at the same pace. Of course, we won't provide you with any indication in terms of split of CapEx between the different areas of CapEx, and especially not about refurbishment. Let us say that we continue to refurbish as planned the network. If I remember well, we should be at something like 109 refurbished stores at the end of H1.
Year-to-date, we are 109.
Well, yes. Year-to-date, 109 at the end of H1 with the ambition to be around 120, 150 by the end of the year. We have already 20% of the network with the new concept. Let us say that considering the net openings you have noticed at Gucci, it is clear that the bulk of the CapEx dedicated to the store network is on refurbishment.
Good evening, John. I confirm that there is no change in the Puma stake at the end of June, and I also confirm that our priority remains on sustaining growth, enhancing profitability, and improving cash flow.
That's very clear. Thank you very much. Jean-Marc, sorry, just one final one. Did you just say that your target for Gucci store refurbishments was 120 for the year-end or 150?
150, sorry. 150.
Thank you very much indeed, both of you.
Thank you, John.
Thank you. We'll take the next question from Louise Singlehurst of Morgan Stanley. Please go ahead. That question is from Louise Singlehurst. Please go ahead. Your line is open.
Hi there. Apologies. A quick question from me, just in terms of the back on the Gucci growth. Can you just give us a little bit of an idea in terms of very strong like for like, how you're managing the supply chain? Are there any capacity constraints? Just remind us about how much is internalized production versus external. On the second question, Jean-Marc, you touched on the omni-channel approach. Can you talk about specific initiatives in H1? I remember you talking earlier this year of a new hire within customer relationship manager. If you just talk about initial projects there. Thank you.
In fact, as soon as 2016, Gucci launched already several initiatives in order to re-engineer its supply chain organization and to adapt its production capacity. I wouldn't say that there was not at all some shortage of product during the semester. There have been some shortage, and we have some delays with leather good production. For some SKUs of approximately one month, let's say, due to the continuous double-digit growth which the brand is experiencing. It's true that we have been able because we have worked on that for now several months to adapt the supply chain. Beyond the long-term objective, which is clearly to increase the share of internalized production, there was primarily a short-term need, in fact, to address the growing demand.
During H1, we have been able also still to reinforce the handbags and the luggage production, thanks to the introduction of new suppliers and also the increase of the scale of the existing ones. Let's say that we have been able to address the demand, but with some shortage, and as we had the occasion to mention already, we are still working on increasing the share of internalized production. We will have also to rebound on the question of John, some more investment on CapEx on production facilities. Regarding the omni-channel, I think it's a continuous journey at Gucci, which started a few months ago with the new gucci.com, launched in the U.S. first.
We are very happy to have launched also now gucci.com in China, with an official launch beginning of July, with already a lot of success and with very encouraging trends because it does allow Gucci to penetrate further the Chinese territory and also to sell on some tier 3 cities. We have also the initiative with Farfetch, which has been communicated, which is also a way to increase the omni-channel penetration of Gucci. In 2017, we have also on the gucci.com, on top of all the content we are providing quite regularly, and which is probably one of the strengths of the brand, which is able to provide many contents to an audience which is younger and younger, more and more demanding in terms of contents.
We have been able to propose also some new services in terms of availability of the inventories in store with, of course, I've already mentioned it, the initiative with Farfetch, with a 90 minutes delivery in some major city. I think it's now completely encompassed in the strategy of Gucci, that all the initiatives regarding logistic, regarding production, regarding media and communication, are taking into account this 360 approach. Thank you.
Thank you. We'll take the next question from Thomas Chauvet of Citi. Please go ahead.
Good evening. I have three question, please. The first one on Bottega Veneta. If I look at the growth in the second quarter, it was only driven by Western Europe retail, with all other regions down, wholesale down, so possibly driven by tourism and maybe still parallel markets. Are you doing enough to revive this brand? Do you think it's basically an 18, 24 months plan from here? How should we think about the second half? Should we have any hope of maybe a pickup in demand as you will face most of your branding, including Bottega, slightly tougher comps in the second half. Secondly, on free cash flow, if you continue at this pace, you'll be probably close to one times net debt to EBITDA. I think that's at the lower end of your one to two times target leverage ratio.
Jean-François, you focus on net debt reduction and return to shareholder in your slide, could you just remind us what you think is the target leverage ratio for the company in terms of net debt to EBITDA? I had in mind one times to two times. We're seeing obviously a pickup in M&A activity in the sector since the end of last year. I think Mr. Pinault was discussing that on CNBC today. Can you maybe give us more color on where you stand on the potential need to complement your portfolio with additional brand, perhaps in jewelry? Finally, could we have a little bit more color on your hedged rates for 2017 and 2018 on USD and Japanese yen? I think you're generally reluctant to give those. I don't know if you can give that today. That'd be useful given the appreciation of the euro.
Are you still doing a mix between forward contracts and options or is it mostly forward still? Thank you.
Good evening, Thomas. We have implemented a series of actions regarding Bottega, from product to communications and also retail excellence. These measures have not brought fruit yet, and they will barely improve the situation in H2. They are more likely to be effective and visible in Q1 next year. Regarding our objective in terms of leveraging, it remains the same. I would say we want to gradually reach a ratio of one time EBITDA in debt. To make it more clear, we do not contemplate any acquisition short term. Thomas, before answering your last question, just also to mention regarding Bottega Veneta, that one of the actions which is very important to us is to protect the exclusivity of the brand. Also like Gucci in a way, we have reduced significantly the markdown activities, especially on Intrecciato.
Clearly it had had an impact on some markets, especially with the tourist and the Asian tourist and also in APAC. That does explain why during the Q2, the performance in some regions was slightly below the one of the Q1. Let's say that we are also very encouraged by the trends we see in Europe, because in Europe it's equally driven by locals and tourists, and we have a very good response of the European customers. I will come back to your statement about the fact that I may be reluctant to provide you with information on hedging, which is completely wrong, I must say. Let's say that as for the instruments used, as we said in the past, the currency hedging is mostly done with forward, it's true, and in a lesser extent with options.
The optional component now represents more than 15% of the USD hedges and slightly more for the Japanese yen hedges. If we consider 2017. The hedging rate for 2017 are 1.10 for the USD and 121 for the Japanese yen.
Thank you. That's for 2018?
For 2018, we should be at 1.08 for USD and still around 121 for Japanese yen.
Okay. Pretty good rate.
Yes.
Thank you. Thank you very much. Apologies. I have thought that they were not disclosed. I looked for it in the-
I was-
in the full year transcript, I couldn't find any trace of that info. That's useful. Thank you, Jean-Marc.
Bye-bye, Thomas.
Thank you. We'll take the next question from Luca Solca of Exane BNP. Please go ahead.
Yes, good afternoon. I was wondering how is the social demographic profile of the Gucci customer base changing? My impression is that Gucci is acquiring many more younger consumers and being very effective with millennials. I wonder if you could confirm that in terms of age group and also if there's any change which is meaningful in terms of nationality mix. Looking at Gucci's operating margin, which has improved significantly, I wonder, considering the very brilliant improvement in top line, whether this could have been even higher, I mean, the EBIT margin improvement. If there's a little bit in the back pocket for the second half. I take your point.
You were saying that in the second half, of course, there will be more difficult comparables, but I wonder whether there could be a bit of a slack and if some of the SG&A commitments are being made prudently and brought to some extent forward in the first half. Last, it's a Richemont problem. Kering Eyewear is doing very well. How is the problems at Safilo impacting you and how are you moving on in order to secure more made-in-Italy capacity outside of Safilo, if you can comment on that? Thanks very much.
Thank you, Luca, for your questions. In fact, Gucci registered a positive increase in sales across all segments in terms of age in H1 2017. It's true that there is a big push in terms of initiatives with the millennials. If we look at the millennials age range, let's say 18-34, it's true that Gucci registered very high double-digit increase in sales. In fact, all other age segments grew also double-digit. It's a quite healthy and balanced growth across the board. Now if we consider the share of millennials, it's quite similar to the one of Q1 because in fact, the animation we have at Gucci clearly skewed to millennials, is very effective also with the other segments. Millennials are more and more considered as promoters to the brand.
I would also mention something which is very important to us because there is always a theme around the versatility of the young customers. In fact, what is interesting is that we have a retention of young customers, which is quite strong. We are very happy with that because it's very encouraging for the future and about the sustained performance of Gucci to see that thanks to the animation, we are able to provide in terms of content, but also because of the retail excellence we have, the experience is such and also because of the product, of course, and it just starts with the product. Finally, we have a very good retention rate with the millennials. I would say that so far it's a very well-balanced growth among the different clusters of clientele.
Jean-Marc, if I may interject. I fully appreciate that there could be no significant mix change between first quarter and second quarter. I was thinking more along the lines of the past two or three years and prior to the new leadership being in place. I wonder if the Gucci consumer mix has changed when you take a perspective of two or three years.
For sure. It's absolutely evident, it's typically the situation we had to face in Japan, where we had acquired old clientele, when we have introduced the new aesthetic. It's true that it took some time to gain traction with the Japanese millennials, we have suffered from, I think, a quite old clientele in Japan. In the average, the clientele was more old in the past. I have not the figures in front of me regarding the share of millennials, but let's consider that during Q1 2016, we were below 50% in terms of millennials. Now we are above 50%. Probably, two years ago, we were at about 40% of the sales with millennials. Three years ago, probably slightly less. I think that it's back to normal, considering also the demographics now to be at this level.
Once again, it's clearly key and strategic for us, considering that millennials are promoters. You are totally right, on a three years perspective, it's true that we have increased the share of millennials. Regarding the evolution of the EBIT margin. First, I would like to remind that we have reached a record in terms of EBIT margin. If we consider the peak we had reached a few years ago, we are above the peak, and we are above the target and the objectives we had set when Marco presented its plan in summer 2016. We have made substantial progress. Once again, I think that we continue to invest massively in different actions to sustain the growth. We don't want to push too fast the profitability.
As I mentioned before, we have a lot of initiatives in terms of omni-channel, but also in terms of supply chain to sustain the demand. It's true that we continue to apply a quite prudent approach regarding inventory depreciation, which is reflected in the evolution of the gross margin also. Let's say that going forward, as I mentioned, we believe that progressively, we are able to continue to grow the EBIT margin at Gucci, but we want to make it very progressive. Good evening, Luca. Regarding Kering Eyewear, as you know, we have a supply contract with Safilo, and we are very satisfied with the timing of deliveries and quite satisfied with quality. Nevertheless, it's been a long time that we have secured a reservoir of potential substitute vendors. As a consequence, we are not worried at all with the present situation at Safilo.
Well, you've been very lucky because apparently they had major issues as far as deliveries and on the back of the new IT implementation.
True.
You need to be good and lucky. Congratulations on that.
It's true that we have experienced a few delays, generally speaking, we are quite satisfied with the deliveries.
Understood. Thanks very much.
Thank you, Luca.
Thank you. We'll take the next question from Erwan Rambourg of HSBC. Please go ahead.
Hi there. Congratulations, and thanks for taking my questions. First of all, I was wondering if you could mention any FX implications in terms of possible changes in travel flows with the strength of the euro dollar. Is this bound to affect European sales and bound to help Greater China sales? Linked to that, are you thinking differently about price points related to this big shift? That's my first question. Secondly, you mentioned, I think that European consumers were up more than Asian consumers for both Gucci and BV. Is this a reason to be nervous or a reason to be positive? I'm thinking if you spin it negatively, European consumers are probably not the future of luxury. If you spin it positively, European consumers might influence other consumers, notably tourism-related. I'm just wondering how you think about this fact that European consumers are outperforming.
Thirdly, last little point, you have two little jewels with Pomellato and Boucheron with very strong CEOs, and I think you mentioned that the margins were under pressure because you were investing for the long term, the next three years, I think you mentioned. Does this mean that margins will be muted over the next three years, or is this really a 2017 investment to catch up on brand building there? Could we see a bit of a shift over the following two years? Thank you.
Thank you, Erwan, for your questions. Regarding FX evolution, it's obviously very soon to anticipate what will be the impact of the strengthening of the euro. It's always very difficult to predict, especially at the beginning, and we don't know what will be the long-term evolution. Of course, there would be some implications in terms of pricing, in terms of tourism flows, in terms of revenues translated into euros in terms of margin, in terms of absorption of the cost in euros. The reason why I think that the message clearly expressed by Jean-François was to say that we are quite cautious regarding the evolution of the business during H2. I think that our brands have still this strong momentum, but it's clear that we have some headwinds due to the FX. Does it imply that we are considering some price increases?
Once again, I think it's too soon to say that. We have a very good dynamic across the regions. Each time there is such a situation, we are reluctant to consider that price increase is the only one solution. We will reconsider this case by case, brand by brand, and SKU by SKU, because there is not a unique answer to that. Once again, it's too soon, so let's spend the summer and we will see after, what is the evolution of the consumption based on that. Regarding your statement about the European customers, I find you quite tough, because in a way, we have still in Europe a base of very good customers with a high purchasing power.
The wealth is Europe is, in a way, and we could complain, but for the business, that's a fact that there is a sort of concentration of wealth in the mature countries so that we have more and more customers in Europe, but also in North America. Just as a reminder, during H1, it's clear that we had very wealthy American customers with a very good sentiment because of the situation of the equity market. I would say that the macro is more positive in Europe, so it doesn't really explain why we have such a situation. Where we are quite happy, and I think that we have always said that we want to have a more balanced growth between local and tourist, and this is typically the case for this H1, in Europe at least.
We are quite satisfied with this situation. You know that from one year to another year, you may have some switch in terms of clientele. We had quite a positive trend a few years ago in the U.S. and in Japan, offsetting the weakness in Europe. We are quite happy to see this evolution in Europe. Once again, I don't know if it's a strength or weakness, but that's a fact, and we are benefiting from that with all of our brands.
Right.
Good evening, everyone. Regarding the trajectory of our jewelry brands, our plans show that Pomellato will recover margin-wise as early as 2018, whereas Boucheron will still be affected, although to a lesser extent, and then will take off again in 2019.
Excellent. Thank you very much.
Thank you, Erwan.
Thank you. We will take the next question from Mélanie Flouquet of JP Morgan. Please go ahead.
Yes, good evening. I have three questions, please. The first one is, sorry, it is about Gucci profitability again. Usually, your profitability in the second half of the year is higher than in the first half at this brand. I was wondering whether you foresaw any reason why this wouldn't be the case this time around. I appreciate there are a lot of moving parts like Forex, et cetera, but you are partially hedged, so could 32% be something that we could forecast? The second question is actually whether you can lay out a bit more the plans on Pomellato and Boucheron. What are these initiatives? Maybe more from a strategic standpoint. I think you have laid out what it will do on the margins, but what are these initiatives and what would they do maybe on sales? My third point is on watches and jewelry.
You were kind enough to give us an idea of the hard and soft split. I do not recall it in Q1, sorry. If you could give it in Q2 and in Q1 so we had an idea of the evolution of hard and soft in comparison. Thank you.
As you will have understood, Mélanie, I won't elaborate too much on profitability at Gucci. Let's say that even if we are continuing to invest in the brand, and also because we will have, during H2, less operating leverage, probably because of the comp on the revenues and also maybe because of some headwinds in terms of currency. Let's say that overall, yes, we can consider that we should be able to deliver the 32% EBIT at least during H2. For the full year, let's say that the 32% margin looks as a good estimate of what we can deliver.
Hi, Mélanie. Regarding our plans for the jewelry brands, I would say that they aim primarily at enhancing the communication and increasing our share of voice, also opening new stores. This is also one of our objective being to enlarge our footprint in some regions where we are barely present, such as China and also the rest of Asia. As you can imagine, this will have a progressive impact on sales. Like I said, this will first impact our EBIT and our cash flow. Also noting that for Boucheron, in particular, we want to increase our inventory of jewels and diamonds.
For your last question, Mélanie, in fact, we have provided during Q1, the split between soft and hard. You have the split for H1, normally you could, and I know you can, recompute this quite easily. Let's say that we had a phasing of deliveries in watches, which has clearly impacted Q2. You know that globally in this industry, and you can notice that when you look at the data of the Swiss watch industry, you have some months of deliveries, and let's say that the Q2 has been less dynamic for the watches brand. Otherwise, the trends have been very consistent from Q1 to Q2 for the soft luxury brands and also for the jewelry brands.
Thank you very much.
Thank you, Mélanie.
Thank you. We'll take the next question from Marion Boucheron of Raymond James. Please go ahead.
Hi, good evening. I have two follow-up questions. One would be on Gucci, I was wondering if you could give us a bit more information on the leather goods, on which line they're the best performing, both in terms of price point but also styles. Is it the more furrows or more understated product? Also, are there any new categories on Gucci where you're now pushing? I was under the impression there was some more communication on the jewelry lines. The other question would be on Balenciaga. What could you detail a bit more the ambitions you have for this brand? Thanks.
We don't provide a detailed analysis of the performance by categories and within the category by lines. Let's say that the handbags, the trends in handbags have been absolutely outstanding during H1. Major improvement in terms of small leather goods and progress in terms of luggage. Within the handbags, I won't provide more details, but let's say that we have success with newness and carryovers. I think that it's clearly demonstrated that Gucci has been able to have in its assortment a bunch of carryovers delivering solid performances quarter after quarter. I think that you know very well which are these lines. I think that Gucci is very good at animating these iconic lines, so that at the end of the day, carryover lines and seasonal items are performing very well. We don't see any major weaknesses when we look at the different lines and SKUs at Gucci.
Regarding categories, as you know, we have finalized more or less, at the end of 2016, the revamping of the offer in the major categories. I think that 2017 is clearly the year where we will accelerate in terms of finalizing the installation of the new aesthetic in some traffic-builders categories, which are not necessarily super significant in terms of percentage of sales, but which are obviously important in terms of traffic, and in terms also because they are more aspirational. I think about eyewear, typically because we have now the license fully internalized, it will be one of the driver also for some room for improvement there. Jewelry and watches, we are continuing to fine-tune the offer, and with a very good response as regard the watch during Q2.
We are starting to deliver the watch, the new offer to the wholesale more during H2, let's say. We are waiting also for the new launch of a fragrance with Coty, which is scheduled during H2. This will be the first fragrance with Alessandro Michele. It's one of the category on which we know that we have some progress when you look at the performance of the royalties, but also because once again, it can be a traffic-builder in our stores.
About Balenciaga, we are very well aligned now, the brand is fully on roll, enjoying an outstanding creativity and spectacular trading momentum. Now we can consider the EUR 1 billion mark as first mid-term milestone.
Okay. Thank you.
Okay, we will take the last question.
Thank you. That comes from Mario Ortelli of Bernstein. Please go ahead.
Good afternoon. The first question is on the e-commerce of Gucci. gucci.com is growing a lot. Is e-commerce reached already the critical mass to be more profitable of the Gucci sales in your retail shop? If not, in how long time do you expect that the profitability of the sales in e-commerce for Gucci will be as high as in retail or higher? The second is on the wholesale of Gucci. In the last years, you made a great rationalization of your wholesale partner of Gucci. In the recent time, you have changed your markdown strategy. You're not doing markdowns anymore in your retail shop, and you cannot control the pricing of the wholesaler. Can we expect that going forward, you will rationalize even further your network of wholesaler at Gucci? Probably in the long run, become a fully distributed retail like other French brands are doing.
The last question is about the two brands that were not nominated a lot in this conf call, that does not seem a priority for the group, that are McCartney and McQueen. If you can give us an update of how these two brands are performing in the first half of the year, and what are the plans for these two brands. Thank you.
Thank you, Mario. To stress the performance of e-commerce at Gucci, which is booming also thanks to the investments we made in omni-channel. It does validate, in a way, the strategy we have to reinvest part of the profit at Gucci, because it does require a lot of investment to provide with content and to be able to roll out this platform across the board with some major changes in the way also the consumers are buying, because the traffic on smartphone is booming. It's more than 100% growth on smartphone. It clearly becomes a driver of the growth online. We are constantly reshaping also our capabilities to serve the needs of our customers. That said, it's true that because of the critical mass of the e-business at Gucci, it was already a very profitable business.
Of course, you can imagine that we won't provide any precise detail about this. Also considering that sometimes it's very difficult to split some corporate costs and administrative costs. How you split, for example, the design cost between e-commerce and a retail sale, it's obviously very difficult. It's a very profitable business. It goes on par with the retail expansion. I think it's really a 360 approach. What we can tell is that compared to the smaller brands of the group, this is already a very profitable business. Your second question was about wholesale, if I remember well. First of all, as a reminder, you will have noticed that retail sales are representing something like 85% of the sales. In the 15% remaining, you have already the watches business. Let's say that the share of pure wholesale business is quite tiny today.
It's very concentrated on some key partners. Clearly, the strategy today is more to be more selective with wholesale partners to increase the collaboration, so that in terms of pricing policy, in terms of communication, we are more aligned. The plan is not at all to skip that channel, which is very important for some categories. You remember that we have a very strong business at Gucci with ready-to-wear and also shoes. Regarding shoes, wholesale distribution is absolutely strategic in some regions. I would mention, of course, North America, but also U.K., where distribution of shoes in U.K., you have a very important share of business with wholesale accounts. That's the reason why we believe that in the long run, we will be maybe more concentrated, more disciplined with wholesale accounts. We don't want at all to cancel that channel.
We believe also that we have super good partners in online or with pure players online, I think we need to continue to collaborate with these players. I think that regarding McQueen and McCartney, you're right to mention these two brands on which we are continuing to invest. Also, if you look at the evolution of the total count of directly operated stores, you see that there is an increase because of Saint Laurent, because of Balenciaga, but also with some selected openings at McCartney and McQueen. I think that they are doing a good job in retail with good development of the business. Of course, these brands are more exposed to the weakness of the U.S. wholesale.
You know that in the U.S. today, the wholesale partners are risk averse, and they prefer to concentrate their purchase on the big brands or the brands which have a clear momentum in the region. In our case, it's Saint Laurent and Gucci. It's true that the exposure to wholesale is more challenging for Stella McCartney and Alexander McQueen. At the end of the day, they deliver overall a very solid performance in terms of sales with still a very satisfactory level of profitability. We are continuing to invest in these brands, and we are very confident that we can once again unleash their full potential.
Thank you very much.
Thank you very much for being on our call and for your questions. We know it's a very busy period for all of you, and we hope to have provided you with all the information you need. We are proud of the performance of all our brands in the first half and working hard to maintain a strong momentum in the second half and beyond. We wish you an excellent and relaxing summer following this hectic reporting week, and we will talk to you again in the fall. Have a nice evening.
Goodbye.
This concludes today's call. Thank you for your participation, ladies and gentlemen. You may now disconnect.