The Luxury Goods Market

Aided by global currency fluctuations and continued purchases by “borderless consumers,” the personal luxury goods market expanded to more than US$277 billion in 2015. That represents 13% growth over 2014 at current exchange rates, but real growth (at constant exchange rates) has eased to only 1% to 2%. The slowdown confirms a shift to a “new normal” of lower sales growth in the personal luxury goods market. The challenge for luxury brands in this environment is to successfully navigate market volatility driven by currency swings and fluctuating tourist flows.

The world’s largest publicly traded luxury goods companies generated sales of some $222 billion in financial year 2015, 3.6% higher year-on-year. The average luxury goods annual sales for a Top 100 company is now $2.2 billion. The global luxury goods sector is expected to grow more slowly in 2016, at a rate many retailers may find disappointing. Businesses are undergoing headwinds in markets such as China and Russia, although some markets continue to perform well and there are pockets of opportunity across the globe. India and Mexico for example are growing quickly, the Middle East offers further growth potential, and the U.S.– the world’s largest luxury goods market, is underpinned by a solid consumer spending environment. The European luxury goods market has bounced back since the difficult days of 2012-2014 but national economies are recovering at different rates.

China’s Role

In mainland China, the slowing economy has resulted in lower spending, and government measures against luxury gifts in the corporate sector have also had an impact. The country’s performance depends on how quickly the government can shift the focus of China’s economy from construction and industry to consumer spending. Exposure to China explains, in part, the rather average performance of luxury goods share prices over the last 12 months.

Chinese consumers play a primary role in the growth of luxury spending worldwide. They account for the largest portion of global purchases (31%), followed by Americans (24%) and Europeans (18%). Chinese shoppers continue to spend far more abroad than in Mainland China, which accounts for only 20% of their global purchases

Shifts in Purchasing Behaviours

There is also a shift in consumers purchasing behaviour. Empowered by social networks and digital devices, luxury goods consumers are dictating increasingly when, where and how they engage with luxury brands whether it be online or in a shop and demanding a more personalised luxury experience. Luxury goods companies must seize and develop the digital opportunity.

The Decade of Change

The luxury goods sector has now passed the mid-point of what some analysts have termed the ‘decade of change’ and predict there will be a discernible difference between 2010 and 2020. The first half of this period was characterised by the Chinese consumer and the explosion in the use of online technology. This period offered up strong growth, new markets and exciting channels.

The second half of the decade will be a transitional period for luxury goods companies. Industry analysts predict a sea change in consumer buying behaviours; the merging of channels and business model complexity; an increase in international travel and the growing importance of the millennial consumer. Certainly the global economy will remain an important underlying influence.

That said demand for luxury goods is still growing despite near term economic challenges. For the world’s leading luxury goods companies, low oil prices have mostly been good news. Lower fuel costs have translated into increased purchasing power for consumers and higher real (inflation-adjusted) wages in most major markets.

LVMH Moët Hennessy Louis Vuitton

Macrovue’s Dream Up Vue holds LVMH Moët Hennessy Louis Vuitton (LVMH), the world’s largest luxury goods conglomerate and a dominant player in the global luxury goods market. Through its Louis Vuitton segment it makes and sells high end leather goods, luggage, and accessories. It produces champagne under the brands Moet & Chandon, and Veuve Clicquot. LVMH also produces cognac through the Hennessy label – which represents nearly half of the world’s cognac. The company manufactures perfumes, cosmetics, watches and jewelry, as well as haute couture through its Christian Dior, Marc Jacobs and Loewe brands.

The company controls over 60 brands. Recognizable names would be Krug and Dom Perignon Champagnes; Loro Piano, Thomas Pink, and Australia’s R.M. Williams in apparel; Bulgari, Tag Heuer, De Beers Diamond Jewelers, and Zenith in watches and jewelry: Guerlain, Pafums Givency, and Kenzo Parfums in perfume and cosmetics. LVMH also owns DFS (Duty Free Stores), Le Bon Marche (the iconic Paris department store) and cosmetics retailer Sephora.

As an institutional portfolio manager, I have been an investor in LVMH off and on for a number of years. I have also owned, at one time or another, Bulgari, Hermes (a portion of which LVMH just divested), Christian Dior, Richemont, Michael Kors, Burberry, and Tiffany. Luxury goods has traditionally been a growth industry driven by the aspirational desires of consumers, globalization, and increased world travel. It is also a category that can raise and maintain premium prices via strong brands and superior workmanship. I have always preferred it to general retail.

LVMH shares are not expensive – trading on a headline 2017E P/E of 18X, a 10% discount to the sector. LVMH is a true global player, tends to absolutely dominate most of the categories that it operates in, and generates some of the highest operating margins in the industry. Euro depreciation is a huge tailwind (a 10% depreciation in the euro increases EBIT by some 5%), and guidance given in the most recent earnings release suggest end market confidence in 2016/17.

Retail (even luxury retail) is a cyclical business. Fortunately the most cyclical segments of LVMH are probably less than 30% of total sales and would include champagnes, watches and duty free shopping. Vuitton on the other hand, is almost 50% of sales and remains one of the industry’s strongest and most profitable brands via the legacy of a long track record of innovation and a sophisticated supply chain.

Analysts have pointed out that while LVMH, Richemont, and Kering have acquired a plethora of luxury brands over the past decade and a half there are still a number of high quality privately held firms that may be pressured by the current global macroeconomic environment and subsequent currency fluctuations.

Brands such as Chanel, Versace, Ermenegildo Zegna, Rolex, Patek Philippe, Audemars Piguet, and Chopard could possibly be in the sights of larger acquirers such as LVMH in 2016. With a net debt / EBITDA multiple of less than 1 and fixed charge cover of 4X, LVMH is lowly geared and could easily absorb further selective acquisitions.

See Clay Carter’s article in The Australian October 4 2016 – To Invest in luxury, consider the famous four

Risks

  • Changes in demand for luxury goods are correlated to the macroeconomic environment and the health of consumer spending patterns. Any major change in the political or economic status quo may affect consumer confidence and LVMH’s sales. A hard landing in China, for example.
  • LVMH’s businesses are highly dependent on sales to tourists and thus vulnerable to geopolitical developments such as terrorism.
  • The group is an exporter of products sourced in Europe and therefore can suffer adverse pressures from currency.
  • The key profit centre in the group and over 50% of enterprise value (EV) is Louis Vuitton. Demand for Louis Vuitton products has grown at very positive rates. However, the product is overtly branded and the group would be vulnerable to changes in consumer taste in this area. (However it has been producing high demand leather goods since Louis XVI was on the throne of France!)
  • Counterfeit goods remain a problem for luxury goods companies notably for the Vuitton brand.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.