Magazine Issues » July 2008

COVER STORY: Luxury Goods, Forever Fashionable

Funds that invest in luxury goods also play on emerging markets and could even hold up in a recession, finds Angele Spiteri Paris

cover_story_pic.jpg Let’s hope the recent death of Yves Saint Laurent, the fashion designer, will not come to symbolise the fortunes of expensive fashion houses.

In recent years Hermès handbags have flown off the shelves while the Burberry check has become ubiquitous across every ‘sink’ estate in Europe. Mass wealth increased the appetite for luxury goods, and easy credit put top brands within reach of the less well heeled.

This trend spurred a number of investment managers to launch funds dedicated to stocks in luxury goods companies. Investors did well out of them, with returns in some funds hitting 16% in 2006.

But the credit crunch has seen this easy credit dry up, and with fears of recession haunting the minds of European and US consumers, will not luxury brands fall out of vogue while cheaper clothing labels, like the UK’s Primark, take over?

At first glance, this is what is happening. Luxury-goods stocks and the funds dedicated to them have struggled in the past twelve months. The sector has slipped between 15% and 20% from July last year.

Stocks down
“This year luxury goods funds are doing worse than the indices and consumer confidence is at a 30-year low. The old-standing idea that the sector is not cyclical or is immune hasn’t held up when it came to these stocks,” says Lucia Würmly-Kryenbühl, fund manager for the Clariden Leu (Gue) Luxury Goods Equity Fund.

Scilla Huang Sun, a fund manager at Julius Baer, says: “These stocks are more volatile than their fundamental businesses and so they will react like broader consumer stocks.” There is “no way” that luxury stocks could have escaped the kind of market and economic shocks of the past year, she adds.

 According to Morningstar figures, the Clariden Leu (Gue) Luxury Goods Equity Fund registered a return of -13.4% at end of May 2008, compared to 16.8% in 2006. The Pictet Premium Brands Fund also saw a decrease in returns from 16% in 2006 to -1.4% in 2007 and -10.4% year-to-date.

But the picture for the longer term is different. Caroline Reyl, fund manager at Pictet Asset Management, says: “The market seems to be anticipating some massive earnings deceleration over the rest of the year. But so far there are no signs of it within the luxury sector.”

Companies like LVMH and Richemont showed strong sales figures for the financial year ended March 2008 – with the latter registering a 10% increase in sales and a rise of 21% in operating profit solely from its luxury goods business.

According to a source, Nick Hayek, the CEO of Swatch Group, which offers luxury watches such as the Glashütter brand and has had two record years of earnings in 2006 and 2007, cancelled meetings with analysts after they published negative papers that went against his upbeat forecast for this year. A Swatch spokeswoman said that an April analyst meeting was cancelled but not due to this reason and that the annual March conference call with analysts did take place.

Whatever the case, Hayek was right and exports picked up 22% in April and again in May.

It is the wealthy, being largely immune to recession, who have traditionally supported luxury goods. The spending habits of rich people on discretionary items are much less cyclical than those of the entire market, notes Huang Sun at Julius Baer. She says that there is a dichotomy between the present stock prices of luxury goods companies and the fundamentals of their businesses.

Similarly, Würmly-Kryenbühl of Clariden says: “There is a huge divergence between the stock prices of luxury companies and their actual operating businesses.  So far, all the major companies, apart from Gucci, have come out with strong figures.”

Pictet’s Reyl says there are no indications that sales figures and strong margins should falter at any point in the near future. “If companies are able to maintain their momentum by the end of the year, there should be a massive re-rating in their stock prices.”

Emerging trendsetters
It is the emerging markets that are the crux of the luxury goods story today, much less the developed world’s rich. The main driver of sales of luxury goods has been growth in China, Russia and the Middle East. China alone is responsible for 15% of total world luxury goods consumption, a figure that has been forecast to grow to 24% by 2012.

“There has been no deceleration in sales in these markets,” notes Reyl of Pictet. “In fact, the companies that have performed best are those with exposure to the emerging markets.”

According to data from Clariden Leu, the ratio of sales of developed markets to emerging markets is due to reach 50-50 by 2015. This is a staggering jump from an 87-13 split between 1995 and 2000.

Any amateur psychologist will say that possession of classy clothing labels and jewellery is explained by a desire to portray success. In a paper on the prestige goods industry, professors Antonio Catalani and Giovanni Comboni say: “People feel the need to distinguish themselves, to communicate their social status to other people by possessing symbols of prestige, rare or unique things, things that are special due to their shape.”

This need is exceptionally pronounced in China and Russia as large sections of their people emerge from decades of either oppression or poverty, or both, with a taste for opulence.

But consumers of luxury goods in China and Russia vary a great deal. The Russians all aspire to ostentatious and extravagant items to show the world that they have the money to purchase such things. On the other hand, the Chinese are said to maintain their love of conformity and simply look to keep up with one another in the brand stakes.

Würmly-Kryenbühl says: “Consumers from Russia and China exhibit very different behaviour but always fall back on the same stores and same cycle of mega brands.”

In short, the companies that reach the ‘mega brand’ status are those with the power of instant recognition. The brands that go hand-in-hand with social status – Louis Vuitton and Cartier for example – flourish in the emerging economies as new rich consumers strive to assert their success.

Another reason for the triumph of mega brands in the emerging markets is that the larger companies have the financial muscle to make the investment necessary to break into these new frontiers.

Big budgets
“To penetrate these markets you need to have deep pockets to be able to afford the marketing spend necessary to succeed,” says Huang Sun, at Julius Baer.

Also, businesses like Richemont, LVMH and Swatch have the power to choose the most prestigious locations for their stores in emerging markets.

Isabelle Ardon, fund manager at Société Générale Asset Management, says that the emerging economies of Asia ex-Japan, Russia and the Middle East, can be credited for the boom in luxury goods stocks experienced between 2002 and 2003. “The emergence of these economies brought about a big change in the luxury goods sector, which had not done so well in the years before,” she says.

High-net-worth individuals worldwide have increased by 7.5% between 2006 and 2007. The growth of rich people in the emerging economies is markedly faster.

“The expansion of the Asian market is more than compensating for any potential slowdown in the more mature markets,” says Clariden’s Würmly-Kryenbühl. Interestingly however, consumption in the US has come out quite strong. But this could very well be testament to the power of tourists’ purchasing power.   

Shiny, pretty things
We all probably spend more when on holiday. People may not buy so much luxury on their doorstep; instead they go on holiday in search of ‘shiny pretty things’. The travel aspect is vital within the luxury goods sector, considering around 30% of purchases are made while travelling.

Sales in the US have been buoyed by the high number of tourists visiting the country, fuelled by attractive exchange rates and tax breaks. The weak dollar means international travellers can get more bang for their buck.

Würmly-Kryenbühl says that in Russia, China and India luxury goods taxes are very high and so it is cheaper for those who can afford it to go abroad to Europe and America to purchase goods there instead. This may, to some extent, be reflected in the operating results of Tiffany & Co, where sales at its flagship store in New York City far outshone the sales figures in any of its other US stores, although SGAM’s Ardon notes that this could also be due simply to the greater affluence of New York residents compared to the rest of the US.

All this suggests luxury goods stocks should have greater popularity beyond just themed funds. They are an emerging market play too, and may even be recession busting.

“Luxury goods are never going to go out of fashion,” says Ardon. “At the end of the day people are buying a dream when they buy luxury goods. It is not a rational need and therefore you can’t put an end to it.”

©  2008 funds europe