Luxury Outlook | Richemont reels

Jude Law for Dunhill, courtesy of Dunhill

ZURICH, Switzerland “Demand for luxury goods…has fallen dramatically and Richemont is currently facing the toughest market conditions since its formation 20 years ago…we see no cause for optimism. We must assume that there will be no significant recovery in the foreseeable future and plan accordingly to cope with this situation.”

With those ominous words in its trading update on Monday, Richemont provided the first concrete signal to the luxury industry of the depth of the global downturn, raising the question of its long-term impact on the sector as we know it.

Sales at Richemont for the third quarter of fiscal 2008 were down 12 percent overall, on a constant currency basis, but down seven percent when taking into account the dramatic currency fluctuations of recent months, which have seen the dollar and the yen soar versus other currencies.

Still, the larger than expected drop in constant currency sales was nothing less than astonishing, catching many analysts off guard with a performance that was below already conservative expectations. The plunge was led by a 28 percent decline in U.S sales, echoing an American trend seen at Saks and Neiman Marcus in recent months.

Japanese sales sank 18 percent and Europe declined nine percent. China was the only bright spot, but even its 24 percent spike couldn’t make up for an anemic performance almost everywhere else.

In notes to the investor community today, analysts weighed in on the surprising news. Luca Solca, Senior Research Analyst at Sanford Bernstein advised against any short-term investments in the sector, saying that “luxury stocks are unlikely to re-rate in the short-term, but rather risk remaining range-bound as the macro environment continues to worsen.”

For her part, Lisa Rachal, a Partner at equity research firm Redburn Partners, raised the question as to whether we are facing just a “cyclical downturn,” or a more permanent “structural correction” in the size of the luxury goods market overall.

It’s a good question and it also raises the another one. If the market shrinks, who will disappear?

One theory says that “affordable luxury” will suffer as customers retreat to their comfort zones. For the rich, this means only the best products (no trading down) and for the poor, it means highly accessible, mass-produced products (“value retail” as another expert recently described it to me), theoretically leaving an eviscerated swath in the middle of the market, where Coach, Juicy Couture, and Theory are playing.

Others say that small, independent brands are the most at risk. With tough credit conditions in a highly cash-flow intensive stage of their development, these businesses lack the oxygen they need to grow. What’s more, they argue that department stores will flee to “names people know,” a euphemism for those with big brands and advertising firepower.

But big brands are not immune to this slow down either, especially if we take a longer-term perspective of what is going on. Unlike small fragile businesses or overextended banks, it may take years for the eventual decline of some of the big brands we know to play out, as it is unlikely to come from cash flow or liquidity issues. But, it will happen, eventually. Even big names, as we have already seen across the retail sector (and the economy more generally), can fail.

So in truth, there will be companies who will struggle in all of these segments, while others will thrive. This is a good thing. Joseph Schumpeter called it creative destruction; the process whereby sleeping giants are replaced by innovative upstarts over the longer-term.

In the meantime, we await the latest results from Burberry, which will be announced Tuesday morning in London, and the debut of Kim Jones menswear collection for Richemont-owned Dunhill, which will be unveiled in Paris on Sunday.