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Losing Hong Kong: A Catastrophe for Luxury Retail

Violent clashes between pro-democracy protesters and China’s government spell long-lasting damage to the local retail sector, leaving Richemont, LVMH, Kering and others exposed. What options do brands have? BoF does the analysis.
Riot police officers rush through the streets during anti-government protests in Hong Kong | Source: Getty Images
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  • BoF Team
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Hello BoF Professionals, your exclusive 'This Week in Fashion' briefing is ready, with members-only analysis on the key topic of the week and a digest of the week's top news.

Luxury is highly exposed to key global cities: the world’s top ten fashion capitals account for one-fifth of all luxury points of sale. Not long ago, Hong Kong alone was responsible for more than five percent of global luxury sales, according to analysts, putting its importance up there with Paris. This is unlikely to be the case this year.

Months of clashes between pro-democracy movement and the Chinese government have already put a serious dent in luxury retail. And matters came to a head earlier this week as protesters shut down Hong Kong International Airport — a gleaming symbol of the city’s long legacy of internationalism, openness and efficiency — landing the conflict on the front pages of newspapers worldwide. The latest round of protests, which kicked off ten weeks ago in response to a proposed extradition law, have since become a wider call for the government in Beijing to honour the city’s autonomy and the “One Country, Two Systems” agreement made when the island was handed back to China, in 1997, after 150 years of British rule.

Currently, Hong Kong is a special administrative region (SAR) that has its own currency, a common law legal framework and liberties not afforded to mainland citizens — such as freedom of speech and of assembly — while remaining a part of the People's Republic of China. But the agreement that underpins the city’s special status is due to expire in 2047 with no clarity about what happens next, making locals nervous. Indeed, many fear their current rights will be revoked in far less than 28 years’ time. While Beijing sees the protests as terrorism, the Hong Kong protesters view their actions as a response to an existential crisis.

This week’s airport flare-up, which started as a peaceful sit-in, included calls for an end to alleged police brutality, particularly the use of pepper spray and rubber bullets against demonstrators. The increasingly violent confrontations between protestors and police — who have strong support from citizens in mainland China, where the government has been stoking nationalism — have pushed the situation into a dangerous new phase that, some say, could end in a military crackdown, prompting renewed consideration about the long-term impact for the luxury sector, which has long relied on Hong Kong.

Following days of disrupted and cancelled flights, the scene has calmed at the airport after a court injunction ordering the protesters to leave, but it’s far from the end of the story.

Some are comparing the fallout for luxury sales to the impact of the gilets jaunes protests in Paris, which hit the French capital in 2018 during its peak holiday spending season. Research from RBC Capital Markets found that European luxury goods groups derive about six to seven percent of their sales from France (a proportion similar to Hong Kong). Estimates suggest that sales in France fell about 10 percent (excluding currency movements) in the fourth quarter. This precedent will make luxury executives nervous about their performance in Hong Kong. The Hong Kong Retail Management Association has already revised its total retail sales projections for 2019 from single-digit growth to double-digit decline.

Even if the issue is resolved, the industry needs time to recover and tourists need to regain confidence in Hong Kong.

Unlike the gilets jaunes movement in Paris, however, Hong Kong protesters have not overtly targeted high-end retailers. But this doesn't mean luxury hasn't been seriously impacted as protestors moved en masse into Hong Kong's central business district, where a great deal of luxury retail is concentrated. Stores have routinely being forced to close in the district, and more recently at the airport. The result has been a painful pinch in a market with one of the world's highest retail rents.

According to data from UBS, Richemont is the most exposed to disruption in Hong Kong, with an estimated 11 percent of its sales coming from the market. Swatch gets about 10 percent of revenues from Hong Kong, while Burberry makes about 9 percent of total sales there. Though less exposed, UBS also cited Hermès, Moncler, Prada, Tod's, Ferragamo, Kering and LVMH as being “at risk.”

Though analysts say the exact impact of the protests on sales at each company is “difficult to estimate,” they pointed to a potentially greater threat in the form of souring investor sentiment. The city’s large scale ‘umbrella movement’ protests in 2014 resulted in the luxury sector losing about 23 percentage points on its price-to-earnings ratio, compared to the broader MSCI Europe index.

In spite of these concerns, optimists point out that Hong Kong retailers have shown resilience in the past, bouncing back quickly from those 2014 protests, which lasted almost three months but were less confrontational. According to Annie Tse, chairwoman of the Hong Kong retail association, this time is worse as the protests are taking place over a wider area.

“Even if the issue is resolved, the industry needs time to recover and tourists need to regain confidence in Hong Kong,” she said.

Last year, tourists accounted for about 80 percent of luxury spending in Hong Kong, with the majority of that spend coming from mainland Chinese tourists, 350,000 of whom will not be travelling to Hong Kong this year due to the protests (according to estimates from HSBC).

But, it would be a mistake for brands to believe the lessening of mainland tourist spend in Hong Kong is just about the recent protests. Hong Kong tourism data shows mainland arrivals declining since January, long before the protests began, with more far-flung destinations gaining in popularity among tourists with a “been there, done that” attitude to the city.

Meanwhile, the yuan’s recent slump to an 11-year low (seen by many as a reaction to new tariffs introduced by the US as part of its ongoing trade war with China), make it even less attractive for mainland visitors to buy big ticket items in Hong Kong, where the local currency is pegged to the US dollar.

It will be very bad in the short term, but it's too early to know what will happen long term.

Moves from Beijing have also impacted Hong Kong's mainland tourist spend, with a government crackdown on cross-border daigou agents and a reduction in tariffs for imported luxury goods working to rapidly refocus luxury spend within mainland China.

“The only good news there is that if there are less Chinese tourists in Hong Kong, they buy more in the local market,” L’Oréal Chief Executive Jean-Paul Agon said after the company’s recent earnings report. “I think it will be more [of] a tailwind than a headwind.”

Hong Kong’s escalating protests are a problem with no immediate end in sight, but brands operating within the SAR in order to reach mainland tourists should be able to offset some of their losses by shifting resources to the massive market next door. And if Hong Kong becomes more aggressive at targeting other nationalities, some of the tourist spend loss could theoretically be recovered.

For years, Hong Kong’s proximity to the mainland has made it a valuable launchpad for those looking to enter the Chinese market. As the city’s east-meets-west culture allows companies to court a diverse global audience and gauge demand from Chinese visitors, brands from Moncler to Charlotte Tilbury have opened freestanding stores there before crossing the border. But in response to the airport shutdown, there are now murmurs of neighbouring Shenzhen becoming a mainland beneficiary of Hong Kong's volatility.

As Mario Ortelli, managing partner of luxury advisors Ortelli & Co, points out, many luxury companies run their Chinese and even Asia-Pacific operations from tax-free Hong Kong and keep inventory there, but he believes the climate would need to get significantly worse before companies decide to relocate these operations.

“Luxury companies need to decide what is their ideal footprint in a market that clearly doesn't have the same sales [as it did previously] … [And] how to perhaps rebalance their operations between Hong Kong and mainland China,” he said. “It will be very bad in the short term, but it’s [too] early to know what will happen long term.”

In the meantime, brands need to find ways to rebalance their footprint in Asia, and fast, but they will continue to be caught between a rock and a hard place for as long as tensions remain between officials in Beijing and protesters in Hong Kong.

THE NEWS IN BRIEF

FASHION, BUSINESS AND THE ECONOMY

Canada Goose ad | Source: Canada Goose

Canada Goose misses margins on higher sales of less profitable clothes. The luxury apparel maker's quarterly gross margins missed estimates Wednesday, as it sold more of its light-weight spring season clothes, which are not as profitable as its $1,000 parkas. Toronto-listed shares of the company fell as much as 5.4 percent. Known for its cold-weather, fur-trimmed parkas, Canada Goose ventured into raincoats, light-weight jackets and knitwear a few years ago to cater to seasonal needs and to move away from fur, which has increasingly become distasteful.

Macy's tanks after forecast cut, signalling department store woes. The retailer's shares plunged 15 percent Wednesday after a worse-than-expected second quarter, underscoring investor fears that department stores are slated for more pain ahead. Macy's, which is the first in its sector to report earnings, slashed its profit outlook for the year by 20 cents, and warned that the cut doesn't even take into account the next round of Chinese tariffs, some of which will hit as soon as September 1. CEO Jeff Gennette insisted that per-share profits would not drop by more than 5 cents due to tariffs.

Nike launches new subscription service for children. The service is the sports giant's latest plan to keep shoppers coming back to its brands as it struggles with strong competition from Adidas in its US home market and a resurgence of retro brands like Fila and Reebok. With three tiers of subscription – $20, $30 or $50 a month – Nike Adventure Club is aimed at 2 to 10-year olds and effectively gives subscribers a new pair of Nike sneakers once a month, once every two months or once every three. Nike hopes to woo parents with the offer of fewer trips to the shoe store in exchange for brand loyalty.

Allbirds steps into apparel with sustainable socks. The company is dipping its toes in the apparel market with its first non-shoe product: socks, made from a new yarn called Trino — a blend of the company's existing tree and Merino fibres. The socks are meant to keep your feet sweat-free, whether you're wearing Allbirds shoes or not. The socks' fibres also incorporate recycled plastic water bottles; Allbirds claims they are 100 percent carbon neutral as part of its ongoing commitment to creating sustainable products.

The Extinction Rebellion group plans to "shut down" London Fashion Week. On July 26, the organisers of the Extinction Rebellion wrote to the British Fashion Council "begging them" to cancel London Fashion Week. Caroline Rush, CEO of the BFC replied to the plea, agreeing that the climate change emergency required action. This, however, was not enough to pacify the environmental activists, many of whom took part in the mass demonstrations against global warming in London back in April. They are now mobilising supporters to "shut down" the five-day fashion event in mid September.

Pandora turns to Harry Potter in bid to relaunch brand. Following poor results in key markets and waning favour from investors, the danish jewellery company has signed a contract with film production company Warner Bros as part of its two-year restructuring plan. Pandora will introduce a 12-piece jewellery collection including charms, pendants and a bracelet based on the characters of the Harry Potter franchise, available from late November.

Britain's number of empty shops hits the highest level since 2015. The number of empty shops hit its highest rate in four years in July. The national town centre vacancy rate was 10.3 percent in July, up from 10.2 percent in the previous quarter and the highest since January 2015. Shopper footfall also fell by 1.9 percent, the worst decline for July since 2012. Footfall was down 2.7 percent on UK high streets and down 3.1 percent at shopping centres but up 1.2 percent at retail parks. The ongoing challenges faced by brick-and-mortar destinations is reflected in the rising vacancy rate.

THE BUSINESS OF BEAUTY

Olaplex haircare products | Source: @olaplex via Instagram

Californian start-up beats L'Oréal in patent feud. In a David and Goliath-like case, Olaplex, born in a Santa Barbara garage to a pair of polymer chemists, accused L'Oréal of stealing trade secrets in 2015. L'Oréal may face charges of up to $91.3 million for stealing Olaplex's trade secrets, breaching a contract and infringing two patents related to a popular, three-step system that protects hair during bleaching treatments. Olaplex expects to net about $37.4 million once US District Judge Joseph Bataillon has combed through the damages. The jury also found that L'Oréal's acts were intentional, leaving the door open for the damages to increase at the judge's discretion.

Natura's second quarter profit more than doubles, beating estimates. The Brazilian cosmetics group has said its second-quarter net profit more than doubled from a year ago, slightly above market expectations, helped by solid sales growth in all segments as well as cost cuts. Quarterly net income grew by 109.4 percent year-on-year to 66.6 million reais ($16.6 million) compared to a consensus estimate of 61.7 million reais ($15.3 million). The company said all three of its brands — Natura, Aesop and The Body Shop — contributed to the quarter's performance and that it hopes to complete its acquisition of Avon Products in early 2020.

Botox rival Jeuveau reports early sales. Evolus has reported revenue of $2.3 million from early sales of its newly launched rival to Allergan's Botox, ahead of its own expectations. Jeuveau, a neurotoxin drug to treat forehead wrinkles, was launched on May 15 and competes with Botox, which has grown to dominate the medical aesthetics market since it was launched in 2002. Evolus has rolled out a marketing program called J.E.T (Jeuveau Experience Treatment) that links clinics to customers. The company said over 5,000 accounts had enrolled in the program in the first 90 days of its launch, exceeding its own expectation of 3,000.

PEOPLE

Anna Wintour at the 72nd Annual Tony Awards | Source: Getty Images

Condé Nast announces leadership restructuring. As part of Condé Nast's management restructuring, Anna Wintour has been named global content advisor, an addition to her existing role as US artistic director and editor-in-chief of Vogue US which will add oversight of Vogue International to her responsibilities. Wolfgang Blau, president of Condé Nast International, has also added international and chief operating officer to his title. Pamela Drucker Mann, formerly chief marketing officer of Condé Nast, has been named global chief revenue officer and president, US revenue. Jamie Jouning has been promoted to chief client officer.

Canada Goose hires design lead from Columbia Sportswear. Woody Blackford has been named executive vice president of design and merchandising at Canada Goose. Blackford will join the company in autumn 2019 from Columbia Sportswear Co., where he was most recently vice president of global design and innovation. The outerwear brand also announced that Chief Product Officer Lee Turlington will be stepping down at the end of 2019 to return to his consulting practice.

MEDIA AND TECHNOLOGY

The RealReal rises after reporting smaller net loss than expected. In the company's first quarterly results since its May IPO, revenues rose 51 percent to $71 million in the second quarter, beating the estimate of $70.1 million from analysts. The resale company still posted a net loss, although it was slightly narrower than expected. Shares rose as much as 20 percent to $20.42 in late trading Tuesday, above the IPO price of $20 after a recent decline.

Amazon faces backlash for T-shirts with Hong Kong democracy slogans. Chinese social media users directed their fury at Amazon Thursday, after discovering T-shirts on its website sporting slogans that support anti-government protesters in Hong Kong, such as "Free Hong Kong, Democracy Now" and "Hong Kong is Not China." The hashtag "Amazon T-Shirts" became the fourth-top trending topic on Weibo in the latest backlash for an overseas company that broached matters regarding Hong Kong's territorial status. Amazon has not yet responded to requests for comment.

Snap launches new augmented reality Spectacles. The new version of Snap Inc's eyewear will be able to capture photos and videos and upload them directly to Snapchat, as the company works to develop its augmented reality features. Snap has struggled to make money from its Spectacles business, and wrote down $40 million in unsold glasses in 2017. Spectacles 3, which will begin shipping in the autumn, will cost $380 (almost twice the previous version at $200 apiece) and will have dual cameras to add depth and dimension to photos and videos.

Alibaba defies China slowdown as sales beat top estimate. Quarterly revenues beat the highest analyst estimate after personalised shopping recommendations and a June sales bonanza drove up China's leading online retail business. Revenue rose 42 percent to 114.9 billion yuan ($16.3 billion) in the three months ended June, surpassing the 111.6 billion yuan average estimate. Shares climbed 2.6 percent in pre-market trading. Alibaba, whose business is predominantly domestic, is riding a surge in internet shopping in defiance of a slowing home economy.

China's JD.com beats revenue estimates, forecasts upbeat third-quarter sales. The Chinese e-commerce company posted better-than-expected quarterly revenue and forecast third-quarter sales above Wall Street estimates. Sales from its product segment, which includes online retail sales, rose about 21 percent to 133.52 billion yuan (around $18.95 billion) during the quarter. Total net revenue rose 22.9 percent and shares were up 5 percent as a result. Both JD.com and bigger rival Alibaba Group Holding are seeking to diversify amid slowing e-commerce revenue growth at home.

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