LONDON, United Kingdom — The luxury goods market is drifting under the influence of disparate variable factors, with few fixed reference points in sight: the global economy remains unsettled; the easy option of adding more stores in China is no longer available; Chinese visitor numbers to Europe are falling; foreign exchange rates are all over the place; inventories are high and consumers are spoiled for choice.
In trying to understand how investors in the sector are managing their portfolios, I have identified four distinct investment strategies: hiding away, bottom fishing, looking for quality fallen on its face, and backing the self-helpers. Each of these strategies has its merits and supporters, based on the compromises one is willing to accept.
When I talk of hiding away, I’m thinking of people who are happy to play safe pending better times. These are people with a long-term approach who want stability. At times like this, they probably also invest in commodities.
LVMH and Hermès come to mind. Two very different companies — one the champion of “mass luxury,” the other the epitome of high-end, although in practice much more like a mega-brand than appears at first sight. LVMH has the advantage of size, diversity (by category, price and geographically) and strong leading positions to help it weather the storms. This combination also means that LVMH tends to be a proxy for the luxury sector and its shares would likely drift if investors decided to avoid exposure to cyclicality and emerging markets.
In this strategy, Hermès has the advantage of being a highly coveted brand with a deep well of pent-up demand and long waiting lists for its iconic products to help reduce cyclical volatility. True, the company’s plans to expand production capacity and develop online risk dimming its aura of exclusivity in the long term. However, proponents of hiding away are looking for short-term havens and believe that quality will always shine through.
“Bottom fishers” have a positive view on the economy. They believe that this is the darkest period of the year, overshadowed by the terrorist attacks in Paris and Brussels. In this view, companies whose share values have dropped very low could bounce back, at least in the short term, as the macro climate improves — assuming it will.
Where to start? Swatch’s brand strength, mix and economies of scale are offset by its management’s lack of capital discipline, but the company could benefit when wholesalers start to restock. Burberry? There’s much going for the brand: digital, cool image and mega-brand status. But each of these factors has a downside as well. Take your pick, if you like...
Quality Fallen on Its Face
Next are investors looking for quality that has fallen on its face. They take a long-term view and are interested in structural appeal rather than short-term trading, but want to make the most of the current volatile environment.
Several names come to mind, including Richemont and Luxottica. At the risk of over-simplifying, the former is dependent on the Chinese and the latter on American consumers. But both have been going through a rough patch and their immediate outlook is mixed.
Richemont’s strength is its oligopoly position in jewellery, one of the most interesting categories in luxury goods, and the fact that it owns some of the best high-end watch brands. It also has a management team focused on returns and cash flow, and which is committed to increasing dividend payments. But it has weaknesses: entry-price point watches; unconvincing forays into leather goods and fashion; high exposure to the Chinese economy.
Luxottica is a de facto monopoly in high-end eyewear. The group has a formidable and well-balanced brand portfolio. It also has a strong retail presence worldwide, which aids planning in an industry where product cycles are short and complexity is high. However, Luxottica’s price points have been out of reach to most emerging market consumers. Also, its CEO transition has been unusually bumpy. Luxottica is a de facto American company — economic weakness in the US and/or a weaker dollar can be cold headwinds.
The most important catalyst for Richemont would be stabilising sentiment on China — possibly helped by the government’s recent stimulus package — and the end of destocking in the wholesale watch market. Luxottica would benefit from stronger confidence on the US economy and a sense that the company’s in-house efforts are on track and that there is stability at the top of the company.
Backing the Self-Helpers
Finally, I come to what I call self-help stories. These are companies that are working hard and trying out different ideas to move themselves forward. Whether their efforts will pay off is another matter — time will tell.
Which brings me to Kering, formerly PPR. The company’s reputation is mixed. On the one hand, the company has divested a hodge-podge of businesses, including its general retail assets, to focus on luxury. On the other, it acquired Puma despite the lack of obvious synergies with the rest of the business. Yet Kering should also be credited with creating a “growth relay” with Bottega Veneta and Saint Laurent. The smaller brands are also doing well. There again, the hard luxury diversification and the Kering Eyewear initiative seem overambitious. That leaves Gucci, where the new CEO and creative director have hit the ground running and the brand, for the moment, seems to be moving in the right direction.
Lots of work, but will it work? Will Gucci succeed, Puma go and Bottega Veneta limit its slide? Would this allow the group’s strengths to shine through?
Four different strategies. Which one is yours?
Luca Solca is the head of luxury goods at BNP Exane Paribas.