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Luxury Goods – The Continuing Uptrend

03.01.2014

Driven by the increasing purchasing power of the middle class in emerging countries, particularly Asia, and stronger trends in the US and Europe, luxury goods brands are enjoying strong sales growth and the industry is in a secular uptrend.1

Luxury Goods – The Continuing Uptrend

The biggest surprise in 2013 was that, despite many macroeconomic concerns, Chinese consumers continue to be the most important customer for the luxury industry, accounting for 25 percent of global luxury goods sales through purchases at home and overseas. While China's domestic luxury sales growth for many brands was in the low single digits during the year, overseas spending by Chinese tourists was unprecedentedly strong. In fact, it is estimated that roughly 80 percent of purchases occurred outside Mainland China, given the higher import duty favoring Chinese tourists to shop in Macau, Paris or New York. Typically, a luxury lady's handbag costs 40 percent less in Paris than in Beijing. This shift towards an increasing proportion of Asian consumers is ongoing and happening for most luxury goods brands.

Chart 1

Chart 1: Development of luxury goods market by consumer nationality

Source: Bain & Co.

Valuations based on P/E ratios in the luxury goods industry vary significantly, depending on product category and geographical breakdown of sales. However, luxury goods companies typically trade at a premium to the overall equity market given superior sales and earnings growth as well as high margins and strong balance sheet metrics. The Credit Suisse Global Soft Luxury Index (including producers of leather goods, clothes etc.) is currently trading at a 12 month forward P/E ratio of 18.3x, whereas the Credit Suisse Global Hard Luxury Index is trading at a historically low multiple of 14.9x. Italian brands look more expensive on a P/E comparison compared to French and US brands, while Asian high end brands are trading at multi-year lows. The Credit Suisse Asia Luxury Index is trading now at a P/E of 11.7x. In 2013, sales in the US and in Asia have started trending upwards. Thanks to this Asian and US-led recovery, we now expect the luxury goods industry to grow sales by 11 percent and earnings by 13 percent for 2013. We expect higher sales for 2014 and have identified the following five strong themes.

The rise of Americas' luxury consumption

In the US luxury market, continuing strength in major cities like New York and Miami can be observed through all luxury categories including luxury real estate. Investors should keep in mind that there are 442 US dollar billionaires in the country, almost four times that of China. Flagship stores of leading European brands who have been underrepresented in the major US cities have been growing at double digits recently. This stronger demand has been driven by a stronger domestic luxury consumer base as well as an increase in tourists from emerging markets. For instance, stores located in popular tourist areas frequently visited by Brazilian tourists are booming. Some high-end brands in Miami are enjoying same store sales growth of between 30-80 percent. Miami is definitely best positioned to be the gateway for Brazilian tourists.

Chart 2

Chart 2: Growth contribution by consumer group (2013-2020E)

Source: CLSA

Asian-led luxury sales recovery

Looking at Asia's spending on high end product categories, two key indicators, namely Chinese jewelry retail sales and Macau's VIP gaming revenues, continue to show recovery strength. Jewelry retail sales in Hong Kong increased by 30 percent y-t-d to August, the ninth consecutive month of double digit growth. China's jewelry retail sales were up 29.6 percent y-t-d to September. Positive surprise continued to come from Hong Kong listed jewelry retailers reporting strong sets of same store sales growth in Q3 2013. Across their stores in Hong Kong and Mainland China, they achieved solid same store sales growth of 18-30 percent. We expect the jewelry sales momentum to continue, with a sector re-rating to follow.

Casinos in Macau also benefited from the obvious pick up of high roller gaming and broad based tourism arrivals. After a brief pause in 2012, Macau's VIP gaming revenues are firmly in double digit growth territory, growing by 10.7 percent for the first nine months of 2013. Given the low market expectations for VIP gaming and the robust mass market gaming revenue growth, we believe Macau gaming names will continue to be in a sweet spot. Some of the brands we are invested in have reported their best same store sales for their Macau stores.

Strong luxury markets emerging in South East Asia

Today, the South East Asia luxury market is growing at a similar pace to the Chinese market. It is a quarter of the size of the Chinese market but is making a significant contribution to global luxury goods spending. Luxury malls in cities like Bangkok are rising and growing at 25 percent a year with several new luxury developments coming up in the next three years. In fact, Thailand is planning to allow Chinese tourists to enter the popular holiday destination without tourist visas and, at the same time, will significantly cut import duties for luxury brands, helping it compete with places like Hong Kong and Macau in the future.

Elsewhere, the Indonesian onshore luxury market has doubled in size since 2007 to USD 1bn currently. More importantly, if you include the offshore spending of Indonesians in Singapore, the number is even more promising. The "Singonesia" luxury goods market should reach around USD 8bn by 2015, representing the lion's share of the luxury market in South East Asia.

1The figures in the text are based on information provided by individual companies in the luxury goods industry, research papers by sector specialists and own analyses and estimates.

Quote by François-Henri Pinault:

"The world number one jewelry brand is already Chinese. Creating a luxury brand is not only about branding but is about its heritage and experience. I believe that we will see very significant Chinese brands but I believe it will be in categories other than apparel."

Source: François-Henri Pinault, Chariman and CEO, PPR, March 2013, Thailand Tatler Magazine 02/2013

More M&A and more Italian IPOs in the luxury goods industry

Most leading brands have sizeable cash holdings. There is a visible trend to deploy cash for acquisitions of strong established brands as well as new Asian brands offering the potential to expand globally. Many Chinese luxury brands have emerged in the last years and could be targets for European luxury groups. For instance, the French luxury giant Kering (Gucci Group) is continuing to divest its non-core assets and develop their luxury brands portfolio. It recently added a Chinese luxury jewelry brand called Qeelin and the Italian jewelry brand Pomellato to their portfolio. LVMH acquired the ‘King of Cashmere' Loro Piano to strengthen their top of the pyramid luxury offering.

After a quiet period, we expect to see a clear acceleration of initial public offerings (IPOs) for distinctive global luxury brands. Many well-known and large luxury brands, especially in Italy, are still owned by founders, families or private equity investors. Most of the mid-sized luxury brands might have to raise capital to finance their expensive store expansion into emerging markets. Given the improved market conditions, we also expect some private equity investors to look for an exit in the coming months.

Domestic European recovery

The recovery in Europe is still fragile. But after five years of decline, executives at luxury brands have pointed out that demand has at least been stable in markets like Italy, with very positive developments in markets like Germany and the UK. Europe could be the most important positive surprise in H2 2013 and beyond, considering the improving domestic spend that will add to the continuing boom of overseas tourist demand.

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