They were hit by the recession, but luxury goods firms are bouncing back spectacularly – and it’s mostly driven by China. Simon Wilson reports.
Don’t rich people always spend?
There’s a persistent myth that luxury goods sectors sail through recessions because the rich keep spending, come what may. But it’s just that – a myth. The business of luxury is highly cyclical. The early part of the 2000s were a dire time for the market: the terrorist attacks in America, the Sars scare and the Iraq war all put a dampener on demand for international travel and deluxe items. There was then a strong upswing from 2004 to 2007, followed by a slump with the onset of the financial crisis. Luxury retailers, which were growing a hefty 9% a year before the recession, saw sales slump by more than 13% from 2007 to 2009, according to a recent report on the sector from management consultancy firm McKinsey. Luxury manufacturers were down 21%.
What about now?
The past year has seen a pretty spectacular bounceback which is continuing to gather pace. LVMH, for example, reported a surge in sales of 18% in 2010, compared with a 9% fall in the previous year. PPR reported 14.4% growth in the fourth quarter of 2010. And both these companies, plus Richemont (the owner of Cartier), have just reported stunning sales growth in recent months, especially in Asia. Richemont reported Asia-Pacific sales up 57% in the fourth quarter; Hermes said its Asia-Pacific (ex-Japan) figures were up 45% year on year. And this week the jeweller Tiffany projected worldwide sales to rise between 12% and 14%.
What’s going on?
In a word, China. The luxury market is pulling out of recession globally, but Chinese growth is the engine. China is already the largest single market for Louis Vuitton, for example. Brokerage firm CLSA projects that the luxury-goods sector is likely to grow at an annual rate of 25% for the next five years (compared to overall growth in consumption of 11% annually). By 2020, China will account for getting on for half the total global market – 44%, compared to 15% now – if purchases made by Chinese people abroad are included. According to CLSA analyst Aaron Fischer, there’s been a complete turnaround in a decade. Today, says Fischer, “you have mainland Chinese queueing up to buy real luxury goods outside the Louis Vuitton store in Hong Kong, while in Kowloon you might find European tourists looking around in side alleys for fake goods.”
What’s driving the expansion?
Rising wealth in China, together with – according to a recent McKinsey report on the sector – the “shifting social mores that sanction the display of that wealth”. Markets are opening up not just in the large coastal cities: growing wealth in new geographic markets is creating sizeable pools of luxury consumers in 30 Chinese cities today, rising to 60 cities in five years’ time. In addition, McKinsey credits an explosion of information available on the internet (still a small channel to market for the luxury sector, but fast-growing) and a massive rise in overseas travel by wealthy Chinese.
Why does that matter?
A hefty 55% of all luxury purchases by Chinese people are made outside mainland China (according to CLSA). That’s partly because they want to avoid high import duties that can top 30%, and partly because of the endemic counterfeiting in China. The authorities have launched a huge crackdown in recent months, arresting more than 3,000 suspects across the country. In addition to growing wealth and travel, there are other social and economic factors that mean China is set to dominate the luxury market. Chinese millionaires are younger than in other countries – average age 39 rather than 54 – so they spend sooner. For now, Japan remains the single largest market for most luxury goods, but China is rapidly closing, and projected to overtake it by 2015.
Why else is China different?
Compared to other countries, the market is male-dominated – due to the culture of gift-giving in business. That means that there is plenty of room for further expansion into the traditional female areas, such as apparel and accessories. Moreover, at the top end, consumers appear to be less price-sensitive. Indeed, some analysts argue that there remains a cultural attitude in China that paying top whack is part of the attraction.
There is backing for this view in a McKinsey survey, which found that only 8% of Chinese luxury consumers reined in spending in 2009, compared to half of Americans and Europeans. More concretely, there is evidence from the astonishing surge in prices paid for fine wines, up 40% last year, driven by Chinese demand. A sign of a bubble economy about to go pop? Perhaps, but for now, the luxury sector is cashing in.
How to play the boom
Investors looking for some exposure to the luxury market can buy directly into the well-known listed European brands that are selling to Asian consumers and the Chinese in particular. However, finding a bargain isn’t easy. But ongoing consolidation – including the possibility of acquisitions by Chinese businesses – could further boost stock prices. For more China-focused exposure, CSLA’s Aaron Fischer suggests Hong Kong-listed global player La Occitane (HK: 973), the high-end beauty-product maker. It trades on a forward p/e ratio of 23 and a forward p/e to growth ratio of just over one. Prada plans to float in Hong Kong later this year, but in jittery markets, after Japan’s disaster, a successful float is far from guaranteed.