GAM’s Scilla Huang Sun reflects on the Q2 reporting season in the luxury segment of the equity market and identifies some interesting themes worth focusing on.
23 August 2017
Most luxury companies had reported Q2 earnings by mid-August. The majority of numbers beat expectations, while a number of CEOs took the opportunity to raise guidance. In addition, the solid trend of luxury sales seen over the past months continued to be evident, but we also saw many interesting details at the company level among winners and losers.
Luxury spending by Chinese consumers again surprised positively while robust economic momentum and reduced political risks in Europe helped bolster consumer sentiment. There were signs of similarly positive forces at work in the US, but the issue of a surplus of retail outlets, coupled with the increase of online shopping, is a mitigating factor. In addition, political concerns regarding the ability of President Trump to push his well-documented reform agenda through Congress is tempering sentiment, leading to a more mixed picture in the US in terms of corporate results.
Outlook - strong fundamentals set to prevail
We expect the strong fundamental trends and appetite for luxury products to prevail, however, companies will have to face up to a higher comparison base in the second-half of the year, while FX is no longer a tailwind. Despite the outperformance of luxury stocks year-to-date, valuations relative to the broader market are in line with history by virtue of earnings upgrades offsetting some of the impact of rising share prices.
Solid luxury sales in Q2 also contributed to a better cost leverage, resulting in higher profitability for many companies. For example, one notable French designer of luxury, sports and lifestyle goods achieved sales growth of 28% in the first-half of the year, which translated into a 57% improvement in earnings over the same period.
We believe that, in overall terms, the luxury industry will achieve organic growth of around 5% or more this year. Consequently, we feel that this robust momentum, coupled with solid financial metrics (ie brand franchises and cash generation), continues to provide a compelling investment story.
A fertile ground for security selection
We continue to see clear winners and losers in the luxury space, where the top iconic brands remain in high demand. This is confirmation of a trend that has been building over previous quarters. At the sub-sector level, the cosmetics segment provides an example of where the luxury end of the universe is growing at a much faster pace than the mass market. Consequently, certain companies in this space are growing in the low double digits, while the results of the laggards are flat or even declining. Meanwhile, the athleisure complex provides another notable example of intense competition where some companies are aggressively stealing market share from their rivals.
We are also seeing some companies reaping the positive benefits of their restructuring efforts and staging recoveries. The most compelling story surrounds a German designer of luxury clothing, which, following a brand rationalisation and a cleaning up of its wholesale channel, has returned to organic growth in Q2, supported by increasing momentum in its online business.
Furthermore, with millennials exerting an ever-increasing increasing influence on the shopping experience, we are seeing an eagerness among luxury companies to stay on top of digital developments. This, in turn, is resulting in a number of boardroom reshuffles as cost control and a focus on core brands races to the top of the agenda.
We retain confidence in the outlook for the luxury market in general and this is reflected in our well-diversified portfolio featuring different luxury segments, including accessories, fashion, jewellery, watches, cars, spirits, cosmetics and high-end food. However, we very much remain focused on developments at the corporate and brand levels, where we believe we can add significant value through bottom-up security selection.
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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.