Active Thinking

At the latest Active Thinking forum, Swetha Ramachandran explains why she expects the Chinese consumer, which forms the engine of the luxury sector, to make a strong comeback in 2023.

15 February 2023

2022 was a challenging year across our asset class but we are strongly hopeful that this year will mark a very different outlook for the sector, primarily because of the return of the Chinese consumer, the engine of the luxury sector. In 2019, the Chinese consumer drove a third of the sector’s demand and 90% of its growth, but has been virtually absent from the world stage for the last three years due to the pandemic. Even following the luxury sector’s strong performance in January 2023, we do not believe the return of the Chinese consumer is anywhere near to being priced into current earnings expectations.

Over half of all Chinese consumer spending on luxury was occurring outside of mainland China in 2019. From 2020 onwards, however, there has been virtually no Chinese travel outside of China. In 2019, there were 170 million outbound Chinese trips, while in 2022 this figure was just 8.5 million (this is the same number as in the year 2000 when China was a very different economy from what it is today). This has meant that the share of overseas spend on luxury – what the Chinese consumer may have spent on luxury were they travelling abroad – has been decimated. Even though there has been a huge repatriation effort, with mainland Chinese business for many companies increasing threefold, not all companies have benefited because they do not all have a footprint within China.

Next, it is worthwhile considering the change between 2021 and 2022. The first quarter of 2022 began strongly, but we then saw lockdowns implemented at the end of March in Shanghai which were crippling, not just from a demand standpoint but also because Shanghai is a logistics hub for many luxury brands. Their Chinese operations were consequently interrupted, which is different from what we saw in 2020 when luxury logistics hubs continued to operate. This all had a cumulative, negative impact on Chinese consumer sentiment, as well as on their access to these goods because of the unavailability of online demand. As a result, Chinese consumers again declined last year even on a like-for-like base when they were consuming at home.

What we know is that this is not attributable to a loss of consumer appetite. Data suggests that the most resilient category in 2022 was luxury beauty, which is 50% online and recovered very sharply, even though it suffered in Q2 because of the interruptions to logistics. In Q3, as soon as the economy opened up and online demand was able to be fulfilled, the luxury beauty market recovered. Unfortunately, the categories which are more exposed to bricks and mortar, such as fashion and jewellery, did not benefit because those are primarily offline, with only 10% online penetration. Consumers were very nervous about going into shopping malls because they had to test each time and at no notice they could find themselves locked up in quarantine inside a shopping mall should it be shut down. Further, there were no occasions: weddings and parties were cancelled or postponed and consumers were not travelling, all of which tend to be big factors behind buying luxury goods. The important point is that, after having rebased to this low level, we believe there is nowhere to go but up and we are already seeing this.

Similar to Western economies when they reopened, Chinese households are benefiting from substantial accumulated excess savings. These are savings that households have made because they were not able to spend over the last three years on travel, experiences or restaurants. These excess savings are highly concentrated in urban households, which are notably the target luxury consuming households because this is where the upper middle class is concentrated. We therefore see attractive confluence here between the ability to spend and the appetite for spending.

We have two precedents supporting this view. Firstly, China itself in 2020 which was first in, first out from the crisis following which we saw a huge wave of revenge spending. This wave of spending occurred when the Chinese had only three months of accumulated savings; they now have close to three years’ worth of savings. The other precedent we have is in Western markets where again, as soon as there has been a reopening, consumers have rushed back towards discretionary spending.

Data points on travel are also recovering quite substantially. Domestic Chinese tourism is already at approximately 75% of pre-pandemic levels, while international travel at the start of the year is at 10% of pre-pandemic levels. Prior to the pandemic, there were three daily flights between Shanghai and Paris and now there are four a week. We expect this to recover over time and for the Chinese to return to the world stage. Europe is likely to be among the top destinations not only because the Chinese consumer is attracted by the cultural sights, but also by the price gap between luxury good in China and Europe which currently, because of the weak euro relative to pre pandemic levels, is between 30-35%. This makes it very attractive for Chinese tourists to travel abroad and shop for luxury.

There is always a question of which country is going to be the next China but we believe, as does Bain in its China Luxury 2023 study, that the answer is that China will be the next China as we have barely scratched the surface in terms of penetration of this market. It is estimated that Louis Vuitton, the biggest luxury brand both in the world and in China, had roughly five million Chinese consumers in 2018. That is five million consumers of a middle class of roughly 400 million set to double to 800 million by the end of the current decade. This clearly demonstrates that there is a substantial runway for the company to expand from current levels without devaluing its brand. China remains the market which is adding the greatest number of mid- and high income consumers. India, south-east Asia and emerging market African countries will play a role but none to the extent that China will, which is why we are excited about the immediate and current recovery of this market.

The decreased contribution of the Chinese consumer (from 33% of global luxury spend to 17% last year) amounts to approximately EUR 33 billion in absolute terms, thereby creating huge scope for catch up. This is not a catch up which we think will take a long time. In fact, it is happening already, with queues forming and consumers beginning to spend their excess savings. We think this is similar to what we saw in the US whereby all of 2021 and most of 2022 was a catch up story with companies constantly reporting better than expected sales and consensus earnings rising with a lag, as a consequence. We believe the market has still not fully appreciated the extent of the catch up from this key consumer group, which is why we expect the shares to continue to react positively as these earnings upgrades are priced in.