14 November 2019
The luxury sector is changing with the times, according to GAM Investments’ Swetha Ramachandran. She believes secular trends in the urbanised areas of emerging markets (EM), particularly in Asia, as well as evolving demographics are significantly impacting consumers’ marginal propensity to spend here, providing a tremendous boon to Western luxury brands with strong heritage and provenance.
The growth in EM middle class consumption is likely to remain a key theme for investors in luxury equities long-term given the continued rise of the aspirational middle class consumer here. Of the luxury company earnings that come from EMs, a large chunk comes specifically from China.
Robust demand driven by the EM middle class consumer
From an investor perspective, luxury equities are an exciting space to be in. Long-term luxury demand is incredibly robust. According to data from Bain, the compound annual growth rate for the global personal luxury goods from 1996-2018 was 6%, outpacing eurozone and US GDP growth of 2.5% and 4.1% pa, respectively. In turn, high compound growth, at high and stable margins, ultimately drives high shareholder returns.
The past two decades have been very dynamic for the luxury market, where short-lived lull periods of demand have been turned around by a wave of younger consumers – mainly Asian – entering the market. According to estimates from the Brookings Institute, five people join the middle class every second in Asia and the global middle class could spend USD 10 trillion more by 2022.
Circa 70% of the next billion additions to the global middle class are estimated to come from China and India alone. China, in particular, has been, and remains, the key engine of growth for Western luxury brands. The entry point into the luxury arena is occurring at a much younger age in EM. This younger, more urban, cash-laden, tech-friendly consumer is looking to ‘trade up’ – favouring premium products and experiences as a marker of social status. This in turn forces companies to be on the front foot when it comes to engaging with these consumers through new digital channels and upping the ante on customer service levels.
Growth has been fuelled both by significant innovation by the mega-brands and increased investment in digital capabilities to reach a younger consumer in China than in the companies’ other markets.
LVMH’s Q3 results showed the business continues to display strong operational momentum across its various divisions, deftly shrugging off external headwinds. Meanwhile Hermès, Kering, Puma and Moncler all reported double digit growth over the quarter. We believe this serves as strong evidence that sector growth is far from running out of steam. The Chinese customer remains robust for these brands but, interestingly, so is the US market, on a selective basis. Strong brands are continuing to get stronger; reinforcing their ability to invest in their businesses and further outperform the market, which is growing at an underlying mid-to-high-single digit clip. Furthermore, soft luxury (fashion, leather goods), for which we have a preference, is significantly outperforming hard luxury (watches/jewellery).
Given luxury’s growing appeal to a younger clientele, Environmental, Social and Governance (ESG) factors are an increasingly important factor in the production of luxury items – with sustainability concerns increasingly making their way into purchasing patterns of millennials and generation (gen) Z.
BCG estimates that nearly two-thirds of global millennial and gen Z luxury consumers are influenced by sustainability when making purchases – with environmental, animal welfare and ethical manufacturing concerns dominating consumer attention in this area. Over half of luxury consumers say they investigate a brand’s social responsibility – up significantly versus five years ago, with 62% saying that for a given product, they would prefer to purchase it from brand seen as more sustainable than the alternative. Interestingly, Asian consumers are noted to be more sustainability driven than their Western counterparts – making this theme especially salient as we go forward into a luxury environment set to be dominated by Asian millennial demand.
Sustainability has wide implications for the industry – for brands as well as business models. Second-hand luxury for instance, is now 7% of personal luxury market by value and growing 12% per year. Companies such as The RealReal are tapping into millennial desires to reconcile both a desire for constant novelty with concerns about sustainability by establishing an infrastructure for the flourishing of a circular fashion economy.
Not just Asia - US growth is important too
While the single largest market for the luxury industry by size (33% of total) and by growth remains China, the US consumer is a sizeable second market – with American consumers making up just over 20% of industry revenues. It is an interesting market – in that despite having the world’s largest absolute number of HNWIs (High Net Worth Individuals) – those with investable assets of USD 1 million or more, excluding their primary residence) at 5.3 million (ahead of China at 1.3 million), the wealthy American consumer spends significantly less per capita on luxury than their Chinese counterpart.
Millennials and gen Z consumers are seen here as influencing the direction of American luxury demand through their greater willingness to buy full-price items – in the vein of “less but better” which benefits the European luxury brands over the US “accessible luxury” ones, on the whole. Their discovery of global trends thanks to social media has benefited brands like Gucci, Becca, Moncler, adidas, Aperol – just to name a few. Millennial men especially are seen as fuelling growth in the US luxury industry through their enthusiastic embrace of streetwear, which is a trend that shows no signs of dying out yet with retail concepts like Kith and brands like Supreme hitting the mark with their target consumers through ongoing innovation – the way the incumbent companies have nimbly capitalised on this trend has been through collaborations – Estee Lauder with Kith and Louis Vuitton with Supreme.
Social Media Influence
Digitisation is bringing forth new ways for luxury brands to connect with consumers. Research by Forrester shows there has been a 32% decline by luxury brands in print advertising investment worldwide over the last five years. Brands are still focused on traditional media but increasingly a millennial state of mind is permeating the luxury industry, with brands changing their communication mix to target their consumers where they spend most of their time – which is social media, rather than print.
The reason this model has been so successful in China is that 80% of Chinese luxury consumers are on social media, with the customer journey very different in China from the West. In China, 40% of Chinese luxury customers are on Weibo (China’s Twitter), with 15% on Little Red Book (a product search engine for luxury) and 5% on Douyin / Tiktok (Snapchat). Compared to a “traditional” digital purchase in Europe where the four touchpoints might be Google, Instagram, Facebook and ultimately Farfetch to conduct the transaction, in China, all the major touch points in a sales cycle are directly related to influencers. For brands, too, this makes the link between media impact value and conversion to actual sales much more direct and therefore increases the continued usage of influencer marketing strategies.
What does this mean for luxury investing? With the growing importance of millennial, and especially Asian millennial customers to luxury demand, companies that can appropriately target these customers on their preferred channels will continue to win.
Moats remain wide around established players
The incumbents within the luxury space still retain wide moats around them – effectively, barriers to entry in the established luxury industry remain very high and are hard to penetrate. The provenance and heritage of brands such as Hermes and Louis Vuitton cannot simply be replicated overnight, allowing these brands to invest for future growth and retain their market status as established, flagship luxury brands. At the company and brand level, we believe the difference between the performance of winners and losers is much greater than in the preceding era, where a rising tide of luxury sales, during an earlier stage of China’s growth, effectively lifted all boats.
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. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Reference to a security is not a recommendation to buy or sell that security.