29 October 2020
GAM Investments’ Swetha Ramachandran discusses Q3 results from some of world’s largest luxury brands and comments on key themes that emerged over the period.
On 22 October, we had results from the world’s oldest leather goods brand Hermes (1854), contemporary puffer jacket maker Moncler, premium spirits brand owner Pernod-Ricard, cosmetics and skincare company L’Oreal and soft and hard luxury conglomerate Kering (owner of Gucci, Saint Laurent, Brioni, etc). This followed on from LVMH and Remy-Cointreau – both firms reported earlier in October. What the above companies have in common is that, overall, they exceeded market expectations on their top-line growth – driven by a sharper and quicker sequential rebound in their trading than had been forecast, driven primarily by a resurgent Chinese consumer but also supported by their US and European counterparts.
Management teams pointed to their sales benefitting from the shift in wallet share among middle-class consumers from experiences (travel, restaurants) to goods, as well as the generally good financial position in which these consumers entered the crisis, which is echoed by the data from Credit Suisse’s Global Wealth Report 2020, published on 22 October. Furthermore, the wealth effect from rising stock markets in the spring and summer was a further boost to consumer confidence in the US while in China, companies reported it was back to ‘business as usual’ with premium consumer brands back to their pre-Covid-19 trajectory, driven by younger consumers as well as growing premiumisation among tier two and three city dwellers. Even in formerly moribund Europe, the industry saw the local consumer in Germany, Italy, France and the UK engage with luxury brands to a greater extent than in prior years – reminiscent of the manner in which a mature Japanese luxury market sprang back to life in the aftermath of the 2011 Fukushima disaster.
Table 1: Quarterly organic growth (year-on-year percentage)
The return of ‘winner takes all’ as trusted brands dominate in an uncertain time
The fashion / luxury industry is one where 20% of companies generate 80% of the industry’s economic profit. During Q2, which suffered the peak of the worldwide lockdowns, there was little to distinguish one closed store from another for an industry which is still substantially underpenetrated online (10% of sales pre-Covid-19, versus 25% for apparel and 60% for consumer electronics). With the reopening of stores as well as a gold rush by companies to target consumers where they were – ie online – the return of polarisation in performance is back. So far, we have had the ‘best of breed’ like Hermes and LVMH report results, buoying hopes for the smaller players due to report soon. Across categories from skincare and spirits to soft luxury, the echoing refrain is that brands that are trusted by consumers and are top of mind (thanks to their consistent investments in advertising and marketing) are gaining ground from niche upstarts that may have won consumer attention in more normal times. Consumers are flocking to the tried and tested – benefitting iconic brands, such as Jameson in Irish whisky, Lancôme in skincare and Hermes in handbags. It was just a year ago that LVMH, on the back of record-high growth in its fashion and leather division in H1 2019, failed to deliver any margin expansion, preferring to reinvest all of its revenue increase back into its brands. This strategy was widely questioned by the market at the time yet, a year on, it is vindicated by the group’s fashion and leather division recording the highest growth of any soft luxury peer in aggregate in Q3. Meanwhile L’Oreal, thanks to its consistent investment in the online channel in China which comprises over half of its sales in that market now, grew by +21% in China in a flat beauty market.
E-commerce: five years’ worth of growth in five months
Luxury has historically been an industry reticent to embrace online, believing the channel to be unsuitable for the sale of high-ticket items. However, as a result of Covid-19, consumers have discovered an appetite for spending large sums of money online – Sotheby’s for example, reported that the average value of lots sold via online auction has more than doubled, up by 125% to USD 19,650 in H1 2020, from USD 8,749 in H1 2019. Hermes reports that e-commerce is now the group’s largest stores, even as it excludes the possibility of selling its iconic waitlist-only Kelly and Birkin bag models on this channel. L’Oreal noted that e-commerce expanded by more than 50% for the fourth consecutive quarter, and accounted for 22% of L'Oréal's total sales in Q3. As a result, enthusiasm among management teams for embracing online is at an all-time high. We believe an omnichannel strategy with stores at the heart of luxury distribution (suited well for events as well as for brand-building) supported by clienteling online (live-streaming is the buzzword of the day) to encourage e-commerce transactions is the way forward for the industry to maximise value creation.
Consumer behaviour and household wealth support luxury growth
It seems somewhat counterintuitive to consider the quicker than expected rebound of the industry against the wider macro backdrop without considering finances at the level of the household. The Credit Suisse Global Wealth Report 2020 highlights that the world went into Covid-19 after a year of exceptional wealth creation in 2019 –with total global wealth rising by USD 36.3 trillion to USD 399.2 trillion, and wealth per adult reached USD 77,309 (+8.5% versus 2018). Although there was a USD 17.5 trillion (-4.4%) decline in household wealth between January to March on plunging stock markets, the rebound over the spring and summer, together with rising house prices has meant that by the end of June, total household wealth is estimated to have risen a further USD 1 trillion from the level at the end of last year.
Table 2: Change in household wealth 2019, by region
Kering mentioned the wealth effect and the shift in wallet share from vacations abroad to investing in one-off iconic purchases as a key driver of the sequential recovery it saw in its brands over the summer. Similarly, premium spirits brand owners Pernod-Ricard, Diageo and Remy-Cointreau have seen that consumers are more willing to ‘trade up’ when buying brands for at-home consumption, where the cost per unit is lower than at bars, boosting the sales of high-end spirits brands. Moncler, the one brand which is definitely dreaming of a white Christmas, noted that while customers are waiting longer to buy winter wear this year, as the weather turns in the Northern Hemisphere, they are now returning to stores and with strong purchase intent – so that even with lower footfall, brands are seeing higher sales conversion.
Brands that have higher engagement with their local customer base over a reliance on tourist traffic undeniably did better in this reporting period. Gucci (+2% excluding travel retail) is the largest brand to suffer from a disproportionate reliance on not just travel retail but also a travelling consumer. The brand’s lower engagement with its local European consumer base was the main driver of its underperformance relative to LVMH and Hermes, which it hopes to redress through investing in these communities in coming months. Based on its success with the Saint Laurent (+4%) and Bottega Veneta (+21%) brands, we believe this is achievable – especially considering its performance in the US market, which was led by domestic demand, where Gucci grew by nearly 45% year-on-year.
Chart 1: What is priced into the sector’s shares?
The recovery in operating momentum for the sector has, to some extent, been anticipated in the share price recovery over the summer. Yet, the rising tide has not lifted all boats and the share price performance and valuation disparity between the ‘haves’ and the ‘have-nots’ in the sector, since 17 January 2020, has never been wider. We remain watchful for an intra-sector ‘value rotation’ but in the absence of any fundamental improvements, find valuation alone to be an insufficient reason to own struggling brands and businesses at a time when consumers are voting with their wallet in favour of leading brands. Moreover, consensus forecasts for mid-single digit top-line growth in 2021 with continued margin pressure for the sector’s leading brands suggests they could benefit from an upgrade cycle should current momentum be maintained. While Chinese demand appears idiosyncratic (more about structural growth in an underpenetrated market), in the US the sector is more exposed to the economic cycle. The revival in the sector’s engagement with European consumers is a strong positive given the backdrop.
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.