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Polarisation in the luxury space

Tuesday, June 26, 2018

GAM Investment’s Scilla Huang Sun evaluates some interesting trends in the luxury market and explains why this is a sector in which active management can add considerable value.

Demand for luxury goods remains unrelenting. During the first-quarter earnings season, many companies reported numbers that were better than expectations. In spite of demanding comparison bases, the big iconic brands, notably Louis Vuitton and Gucci, achieved accelerating sales growth which boosted the share price of their respective parent companies. Nevertheless, a negative FX impact in a range of 4%-9%, depending on regional exposure, ensured that reported earnings failed to fully reflect organic growth, but the latter metric remains key both in terms of measuring underlying performance and assessing future potential. For now, it would appear that the fundamentals of the luxury segment continue to be very robust and the secular growth story remains on a firm footing. We expect the industry to deliver another year of organic growth in excess of 5%.

The Chinese love affair with luxury is here to stay

Asia was again the best performing region in the first quarter, driven by very robust Chinese demand. In addition, the weakening of the US dollar has brought back Chinese tourists to Hong Kong and Macao. The rebalancing of the Chinese economy is well underway and consumption will contribute progressively more to economic growth. So far China has managed its economy better than many predicted a few years back. In China, the affinity for Western brands remains very high, especially among millennials. We estimate that the Chinese make up one third of global luxury demand currently.

According to Bain & Company1, millennials’ share of the luxury market has increased from 27% in 2016 to 30% last year, at the expense of the baby boomers who are retiring. Millennials, aged between 18 and 37, have different shopping behaviours than their parents. Customers nowadays are asking for the omni-channel option but brick-and-mortar shops remain key for luxury products. Online, although still below 10% of luxury sales, is the fastest growing channel. It is more advanced in Asia and the US than Europe, and is a complex business. Providing a seamless and exciting shopping experience online involves a lot of details. This means new challenges but also new opportunities. Luxury brands will know much more about their end clients and can better target customers’ needs in the future.

Polarisation within the industry continues

One of the most striking features about the recovery of luxury this time is the strong polarisation within the industry. Winners continue to gain market share reporting double-digit growth, while sales at the laggards grew only slightly or showed no growth at all. According to the Bain study1, 65% of brands managed to grow revenue over the last three calendar years, but only a little more than a third of these managed to improve their profitability over the same period. Those that ‘win’ over the next few years will need to accurately interpret customer aspirations in order to re-invent offerings for this new luxury era, while staying true to their brand identity. This challenge should ensure that the polarisation continues, creating a very fertile environment for stock picking.

1Luxury goods worldwide market study (December 2017)
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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.
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