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Weekly Manager Views

13 March 2020

At GAM Investments’ Weekly Investment Meeting held on 11 March, Swetha Ramachandran commented on the impacts to luxury equities from the coronavirus and discussed the long-term prospects for the luxury sector as a whole.

Luxury Equities

Swetha Ramachandran

  • We view the coronavirus as a short-term disruptor to luxury demand in China – a country which accounts for a third of the total industry demand, hence the importance of the recovery. A lockdown on population mobility and store closures is slowly reversing and while Chinese tourism will likely be down in 2020, it is our view that the coronavirus will hasten the repatriation of luxury spending to the mainland. As well as making up 35% of industry demand, Chinese nationals are driving over 80% of industry growth.

  • French luxury conglomerate Kering – whose brands include Gucci and Yves Saint Laurent – has noted that with previous crises, in Asia in particular, there tends to be a period of “euphoria” when the crisis passes during which consumers buy more than they otherwise would have had the crisis not happened. We note this is supported by empirical evidence following the 2011 tsunami in Japan, where a formerly declining luxury market sprang to life in the aftermath of the Fukushima disaster to reverse its 6% per annum decline between 2007-2012 to grow by 8% per annum between 2012-2016. McKinsey has nicknamed this phenomenon the “Godzilla effect”.

  • In our view, supply issues in the luxury sector can be managed given the relative flexibility of the manufacturing base and also the longer lead times than fast fashion. Meanwhile, we expect the e-commerce channel shift in the luxury sector to accelerate, especially for beauty / skincare. An uptick in online gaming, with people enjoying unexpected leisure time, appears to have been echoed in an uptick in e-commerce sales for L’Oréal (50% of whose sales in mainland China are online). The company has reported that online sales of beauty products in China are “stronger” year-to-date in China than the previous year; with the acceleration likely due to the channel shift from offline (with stores closed) to online.

  • Travel-related stocks have borne the brunt of virus concerns to date. Cruises, gaming and hotels subsectors are down between 30-60% versus soft luxury, sporting goods and cosmetics down 10-20%. We believe a bounce back is likely to favour goods over experiences. The sector as a whole benefits from high margins, strong cash generation and underleveraged balance sheets – providing further impetus for value-adding consolidation should this situation persist, possibly forcing the hand of many hitherto reluctant family owners of coveted brands.

  • On a positive and long-term note, luxury demand has outpaced global GDP growth over the last two decades. The key driver of the luxury sector remains the continued strength of the key Chinese millennial consumer cohort, which continues to grow (virus impact excluded) at a double-digit rate for the better-positioned companies within the sector. We believe this reflects the structural appeal of the luxury sector, with its exposure to the growing first-time aspirational middle class consumer.

Important legal information
Source: GAM unless otherwise stated. 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. The companies listed were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers.
March 2020