Rising energy and food prices continue to erode consumers’ real purchasing power and, combined with challenges in global supply chains, are placing a significant burden on the global economic outlook.
Rising energy and food prices continue to erode consumers’ real purchasing power and, combined with challenges in global supply chains, are placing a significant burden on the global economic outlook. In this context, U.S. consumer discretionary stocks have declined by nearly 40% over the past year. Within the sector, however, luxury segment sales proved much more resilient in 3Q22, with almost universal corporate earnings above market expectations. As such, there continues to be no evidence of a slowdown in sales growth. Despite ongoing inflation concerns and the risk of continued tight monetary policy, demand for luxury goods remained solid in Q3 2022 despite the zero covid policy in China.
The luxury goods industry is characterized by properties which, in our view, appear particularly attractive in times of heightened economic uncertainty:
High quality products
Strong brands
Strong market entry barriers
Stable organic sales growth over 20 years
To this end, we believe that the luxury goods market is considered by market participants to be much more cyclical than it actually is. Over the past 20 years, the sector has grown sales in every year, with two exceptions (2009: -4% as a result of the financial crisis; 2020: -17% as a result of lockdowns). Comparing the growth rates of the sector of different periods at constant exchange rates, the sustainability of the sales growth can be seen:
Time frame ______ Sales growth p.a. (CAGR)
2005-2010 ______9%
2010-2015 ______ 9%
2015-2019 _______9%
2019-2022 (Estimate) ______9%
2005-2021 ______9%
While demand for luxury goods has remained exceptionally stable over the past two decades, the drivers of that demand have not. The main growth driver changed from a focus on geographic expansion and increasing purchasing power of Chinese consumers to a beneficial shift of the sales mix within developed economies. Going forward, we expect two main structural growth drivers for the sector:
1. Expansion of the product portfolio can lead to a doubling of the addressable market.
While between 2009-14, most of the revenue growth was generated by market entries in China, this trend lost momentum between 2014-16 in the context of an intensified anti-corruption campaign in China. Between 2016-2019, sales growth in the sector was largely driven by volume increases related to product innovation. In the aftermath of the pandemic, we observed mainly strong price increases between 2021-22 (mainly by leading brands such as Chanel, Dior, Louis Vuitton and Rolex), which also allowed smaller companies to expand margins. This is remarkable in our view, as not a single company within the sector complained about declining volumes in the wake of price increases. In response to the pronounced USD strength in 2022, we expect continued price increases in Europe, the UK and Japan in 2023. While those price increases are largely anticipated by the market, we believe that product mix tends to be underestimated. For example, using Louis Vuitton as an example, we can observe that the company is trying to increase the average selling price of its products through a higher sales share of leather goods and seasonal product variations. For example, the company offers the classic Neverfull MM bag for EUR 1,500 (February 2022: EUR 1,200), but adds two variations to the offer (EUR 2,000 and EUR 2,250, respectively). Similar examples can also be noted for Dior (Lady Dior / Book Tote).
Furthermore, it should be noted that in 2021 the global luxury market had a turnover of circa EUR 200 billion, but this was only in terms of leather goods, watches, jewelry and footwear. However, with the entry into new segments (streetwear, beauty, home decoration, pet accessories, fitness), we now expect the market potential to double.
Although China has recently lost significant relevance as a sales market, a sustained shift away from the zero covid policy would be a massive catalyst for sales and margins of luxury companies.
2. Increased cultural relevance also makes luxury goods attractive for the next generation.
A growing proportion of young customers can be observed, which is usually taken as evidence of the declining quality of luxury companies due to lower purchasing power. While those “smaller customers” account for 35% of the customer base, they contribute only 9% of total sales. Therefore, we assess the risk of declining sales in times of economic pressure as low (40% of sales come from “heavy spenders” who are less affected by economic dislocation) – and evaluate the high number of customers as evidence that the companies enjoy an increasing cultural relevance among young customers. This can serve as a foundation to develop this customer group into “heavy spenders” over the long term as their incomes increase. This is supported by social media platforms where brands showcase themselves through collaborations, designers and ambassadors. Similarly, luxury brands are increasingly represented in the music industry; for example, 817 luxury brands were named in Top 100 songs in 2020 (2000: 123).
In summary, we are convinced of the long-term growth prospects of the luxury segment and the quality of the underlying products and business models. In our view, the market is overestimating the risk of slowing earnings growth and therefore believe the valuation correction that occurred in 2022 is overdone.