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Luxury goods outlook

8 months ago

Seamus Lyons, Senior Investment Manager

Seamus Lyons, CFA,

Senior Investment Manager, Architas

Luxury goods outlook

Luxury brands are characterised by very high levels of quality, price and crucially, exclusivity. Ferrari founder Enzo Ferrari stated that “Ferrari will always deliver one less car than the market demand”. While premium brands can be high quality and may also be expensive, those in the luxury sector are not looking to maximise their appeal by maximising sales. Instead, product scarcity and the difficulty in purchasing these goods help to drive their desirability. Reflecting how different merchandising is at this top end of the retail spectrum, prospective buyers of a new steel Rolex Daytona or a Hermès Birkin or Kelly handbag will need a track record of previous product purchases before they are considered for allocation. Though this alone does not guarantee they will be successful. 

A European dominated sector

Luxury merchandise covers an extensive range of products – designer clothing, handbags, cars, jewellery, watches, cosmetics and fragrances, as well as wines and spirits. European companies dominate the
sector – LVMH and Kering both quoted in France, one unlisted (Chanel), along with US based Estée Lauder. In 2021, sales for the top 100 leading brands were a record $305bn, exceeding 2019’s pre-pandemic $281bn. Yet it may be difficult to think of a consumer sector which is potentially more negatively exposed to the current environment of higher interest rates and more reticent consumer demand.

2023 push pull factors for luxury

Cautious comments this summer from Cartier owner Richemont and LVMH’s reluctance to give a specific H2 2023 outlook contributed to a limited sell off for the quoted luxury sector, though this followed an extended period of strong performance. Yet bellwether LVMH did highlight the post pandemic rebound in China, helping to reinforce what many saw as the sector’s bullish longer term prospects. A spring 2023 luxury goods insight by consultancy Bain and Italian luxury research house Altagamma expects the luxury goods market to double in size to €530-€570bn ($566-$608bn) between 2020-2030. With sentiment ‘data dependent’, luxury shopping in the US has been held back by economic uncertainty, though markets in Europe have picked up some of this slack, thanks to US and Middle Eastern tourists and the return of some Chinese shoppers. In Europe, tax free shopping and favourable exchange rates for non residents are further drivers. An optimistic scenario for the 2023 global luxury goods market by Bain/Altagamma sees growth of 11-13%, fuelled by 20%+ year-on-year growth in China. Their more cautious base outlook sees global growth of 7-9%, with China rising by 15%, while low consumer confidence in Europe could result in that region experiencing mid-low single digit growth.

Resistant to economic downturns

Historically, the luxury goods sector has managed to rise out many economic downturns. This is because the top end consumers, often high net worth individuals, are less likely to be affected by short-term turbulence. Luxury shoppers at the top of the purchasing pyramid, those spending between €20-€50,000 per year on luxury goods represent less than 1% of the global customer base for luxury goods, but account for a disproportionate 10% of sales, according to the Bain/Altagamma study. They are likely to continue to drive growth in the sector. Top performing sectors include watches and jewellery. Selectively, bags are in demand as they are perceived as valuable assets. Luxury experiences and travel are further growth categories. 

What makes luxury special

An attractive feature of luxury goods are the high profit margins in the sector. Louis Vuitton, part of the LVMH conglomerate, was estimated to have 50% operating profit margin in 2022. By comparison, Apple’s 2022 operating margin was 30%. Yet there would be no point in a manufacturer trying to undercut Louis Vuitton, offering a cheaper product with a lower margin. Status underpins the psychology of luxury
goods – that is, the higher the price, the more status is being bought/achieved. In this way luxury items are examples of Veblen goods, for which demand increases as the price rises. Raising the price of an already expensive product enhances its attractiveness for many buyers, as it means it is further out of the reach of most other consumers. This runs counter to the more traditional (and intuitive) expectation that demand for a product will slow as the price rises.

Architas view

Our view

Luxury goods are not immune from creeping margin pressures. However, their status as Veblen goods, and the increasing number of buyers whose wealth is disconnected from the volatility of the wider economy, is likely to continue to prove supportive. Valuations are high and Architas avoids a strong active position in the sector, although we acknowledge its merits within a balanced portfolio aimed at navigating uncertain markets.

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