Demand for luxury goods can be seen as a bellweather of burgeoning economies, as wealthy population segments consume more leather goods, clothes, watches, liquor and other high-end goods during boom times. The epicenter of this industry is in Europe, where companies such as LVMH, Swatch and Hermes have established dominant portfolios of luxury goods in a largely consolidated market. However, some of the most interesting regions of luxury consumption are Japan and China:
Those seeking to ride the trend of luxury consumption in the U.S. may be best suited investing in U.S.-based "near luxury" companies such as Polo Ralph Lauren (RL) and Tiffany (TIF) or looking at luxury retailers based in the U.S., including Nordstrom, Macy's Bloomingdale's and Saks (SKS).
The biggest luxury houses own a portfolio of various brands across different luxury categories such as clothing, jewelry, watches, handbags, shoes and even wine and liquors. The table below shows the spread of products offered by several key luxury goods companies (biggest product categories in grey, where information is available).
It should be noted that leather goods and ready-to-wear clothes typically garner the highest operating margins among these categories. For example, LVMH, the largest and most diversified luxury goods manufacturer, generated operating margins of about 30% in these categories compared to 10% and under for its other products. Wines, spirits and liquors are also a high operating margin (30%+) category; LVMH is the only company of those mentioned in this article with substantial holdings in alcohol.
|LVMH||Richemont (Cartier)||The Swatch Group||Gucci Group||Valentino||Hermes||Hugo Boss||Bulgari|
|Revenue (Euro, B)||15.3||4.3||3.0*||2.1||2.0||1.5||1.5||1.0|
|Operating EBIT Margin||20%||17%||19%||29%||12%||26%||12%||16%|
*Based on CHF to Euro exchange rate in May 2007
Directly operated stores (DOS) helps to increase margins in times of rapid growth and high demand and increase the market presence of key brands. However, in times of slower sales, the fixed cost of stores can drag down financial performance.
Luxury retailers are increasingly shifting manufacturing to cheaper labor regions such as China. While such outsourcing activities generate short-term cost savings to operating margins, these activities may have a particular effect of de-valuing the brand. Burberry suffered from negative publicity when it announced a relocation of polo shirt making operations from a British factory to one in China. Public image is crucial the the success of luxury goods companies, as consumers pay a large premium for brand.
One extreme example of controlled in-house production is Hermes' handcrafting of its leather goods by highly skilled craftsmen. This slower manufacturing process often results in waiting periods for many of the brand's leather goods; but as is the case for many scarce products, Hermes enjoys up to 40% price premium on these goods over similar brands. One of their legendary items, the Birkin bag, takes five weeks to craft and prices start around $6,000, sometimes reaching into six figures (i.e., the latter being made with alligator skin and diamonds). The waiting period for this item is over two years.
Virtually all large luxury goods makers hail from Europe, and while Europeans and Americans consume a large portion of luxury goods, some of the most compelling opportunities recently seem to be emerging from the emerging markets of Asia, particularly China and India. Furthermore, the Japanese obsession with luxury must never be forgotten.
The Japanese market has demonstrated a near insatiable appetite for luxury items, and leading luxury goods companies responded by flooding the market with branded boutiques (i.e., DOS) in recent years. Japan consumes about 25% of luxury goods--the same as Americans and Europeans each; as a point of relative comparison, Japan's population is about 125 million and the U.S. is around 300 million, meaning that Japan consumes luxury goods at about twice the average rate as Americans. One stunning fact is that nearly half of all Japanese women over the age of 20 own a Louis Vuitton handbag and over 90% of all Japanese women own at least one Louis Vuitton item
Many luxury companies have scrambled to establish a foothold in a luxury crazed market that was largely immune to the recent lengthy economic recession. The market is fairly mature, however, and luxury companies are all fighting for a piece of a fairly saturated pie.
Hermes and Bulgari have high exposure to Japan, with about 30% of all product sales coming from that country. Louis Vuitton (the brand) has one of the highest exposures at 33%, but its parent company, LVMH, generates only 15% of overall revenue from Japan due to its vast brand and product diversification. The average exposure to Japan's luxury goods economy is about 20% for other luxury houses.
Unlike the Louis Vuitton phenomenon in Japan, no brand or luxury company dominates the luxury fashion sector in China. One reason is that the luxury goods industry is in its nascent stages and currently, relatively fewer Chinese consumers can afford luxury items.
The attractiveness of the Chinese market is two-fold. First, the potential market is very large. The country currently consumes 10-15% of the world's luxury goods production, and if the economy continues to boom at a double digit clip and wealthy population segments grow, demand for luxury fashion goods could skyrocket. Compounding this effect is that the Internet, travel and marketing have accelerated the embrace of different cultures, especially European in regards to luxury goods. Second, no company has established a dominant brand in the region; brands are especially important given consumers’ loyalty to certain designers and labels. Luxury fashion companies may reap large dividends from early market penetration.
Luxury goods are cyclical and correlate with GDP in specific regions, often exaggerating the up- and down-swings; in boom times, consumers' demand tends to grow faster than the growth of economies (as measured by GDP). On the flipside, slowdowns can cause sales to retreat rapidly, as consumers buy fewer high-priced luxury goods. In addition to GDP swings, regional economies can drive a disproportionate amount of growth; in China and to a lesser extent, Russia, a small but growing segment of the population is becoming very wealthy and driving a large portion of demand for luxury items. Some interesting items of note:
While it may be difficult to invest in European-based companies, Nordstrom (JWN) and Saks (SKS) are high-end department stores based in the U.S. that sell a wide variety of luxury items, including most of the top European brands. Macy's Bloomingdale's division is a luxury department store retailer aimed at a slightly younger, sportswear-oriented crowd. These retailers benefit from an increase in luxury consumption, though they are competitive to luxury manufacturers' own directly operated stores.
True luxury goods are aspirational products few people can afford. Many companies such as Tiffany, Abercrombie & Fitch and Ralph Lauren depend heavily on the "near-luxury" market, which provide branded goods more accessible to the masses (i.e., at lower price points). Near-luxury companies, like luxury goods companies, tend to track with economic growth (i.e., GDP) but are more volatile. Wealthy consumers are more likely to continue buying high-priced goods--but in fewer quantities--than middle class consumers are likely to continue buying near-luxury items, which are affected by lower-priced substitutions. Several important companies in this space include Ralph Lauren, Coach and Tiffany, all of which experiences significant (>60%) gains in stock price over the past 12 months.