Growing market for luxury goods - the brand makes the difference

Thanks to steadily increasing demand from Asia the luxury sector has developed above average in recent years. Both leather goods and jewellery enjoy high popularity. In the watch market selected high-priced watches from popular, privately managed brands are in high demand. In the mid-range and lower price segments luxury watches are competing with the success of smartwatches.

By Hagen Ernst, Deputy Head of Research & Portfolio Management at DJE Kapital AG

In the luxury goods segment brands enjoy a particularly high status. As a rule they also have greater pricing power and enjoy stable demand even in difficult times. This leads to significantly above-average margins. In general, the market for luxury goods has grown twice as fast as global GDP since 1995.

Demand from Asia in particular developed well with increasing prosperity and today often accounts for almost half of the companies' turnover. Anyway, it is important to consider further developments in China. After years of focusing on economic growth head of state Xi now wants to prioritise sustainable growth, which should primarily serve "shared prosperity". Therefore, some fear a stronger taxation of wealthy Chinese and the introduction of a luxury tax.

Leather goods particularly in demand - Hermès and LVMH dominate the segment

Leather goods have been particularly in demand for some time. One of the most respected brands in this segment is Hermès. The French family business has grown by an average of 12.5 per cent in turnover and 15 per cent in profit over the last ten years. The luxury goods provider also recovered quickly from the Corona crisis. Sales in H1 2021 rose by 77 per cent, 33 per cent higher than in 2019, the year before the crisis. Hermès is particularly popular in Asia, where it generates more than half of its sales (62 per cent, including 11 per cent in Japan). In addition to leather goods (47 per cent), accessories (24 per cent) are also in high demand. But not only the products of the luxury labels are particularly high-priced, the share is also quite highly valued with a PE of 63 for the current year, but historically has always enjoyed a high premium in the sector and thus underlines the importance of brands in the luxury segment.

The leather goods segment is also developing very well at the French luxury goods group LVMH. The company Louis Vuitton, which belongs to the group and is primarily known for its classically timeless and high-priced luggage series, handbags and accessories, continues to be in strong demand. In addition Christian Dior - also owned by LVMH since 2017 - is the second up-and-coming brand that is currently one of the fastest growing. LVMH's sales figures in the leather goods segment are also impressive in the first half of the year, with +57 per cent year-on-year and +38 per cent compared to the pre-Corona crisis year of 2019. As a result, three-quarters of the LVMH Group's operating profit currently comes from this segment. A key feature of Hermès and LVMH is that both distribute their goods almost exclusively through their own sales channels. This means that they have one hundred percent control over the price at all times and can ensure that the brands do not suffer any reputational damage through discounts, even in times of crisis.

For a long time Gucci bags were also in high demand thanks to the new designer Alessandro Michele. In the meantime, however, the momentum has weakened considerably. Gucci grew by only 3.8 per cent in the third quarter and its operating profit is not yet at pre-crisis levels, but it is still the main profit earner within the Kering Group, which also comes from France, with a dangerously high 74 per cent.    

Strong jewellery demand - Cartier leads the way

Jewellery continues to be in high demand. Here, Cartier is by far the largest supplier with a turnover of more than 5 billion euros. Products such as the "Love Bracelet" or the "Trinity" ring have cult status and sell so well worldwide that Cartier now generates almost twice as much turnover as Tiffany, which was on a par 20 years ago. Together with Van Cleefs & Arpels, jewellery now accounts for almost all of the Richemont group's profits. Sales in the latest quarter rose 142 per cent year-on-year and were 35 per cent higher than pre-crisis 2019. LVMH has also discovered jewellery for itself, buying Bulgari in this segment for €4.3 billion in 2011 and Tiffany for $15.8 billion in 2019. The Swatch Group acquired the US fine jeweller Harry Winston for 1 billion US dollars in 2013.

Smartwatches displace watch brands in the mid and lower price segments

Watches, on the other hand, have performed less well. While high-priced watches from popular, privately managed brands such as Rolex, Audemars Piguet or Patek Phillipe continue to be in high demand and supply is so scarce that used watches are now more expensive than new ones, brands in the medium and lower price segments are struggling with the success of smartwatches (Apple Watch & Co.). The Swatch Group, which operates exclusively in the watch market, was particularly affected by this. Accordingly, the share has performed poorly and stagnated over the last five years. Thanks to the Cartier success (now the main profit earner) the Richemont share performed better with +84 per cent over the same period, but could not keep up with the other groups dependent on leather goods, LVMH (+350 per cent), Kering (+306 per cent) and Hermès (+252 per cent). After Rolex - with a market share of 27 per cent - the Swatch Group is the second largest watch producer with 25 per cent followed by Richemont with 18 per cent.

Niche providers - interesting takeover candidates

In addition to the aforementioned luxury brands from the leather goods, jewellery and watches sectors there are some smaller interesting brand suppliers that have mostly focused on a specific product/segment. These are particularly interesting as potential takeover candidates. Time and again, for example, there has been speculation about a takeover of Burberry. These include Moncler, with its high demand for high-quality down jackets and Burberry, which is known for its scarves with the distinctive pattern. Among the traditional Italian companies, Salvatore Ferragamo comes from the luxury footwear segment, while Prada was originally focused on leather goods. Both segments are traditionally combined at Tod's. The Cucinelli brand focuses on premium knitwear.

However, with the exception of the shares of Moncler (+261 per cent in five years) and Cucinelli (+183 per cent), all shares have tended to underperform over a five-year period. Globally known brands as well as economies of scale are especially important in the luxury sector and lead to the fact that large globally known houses such as LVMH or Hermès tend to perform best.

Digital luxury: e-commerce platforms on the rise

E-commerce offers a lot of potential in the luxury segment. The luxury goods market is growing twice as fast as the global economy. On the other hand, the online penetration rate of 23 percent last year is still one of the lowest within the e-commerce sector. The market is still very fragmented. However, Farfetch has now been able to establish itself as the largest e-commerce platform for luxury fashion. In the Corona year 2020 sales grew by 64 per cent to 1.7 billion US dollars. But even in the current environment, in which almost all shops are open again worldwide, the sales growth of 43 percent in Q2 is impressive.

Together with Alibaba and Richemont, an online platform for fashion in the higher price segment will now be established in China. All three companies want to invest a total of 1.1 billion US dollars for this purpose. Richemont bought the online fashion platform Yoox Net-à-Porter in 2018 for 2.7 billion US dollars in order to gain a stronger foothold in the e-commerce business. However, the purchase has not paid off so far. Both growth and margin development have been disappointing.

Other large prestigious luxury houses such as LVMH rely almost exclusively on their own website given the high level of brand awareness. For example Louis Vuitton bags can only be bought on the internet via LVMH itself. In Switzerland, Chronext recently planned to go public, but then cancelled at short notice "due to the current unfavourable market conditions for growth companies". They operate one of the largest online watch portals and sell both new and second-hand watches from the middle and higher price segments. Chronext guarantees authenticity and also gives a 24-month warranty on used watches. At just over 10 percent the online share of watches is only half as high as in the luxury sector as a whole. Moreover, watches are actually predestined for online sales. Especially with used watches it is essential for potential buyers to know that the watch is genuine and of good quality.

Risk factor China: Keep an eye on regulation and weak growth

The luxury sector has performed above average in recent years thanks to steadily increasing demand from Asia. Here, it remains to be seen to what extent the recent stronger regulatory intervention by the Chinese government as well as the slowing growth will have a negative impact on the luxury goods market. As a rule, demand for luxury items is relatively inelastic, so this is only likely to come into play if tougher measures are taken, such as the introduction of a luxury tax. In the long run, the successfully growing luxury groups with their globally well-established and renowned brands will hold their position in the market.

Note: All information published is for your information only and does not constitute investment advice or other recommendation. Long-term experience and awards do not guarantee investment success. Securities are subject to market-related price fluctuations which may not be compensated for by the active management of the asset manager or investment advisor. This information cannot replace a consultation. All information has been provided with care and to the best of our knowledge at the time of preparation. Despite all due care, the data may have changed in the meantime. Further information on opportunities and risks can be found on the website www.dje.de. The sales prospectus and further information are available free of charge in German from DJE Investment S.A. or at www.dje.de The fund management company is DJE Investment S.A. DJE Kapital AG is the distribution agent. A summary of investors' rights can be obtained free of charge in German in electronic form on the website at www.dje.de/zusammenfassung-der-anlegerrechte. The funds described in this marketing document may have been notified for distribution in different EU Member States. Investors' attention is drawn to the fact that the relevant management company may decide to withdraw the arrangements it has made for the distribution of the units of its funds in accordance with Article 93a of Directive 2009/65/EC and Article 32a of Directive 2011/61/EU.