The impact of foreign exchange rates, particularly the strong Euro, has dampened company profits in recent months, however this will ease in the second half of 2014. Russia accounts for between 4 and 7% of the global luxury market and the crisis there has undoubtedly been felt, but despite these headwinds we still expect solid organic growth for the sector of 6 to 7% this year.
The long term story for luxury goods remains firmly intact and the sector is likely to continue to exceed growth in GDP over the long term. Past cycles have shown that periods of global economic recovery, even at a slow rate of growth, have been beneficial for luxury stocks.
While it is evolving, demand from China remains a key driver of luxury growth. Against the backdrop of a weaker domestic economy in the country, Chinese tourists are looking to take advantage of global differences in product prices and foreign exchange rates. With luxury goods cheaper in Europe, an increasing number of Chinese citizens are booking shopping holidays to bag themselves a bargain. Chinese shoppers are reported to spend as much as £650 (source: hotels.com) a day on foreign high streets, and the competition to attract these shoppers is heating up. The UK, for example, is under increasing pressure to streamline the visa applications for Chinese travellers. Reforms would make the UK an even more attractive destination for the Chinese, significantly boosting travel flows and driving further growth in the sector.
In the current environment, we favour branded jewellery manufacturers such as Richemont, owner of the Cartier brand, and Tiffany. Also interesting are providers of affordable luxury goods which are able to benefit from Chinese consumers buying their first Western piece of jewellery or perfume. Swatch, Nike and Estée Lauder all fall into this category. Companies which have significant potential to further grow market share, for example Michael Kors and Lindt, are also attractive. We also like companies that are further improving their operating efficiency, such as Hugo Boss and Ferragamo.
Providers of luxury goods are in a strong position, grounded on very healthy foundations. Many companies are generating strong cash flow, with pre-tax profits of between 15 and 25% and low debt levels. Buying into these businesses enables investors to benefit from demand from emerging markets via sound and well-managed Western companies.
