How China fell in love with Louis Vuitton

China's middle classes are eager to show off their new-found wealth. We pick two of the brands most likely to benefit from this consumer boom.

Over the last 20 years, China has grown at an extraordinary rate. GDP has expanded at a good 10% a year every year and looks set to continue doing so, while the urban population has more than doubled from 251 million to 562 million. All this new wealth has driven the emergence of a new middle class, and one that is keen to show off just how far it has come from the rice paddies. And the best way to do this? With a Louis Vuitton bag, Omega watches and a bottle of Met. The result is an extraordinary boom in the big luxury brands in China. The Chinese spent $4bn-$5bn on luxury goods in tourist hotspots such as Hong Kong and Italy last year (like the Japanese, they tend to equate holidays with shopping) and another $1bn-$2bn at home.

Until now all this money has been pouring out from China's "first tier" cities, such as Shanghai and Beijing, but the real growth area for luxury goods in China is in the smaller second- and third-tier cities. China has about 100 cities with a population of more than a million people and as the spoils of economic growth spread, so will the demand for high-end merchandise. Goldman Sachs estimates that within the next five years the number of Chinese people in a position to spend on such non-essentials will rise from the current 40 million to 160 million. The result? "Citigroup expects that annual sales of luxury goods in China will grow by 21% over the next five years," says Elaine Moore in the FT. Goldman Sachs is just as bullish: it expects the Chinese to be buying nearly 30% of the world's luxury goods within ten years.

This is good news for the big brands. The more sophisticated consumers in the likes of Shanghai have (again in the same way as the Japanese) started to shift towards buying lesser-known brands with an eye to exclusivity. That means that they need second-tier consumers who are pleasingly interested in getting their hands on the brands that leave casual observers in no doubt about their financial status to keep sales rising. It's textbook status anxiety, says Shaun Rein in Forbes. "Luxury goods allow consumers to project an image of success." All this means that the big global luxury brands that have proved popular in China's large cities Louis Vuitton, Fendi and Met & Chandon should enjoy copy-cat demand from this second round of Chinese consumers. "Even if economic growth slackens, the shopping spree will continue because so many Western goods are must-have' status symbols in Asia," says Tom Burroughes in The Business.

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What's more, having adopted the one-child policy in the 1970s, China has a bulging class of young, aspiring spenders. "Over the next few decades, wealthy, spoilt little emperors' will begin to make up the country's largest population group," says Elaine Moore. Having not experienced Mao's Cultural Revolution, these consumers are unlikely to be bothered by the same anxieties as their grandparents or parents about stability and the weakness of the country's social safety net. As a result, they should drive wave after wave of demand for luxury goods over the next decade. Surveys show that 92% of Japanese women own a Louis Vuitton handbag. There is every sign that the Chinese are in the middle of being gripped by a similar madness. We have a look at some of the companies likely to benefit from this binge below.

Luxury brands most likely to benefit from the boom

Of the all the iconic brands that China's second-tier consumers are likely to latch onto, Louis Vuitton Moet Hennessy (LVM) the French luxury powerhouse behind Louis Vuitton, Fendi and Moet & Chandon owns the ones that look likely to be the most in demand. The company reported a 30% rise in full-year profits in February and is currently establishing stores throughout the country, putting it in a good position to benefit from second-tier consumption. The shares trade on a p/e of 21.7, which is not cheap, but is still something of a discount to Citigroup's estimated sector average of 24.7. This valuation may seem racy, says Elaine Moore in the FT, but given the massive growth potential of the sector, it is probably worth paying. Note that LVMH is on a price to earnings growth ratio of only 1.36 times.

China's $3.8bn watch market is almost completely dominated by Swatch Group (SWR), which has a 70% market share for high-end watches. The Swiss group has increasingly geared the company towards products such those sold under its Omega label, currently the most popular luxury watch brand in China. The firm's shares trade on a forward p/e of 19, according to Bloomberg, and a price to earnings growth ratio of just over one.

Eoin came to Money Week in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.

Eoin acts as managing editor of MoneyWeek's newsletters.