Investing in luxury goods: a sector set for years of galloping growth
Rising Chinese consumption and the advent of e-commerce are two long-term trends powering the premium-goods industry, says Stephen Connolly. That implies market-beating returns for investors.
“I’m a man of simple tastes”, Oscar Wilde used to joke. “I’m always satisfied with the best.” People’s idea of luxury goods will depend on their location, income levels and plain old individual taste, while these products also span several industries. Fashion – ranging from haute couture such as Christian Dior to Chanel’s shoes and handbags – is perhaps the most eye-catching area but there are luxury brands in areas as diverse as automobiles, jets, yachts, travel, drinks, watches and jewellery, as well as cosmetics and perfumes.
Whatever your exact definition, however, it is the combination of a strong brand name and perceived high quality that gives luxury goods their cachet – and also explains why they are such a lucrative business and a market-beating long-term investment.
Think of luxury-goods stocks as funds
Many luxury groups are like funds: portfolios of brands spread across a range of product types from watches to handbags that appeal in a variety of different regions at different times. Corporate managers are the stewards of these brands and invest and expand them to maximise the value in their “names”.
Their work has delivered big rewards for the industry and investors alike. Last year, for instance, according to Bain & Company, a consultancy, high-end cars were the top-selling global luxury category at nearly $600bn, followed by personal goods on $260bn. Fine wines and spirits alone account for $80bn.
Let’s take a look at the stockmarket performance. The S&P Global Luxury index, which was launched just over ten years ago, tracks around 80 global companies either making goods or providing services that can be classified as luxury.
Many of the names are instantly recognisable: champagne, cognac and leather-goods leader LVMH, for example, alongside Gucci-owner Kering and Swiss group Richemont with its enduring brands such as Cartier, Dunhill and Montblanc.
Over ten years, the total return (capital gains plus income) in US dollars from the stocks in this index is a reassuringly luxuriant 13.7% a year. That’s over 3% more than the 10.4% from the S&P Global 1200, an index tracking the overall performance of stocks worldwide. Few professional fund managers have been able to beat markets as a whole so comprehensively and consistently over such a long time period.
Looking at the shorter time periods of five and three years, the luxury goods sector’s performance is even stronger. And over the past year, a timeframe marking the early onset and spread of Covid-19 in many countries, the numbers are nothing less than sparkling – for every 1% gain in global stocks, luxury stocks added 2%, giving a total return of 105%.
To put this into perspective, the S&P Technology Select Sector index – tech has been endlessly talked about as the “engine” of stockmarkets over the last year – actually delivered a still strong but markedly less robust 67% over the same period. Admittedly, the one-year returns date almost exactly from the start of the pandemic, so they start from a low base, but the sector still looks resilient and dynamic compared to the overall market. The long-term numbers suggest that luxury goods stocks have defensive qualities and also generate attractive returns.
The post-pandemic bounce...
Luxury goods’ long-term strength is well documented, yet plenty of analysts succumbed to doom and gloom last year as Covid-19 struck. But what they foresaw as a bombshell turned out to be little more than a blip. Of course few global industries can escape the impact of an economic shutdown, and luxury sales are estimated to have fallen 20% last year, according to Bain & Company.
But analysts now reckon – thanks to effective vaccination programmes and various rounds of government aid to businesses as well as individual taxpayers – that sales this year could get back somewhere close to the pre-pandemic levels of 2019. Even if this proves slightly optimistic it seems clear that the turnaround has momentum and will follow through to a recovery by next year.
Some of the upturn will be visible in fashion haunts like London’s Bond Street and Manhattan’s Fifth Avenue but the real action will be seen in the Asia-Pacific region. Resurgences in the spread of Covid-19 can’t be ruled out but with China recovering quite early, for example, investors are counting on burgeoning business and consumer confidence in the Far East. More broadly, post-lockdown buying splurges are on the cards as consumers hitherto trapped in their homes finally get to scratch the itch to go shopping.
... will be followed by years of growth
Investing in luxury goods has been profitable over the long term and should remain so. Firstly, there is what analysts call “secular” growth, by which they mean growth is less affected by trends in the wider economy. The best examples are things like alcohol, cigarettes, medications, many other healthcare products and staple foods.
While they might fluctuate a bit, it’s nothing compared to the rollercoaster ride of companies whose performance is heavily dependent on general business trends determined by economic cycles: the likes of raw materials including steel and chemicals, as well as activities such as fuel-refining or travel.
A sector in a secular growth trend won’t escape a downturn. If the economy tanks, and people are feeling less wealthy and financially insecure, they will travel less and become less indulgent. However, the wealthy are not always affected by the economic constraints experienced by others. And the luxury goods sector has another advantage.
Companies can still grow when there are compensating factors boosting profits even when sales are coming under some pressure. These factors can be referred to as “structural” trends – shifts in the way whole industries operate that are being driven by forces so strong and so far-reaching that they can sustain growth even in weaker economic periods. An example is smartphones leading to apps and changing how we consume, network and find information. Companies will have lost out (camera-makers, for example) but many have gained hugely in ways that can seem almost to defy prevailing economic conditions (think social networks, online advertising and videogames).
Transforming the landscape
The two key structural changes in the luxury industry are e-commerce and the unrelenting growth in Chinese consumption. Both have transformed the commercial landscape beyond recognition. And the good news for investors is that neither is anywhere near over – there are many years of structural change to come, and this suggests more and more growth resistant to economic woes, which in turn presages further market-beating share-price gains.
As economic hits go, Covid-19 was certainly a big one, breaking centuries-old records in many cases. Yet although almost every sector fell when the pandemic first took hold, luxury goods outpaced the general recovery in stocks thanks to the rebound in Chinese consumption and the accelerating expansion of e-commerce. Covid-19 did more than anything else to help online shopping finally break the high street’s hold over shoppers after years of chasing.
Luxury for the next generation
When it comes to China one of the best gauges of consumption trends comes from following Alibaba’s Tmall, the country’s biggest business-to-consumer e-commerce website; it is essentially an online mall. Bain estimates that 70% of the site’s luxury-fashion segment is made up of Millennials – consumers born in the early 1980s and so coming of age in the late 1990s – closely followed by the subsequent, fast-accelerating Gen Z, a huge cohort.
These groups are very important because the amount they are spending on luxury goods is growing faster than in older generations. The average annual spending on the site by the latter is expanding by an impressive 22% a year. But the rate for Millenials is 24% and for Gen Z it is 33%.
These two generations should consume more as they grow older and wealthier. They also have a greater propensity towards spending money on quality goods and experiences than previous generations, who had less disposable income because their first move was getting on the mortgage ladder. This generation is also more switched on when it comes to environmental sustainability, an increasingly important theme with bespoke, hand-made luxury goods.
It is also significant that Millenials and Gen-Z in particular have a much stronger online presence and so they can influence others and spread trends much more quickly than their elders. The future will feature viral, word-of-mouth online marketing often beyond the control of the luxury goods companies themselves, even though they stand to gain.
All this helps explain why China’s share of the global luxury goods market almost doubled in 2020, according to Bain & Company, while luxury spending is expected to grow by more than 20% a year over the next few years. The Middle Kingdom is on track to become the world’s biggest luxury market by 2025.
One growth driver, and noteworthy development, in the past year was Beijing’s promotion of duty-free shopping on the offshore island of Hainan, which helped offset the decline in Chinese spending on luxury goods in duty-free shops overseas. There may be more local duty-free zones in future as China tries to keep consumers’ expenditure at home. This is a trend the industry will need to keep an eye on to ensure it is in the right place at the right time.
How websites have improved
As for the internet, many companies in the luxury goods sector were initially snooty about e-commerce, seeing luxury sales as something that happens in boutiques with a personal touch. This attitude has changed profoundly. Many of the websites are light years ahead of how they looked five years ago, showing the full range of products rather than simply being an outlet on the side for end-of-line goods.
Better distribution has helped matters, while companies have been able to temper consumers’ anxiety about poorly-fitting clothes or purchases that don’t live up to their website image through online facilities that make it easier to get refunds quickly or pick up alternatives. The impact of online revamps has been revolutionary.
For investors, the numbers are stark. Only in 2015, luxury shopping online accounted for 7% of sales. In 2019 it was 12%. Last year it is estimated to have almost doubled to 23% (with a big boost coming from the pandemic as consumers sat at home) and it is expected to more than hold on to its gains: the share of online sales of luxury goods should be over 30% by 2025.
But of course it is not simply about sales, strong though this growth is. It is also about the longer-term effects of penetrating new regions and markets online, which can speed up the rate at which companies attract customers and enhance their profit margins: they benefit from the lower distribution costs of direct sales instead of having to sell through stores, whether their own or other retailers’. And as China and e-commerce drive the structural shift supporting the long-term growth story for luxury goods, they also highlight two other related key attractions.
First, investing in high-quality luxury-goods groups which are in effect a diverse portfolio of brands can be a cost-effective way of gaining broader exposure to Asia beyond China. The advantage is that one can gain from Asian growth but often from lower-risk, more stable stocks than those that tend to be available locally.
And secondly, given that luxury goods are growing at rates higher than GDP, you are getting more “bang for your buck” buying luxury stocks than simply betting on global equities. The sector may look expensive, but it is worth the geared play on global growth.
The luxury-goods sector is a large portfolio of global brands that offer an unusually high degree of strong balance sheets, good compounding sales growth and high and steady margins.
Throw in the product and regional diversity plus lower-risk exposure to emerging-market growth trends, and it all adds up to a compelling addition to any portfolio. Below we look at some key quality equities as well as two funds offering comprehensive access to the theme and, hopefully, market-beating returns.
The stocks and funds to buy now
Many luxury-goods stocks are in fact a portfolio of different brands that offer a degree of diversification by product and region. This works well for investors as diversification is key to healthy long-term returns.
A top example is French giant LVMH (Paris: MC), a megabrand conglomerate that businessman Bernard Arnault began building in the late 1980s. It began with the Louis Vuitton malletier and Moët & Chandon champagne maker; labels including Givenchy, Berluti, Bulgari and Christian Dior have since been added. This is a powerhouse of top fashion brands that has strong defensive qualities with excellent scope for above-average long-term rewards.
Another option is the Swiss group Richemont (Zurich: CFR), owner of labels such as Cartier, Montblanc, Dunhill and Van Cleef & Arpels. Some see the shares as relatively undervalued compared with its peers, and as if to underline that view, there have been rumours that the French group Kering, which owns Gucci, has been planning to make an offer for it. In the meantime, the stock offers further recovery potential.
For a US stock with a brightening outlook, seek out Ralph Lauren (NYSE: RL). Most will be familiar with the preppy look, which has undeniable staying power, and analysts have recently upgraded their estimates. The company is showing disciplined focus on stock management and its core brands while the future for direct online sales looks positive; the website is pulling in much-needed younger audiences.
And for those who like something riskier, Farfetch (NYSE: FTCH) could be the answer. This British-Portuguese fashion outlet seems to be making great strides in online luxury retail. Bank of America has been singing its praises and it has formed an alliance with Alibaba to sell on China’s Tmall platform. Farfetch is a clean combination of the two structural drivers of luxury growth: China and e-commerce. For those willing to accept that there will be ups and downs, Farfetch is potentially a big winner. Among the cheapest approaches to “hands-off” investing in the sector is an exchange-traded fund that simply tracks the S&P Global Luxury index. The Amundi S&P Global Luxury UCITS ETF is available priced in sterling (LSE: LUXU) and can easily be bought online including in self-invested personal pension (Sipps) and individual savings accounts (Isas).
It is a global fund with 40% exposure to the US and 22% to France, while the biggest holdings include Tesla, leather-bags-to-champagne group LVMH, Switzerland’s Richemont, France’s Hermès and Diageo, owner of brands such as Johnny Walker. It looks good value with ongoing charges of 0.25% for solid equity outperformance.
If you prefer a fund that doesn’t simply track but is actively managed by professional stockpickers then there is the GAM Luxury Brands Equity in sterling (LU0984218668), although the annual charges are around 1.25%. It has fewer holdings but still has some overlaps with the tracker, as might be expected when investing in a concentrated sector.
Stephen Connolly heads a family investment office, and has worked in investment banking and asset management for nearly 30 years (firstname.lastname@example.org).