Are luxury goods next for comeback?

Interactive Investor International, September 2009

Luxury brand retailers have been hit hard by the economic turmoil but investment managers are predicting a bright outlook as many companies look east for future profits.

The luxury sector faces a net decline of 10% for 2009 as luxury shoppers spend less, travel less and feel less confident, according to a study on the worldwide luxury goods market by consultancy firm Bain & Company.

Marc Cohen, company director at high-net-worth research firm Ledbury Research, says there is a common misconception the luxury goods market is immune to economic downturns. "This is often bandied around but it's just not the case. The rich are usually the ones who have invested heavily in property and the share markets so their wealth in percentage terms has been hit more than the mass market," he says.

Profits in the luxury goods market have come under pressure since the onslaught of the global financial crisis. Luxury car makers Porsche, Lamborghini, Rolls Royce and Bentley have all reported a big slump in sales.

The jewellery and watch sectors have also had a tough time. In August, luxury jewellery maker Tiffany reported a drop in net profit of $56.8 million in the second quarter, from $80.8 million a year earlier. Net sales slumped 16% to $612.5 million.

Upmarket jeweller Theo Fennell also lost its sparkle this year after it reported a pre-exceptional loss of £2 million for the year ending 31 March. This was down from a £1.9 million profit the previous year. The group also had to write down £1.3 million after an unsuccessful move into fragrances and the closure of a number of store concessions.

In May, Angela Ahrendts, chief executive officer at fashion house Burberry, admitted 2008 to 2009 was one of the "most challenging years" the luxury sector has ever faced. While the luxury goods market is over 10% down compared to last year, it has experienced nearly a decade of unbroken growth, says Ledbury's Cohen.

Cohen believes luxury brands remain a good investment in the long-term. "Big global brands have a huge market so in the long-term there's no problem," he says.

However, a key factor in future profitability is largely down to a company's geographic spread. The more exposure a luxury brand has to the emerging economies such as China and Brazil, the more likely it is to experience a higher growth. The report by Bain & Company estimates a projected growth of 7% in China and 2% in the Middle East this year.

Cohen points out jewellery firm Tiffany is much more heavily exposed to the US market and has therefore experienced greater losses. Hargreaves Lansdown investment manager Ben Yearsley says geographic spread is a big factor. "Generally the luxury goods market has a pretty bright outlook - [but] not necessarily in the developed world, more in emerging economies," he says.

"As many in China, India and Russia become wealthy, they naturally become more aspirational. They want what we in the developed nations have had for years; BMW, Mercedes, Gucci, Prada and they now have the money to do it."

Yearsley says a lot of luxury brand companies saw their share prices fall dramatically at the start of the credit crunch as many believed their future prospects would be slim due to lower consumption in the west; however these fears appeared overdone with the east taking up the demand.

One fund manager who believes the luxury market has a promising investment future is Dominion Group chief executive Alex Bell who launched its Chic investment fund in 2007, giving investors a chance to invest solely in the luxury goods market. The fund's performance reflects how the luxury market has fared over the past year.

In the 12 months to 8 September 2009, the Chic DC fund has dropped 11.20% in sterling terms. In the year to date it has done better, up 16.24%, while in the past three months it has returned 13.47%.

The fund invests in a wide ranging portfolio of companies including Apple, Pernod-Ricard, Swatch and Polo Ralph Lauren. Bell says the fund has avoided small cap companies since the start of the global financial crisis due to the big fall-out in the sector. "Eighty per cent of our portfolio is made up of large cap companies with over $1 billion market cap but we're now starting to slowly introduce some small cap companies back into the portfolio," he says.

He says luxury brands which are financially strong and have a good geographic spread will remain good investments. Cohen agrees. "This is not a sector that is in terminal decline. Figures have shown that in the four or five last recessions, luxury retail sector has rebounded before the end of a recessionary period. People will always pay more money if they can for something they believe is better."