Future Returns: Investing in the Global Luxury Industry

The global luxury industry has had a good run over much of the past decade and signs are pointing to continued strength despite a difficult stretch during the pandemic.

S&P’s Global Luxury Index has beaten the MSCI All Country World Index over the past five years by about 4.3%. It’s been a hotbed for M&A activity, including LVMH’s recent US$15.8 billion acquisition of Tiffany & Co. The sector has proven popular with investors from individuals through to private equity—a pre-pandemic Deloitte survey found 70% of respondents, most of whom were small-medium private equity funds were considering investing in a fashion and luxury asset.

Jessica Gerberi says structural growth themes in the industry have turned luxury stocks from a cyclical to secular growth opportunity.

Gerberi, a senior research analyst with Calamos Investments in Naperville, Ill., was positive on the industry before the pandemic, partly based on the resilience of luxury goods companies, some a century or two old. “Their resilience was just tested in such an unprecedented way with Covid, and Covid’s really been an accelerant for positive change in this industry,” she says.

Bain & Co. finds despite a contraction in the overall global luxury industry due to the pandemic, global online luxury sales grew almost 50%, to about US$59 billion, in 2020, compared to about US$39.7 the prior year. This sales channel is forecast to grow further, from an estimated 23% last year to more than 30% by 2025. Gerberi says the industry may not see a full recovery until 2022 or 2023, but the speedy adaptation to selling online undertaken by many companies offers a compelling reason to consider investing in luxury stocks.

“The strong getting stronger will likely continue to be a theme in this industry,” she says.

Besides the anticipated post-pandemic rebound, growth in emerging markets offers another compelling reason for the sector’s strength. One estimate anticipates the global middle class ballooning to 5.3 billion people by 2030, bringing about 2 billion up the economic ladder. This group is expected to splurge on luxury items, and the industry will reap the reward, particularly in China.

Due to these developments, Gerberi says in a post-Covid, normalized environment there could even be some upside to the industry’s approximate 5% annual growth rate. She shared three tips with Penta on how to invest in the global luxury industry.

Understand Different Exposures

Not all luxury stocks are equally exposed to different elements. For instance, some companies focus on a single brand while others have what Gerberi calls “natural diversification,” meaning multiple brands or that they operate in multiple categories.

“Some of these big luxury conglomerates have built their businesses upon M&A and acquiring new brands, which I think speaks to their ability to balance growing the equity and managing the heritage of their legacy brands,” she says. “But [they are] also keeping on top of current trends and being willing to take a risk on a brand that might not be fully in their wheelhouse.”

She mentions Moncler’s US$1.4 billion acquisition of Stone Island, which brought the down jacket maker together with a streetwear brand. Gerberi says these moves allow companies to tap into certain trends or companies growing at a faster rate than the overall luxury industry.

Geographical exposure comes into play as well. Much of the industry is listed in Europe rather than the U.S., for instance. And though the customer base is often considered from North American or European vantage points, luxury companies serve a diverse, global base of consumers beyond those regions. This means they’re impacted by much broader, global trends.

Embracing Digital Evolution

“Covid really accelerated the digital strategies that companies in the industry are pursuing,” Gerberi says. “And of course they came into the pandemic in varying degrees of development.” This follows other accelerations in online retail, which observers say advanced e-commerce sales and technology by several years during the pandemic.

This evolution is about more than simply having a robust e-commerce site, offering products for sale via third party or increasing the depth and breadth originally offered online. Gerberi says luxury brands have created new digital avenues to engage with their customers and build customer relationships including special sales events, setting up virtual showrooms—even biometric scanning to offer virtual beauty trials.

Investors should watch how companies have embraced this shift, as not all companies have seized the chance to innovate their digital platforms and complement their in-person shopping experiences. “That gap between the haves and have nots has widened,” Gerberi says.

China’s Growing Consumption

The growth of emerging market middle classes is a promising tailwind for luxury goods, Gerberi says. “But in the near term it likely wouldn’t be anywhere as meaningful as the continued growth of the Chinese consumer in this industry.”

In 2019, the Chinese consumer accounted for 35% of global luxury sales. That figure is estimated to rise to 50% by 2025. This may pose attractive investment opportunities in brands with less-established presences in China, offering room to expand their customer base there. Though China-based luxury brands are emerging, globally-recognised brands are expected to be the main driver of this consumption.

Gerberi expects “a good pipeline for luxury consumption” to continue, as China’s Gen Z population ages and gains more disposable income.

Factors like relatively quick economic bounce back from Covid, unemployment returning to pre-Covid levels, and a continued strong appetite for luxury goods bode well for continued sales growth. “All of those things continue to bode well for the outlook for the Chinese consumer with regards to luxury,” she says.

China’s economic recovery isn’t gaining the momentum money managers are awaiting.

Data from China Beige Book show that the economic green shoots glimpsed in August didn’t sprout further in September. Job growth and consumer spending faltered, while orders for exports came in at the lowest level since March, according to a monthly flash survey of more than 1,300 companies the independent research firm released Thursday evening.

Consumers’ initial revenge spending after Covid restrictions eased could be waning, the results indicate, with the biggest pullbacks in food and luxury items. While travel remains a bright spot ahead of the country’s Mid-Autumn Festival, hospitality firms and chain restaurants saw a sharp decline in sales, according to the survey.

And although policy makers have shown their willingness to stabilise the property market, the data showed another month of slower sales and lower prices in both the residential and commercial sectors.

Even more troubling are the continued problems at Evergrande Group, which has scuttled a plan to restructure itself, raising the risk of a liquidation that could further destabilise the property market and hit confidence about the economy. The embattled developer said it was notified that the company’s chairman Hui Ka Yan, who is under police watch, is suspected of committing criminal offences.

Nicole Kornitzer, who manages the $750 million Buffalo International Fund (ticker: BUIIX), worries about a “recession of expectations” as confidence continues to take a hit, discouraging people and businesses from spending. Kornitzer has only a fraction of the fund’s assets in China at the moment.

Before allocating more to China, Kornitzer said, she needs to see at least a couple quarters of improvement in spending, with consumption broadening beyond travel and dining out. Signs of stabilisation in the housing market would be encouraging as well, she said.

She isn’t alone in her concern about spending. Vivian Lin Thurston, manager for William Blair’s emerging markets and China strategies, said confidence among both consumers and small- and medium-enterprises is still suffering.

“Everyone is still out and about but they don’t buy as much or buy lower-priced goods so retail sales aren’t recovering as strongly and lower-income consumers are still under pressure because their employment and income aren’t back to pre-COVID levels,” said Thurston, who just returned from a visit to China.

“A lot of small- and medium- enterprises are struggling to stay afloat and are definitely taking a wait-and-see approach on whether they can expand. A lot went out of business during Covid and aren’t back yet. So far the stimulus measures have been anemic.”

Beijing needs to do more, especially to stabilise the property sector, Thurston said. The view on the ground is that more help could come in the fourth quarter—or once the Federal Reserve is done raising rates.

The fact that the Fed is raising rates while Beijing is cutting them is already putting pressure on the renminbi. If policy makers in China wait until the Fed is done, that would alleviate one source of pressure before their fiscal stimulus adds its own.

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