European companies remain the world leaders in luxury goods. Despite some wobbles over the weakness of China and a weaker domestic consumer, these companies have remained remarkably resilient. Stefan Gries, manager of the BlackRock Greater Europe fund, asks whether they can maintain their strength in the face of weaker economic conditions.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Luxury goods companies are an increasingly important part of European markets. It is an area where Europe is dominant, accounting for around two-thirds of all sales of luxury products1. The sector has proved resilient in spite of rising interest rates, the weakness of China (an important market for luxury) and flagging global economic growth. However, 2024 may bring tougher economic conditions and greater challenges for the luxury market.
Europe’s luxury goods companies have grown considerably in recent years. Four of the top 10 largest companies in Europe are now in the luxury sector – LVMH, L’Oreal, Hermes and Dior (owned by LVMH)2. In April, LVMH became the first European company to surpass $500 billion in market value3. These luxury behemoths can command significant margins, with earnings amounting to nearly 25% of revenue4. This rivals the margins of the major technology companies.
Nevertheless, they face some challenges. Valuations have come down, but – like the goods they sell - many luxury goods companies still attract a premium price. This means earnings have to grow faster to justify their share prices. Yet economic conditions are becoming more difficult. China’s reopening has been weaker than expected, curbing an increasingly important source of growth for luxury good. The US and European consumers, also an important source of demand, are showing signs of weakness5.
While we don’t see signs of a prolonged slowdown in spending, with saving and employment levels high and inflation falling, it remains a risk for the sector and will hit weaker names. We see a lot of dispersion in the sector, but believe the stronger luxury goods companies can transcend the economic climate and any slowdown in consumer demand. They have certain key characteristics that enable them to protect their margins and profitability, even as interest rates rise and the economy weakens.
The scarcity premium
Luxury goods companies deal in rarity. They have to ensure their products are ‘special’. Hermes, for example, deliberately maintains low stock, looking to grow its leather goods capacity by just 7% each year.6 It focuses on the hiring and training of artisans in order to give them the necessary skills to produce their complex bags. As a result, it takes multiple years before a production facility is near full capacity. Growth is not reliant on volumes, and scarcity allows the company to push up prices.
It is a similar picture at Ferrari, where production capacity has been increased slowly and carefully. It is currently in the process of creating an ‘e-building’, where it will manufacture components for and assemble its future battery electric vehicles. As with Hermes, volume growth is only a small part of its revenue growth, with the company instead trying to drive revenues through its product mix and pricing.
Luxury goods companies also need to be looking at new markets. The Chinese market has become increasingly important. It now accounts for 35-40% of the personal luxury goods market, while the European and US markets together represent 40%.7 This is why China’s lacklustre reopening has been painful. For companies to thrive in this environment, they need to seek out new markets to shore up demand. Hermes has been expanding into Asia and previously under-served parts of the Americas. Other luxury goods companies are looking to the Middle East as a source of new opportunities.
These companies also have to take good care of their brands. In this, scale matters. Larger companies have deeper pockets and can spend money on supporting their brand through advertising and marketing. This can create a virtuous circle and has seen some of the larger groups outpace their smaller peers.
Tracking the success or otherwise of individual brands has become considerably easier by using ‘big data’. At BlackRock, our data scientists can produce granular analysis of the performance of different brands, in different regions and among different consumers. This can be important in judging a brand’s resilience – for example, the wealthiest consumers are less affected by interest rate rises and economic conditions, but these can hurt affluent middle class consumers, so it is important to know where a company draws its revenues.
A report by US consultancy Bain & Co said it expects the sector to grow its revenues by 8-10% in the year ahead, and then sustain growth of 5-7% per year up to 2030.8 This is an attractive backdrop for luxury goods companies to sustain their profitability. However, not all companies will be resilient in the current environment. Companies need a number of key qualities – new markets, brand management and careful volume growth – to thrive. This is where we are focusing our attention.
Sources:
1 FT - Europe’s new success stories are built on high luxury, not high tech – 06/12/23
2 Companies Market Cap - Largest companies in the EU by market capitalization – 06/12/23
3 CNBC – LVMH first European company to surpass 500 billion value- 24/04/23
4 FT - Europe’s new success stories are built on high luxury, not high tech – 06/12/23
5 Reuters – Euro zone retails sales fall in Sept – 08/11/23
6 FT - ‘The Hermès Game’: how the luxury house is defying the slowdown – 02/11/23
7 PR Newswire – Global luxury market to reach €1.5 trillion in 2023 – 14/11/23
8 Euronews – Is the luxury goods market back to normal? – 14/11/23
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