China is a problem for American luxury, too
U.S. brands like Michael Kors and Coach are less dependent than European ones
If China is buying fewer iPhones then there’s a good chance it’s buying fewer $1,000 handbags too. European brands are more directly in trouble, but may still weather the storm better than their U.S. rivals.
After a bumpy end to 2018, shares in the global luxury sector dropped again this week after Apple Chief Executive Tim Cook warned that weak Chinese consumer spending hit iPhone sales in the quarter through December. That backed up bears’ fears that demand for expensive leather accessories and watches will be hit next. Luxury labels are heavily reliant on Chinese shoppers, who buy one-inthree of their products globally. Some may question why shares in companies like Michael Kors were treated more harshly than those on the other side of the Atlantic. U.S. labels have far less direct sales exposure to Chinese shoppers than European brands, some of which have been pushing ag- gressively into China for two decades. Tapestry, formerly Coach, makes just 12% of total revenue from Chinese shoppers compared with 44% for Cartier-parent Richemont, according to Morgan Stanley estimates. Despite this, shares in U.S. brands are now deeply discounted, with Michael Kors and Tapestry fetching 7 and 12 times projected earnings respectively.
Investors have always been willing to pay over the odds for French and Italian brands, whose elite customers have a better chance of shrugging off macroeconomic problems. Stronger pricing power means their operating margins tend to be higher too. But the valuation gap is becoming more extreme. On a projected-earnings basis, European luxury currently changes hands for roughly 60% more than U.S. names—double what shareholders paid this time last year.
Sadly, this doesn’t look like a genuine bargain: U.S. brands have other problems. They make the majority of sales in their home market, which most analysts expect to slow in 2019. Tapestry and Tiffany pinned their future growth hopes on store expansion plans in China, so could face a double whammy to demand for their handbags and jewelry on both sides of the Pacific. And unlike European brands, which resisted shifting manufacturing to Asia, U.S. labels like Michael Kors are at risk from tariffs. Mr. Trump planned to increase import taxes on Chinese-made handbags to 25% at the beginning of this year, but last month agreed to suspend the change for three months to allow for trade talks.
The entire luxury sector will likely be in the doldrums for months as the negotiations play out. But investors looking for safe havens are better off shopping in Paris than in New York.