Lux­ury brands limp to­wards re­cov­ery

The lux­ury goods sec­tor has been un­der pres­sure, partly due to the in­creas­ing pop­u­lar­ity of smart­watches and the clam­p­down on gift-giv­ing by the Chi­nese govern­ment.

Finweek English Edition - - COVER LUXURY GOODS - By Mar­cia Klein

re­cent news of a profit slump, man­age­ment shake-up and pos­si­ble job cuts at Jo­hann Ru­pert’s lux­ury goods group Richemont sent rip­ples of fear and anxiety through in­vestors in the his­tor­i­cally de­fen­sive lux­ury sec­tor. The sec­tor has felt pres­sure since the 2008 global fi­nan­cial cri­sis, but there have, more re­cently, been new chal­lenges which have thrown it into a new era of cut­backs and con­sol­i­da­tion.

In­stead of the ex­ter­nal en­vi­ron­ment im­prov­ing, as was hoped, it has con­tin­ued to de­te­ri­o­rate and Richemont, which is one of the lux­ury goods groups that is most ex­posed to watch­mak­ing, has been among the most af­fected, says Fairtree Cap­i­tal’s Jean Pierre Ver­ster.

“The first is­sue to af­fect lux­ury goods groups over the last decade was the post2008 eco­nomic en­vi­ron­ment, the sec­ond was the clam­p­down on gift-giv­ing in China since 2012 [by govern­ment, as part of its anti-cor­rup­tion cam­paign], and the third has been a gen­er­a­tional or tech­no­log­i­cal is­sue – the ad­vent of the smartwatch, which has been a dis­rup­tor in the in­dus­try.”

Lux­ury watches have al­ways had an ad­di­tional use apart from their time­keep­ing util­ity – they rep­re­sented value, sig­ni­fy­ing the sta­tus of their wearer. To get some idea, Richemont’s Pi­aget Alti­plano costs more than $91 000 and its Vacheron Con­stantin $150 000.

But the smartwatch now has func­tion­al­ity that a lux­ury watch has not been able to add, forc­ing the hand of com­pa­nies like Richemont. “This is a struc­tural in­dus­try is­sue, which lux­ury watch­mak­ers have had to grap­ple with, and they are now cut­ting back on pro­duc­tion, re­trench­ing and cost-cut­ting, so re­ally it is a tor­rid time, es­pe­cially for Richemont, which de­rives 40% of rev­enue from watches,” says Ver­ster.

Richemont’s re­sults were a shocker. Sales fell 13% to €5bn, op­er­at­ing profit dropped 43% to €798m and profit slumped 51%. The group had to make some rad­i­cal ad­just­ments in­clud­ing buy­ing back slow-mov­ing stock from re­tail­ers and “op­ti­mis­ing” (clos­ing) some stores, re­flected in one-time charges of €249m.

Chair­man Ru­pert an­nounced a big man­age­ment shake-up, which in­cluded get­ting rid of the CEO po­si­tion. The group is also look­ing at hir­ing freezes, early and vol­un­tary re­tire­ment and re­trench­ments.

It is not just watches. Across the sec­tor there have been re­minders of the chal­lenges ahead. Her­mès, which makes Birkin hand­bags, scrapped its 8% sales tar­get and the UK-based Burberry, which is fight­ing off a takeover bid by US ri­val Coach, saw its half-year prof­its slump 34%. Swiss watch­maker Bre­itling is re­port­edly for sale.

Trou­ble in China

Af­ter a pe­riod in which lux­ury goods com­pa­nies clam­oured to open stores ev­ery­where they could in China, they are now clos­ing some down.

In­vest­ment Week said lux­ury goods com­pa­nies “have to re­think strate­gies as the im­plo­sion of the gift-giv­ing bub­ble, the store open­ings eu­pho­ria, and shift­ing con­sump­tion pat­terns have led to an in­creas­ingly com­pet­i­tive land­scape”.

But, it said, their bal­ance sheets are strong and China re­mains a grow­ing mar­ket. China ac­counted for 30% of lux­ury goods pur­chases, ac­cord­ing to Bain & Co. Although this is down, re­cently, from 31%, Chi­nese pur­chases were only 1% in 2001.

Bain ex­pects the mar­ket to grow

be­tween 2% and 3% a year be­tween now and 2020, and Bloomberg points out that the sec­tor will, for the first time, not grow above GDP.

Cobus Cil­liers, in­vest­ment an­a­lyst at 36ONE As­set Man­age­ment, says the ef­fect of anti-ex­trav­a­gance mea­sures in China “was very pro­nounced for the Swiss watch in­dus­try, as well as high-end cognac and scotch in­dus­tries in China. These clients are not buy­ing lux­ury goods for gift­ing pur­poses any­more, but now only for per­sonal con­sump­tion. Ter­ror at­tacks in France and Ger­many have also led to lower tourism num­bers, which af­fected lux­ury sales.

“The sup­ply chan­nel is also over­stocked, hence Richemont’s buy­ing back in­ven­tory from some sup­pli­ers. Swatch has not done the same, which is a lit­tle con­cern­ing.”

Richemont’s re­ac­tion to its poor re­sults is sig­nif­i­cant, says Ver­ster. “It is try­ing to re­spond quicker to changes in the mar­ket and try­ing to be closer to the mar­ket, to try find out what the cus­tomer wants and what of­fer­ings it should be mak­ing to the cus­tomer. It has, for ex­am­ple, talked about the de­vel­op­ment of a smart strap.”

He says Richemont is buy­ing stock that is not mov­ing in­stead of see­ing it dis­counted by re­tail­ers. “This is an ex­treme re­ac­tion. It wants to con­trol the route to mar­ket to main­tain the ex­clu­siv­ity and rar­ity of its prod­ucts.”

Cil­liers adds that time will tell if these changes will be pos­i­tive or neg­a­tive, but “we be­lieve it will be pos­i­tive in the long run. We are op­ti­mistic that Mr Ru­pert will be guid­ing the com­pany out of the dif­fi­cult times it is fac­ing to­day. This will take time and he takes a very long-term view on these mat­ters, which is good for the com­pany longer term.”

Mar­ket dis­rup­tions

Lux­ury goods groups need to align their busi­nesses with changes in their mar­kets.

While tech­no­log­i­cal dis­rup­tion has caused a trend from lux­ury to smart­watches, other trends are less clear. How­ever, says Ver­ster, there has

been a de­crease in the ap­petite for con­spic­u­ous con­sump­tion and a crack­down on bribery and gift­ing as well as on tax havens, so many peo­ple no longer want to stand out or flaunt their wealth as it will at­tract at­ten­tion, lead­ing, for ex­am­ple, to tax au­dits or other crack­downs.

By open­ing a large num­ber of stores, es­pe­cially in China, lux­ury goods groups saw their prod­ucts lose some of their sta­tus as premium prod­ucts. “They al­ways run the risk that if they grow too quickly and their prod­ucts are avail­able too widely, they are not seen as that ex­clu­sive any­more. This has hap­pened in lux­ury lug­gage where dis­count­ing and avail­abil­ity can make them mass af­flu­ent prod­ucts rather than lux­ury prod­ucts. Michael Kors and Coach are such ex­am­ples. Lux­ury goods groups have opened lots of stores in China and are now start­ing to close some,” says Ver­ster.

Cil­liers says the Chi­nese are buy­ing more lo­cally, whereas be­fore they used to pur­chase lux­ury goods while trav­el­ling. “We are see­ing more lo­cal buy­ing and in main­land China, Ma­cau and Hong Kong lux­ury sales com­ing back.

“There also seem to be pock­ets of growth for some com­pa­nies,” he says. “Gucci (Ker­ing) is do­ing very well, while TAG Heuer (LVMH) is also do­ing well de­spite the slow­down in the Swiss watch sales num­bers.”

Outlook

De­spite the chal­lenges, there is hope for the lux­ury goods sec­tor.

First, it has not been all bad. LVMH, the world’s largest lux­ury goods group, said rev­enue in the third quar­ter, which had im­proved since ear­lier this year, was up 6%. Sec­ond, LVMH said in its re­sults that de­mand from China, which was flat in the first half, has picked up con­sid­er­ably.

And with lux­ury goods groups sit­ting with strong bal­ance sheets, they are likely to weather the storm, but not with­out some pain.

Bain, in its most re­cent lux­ury mar­ket re­search, says this sec­tor has reached a mat­u­ra­tion point. “Brands can no longer rely on low-hang­ing fruit. In­stead, they re­ally need to im­ple­ment dif­fer­en­ti­at­ing strate­gies to suc­ceed go­ing for­ward.”

Ver­ster ex­pects some merger and ac­qui­si­tion ac­tiv­ity as the sec­tor con­sol­i­dates. “The mar­ket is not go­ing to die but it is chang­ing and the ad­dress­able mar­ket is smaller, so they need to right­size their cost base, which is ex­actly what they are do­ing by re­trench­ing and cut­ting back pro­duc­tion and clos­ing some fa­cil­i­ties. This is not easy be­cause com­pa­nies nat­u­rally fo­cus on growth. But these are the right steps to fol­low for now.

“Ru­pert is a strong leader and has street smarts, and he sees the writ­ing on the wall and is driv­ing the process of shrink­ing. The sil­ver lin­ing is that they have lots of cash on the bal­ance sheet, which al­lows them op­tions,” ac­cord­ing to Ver­ster. Cil­liers says they are a bit cau­tious about the cur­rent price of Richemont. The share, trad­ing at around R90, has lost 16% this year but is on a for­ward priceto-earn­ings ra­tio of 27.

“But the div­i­dend is still at­trac­tive, the bal­ance sheet is rock solid, but if you look at the share price it looks like it is pric­ing in a lit­tle too much. With the most re­cent Swiss watch ex­port num­ber up­date for the month of Oc­to­ber (down over 16%), we are still a lit­tle con­cerned that the re­cov­ery that ev­ery­one might be pric­ing into the share is not there yet,” he says.

An em­ployee ad­justs a watch by Jaeger-LeCoul­tre, a watch­mak­ing unit of Richemont, in a dis­play at the Tourneau Inc. Madi­son Av­enue store in New York.

Jo­hann Ru­pert Chair­man of Richemont

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