A Nasty Profit Warning in the Luxury Goods Sector
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Burberry Group delivered a weak trading statement and shocked the luxury goods sector with its 21% share price plunge in London recently. Naturally investors will be worried about a read across to the whole sector and it’s time to take a look at why this happened and whether other companies are likely to get hit too.
It’s an interesting sector because over the years the market has gradually woken up to the idea that the luxury goods sector is a great way to play three strong economic trends. The first is the tendency of the Anglo-Saxon to shift towards increasingly polarized income distribution. The rich are getting richer and they aren’t in the mood to stop spending. The second trend is the growth of the wealthy in emerging markets and their aspiration to buy prestige Western brands, and the third is their willingness to travel and shop abroad in marquee luxury stores around the world. Is this all coming to an end?
Burberry’s Growth Checked
There are fewer companies that represent these trends better than Burberry Group and the recent warning that the environment was becoming more challenging was a disappointment. Profits before tax were guided at the lower end of market expectations with comparable same store sales unchanged in the ten weeks to 8 September. In addition, recent weeks have seen a declining trend develop.
I have one word to sum up what I think about it. China.
It is increasingly clear that China's growth is slowing and its property market is stagnating. It is a general rule of economics that whenever people’s key assets start to decline, they stop spending money. If you don’t believe me, just look at how US consumer spending correlates with net household wealth movements.
China is no different and recall that Burberry Group is an extremely strong brand in Asia. Also don’t underestimate how much of its sales in flagship stores actually come from Asian shoppers abroad.
Is it Really China or is it Burberry?
The other stock that has been serially weak in the sector has been Tiffany (NYSE: TIF) and it seems that a quarter doesn’t go by without it disappointing. On Aug 27 it reduced its full year worldwide sales growth forecast to 6-7% from 7-8% and cited a moderation in fourth quarter growth. It also reduced its adjusted EPS forecast to $3.55-3.70 from $3.70-3.80.
Of course Burberry and Tiffany aren’t the only brands popular in Asia. Coach (NYSE: COH) is a hugely popular brand in the region and I don’t think its ‘affordable luxury’ offering will make it immune from any consumer moderation. In its last set of results Coach reported sales up 60% in China and it is committed to opening a further 30 stores in China this year. The company is becoming increasingly reliant on the country and if Burberry's warning is a sign of things to come then Coach's prospects must be diminished.
In addition, Michael Kors (NYSE: KORS) is eating away its traditional mid-market niche. Incidentally, I would be cautious on both names. Fashion is fickle and it doesn’t make sense to chase a name because it was fashionable last season, only to be disappointed next year when Carrie Bradshaw starts eulogizing over some new Hyena leather handbag designer or other. It’s true that Coach offers a more classical offering but when you compete on price, you have to expect to be beaten on price too. Kors is doing a great job this year but it wll have to stay innovative to retain the market share in accessories that it took from Coach. History suggests this will be hard to achieve.
Turning back to China, the two leading European luxury plays, Richemont and Louis Vuitton do continue to see strong growth but of course they will be aided by significant currency tailwinds as the Euro has weakened. However, even Richemont has talked of sales moderating since May and given its exposure to China, it's hard not to conclude a correlation here.
Furthermore, it’s not just the luxury sector, we have seen plenty of companies talking of a moderation in growth in China and in my humble opinion investors need to be careful with stocks that are relying on emerging markets for their growth.
Alternative High End Plays?
If China is moderating and taking other emerging markets with it, then where else to go in the sector? I think investors should stick to the high end retail plays in the US. The US economy is improving, albeit slower than anyone wants it too, and in general retail sales in the US have been pretty good.
The key is to understand that there are some key intra-industry trends going on. I’m talking about the desire for middle-income consumers to trade down and the rise of e-commerce. Both of which are reasons why I like what Nordstrom (NYSE: JWN) is doing by expanding its online presence and its discounted Rack stores. Nordstrom is also not constrained by having to defend or develop a particular brand. In fact its recent deal with Top Shop is an attempt at diversifying its product lines even further. The recent anniversary sales went very well and there is no reason to expect Nordstrom to slow down from here particularly as it is primarily a US centric play.
Similarly a stock like Macy’s, (NYSE: M) has been reporting sales that exceed expectations recently. Throw in a PE of 12 and a dividend of 2% and the stock is hardly expensive. The China plays may well have the sexier long term story but investing is also about spotting opportunities to buy companies whose results can exceed expectations going forward rather than disappointing. On this basis I think Nordstrom and Macy’s are more interesting than hoping that the moderating trend in China suddenly turns around.
SaintGermain has no positions in the stocks mentioned above. The Motley Fool owns shares of Coach and Tiffany & Co. Motley Fool newsletter services recommend Coach. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.