Gucci Looks Like Fashionable Pick for Luxury Rebound
Brands can no longer count on store rollouts and timeless appeal to drive growth
Demand for luxury goods is rebounding, but the rising tide may not lift all boats. Investors need to pay more attention to fashion than they used to.
Last year was the luxury industry’s worst since the 2009 crisis: HSBC estimates that sales grew just 1% at constant currencies. Chinese consumers, whose spending accounts for roughly 40% of revenues, much of it outside of China, seem to have been spooked by terrorist attacks in Paris and Brussels as well as a weaker renminbi.
Fortunately, the trend improved as 2016 progressed, with a contraction in the first half followed by a rebound in the third quarter. Early sales updates from Cartier-owner Richemont and Burberry this month have reinforced hopes that the fourth quarter was even stronger than the third.
Stores in mainland China have led the recovery. But investors would be unwise to assume a return to the good old days when China’s appetite for European luxury brands seemed both limitless and indiscriminate. There are two crucial differences between today’s industry and the postcrisis world of 2010-13.
Brands can no longer guarantee growth by opening hundreds of new stores. Most already have retail estates stretching well into the Chinese mainland. Companies are therefore looking to improve the productivity of the stores they already have—a sensible strategy, but one that inevitably pits them against each other more than they are used to.
Second, luxury consumers, including in China, are increasingly choosing innovation over tradition. Burberry reported last week that “fashion” -- or newly designed items—outperformed sales of core products like its famous trench coats in the Christmas quarter. Such is the thirst for novelty that the British brand is experimenting with a “see now, buy now” model, whereby clothes modeled on the fashion-show runway are immediately available for sale.
This trend is a challenge for companies used to selling products on the basis of timeless appeal. It is also a challenge for investors. Barclays has charted social media mentions and “likes” in an effort to assess “brand heat,” but admits it is hard to draw firm conclusions.
An alternative way to gauge fashionability is to look at the share of a brand’s product range that has been recently redesigned. Companies don’t typically advertise data of this kind, but one that has reason to is Gucci, which accounts for three-fifths of operating profits at luxury group Kering. Following a complete product overhaul since the appointment of a new creative director in early 2015, more than 80% of Gucci products for sale in the third quarter were new—up from 50% to 60% in the second quarter. Quarterly sales rocketed 17% year-over-year, suggesting this is having a major impact. In the fourth quarter, some 90% of products were new, which bodes well.
Share prices have risen sharply across the sector since October. Sector bellwether LVMH Moët Hennessy Louis Vuitton now trades at 24 times prospective earnings, well above the 10-year average. With expectations already high, investors need to be careful they don’t buy shares in a company that only participates halfheartedly in the rebound. A clear turnaround story like Gucci may be the best hedge against disappointment.
