* Sector likely to remain under pressure
The Luxury Goods sector is down 7% ytd, underperforming the broader market.
Despite this underperformance (and weak investor sentiment / positioning), we
remain cautious in the near term given [1] uncertainty around China growth (click for
BofAML China GDP downgrade); [2] significant currency headwinds; [3] on-going
EPS broker downgrades; and [4] sector valuation in line with historic average. Q1
results are unlikely to be a positive catalyst given volatile trends in China, weaker
than expected US (partly weather related) and for most 2014 growth H2 weighted
* Downgrade 2014-15 by 4-5% on FX mark-to-market
We downgrade our sector earnings by 4-5% largely related to a stronger EUR, GBP
and CHF. The mismatch between revenue & COGS currency exposure, combined
with lower hedging gains means the FX drop through impact on 2014 EBIT can be
significant. We made the biggest downgrades to Burberry (-11%), Swatch (-5%),
Richemont (-3%) & LVMH (-3%). Our PO changes are shown in Table 1.
* BofAML estimates 5-6% below consensus
Our forecasts are now 5-6% below consensus. Stocks where we see the greatest
downside risk to consensus earnings are Burberry (-9% in 2014), Swatch (-8% in
2014) and Kering (-8% in 2015).
* Burberry downgrade to Neutral as FX & Japan mute growth
Burberry's best in class digital strategy should continue to support SSSG above
peers. However a significant FX headwind in 2015 and the Japanese integration in
2016-17 will likely impact group EPS growth (3-yr CAGR of 5%). Burberry trades at
a 20% PE premium to peers, limiting outperformance in near term in our view. Click
here for note.
* Top picks: Buy Hugo Boss & Prada
In our view Hugo Boss has one of the most attractive medium term stories. Hugo
Boss is trading on 14.5x 2015 EPS, a 10% discount to luxury peers despite having
[1] lower maturity & increased penetration opportunities; [2] a retail roll out story; [3]
above sector EPS growth; [4] 4-5% dividend yield, twice that of peers; [5] the
potential for a €350m capital return; and [6] a multiple re-rating towards general
retailers. Prada is now trading in line with the sector on 2015 EPS, in our view a
premium is still warranted given above sector EPS growth.
* Retain U/P on TOD’s, Swatch & Kering
Current trading at TOD’s is very weak (-6% in first 10 weeks of 2014). Its earnings
growth profile over the next 3 years one of the lowest in our coverage and in our view
no longer deserves its premium valuation. Swatch is trading in line with peers, but at
a 10% premium to its own history. In our view this does not discount the potential for
increased competition associated with smart watches. We expect the very weak
momentum at Gucci & Puma to continue in H1, given its Kering’s key sentiment
driver we see little rationale for its discount to peers to close in the near term.