* Compelling growth prospects. We reiterate our positive stance on the
branded jewellery sector. We think branded jewellery will continue to enjoy
the fastest and least volatile growth in luxury, driven by a (i) +6.5% annual
increase in global wealth until 2020, (ii) rising consumer preference for
brands over independent jewellers, (iii) further opportunities in engagement
rings, and (iv) growing consumer sophistication in China and India.
* Barriers to entry moving higher. The economics of the jewellery market
remain unattractive for new entrants owing to the level of vertical integration.
Our analysis suggests that the well-established premium brands can charge
150% more than unbranded substitutes, up roughly 20ppt in the past year.
This allows branded jewellers to produce higher margins, compensate for
low asset turns and therefore produce superior ROIC.
* Commodity tailwinds for branded jewellers. Diamond prices have fallen
by c.15% YTD, as softer consumer demand for affordable gem-set jewellery
triggered destocking. Our mining analysts note that miners have already
started reducing supply to limit pricing pressure. The team expects a sales
volume recovery from mid-2016 and a modest price rebound from 2017 (see
Diamond Outlook, also published today). In addition to the declining gold
price, lower diamond prices should be beneficial for branded jewellers as
they typically do not cut prices. Due to low inventory turns, gross margin
should start seeing the benefits from 2016-17.
* We prefer Richemont (Outperform) to Tiffany (Neutral). We reiterate our
Outperform rating on Richemont but trim our TP to SFr91 (from SFr100)
following H1 results. We estimate jewellery now accounts for 59% of FY16
profit, which should be enough to mitigate prolonged weakness in the watch
market. We see better earnings visibility than most peers into next year and
the potential for positive surprises on input costs. For Tiffany, we believe
earnings power will be depressed in the near term due to cyclical headwinds,
unfavourable foreign currency exposure and operational challenges
associated with a shift from its high gross margin silver and gold businesses.