* Bearishness on the sector is reaching new highs. New year but same volatility and China macro uncertainties. The luxury sector underperformed the market by 15% in the last three months, the short interest has risen for almost all our stocks in 2015, bearishness among the sell side is nearing all-time highs and the sector P/E de-rated to a c.10% premium to European equities. We believe a poor 4Q and slow growth in 2016 are now partly baked into expectations but we still see downside risk to our +4% organic sales growth forecast in 2016e, broadly in line with current consensus.
* Pressure on the cost base may be moderating. We remain structurally negative on the sector and we are not yet calling the end of the earnings downgrade cycle. That said, we see encouraging signs as management teams start taking actions to better control costs. Hiring freezes are in place and net store closures are now common practice. In addition, rent inflation is moderating to mid-single digits, more in line with sales trends.
* The sector remains highly cash generative. Investors no long receive better growth by investing in Luxury vs. European equities. But, do get exposure to long-term cash return optionality. Balance sheets are strong as we estimate a net cash position at sector level by 2016 and FCF generation should improve as capex spend declines, despite margin pressure. We believe Hugo Boss and Hermes have attractive cash return potential.
* LVMH up to Neutral, reiterate Underperform on Burberry and Kering. Demand recovery is unlikely to rescue the sector so defensive attributes and well-managed cost bases will be the order of the day for luxury stocks in 2016. We think Burberry is structurally challenged and we should see further earnings downgrades. Kering has performed well on expectations of a recovery in Gucci thanks to new products but we expect a slower relaunch and further pressure on Gucci margin. We upgrade LVMH to Neutral in a note published today