The recent "growth paradigm" crisis & the “old normal”
Luxury growth in recent years has hinged on a) retail network expansion + b)
price inflation
Luxury market growth in the most recent ten and five years has been ca. 5% p.a. Retail
network expansion and higher prices have been the two key drivers behind this –
acting in broadly equal proportion;
This growth model has failed to produce shareholder value in the past three
years
ROIC for the luxury goods industry has on average continued to decline since 2012.
Adding retail space in a more muted market is a recipe for space productivity dilution,
ROIC compression and TSR deterioration. This is inevitable in a luxury goods industry
that is more and more resembling retail, in terms of cost structure and capital allocation
– albeit operating at higher prices vs. general retailers. We find that companies that
have invested the most are also the ones that have suffered the most severe ROIC
deterioration in recent years;
We see many reasons to anticipate lower contribution from both retail network
expansion and price inflation in the future
a) The most important new frontier – China – has enough stores. There is limited
opportunity for the companies in our coverage to add DOS in that market;
b) Several deflationary forces are at play:
b1. The bulk of new luxury demand growth is coming from middle class consumers in
China. Middle class consumers have lower spending power than early adopters;
b2. Chinese authorities are keen to stem capital outflows and increase tax receipts.
Repatriating luxury spend is one way to do so. This demands lower price gaps vs.
Europe;
b3. Chinese consumers have unprecedented levels of price transparency, in the era of
digital luxury;
Luxury goods companies need to adjust to an “old normal” of more moderate
growth
We note that capex / sales is above the long-term average, when it should be below it.
More muted retail network expansion will require lower capex levels. Digital
development is not going to pick up the slack. Luxury goods companies will likely
produce significantly higher free cash flow. The investment case for luxury goods will
likely move from one of “pure growth” to one of “growth and dividend payouts”;