The shift to global pricing is under way – the grey market and shopping habits of millennials are catalysts for change. We assume negative pricing in 2016-17 driven by Asia, with a more binary performance among peers in a low growth environment. Our EPS forecasts are 8% below consensus in FY17.
A broken pricing model to disrupt growth... As we set out in our January
26 report, pricing growth for the luxury peers historically accounted for ~25%
annual growth on our estimates, but this has now almost disappeared. We
think regional price lists look dated in a digital era, and greater transparency
will deem brands as 'overcharging' in certain regions. Our base case assumes
~15% price deflation in Asia over the next two years. We consider the digital
proposition across the major brands as this is key to attracting new consumers
– however, it will also accelerate the move towards global pricing, we believe.
This is no 'recessionary' scenario, but we see risks of a lower growth
environment which will require a new 'cost culture'. We see ~5%
average annual sales growth in 2016-19 and ~8% in EPS, but this compares to
~10% and ~16% pa, respectively, over the past five years. We also now
anticipate a wider divergence in performance across peers (2016e EPS growth
range -6% to +15%). Managing brands for growth is clearly the priority, but
companies will need to embrace greater cost control. We forecast sector
margins to be broadly flat in 2015-17, but this masks the -320bp decline we
expect for the more mature core European luxury brands.
There should be winners – we upgrade Richemont to OW. In line with our
prior analysis, we see the jewellery category as largely immune to the pricing
debate. Risks still exist (particularly in HK/China), but the risk/reward now
looks more compelling and watches may have troughed. We see a 12% EPS
CAGR in 2016-18 (cal), one of the highest among peers. We stay OW LVMH,
which we see as one of the cheapest quality assets in global consumer.
Risks are greatest for those brands not embracing change fast enough,
in our view – Swatch, Prada, Tod's, and Coach. Despite material
underperformance so far this year, we lack conviction in a turnaround. While
different product categories, there is a common theme – we think they risk
being too 'traditionalist', with existing strategies not focused enough to engage
with younger consumers in a highly competitive market.
Where we could be wrong? We may be too bearish on our pricing outlook –
in the past, brands have been price 'setters'. A more pronounced recovery
within HK/China would make our sales and margin forecasts too conservative.
Our strategists are more constructive on cyclicals and exposure to EM overall,
but agree that valuations remain demanding in global luxury.