Luxury Companies, Cash Rich, Ready to Splurge
If acquisition targets don’t emerge this year, investors can expect a step-up in dividends
Whatever happens to demand for luxury goods this year, one thing is sure: Corporate cash will pile up.
Brands like Louis Vuitton, which anchors the portfolio of LVMH, and Gucci, owned by rival Kering, invested vast sums in opening shops in recent years. Strategic fashion now favors retail—selling goods directly to customers from opulent city-centre shops—over less controllable wholesale and licensing business. And rampant demand from China and other emerging economies, particularly after the 2008 financial crisis, encouraged flag-planting.
The market eventually buckled as falling commodity prices hit Russia and Brazil and China clamped down on corrupt gifting. Brands slowed store-opening programs to the point where they actually closed more outlets than they opened in the first half of 2016, according to brokerage Bernstein. Now demand seems to be rebounding, but with retail networks already in place, new-store numbers aren’t expected to follow.
The financial consequence of this “new normal,” as industry executives refer to it, will be a surge in free cash flows. Without having to spend on even more glitzy new stores on the world’s most expensive streets, corporate cash piles should swell. Even in the darkest hours of early 2016, luxury groups remained highly profitable. That raises an enticing question for investors: What will executives do with the cash?
One possible outcome is a pickup in mergers and acquisitions. LVMH, Kering and Swiss-watch giant Richemont have historically acted as industry consolidators. Kering wants to pay down debt, but the other two groups are cash-rich and could easily afford to play this role again.
Whether deal activity recovers—after a muted few years -- depends less on consolidators than their targets. Trench-coat specialist Burberry is one of the rare luxury companies not controlled by a family stake—hence it is the subject of periodic takeover rumors, most recently involving U.S. group Coach. Otherwise business owners must want to sell. With growth prospects looking more mundane than during the store rollout boom, but valuations still high, some could be tempted to cash in.
If deals don’t materialize, the other likely consequence of bigger free cash flows is bigger dividends. Most luxury stocks yield in the region of 2%--a level more associated with growth than today’s more mature market environment. Share buybacks have been minimal.
There are obstacles to greater cash returns: All the major luxury groups are controlled by magnates with long investment horizons and little incentive to increase shareholder payouts. Richemont’s net cash position is already equivalent to 12% of its market value—a financial inefficiency that probably wouldn’t be tolerated if activists could buy a louder voice on its shareholder register.
Yet mounting cash piles will make it harder for industry executives to bat off calls for more generous returns. That could give luxury stocks a new way to shine.