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December 21, 2015

Holiday 2015: Who Will be the Luxury Retail Winners?

by Jharonne Martis.

Jewelry, watches, high-end leather bags – the luxury retail market kicks into high gear for the holiday season. Lately, the most enthusiastic buyers of luxury goods have been in China, but the consensus shows that China’s economy might start to lose steam in 2016. What does this mean for luxury retailers?

The latest reading on the Ipsos consumer sentiment report suggests that the outlook looks dim in both China and the U.S. In addition, the U.S Federal Reserve finally raised interest rates, which will mean an even stronger dollar abroad.

Our estimates suggest that the holiday season won’t be as stellar as in the past for most of these luxury names. For instance, Prada reported weaker than expected earnings due to weakness in China. Yet this sector tends to be more resilient than others. Let’s look at four big players that are best poised to withstand global weakness.

Growth outlook

Turning to estimated growth rates, the names in the chart below are expected to see revenue growth for the current period vs. a year ago. Four out of 16 are expected to see double digit growth on both revenue and net income: Compagnie Financiere Richemont SA (CFR.VX), Kate Spade & Co. (KATE.N), LVMH Moet Hennessy Louis Vuitton SE (LVMH.PA) and Hermes International SCA (HRMS.PA).

LVMH and Hermes are reputable brands known for superior leather goods. Compagnie Financière Richemont’s jewelry and watch brands include Cartier, Van Cleef & Arpels and Piaget. These companies enjoy a solid affluent consumer base and as a result are considered less vulnerable to global economic weakness. Because of their brand strength, they are also seen as having more pricing power and are capable of performing more efficiently than other luxury names.

Exhibit 1: Earnings and Revenue YoY Growth – Current Period

Source: Thomson Reuters I/E/B/S

Source: I/E/B/S data

All that glitters

Looking at the top of the growth list, Compagnie Financiere Richemont is leading the global luxury market with on-trend merchandise, especially its fine jewelry which accounts for 54% of its total revenues.  Moreover, estimates show optimism on its long term strategies, and its ability to continue increasing earnings into 2017. Similarly, LVMH, Hermes and Kate Spade are expected to see double digit growth on both top and bottom lines, as they launch fashionable handbag designs.

Meanwhile, six out of 16 are expected to see a decline in earnings growth for the current period. Coach and Christian Dior are expected to see double digit decline in earnings.  However, Coach might be coming out of the drought, starting in 2016. Analysts have been lifting Coach’s earnings estimates. Those upward revisions may not be over: the StarMine Analyst Revision Model (ARM) indicates that analysts are likely to continue to revise their earnings upward as the quarter progresses.

Exhibit 2: StarMine ARM and Price-Mo Scores

Source: Thomson Reuters Eikon

Source: Eikon

Struggling brands

On the flip side, both Burberry and Jimmy Choo score in the bottom decile for the ARM score suggesting that analysts are bearish on the companies and are revising downward. It’s very rare for high-end brands to offer discounts and compromise margins. However, Burberry has been offering discounts to lure sales in Asia. Analysts’ pessimism is evident. For Burberry, buy recommendations have declined and sell recommendations have risen in the past 30 days.

Exhibit 3: Burberry Stock Recommendation

Source: Thomson Reuters Eikon

Source: Eikon

Stock price valuation

Meanwhile, there are a number of luxury brands that score in the bottom quintile for all measures related to the StarMine Value-Momentum (Val-Mo) model. The model incorporates two other valuation methods: Intrinsic and Relative Valuation models designed to measure a stock’s merits from both a value and growth perspective

The StarMine Value-Momentum (Val-Mo) model suggests that Hermes, Kate Spade, Blue Nile, and Mulberry rank in the bottom 20% of all stocks in its region – indicating that they are expensive stocks. However, Hermes also scores a 92 on StarMine model suggesting that its earnings are coming from sustainable sources.

Exhibit 4: StarMine Val-Mo, Relative and Intrinsic Valuation Scores

Source: Thomson Reuters Eikon/ StarMine

Source: Eikon/ StarMine

Adjusting for bias

Hermes stock remains the most expensive when examining its intrinsic value. Our StarMine Intrinsic Valuation (IV) model accounts for the systematic biases that our quantitative research team found in sell-side estimates. Thus, the faster the expected growth rate, the more optimism bias. And more-distant estimates are more optimistically biased than nearer ones. For Hermes, after adjusting LTG estimates for optimism bias, the StarMine IV model places fair value at €184 per share. In contrast, the market price is considerably higher at €319 per share. Plugging in today’s price and solving for growth suggests that investors are optimistic. Hermes market expectations are high with an implied 5-yr CAGR of 19.3%. The same can be said about Mulberry Group, which is trading at 913.8 pence per share vs. StarMine fair value of 217.6 pence per share.

Exhibit 5: StarMine Hermes IV Score

Source: Thomson Reuters Eikon/ StarMine

Source: Eikon/ StarMine

Currency effect

Due to the strong dollar in 2015, retailers were hit by weaker tourism spending in the U.S. this year. The Fed finally raised rates, which translates into a stronger dollar and weaker yuan. The Chinese yuan is now at 6.47 to one U.S. dollar, its weakest value since summer 2011. And looking at the FX polls estimates, it’s evident that a rebound is not expected in the near term. One thing luxury brands are doing is adjusting their prices in China to entice shoppers there.

Exhibit 6: FX Rate – US Dollar/Chinese Yuan

Source: Thomson Reuters Eikon

Source: Eikon

Travel fears

On top of a stronger dollar and weakness in China, there’s been global fear that’s hurt travel to Paris – one of the fashion shopping meccas. The biggest consumers of luxury goods have been in China. However, seeking safe travels and aware of a stronger dollar, shoppers might be encouraged to go somewhere closer to China for their shopping.

In fact, during Prada’s earnings call they mentioned inventory was up, and that hotel bookings were canceled by 30% and flights to Paris/London and Milan were canceled by 20%. Now tourists are traveling to Korea and Japan instead (Prada Earnings Call, StreetEvents).

Brazilian shoppers also love traveling to international destinations, but the safety factor is also kicking in here. International air traffic has been falling over the past four months for Brazilian passengers who are attracted to the fashion centers of New York and Paris.

Exhibit 7: FX Rate – Passenger air transport carried by Brazilian aviation internationally

Source: Thomson Reuters Eikon

Source: Eikon

Asia travel

During the Hong Kong protests last October, jetsetters who love to shop escaped to Korea instead. Luxury retailers paid attention and started opening shops in Seoul. Add in the safety factor, and this destination is becoming more popular rather than the U.S. and Europe.

Luxury names are not only noticing weakness in the U.S., but also from their core shopper, China. Prada recently said in their earnings call that “macroeconomic conditions deteriorated since August, affecting the consumer attitude in the quarter mainly in greater China and the U.S.” (Earnings Call, StreetEvents, 12/15/2015)  Indeed, the overall Primary Consumer Sentiment Index (PCSI) continues to climb in December 2015 as consumers enjoy a jolly holiday season. However, versus this time last year, consumer confidence is essentially unchanged, indicating 2015 was a bit of a lost year.

Meanwhile, the China Primary Consumer Sentiment (“Consumer Confidence”) Index (“PCSI”) as measured by the Thomson Reuters/Ipsos PCSI for December 2015 is down 2.4 percentage points over last month. The index is comprised of four sub-indices, which are all down. The job sub-index is dragging the overall index the most by 4.6 points, followed by sentiment on expectations, investment, and current conditions. This emphasizes Chinese concerns about the job market and near future outlook, which looks dim.

Exhibit 8: The Thomson Reuters – China Primary Consumer Sentiment

Source: Thomson Reuters Eikon/ IPOS

Source: Eikon/ IPOS

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