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GAM sees a turnaround in the luxury sector

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Scilla Huang Sun, luxury brands expert at GAM, comments that luxury companies are starting to overcome the headwinds of the past few years and adjust to more moderate growth rates. Huang Sun sees a turnaround in the sector and upbeat second-quarter earnings results. 

She writes: “The second-quarter earnings results of global luxury companies have come as a big relief to investors. Although some names are yet to report, we can safely say that overall results were better than expected against continued geopolitical turmoil and macroeconomic challenges. Part of the reason for this positive surprise is that analysts went into the reporting season with low expectations. The strong results by the luxury bellwethers, such as LVMH (owner of the Louis Vuitton brand) and Kering (owner of Gucci), were well received by the analyst community.”
 
Huang Sun reports that areas that have performed particularly well include athletics companies, cosmetics and some top luxury leather brands. However, ‘hard’ luxury, watches and jewellery, have continued to struggle. She writes that as growth remains moderate at best, cost control becomes more important, and both Ferragamo and Hugo Boss have demonstrated success in that area.
 
“Luxury sales continued to grow by around mid-single digits in the second quarter, much in line with the previous three months. We believe that 5 per cent organic growth for the companies we own can be achieved in 2016. This is supported by our experience that adverse events, such as the terrorist attacks across Europe, and political issues, such as the US presidential elections, tend to have only a short-term effect on luxury sales.
 
“Particularly encouraging is that some of the top brands have resurfaced from the challenging environment even stronger than before. This is true for Louis Vuitton and Gucci, which had lost some of their lustre over the past few years, but it appears now that the hard work put into the revitalisation of these brands is paying off. New products and innovations are particularly appealing for local European clients, which have contributed to the better-than-expected sales in a quarter that saw fewer overseas tourists due to security concerns. Gucci, for example, managed to increase sales in Western Europe by an impressive 20 per cent since the beginning of the year.”
 
In the luxury world, watches remain the industry’s problem child, Huang Sun writes, with fewer tourists visiting Europe, particularly France and Switzerland, both important markets. “Sales in Hong Kong have remained weak, with no sign of improvement. We believe the negative momentum will abate in time, given that this is the second year running with declines in sales. There are also concerns about the level of inventory in shops, while geopolitical uncertainties mean that customers are reluctant to spend money on big-ticket items. Given that watches are mainly a wholesale business, order pick-ups (by wholesalers) usually lag in a recovery phase. The Swatch Group expects a better second half of the year, aided by an easier comparison base.”
 
Turning to e-commerce, she writes that this is a major secular trend for luxury companies, as digitalisation is changing the way people shop. “In a world where creating excitement is more important than ever, the role of brands is crucial. Millennials buy more on endorsement from their peers and are less influenced by traditional advertising. As a result, we expect luxury companies will spend less on new stores and traditional media and more on e-commerce fulfilment and social media marketing. This is already being reflected in lower capital expenditure spending.
 
She concludes: “We believe that the tide is starting to turn for luxury names and the poor sentiment towards them seems more than adequately priced in. Demand for luxury goods should continue to grow as the middle class in emerging markets expands further. Meanwhile, companies have done their homework, and a rise in revenues should help earnings to grow disproportionately.”

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