Investors forecasting the euro and Swiss franc will weaken against the dollar may find comfort in shares of European luxury-goods companies.
Cie. Financiere Richemont SA (CFR) and LVMH Moet Hennessy Louis Vuitton SA (MC) are among stocks that would benefit disproportionately if the currencies fall further from year-ago levels, according to Thomas Mesmin, a Paris-based analyst at brokerage CA Cheuvreux. For every 1 percent decline in exchange rates, the industry’s average earnings before interest and taxes may rise 1.3 percent to 1.5 percent, he said.
“This will help luxury-goods companies, because a high proportion of their sales come from outside of Europe, while their cost bases are in euros, Swiss francs or the British pound,” Mesmin said.
Richemont, owner of Cartier and Montblanc, will be “one of the best currency plays,” because about 65 percent of its sales are in non-European denominations, its costs and accounts are euro-dominated, and its shares trade in Swiss francs, he said.
Worldwide sales for the Geneva-based company grew 24 percent at actual and constant exchange rates in the quarter ended Dec. 31, compared with a year ago, it said Jan. 16. Richemont reconfirmed its forecasts that operating profit for the year ending March 31 will be “significantly higher than last year,” Chief Executive Officer Johann Rupert said that day.
A weaker euro helps Salvatore Ferragamo SpA (SFER), the Italian maker of handbags and shoes, by making it more competitive and boosting margins, Chief Executive Officer Michele Norsa said at a Jan. 15 fashion show in Milan.
Rising Luxury Index
The newly-created Bloomberg European Luxury Goods Index (BNLXGDEU), which includes LVMH and Swatch Group AG (UHR), has risen 357 percent since Nov. 18, 2008, while the Stoxx Europe 600 Index has increased 27 percent. The luxury index has outperformed the market by 6 percent this year; between Sept. 21, 2011, and Dec. 30, 2011, it underperformed by 18 percent.
Industry organic growth, before the impact of exchange rates and acquisitions or disposals, probably will outpace global gross domestic product expansion during the next decade, said Scilla Huang Sun, head of equities at Swiss & Global Asset Management in Zurich. She oversees the Julius Baer Multistock - Luxury Brands Fund, with holdings in LVMH and Richemont.
Bloomberg’s luxury index is trading at 14.5 times Mesmin’s estimate for 2012 earnings, before goodwill and extraordinary items, and 12.8 times his 2013 calculation, compared with 19.3 times in 2007. The Stoxx 600 is trading at a multiple of 10.8.
This appeals to investors, particularly if the industry grows 10 percent each year through 2015 and there’s a positive impact from exchange rates this year, Mesmin forecasts.
Because these companies operate in Europe and sell goods worldwide, their sales convert to higher revenue in euros as the currency falls relative to the dollar. There’s also a gain to margins because profits grow more than sales given the euro cost base, Mesmin said.
European currencies will weaken this year as a result of the region’s sovereign-debt crisis, said Valentin Marinov, a London-based senior foreign-exchange strategist at Citigroup Inc. The average exchange rate between the euro and the dollar will decline 10 percent to $1.25, compared with $1.3926 last year, according to Citigroup’s estimates. The pound will drop an average 4 percent to $1.53 from $1.6041, while the Swiss franc- dollar exchange rate will fall about 11 percent to $1.00 compared with $1.1323 in 2011.
The euro will end the year at $1.30, the pound will trade to $1.56 and the Swiss franc will be $1.01, according to the median forecasts of currency strategists in Bloomberg surveys.
The number of Chinese and Indians who can afford high-end goods is increasing, and they may save for months to buy an expensive handbag, Huang Sun said. “This is a European industry with a high exposure to emerging markets, where you are going to see strong growth in consumer spending.”
A “made in Europe” label is highly coveted abroad, and brands such as Hermes and Louis Vuitton have pricing power, which is “very rare in the current environment,” said Rahul Sharma, founder and managing director of Neev Capital, a London- based consulting company. “In emerging markets, luxury-goods prices are actually much higher than in Europe.”
Shoppers in China accounted for 25 percent of industry sales in 2010, compared with 21 percent for European shoppers, according to a Jan. 4 report written by Goldman Sachs Group Inc. analysts led by William Hutchings in London. By 2025, China may make up 46 percent of total revenue, they wrote.
The revenue potential is important from China and from India, where market estimates for growth are “very conservative,” Sharma said. India has a longstanding tradition of jewelry consumption, and consumers now are increasingly fond of European high-end brands, making them a significant demographic for luxury products, he said.
Global travel also has been a “key driver” of revenue; as much as 50 percent of sales at luxury-goods retailers in Europe are to foreigners, which may increase to 60 percent by 2015, Hutchings wrote.
Successful Chinese entrepreneurs have created more affluent consumers who can afford brand-name clothing and accessories, while the government has “deliberately encouraged consumption,” said Charles Robertson, global chief economist at Renaissance Capital in London.
These wealthy shoppers are looking for places to spend their money, given the Chinese stock market’s poor performance and a slowdown in the housing market, Robertson said. Meanwhile, there’s been easy access to credit, so “the incentive to spend more is quite high.”
For London-based Burberry Group Plc (BRBY), “flagship markets” including London and Hong Kong “benefit from the traveling luxury customer” and performed well in the quarter ended Dec. 31, Chief Financial Officer Stacey Cartwright said on a Jan. 17 conference call. “China comparable-store growth was again strong, up around 30 percent on top of the over-30 percent growth in the prior year,” she said.
Investments for larger companies, including in retail locations, aren’t outpacing sales, so their cash flows remain strong even with these expenditures, Sharma said.
One change that may hurt high-end spending would be a depreciation in luxury-property prices, which have supported growth in the number of Chinese millionaires, Robertson said. Meanwhile, wealthier European consumers may curtail spending if the region slips back into another recession, triggered by a “disorderly default” in Greece, he said.
Slowdown in Spending
Tiffany & Co. already has experienced a slowdown in spending by Americans and Europeans, prompting the New York jeweler to lower its earnings estimate for the year ending Jan. 31. The company now forecasts earnings will be between $3.60 and $3.65 a share, compared with its November estimated range of $3.70 to $3.80, it said Jan. 10.
“Sales weakened markedly in the United States and Europe during the holiday season,” Chairman and Chief Executive Officer Michael Kowalski said in a statement that day.
Even if the euro doesn’t fall any further in relation to the dollar this year, current exchange rates still are “a very big benefit” for European luxury-goods retailers, Sharma said. The euro is down about 12 percent since May and traded at $1.2667 on Jan. 16, the lowest since August 2010. The Swiss franc has fallen almost 23 percent since August, and traded at $1.0730 as of 4:30 p.m. in New York yesterday.
This means luxury stocks will continue to appeal to investors, even as concerns about a euro-area recession persist, Sharma said.
“These companies are much more resilient than they used to be as exposure to new markets in Asia is up sharply from even three years ago,” he said.
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