Trade war threatens reign of luxury stocks

A Chanel handbag for sale is displayed at The RealReal shop, a seven-year-old online reseller of luxury items on consignment in the Soho section of Manhattan, in New York City, New York, U.S., May 18, 2018. Net.

An escalating trade war between the United States and China could abruptly end a glittering stock market run for luxury goods firms, with some investors already put off by lofty valuations in a sector powered by shoppers in the two countries.

From pricey handbags to designer shoes, booming sales at the European companies that dominate the industry like Louis Vuitton owner LVMH and Gucci parent Kering have made them investor favorites, with shares still near record highs.

But the possible trickledown effect of tit-for-tat tariffs hikes on consumers is adding to jitters over heady valuations, even though luxury firms are not as directly threatened by rising protectionism as carmakers and industrial companies.

The sector has an average valuation of 21 times 12-month earnings forecasts, according to Reuters data, down from its May peak, but still 23 percent above its 10-year average.

“We are not making a call that they are bad companies, we think they’re great companies. But they’re bad investments,” said Edinburgh-based David Keir, co-manager of the Saracen Global Income and Growth fund, which dropped its LVMH holdings last year and sold out of German suit maker Hugo Boss in early July. “Now there’s an incremental risk from the great unknown of trade tariffs as well.”

It would not be the first demand-driven wobble the luxury industry has faced. In 2012, a Chinese crackdown on corruption caused purchases of premium cognac and other high-end goods used as gifts to fall sharply, taking the likes of LVMH and Remy Cointreau shares down with them.

This time, tariffs threaten consumers’ spending power in both the United States and China – the world’s two biggest consumers of European luxury goods, which make up just over half the industry’s revenues.

The impact on confidence in China’s markets, including the depreciation of the renminbi that would eat into Chinese tourists’ budgets for shopping in Europe, is among risks that may not be fully reflected in stocks yet, analysts warn.

“We see very little priced in so far,” said UBS analysts, who forecast as much as a 30 percent share price drop in the sector index in the event of a fully-fledged trade war.

Among the stocks that would be worse affected, UBS included Italy’s Salvatore Ferragamo and Britain’s Burberry . The two brands are in the midst of turnaround plans that have yet to fully hit their stride.

So far, the knock-on effect on revenues has been muted.

If anything, Chinese demand for Louis Vuitton’s leather goods ticked up in the second quarter compared to the first, LVMH reported, while most firms argue their core clientele is here to stay.

“We have still an expansion of the middle and upper class in China,” Kering’s group managing director Jean-Francois Palus told analysts following the company’s half-year results.

Sales in China have been largely driven by a young clientele unafraid of splurging on branded goods, and often financed by their parents and grandparents, with rising property prices also providing a source of wealth.

Economic Times

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