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Consumer Brands & Retail Global luxury goods – Equity March 2013 abc Sector valuation history (forward PE) 40.0 x 2000 bubble 35.0 x 30.0 x 25.0 x 20.0 x SARS epidemic China starts to matter 2007 market peak Average since 01/01/2003: 16.8x 15.0 x 10.0 x 5.0 x Asian financial 09/11 attacks crisis Post-Lehman collapse 0.0 x Jun-97 May-98 Apr-99 Mar-00 Feb-01 Jan-02 Dec-02 Nov-03 Oct-04 Sep-05 Aug-06 Jul-07 Jun-08 May-09 Apr-10 Mar-11 Feb-12 Jan-13 Source: FactSet, HSBC estimates Outlook Killing me softly? Not really but still… The luxury goods industry entered 2012 facing one of the highest bases of comparison in its history: the 20% organic sales growth rate seen in 2011 was itself on top of the 15% registered in the recovery year of 2010. The issue for the sector thus was that growth rates could only slow from there, which they did but in a gradual way: 16% in Q1 2012, 12% in Q2, 8% in Q3 and an aggregate 9% in Q4, meaning 2012 organic sales growth was still an impressive 11% (2pp higher than our original forecast 15 months ago). We believe that as growth stabilises, there will be market share gainers and losers, companies better positioned to capture tourism trends, and winners and losers on currency impacts. Overall, however, the fact that trends are still in a soft landing phase (ie 2013 will not, in our view, see an acceleration on 2012) should not be supportive overall to this “momentum” sector. What is quite supportive is this widespread (and fairly true) idea that if luxury demand is not booming, other sectors are not either and the barriers to entry, cash generation and returns for this industry remain extremely compelling on a long-term view. Although the stocks in the sector have tended to move together in the past 18 months, with a derating in autumn 2011 on the back of fears of a hard landing for China, a re-rating early in 2012 on greater confidence, a pullback in Q2, and then another leg up since last summer, we believe there are reasons for stocks to behave differently short term. So far in 2013 the outperformers have been Ferragamo (+28%), Luxottica (+26%) and PPR (+21%) and the underperformers Hengdeli (-20%), Coach (-10%) and LVMH (-7%). Are you in it for a quarter or for five years? The difficulty in the sector remains how to align family or management imperatives (where will brand equity be for the next generation?) and short-term share price performance. 2013 will be a game of two halves in terms of sales, mirroring the basis of comparison of a strong 2012 H1 and weaker H2 but also linked to the issue of ongoing wholesale rationalisation, which should weigh in the next six months for many players. 9
Consumer Brands & Retail Global luxury goods – Equity March 2013 abc Taking the brand equity view, it is natural for many operators to continue to invest heavily in retail, production capex and people and this means that lower sales and still punchy costs will see some margins get squeezed in H1 before they potentially pick up later in the year. What to expect In H1 2013, we believe that wholesale’s historically lesser resilience and initiatives by some brands to close some unsuitable points of sale will weigh on the performance of companies still exposed to this channel (Swatch, Richemont, Tod’s, Hugo Boss, Ferragamo and Burberry). Over the full year 2013e, we forecast a limited sales deceleration y-o-y (10% versus 11% in 2012e), but with mid single-digit growth in H1 (with Q2 2013e marking the trough of the current cycle) and low double-digit growth in H2. Asia: finally more sustainable growth Although trends elsewhere surprised positively, growth rates in Asia ex-Japan did not meet expectations in 2012. After years when growth rates in mainland China were sustained in spite of the country reaching 10% of global industry sales in 2011, growth was eventually expected to start ‘normalising’. Two factors supported the trends: the weakness of the EUR, which made it even more compelling for Chinese shoppers to buy when travelling in Europe, and the slowdown in gift giving (wait-and-see attitude ahead of the once-in-a-decade government change, fewer real estate deals, and government officials being more vocal against corporate gifting). The ‘first-mover disadvantage’ theme described in the next section is clearly playing out, with Chinese shoppers becoming more sophisticated and discriminating, which means some established brands are losing market share. That theme also explains the widely disparate performances of the different brands seen in other non-Japan Asian countries. Finally, Japan continues to be in a stabilisation phase (low- to mid-single-digit growth rates). For 2013 local trends should be analysed in tandem with sales to Chinese tourists abroad (part of the reason we are publishing on our theme). Certain brands which had seen slower growth in China (and even Hong Kong) recently mentioned that sales trends had picked up since October, notably in Hong Kong. Certainly, the fact that the change in government has now taken place in China and that Chinese GDP is expected to gather pace in 2013 (HSBC economists forecast 8.6% GDP growth in China in 2013 vs 7.8% in 2012) should boost consumer sentiment in the region. But, as outlined in the paragraph below (travel theme), Chinese demand must be analysed globally, and if the basis of comparison is favourable in terms of local sales in China, this is not the case for Chinese consumption as a whole (ie including sales to Chinese tourists abroad, especially in Europe). In 2013, a risk for luxury companies is a possible reversal of the trends seen in 2012, ie Chinese consumers buying more at home, but less abroad (notably because the EUR recently strengthened and because several brands have increased prices in the eurozone in September/October 2012). This trend of buying closer to home has already affected regional mix in calendar Q4 in our view, with Hong Kong so far benefiting greatly. We forecast Japan will grow by 1% this year (vs 3% in 2012), mainland China by 20% (vs 19%) and the rest of Asia 15% (vs 14%). The West: a 2012 positive surprise, brace yourself for a light slowdown now In Europe, despite the economic uncertainties, business has been stronger than expected in 2012 as: 10
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