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Pricing Power Helps Luxury Stocks Thrive

The high street is struggling but high end retailers are prospering. Where are managers investing?

Holly Black 19 November, 2018 | 3:14PM

Burberry Store in China

The woes of the UK high street are well-documented, but investors may be wrong to avoid all retailers as some luxury brands are bucking the downward trend.

Nicla Di Palma, equity analyst at Brewin Dolphin says a revival of consumer interest in the luxury sector could create opportunities for investors.

This month, for example, Burberry (BRBY) revealed a 4% rise in revenue in its interim results and said that adjusted operating profit had climbed 8%. The firm said its debut collection from new chief creative officer Riccardo Tisci had received an exceptional response.

So how is the luxury end of retail managing to thrive while the high street is struggling to survive?

One of the main factors driving the trend is strong economic growth in China where a growing middle class, rising house prices and employment growth are helping to improve consumer confidence and so prompt a rise in spending on luxury goods. As well as that, Di Palma says ranges from top-end brands such as Louis Vuitton and Gucci have managed to tap into trends which appeal to millennials, who often have more disposable income to spend.

Russ Mould, investment director at AJ Bell, says: “Luxury good firms have one key attribute above all others, which makes them potentially excellent, long-term investments and that is pricing power. That is a rare quality in a world where consumers are ever-more cost-conscious.”

While high-end luxury has typically been geared towards older, wealthier consumers, brands have started to shift their focus in recent years. Chanel, for example, has nearly 30 million followers on social media app Instagram. Online sales are growing too, albeit from a relatively low base, now accounting for around 8% of luxury sales.

But not all brands are managing to adapt. Di Palma says: “In luxury, as in general in apparel retail, the consumer is looking for either differentiation or bargain basement prices – this explains the success of Ted Baker and Zara on one hand on the high street and Primark on the other. Undifferentiated retailers are in a more vulnerable position.”

What Are Managers Buying?

David Eiswert, portfolio manager of the T Rowe Price Global Focused Growth fund, says the key is to look for high-quality names “on the right side of change” who have dominant market positions. The fund recently invested in the IPO of online luxury fashion marketplace Farfetch (FTCH). The business initially focused on working with local boutiques but has recently partnered with big brands such as Gucci, Prada and Fendi.

Meanwhile, Chris Elliott, portfolio manager at Evenlode Global Income, likes firms with high barriers to entry to stave off any would-be competitors. He invests in Essilor Luxottica (LUX), which was formed by the merging of Essilor, which sells lenses through retail opticians, and Luxottica, which sells luxury frames and sunglasses across the world.

Elliott says: “Most luxury designers choose to licence their brands to the firm rather than try to compete directly.” He points out that consumers still need glasses in a recession, which makes the business less cyclical than other areas of retail.

But not all firms are able to strike the right balance. Mould says Mulberry (MUL) is an example of a brand which tried to make itself more exclusive and ended up pricing its customers out. Meanwhile, Michael Kors (KORS) has acquired Jimmy Choo and Versace so it has a portfolio of brands across a range of price points, which should provide some protection from economic ups and downs.

Graham Spooner, investment research analyst at The Share Centre, is concerned that the luxury sector is too reliant on growth in China, which could be a problem if trade wars impact demand. Chinese consumers who used to flock to international luxury brands are now starting to spend more money at home, he says – domestic luxury spending is set to double over the next 10 years.

Spooner adds: “There are more restrictions being applied to people taking luxury goods into China, although that may not necessarily be a bad thing for the products, as there is a substantial premium on their goods sold inside China. But I think the reliance on the Chinese market is a cause for concern.”

Elsewhere, there is evidence that Western investors are nonplussed about opportunities in the luxury space. Aston Martin (AML) floated on the stock market at the start of October with shares at the lower end of its initial range. After floating at £19 they fell to a low of £13.60. Shares in Ferrari (RACE) have recently fallen to their lowest point in six months, too.

Investors looking to add some luxury to their portfolio need to be selective, as this part of the market is not immune to the strife being felt elsewhere in the retail industry. But those who are able to separate the winners from the losers could see bumper returns.

 

 

 

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Aston Martin Lagonda Global Holdings PLC Ordinary Shares451.40 GBP0.00
Burberry Group PLC2,050.00 GBP0.00
Capri Holdings Ltd35.19 USD0.00
Farfetch Ltd Class A9.20 USD0.00
Ferrari NV164.41 USD0.00
Mulberry Group PLC285.00 GBP0.00
T. Rowe Price Global Fcs Gr Eq C GBP13.62 GBP-0.13
TB Evenlode Global Income C GBP Acc1.26 GBP-0.48

About Author

Holly Black  is Senior Editor, Morningstar.co.uk

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