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Affordable Luxury?

The global ‘luxury’ sector is home to a number of high quality companies with long track records of strong shareholder returns and exciting growth prospects. The term ‘luxury’ is broad based and can be used to encompass a range of businesses within differing industries. Well-known brands such as Louis Vuitton (leather goods) or Jo Malone (perfume) may be synonymous with the sector while the likes of Ferrari (auto manufacturer) may not be considered by many as a luxury goods business. Many of the same structural drivers are benefiting these varied companies, most notably the population and wealth growth in the emerging markets and Asia.

The global middle class of around three billion people has been growing at a rapid rate with some economic forecasts suggesting that a further one billion people will join this social class every six to seven years.  Estimates also point to the significant role that Asia will play in this growth with almost 90% of new middle class citizens coming from the region.  While the demand from Asia is already growing rapidly, the reported figures by many businesses mask the true impact of this rapidly growing region.  Purchases by travelling Chinese tourists now represent a significant proportion of sales in other regions.

The rise of the internet has provided a number of opportunities and challenges for luxury focused companies. Historically fashion shows and new clothing releases would be restricted to industry professionals - now they are broadcast instantly to millions of interested customers.  Social media has provided a platform for established businesses to reach new audiences as well as allowing new businesses to flourish in sectors that were historically difficult to enter.  The established market players are very conscious of potential threats and have responded through various avenues. Bolt on acquisitions, increasing innovation and joint ventures with start-ups are the most common defence mechanisms.

Not only are these businesses benefiting from what appear to be multi-decade growth tailwinds, the power of the brands that they own and nurture should allow them to stave off competition.   While some products are susceptible to own brand copycats or cheap alternatives, the decades or even centuries of history and prestige built up by many global luxury brands is almost impossible to replicate.  The brands these businesses own are generally the greatest asset they possess.  Careful refreshing and growth of the brand is often the most difficult and important task for a luxury goods business. 

The fashion and luxury industry can be a fickle business with changing tastes a major concern. Burberry’s transition from global luxury brand to must have accessory for 90’s football hooligans is perhaps one of the more extreme examples of how brands can be easily tarnished. Through careful management and brand investment, Burberry was able to rebuild its image.

Many of the most powerful global luxury brands have been acquired by larger conglomerates, helping to reduce individual brand risk and allowing the owners to leverage the advantages of scale.  French giant LVMH is perhaps the best example of this with over 70 highly regarded fashion houses ranging from clothing (Marc Jacobs) to watches (TAG Heuer) and fine wine (Cloudy Bay). ). US listed Estée Lauder is focused on high end cosmetic brands such as Jo Malone, M.A.C. and Bobbi Brown. L’Oréal is another such example with over 30 brands including LANCÔME, Yves Saint Laurent and Kiehl’s.

We are continually looking to invest in the best global companies, although the current decade-long bull market has driven the valuation of many of these companies to historically high levels.  Assuming that brand equity remains intact, these business should be able to compound attractive returns long into the future.

 

Stuart Milne
Investment Analyst

11 October 2018