By: Mark Nelson
22.05.2020
INDUSTRY INSIGHT – WHAT A WEALTH TAX MIGHT MEAN FOR THE LUXURY GOODS SECTOR?
The fiscal response from policymakers to the Covid-19 pandemic has been on an unprecedented scale, and it seems so far, if measured by the performance of global equity markets, to have had a positive impact, as most major indices have recovered strongly from March’s sharp sell off. However, as some begin to look beyond the current crisis, the subject of how this significant increase in government spending will be paid for is beginning to receive greater focus.
In the UK, a recently leaked Treasury document revealed that the Exchequer estimates that, in its base case scenario, Britain’s budget deficit could reach £337bn this year, up from a £55bn forecast in March’s Budget and more than double the post financial crisis budget deficit.
The response of many governments around the world to the 2008 financial crisis was to introduce years of austerity measures which drew criticism for increasing economic inequality, particularly as easy monetary policies helped to support a rise in financial asset values, including equities. This time around it appears unlikely that governments will follow the same route, particularly as there is evidence that pandemics historically have widened the gap between the rich and the poor. The current pandemic is expected to follow suit, with a poll of 44 leading economists carried out by the Chicago Booth business school finding that 84% expected low-income workers to suffer a relatively bigger hit to their incomes than those that earn more money.
As a result, there is a suggestion that the wealthy and higher earners might be targeted by governments to try to improve their budgets, whether that be through an increase in income tax or potentially a wealth tax. Exactly what form these taxes might take, the rationale for introducing them, and, in the case of a wealth tax, how successfully it could be implemented are topics not addressed here. Instead, below we try to look at it from an investment perspective and consider the potential implications for one industry in particular, the luxury goods sector.
Luxury goods, as Jean-Noel Kapferer and Vincent Bastien write in The Luxury Strategy, were born out of social stratification, where the aristocracy or those at the top of society could access luxury goods, while those in the lower classes could not. The growth in democracy over the last several centuries has in turn led to the democratisation of luxury and the emergence of the luxury goods industry. Such goods are now, in theory at least, available to anybody, but have also become an indicator of social standing to many.
While there has been some divergence in performance between individual stocks, the luxury sector in aggregate has performed well since the financial crisis, a period which, as mentioned, has been characterised by easy monetary policies by major global central banks and growing economic inequality in certain parts of the world. Low interest rates and the wealthy becoming wealthier in some countries including the US and the UK have supported demand for luxury goods. This is represented by the rising share prices of most of the major listed luxury companies and also by the lengthy waiting lists and elevated second-hand prices on iconic handbags like the Hermes Birkin and certain models of watches. Increased taxation on the wealthy or higher earners could potentially dent such demand.
However, the structure of the luxury goods industry has also changed over the last ten years to one which is increasingly reliant on the Chinese consumer. Chinese nationals account for approximately 30% of global luxury spend, and it is the growth of the middle class in this country that has been the predominant driver of growth in the industry since the financial crisis. The Chinese economy, according to a study by the IMF, is one of the most unequal in the world, however, this inequality has been on the decline since its peak in 2008, driven by gains for the middle of the income distribution. Therefore, it is not clear that efforts to address economic inequality would have a negative impact on the demand for luxury goods, especially if the gap were reduced by growth in the middle class.
While the crisis and an increased focus on economic inequality may not have a lasting impact on demand for luxury goods in aggregate, it may, if the past is anything to go by, cause a shift in consumer preferences within the sector to the benefit of some brands and to the detriment of others.
The 1920s, for example, following both the First World War and the 1918 Spanish flu, was a period of prosperity and of advancement in women’s rights. Women entered the workforce in increasing numbers and in the US were given the right to vote by the 19th Amendment. This greater freedom fed through into women’s fashion, with restrictive corsets being replaced by more practical, looser fitting dresses. What would have been considered masculine items also became popular with women, helped by Coco Chanel and her now-iconic tweed sports suits. The designer also made wearing trousers popular amongst women.
There was another shift in fashion in the late 1940s and during the 1950s as the Paris fashion houses reopened following the Second World War. Christian Dior’s New Look, a collection launched in 1947 which included the designer’s Bar suit, brought structured designs back to women’s fashion following the almost two decades of austerity that had begun with the Great Depression. Cristóbal Balenciaga’s “semi-fitted look” would follow shortly behind.
More recently, the years that followed the financial crisis were notable within the industry for the success of LVMH-owned brand Celine and its creative director Phoebe Philo. The British designer is known for her minimalist aesthetic and “back-to-reality” approach to fashion which chimed with consumers coming out of the worst financial crisis in almost 80 years, resulting in double-digit revenue growth for the house and a legion of followers for Philo. Since then, however, the influence of streetwear and the popularity of logos has grown, leading to bolder and more extravagant designs.
However, “logomania” may have peaked if the sharper focus on economic inequality sees consumers preferring a less conspicuous style post the coronavirus crisis – something that might be considered a more progressive take on the hemline index first put forward in the 1920s.
Phoebe Philo is no longer at Celine, but brands that might benefit from such a trend include Prada which has a history of minimalist designs, Kering-owned Bottega Veneta whose Creative Director Daniel Lee worked under Philo at Celine, and LVMH-owned Loewe and Loro Piana.
Such trends, however, are difficult to predict and we prefer to gain exposure to the luxury sector through one of its conglomerates, LVMH.
LVMH is the world’s largest luxury goods company, operating across six different subsectors of the luxury goods market; Fashion & Leather Goods, Wines & Spirits, Selective Retailing, Perfumes & Cosmetics, Watches & Jewelry, and Other Activities.
The company has an outstanding track record of producing strong organic growth from its portfolio of brands but also of acquiring and then, more importantly, improving the operating performance of businesses. Louis Vuitton is the cornerstone brand of the group, generating approximately 50% of operating profit by our estimates, but the company also owns other leading brands including Christian Dior, Hennessy and Dom Perignon.
We believe there are several positives to being a luxury conglomerate, including allowing a company to lean on different brands to drive growth at different times, and by providing greater bargaining power with landlords, with rent the most significant cost in what is a high fixed cost sector. Having a range of businesses across subsectors of the industry may also make the company relatively more defensive than some of its peers, something which has proven to be the case during the current crisis.
A luxury goods company faces the challenge of trying to increase demand and to sell more of its products in order to grow its earnings, while at the same time maintaining the perceived exclusivity of its brands. This is the challenge of achieving “abundant rarity” and there are several examples of companies that have failed to do this. However, we believe that LVMH is well positioned to meet this challenge, due to its unparalleled portfolio of brands, its scale, which allows for greater relative investment in order to support said brands, and the company’s tight control over distribution, particularly at its largest Fashion & Leather Goods houses, which helps it to protect its brand equity and its ability to control pricing.
Should you have any questions about anything raised in this article, please don’t hesitate to contact us via email, or on 0207 337 0777.
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This note has been produced by Killik & Co on the basis of publicly available information, and all sources are believed to be reliable, but we have not independently verified such information and we do not give any warranty as to its accuracy. Some of the stocks mentioned in this note are covered by Killik & Co’s Equity Research team and others are not. The mentioning of the stocks does not represent a recommendation to buy or sell any securities, and the note is intended as a marketing communication rather than research. This note does not purport to be a complete description of the securities, markets or developments referred to in the material. All expressions of opinion are subject to change without notice. Nothing in this note should be construed as investment advice or as comment on the suitability of any investment or investment service. Prospective investors should take advice from a professional adviser before making any investment decisions. There are risks with almost every investment that you may not get back the original capital invested. The value of your investments may fall as well as rise and the past performance of investments is not a guide to future performance.
