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Luxury Goods
Frugality, the new zeitgeist
As the worst economic crisis since the Great Depression unfolds, frugality has
become fashionable again. We believe household savings ratios will need to rise
in some countries well above average historical levels. We initiate coverage on
LVMH and Richemont with Sell recommendations.
Table 1 : Recommendations and potential downside
Company Reuters Rec Currency Price
Target
price Upside
LVMH LVMH.PA Sell EUR 43.94 33.10 -24.7%
Richemont CFR.VX Sell SFr 17.90 14.90 -16.8%
Source: Reuters, ABN AMRO forecasts
Consumer spending set to slump
Consumer expenditure is largely driven by income, wealth creation and credit. However,
households in many countries currently have a significant funding gap, ie debt outweighs
savings, and we believe household savings ratios will need to rise to high, perhaps
unprecedented levels, at least short term. This adjustment may take years to wash through.
Asia is not coming to the rescue
Since the Asian crisis and China’s accession to the WTO in 2001, the Asian growth model
has evolved from being relatively balanced to one emphasising exporting to the US
consumer. The resulting rise in Asia ex-Japan current account surplus has been recycled
into US treasuries and, for a considerable period, this recycling had prevented a blow-out in
US interest rates or the US dollar. This growth strategy has profoundly changed the
economic structure of Asia ex-Japan economies by depressing consumption on the one
hand and raising export intensities and investment in the tradables sector on the other. We
believe an economic recovery in Asia ex-Japan is therefore dependent on a US recovery.
High operating leverage, limited scope to cut costs
We estimate that fixed costs account for around 70% of a global luxury brand’s cost
structure, so flexibility to cut costs appears limited. Just like in 2001, we believe most brands
still have a business and cost structure designed to sustain double-digit sales growth. Limited
temporary and/or permanent lay-offs have already been announced by Burberry (540),
Chanel (200) and Cartier (160). For LVMH, we expect an EBIT decline of 1.5% in 2008,
20.5% in 2009 and 21% in 2010. For the more cyclical Richemont, we expect a 7.7% decline
for FY09, 41% decline for FY10 and 24% decline for FY11.
Initiating coverage of LVMH and Richemont at Sell
We initiate coverage of LVMH and Richemont with Sell recommendations and DCF-implied
target prices of €33.1 and SFr14.9, respectively, because of our more bearish stance on the
global macro-environment vs consensus, despite significant tailwinds from FX in 2009F.
Contents
Luxury in crisis 4
We believe the luxury goods companies will face a severe downturn in 2009 and
2010, one that could be deeper and more prolonged for some companies than the
9/11 and SARS crises that hit the industry in 2001 and 2003.
Consumer propensity to spend looks set to slump 4
Luxury goods profitability in a downturn 7
FX: Major tailwind for sector in 2009F 14
Strong macro headwinds 16
We believe that household savings ratios in many western countries will need to
rise to structurally high levels, possibly surpassing historical levels (at least short
term). This savings rate adjustment may take several years to wash through.
Luxury goods sector performance 32
In this section we conduct a peak-to-trough PE multiple and share price relative
analysis for the luxury goods stocks that have a good enough history through
recession and boom.
Peak-to-trough analysis 32
Sector performance and valuation 37
Luxury goods market 39
Over the past four years, the luxury goods industry has expanded by a CAGR of
7%, to
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