In our recent Quarterly Outlook, Ric Palombi, Director of Research, discussed the performance of the luxury goods sector in relation to that of the FAANG stocks. In this blog, we break down why having exposure to the former has been – and will continue to be – important for long-term investors despite COVID-19 or the U.S. election.
We began investing in the luxury goods sector about a decade ago. At the time, the Chinese government had laid out a long-term plan of shifting its export-driven economy to a more balanced economy of exports, services, and consumerism. After considering some of the long-term beneficiaries of this move, we believed that a growing middle and upper class would be supportive of consumerism and, in turn, would benefit the luxury brand space.
Chinese consumers made up only 19% of the global luxury goods spending in 2012 (Figure 1). Today that number has grown to 35%, with more room to expand in the future. This is one of the key elements in our thesis.
Figure 1: Evolution of the Global Personal Luxury Goods Market
Source: McKinsey & Company
When COVID-19 hit in early 2020, sentiments towards the luxury goods sector turned extremely negative:
"Coronavirus chills luxury brands in- and outside-China"
(CBS News, Feb 13, 2020)
"Global fashion industry facing a 'nightmare'"
(BBC Feb 14, 2020)
"Coronavirus wreaks havoc on luxury and fashion groups"
(Financial Times, Feb 20, 2020)
We anticipated that the fallout from COVID-19 would negatively affect the earnings of companies we owned. However, we also believed that the situation would not last indefinitely, and that our strategy of owning select quality businesses within the sector was prudent – it just might take some patience.
Figure 2: Canada, U.S., Euro zone, and China (%) GDP
Source: Trading Economics
Today, we see that global economies are recovering as annual GDP numbers for key areas around the world are improving. As indicated by the chart above, China is leading the world due to their first-in first-out position and their response to dealing with the pandemic. This is good news for the luxury goods stocks we own as they continue to be strong contributors to the portfolio’s performance.
Our largest weighting in this sector is Louis Vuitton Moet Hennessy (LVMH). Over the last ten years, the stock has returned over 451% or 18.6% annualized. While impressive performance, it has not always been clear sailing for the company and much like all great businesses, it faced its own challenges along the way. Nevertheless, with a relentless pursuit by management to preserve and elevate the brand through continued marketing and product innovation, our patience as shareholders is paying off. These initiatives led the way to improved sales, earnings, and share price appreciation.
Figure 3: LVMH Share Pricing Over 10-Years
Source: Bloomberg. As of November 12, 2020.
The long-term fundamentals of the luxury goods sector remain positive from our perspective. Today, we own four names in the sector, which are all based in Europe: LVMH, Prada, Remy Cointreau, and Richemont. Our investments are based on each company’s own merit and the opportunity that we see within the broader sector, and we look to be rewarded through our patience and perseverance.