Luxury Sector Looks a Little Less Rich
Concerns over the health of Chinese consumers has led to a sell-off.
While the luxury sector has been battered over the past few days, we're maintaining our fair value estimates for the firms in this space. We believe the sector valuations are now returning to more palatable levels, after being materially overvalued for most of 2018. While many valuations are still stretched, the sector sell-off has created a few opportunities for long-term investors. We consider wide-moat Richemont a top pick in the space, trading in the 4-star territory at a 20% discount to our valuation.
The main reason for the sell-off is the concern over the health of Chinese consumers. China has led the sector recovery since mid-2016, with Chinese luxury spending growing in double digits, versus 3% elsewhere. Chinese spending now accounts for 20%-50% of revenue among companies under our coverage (with the lowest exposure for U.S.-based Tiffany and the highest for Swiss watchmakers).
So far, China-U.S. trade tensions have materialized in a Chinese stock market decline and currency weakness but have yet to meaningfully dampen luxury demand. LVMH, the first luxury company to report third-quarter results, saw only slight deceleration in Chinese global spending in its biggest fashion and leather goods unit from a mid- to high-teen growth rate.
However, luxury industry valuations reached their 10-year peak levels around midsummer, with no cyclical risks priced in. With geopolitical risks mounting, it should not be surprising that the sector is rerating and perhaps there is more to come, as it is still trading at an average 8% premium to our fair value estimates (with most stocks in a 3- or 2-star category). Our preferred play on the luxury space is wide-moat Richemont, due to its strong brand portfolio in the long-product-cycle industries (watches and jewellery) with both conspicuous and investment value. We remain cautious with Moncler (MONC) and Hermes (RMS), which still trade at a meaningful premium to our fair value estimates.
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Jelena Sokolova does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.