Coronavirus: No Effect on Luxury Sector Forecasts

We believe the short-term impact of the coronavirus epidemic in China could have more severe implications for the luxury sector compared with SARS in 2002-04, given the much higher share of Chinese luxury buying compared with 17 years ago. We believe the share of Chinese luxury purchases increased from just over 2% global share at the time of the SARS epidemic to 35% currently. Further, while mainland China accounts for 11% of luxury purchases and Hong Kong for a low single digit, the bulk of Chinese luxury purchases are made abroad and can be hit by travel restrictions. Online channels (such as YNAP, part of Richemont, 4-star-rated Farfetch and the brands' own online channels) could be short-term beneficiaries as buyers refrain from travel and visiting department stores.

However, since epidemics tend to be short-term, we don’t see the epidemic having long-term negative implications on the sector’s earnings power. Should fears over the virus subside consumption and travel, put on hold, could quickly return to the market. Hence, we don’t expect to adjust our fair value estimates for luxury coverage downward. In mainland China, store rental agreements have a higher share of variable costs, compared with the global average, according to LVMH, which should protect profitability during the epidemic. We believe Chinese luxury consumption could grow at 5%-7% over the decade, boosted by higher-wage employment.

That said, with many luxury stocks trading close to record high multiples, we don’t see many compelling investment opportunities in the sector. We still see value in Richemont (wide moat, 4-star rating, revenue exposure to Chinese consumers 40%), Swatch (narrow moat, 4-star rating, sales in greater China of 36%), Dufry (narrow moat, 4-star rating, exposure to Chinese consumers around 6% and 13% of revenue in Asia, Middle East and Australia), Hugo Boss (narrow moat, 4-star rating, 15% of sales in Asia) and Pandora (no moat, 4-star rating, 9% revenues from China).

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