Carmignac: Earnings season - a spotlight on luxury
In 2021, amidst booming post-Covid markets and economic growth, the luxury sector was riding high. But this euphoria is long behind us. Share prices are down by an average of -10% year-on-year.
With uncertainty hitting a new historical high and concerns that the stagflationary nature of US policies will morph into a significant downturn, both ends of the consumer-sector spectrum are now indicating that recessionary pressures are mounting. With the real economy braced for more pain to come, global equity investors looking for an opportunity this earnings season might be contemplating luxury names, considering the recent absolute and relative weakness in the sector.
A tale of two stocks
The global macro-economic and macro-political backdrop is very tough to call, so looking at individual companies for some form of insight is helpful.
First, LVMH, often considered the sector bellwether.
LVMH was the first Luxury goods firm to publish results, falling short of market expectations. Consensus predictions were for the Group’s fashion and leather goods division to post flat organic growth over the first quarter. The reality was worse. Especially in the high-margin fashion and leather division driven by a weaker American, Japanese, and to a lesser extent, Chinese consumer. This, coupled with the more severe deterioration of lower tickets brands with less pricing power.
This ‘miss’ doesn’t bode well for the rest of the sector.
Looking beyond Q1, hopes remain high that the stock will see a return to form in the second part of the year. Consensus expectations are that profits will grow at a rate of +12% versus a decline of 3% year-on-year in H1. But this looks increasingly unlikely given the rate at which the company’s revenue is growing organically. Furthermore, negative wealth effects, the stagflationary nature of Trump’s policies and the weaker dollar all weigh on the company’s prospects. We see an increasing risk of flat to very low single-digit growth in sales for the calendar year.
What about the other side of the equation? LVMH could reduce costs, notably on the marketing side but the reality is, this won’t make a huge difference. Staff and rent-related costs account for about two thirds of total operating expenses, and (apart from Asia) the latter are not indexed to revenue. Layoffs aren’t part of the culture of a family-owned business particularly given the importance of employee developments and training. So, given the company’s cost structure, lackluster revenues will be largely reflected in earnings.
But not all luxury stocks are created equal. How will ‘top-of-the-class’ Hermès fare?
As the sector floundered in 2024, Hermès was able to buck the trend with the company largely outperforming as its full-year revenues grew at +13% - a similar pace to the past 10 years. But even it could fall short of expectations.
Hermès has seldomly ‘missed’ (only once over the last six years), however, after a phenomenal fourth quarter of 2024 and a period of extremely high demand that has been difficult to meet, inventories are likely to be diminished. The bad news is Hermès looks set to report its weakest quarter of organic growth since Covid. The better news is that this is still likely to be a mid-to-high single-digit number. And weakness because you’ve run out of stuff to sell is a relatively good problem to have.
Consensus opinion has started to adjust to reflect the tough outlook but we believe it’s still too high, at +8.7% versus last year.
The main positive for the Birkin-bag maker is, as usual, the new year comes with the yearly change in prices (circa +8% on a global basis). As such, rather than year-on-year or quarter-on-quarter numbers, management and investors are most likely to focus on sequential revenue and Q1 2025 is set to be above Q4 of 2024. This is likely to be an exception rather than the rule for the sector. But there is not too much to rejoice over, as in volume terms, this equals a flat to negative evolution over the quarter.
Of course, one can hope for a blooming spring, with Chinese consumer-oriented stimulus lifting all boats or the US going through a ‘soft patch’ rather than a more severe slowdown. But hope is not an (investment) strategy and the downside risks of Chinese authorities depreciating the yuan/renminbi or Trump and Navarro doubling down on the trade war cannot be ignored.
In short, Hermès is expected to manage better than peers, as its growth is more supply driven than demand driven but given the bigger picture, in the short term, it is difficult to see better days ahead for the sector as whole.
As for the other side of the consumer trade - staples - the luxury sector may serve as a cautionary tale to those wondering how to lower the beta of their portfolios.
Many investors have tried to chase luxury stocks seeing the potential for earnings to bounce back as the sector was trading on 25x forward earnings. Hunting consumer staples, like Walmart that trades above 30x next year’s earnings because of its defensive attributes, may well end badly.
Despite the current record level of uncertainty markets are proving to be very efficient. Catching a falling knife is never an easy task, hence focusing on those stocks which display relatively high and regular growth prospects and therefore tend to hold better in case of a moderate downturn is key.
