Have European Luxury Companies Peaked?
This is the big question generated by reading several analyst reports on the future of the European luxury industry. Credit Suisse, Nomura and Goldman Sachs, among others, are pessimistic about the market evolution of the European luxury sector
In a rather pessimistic report, Nomura says it does not see any short-term catalyst for the sector in the stock market due to limited potential for earnings growth. Meanwhile, Credit Suisse warns that negative sentiment for the sector is growing because the current level of stock prices is not justified by their current benefits or expectations. Meanwhile, Goldman Sachs warns that the growing concern over Chinese demand is affecting European brands.
Reviewing the figures and industry expectations, it is true that the actual situation is not as buoyant as the stock prices suggest (many have reached record highs this year), but it is also true that most of the brands are navigating through this complicated scenario without an excessively adverse impact in their expectations.
It is an evidence that the results of the sector have been greatly benefited by the tourism momentum, which has not only enhanced by the improved economic situation, but also more European products have been bought by the week euro against other currencies (it has lost 30% against the dollar in less than a year, for example). This effect has compensated so far (to a greater or lesser extent, depending on the different brands) the slump in Asian demand, especially in China and Hong Kong. It remains to be seen whether the positive effect of tourism will balance the weak demand from China or not; for now, it appears that the weakness in China will continue at least for the remainder of the year.
Many European companies have invested strongly in Asia in the last five years to compensate the lower demand in Europe due to the crisis. We are now just in the opposite process. Most companies of the industry have taken steps to re-balance the situation, such as reducing prices in China and increasing them in Europe. This rise in Europe, taking advantage of euro weakness, is allowing them to get a clear improvement in margins that helps to make the situation more bearable.
Moreover, analysts’ forecasts point to a moderate increase of results in the next two years, with growth rates below 5% in sales and lower than 10% in net profits… in the best cases!. These expectations are based on the conviction that there are factors that support a slight increase (euro, tourism, low interest rates …), but the underlying trend still shows a complicated scenario for the industry.
Regarding valuations, shares of European luxury companies are trading at an average P/E-2016 expected at 18x (according Nomura´s forecasts). This means that are trading at a premium of around 25% vs. the European equity market, a high level considering the growth forecasts we mentioned above. Hence Nomura experts wonder if those record highs that we mentioned before were the peak that we have left behind…
Analysts´ Preferred Companies: Strong differences. After all those commentaries, we will now review the companies mentioned by analyst as their «favorites», which at the end is the most interesting topic for investors. Most striking is the huge difference in assessing the companies themselves: what is at the bottom of the industry for some of them it is the best option for others…
Credit Suisse recommends overweight Swatch, Hugo Boss and Richemont, it is neutral with Hermès and it recommends underweight Burberry, Kering and LVMH. Meanwhile, Nomura recommends to buy Burberry and Kering (just the opposite of what Credit Suisse said) is neutral with Hugo Boss and LVMH and it recommends reducing positions at Prada. And Deutsche Bank recommended overweight LVMH thanks to its defensive character.
Disclosure: The author is not responsible for the views expressed in the article. The text was written freely expressing ideas, without receiving any compensation. The author has no business relationship with any of the companies whose shares are listed in this article.