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Wealth creation benefits everyone. But when the haves do better than the have-nots, you might think luxury stocks should perform better. However, investors should focus on a different type of inequality. In the context of a slowdown in luxury spending worldwide, companies in the sector are increasingly divided between the haves and the have-nots.
Hermès and Kering are an example of this. In a sector that has so far seen an organic revenue decline of 2 percent, according to Bernstein’s Luca Solca, Hermès challenged the slowdown with an 11.3 percent increase in third quarter sales. Kering’s fell 16 percent, with the Flagship brand Gucci was down a quarter. Following multiple profit warnings, the group led by François-Henri Pinault now expects full-year operating profits of 2.5 billion euros, almost half less than last year. These divergent fortunes are reflected in stock market valuations, with Hermes trading at almost three times Kering’s forward price/earnings multiple.
In part, this highlights the two companies’ different customer bases. With bags costing tens of thousands of pounds, Hermès caters to the truly wealthy, rather than the simply very well off. These tend to do better in a slowdown. Meanwhile, Gucci’s streetwear phase attracted a slew of younger and potentially less wealthy customers. Gucci’s problems may also reflect a more complex brand DNA. Known for her over-the-top designs, she is more likely to take fashion risks when the zeitgeist turns against her.
A change in Gucci’s fortunes seems very far away. What the company calls “new” (its latest launches) already represents 35 percent of sales. It is evident that its impact has not been sufficient to offset a significant drop. To make matters worse, Kering’s second-largest brand, Yves Saint Laurent, is also faltering. That leaves analysts delaying their recovery forecasts. Citigroup expects consensus operating profits to decline by 10 percent by 2024 and 2025.
Prolonged poor operating performance is accompanied by rising leverage. Kering has spent money on several acquisitions lately, including 30 percent of Valentino for 1.7 billion eurosthe perfumer Creed for 3.5 billion euros and a series of elegant stores. Net debt is expected to reach 2.5 times ebitda in 2025, according to UBS analyst Zuzanna Pusz. It could rise further if Kering acquires the 70 percent of Valentino that it does not already own, a commitment valued at €4 billion in its annual report and governed by purchase and sale options. The gap between the top and bottom of the luxury sector is likely to widen further.