Why investing in luxury stocks has never been more lucrative

You can imagine the horror that must have rippled down Burberry executives’ spines in 2002 when EastEnders actress Danniella Westbrook was photographed in head-to-toe Burberry on an outing with her similarly clad daughter Jody, pushing an equally over-the-top pushchair.

After years as something of a fusty but still classic brand, Burberry had suddenly become cool. So cool, in fact, that everyone wanted a piece of it — including B-grade actors, in-yer-face football hooligans and swathes of the great British public personified by Little Britain character Vicky Pollard: the loutish chavs.

"As in many branding missteps, it had begun innocently enough," the BBC later reported dryly.

In 2001, Burberry had lured talented UK designer Christopher Bailey away from Gucci’s womenswear division. Bailey, apparently, was "key to injecting sex appeal into a conservative brand".

His decision to make model-of-the-moment Kate Moss the face of the company was a masterstroke.

But Burberry got greedy: determined to cash in on its sudden popularity, it began to extensively license its products, allowing other companies to stick its brand on things as bizarre as nappies for dogs.

It boosted Burberry’s cash — but it cost the company its air of exclusivity, and opened the door to imitators and counterfeits.

By 2008, Burberry was in trouble.

So ubiquitous had the brand become that in an interview with the BBC, marketing consultant Peter York famously commented that it had come to be "associated with people who did bad stuff … Quite a lot of people thought that Burberry would be worn by the person who mugged them."

Burberry remains a classic study both in what not to do as a luxury goods group, and also in how to come back from the brink.

It took a change in management — Angela Ahrendts was brought in as CEO in 2006 — for Burberry to claw its way back into the upper reaches of the luxury goods sector. Under Ahrendts and her successor, Marco Gobbetti, Burberry stopped discounting to focus on full-price sales, cut back on its wholesale client list and shrank its seasonal sales period, according to trade journal Women’s Wear Daily.

But even now, Burberry underperforms the big dogs such as French powerhouse LVMH. And the recent announcement of Gobbetti’s departure for smaller Italian luxury house Salvatore Ferragamo — maker of the classic leather pumps beloved of former UK prime minister Margaret Thatcher — may hold back any such ambitions.

Given the fine line between selling sufficient volumes of sought-after product to keep profit margins up, but not so much as to lose exclusivity, what is the investment case for the luxury goods companies?

A ‘bulletproof’ sector

"A company that describes itself as being in the business of selling luxury goods effectively sells something where the demand increases as either the price increases, or as people have more money," says Protea Capital Management director Jean Pierre Verster. "Why it is so attractive from an investment perspective is that your clientele are less price-sensitive."

For Sasfin Securities’ portfolio manager David Shapiro, this means demand for luxury goods is basically bulletproof. "For the people who buy Rolls-Royces, it doesn’t matter what’s happening in the world, nor do they ask about the price," he says.

It’s a sentiment largely echoed by Kruger International portfolio manager Mia Kruger. "Affluent consumers will shop throughout," she says.

Local investors don’t need convincing.

Shares in Richemont, the JSE-listed luxury goods company chaired by Johann Rupert, have exploded 76% in the past year — three times the 23% gain of the JSE’s all share index.

It’s a sign that Richemont’s brands — including jewellery brand Cartier, specialist watchmakers Piaget and IWC Schaffhausen, fashion brands Chloé and Alfred Dunhill, and penmaker Montblanc — have never been stronger.

LVMH, which is listed on Paris’s Euronext exchange, has done even better, up 86% in a year. (Its brands include French fashion house Louis Vuitton, champagne maker Moët & Chandon, and cognac maker Hennessy, all of which make up the name.)

"Both those companies are pretty well priced compared with the alternatives in that sector, like Hermès and Prada," says Kruger. "These companies tend to be very well diversified and are seldom a bad investment."

But it’s not just Richemont and LVMH: overall, the stock of the world’s best-performing luxury goods groups have roundly bested the returns from the general market over the past five years.

Consider this: $100 invested in the S&P500 index five years ago would today be worth $199, an annual return of 14.7% a year. That’s hardly to be sniffed at — but that same $100 in LVMH would now be worth $486 (up 37% a year). Then there’s Gucci-owner Kering, which has delivered a mouth-watering 40% increase every year for five years.

But is this trajectory sustainable? Is there still time for investors to catch the luxury train, or have they missed out?

The key to this question is China, the largest luxury goods market in the world. In China, the value of a luxury product isn’t just its quality — it’s also its utility.

"It is an Asian phenomenon that ‘face’ and ‘saving face’, and projecting the appearance of skill or wealth or superiority, are quite important," says Verster. "And therefore luxury goods do not just have the utility of what they are practically used for, they have the utility of sending a message: ‘I am wealthy, I am important.’"

But as the Burberry example shows, you have to get the sales balance right: you don’t want to sell too few products, but you also don’t want to sell too many.

One company that seems to have successfully straddled both the Everest of wealth and the trenches of the aspirational markets is jeweller Tiffany, which LVMH bought last year for just under $16bn.

You can pick up a Tiffany pendant or necklace for a couple of hundred dollars — a nice present for a bat mitzvah to be sure, but also one that doesn’t break the bank.

"[Tiffany] handles it well," says Shapiro. "It’s got affordable stuff. What is it? A little silver disc, that’s it. And [the company] will charge you a mint for it — $250. A jeweller next door can make you exactly the same thing for $100, but you don’t want it, because it’s not Tiffany."

Verster says the impact of particular designers, and how the product is represented in the media, makes a "huge" difference to consumers when deciding if it’s worth paying top dollar.

"When a luxury goods company slips, and slips up, and loses the appearance of being luxury — the most common way is by decreasing the price such that too many people can afford it, or by not keeping a tab on excess inventory and counterfeit products — that cheapens the brand."

Intangible value

Losing cachet is almost as bad as losing face; once that’s gone, a brand will no longer be able to command the extraordinary prices it once did.

Think of 1970s designer Roy Halston. The eponymous brand was so devalued by voracious accountants keen to capitalise on the Halston name that it ventured into everything from womenswear to wigs.

In the end, Halston’s inglorious suicide as a luxury brand was the 1983 deal it signed with mass-market retailer JCPenney to create a line "for the American people". It was an ill-advised move that led to high-end retailers such as Bergdorf Goodman dropping Halston from their floors.

Perception is also why the departure of Burberry’s CEO recently sent such shivers down investor spines, causing the group’s shares to sink 8% on the news.

Verster and Shapiro both see Burberry in the "attainable luxury" category. Verster reckons this "makes it very difficult from this point forward to push prices further".

That’s not to say companies can’t reclaim their former glory. When a luxury goods company loses its stature and edges towards bankruptcy, it may be picked up on the cheap by an entrepreneur with a flair for marketing and design, nursed back to health and become spectacularly profitable again.

The person who has pulled off probably the most success in this regard is now one of the richest people on earth: LVMH CEO Bernard Arnault.

The LVMH empire — besides the brands that make up its name, it also owns Christian Dior, Givenchy, Marc Jacobs and Bulgari, among others — is Europe’s largest company, and six times the size of SA-and Swiss-listed Richemont.

Two weeks ago LVMH announced it was buying the majority stake in designer streetwear brand Off-White. It’s more evidence of the luxury world’s current love affair with sneakers, tracksuits and "athleisure" kit.

Another success is Moncler, the listed ski-jacket company beloved of Julius Malema and his EFF party faithful, which tipped into bankruptcy in the early 2000s and was sold to current CEO Remo Ruffini for one franc. Today, it’s worth about €10bn.

Of course, it’s not always that simple. It’s one thing having the name, says Shapiro, but quite another maintaining it. "You have to be ahead in design, you have to spend money on your brand. You’ve got to define that."

Heritage also plays a big role.

As Verster explains: "Heritage mostly comes with time, and if you aren’t careful and you don’t nurture your brand, that heritage can become cheapened. That’s what happened to Burberry."

Mergers on the cards?

This again raises the question of where the investment case ends.

If a luxury brand isn’t able to indulge in mass production to protect its exclusivity, it means there’s only so much of any one item it can sell. Surely that will cap profit, which is what shareholders typically want out of their investment? How do they grow?

After all, if a company wants to make more money, it has only two options: hike the price of its product or its output. This, says Verster, is where so many luxury goods companies have stumbled.

"They think: ‘Oh my goodness, this thing that we are selling is so expensive, we surely cannot push this price any further, otherwise the market is going to shrink. Let’s increase volume.’"

The next thing that happens, he says, is that the companies make more products, and make them slightly more cheaply, "and you get so many more customers who will buy it".

The answer, says Verster, is for luxury goods companies "never, ever" to try to grow by volume — only by price. "And you know what?" he says. "Every year there are more rich people around."

Take the example of Hermès. Its famous Birkin bag is still handmade. And a 2005 croc version will still sell for close on $71,000 on fashion e-tailer FarFetch.

"The technology is out there, and you could make an equally good-quality Birkin bag with a machine," says Verster. "But to protect the heritage, [Hermès] will never, ever automate the process. It can therefore state in its marketing that each bag is unique; that each one is made with care."

That commitment to heritage (and price) shows in the margins. Companies that haven’t protected their heritage have lost their above-average margins; those whose heritage is intact (even if that comes at a higher cost) can sell their products at the best price.

There is another way for luxury goods companies to grow: by buying rivals.

According to HSBC analysts Erwan Rambourg and Anne-Laure Bismuth, the luxury goods sector has experienced a "frenzy" of M&A deals recently. And they expect more deals to be struck as consumers buy less, but spend more.

In June, Richemont snapped up Belgian leather-goods group Delvaux in a deal which analysts estimated to be worth about $300m. In April, LVMH spent nearly $90m in increasing its stake in Italian shoemaker Tod’s to 10%.

Bloomberg reckons Tod’s, Burberry, Hugo Boss and Salvatore Ferragamo are all potential takeover targets, with Kering a likely buyer.

Verster’s Protea Capital Management owns Kering stock and, until recently, also owned LVMH.

"It’s a great quality company and it’s got a best-in-class portfolio, but it just got too expensive in our mind," he says of LVMH. "Hermès is similar — in quality, it is a stand-out company, and [it has] a wonderful heritage, and LVMH actually has a minority stake, but it is too expensive for us."

Market talk has also suggested that Richemont and Kering may merge.

It’s a move that analysts say would make sense — given the portfolio of brands between the two groups, it could make for a player to rival the mighty LVMH. And that could only be good for Richemont’s thousands of SA investors.

The best-performing luxury goods groups, including Richemont, have thrashed the market over the past five years

—  What it means:

Big bucks for Gigaba’s fave

Century-old family-owned Italian luxury fashion house Ermenegildo Zegna, beloved by former finance minister Malusi Gigaba, is set to go public after joining a special purpose acquisition company (Spac) in a deal that values the businessat $3.2bn.

It’s no surprise, says Protea Capital Management CEO Jean Pierre Verster. “There’s so much money in Spacs you can imagine that some of these companies might be shaken loose from family owners hip.”

In fact, he believes a few luxury goods businesses might become public companies in the near future.

The Zegna family will keep 62% of the business. “We could have remained independent for another 100 years,” CEO Gildo Zegna told the FT. “But the moment is appropriate, and the world has changed a lot, and luxury has become very challenging.”