¿What's going on in the luxury industry?
During the post-pandemic boom, luxury watches, bags, and cars were often bought just to be stashed away and resold later, rather than actually being used. However, by 2023, the demand for these products started running out of steam. Louis Vuitton warned that its sales had stalled, and Swatch Group, owner of big brands like Omega and Breguet, saw its sales grow mainly thanks to the boost from its lower-priced segment.
Despite these signs of a slowdown, the personal luxury goods market – the bread and butter of the luxury sector and the focus of this analysis – continued to grow, reaching €362 billion in 2023. That's a 4% increase from 2022 at current exchange rates (8% at constant rates). According to Bain’s half-yearly report, this growth was driven by a rebound in demand across Asia, especially following China’s reopening, and a surge in tourism in Europe. However, by the time the fourth quarter rolled around, the market's performance had weakened due to a slowdown in the US and Europe.
Current year kicked off with a cloud of uncertainty, and concerns were brewing about whether the industry could sustain its sales levels after such a meteoric rise, especially with shaky macroeconomic conditions. By mid-2024, investors' worst fears were confirmed. The revenues of some brands took a nosedive. But what’s the real issue here?
A Clear-Eyed View
When we try to explain the drop in revenue for companies like Burberry or Gucci, we’re met with excuses like, "China is facing significant economic challenges" or perhaps a hint of "luxury shame" driven by that situation. Honestly, anyone saying that is either lying or clueless about China. In any case, be wary of anyone who blames all their problems on China.
You only have to glance at the calendar to realise that the first quarter of 2023 was the first after China lifted its strict health measures in December 2022. Sales skyrocketed during that period, so, out of context, the early 2024 figures might seem disappointing. Hermès actually acknowledges this in its latest quarterly report. But then again, Hermès doesn’t really need excuses, do they?
In Q1 2024, Burberry and Gucci saw their sales plummet by 19% and 28% respectively in China. Meanwhile, Hermès managed to grow by 6.8% (9.9% at constant exchange rates) in the same period.
If we’re really after the truth behind this situation, we need to take an objective approach and let the facts do the talking.
Far from being a problem, China has been the main driver behind the growth in personal luxury goods consumption, with an average annual growth rate of 15% from 2010 to 2023. That's an absolutely staggering figure.
This graph (which we sadly don’t have here, but let's imagine it!) would kill several birds with one stone. Not only would it show China’s massive contribution to industry growth, but it would also highlight the rebound effect in consumption after the 2020 health crisis. On top of that, it would clearly demonstrate the long-term upward trajectory of the sector. Just like luxury demand exploded in 2022 and 2023, it’s only natural that it would slow down in the following years, as predicted, before continuing its upward march.
However, this doesn’t seem to calm investors. Many companies are trading at levels we haven’t seen in decades. So, how do we explain that?
The Brands' Dilemma
What’s happening to Burberry and Gucci is not an isolated incident. Competitors like Aeffe and Ferragamo have also seen their results take a hit, while companies like Prada and Zegna have shown growth. So, what’s behind this asymmetry?
In general terms, this disparity reflects how luxury sales have become heavily dependent on brand-specific factors and their ability to adapt to market shifts.
As highlighted in Bain’s latest report on luxury goods, brands are facing a significant dilemma: should they focus on catering to their core high-end clientele or try to attract new audiences? All this while grappling with persistent complexities and navigating an uncertain economic environment.
Although they might not admit it, brands like Burberry and Gucci, which are traditionally more "legacy" brands, have been busy trying to lure in new audiences and, as a result, have neglected their core clientele. In times of economic growth, this might seem like a good strategy, but in a more uncertain environment, it can be risky.
Now that we’ve cleared up the current state of the sector, let’s look at where it’s headed.
Industry trends
The rise in luxury goods sales isn’t just because more people are buying these products, but also because the average price of luxury items has increased dramatically. According to Bain & Company, 70% of the growth in luxury leather goods sales in 2022 came from price hikes, with only a small portion coming from higher sales volumes.
Another source, DataWeave, reports that luxury accessories on Farfetch saw nearly a 39% price increase between February 2020 and May 2021. Meanwhile, Chanel has come under fire recently for raising prices on some of its bags by more than 70% since 2019. The company defended these hikes, saying that the cost of materials had gone up. That’s probably true, but it doesn’t quite explain such a massive price surge. So, what’s really behind these price increases?
During the pandemic, in the US, luxury clothing purchases by people earning $40,000 a year or less spiked, with a 365% increase by the end of 2021 compared to January 2020, before lockdowns started. Another trend that’s made luxury goods more accessible to younger shoppers is the rise of “buy now, pay later” platforms, which let people finance expensive purchases in instalments.
Although luxury products are obviously designed for the wealthy, a significant chunk of recent growth is coming from middle- and low-income buyers. According to GlobalData, Americans with a household income of less than $50,000 account for around 27% of regular luxury consumers—nearly as high a figure as buyers earning up to $150,000 a year.
On top of this mass of consumers, we have the growing number of millionaires worldwide. The Global Wealth Report from Credit Suisse found that in 2022, there were approximately 62.5 million millionaires globally, up from about 46.8 million in 2017—a 30% increase, fuelled by global economic growth and rising asset prices. By 2030, the number of millionaires is projected to exceed 100 million worldwide, with significant growth in emerging markets.
So, what does this shift mean for the luxury industry?
Veblen goods
In economics, the term Veblen goods refers to products whose demand increases as their price goes up. This concept was introduced by Thorstein Veblen in his 1899 book The Theory of the Leisure Class, where he argued that certain expensive goods are not bought in spite of their high price, but precisely because of it. Veblen thus introduced the idea of conspicuous consumption, where people purchase goods specifically to display social status.
The greater accessibility of these products reduces the sense of exclusivity and, therefore, the perceived value of the item. The luxury industry plays with this dynamic by limiting the availability of certain products to maintain exclusivity, while at the same time expanding their offering of more accessible items to capture a larger market share.
This approach can sometimes backfire, as it did for Burberry in the early 2000s when the brand became associated with the "chav" culture in the UK after selling too many affordable products. Are Burberry and other brands now experiencing déjà vu? Can they adapt?
Conclusions
The challenge of boosting brand value has become a tough nut to crack. After the price hikes across the sector, raising prices to achieve the Veblen effect no longer seems to work. Even Gerry Murphy, chairman of Burberry, admitted in July that the company "probably went a little too far and too fast" with its price increases.
Meanwhile, brands that attract wealthier buyers and can charge the highest prices are thriving. Hermès, defying all the pessimism, reported a 13% increase in sales in Q2 of 2024.
Hermès has remained loyal to its classic, exclusive positioning, while Burberry, despite its heritage, has modernised the brand and leans more into contemporary, urban fashion. There's no doubt Hermès has done a better job of preserving its brand value, and as a result, its sales and stock value have surged. Proof of this lies in Hermès’ skyrocketing valuation over the past few years, while Burberry has lost a considerable portion of its value.
Currently, Hermès trades at 46 times its net profit over the last 12 months, whereas Burberry is trading at just 8 times. So, are these good investment opportunities? Which is the better bet?
In a year when doubts about future performance weigh heavily on investors, the luxury sector demands close attention. Seizing the uncertainty is key to buying at discounted prices and securing better returns. After the significant drops in recent months, some opportunities are becoming too tempting to ignore. At Breaking Bucks, we’re investing in the sector, capitalising on the pessimism spreading across luxury brands, including Hermès, which has seen its value drop by 25% in the last six months, while Burberry has suffered a 70% decline over the past year, offering a highly attractive valuation multiple.
Let’s not forget, a 46x multiple means Hermès is trading at an almost perfect performance. Although Hermès is no stranger to such ratios, any misstep could trigger a significant drop. Plus, with its growth already priced in by the market, achieving substantial returns may be challenging. Still, at recent levels of €1,900 per share, it’s an interesting buy, taking advantage of the fear sweeping the industry.
On the other hand, Burberry is trading at a multiple of just over 4x its net profit from the year ending in March 2023, and 8x for 2024. While the road ahead seems daunting, the brand has already announced several changes to restore its once-privileged status. With its historical value, Burberry is unlikely to experience further drastic declines. If it holds around £0.60 per share, it remains a buy for Breaking Bucks.
The risks of investing in Burberry stem from uncertainty around its recovery. The most optimistic forecasts point to 2025, but changes in brand perception can take years. However, with Burberry's heritage and a potentially more favourable global environment, achieving this goal should be more manageable.
