Investment update - Luxurious woes
As European economies tentatively open up, there is one market sector that is dubiously quiet - the luxury sector. A sector once revered as ‘recession proof’ now seems to have lost its immunity to the economic illnesses that can floor other sectors. A major reason for this increase in susceptibility has been largely one of its own making. The sector, once focused on the rich and especially those in Western countries, has broadened its consumer base over the last 20 years by tapping into a younger and more aspirational buyer from the East where burgeoning economies, particularly China's, have dragged millions out of poverty and into the consumer middle classes minting more than their fair share of millionaires and billionaires in the process.
Shop openings along prestigious strips of retail real estate in cities dotted around China’s East coast will have certainly helped foster appeal and growth for some of Europe’s most luxurious brands. However, it was the unexpected increase in sales which the travelling Chinese consumer brought to flagship stores in Europe that provided the greatest boost to growth for the brands' ‘home’ regions. Prior to COVID-19, Chinese tourists accounted for an estimated two thirds of the sector's sales in Europe. However, due to restrictions on travel imposed on a COVID-19 riddled world, the Chinese aren’t able to travel like they used to and luxury brands are having to adapt.
Ravenscroft’s Blue Chip fund owns two luxury companies; Swiss-based jewellery and watchmaker Richemont and French-based luxury conglomerate LVMH. Both companies’ share prices were hit hard during the March crash losing over a third in value. Whilst LVMH's may have recovered better, the journey to normality is far from complete and their flamboyant owners know it.
Despite possessing strong balance sheets, both announced a reduction in dividends during their Q1 sales updates - a warning sign of tough trading conditions ahead, further reinforced by Richemont’s Johann Rupert's comment that he saw 'no quick rebound’ for his sector - maybe it’s this bearish sentiment that has weighed on the company’s stock. It may also be a reason why his contemporary, Bernard Arnault, CEO and chairman of LVMH, is trying every trick in the book to renegotiate the terms he signed his company up to last November in order to acquire US jeweller Tiffany & Co.
Many wouldn’t blame him and would consider it his duty - the price offered was $135 a share, valuing Tiffany’s enterprise (which includes net debt) at $16.6bn - an eye watering 17x greater than its earnings before interest, tax, depreciation and amortisation (EBITDA). To put this purchase multiple into perspective, it is around 50% above Tiffany’s 10-year average for this metric! In a pre-COVID world, this may have been considered a price worth paying in order to cement a number one position in the hard luxury sector as well as augmenting its market share in the US - its second largest market. In today’s environment, the deal looks ridiculously pricey. In the three months running up to April, Tiffany’s sales plunged more than 45%, yet it has continued to pay dividends and full property rents despite closed shop floors. Arnault is clearly rankled and if he's to stand any chance in renegotiating the iron-clad merger agreement, he’ll need to draw on all the crafty deal making skills which helped him build one of the world's largest fashion houses as well as earning him his ’The Wolf in Cashmere’ nickname.
The ‘Wolf’ is already purported to be up to his usual tricks. A well-timed article in Women’s Wear Daily about a board meeting in Paris, which was to discuss the proposed deal amid the deteriorating situation in the US market, was designed to create uncertainty around the deal and unease Tiffany shareholders. A number of those investors would include hedge funds that have a great deal of money at stake through arbitrage trades, prompting them to apply pressure to Tiffany’s board to ensure a deal does go through, even at a lower price.
As Tiffany’s share price fell away, LVMH did little to firm-up confidence, despite having chances to do so. Yet Tiffany’s CEO, Alessandro Bogliolo, remains one step ahead of the cashmere-clad Wolf having managed to renegotiate the company’s debt terms with lenders to ensure it doesn’t breach covenants and ultimately its merger arrangement. Right now, it looks like LVMH is still on the hook for some very expensive jewellery inventory but this deal still has time to run before its concluded; we’ll be watching with keen interest before drawing any firm conclusions on how we feel about its impact on LVMH’s value proposition.
If there is a sliver lining, then demand is re-emerging in the East as retail outlets re-open whilst online activity has also soared. The efforts to cater for Chinese tourists in Europe may be redundant for now, but the infrastructure built in the East is starting to service a clear desire for iconic, expensive and nice things. COVID-19 may not have dampened our desire for luxury products but how we go about buying and selling them may well have changed.
The Blue Chip portfolio has roughly 7% invested across Richemont and LVMH.
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