Monthly Archives: October 2010

Global luxury goods market: the ninth annual Bain study, October 2010

October 25, 2010 By in China, emerging markets, Hong Kong, Industry Analysis, Luxury goods, Retail Tags: , , , 1 Comment

Note:  You can also get my analysis of the 10th Bain Luxury Goods Worldwide Market Study from October 2011.

I’m going to write about this topic in two posts.  Today’s will cover the present structure of the luxury goods market and the effect of the Great Recession on it.  Tomorrow’s will look at growth prospects for the industry, changes occurring to its structure and investment conclusions.

The industry data come from the 9th annual Bain and Company Luxury Goods Worldwide Market Study, directed by the partner who heads Bain’s fashion and luxury practice, Claudia D’Arpizio.  The results were presented at the Fondazione Altagamma conference in Milan earlier this month (thanks to Bain for sending me a copy of the presentation). You can find a summary on the Bain website.

structure of the market

size

The global luxury market peaked in 2007 at a sales value of €170 billion ($238 billion) in 2007.  Revenues fell during the recession (an unusual occurrence) by about 8%.  Bain predicts that the industry will bounce back to around the former peak this year and exceed it by a few percentage points in 2011.

participants

Bain counts 232 brands in the luxury goods market.  The top 6% of the brands average €1.8 billion ($2.5 billion) each in sales and together control 10% of the market.  The bottom 38% average €300 million each and control only 15% of the market.  It seems to me this segment, which has suffered more than bigger brands from the recession, is ripe for consolidation.

distribution

In 2008, 78% of the industry’s sales were made through third parties, notably department stores.  The remaining 22% went through company-owned stores.  Bain thinks that this year 27% of sales will flow through the direct channel, with indirect shrinking to 73%.  The percentage of direct sales will likely continue to increase, for two reasons:  luxury brands continue to open new stores, and company-owned stores tend to exhibit much stronger sales growth than luxury counters in department stores do.

Outlet stores make up about 5% of sales.  On-line comprises somewhat over 2% of the industry.

geography

Sales of luxury goods take place approximately as follows:

Europe     37%

Americas     30%

Asia Pacific (ex Japan)     17%

Japan     11%

Rest of the world     5%

One caveat about location:  Purchases by foreign tourists is a significant factor in this industry.  This is partly because of fluctuation in exchange rates and differences in import and other taxes.  But it is also partly the result of manufacturers’ decisions to price the same item as much as 40% higher in Japan and China as in Europe.

The top cities for luxury goods in the world?  They rank as follows:

New York City     €9 billion ($12.6 billion) in 2009

Paris     €6.0 billion ($8.4 billion)

London     €4.5 billion ($6.3 billion)

Bain estimates that Hong Kong will account for €4.4 billion ($6.2 billion) in sales for 2010, possibly edging it ahead of London in the rankings.  Actually, given that nearby Macau will likely chip in €700 million ($980 million) in sales of luxury goods this year, the two SARs together doubtless already surpass London and likely move ahead of Paris as well within the next year.

Greater China (that is, the mainland plus Taiwan, Hong Kong and Macau) will generate  €17.5 billion ($24.5 billion) in luxury goods sales in 2010 according to Bain, making it larger than any single country market, save the US.

gender

Currently, 62% of purchases are for women, 38% for men.  The numbers are influenced by two factors:  there is a long-term trend of increasing sales to men, counteracted by the much higher cyclicality of the watches and formal wear that men typically buy.

product categories

Apparel     27%

Accessories     24%

Perfume and cosmetics     24%

Hard luxury (jewelry and watches)     19%

Art de la table     4%

luxury in the Great Recession

Bain says the downturn just ended marks the first ever decline in luxury goods sales.

The industry’s customers can be divided into the truly wealthy, for whom luxury goods are everyday items, and a much larger group of what the industry calls “aspirational” buyers, for whom the products also act as badges of wealth, taste and status.  As one might expect, the second group of buyers is much more cyclical than the first.

In addition, in any downturn the indirect distribution channel cuts its new orders back to below the (reduced) level of sales as it tries to shrink its inventories.  This adds to the sales decline for manufacturers.

As one would expect, hard luxury was especially hard hit.  This is due, mostly because of the high price points in this segment, but also to the less-affluent and mostly male composition of the buyers.

Why is gender an issue?  Men’s items tend to be higher-priced and to be purchased less frequently.  As a result, it’s easier to postpone their purchase.  Also, it appears (to me, anyway) that women tend to control the purse strings in most households around the world.  They tend to continue to allocate funds for their own purchases, although they may move down market or buy less frequently, but to zero out their husbands’ allocations.

Surprisingly, and contrary to the Wall Street cliché, cosmetics suffered in this downturn as well. In fact, Bain calls them the “first thing to cut!”  In particular, sales of anti-aging products fell for the first time, as customers turned to non-luxury offerings.

The turn came in the December quarter of 2009, when year on year sales stopped declining.

That’s it for today.  Tomorrow:  the recovery in 2010, growth prospects and investment implications.

Thinking about 2011

October 24, 2010 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Shaping a portfolio for 2011, Strategy Tags: , , , , , , 2 Comments

it’s time

As the leaves begin to turn bright colors and drop from the trees (at least here in the northeastern US), a professional investor’s thoughts start to turn to preparing for the coming year.

the most important issue

The essential question, though equity professionals would never phrase it this way to clients, is whether stocks are likely to go up or down in the twelve months ahead.

My answer has two parts:

First, for 2011 the answer is relatively easy to arrive at, and

Second, I think stocks will go up, at least modestly.

next in line is…

The next task, in (what is to me the) logical sequence, is to figure out what elements of a successful investment strategy for 2010 will carry over into 2011 and which ones will surprise the consensus by reversing themselves.

This question is a lot harder.  Giving concrete content to a general perception of trends is always difficult.  Today it’s especially so, since the same portfolio-structural keys to a successful sector and individual stock strategy have been in place for almost two years.  They’ve been:  bet on near-death experiences; bet on cyclical sectors; bet on emerging markets–especially Asia, and against the developed world.

Experience suggests that at least some of this is bound have become pretty long in the tooth by now, despite the fact that conviction in them is probably much higher today than it was in March 2009.  After all, the stock market does act to make the greatest fools out of the largest number of people.

…looking for non-consensus ideas

Knowing this, I’ve been casting about for a while for ideas that run counter to the consensus.

…finding one Continue reading →

Disney’s deal to distribute Marvel films “The Avengers” and “Iron Man 3”

October 22, 2010 By in Entertainment, Industry Analysis, Stock ideas Tags: , , Leave a comment

the new deal

It was widely reported (here’s a link to the story in the Washington Post) on Tuesday that DIS retrieved the worldwide rights to distribute upcoming Marvel movies The Avengers and IM 3 when they are released in 2012 and 2013 from Viacom’s subsidiary Paramount.  Paramount will still distribute Thor and Captain America.

I haven’t been able to find an official release either on the DIS or VIA websites, or on PR Newswire, for that matter, but the terms of the agreement seem to be as follows:

–DIS will assume responsibility for distribution of the two films

–DIS will pay VIA the 8% of box office it would have earned from distributing The Avengers and 9% (1% extra) of the box office from IM3.

—when the films are initially released, DIS will also pay VIA a total of $115 million as a non-returnable advance against its distribution percentage.  Further details on the timing of the payment (which I don’t think are that important) aren’t clear.

Why did DIS do this?

Is it a good move?

Yes, for several reasons:

–DIS has a stronger global distribution network than Paramount

–DIS will be able to create a total marketing plan, including merchandise and other extras, for the films,

–as I understand it, the existing arrangement calls for Paramount to collect the film’s share of box office, subtract its 8% fee, recover its costs, and return the rest to Marvel.  The only contractual constraint on Paramount’s spending is a guarantee that Marvel will get a minimum percentage of the box office.

Paramount’s goal is to maximize box office, not film profits.  So it will have a natural tendency to overspend to generate ticket sales.  In theory it would benefit the distributor to spend an extra $100 on promotion to generate even an extra $50 in box office, provided it didn’t violate the minimum return guarantee.

–the film industry is noted for its unusual ways of reckoning up revenues and costs.  Having everything in-house makes it simpler for DIS to see and control them.  It will also save on audit fees.

As for Paramount, it no longer is exposed to the risk that the two films will be flops.  It will collect an up-front fee set at the blockbuster level.  It will collect more money if the films are super-hits, all without having to do any work.

by itself this is a footnote, not a big story

Why write about it then?

I think this deal is an indicator of a healthy attitude of responsibility and attention to detail by DIS’s management.  It’s kind of like the story that the new head of Disney Films is willing to accept input from Pixar, which his predecessor refused to do.  Not it itself a big thing.  But it gives the shareholder (I own DIS) confidence that the company’s management has professional skill and is using it for the benefit of the company’s owners.  In the case of DIS, it’s another piece of evidence that the neglect that characterized the Eisner years is being systematically addressed.

more thoughts on AAPL’s 4Q10

October 21, 2010 By in Constructing a Portfolio, Current Market Thoughts, earnings conference calls, Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , , , , , Leave a comment

I’ve already written about the basics of AAPL’s stellar September quarter earnings report.  Reading and listening to investors’ comments, I think there are basic elements to the AAPL story that are not well understood.  Maybe it’s just me, but, for example:

The iPhone is much more important to AAPL than the iPad.  For one thing, there’s the fact that the smartphone market is bigger than the consumer PC market and growing much more rapidly.  AAPL also collects a portion of phone subscription revenue from some network operators and that the iPhone represents half the profits of the company.  But, I think it’s mostly that phones are typically subsidized by carriers eager to have customers sign one- or two-year contracts.  So iPhone aficionados are, like clockwork, going to buy new ones every two years.  Therefore, iPhone hardware has an annuity-like aspect to it.

To me, it’s clear that the iPad is deliberately designed so it doesn’t compete with the iPhone.  To my mind, this makes the device somewhat less attractive than it might be.  It also means that the iPad isn’t supposed to cannibalize the iPhone.  And it hasn’t.  The fact that AAPL is selling iPhone4s as fast as the company can make them is way more important than that it sold “only” 1.3 million iPads per month in the September quarter.  (After all, in April, Wall Street scoffed at the idea that AAPL might sell as man as one million a month.)

It may also be that the same economic weakness that may have hurt sales of low-end consumer PCs during the September also held back sales of the iPad.

Lower margins are here to stay–and that’s good.  Some investors see high margins as a sign of the strength of the intellectual property the firm possesses and worry when they begin to decline.  I don’t think that’s the right way to look at AAPL, but margin decline seems to have been at the top of the list of institutional investors’ worries after AAPL reported this week.

In consumer-oriented businesses, high margins can be a bad thing, since they create a pricing umbrella that invites a competitor to undercut the incumbent.  Apple-speak aside, the iPhone has serious competition for the first time in the Android family.  It would be a terrible mistake for AAPL to allow Android phone makers to sell their products at lower prices.

The same is the case with the iPad, where we are just about to see the first Android competition.

Steve Jobs’ conference call remarks are puzzling.  He basically trashed all his competition.  Maybe that’s just Steve being Steve.  But when a CEO says this stuff, it’s usually a sign of weakness and worry.  His two major points seem to have been, first, that app creators for Android devices have got to deal with a lot of different form factors and app stores, whereas with AAPL the task is a lot simpler.  Second, he thinks competitor tablets with 7-inch screens are too small.  They can fit in your pocket, but that’s not an attribute that customers will want.

AAPL is a growth stock but not priced as one.  As I’ve pointed out elsewhere, as a typical growth stock gains earnings momentum in the way AAPL has over the past few years, the price-earnings ratio typically expands.  The multiple can easily double.  –which creates a problem when the period of very fast growth ends.  At the first earnings disappointment, the stock declines, not only to the extent of the earnings shortfall, but the PE begins to contract as well as the market stats to factor in slower growth in the future.  The stock may be cut in half simply by PE contraction from, say, 40 to 20.

In AAPL’s case, the multiple has already contracted by about a third and isn’t that much higher than the market’s.  In fact, if you factor out the $51 billion (18% of the present market cap) the company has sitting around in cash (in case an acquisition comes along, according to Mr. Jobs), AAPL is already trading at a sub-market multiple.  So, strange as it seems, given the stock’s stellar performance over the past half decade, the multiple seems to give it a considerable amount of downside protection.

US corporates lobby for a new tax amnesty

October 20, 2010 By in Cash position, Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Securities regulation Tags: , , , , , , , , , , 1 Comment

Yesterday’s Financial Times contains three (count ’em, three) articles, one on the front page and prominently above the fold, talking about recent efforts by US corporations in lobbying Washington to allow them to repatriate foreign cash holdings while paying little or no income tax.

This appears to be the start of a public relations campaign by the US Chamber of Commerce aimed at persuading Congress to pass a tax amnesty bill like the Homeland Investment Act (HIA) of 2004.

US tax law, unlike that of many other countries, makes multinationals incorporated in the US pay domestic income tax (less a credit for foreign income taxes paid) on any foreign earnings repatriated here.  This can be a big deal.  For a US company recognizing Asian profits in Hong Kong, for example, the corporate tax is zero.  This means a firm bringing money like this back home would typically have to pay 35% of it to the IRS.  The funds are probably going to be reinvested in growing Asian businesses.  But even if not, unless the funds are crucially needed in the US it would be financially foolish to repatriate it.

HIA allowed firms to pay a maximum of 5.25% tax on any money brought back to the US during a specified period of time.  Companies were required to use the repatriated funds only to hire new workers or to invest in plant and equipment.  The idea was that this would reduce unemployment and spur new investment.  None could be used for stock buybacks, dividend payments or executive compensation.

According to forthcoming research, the reality of the HIA was quite different.  Corporations repatriated around $300 billion from abroad.  Strictly speaking, all the money was used for the purposes intended.  But aggregate employment and capital investment didn’t increase.  The funds simply freed domestically generated profits to be used for dividends etc..  In fact, some firms actually used the repatriated funds to replace domestic profits that they shipped abroad.

Proponents of  HIA II, which the FT says include Cisco, GE and Microsoft, are not making strong claims this time around.  They label the cash, which is estimated at about $1 trillion, as being “trapped” abroad.  They argue that maybe $400 million would be repatriated under HIA II, giving the government $20 billion or so in tax money it wouldn’t otherwise have.  And the repatriated funds would likely slosh around doing something–presumably economically good–in the US.

So far the Obama administration is saying no, seeing that it’s in enough trouble without advocating a big tax break for cash-rich corporations.

investment implications (there actually are some)

1.  I wrote about this topic a bit last April, specifically regarding the large buildup of cash on the balance sheets of technology companies.

2.  To be able to pay it out in dividends, a US-incorporated company has to have the cash available in the US.  But most publicly-traded companies don’t disclose enough about where there cash balances are, or the cash generating/cash using characteristics of their US and foreign businesses for an analyst to see how well a given dividend is covered.  This didn’t make any difference when dividend yields were very low and investors were interested in capital gains.  But it does now.

3.  It takes a US$1.50 earned pretax in the US to give the same lift to the reported earnings of a US company as US$1 earned in Hong Kong.  So a corporation concerned with maximizing eps might well choose to recognize profits in Hong Kong rather than the US, assuming it had a choice.  Similarly, a decision to shift the profit stream to the US in order to may dividends–again, assuming this were possible–would mean a structurally lower level of eps.  I suspect that at some point, investors will ask for earnings estimates that are “normalized,” in the sense of adjusted to what they would be under a standard 35% tax rate, in order to get a more apples-to-apples comparison.

4.  Why lobby for HIA II?  The paper I linked to above argues that it makes very little difference to corporations in the aggregate.  But there may be firms–most likely in the tech area–who will be forced to borrow or to repatriate foreign cash balances (and pay tax on them), either to be able to maintain the current dividend or raise it.  The strongest advocates of a new HIA might well be in this position.