the trouble(s) with the luxury goods industry

For most of the past quarter-century, the publicly traded luxury goods industry, both companies based in the EU and in the US, has been a source of almost continual outperformance.

the old pattern

Its appeal rested (and I do mean the past tense) on two major trends:

–the gradual aging of the working population in the US and EU.  A twenty- or thirty-something in either area typically aspires to own a work wardrobe, a car and a house.  A forty- or fifty-something, in contrast, wants to own jewelry and a vacation house, and to go on a cruise.

So the rising affluence of older workers in the US and Europe has meant increasing demand for luxury goods.

–growth in Japan and the development of capitalism in China, beginning with Deng’s turn away from Mao in the late 1970s.  Again, increasing affluence has sparked higher demand for globally recognized luxury goods.  In addition, in China “gifts” (read: bribes) of luxury goods have long greased the wheels of bureaucratic approval of new projects–until the ongoing anti-corruption crackdown there began a few years ago, that is.

What has been less well understood is that the unit profits from selling a given luxury good in either China or Japan has been much, much higher than elsewhere (double would be my first approximation).  This means that if Japan/China accounted for 25% of a company’s sales (and a sales figure would typically be all a luxury goods firm would announce), they would represent half the company’s profits.

the new

–the rise of Millennials (the suit, car, house people) in the US and EU and the gradual retirement–and loss of income–of Boomers are putting a crimp in demand for luxury goods in these areas.

–luxury goods sales in Japan have hit a brick wall in recent years.  This is partly demographics, partly the immense loss in purchasing power that the Abenomics-induced depreciation of the yen has caused.

–the China case is a little more complicated.  The main reason for the falloff in Western luxury goods sales there is, of course, the anti-corruption campaign.  But even before this, there was a clear trend of high-end consumers in China away from foreign luxury brands and toward domestic ones.   It also seems to me that years of economic stagnation in the EU have further undermined the image of European brands as cultural symbols of power and influence.  So my guess is that even as/when the anti-corruption campaign runs its course, the bounceback of traditional European luxury goods sales will be muted.

my bottom line

Studying stock performance patterns of the past twenty or thirty years suggests that major selloffs of luxury goods stocks are always buying opportunities.  I don’t think this will be the case any longer.   This is not to say the stocks won’t go up in market rallies.  They likely will.  Bur they won’t be leaders.   And the best-known names will lag firms that primarily serve Millennials, as well as companies that tap into growing consumption in China.

on the Apple Watch

Yesterday, AAPL formally introduced its new Watch, which “was designed with a deep reverence for fine watchmaking,” and which has “a beauty that is both timeless and thoroughly modern.”

It comes in aluminum, stainless steel and 18-karat gold versions so far.  The first costs $350;  speculation is that the last will go for $10,000+, maybe $10,000++.

Analyst and media comment has focused on three points:

–smartphones have replaced watches to some degree, particularly with younger people, so it isn’t clear how big the market is

–the Watch is fully functional only when tethered to an iPhone, so Android users need not apply, and

–AAPL now gets,say, 60% of its revenue and 75% of its operating profit from cellphones.  Whatever its success, the Watch will just be a drop in the bucket.

I think the Watch is more important than that.

I think it’s an experiment, imitating something Nokia did almost two decades ago.

In its heyday, Nokia sold a small number of luxury cellphones, initially under its own name, later under the Vertu brand (long since spun off).  Although Nokia didn’t call much attention to Vertu, it represented maybe 5% of Nokia’s unit volume but (my estimate) around 25% of its profits.

Two implications, if the high-end Watches sell well, which I expect they will:

–AAPL’s Watch profits will be much higher than is generally expected, although they will probably remain in the drop-in-the-bucket category. More important, though,

–if very upscale Watches work, meaning they amount to 5% of unit volume, why wouldn’t $10,000+ iPhones work, too?

the Apple – IBM partnership

Jobs 1.0

Back in the early 1980s, AAPL made a better personal computer than IBM, at a time when the PC was beginning to displace the minicomputer in corporations and when individuals were starting to become a viable market for computing power.

Steve Jobs made two strategic errors, however, that ended up preventing AAPL from exploiting its advantage, which ultimately marginalized his company and put it on the verge of bankruptcy.

–AAPL priced its PC at 2x -3x the level of its MS-DOS alternatives, providing an overwhelming economic incentive to put up with the clunkiness of an IMB or a Compaq.

–Jobs marketed solely to company IT departments, which at that time had no power to make purchasing decisions.  He completely ignored the CEOs and COOs who did.  This may have enhanced his counterculture image, but it effectively closed the door to any corporate sales.

Jobs 2.0, Groundhog Day–except better so far

Arguably, Jobs 2.0 repeated the same game plan as 1.0:  make high-end, high-priced consumer devices and ignore the corporate world.  

In the post-Jobs era, and after a whole lot of waffling, AAPL management has decided to stick with Page One of the Steve playbook and is continuing to define itself as a maker of high-end consumer devices.  On the other hand, it lived (by the skin of its teeth) through Jobs 1.0 and knows how that story ended.

That’s why I think AAPL’s just-announced decision to partner with IBM to sell mobile products to corporations is potentially very significant.  It suggests AAPL is no longer willing to be straitjacketed by the Jobs mystique.  This is a good thing, because growth companies only continue to prosper if they periodically reinvent themselves.  

Also, given the continuing ineptitude of Ballmer-led Microsoft, the corporate market is much more wide open to AAPL smartphones and tablets than AAPL had any right to expect.  

I’m not rushing out to buy AAPL on the strength of a single new venture.  But it’s a start.  It suggests that Tim Cook is doing more than rearranging the deck chairs.  It argues that we should also be on the alert for further signals of favorable change in the company’s strategy.

 

 

 

 

 

Bain Luxury Goods Spring update (II) : structural changes in the luxury market

structural changes

Yesterday I wrote about Bain’s analysis of prospects for global luxury goods sales in 2013.  Today, I’m going to take a look at what the consulting company perceives as possible structural changes in the worldwide luxury goods market.

There are two big ones:

Asian tourists remaining closer to home

Japan:  Twenty years + of economic stagnation had finally begun to take a toll on the seemingly insatiable Japanese demand for European luxury goods a few years ago.  Recent sharp devaluation of the yen has depressed this appetite further.  Skeptics (like me) of the ultimate success of Abenomics must believe that this is a permanent change.  Given that, pre-devaluation, the price of luxury goods in Japan has typically been much higher than elsewhere, the negative effect of lower Japanese spending on the profits of luxury goods manufacturers will probably be disproportionately high.

China:  Weakness of the renminbi vs. the euro is a mild negative.  More important, Bain points out that Chinese luxury buyers are beginning to turn away from Europe toward Macau, Hong Kong and Australia as vacation destinations.  On the surface, it shouldn’t make much  difference whether Chinese customers on holiday buy in France or Cotai.  However, the change in vacation travel venue may give a significant opportunity for budding Pacific-based luxury brands to take business away from European rivals.  I think this is already happening.

the Baby Boom passing the baton

Bain characterizes the luxury goods preferences of different age groups as follows:

Baby Boomers (55+)  want:

–a bricks and mortar store

–a one-to-one interaction with a salesperson who represents the brand ans who also knows them well

–high-priced scarce or one-of-a-kind items that they think confer status on them individually as people of unusual taste and means

–a formal buying ritual.

In contrast, Generation Y (20-35) and Generation Z (0-20)–i.e., the children of Baby Boomers–want:

–instant availability 24/7, whether through physical stores or online makes no difference

–to be defined by brand values, but to be able to influence those brand values as well

–unique or novel items, which are not necessarily the most expensive, but which are personalized and which identify them as members of a certain group

–to be entertained.

In a nutshell, this is the difference between buying statement jewelry in a private room and buying a handbag in an online flash sale.  The branding, selling and infrastructure skills differ greatly from the first transaction to the second.

This difference in outlook is increasingly important, because the Baby Boom is retiring and its children are emerging as a new generation of luxury buyers.  One might even argue–with how much validity I’m not sure–that the sudden drying up of demand for traditional high-end European luxury goods in Japan is mostly a function of an aging population and a shrinking workforce.  If so, we may begin to see the same phenomenon in Continental Europe before this decade is out.  Again if so, luxury goods companies that don’t refocus themselves to cater to the preferences of a younger generation of consumers will find themselves struggling to retain relevance.

Bain Luxury Goods Worldwide Study: Spring 2013 update

Consulting firm Bain issued the latest in its series of important studies on the global luxury goods industry last month.  Thanks to Bain, I’ve just received a press copy of the study itself.

I’m going to write about it in two posts.  Today I’ll cover Bain’s view of industry prospects for 2013.  Tomorrow, I’ll write about longer-term structural changes underway for luxury goods.

2012 results

(It’s important to note that the study, conducted by well-known Bain analyst Claudia D’Arpizio, is done in cooperation with the Italian luxury goods trade association, Altagamma.  This means the sales figures are presented in €.  Also, the concept of luxury goods used has a strong traditional European emphasis.)

in € terms

In € terms 2012 was an above-trend sales year, one very close to being on par with 2011.  In both period luxury goods revenues grew by just over 10%, in an industry whose long-term growth rate is closer to +5%-6%.

in constant currency

In constant currency terms, however, 2011 was a +13% year (meaning strength in the € understated how strong the worldwide luxury good business was).  In contrast, 2012 was a +5% year in constant currency (meaning half the revenue rise came from € weakness).

the holiday season

Four factors characterized the key yearend holiday sales season in 2012:

–weaker than expected traffic in the US and Europe

–purchases tended to be for the buyer’s own use, rather than as gifts for others

–online sales, especially mobile, were very strong

–online sales were increasingly driven by special offers and by discounted shipping

2013 prospects…

1Q13 appears to have been a low point.  Sales were up a mere 3% year-on-year in constant currency.  € strength cut that in half in current currency terms.

Bain forecasts a 4%-5% full-year rise in €-denominated sales.

…by region

Japan:  Sharp devaluation of the ¥ has had a strong negative effect on Japanese luxury goods consumption–driven by the resulting loss in wealth and purchasing power of Japanese citizens.

Bain expects luxury purchases by Japanese abroad–notably Hawaii and the EU–to be down by 40% yoy as foreign travel declines and because $- or €-denominated goods have become less affordable.

Bain estimates that an estimated 10% increase in domestic luxury goods purchases will offset some of the shortfall.  But the overall effect will be about a 20% yoy contraction in luxury goods consumption by Japanese this year, a figure more or less in line with the fall in the Japanese currency.

In  Bain’s view, continuing ¥ weakness will limit the luxury goods industry in Japan to +4%-6% growth in € terms in 2013.

China

Chinese spending on luxury goods grew by 20% in constant currency last year, and by 30% the year before.  Bain is forecasting a relatively modest increase of +7% for 2013, however.

The main reason is change in policy by the newly installed central government.  The new leadership in Beijing is discouraging conspicuous consumption by the ultra-wealthy, particularly those with family connections to high-level present or former Party officials (although Macau gambling doesn’t appear to be suffering).  Perhaps more important, the administration has launched an anti-corruption campaign aimed at the widespread soliciting of “gifts” by officials from those seeking, say, business or construction permits.  Some estimates I’ve heard are that such gifting has made up as much as 25% of the sales of certain luxury brands.  Bain only mentions that sales of watches have been especially hurt.

No mention of a shift away from European to domestic Chinese luxury brands, but I think this is also part of the story.

Europe

Although it seems to me that Europe has passed its cyclical low point, and will gradually improve through 2013, the region will scarcely grow at all this year.  As a result of continuing economic weakness, aspirational buyers of luxury goods continue to trade down.  Japanese tourism has slowed dramatically.  And Chinese visitors are purchasing less on their European trips, as renminbi weakness makes €-denominated goods look more expensive.

Bain pegs European luxury goods sales in 2013 at 0%-2% growth.

US

Bain has little to say–good or bad–about US luxury goods buying.  It has penciled in growth of +5%-7% for this year.

the world

Asia ex China’s the best, at +7%-9% growth.  China’s a close second.  Europe’s the worst.  Overall, Bain thinks worldwide luxury goods sales will advance by +4%-5% in 2013.

More tomorrow.

a promising 1Q13 for Tiffany (TIF)

my bottom line on the stock

I no longer hold TIF.  Great company, expensive stock (the current 22x fiscal 2013 eps is at the high end of the company’s historical PE range).  Also, thematically, I’d prefer to get Consumer Discretionary exposure through firms that cater to average Americans, the segment where I think spreading economic rebound will bring the best year-on-year earnings gains, rather than the affluent.

Nevertheless,

TIF is an important bellwether

for how the wealthy, foreign tourists and China are feeling. So the results are well worth monitoring.   All three  groups appear to be starting to come out of their recent spending funk.

April quarter results

Tiffany reported 1Q13 (ended April) results before the bell yesterday.  They were surprisingly good.  Worldwide sales were up by 9%, yoy.  Eps came in at $.70, also up 9% over the $.64 posted in the year-ago quarter.

The figures were massively better than the consensus estimate of Wall Street analysts, who had penciled in $.52 for the April period.  This is also the first quarter in the past five where yoy earnings gains have been significant.  And 1Q13 exceeded the previous high water mark for the first quarter of $.67 a share set in 2011.  Good news.

all regions looking up

Here are TIF’s yoy sales gains by region:

US          +6% in 1Q13   vs    +2% in 4Q12

Asia Pacific          +15%   vs     +13%

Japan          +2%    vs     -6%

Europe          +6%     vs      +3%

Total         +9%  in 1Q13     vs.     +4% in 4Q12

a dividend increase

Two weeks before the earnings report TIF’s board increased the quarterly per share dividend from $.32 to $.34.  On the one hand, the rise comes at the normal time of year for TIF.  And the bump up is smaller than 2012’s.  On the other, if we make the reasonable (to me, anyway) assumption that the board of directors is targeting a payout of 25% of cash flow and/or a third of profits, the dividend increase signals there’s still upside to the Wall Street consensus.

More important, the board is comfortable that business is improving.

Tiffany (TIF) reports so-so 4Q12 earnings

the results

Before the opening bell this morning on Wall Street, TIF reported 4Q12 (the company’s fiscal year ends in January) results.  Sales were up 4% year on year during the quarter, at $1.2 billion.  Net earnings were up 1% yoy, at $180 million.  That works out to eps of $1.40, vs. the $1.39 reported for 4Q11.  But it was $.04 above the brokerage house consensus of $1.36.

For the full year, sales were up 4% at $3.8 billion.  Net income was $416 million, down from $465 million in fiscal 2011.

In its earnings release, TIF also gave its first guidance for fiscal 2013.  It expects sales to be up by 6%-8% and eps to move roughly in line–but possibly with a touch of positive operating leverage evident later in the year.  1Q13 will be relatively weak (TIF fingers marketing costs and high raw material prices as the culprits), but earnings comparisons will likely improve from then on.

As I’m writing this, shortly after the open, TIF shares are up almost 3% in a market that’s up by about half a percent.

I don’t see why.

my take

TIF is an exceptionally well-managed company with a powerful brand name in the Americas and the Pacific, and in a business, luxury goods, that has strong long-term growth prospects.

This is the first time in five quarters that TIF results have exceeded the Wall Street consensus.  That’s a plus, although the “beat” is at least partly due to analysts’ low-balling their estimates after having whiffed four quarters in a row.

Management guidance of 6%-9% eps growth for fiscal 2013 is also a low-ball number, in my view.  I think +10% is easily attainable but believing in +15% would be a stretch.

my issue is valuation

I’ve owned the stock in the past but don’t now. Based on management guidance, the stock is trading at 20x year-ahead earnings, which is about as high as the PE has gotten over the past decade.

–Yes, there have been short periods when the multiple has spiked higher, but who wants to count on this happening again.

–Yes, there may be another, say, 5% to count on in the stock as earnings come in better than guidance.  But a professional investor should be looking for the potential +30%s and the +50%.  There’s just not enough upside here.

–Yes, there’s recurring speculation that some EU luxury conglomerate may buy TIF.  But, again, is this enough of an investment thesis?  In my view, no.  If the stock were trading at 15x earnings, however, it would be a different story.

what catches my eye in the release

TIF still doesn’t have its balance sheet completely back under control.  A while ago, when world economic prospects looked brighter, TIF decided to boost its inventories significantly.  That was so as not to lose sales for lack of stuff to sell, as well as to support a quickened store expansion plan.    …an aggressive, but very sensible strategy.

As global growth started to fade, TIF put on the manufacturing brakes.  But at 1/31/13, inventories were still $161 million higher than a year earlier.  And debt, net of cash, was up by $176 million.  That’s the reason, I think, why TIF bought back no stock during 4Q12, despite the fact the shares spent much of December in the mid-high $50s–vs. TIF’s full-year average buyback price of $66.54.

Comparable store sales in the Pacific, ex Japan and ex currency effects, were +6% for 4Q12.  I interpret this figure as saying sales there, which I view as the key factor that could make fiscal 2013 surprisingly good for TIF, have passed their low point.  TIF is penciling in a “mid-teens” total sales increase for the region–implying, I think, +10% for comparable store sales.  In a better Chinese economy and with clarification of the new government’s view on luxury goods consumption, that figure may be way too low.   If there’s one thing TIF bulls should monitor, this is it.  If there’s one thing that could change my mind about the stock, this is it.