Forecasts for the luxury sector in the second half of 2022

During this scorching summer, luxury group sales results of have raised the excitement of investors, who have been undergoing stress for months. LVMH recorded first half sales up +28% to 36.7 billion euros, Hermès saw its sales increase +23% to 5.5 billion euros, Kering totaled +23% sales growth to 9.9 billion euros, Swatch Group increased by 7.4% to 3.6 billion Swiss francs and Richemont, in a delayed fiscal year, published its quarterly results with +12% increase at constant rates to 5.26 billion euros. Overall, the fashion and leather goods sector is performing well with an increase in operating income before non-recurring items at LVMH of around +33%, followed by the watches and jewelry sector at +26%. At Swatch Group, the watches and jewelry sector increased by 15.7%, at Richemont watches were up by 10% at constant exchange rates in the quarter (April to June 2022) and jewelry recorded an increase of 12%.

The double-digit organic growth of luxury companies did not disappoint investors, on the contrary. Arthur Jurus, Senior Investment Strategist at ODDO BHF, comments: "The results of LVMH, Richemont, Swatch Group, Kering and Hermès continued to progress, with sales on average 4% higher than expected and after-tax profits 6% higher than expected. Basically, the results of the major luxury groups are improving, which is not the case for other industries, such as the tech sector, which is accumulating disappointments. Large technology stocks are growth stocks that are more sensitive to economic slowdowns and rising long-term interest rates. When the latter rise, discounted earnings for the future decline. If tech stocks have underperformed, it is because long-term rates in the US have risen to 3.40%. But for the past ten days (at the end of July), these long-term rates have been falling in Europe and the US, as the probability of a recession in the second half of the year is confirmed at 50%, a leverage that pushes long-term rates down. And luxury groups like LVMH are also part of these growth stocks while being more resilient in a recessionary phase."The double-digit organic growth of luxury companies did not disappoint investors, on the contrary. Arthur Jurus, Senior Investment Strategist at ODDO BHF, comments: "The results of LVMH, Richemont, Swatch Group, Kering and Hermès continued to progress, with sales on average 4% higher than expected and after-tax profits 6% higher than expected. Basically, the results of the major luxury groups are improving, which is not the case for other industries, such as the tech sector, which is accumulating disappointments. Large technology stocks are growth stocks that are more sensitive to economic slowdowns and rising long-term interest rates. When the latter rise, discounted earnings for the future decline. If tech stocks have underperformed, it is because long-term rates in the US have risen to 3.40%. But for the past ten days (at the end of July), these long-term rates have been falling in Europe and the US, as the probability of a recession in the second half of the year is confirmed at 50%, a leverage that pushes long-term rates down. And luxury groups like LVMH are also part of these growth stocks while being more resilient in a recessionary phase."

At the end of July, it was confirmed that luxury sector stock prices experienced a particularly strong rebound in July, outperforming the Stoxx 600 index by nearly 10 points over the month. But if we analyze the share price (as of August 3, 2022) since the beginning of 2022 "in stock market performance, LVMH is -7%, which is barely better than the European market Stoxx 600, Kering records -23%, Hermes -13%, Richemont -18%, Swatch -11%. There are two stocks that have done better than the markets, they are LVMH and Burberry (-0.5%), adds Arthur Jurus.

Overall, Europe, Japan and the United States were the three parts of the world that drove luxury growth in the first half of the year. China remains uncertain, despite the recovery since the reopening of its stores in June. For the Richemont Group in particular, the quarter to the end of June 2022 recorded 37% lower sales in China, although it should be noted that this dropped to 12% in June. Swatch Group also recorded a significant decline in sales in China, reporting in its statement "a massive decline in sales of about 400 million francs total." The Chinese economy, which has long driven the growth of luxury is particularly scrutinized by financial analysts. "China's GDP has been revised downwards," explains Arthur Jurus. In the second quarter, activity declined and on an annualized basis, it was even negative. Today, the GDP is at 4.1%, while the Chinese authorities expect a growth of 5.5% for the year. But nothing is certain, as it should be noted that the election of Xi Jinping is not yet a foregone conclusion and the Zero Covid policy is weighing on the Congress by creating tensions. A number of stimulus plans seem to be in place at the moment, from a fiscal and infrastructure point of view. This may indeed have a positive effect on the Chinese economic recovery in the second half of the year." And what about GDP in Europe and the US, given the coming recession? GDP growth levels have been cut in half for the US and Europe," says Jurus. Analysts' expectations were averaging 4% growth, but they have been revised downward. The Bloomberg consensus is 2.4% for the U.S. and 2.2% for Europe."

The first-half growth lesson for the second half of the year: investors will look for geographically diversified growth stocks. And this is not always the case for some brands. An example is Gucci, owned by the Kering group, whose sales have been heavily impacted by store closures in the spring of 2022, causing Kering's stock to plummet on April 22. The same is true for the Swatch group's brands, mainly Longines and Tissot, which are very dependent on China. Arthur Jurus adds: "Swatch Group has the advantage of a P/E of 16 (in comparison, LVMH has a P/E of 24, Kering of 19, Hermès of 50) so we pay less for profits compared to the rest of the sector, on the other hand exposure to the Chinese market is riskier, and investors will favor brands whose sales are geographically better distributed."

In watchmaking, while the latest results confirm the sector's strong performance since the beginning of the year, including the noteworthy performance of the Hermès group with a watch sales growth of +55%, one must take into account the headwind that has begun to blow in the secondary watch market with a deflation of the speculative bubble around watches that are highly sought after by consumers, such as a Rolex Daytona, a Royal Oak Jumbo from Audemars Piguet or a steel Nautilus from Patek Philippe. According to Olivier R. Müller, watch industry analyst: "We have seen a sharp decline in the secondary market over recent weeks, much more significant than some people would like to admit. The Nautilus 5711 steel reference from Patek has seen its price drop. It now sells for $110,000 and $115,000 on the secondary market, instead of $190,000. Admittedly, that's still three and a half times the in-store price. The cause: a decline of the stock markets and the collapse of cryptocurrencies, resulting in the exit of speculators from the secondary market. Today, the resale platform Chronext is laying off, as it was overstocked with Rolex watches purchased at the height of the bull market cycle." What will be the impact on the primary market? "Obviously, the markets will calm down. There is some nervousness among dealers. Customer confidence remains correlated to geopolitical and macroeconomic announcements such as rising rates, the war in Ukraine, tensions between the U.S. and China, even though the resilience of luxury is significant. However, the major brands that dominate the watch sector, such as Rolex or Audemars Piguet, will not be impacted, even excluding speculators. Demand for these brands is still 50% higher than availability in stores."

The same observation for Arthur Jurus: "In the luxury sector, investors are looking for the top of the basket. Cautionary statements are being issued due to macroeconomic uncertainties, linked to rising rates. A recession is looming in Europe in the second half of the year according to PMI indicators. And for the past two weeks, activity has been contracting in Europe and the US. Order books are shrinking. Our revenue forecast for the luxury sector is +10% year-on-year for the third quarter and +5% for the fourth quarter."

As we can see, luxury will remain resilient, but will see a decline in growth in the second half of 2022.