On January 23 the Retail & Luxury club hosted Lucy Baldwin and William Hutchings, both equity analysts at Goldman Sachs, to talk about the latest trends in the $270 billion global luxury industry. By sharing their latest research with us, they also provided some interesting insights into the role of an equity analyst.
William Hutchings had worked at Ernst & Young in Project Finance before joining Goldman Sachs’ equity research team. Lucy Baldwin, who was promoted to MD late last year, had started out as an M&A analyst but switched to equity research after a few years. She was impressed at the time by how quickly relatively junior analysts were given the opportunity to interact with high-level management of the companies they covered.
They told us that the presentation would be very similar to what they present to their clients (e.g. pension funds, high net worth individuals, etc.). They also avoided specific stock recommendations, as clients are usually more interested in secular trend analysis rather than concrete trading ideas.
One of the biggest drivers of the global luxury market over the coming years is the growth of the middle class in China. The middle class might be shrinking in most developed countries, in China however it is expected to expand by 200 million people over the next 15 years (though one should note that middle class in China is defined as an income of >$30,000). The Chinese luxury market is therefore forecast to grow at around 9% p.a. to roughly $330 billion by 2025.
The growth in China and in other emerging markets such as India and Brazil along with a relative scarcity of luxury brands has led to a massive cash build-up at the leading firms of about $44 billion (on average 0.4x net cash to EBITDA). Goldman therefore expects further M&A activity by larger companies purchasing smaller niche brands, while some of this money will also be used to further expand their respective retail footprints, primarily in emerging markets.
In order to capture more margin most large companies in the luxury space have started to take control of their own distribution in recent years by opening up stores in high-end retail areas or by setting up in-store brand stores. As a result many companies have transformed from manufacturers to overseeing large retail operations. Prada for example announced before its IPO last year that it would open 80 stores annually for the next three years in China alone.
Despite their strong position in the market for luxury goods, William does not see LVMH, PPR and Richemont quite as positively as other, smaller companies in the space, since a lot of their growth has come from an aggressive acquisitions strategy. This makes their already quite lofty valuations somewhat vulnerable should acquired brands not perform as expected. Still, Goldman projects the stocks in this sector to have an average upside potential of about 50% over the next twelve months.
The main risks to these projections (as for so many) are a substantial slowdown in China or even a hard landing - which has become less likely for the time being. The industry is particularly sensitive to cyclical swings in the global economy as it is generally defined by high operational gearing.