Idea generation: Shorting Luxury stocks

This is an idea which I am contemplating for some time.

Coneventional stock market wisdom says: Chinese / Asians love luxury goods, therefore this is the safest bet to buy Luxury stocks who sell to the Chinese consumer.

As a result, many luxury companies had great runs intheir stock price, for instance:

LVMH

Boss

or Ralph Lauren

However up until now, I did not really no where a “catalyst” would come from. So switch to the brilliant John Hampton at Bronte who really nails it down with Richemont, the Swiss luxury group:

Swiss Watch exports have been increasing, as the Chinese really dig expensive watches:

It is the Rococo stuff that is winning. The Federation of the Swiss Watch Industry publish export data from Switzerland (not sales to end consumers). June data shows a 4.1 percent reduction in volume, a 21.7 increase in value. The average price of a watch is going up sharply. This has been the case for years. The Federation published this graph which shows that (relatively accurate) electronic watches have been flat in value for years – but that mechanical movements (inaccurate but reassuringly expensive) have gone skyward:

Although exports to Hong kong are still increasing strongly, sales seem to have stalled:

There are several data sources I watch to keep tabs on spending by Chinese elite. The Swiss Watch data is obvious.

Exports to Hong Kong in June were up 21.2 percent. It was about the same in May (but the monthly data has disappeared from the web). It was about the same every other month this year. They keep upping the exports to Hong Kong.

But Hong Kong also has sales tax data which comes from the sales tax receipts. There is in the data a series for “Jewellery, watches, clocks and valuable gifts” by both value and volume. The value series – relatively flattering, has monthly sales (versus previous corresponding period) for the last six months as:

+18.3%
+14.1%
+18.4%
+15.1%
+2.9%
+3.1%
Sales growth stopped. However exports to Hong Kong kept up (note that 21.2 percent figure above).

John Hempton is not a guy who would short such a share because of date, he needs a real reason and this is the following:

have a theory given to me by a China watcher. The theory – it turned bad sharply with the ouster of Bo Xilai and now the murder charge on his wife Gu Kailai. Gu Kailai is going to have a hard time avoiding a mobile execution unit. This changes the stakes and it is structural. A half million dollar watch no longer says “look at me”. It says “look at me, I am a kleptocrat”. Thoughts of that beautiful Van Cleef and Arpels hair clip become the last thing that runs through your brain before the bullet.

And he can prove his theory with the example Brazil in the 80ties and 90ties:

We know what a completely collapsed luxury good market looks like. Brazilians like a bit of bling. But in the late 1980s and into the 1990s the kidnapping rate in Brazil went skyward. (There is an horrific documentary about that called Manda Bala which translates “send a bullet”.) After kidnapping became a major industry (particularly in São Paulo) carrying a $3000 handbag no longer said “look at me”, it said “kidnap me”.

Two other data points in the recent weeks show that maybe the Chinese consumer might be (for any reason) a little biut more cautious:

– Sales at Sand’s Chinese casinos disappointed strongly

– and even McDonalds announced that same store sales in China fell

For me, such company news are much more reliable than any Chinese Government statistics.

Let’s quickly look at Richemont:

The stock price ist still below its 2008 highs:

The stock doesn’t look so expensive either:

Trailing P/E 16,6
P/B 2.8
P/S 2.9
EV/EBITDA 9

is not that expensive for a stock with a 17% profit margin and 20% ROIC, a very conservative balance sheet with no goodwill and net cash. Even mean reversion would support current levels. 10 year average net margin is 20%, only 10 year average ROIC is “only” around 10%.

A much more interesting short candidate might be Boss.

Boss is more expensive

Trailing P/E 17.3
P/B 11.9
P/S 2.4
EV/EBITDA 11.5

and 10 year avg. profit margin is 8.6% against current 13%.

Still, I would prefer to short luxury shares with aggressive accounting, but I have to dig a little bit deeper for this.

And do not forget: Luxury sales in Europe are bad anyway and as Coach shows, even the US is not “an island” with regard to luxury sales.

Summary:

I guess shorting Luxury stocks might be an interesting idea at some point in time. I wouldn’t short Richemont, as this is really one of the rock solid companies, but other candidates might be more interesting. Preferably with aggressive accounting and US / Europe exposure.

6 comments

  • ups, Richemont issued great numbers. However, John Hempton immeadiatly recognizes his mistake:

    http://brontecapital.blogspot.de/2012/08/something-is-happening-here-and-you.html

    Not many people would do this.

    Chapeau !!

  • the story that another 800 trillion chinese will move into the city is indeed “the story” which keeps confidence up. At least for now.

  • Bo Xilai galt eher als Bedrohung für die neuen Reichen. Wegen seiner Absetzung und der Anklage seiner Frau von “this changes the stakes” für Wohlhabende zu sprechen, ist m. E. unpassend.

    Auffallend ist in der Tat, dass seit Mitte des letzten Jahres das SSSG in einigen Segmenten merklich abgenommen hat, so auch im Lebensmitteleinzelhandel (v. a. bei Lianhua und etwas weniger bei Wumart) und im Sportartikelbereich (nach Jahren mit schneller Filialnetzausweitung), wo mittlerweile alle Preisklassen betroffen sind. Was aber für Mr. M. nichts Neues ist. Die Frage ist, wo man hier aktuell im Zyklus steht.

    Angesichts der derzeitigen Kreditkrise bevorzugen Investoren neben Rohstoffen vor allem Consumer Staples und in deren Schatten – und vielleicht aus ähnlichen Gründen – waren/sind auch Consumer Discretionaries mit starken Marken gefragt, sofern es im Einzelfall keine enttäuschenden Zahlen gab. Wie stark Discretionaries in China wachsen, hängt vor allem davon ab, ob noch Städte mit einer großen, bislang unbefriedigter Nachfrage erschlossen werden können und daher die Anzahl der Läden deutlich steigt.

    • just compare china’s urbanization to the rest of the world.
      –> There will be urban growth and new customers.

  • Richemont has a solid balance sheet but they can be forced to do widespread recalls in order to reduce an inventory overhang. Luxury goods makers are focused on preserving the long term value of their brands and doing recalls is necessary if their brand’s appearance is threatend by a large overhang. Richemont will probably be able to cope with a large recall however. They have the balance balance sheet as well as the in-house e-commerce channels to allow them to discretely get rid of any surplus inventory and recalled goods.

    For short ideas in this sector I would look in two areas:
    1. Hong Kong listed importers and retailers of luxury goods.
    2. Recently IPO-ed, smaller luxury goods makers such as Brunello Cucinelli, Salvatore Ferragamo, Tumi, Samsonite and L’Occitane. A slow down in sales and the pressure of a recall would disproportionately impact the smaller companies in the sector, Their recent IPO’s also increases the probability of accounting dress-ups.

  • Just recently I had taken a look to another luxury stock: Swatch Group. When looking to its balance sheet the first time, you can only say: Wow! The profitability and the lack of any financial debt is impressive. The valuation of the stock seems not too expensive (P/B 2, P/E 15) given the optimistic outlook for the 2nd half year of 2012 comes true. While digging deeper, I found out that the management is bullish most of the time…
    Another point is the huge position of inventories, which has risen compared to the 2011 numbers. This could be a warning sign.
    Hm, nice company. If I would be forced to buy or sell short, I would still buy yet.

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