The luxury goods sector is currently facing a series of major discussions among investors, which are influenced by sector performance, consumer behavior, and macroeconomic factors.
According to analysts at Morgan Stanley, several key themes emerged that defined investor discussions, centering around demand trends, pricing strategies, regional market dynamics, and operational challenges.
Much of the growth of the luxury goods sector over the past two decades has been driven by Chinese consumers.
In 2019, Chinese nationals accounted for nearly 33% of sales across major luxury brands, making this market a key focus for investors.
However, since the outbreak of the pandemic, demand from Chinese consumers, both domestically and abroad, has declined. For example, in the first half of 2024, LVMH saw a slowdown in demand from Chinese consumers, with growth in its Fashion & Leather Goods (F&LG) division declining from 9% in the first quarter to 6% in the second quarter.
The decline has raised questions about whether there is a structural shift in Chinese demand. Some investors argue that the negative impact of wealth and demographic challenges in China, such as an aging population, could lead to a prolonged decline in purchasing power.
Others believe that Chinese consumers may return to their previous spending levels once economic conditions improve, thanks to a high savings rate and growing demand for social status through luxury goods.
Another major debate is around the pricing strategy of luxury brands, which has pushed middle-income consumers out of the market. With the price of leather goods and basic products rising, luxury companies risk alienating the aspirational customer segment that has been a major driver of growth.
As a result, some investors fear that the luxury goods market will shrink to serve only the wealthy, while others believe that brands will adapt by offering more high-end products to win back the aspirational consumer.
However, with price mix expected to turn negative this year, luxury goods companies may face challenges in balancing volume and pricing strategies to sustain growth.
In the United States, there has been an unusual disconnect between household wealth and spending on luxury goods. Historically, spending on luxury goods has closely tracked household wealth, particularly in relation to stock market performance.
However, despite US household net worth rising to 5.7 times GDP in the first quarter (a near record high), luxury spending has not recovered as expected.
Optimists expect spending by American consumers to eventually pick up as wealth effects kick in, but pessimists argue that luxury spending in the United States is unlikely to recover quickly.
The key issue is that much of the wealth increase is concentrated among baby boomers and older generations, while younger consumers, who are a key component of the luxury goods market, have seen less of this wealth growth.
In the wake of the pandemic, the luxury goods sector has seen a boom, with an average compound annual growth rate of 11.5% from 2019 to 2023, nearly double the historical rate.
This has prompted investors to debate whether the sector is now entering a “digestion phase” that could last one to three years, characterized by slower growth as consumers cut back on purchases after making large post-pandemic luxury purchases.
Some investors believe the sector will only see a short-term slowdown before returning to its growth trajectory, while others claim the market could take up to three years to fully absorb the excess demand generated by the pandemic.
The luxury goods sector has seen a significant expansion in margins during the post-pandemic recovery. Companies such as Hermès and LVMH have seen their operating margins rise sharply, driven by strong sales growth.
However, with growth slowing and operating expenses rising due to inflation and increased hiring, investors are concerned about potential margin pressure.
With many investors questioning the sustainability of growth in the luxury goods sector, there is widespread concern about the potential for valuation declines. Historically, luxury brands have traded at high multiples due to their continued growth and brand momentum.
However, with growth expectations slowing to low single digits, there is pressure on valuation multiples to reflect these softer expectations.