European luxury brands have been waiting anxiously for consumers in China to return to stores following the end of the country’s Covid restrictions. Stringent lockdowns were in place up to the end of last year – putting a dampener on revenue in what is now the most important personal luxury market in the world. As numbers for the first quarter of this year are unveiled, it’s clear that the outlook is brightening. But will a return to growth in China offset a likely slowdown in sales in embattled western economies?
LVMH (FR:MC), the conglomerate that owns labels Louis Vuitton, Dior and Givenchy among others, may serve as something of a bellwether. Last week, it reported a 17 per cent year-on-year revenue uplift in the March quarter – a figure that surpassed both analysts’ and management’s expectations. Although the company does not provide country-specific numbers, it’s clear that one nation was the engine of this growth.
“As far as we are concerned, the situation in mainland China is an excellent surprise compared to what we thought it could be only four or five months ago,” said the company’s chief financial officer, Jean-Jacques Guiony. Flat US sales growth figures did not faze markets in the slightest – LVMH’s shares hit a record high on 12 April thanks to optimism around the impact of China’s reopening. Hermès (FR:RMS), best known as the maker of the ultra-luxe Birkin handbag, reported a 23 per cent increase in Q1 revenue for similar reasons, although also reported strong sales in the US and Europe.
Last year, with zero-Covid policies firmly in place, China accounted for 17 per cent of global personal luxury spend, the same as the US. By 2030, management consultancy Bain & Company expects this to become 25-27 per cent for China and 23-25 per cent for the US. “One of the fundamental enablers of this projection is the expected continued growth of the Chinese middle class through 2030,” said Weiwei Xing, a partner in the firm’s Hong Kong division.
“In fact, the number of middle and high-income consumers is expected to double by 2030,” she added. “Simply put: the next China is China.” Prior to the pandemic, Italian fashion house Ermenegildo Zegna (US:ZGN) had the greatest exposure to China, with the country accounting for 51 per cent of the brand’s total sales, according to UBS. Other brands with high exposure include watchmaker Swatch (CH:UHR) and Burberry (BRBY). China's contribution to these companies' sales has dropped significantly since 2019, however. Zegna China sales are down to an estimated 38 per cent, while Burberry's China share has gone from 40 per cent to 27 per cent, reckons UBS.
For investors, there is significant upside – at least in the short term – for luxury retailers with an established presence in the world’s second-largest economy. Analysts at Morgan Stanley expect the re-emergence of Chinese consumers to boost demand for high-end clothing and accessories by 20 per cent this year. Meanwhile, it’s thought that consumers from the US could spend 1 per cent less on luxury items this year – a significant shift given that sales to this group grew 75 per cent between 2019 and 2022.
There are, however, a few factors that could restrain growth in China for the likes of Burberry and LVMH. Among the most important is the rate of Chinese tourism to Europe – where luxury goods can be between 25 and 45 per cent cheaper than back home. If consumers choose to buy a leather bag while on holiday in Italy, margins for its maker will be lower than if the same consumer bought it in China.
“In general, the larger the price gap, the more likely [it is] there is a rebalance of spend between mainland China and the rest of world,” said Bain’s Weiwei Xing. “Of course, the actual degree of rebalance is also driven by the destination’s ease of travel, availability of flights, currency fluctuations, amongst other factors.”
Morgan Stanley also highlighted the possibility that strong demand from Chinese consumers may be short-lived due to “revenge spending” – shoppers making up for time lost to lockdowns. The European luxury sector has outperformed the MSCI Europe Index in the year to date, which leaves analysts at UBS expecting less upside potential in the short term. In a note published in early April, they cited a “looming US slowdown, with…little visibility on the return of Chinese tourists to Europe” as the reasons for pessimism.
On the other hand, optimists might look at the luxury market and marvel at its resistance to most macro headwinds. Top-end brands, such as Louis Vuitton, have raised their prices at an average of 2.5 times the rate of inflation over the past 25 years – offsetting any downturn in sales volumes. With a track record like that, the luxury sector starts to look unsinkable.
