While growth stocks, bonds and cryptocurrencies have struggled, there is one ‘well-heeled’ corner of the stock market which hasn’t missed a beat this year.

Luxury goods stocks have outperformed their respective domestic stock markets by an average of 19% over the last six months while earnings have been revised upwards as the businesses continue to perform better than expected and surprise to the upside.

The long-term prognosis for luxury goods is no doubt positive given their fundamental strengths and growth opportunities as emerging economies become richer.

But Shares believes there are risks that the sector could struggle to maintain momentum over coming months as earnings growth falters and with valuations already having enjoyed a strong recovery.

THE BULL CASE FOR LUXURY GOODS

Fund manager Nick Clay at Redwheel told Shares in September the luxury goods sector offered better value than traditionally defensive sectors such as consumer staples.

Clay said the sector tends to hold-up better during economic downturns due to its pricing power. Marking up luxury goods just makes them more desirable to own which in turn increases demand, something known as the ‘Giffen’ effect.

Another angle on the bull case is provided by Steve Wreford who manages the Lazard Thematic Inflation Opportunities Fund (FUND:BLNKQF0).

Wreford argues that China’s zero-Covid policy is probably temporary and given the country represents 20% or more of luxury goods company’s sales, allocating capital now means the opportunity to benefit from the anticipated reopening of the economy in due course.

A STRONG YEAR OF GROWTH

It appears the upper echelons of society are continuing to spend despite surging inflation and remain unscathed by the rising cost of living. The YOLO (you only live once) meme is also alive and well in the land of the rich, in contrast to the period running up to the pandemic.

Shares in French company LVMH (MC: EURONEXT) which owns brands ranging from Dior, Tiffany, Moet Hennessy, Krug and Louis Vuitton, and iconic British trench coat company Burberry (BRBY) are trading close to their all-time highs.

Burberry’s 15% share price gains this year have been supported by persistently rising earnings revisions which are around 20% higher than where they stood in early 2022.

The company’s second largest shareholder is asset manager Lindsell Train which holds the stock in various funds managed by Nick Train.

Burberry shares halved in the months following the outbreak of the pandemic in March 2020 but have since surged around 80%. The shares have risen nine-fold since listing at 230p 20 years ago, compared with a 132% return for the FTSE All-Share.

In a June 2022 fund update Train commented: ‘share price gains have been lumpy and often coincide with periods of recovery from economic crises and recovering consumer confidence.

‘As Burberry’s sales mix improves so should profit margins. If you add to that self-help the possibility of more market growth for luxury, driven by wealth-creation in the US and Asia, there is certainly the potential for higher earnings and a higher rating attached to them.’

Burberry’s one-year forward price to earnings ratio has fallen from 18.3 in 2020 to 17.5 today.

Shares in LVMH have outperformed the French stock market by around 20% this year. It is owned by Europe’s richest man Bernard Arnault whose family control just under half of the company.

The firm reported strong growth over the first nine months of 2022, with revenues up 20% to €56.49 billion.

Europe, US and Japan saw a sharp increase in demand from local customers and a recovery in international visitors while China registered lower growth as its economy grappled with restrictions under its zero-Covid policy.

Former CEO of fellow luxury goods company Hermes International (RMS:EURONEXT) Axel Dumas once described Arnault as a ‘brash US-style operator’ who would ruin the 177-year-old company.

The barb came in 2014 after a French court ordered LVMH to sell its 23% stake in the silk scarves-to-Birkin handbags maker Hermes following a decade long dispute over ‘creeping’ ownership amid failed discussions to take over the company.

In October 2022 Hermes revealed third-quarter sales had increased by 24% to €3.14 billion, smashing analysts’ estimates.

JP Morgan commented: ‘The robust momentum across the full product portfolio was expected, but the magnitude of it is still impressive and better than anticipated.’

Demonstrating its strong pricing power, the company said it would increase prices by 5%-to-10% in 2023 after acknowledging no signs of weakness across its markets.

Swiss Luxury goods group Compagnie Financière Richemont (CFR: SWX) owns brands including Cartier, Van Cleef & Arpels, Dunhill and Montblanc. Its shares gained the most in nine months after first-half earnings beat analysts’ estimates (11 Nov).

The company delivered 20% growth in sales and profit as the jewellery and specialist watchmakers segments registered strong growth.

WHO IS LAGGING BEHIND THE PACK?

Slightly bucking the stronger than expected earnings trend, Italian fashion house Moncler’s (MONC: MTA) latest update was slightly more disappointing, although still a marginal beat.

Despite notching-up third quarter sales growth of 12% to €528 million, driven by a recovery in China, the performance was only slightly better than market expectations.

Likewise, Gucci-owner Kering (KER: EURONEXT) marginally beat market expectations after delivering 14% sales growth in the third quarter. But there was disappointment around the Gucci brand where sales lagged expectations.

In contrast to the European luxury goods companies, US group Tapestry (TPR: NYSE) which owns the Coach and Stuart Weitzman brands cut full-year profit and sales guidance. The company blamed the downgrade on China restrictions and slowing demand in the US.

COULD THERE BE A SLOWDOWN IN 2023?

Despite a string of remarkably strong trading updates across the sector some analysts are taking a more cautious view for 2023. Analysts at Consultancy Bain & Co and Altagamma predict growth will slow dramatically next year to between 3% and 8%.

While sales are forecast to pick up again in 2024, the annual growth rate is expected to average 6% between 2022 and 2030, a sharp slowdown on the 20% growth registered in 2022.

Even industry insiders see the risks of a slowdown amidst a tough economic backdrop. At the Milano Fashion Global Summit Moncler CEO Remo Ruffini commented: ‘2023 will surely be a complicated year, because real inflation will be felt in the next 12 months.

‘We must be aware of this and prepare to talk to the market in different ways.’

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