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True Luxury?

True Luxury?

What is luxury?  That’s not a question you would typically expect a fund manager like Montgomery to be contemplating.  We normally don’t care for expensive baubles and I’d break in a second anything too finely crafted. 

But as we begin investing in global stocks on behalf of our clients the question’s answer may allow our clients to luxuriate with the profits.

According to some, true luxury is a “careful balancing of authentic quality and ethereal yet undeniable emotions, which leads to irrational purchasing behavior”.

Irrational purchasing behavior however can be achieved by much less grandiose brands.  The M&M store in New York, for example makes many consumers buy tons of plastic everyday, by simply displaying a lot of it, in every colour.

Travel to Paris, New York, Singapore or London and there appears to be a Prada, Gucci, Zegna or Chanel store everywhere and anywhere.  And it got me thinking; is true luxury really available on every street corner? Clearly the answer is no. 

Advertising your ‘liquidity’ by wearing it on your wrist, neck or arm, or by parking it somewhere noticeable isn’t luxury either – that’s just insecurity, which luxury brands feed off.

In trying to answer the question I simply inverted it and realized it is much easier to know what luxury is not.  Unfortunately for many of the world’s luxury brands, as they expand their storefronts to convenience-store-like ubiquity they lose their prestige and become masstige. 

Witness the increasing number of Italian and English car brands building limited edition, customized super cars or the proliferation of hipster cordwainers in the lanes of Melbourne.  Everywhere you turn, masstige is driving consumers to something even more exclusive or even more exotic.

The destruction of luxury through ubiquity might just be what we have picked up on in the same store sales numbers for some of the world’s luxury brands.

Prada’s 594 stores are now each growing revenue by an average minus 13%.  Over at Coach same store sales across its 973 stores are falling at 23%, Michael Kors – minus six per cent and Abercrombie & Fitch – minus eight per cent.

When revenue on a same stores sales basis turns negative, operating leverage becomes a noose placing pressure on EBITDA margins.  When same stores sales declines can be attributed to the economy, you might argue that the situation is cyclical.  And it is certainly true that the global economy is not strong.  But if the same stores sales decline is due to a proliferation of competitors setting up on every street corner or due to the loss of the brand’s perceived prestige then the effects might be longer lasting and/or structural respectively.

We believe that the global analysts covering this sector are displaying some of the optimism usually reserved for the customers that frequent the stores. 

In the case of Prada, listed in Hong Kong, despite EBITDA margins falling from near 32 per cent to 27% in the last two years and revenue growth declining from 30 per cent to zero, analysts still have the companies profit margins recovering sharply over the next few years and revenue growth bouncing back up to ten per cent.

In the case of Coach sales growth was zero in the first quarter of 2014 and now it is minus 15 per cent.  Analysts have sales growth recovering by 2016 to over five per cent growth.

In the case of Abercrombie & Fitch sales growth has varied from zero per cent in the second quarter of 2015 to negative 14 per cent most recently.  Analysts have revenue growing at two per cent by 2017.  The company’s operating margins have declined from nine per cent in early 2014 to one per cent most recently and yet analysts have the company’s margins recovering, somewhat magically, to over four per cent by 2017.

So what does all that tell you?  It tells you that there’s a very high possibility that a divergence exists between reality and expectations.  It’s a divergence that can be profitably exploited by investors in the right kind of fund.  And if profits do indeed accrue, investors can decide for themselves what true luxury is.

 
Roger Montgomery
Roger Montgomery

Roger shares his stock market insights at his Insights blog, blog.rogermontogmery.com. Investors can also follow Roger on Facebook and watch media interviews at his YouTube channel. Grab your Second Edition copy of Value.able and learn how Roger Montgomery values the best stocks and buys them for less than they're worth. Grab the book now at special price!