Luxury Brands—An Opportunity For Long-Term Investors?LuxuryBrands—AnOpportunityForLong-TermInvestors?

• Despite rising uncertainty and market volatility, many luxury companies have reported strong results over the past year.

• Top luxury brands have benefited from their strong positioning with consumers, the resiliency of demand for their products, and the power of their operational and financial models. 
• Many luxury stocks have experienced significant declines this year and are trading at attractive multiples relative to their growth and consistent results. While we believe caution in the current market environment is warranted, long-term investors may find opportunities in this sector.

Consumer confidence today is under pressure from the pandemic, inflation, war in Eastern Europe, and policy tightening from the Federal Reserve, but luxury brands are flourishing. Top luxury companies have reported strong growth in recent quarters in most key geographies—the United States, Europe, and Asia. In addition, margins for dominant brands remained high, reflecting resiliency of demand for their enduring products, as well as the power of their operational and financial models. 

Big brands are getting stronger in this environment. Scale in the luxury industry brings significant advantages—real estate, talent, marketing—together with shared best practices. Strong brands are protected by deep moats, as there is no simple way for competitors to challenge the deep histories embedded in the appeal of many of the top luxury products. They also control their distribution. The majority of sales are conducted through their own stores, including online. This enables the brands to control inventory, pricing, and the experience—which ultimately protects brand equity. 

Top luxury brands benefit from strong pricing power. Even as consumer confidence has declined, significant price increases for iconic luxury products do not appear to have had a meaningful effect on demand. Some of these products have benefited from long and well-managed waiting lists, which reinforces pricing power. This is visible in the second-hand luxury market, where iconic products not only hold their value, they often deliver strong price appreciation. In addition, luxury companies are generally less exposed to inflation and the supply chain issues that plague many consumer goods companies. Luxury goods tend to be produced in Europe from local suppliers. Where they do see some inflation, they have been able to pass these costs on to customers and thus protect their margins.

Demand for luxury goods has strengthened and diversified. In the United States, as the pandemic limited travel, a whole new set of consumers emerged in cities such as Charleston, Austin, Denver, and Nashville. Today’s luxury consumers are younger—millennials and Gen Z account for a majority of purchases.[i] Finally, more American men have come to appreciate luxury and the top brands, which has helped drive growth.

The rising middle class in China remains a powerful structural growth driver for the luxury market. When the Chinese government first announced its “Common Prosperity” policy—which targeted growing income inequality in China—luxury stocks sold off. However, we believe the policy’s aims are to raise income levels of the middle class, thereby increasing the number of people in China who would be able to purchase these aspirational products. We believe it is a healthy and positive long-term force for the luxury market. 

Shoppers turned to the internet during the pandemic, but the shift to online purchases was not as a strong in luxury goods as it was in other areas. Many brands do not sell their iconic products online, and shopping inside the store is considered part of the luxury experience. However, as in other retail areas, online sales are growing rapidly and help brands acquire new consumers. It is notable however, in our view, that these two channels do not cannibalize each other.

Despite this extraordinary performance, luxury companies face challenges in the current environment. In Europe, the war in Ukraine has raised uncertainty for investors and consumers. COVID-19 continued to force lockdowns in China in the first half of 2022. In the United States, the Federal Reserve is committed to raising rates to combat inflationary pressures.

Due to these and other pressures, many luxury stocks have sold off along with other growth stocks over the past several months. Multiples are significantly off their highs and more in-line with historic norms. In the current environment, we believe caution is generally warranted. However, these companies have strong pricing power, durable top line growth, high margins with strong free cash flow growth, solid balance sheets, and are exceptionally well managed. All of these characteristics, in our view, make these companies attractive opportunities for the long term.