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Alice Rigby
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Updated 27 Jan 2023
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Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.

As the early weeks of 2023 roll slowly by, we are starting to get a sense of what a cost of living crisis really means for businesses on the ground. Data from the latter quarter of 2022 is being published, showing the emergence of several – largely gloomy - trends.

The most self-evident of these is that consumers have rapidly tightened their belts when it comes to discretionary spending as the steep increase in the cost of essentials bites. In the UK, year-on-year sales volumes dropped significantly in both October and November. There followed an unexpected drop of 1% in December in the run up to the first “normal” Christmas for three years.  Meanwhile, in the US sales volumes also fell year-on-year in November and December. Even in the Eurozone, where sales were better than forecast, volumes still fell 2.8% year-on-year.

However, one group has proved relatively immune to the inflationary pressures weighing down most consumers. Luxury goods sales volumes, powered by the ultra-wealthy, rose in 2022 according to the latest luxury market report by consultant Bain & Company, published in full this week.

This despite asset prices – the typical source of wealth at the top end of the spectrum - taking a substantial hit in the latter half of the year.

The report’s authors highlight several long-running trends that point to the lasting strength of the luxury market. Crucially, the luxury market’s consumer base is not a homogenous mass, and its most loyal customers have seen their wealth grow through the last few years.

In 2021, the richest 1% saw their share of global wealth rise for the second year running to 46%, according to Credit Suisse’s Global Wealth Report. Given that the top 5% of luxury’s consumer base accounted for 40% of sales in 2022, a rise from 35% in 2021, this bodes well for the market’s continued success. Further, all of the market’s growth in 2022 was accounted for by Gen Y and Gen Z, with the latter group buying into luxury goods as early as 15 years old, significantly earlier than their forebears.

All this points to a compelling investable opportunity. However, this hasn’t gone unnoticed by the market. The sector’s large listed players, LVMH, Christian Dior, Burberry and Richemont all sit on P/E ratios of 21-35, placing them firmly in the “growth” category.

The fortunes of each of the four during the last year differed to some degree. While LVMH saw revenues rise 28% in the first three quarters of 2022 relative to the same period in 2021, Burberry recorded a more subdued 11% rise at a time when costs were spiraling. While this was to some extent attributable to subdued demand in a still-locked down China, where Burberry is a particularly strong player, the predicted stagnation of Chinese market growth could be a concern for the business going forward.

The Bain report does point to some of the possible growth opportunities for the sector over the next decade. Perhaps the metaverse or NFTs could open up new revenue streams. The fragmentation of content channels points to new opportunities for branded content. More immediately, luxury manufacturers are increasingly taking ownership of their secondhand markets and of their retail propositions, with direct retail on a par with wholesale revenue for the first time last year.

For the sector’s stronger players the future looks bright, and it’s for this reason that they are still attracting the attention of investors, despite those meaty p/e ratios. AVI Global Trust (AGT) is a long-time holder of Christian Dior shares.

Several factors have contributed to its investment case. Dior has a 40% position in LVMH, giving it exposure to those rising revenues, driven by a nimble acquisition strategy and total ownership of its brands’ value chains. Indeed, Dior’s own earnings per share grew c. 150% over 2021. At the same time, the company is 90% privately held by the Arnault family and Joe Bauernfreund, AGT’s manager, anticipates a move to take the business into wholly private ownership at some stage in the future. Given Dior’s shares trade at a discount, this would be a positive for shareholders.

For the trust, Dior is a quintessential example of a company that is, in its view, fundamentally undervalued by the market with a long-term growth story in motion – exactly the kind of opportunities it seeks.

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