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Do Luxury Stocks’ Record Valuations Reflect Reality?

It isn’t just luxury products that are looking expensive these days.

A share in Hermès International will now cost you €2,000 ($2,200) — enough to buy one of the brand’s signature anchor-chain bracelets and a hand-stitched wallet with change to spare.

The company — which debuted on the Paris Bourse in 1993 at around €6 per share (in francs) — saw its market capitalisation overtake Nike this January to become the world’s second-most valuable fashion company, behind LVMH. The stock has continued to rise, up 35 percent year-to-date, to reach a valuation of €209 billion ($229 billion) at the close of trading Tuesday.

LVMH is also trading at a record: the maker of Louis Vuitton handbags and Tag Heuer watches became the first-ever European company to surpass $500 billion in market capitalisation last week. Its valuation now roughly equals that of oil giant Exxon-Mobil and electric vehicle maker Tesla. The high stock price has translated to $51 billion in additional wealth since the start of the year for chairman and CEO Bernard Arnault, according to Bloomberg estimates, further securing his place as the world’s wealthiest person after he nudged out Elon Musk for that title last year.

Shares in Milan-based Prada and London-based Burberry are also up by nearly 30 percent. The list goes on.

Does That Mean Business Is Booming?

No. The increased valuations have come despite relatively gloomy forecasts for luxury after a multi-year surge. Bain estimated last fall that growth would slow dramatically this year, from 22 percent in 2022 to between 3 and 8 percent this year. Two-thirds of economists polled by the World Economic Forum say a global recession was likely in 2023.

Gucci-owner Kering’s sales report Tuesday reinforced this gloomy view. The company’s first-quarter sales grew sales by 1 percent. They’re the exception, though, and consumer fatigue with Gucci’s maximalism and Balenciaga’s button-pushing marketing is as much to blame as a slowing global economy.

In recent weeks, better-than-expected sales reports and bullish comments by LVMH and Hermès have fuelled hopes that luxury’s high-end customer base will be insulated from the slowdown again (as was the case during 2020′s strict pandemic lockdowns, and last year, when rising interest rates and inflation reared their head).

Sales growth is slowing, but investors have become increasingly hopeful for a rapid rebound in China after the country reversed strict Covid-19 measures that hammered sales last year. At the same time, a feared slowdown in the US — which has been the key driver of luxury’s growth since the pandemic — is now forecast by some companies and analysts to be shorter and less severe than feared. Even local clients in Europe, where soaring energy costs crisis have pounded household budgets in the wake of Russia’s invasion of Ukraine, continue to buy: LVMH said sales to French and Italian clients grew by double-digits in the first quarter.

What Else Is Driving Investor Interest?

The brighter outlook for sales is just part of the picture. While the top-10 European luxury stocks have risen over 25 percent this year, estimated earnings-per-share are up only 5 or 6 percent, Citi Bank analysts estimate. That suggests that the majority of the recent stock moves can be attributed to multiples expansion: investor-speak for when shares get more expensive without changes to the company’s fundamentals. For example, Hermès is now valued at 66 times its annual earnings, compared to an average of 14 times earnings for European stocks.

Part of the surge in valuations could be accounted for as investors playing catch-up: last year, luxury shares fell an average of 10 percent even as earnings per share spiked roughly 20 percent.

Another major contributor could be a global “flight to safety” among investors: economic uncertainty and higher borrowing costs are driving capital away from riskier bets, like loss-making tech start-ups, and toward established bets like European luxury — a sector dominated by century-old brands that have already weathered crises, and are managed by seasoned family shareholders.

What About Kering?

In recent quarters, Kering’s trajectory has been somewhat out of step with rival luxury conglomerates: after a historic expansion in the years leading up to the coronavirus pandemic, its biggest and most profitable brand Gucci has struggled since 2020 to navigate a downturn in long-haul tourism and shifting consumer tastes. Much is riding on Gucci’s designer transition: After Alessandro Michele left last November, the company hired Sabato de Sarno, a behind-the-scenes designer from Valentino, who is set to present his revamped vision for the brand in September. The group also faces uncertainty surrounding how long it will take for its smaller Balenciaga brand to bounce back from its scandal last fall.

Still, investors have been willing to bet on Kering’s rebound, too — with shares up 21 percent year-to-date as of 25 April.

When Kering executives spoke to analysts after releasing results Tuesday, investors were listening closely for comments on China’s rebound and US demand, where the company’s experience might more closely reflect the dynamics many companies in the luxury sector are facing compared to behemoths like Vuitton-owner LVMH.

While the results were comparatively lacklustre, some of the brand’s commentary was reassuring. Sales to Chinese customers are rebounding rapidly — growing by a low double-digit percentage compared to the same quarter in 2021, when Mainland China had already bounced back sharply from its initial round of Covid-19 lockdowns. Saint Laurent beat estimates, growing 8 percent. Bernstein analyst Luca Solca asked in a note to clients if, for Kering, “the tide is timidly starting to turn.”

US sales fell 18 percent, however, stepping up the pressure for growth in other regions.

Are These Share Prices Sustainable?

A majority of equities analysts continue to recommend investing in LVMH even at the higher prices, with the most popular rating remaining “Buy.” For Hermès, the more temperate recommendation of “hold” has become more popular at the company’s current valuation (While the brand is famously stable in times of crisis, a strategy of ramping up leather goods production at a controlled pace limits the upside for future growth.)

Looking ahead, luxury companies will eventually need to deliver higher profits in order to hold onto the record valuations. “Luxury shares will not continue to perform without earnings-per-share upgrades,” Citi analyst Thomas Chauvet said.

That could be tricky, as China’s domestic rebound and a relatively mild slowdown in the US are already priced in, limiting room for positive surprises. But a bigger impact from Chinese clients resuming travel is one thing that could help earnings beat the current estimates.

On the other hand, a more severe slowdown in the US would surely dent valuations.

At this stage, investors also aren’t imputing any potential impact from the “quiet luxury” trend surging on social media in recent months. (While luxury brands offer plenty of understated products, the “logomania” of recent years has been an undeniable boon to their cultural relevance and bottom lines.) .

Why Do These High Stock Valuations Matter?

For the most part, if you don’t have these companies in your portfolio, the day-to-day share price moves aren’t all that relevant. Most big luxury companies are family-controlled, meaning it’s the Arnaults or Pinaults who ultimately call the shots; investors can’t apply the same pressure they would at Gap Inc. or Macy’s if they aren’t happy with a stock’s performance.

But higher valuations allow the biggest players in the sector to explore bold moves. Acquisitive companies like LVMH will find easier financing for deals in a climate where many companies are struggling to navigate higher interest rates. On the other hand, the record valuation of LVMH could make it harder to find the off-ramp from rapid growth in recent years.

The comparative stock moves matter, too. Just a few years ago, Kering was exploring a deal to acquire Cartier owner Richemont. But now Richemont is the bigger company of the two.

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