By guest author George Arnett from Vogue Business
Luxury shares are proving resilient in light of the Covid-19 epidemic, but a quick rebound is looking unlikely.
- Analysts are expecting luxury sales to bounce back quickly once the worst of the coronavirus epidemic is over, but the situation will likely get worse before it gets better.
- The coronavirus crisis has drawn comparisons to how brands fared following the Sars outbreak in 2003, but exposure to China has accelerated since.
- Even as sales and profit projections drop, shares have remained stable as analysts hold out hope.
Despite a decline in the number of new cases of coronavirus recorded in China, and the return of Chinese employees to work earlier this week, the near-term outlook for luxury brands is worsening.
New cases of coronavirus, or Covid-19, have cropped up in more countries and many brands are still hesitant to reopen their stores as the scale of coronavirus appears to grow. In a note last week, JP Morgan wrote, “The odds of a V-shape recovery are eroding.”
A V-shaped recovery would mean a bounceback in sales the following quarter. Up until last week, many investors have behaved as if this was likely: few short sellers had touched luxury shares, which have proved relatively resilient to the outbreak. Share prices for LVMH and Kering were until late last week higher than what they were at the same time last year. This is despite the luxury industry’s high exposure to the Chinese market: a majority of executives believe that their yearly sales will be hit by at least 5 per cent.
Historical precedent supports this confidence. During the Sars outbreak in 2003, retail sales growth halved over the course of two months, but jumped back to typical levels while travel warnings were still in place for a number of Chinese provinces.
Bain & Company partner Jonathan Cheng says that clothing sales typically follow a “dip and rebound” pattern during a crisis as shoppers wait until it is safe and then purchase at higher levels than before.
Sars is not a perfect parallel for Covid-19. The luxury industry was not as exposed to China in 2003, nor is the wider Chinese economy growing at the rapid pace it was back then. Goldman Sachs says that luxury goods sales were mostly impacted in Hong Kong, Singapore and Macau rather than mainland China, where the current spending freeze is seen as relatively unprecedented.
Nevertheless, Maximilian Kärnfelt, an economist at the Mercator Institute for China Studies in Berlin, says that the Sars outbreak is the closest reference point for the coronavirus outbreak, and the only guide available for evaluating consumer sentiment post-crisis. Although, he cautions, Q2 will likely be too soon to expect a rebound.
Navigating the return to normalcy
Analysts had initially been encouraged last week by the news that the number of new recorded cases in China was slowing. But Jefferies analysts said in a note from early last month there is likely to be a delay in people feeling comfortable returning to crowded spaces if and when the virus is contained, forecasting an eight-week timeline for a return to normal luxury spending after that point.
A report by Altagamma with BCG and Bernstein wrote that it expected luxury sales to suffer for around six months, before quickly returning to pre-crisis levels with few mitigating actions needed by luxury brands – again, mirroring the aftermath of the Sars outbreak. But brands will have to work to adjust to a return to normality. Many companies have diverted inventory away from China during the crisis to keep stock moving; digital marketing campaigns have been suspended and other promotional activities, like product launches, were paused, according to reports. Moody’s analyst Christina Boni says that the ability to resume operations will vary by brand. “It’s getting that engine going again,” she says.
While sales will eventually resume, the first quarter of 2020 will be a lost period for brands heavily exposed to China. Sports brand Adidas reported business activity in China to be down by 85 per cent year-on-year. Marketing spend and inventory can be directed to other markets, but filling a China-sized hole in sales would be a difficult ask for brands like Burberry, which sells 39 per cent of its inventory to Chinese consumers per JP Morgan estimates.
Others are less optimistic, pointing to the warnings of public health officials that the crisis is far from letting up. “The market underappreciates the duration of this,” says Chris Meekins, a health policy analyst for investment bank Raymond James, adding that it’s already gone on longer than anticipated.
Public health officials in general are wary about forecasting how long the virus will last. The director of the Centres for Disease Control and Prevention, Robert Redfield, told CNN that “the virus is probably with us, beyond this year, and I think eventually the virus will find a foothold and we will get community-based transmission”. The World Health Organisation said on Tuesday that countries should prepare for a pandemic.
The ripple effect
Even if the spread of the virus slows in the next couple of weeks, tourism flows may continue to be impacted, especially as outbreaks play out in Italy, Iran and South Korea. Gloria Guevara, the president and chief executive of the World Travel & Tourism Council, said in a recent statement that travel restrictions will not stop the spread of Covid-19 and that governments should be proportionate in their restrictions.
In mainland China, as stores remain closed and foot traffic stalls, the appetite for luxury looks to remain strong. Kering said January was positive for sales, in part thanks to Chinese shoppers, before the outbreak started. The proportion of mainland Chinese residents saying they were likely to spend less on luxury was largely unchanged from December, according to a recent survey by the Consumer Search Group. One in five people living in China plan to spend less on luxury goods in 2020, per the earlier results drawn from a panel of 2,001, while 44 per cent intend to spend more.
That will be encouraging to luxury brands like LVMH, Kering and Richemont that, per a S&P note, have “(some) ratings headroom” due to their size and global reach. However, luxury’s return to normalcy will not be imminent. “This is going to get worse before it gets better,” says Meekin.