Asian luxury shoppers shift away from Hong Kong to Japan and Europe

Asian luxury shoppers shift away from Hong Kong to Japan and Europe

British luxury-goods house faces sluggish demand in Hong Kong, as Chinese shoppers chase bargains in Europe

Jingyi Gu left Burberry Group PLC’s flagship Regent Street store on July 23, laden with large, full bags—having saved about 20% compared with what she would have paid for the same raincoats and winter wear in her hometown of Shanghai. “The price is cheaper, and that is the No. 1 reason we come here,” Ms. Gu said.

Shopping habits like Gu’s are a big, new headache for Burberry and other Western luxury-goods companies. Large currency fluctuations—in particular a weak euro—have created a sort of grey market for the jet set, enticing well-heeled travellers from Asia to take advantage of deep price discounts in Europe. That is compounding already-slowing sales of luxury goods in China, where an anticorruption drive has dried up demand.

Burberry-Tab-116-07-_2015_14-50-51Burberry said July 15, 2015 that same-store sales dropped by a low-single-digit percentage in the Asia-Pacific region in the three months ended June 30. That compares with double-digit percentage growth for the region in the same period last year. The sales drop was particularly steep in Hong Kong. Excluding Hong Kong and Macau, the company said, sales in the Asia-Pacific region would have climbed by a low-single-digit percentage. Across the company, same-store sales rose 6%, a slowdown from the 12% rise it reported for the same period a year earlier.

While slowing sales in Asia are hitting a string of luxury houses, they are turning into the first big challenge for Burberry’s chief executive of a little over a year, Christopher Bailey. Bailey is widely seen as having kept to the strategy he helped to craft with previous CEO Angela Ahrendts, who left to head retail at Apple Inc., to focus on revenue and reinvest gains into the business.

Bernstein analyst Mario Ortelli said Mr. Bailey hasn’t yet detailed how Burberry plans to boost its earnings-before-interest-and-taxes margin as customers spend less in the typically higher-margin market of Hong Kong. “We expect sooner or later he will be more explicit on how to expand the margin,” Ortelli said. Burberry declined to make Bailey available for comment. The company said it expects its margin for the year to be flat from a year ago.

Purveyors of high-end handbags and apparel in China, the world’s biggest market for luxury goods, have struggled in the region since the government’s anticorruption drive led to a sharp drop in gift-giving of luxury goods. Fewer Chinese are making the trip to Hong Kong and Macau to shop. Slower demand in Hong Kong and China is being only partially offset by better growth in Europe and comes at the cost of thinner profit margins.

Other luxury companies are feeling the pain. French Kering SA, whose brands include Gucci and Yves Saint Laurent, reported a 0.6% decline in same-store sales on a constant currency basis in the quarter ended in March, noting a shift toward more overseas spending and deteriorating demand in Hong Kong and Macau. Hermès International reported a slowdown in first-quarter sales from Asia excluding Japan, pointing to “a more challenging environment in Hong Kong and Macau.” Chinese buyers of luxury goods, feeling spurned by their traditional shopping hub of Hong Kong, have landed nearby in Japan.

French luxury goods’ company Hermès International SCA said July 22, 2015 that sales jumped 31% in the second quarter as it benefited from stronger demand in Japan and the favourable effects of a weak euro.

The maker of the Birkin and Kelly bags said sales rose to EUR 2.3 billion (USD 2.5 billion) in the first six months of the year, up from EUR 1.9 billion in the same period in 2014. Excluding the currency effect, sales rose 9%, the company said. Hermès didn’t disclose profit for the period.

While other makers of high-end designer goods struggle to maintain soaring growth of recent years due to changing tastes in fashion, slowing emerging market demand and a crackdown on corruption and gift-giving in China, Hermès continues to lead the luxury sector with steady large gains in sales.

And recently, more of those sales are happening in Japan, Hermès told analysts on Tuesday. The country is quickly emerging as a top destination to shop as Chinese tourists seek alternatives to Hong Kong, which has long been the traditional first stop of choice.

Hermès said sales rose to EUR 2.5 billion in the first six months of the year. Sales in Japan increased 33% in the second quarter alone as shoppers from mainland China flocked to buy in that country, the company told analysts. At constant exchange rates, Japanese sales still grew 27% as the former British colony has dropped out of favour as the destination of choice.

Political turmoil and increased visa restrictions have constrained mainland tourist visits to Hong Kong. Overnight visits from mainland China to Hong Kong declined 3.2% in May, the most recent figures available from the Hong Kong Tourist Board.

More important, the cash-rich visitors aren’t buying in that city. Last week, Burberry Group PLC said that same-store sales contracted in Hong Kong after years of double-digit increases.

Antoine Belge, an analyst at HSBC, said Chinese tourists now favour other parts of Asia, notably Japan.

Still, the positive impact of the weak euro—sales made in other currencies count for more when converted back to euros—remained the biggest reason for the company’s large revenue increase. In the Asia Pacific region outside of Japan, for example, sales still grew 28%. But when stripping out the effects of currency, sales in the region grew just 6%.

The company said its profit margins “should be down slightly in comparison with the first half of 2014” due to the weaker euro, though it didn’t give details.

Hermès is the first of the three big publicly traded French luxury firms to report its financial figures for the first half of the year. Next week, luxury groups LVMH Moët Hennessy Louis Vuitton and Kering SA will announce their earnings, though analysts don’t expect their sales to be nearly as impressive as Hermès.

LVMH is in the midst of a revamp of its flagship Louis Vuitton brand following faltering demand in 2013. Meanwhile, Kering’s main Gucci brand has seen its sales stall last year and replaced its top executive and designer earlier this year.

Hermès has maintained its dominant sales growth by keeping its prices high and maintaining the brand’s allure. Still, the company has predicted sales would cool to 8% this year, down from 11% last year.

Analyst Luca Solca at Exane believes Hermès could likely continue to exceed its own forecast during the second half of the year.

Burberry is getting a boost from Chinese consumers who shop in Europe, noting on Wednesday that double-digit percentage growth in Europe, the Middle East, India and Africa in the first quarter was driven by traveling luxury-goods customers, of which Chinese visitors accounted for a hefty chunk. “For the Chinese customer globally, we continue to see growth in all markets apart from Hong Kong,” said Chief Financial Officer Carol Fairweather.

But the trend squeezes margins for luxury-goods makers. They typically make fatter margins in Hong Kong, thanks to relatively low taxes, and in Macau, thanks to relatively low rents, than they do in mainland China. China, in turn, delivers better margins than Europe.

Government intervention is exacerbating the matter. The U.K. government this month began allowing Chinese visitors to apply for U.K. and European visas at the same time, making it easier for shoppers to visit. Meanwhile, in April, the Hong Kong government tightened its visa policies for Shenzhen citizens in a bid to discourage Chinese visitors from taking advantage of Hong Kong’s tax regime.

To counter the pressure, Burberry and other luxury-goods companies are dropping prices in China, further denting margins. Burberry has lowered prices for its trench coats and soft accessories—which include things like woven and knitted products—in Hong Kong and China by 12% and 18%, respectively, while raising them by 5% to 6% in Europe. A typical trench coat now costs 15000 yuan ($2,415) in mainland China, down from RMB 17,500 a year ago, according to Exane BNP Paribas. That is still more expensive than the GBP 1,195 (USD 1,868) it costs in London and the EUR 1,595 (USD 1,745) it costs in Milan.

Fairweather said Burberry logged low-single-digit same-store-sales percentage growth in mainland China in the first quarter. Some analysts think Burberry is facing a long-term problem with its business in Hong Kong and Macau. Bernstein’s Mr. Ortelli earlier this month slashed his revenue and margin forecasts for Burberry for the next five years, noting that the declines in Hong Kong and Macau are “more structural than situational.” The two markets historically have captured 10% to 15% of Chinese spending, Ortelli said.

As well as cutting prices, Burberry is taking other steps to revive sales, trying to entice more local customers in Hong Kong by beefing up local marketing and in some cases tweaking the product assortment, Ms. Fairweather told journalists on a conference call. She said about 80% of spending in Hong Kong comes from tourists, most of whom are from China.

For the fiscal first quarter ended June 30, Burberry’s retail revenue, the biggest contributor to overall sales, rose 10% to GBP 407 million from the same quarter a year ago. In the Americas, Burberry reported high-single-digit same-store-sales percentage growth, a slowdown from the double-digit growth it achieved last year.

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