Diamonds in the rough: Does a luxury sell-off spell doom for the sector?

After the post-pandemic surge in the luxury-goods sector, the recent sell-off may feel a bit overdone. Is there still a compelling investment case for the luxury industry? Allan Gray’s Jithen Pillay discusses why he believes the sector is appealing at the moment.

Until recently, growth in the luxury-goods industry showed no signs of abating. From Gucci bags to Prada heels and Cartier watches, the personal luxury goods market ramped up from EUR116 billion in 2000 to EUR369 billion in 2023. However, dampening sentiment in the US and China in particular, resulted in these shares receiving a battering in 2024.

The luxury sector on average saw their share prices dip 16% from their peak in March 2024 to the end of December. Richemont, which has a secondary listing on the JSE, is down 20% in rands since its post-pandemic peak to the same end date.

So, what sparked the sell-off?
Jithen Pillay, portfolio manager at Allan Gray, believes it comes down to pandemic normalisation and weaker demand from China. “Excess savings built up by US consumers during the pandemic, thanks to stimulus cheques and lockdowns that limited physical experiences, saw disproportionate spending on luxury goods,” he notes. “In addition, Chinese customers, who comprise 30% of global luxury spending, are in a weaker position, which has dampened growth.”

According to Pillay, luxury spending is cyclical and correlated with global macroeconomic factors. “Historically, hard luxury is more cyclical versus soft luxury, which includes fashion, leather goods and designer clothing.” This means that it is increasingly difficult for luxury brands to sell more goods each year given the high cost of the items.

Moreover, he states that there’s concern over sustained US demand given global geopolitical tensions. “Investors are naturally nervous about whether this resilience can endure. A global recession, conflict, a stock-market crash and anything else that diminishes the consumer feel-good factor will negatively impact the luxury sector’s revenue and earnings,” he asserts.

The investment case for Richemont
Pillay believes Richemont’s underperformance last year warrants a second look at its investment case. “There are several factors that make Richemont a high-quality company and a better business than it was a decade ago,” he says.

The first reason is its market growth. “More than 50% of Richemont’s revenue comes from selling jewellery, with Cartier and Van Cleef & Arpels being its biggest brands,” states Pillay. He is confident that growth should continue through the cycle, underpinned by gifting and a growing trend of self-purchases by women.

Premiumisation is another factor to consider. “Ultra-premium brands are outperforming as the high-net-worth consumer proves more resilient in tougher economic conditions,” he says. Cartier and Van Cleef are best placed to take advantage of this, given their positioning at the top end of the desirability pyramid.

In addition, high barriers to entry places Richemont in a good position. “Provenance is important in luxury,” states Pillay. “Most luxury brands were established more than 100 years ago. The barriers to entry are even higher in hard luxury, given greater reliance on recognisable designs, such as Cartier’s Love bracelet.”

In terms of its outlook, Richemont exhibits favourable economics. “Owing to steep prices and an increasing proportion of vertical integration, margins are high,” asserts Pillay. He also believes the price-earnings ratio for the share is not overly expensive. “While cautious, the Richemont investment proposition is particularly interesting at present,” he concludes.