Future Returns: Investing in the Global Luxury Industry

The global luxury industry has had a good run over much of the past decade and signs are pointing to continued strength despite a difficult stretch during the pandemic.

S&P’s Global Luxury Index has beaten the MSCI All Country World Index over the past five years by about 4.3%. It’s been a hotbed for M&A activity, including LVMH’s recent US$15.8 billion acquisition of Tiffany & Co. The sector has proven popular with investors from individuals through to private equity—a pre-pandemic Deloitte survey found 70% of respondents, most of whom were small-medium private equity funds were considering investing in a fashion and luxury asset.

Jessica Gerberi says structural growth themes in the industry have turned luxury stocks from a cyclical to secular growth opportunity.

Gerberi, a senior research analyst with Calamos Investments in Naperville, Ill., was positive on the industry before the pandemic, partly based on the resilience of luxury goods companies, some a century or two old. “Their resilience was just tested in such an unprecedented way with Covid, and Covid’s really been an accelerant for positive change in this industry,” she says.

Bain & Co. finds despite a contraction in the overall global luxury industry due to the pandemic, global online luxury sales grew almost 50%, to about US$59 billion, in 2020, compared to about US$39.7 the prior year. This sales channel is forecast to grow further, from an estimated 23% last year to more than 30% by 2025. Gerberi says the industry may not see a full recovery until 2022 or 2023, but the speedy adaptation to selling online undertaken by many companies offers a compelling reason to consider investing in luxury stocks.

“The strong getting stronger will likely continue to be a theme in this industry,” she says.

Besides the anticipated post-pandemic rebound, growth in emerging markets offers another compelling reason for the sector’s strength. One estimate anticipates the global middle class ballooning to 5.3 billion people by 2030, bringing about 2 billion up the economic ladder. This group is expected to splurge on luxury items, and the industry will reap the reward, particularly in China.

Due to these developments, Gerberi says in a post-Covid, normalized environment there could even be some upside to the industry’s approximate 5% annual growth rate. She shared three tips with Penta on how to invest in the global luxury industry.

Understand Different Exposures

Not all luxury stocks are equally exposed to different elements. For instance, some companies focus on a single brand while others have what Gerberi calls “natural diversification,” meaning multiple brands or that they operate in multiple categories.

“Some of these big luxury conglomerates have built their businesses upon M&A and acquiring new brands, which I think speaks to their ability to balance growing the equity and managing the heritage of their legacy brands,” she says. “But [they are] also keeping on top of current trends and being willing to take a risk on a brand that might not be fully in their wheelhouse.”

She mentions Moncler’s US$1.4 billion acquisition of Stone Island, which brought the down jacket maker together with a streetwear brand. Gerberi says these moves allow companies to tap into certain trends or companies growing at a faster rate than the overall luxury industry.

Geographical exposure comes into play as well. Much of the industry is listed in Europe rather than the U.S., for instance. And though the customer base is often considered from North American or European vantage points, luxury companies serve a diverse, global base of consumers beyond those regions. This means they’re impacted by much broader, global trends.

Embracing Digital Evolution

“Covid really accelerated the digital strategies that companies in the industry are pursuing,” Gerberi says. “And of course they came into the pandemic in varying degrees of development.” This follows other accelerations in online retail, which observers say advanced e-commerce sales and technology by several years during the pandemic.

This evolution is about more than simply having a robust e-commerce site, offering products for sale via third party or increasing the depth and breadth originally offered online. Gerberi says luxury brands have created new digital avenues to engage with their customers and build customer relationships including special sales events, setting up virtual showrooms—even biometric scanning to offer virtual beauty trials.

Investors should watch how companies have embraced this shift, as not all companies have seized the chance to innovate their digital platforms and complement their in-person shopping experiences. “That gap between the haves and have nots has widened,” Gerberi says.

China’s Growing Consumption

The growth of emerging market middle classes is a promising tailwind for luxury goods, Gerberi says. “But in the near term it likely wouldn’t be anywhere as meaningful as the continued growth of the Chinese consumer in this industry.”

In 2019, the Chinese consumer accounted for 35% of global luxury sales. That figure is estimated to rise to 50% by 2025. This may pose attractive investment opportunities in brands with less-established presences in China, offering room to expand their customer base there. Though China-based luxury brands are emerging, globally-recognised brands are expected to be the main driver of this consumption.

Gerberi expects “a good pipeline for luxury consumption” to continue, as China’s Gen Z population ages and gains more disposable income.

Factors like relatively quick economic bounce back from Covid, unemployment returning to pre-Covid levels, and a continued strong appetite for luxury goods bode well for continued sales growth. “All of those things continue to bode well for the outlook for the Chinese consumer with regards to luxury,” she says.

U.S. investors’ enthusiasm over Japanese stocks at this time last year turned out to be misplaced, but the market is again on the list of potential ways to diversify. Corporate shake-ups, hints of inflation after years of declining prices, and a trade battle could work in its favor.

Japanese stocks started 2024 off strong, but an unexpected interest-rate increase in August by the Bank of Japan triggered a sharp decline that the market has spent the rest of the year clawing back. Weakness in the yen has cut into returns in dollar terms. The iShares MSCI Japan ETF , which isn’t hedged, barely returned 7% last year, compared with 30% for the WisdomTree Japan Hedged Equity Fund .

The market is relatively cheap, trading at 15 times forward earnings, about where it was a decade ago, and events on the horizon could give it a boost. Masakazu Takeda, who runs the Hennessy Japan fund, expects earnings growth of mid-single digits—2% after inflation and an additional 2% to 3% as companies return more to shareholders through dividends and buybacks.

“We can easily get 10% plus returns if there’s no exogenous risks,” Takeda told Barron’s in December.

The first couple months of the year could be volatile as investors assess potential spoilers, such as whether the new Trump administration limits its tariff battle to China or goes wider, which would hurt Japan’s export-dependent market. The size of the wage increases labor unions secure in spring negotiations is another risk.

But beyond the headlines, fund managers and strategists see potential positive factors. First, 2024 will likely turn out to have been a record year for corporate earnings because some companies have benefited from rising prices and increasing demand, as well as better capital allocation.

In a note to clients, BofA strategist Masashi Akutsu said the market may again focus on a shift in corporate behavior that has begun to take place in recent years. For years, corporate culture has been resistant to change but recent developments—a battle over Seven & i Holdings that pits the founding family and investors against a bid from Canada’s Alimentation Couche-Tard , and Honda and Nissan ’s merger are examples—have been a wake-up call for Japanese companies to pursue overhauls. He expects a pickup in share buybacks as companies begin to think about shareholder returns more.

A record number of companies have also delisted, often through management buyouts, in another indication that corporate behavior is changing in favor of shareholders.

“Japan is attracting a lot of activist interest in a lot of different guises, says Donald Farquharson, head of the Japanese equities team for Baillie Gifford. “While shareholder proposals are usually unsuccessful, they do start in motion a process behind the scenes about the capital structure.”

For years, money-losing businesses were left alone in large corporations, but the recent spate of activism and focus on shareholder returns has pushed companies to jettison such divisions or take measures to improve them.

That isn‘t to say it is going to be an easy year. A more protectionist world could be problematic for sentiment.

But Japan’s approach could become a model for others in this new world. “Japan has spent the last 30 to 40 years investing in business overseas, with the automotive industry, for example, manufacturing a lot of the cars in the geographies it sells in,” Farquharson said. “That’s true of a lot of what Japan is selling overseas.”

Trade volatility that hits Japanese stocks broadly could offer opportunities. Concerns about tariffs could drag down companies such as Tokio Marine Holdings, which gets half its earnings by selling insurance in the U.S., but wouldn’t be affected by duties. Similarly, Shin-Etsu Chemicals , a silicon wafer behemoth that sells critical materials, including to the chip industry, is another potential winner, Takeda says.

If other companies follow the lead of Japanese exporters and set up shop in the markets they sell in, Japanese automation makers like Nidec and Keyence might benefit as a way to control costs in countries where wages are higher, Farquharson says.

And as Japanese workers get real wage growth and settle into living in an economy no longer in a deflationary rut, companies focused on domestic consumers such as Rakuten Group should benefit. The internet company offers retail and travel, both of which should benefit, but also is home to an online banking and investment platform.

Rakuten’s enterprise value—its market capitalization plus debt—is still less than its annual sales, in part because the company had been investing heavily in its mobile network. But that division is about to hit break even, Farquharson says.

A stock that stands to benefit from consumer spending and the waves or tourists the weak yen is attracting is Orix , a conglomerate whose businesses include an international airport serving Osaka. The company’s aircraft-leasing business also benefits from the production snags and supply-chain disruptions at Airbus and Boeing , Takeda says.

An added benefit: Its financial businesses stand to get a boost as the Bank of Japan slowly normalizes interest rates. The stock trades at about nine times earnings and about par for book value, while paying a 4% dividend yield.

Corrections & Amplifications: The past year is expected to turn out to have been a record one for corporate earnings in Japan. An earlier version of this article incorrectly gave the time frame as the 12 months through March. Separately, Masashi Akutsu is a strategist at BofA. An earlier version incorrectly identified his employer as UBS.

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