Sitting Pretty ~ A Tacticle Secret BTC Agent

May 15, 2022

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The World of Luxury Brands, Explained
Neo-classical economists operate under the assumption that consumers tend to spend money rationally. Reality proves this is far from true. Sometimes consumers want to splurge, even without a good reason.

Why buy a $5,500 Hermés clutch when H&M offers a perfectly fine $60 purse? Why purchase a $13,000 Cartier wristwatch when your phone’s home screen has a clock? Why sip on a thousand-dollar glass of Hennessy Cognac that’s older than Warren Buffett when the liquor store sells a handle of brandy for $24?

Suffice to say, consumers are not always rational. In fact, there’s an entire industry worth hundreds of billions of dollars predicated on the idea that consumers occasionally act in ways their bank manager would call irrational. Whether it's a thoughtful gift to mark a double-digit anniversary or a simple act of self-indulgence, just about everyone enjoys nice things. Expensive things. Fancy things. Luxurious things.

And that’s exactly what we are unpacking today — the world of luxury goods. So slip on a pair of $1,800 Dolce & Gabbana reading glasses, and let’s dive right in.

Francly, My Dear
Attempting to trace the history of luxury goods back to any single point is futile. For all of time, humans have treasured items that serve as symbols of wealth, status, and power. The Romans had their exotic fruits (the lemon, believe it or not) and spices (of all things, black pepper). The Renaissance had its appreciation for fine tapestries.

Still, if it’s the Renaissance of modern luxury brands that we’re tracing, we’d have to take you back to…1984. Upon learning that the near-bankrupt textile business Boussac was on the block, young real estate developer Bernard Arnault bought the company for, according to somewhat specious legend, a single ceremonial French franc (though most serious reporting clocks the price at closer to $60 million). Like a pearl inside an oyster, within the struggling outfit’s portfolio lay a hallowed name: Christian Dior.

Within five years, Arnault put Boussac back in black, grew the Dior business, and bought a majority stake in the more-than-a-century-old luxury brand LVMH (itself the byproduct of a mega-merger between fashion firm Louis Vuitton and upscale wine-and-spirit manufacturer Moët Hennessy).

Flash-forward 30-plus years and today LVMH isn’t just the most valuable luxury brand in the world. With a $280 billion market cap, it’s the most valuable company in Europe. At 73 years old, Arnault remains CEO of the luxury conglomerate and the titan’s net worth has ballooned to $147 billion.

So how is it that the luxury business, which would seem to cater to the affluent few, has yielded such outsized growth?

The Economics of Luxury
For LVMH and high-end competitors such as Richemont, Kering (which owns the title deed to the house of Gucci), and luxury eyewear giant Luxottica, the business model is pretty simple. Arnault encapsulates it quite well:

“Luxury goods are the only area in which it is possible to make luxury margins. If you control your distribution, you control your image.”

In another instance of insight, Arnault sums up what makes the industry so intrinsically attractive: “Affordable luxury — these are two words that don't go together.”

That’s the game plan: make high-quality goods, sell them for high prices, and reap high profit margins. In fact, it's this strategy that’s helped luxury brands weather the tumultuous pandemic year of 2020, when just about everyone in the world reevaluated their spending. While sales declined, those outsized profit margins helped some of the biggest names escape relatively unscathed:

According to Deloitte, revenue for the top 100 luxury goods companies totaled $252 billion in 2020, a marked slip from 2019’s $281 billion. Still, over half of the top 100 companies remained profitable, with 13 of them reporting double-digit profit margins.
Leading the fancy pack was Hermès — maker of high-end handbags costing north of $10,000 — which delivered net profit margins of over 21% on revenue of about €6.4 billion in 2020. Hermès’ net profit margins of over 20% in every year since 2016 crush the average for clothing and apparel companies, which analysts peg at 4% to 13%.

Leading brands have kept profit margins high by exercising extra-strict control over their distribution — something they have stressed during the rise of direct-to-consumer e-commerce.

Online and monobrand stores — stores selling items by a single brand — saw a 50% jump in sales from 2019 to 2020, and another 27% uptick from 2020 to 2021, according to Bain & Company. Meanwhile, monobranded websites accounted for 40% of all online sales in the luxury space, up from 30% in 2019.

It Pays to be Big
With luxury brands producing so much excess cash flow, mergers and acquisitions have represented a core tactic for many of the largest players in luxury.

No company exemplifies the trend quite as vividly as LVMH, which has ruthlessly pursued M&A as a growth strategy throughout Arnault’s tenure, with no end in sight. “We are still small. We’re just getting started,” he told the Financial Times in 2019. “ We are number one, but we can go further.” Sounds exactly as humble as one may expect from a man who made his fortune selling flashy status symbols.

In recent years, the M&A trend has intensified, with independent luxury brands getting snapped up by conglomerates left and right. In 2016, LVMH dropped $716 million on German luxury suitcase line Rimowa. In 2018, Versace sold to Michael Kors/Capri Holdings for over $2 billion. In 2019, 100-year-old jewelry house Buccellati sold to conglomerate Richemont.

Conglomeration pays off, too. A 2018 McKinsey study found that 97% of the entire fashion industry’s profits originated at just 20 companies in the previous year, including LVMH, Kering, Richemont, and Inditex. Their outsize influence is only growing. Deloitte found that the 10 largest conglomerates represented over half of all luxury goods sales in 2020.

Growth in Asia: One region, in particular, has proven to be a wellspring of value and growth for the luxury goods sector: Asia. Luxury goods sales in the Asia-Pacific region hit $111 billion in 2021, according to Statista, making it the leading region as far as consumption of personal luxury goods goes.

Leading the charge is China, where sales of personal luxury goods hit $73 billion last year, up 36% from 2020, and more than double 2019’s figure. China’s share of the luxury goods market was 21% in 2021, according to Bain analysts, who expect it to “become the world’s largest luxury goods market by 2025.”

Companies to Watch
Amid fears of inflation, war in Europe, and lockdowns in China, investors have tended to stay away from LVMH so far this year. Its stock is down roughly 30% since January 1. And yet, the French giant’s earnings report from April 22, its most recent, gives reason for optimism. US sales, which account for a quarter of all sales, increased 26% year-over-year, suggesting consumers are still willing to pay up for luxury, inflation notwithstanding. Meanwhile, sales in its important fashion and leather goods division were up 30%, handily beating analysts’ 23% estimate.

Switzerland-based luxury goods holding Richemont has been squeezed by the same market forces as LVMH, and so far this year, its stock also down 30%. The company is now developing an e-commerce platform with luxury retail website Farfetch, which Richemont believes could boost online sales and increase overall revenue by 40%. Richemont had €4.45 billion in revenue per its latest quarterly report, up 62% year-over-year.

Kering posted revenue of $5.37 billion in its first-quarter earnings report last month, up 27% year-over-year. Each of its brands — including Gucci, Yves Saint Laurent, and Boucheron — posted double-digit year-over-year revenue growth, though its stock is still down 40% year-to-date after an August 2021 peak.

Takeaway: Only the largest and best-positioned brands have been able to weather multiple, successive bouts of global tumult. Those that have done it have seen their business and revenues remain resilient, even amid a widespread stock downturn, suggesting there’s still an appetite from consumers for luxury goods — and value waiting to be unlocked by investors. Just ask Bernard Arnault, who at $147 billion is now worth more than anyone on earth except for Elon Musk and Jeff Bezos.

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A Tacticle Secret BTC Agent

Sitting Pretty

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