Luxury’s Hefty Price Tag Awaits Earnings Reckoning: Taking Stock

(Bloomberg) -- As Europe kicks off one of the most uncertain earnings seasons in a long time, market players are hoping for clues on the extent of the damage from the pandemic. For luxury-goods makers -- some of this year’s best performers -- sales figures from LVMH and L’Oreal SA due later today should offer some insight, and show whether investor faith in the sector’s resilience is justified.

So far, no luxury stock has severely de-rated and a number of them appear “more expensive today than last autumn,” according to Jefferies International Ltd. analyst Flavio Cereda. Investors may be “overoptimistic” about 2021, or maybe the magnitude of the downturn this year isn’t fully understood, “but we aren’t even close” to a contraction of stock multiples, he says, adding that valuations aren’t as compelling as he had hoped.

One explanation for the high valuations could be that analysts are waiting for quarterly results before revising estimates. There are “significant earnings cuts” yet to come, according to Swetha Ramachandran, investment manager of the GAM Global Luxury Brands Fund.

She still sees the sector’s outperformance continuing, as healthy balance sheets and Chinese consumers could drive the market. The Stoxx 600 Personal & Household Goods Index, home to several top luxury names, is down 14% this year, compared with a 22% slump in the broader index.

Despite store shutdowns across many parts of the world, investors have backed stocks such as Hermes International, the only gainer on France’s CAC 40 Index this year. A newly reopened flagship Hermes store in Guangzhou reportedly garnered the biggest one-day revenue tally for a single boutique in China earlier this month. Other stocks with high exposure to the country, such as L’Oreal, are rebounding faster than the market since a March low.

Investors may be reading too much into the rebound in demand from Chinese clients, says Bernstein & Co. analyst Luca Solca. While indications from the world’s second-biggest economy are indeed positive, a huge chunk of sales for luxury firms comes from Chinese tourists in Europe and elsewhere, a source of revenue that’s non-existent right now, he says. Solca sees subdued travel and shopping until a vaccine is developed.

The gap between luxury winners and losers will probably get bigger, with powerhouses such as LVMH gaining more market share during the pandemic, Markus Hansen, senior research analyst at Vontobel Asset Management’s Quality Growth Boutique, says.

But LVMH isn’t immune to the downside, according to Cedric Ozazman, chief investment officer at Reyl & Cie in Geneva. Still, strong balance sheets, very low leverage and the quality attached to top luxury names have been supportive following the March sell-off, he said.

Companies may also be split on dividends. Tod’s SpA, Salvatore Ferragamo SpA and Germany’s Adidas AG are among firms that have scrapped them. But payout from conglomerates such as LVMH -- which is donating ventilators and protective masks to French authorities and retooling some of its perfume factory lines to make hand sanitizers for hospitals -- are probably safe, as they pledged not to resort to state aid, says Bernstein’s Solca.

Longer-term, deal speculation may also be helping the sector’s outperformance: Tod’s and Ferragamo and remain widely cited as potential targets, and larger deals also are a possibility, for example a tie-up between Gucci owner Kering SA and Richemont.

To be sure, first-quarter figures may only offer a partial glimpse into the pain this year could bring to luxury brands, with a widespread lockdown across most of Europe only going into effect in late March. It’s still “hard to say how awful 2Q will be,” as the virus situation is evolving quickly, and the magnitude of sales declines “can only increase,” Oddo BHF analyst Jean Danjou wrote last week.

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