Luxury Loses Little Sheen Despite Virus Risk

(Bloomberg) --

“Key downside risk” is how the European Commission now describes the coronavirus outbreak, with its potential to hurt the region’s recovery from a manufacturing slump. Yet, some of the biggest makers of luxury goods have shown greater stock-market resilience compared with other China-reliant sectors. Their massive revenue exposure to Asia may start to bite soon.

On the day Gucci owner Kering said it closed half of its stores in mainland China due to the virus outbreak, the shares were up 6.3%, as stellar results prevailed against potential risks. It took renewed worries yesterday to send the shares slightly lower, but still not far from a record high. LVMH has also shown the same kind of strength.

“The market is in complacency/euphoria mood, getting a bit ahead of itself and focusing on good news,” says Cedric Ozazman, head of investment and portfolio management at Reyl & Cie, citing the double-digit growth at Gucci. Gains in Pernod Ricard SA yesterday even after its warning about the impact on its growth prospects is another example of how investors are brushing off virus risks.

While other China-exposed sectors such as autos and miners have been hurt by virus worries, the Stoxx 600 Personal & Household Goods Index containing luxury names has barely budged. The sector’s resilience lies in the market’s expectation that there will be a V-shape recovery, meaning any weakness in the first quarter will be offset by the subsequent periods, according to Ozazman, a view shared by Sanford C. Bernstein analyst Luca Solca.

“The market seems to be taking the coronavirus in its stride, with the idea that this will be temporary, while the underlying appeal of the sector and its strength is very strong,” Solca says, and investors have “fully understood” that the first quarter will be very bad. In order to get further downside pressure, the sector would need “new and material” negative newsflow, Solca believes.

Big names aside, the overall sector has shown some cracks. The MSCI Europe Textiles Apparel & Luxury Goods Index, which continued to beat the MSCI Europe Index through months of Hong Kong protests, is now underperforming.

• Barclays strategists are not alarmed, despite expecting sharp cuts to luxury stocks’ earnings estimates. They say the coronavirus issue is unlikely to alter the sector’s medium-term prospects and think the recent share-price weakness offers an interesting entry point, even though volatility could remain elevated for some time.
• “The best way to navigate this crisis seems to max exposure to higher-quality names, as they are most resilient – both in their performance and in the way they react to news,” according to Bernstein’s Solca. Looking at the table below, LVMH and Kering, the two larger players, are among the top performers since the escalation of the Hong Kong protests.

Longer term, the structural growth story of luxury names is still in place, says Reyl’s Ozazman, acknowledging it’s too early to draw any conclusion about the magnitude of the virus’ impact on the global economy. Very few names can withstand a slowdown in China, the manager says, seeing Hermes International as a defensive play given its brand power.

European luxury shares may also benefit from the continuous weakness of the euro, given the regional cost base for most of the manufacturers. Periods of yuan appreciation also tend to generally help the sector, as shown in the chart below. China’s response to the virus crisis and its effect on the yuan could therefore be particularly important in the short-term.

--With assistance from Jan-Patrick Barnert.

To contact the reporters on this story: Michael Msika in London at mmsika4@bloomberg.net;Chiara Remondini in Milan at cremondini@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Namitha Jagadeesh

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