We looked back at our many and hitherto futile warning flags about the extended exposure of European Luxury stocks to China as they are facing the diktats of a Chinese governance which has a longer-term objective that transcends that of markets. We warned nine times (!) between February 2020 and now. Not bad and terribly incompetent on our part as the sector’s market cap shot up from €446bn (‘Khol’ stocks; Kering, Hermes, L’Oréal and LVMH) to €775bn.
With China turning Maoist again as Xi’s mandate to run the country on behalf of the CPP is due for a reassessment next year and calls for leftward leaning policies, some of these warnings all of sudden become prescient. Consider this one in May when we suggested that ‘Red hot Khol should look at Tesla’:
…such valuations are a hallmark of a massively crowded trade with eyes wide shut about the dependence of those businesses on the goodwill of the Chinese Communist Party. As Chinese travellers fly to Hainan rather than Paris to splurge on European-branded luxury, the risk mounts that Khôl will get one of those terse indirect signals that the music has stopped. For a taste of what can happen, think of Tesla, too successful in China for its own good, or of Ant dismantled for stepping on the PBoC toes…
In practical terms, the writing of looming problems was on the wall in red letters since the Ant IPO cancellation. Then, the bad news for business accelerated. Last Friday, AlphaValue bit the bullet and dropped its target on main Luxury sector plays. The table below is a summary of changes over the last week. As per AlphaValue procedures, it makes a clear distinction between directions given by the analyst (impact in pink) and market impacts.
The above table is also helpful in tracking the timing factor that makes investment decisions difficult ones for the sector. EPSs have been upgraded to allow for the phenomenal showing of H1 presumably continuing into H2 and possibly in 2022. Recommendation downgrades are about the longer term, i.e. by tweaking the valuation mechanisms to allow for fast-rising risks that the Chinese future will be less friendly to the industry.
As a reminder, a list of items of concern would be:
– China’s luxury demand accounts for 30% of the sector’s revenues and grows/grew at 30% p.a.
– The lurch to equality does not fit with brandishing branded luxury goods about
– Chinese demand for luxury is online-based and largely based on influencers who are no longer meeting communist orthodoxy
– Millennials’ consumption is fast shifting and unlikely to take over
– China’s nationalism can be instrumented against any consumer goods through social media.
Luxury’s valuations went too far too quickly on weak foundations. The downside risk is considerable. Losing say €300bn in sector market cap will also force to unwind a number of risk-taking strategies based on highly liquid issuers. Expect ripple effects.
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