Saturday, September 24, 2005

There will always be a market for imagined prestige.

China's rising middle classes to outstrip Japan on spending LUXURY GOODS.

742 words
21 September 2005
Financial Times
London Ed1
Page 42
(c) 2005 The Financial Times Limited. All rights reserved

For years, the biggest driver of growth in the luxury goods sector has been the buying habits of the Japanese. But they are now facing competition for that special edition Prada handbag or Manolo Blahnik shoes.

Over the next decade the Chinese are set to become the world's keenest buyers of western watches, bags, scarves and trinkets. Four years ago, the Chinese accounted for just 2 per cent of the revenues of the world's luxury goods companies. But such is the size of the country's population and the disposable income of its emerging middle class that the Chinese are expected in about 10 years to overtake the Japanese to become the world's biggest spenders on luxury goods.

"Chinese customers are increasingly driving sector growth and are set to be the heavyweights of luxury goods buying in years to come," says Merrill Lynch.

Goldman Sachs expects the Chinese share of global luxury goods sales to rise from 13 per cent this year to 19 per cent in 2008, 23 per cent in 2010 and 29 per cent in 2015. By contrast, the share of Japanese, who account for an estimated 40 per cent of luxury goods sales, will fall below 29 per cent by 2015.

Jacques-Franck Dossin, Goldman's European luxury goods analyst, expects the Chinese phenomenon to accelerate luxury goods sales growth to 7-8 per cent a year, instead of 5-6 per cent a year.

No wonder luxury goods companies are opening more and more outlets in China. Cartier, the first luxury brand to open up shop in the People's Republic in 1990, has three Chinese boutiques and 172 authorised distributors.

Mr Dossin sees several similarities between the Chinese and Japanese when it comes to luxury goods. One is the view that brands and what you wear help define who you are. This is important in societies where social life tends to take place in restaurants and bars, rather than at home. Another is that both groups shop much more when they travel than at home.

China has recently eased restrictions on its citizens travelling abroad - they can now travel as individuals and not in groups - and they are allowed to take more foreign currency with them. Next year, there are likely to be more Chinese visitors to Paris than Japanese for the first time.

Fans of luxury goods stocks say China is not the only reason to be positive on the sector. Not only is a wealthy middle class emerging in other Asian countries, such as India, but demand for luxury goods is increasing from oil-rich middle eastern countries and Russia.

Another attraction is the barriers to entry, as that is what gives the sector its pricing power. "The luxury goods industry is increasingly controlled by a small number of main players, who have the advantage of being able to set the prices at which their goods are sold, thus protecting their profitability," says Giles Worthington, manager of the M&G Pan European fund.

But luxury goods makers face a number of challenges. One would be any setback, such as a recession, that slows up the emergence of the wealthy Chinese middle class. Another would be any slide in international travel caused by terrorism, bird flu or some other disaster. A third challenge is counterfeiting. "Counterfeiting remains one of the major threats to the industry, especially as the vast majority of faked products are made in China," says Merrill Lynch.

Despite such threats, Merrill favours two luxury goods groups - LVMH and Richemont - partly because of the strength of their activities in China. It estimates that the former derives 9 per cent of group sales from China and the latter 15 per cent. It also likes Swatch, which generates 18 per cent of its sales there. But, for the moment, it is neutral on the Swiss group on valuation grounds.

Valuation is an issue for the sector as whole. Like the goods they sell, luxury goods companies are expensive. The sector has risen 18.4 per cent since its April 28 low, and it trades on a high price/earnings multiple of about 25 times. That may appear steep, but would you expect the companies behind brands such as Louis Vuitton, Christian Dior, Cartier and Montblanc to trade in the bargain basement?


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