China's Economy Spells Trouble for Luxury Brands

As Harry says, the emerging world’s uber wealthy have driven high-end real estate prices higher. And the emerging world’s aspirational rich have driven the boom in luxury goods — from high-end handbags to fine wines — over the past decade.

For example, just look at the granddaddy of all luxury goods companies: LVMH Moet Hennessy Louis Vuitton. The company, which is based in France, is the largest luxury conglomerate in the world. It’s best known for the expensive Louis Vuitton purses, but also owns the Dom Pérignon and Möet & Chandon champagne brands, the Hennessey cognac brand and the Glenmorangie scotch whisky brand, to name a few. It also owns the Tag Heuer and Zenith lines of high-end Swiss watches. It even runs a partnership with global diamond leader De Beers.

In short, it’s a one-stop shop for luxury goods.

It’s also completely dependent on well-heeled Chinese shoppers.

About 30% of LVMH’s revenues come from Asia, not including Japan. Most of these sales are in stores on the streets of China and Hong Kong. Then there’s the spending Chinese tourists do in the company’s American and European stores.

Estimates are informal, but as much as half of the spending in LVMH’s flagship Paris store is believed to be done by Chinese shoppers.

It’s not just LVMH. British luxury retailer Burberry gets 36% of its revenues from the Asia Pacific region with most of this coming from China and Hong Kong. And large chunks of the 39% of its European sales are made to Chinese tourists.

Swiss watches? Same story.

Swatch Group, the maker of Omega and several other luxury Swiss watch brands, gets nearly 40% of its sales from China. Including Chinese tourists buying watches in Europe, the number is estimated to be more than half of sales.

The Economist estimated last year that, industry-wide, about half of all luxury spending in the world is done by Chinese shoppers, either in their home market or abroad as tourists.

All of this was good and well when China was growing at a blistering pace. Now, it’s looking more and more like a liability.

Last year China’s economy grew at its slowest rate since 1990, and is expected to slow again this year. Construction spending has been the driving force behind much of this growth, particularly real estate construction. Yet at least a fifth of new real estate is sitting unoccupied… even as new capacity continues to be built.

Without a doubt, the Chinese economy is a bubble waiting to burst, helped even further along by the country’s crackdown on corruption, which has already sapped demand from the luxury goods sector. In years past, the best way to curry favor with a powerful politician or businessman was to offer him a limited-edition bottle of wine… or perhaps a gold watch. Today, those sorts of arrangements will get you thrown in jail.

When China experiences its hard landing and has the major social unrest that will come with it, no wealthy Chinese citizen will want to be seen in public holding a purse that costs a year’s wages for a laborer.

I expect the stock prices of luxury goods to reflect Chinese weakness long before we see it in the official GDP reports.

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Charles Sizemore

Charles specializes in finding value opportunities and income plays outside of the mainstream stock market.