Luxury stocks have given investors a serious case of buyer's remorse recently. Should they ditch the bling or hang on?
Thanks to a slowdown in Chinese sales and weakness across many emerging markets' currencies, some of the world's flashiest luxury companies have seen their profits squeezed. In turn, their stocks have lost luster: In the last 12 months, shares of Cartier parent Compagnie Financiere Richemont have fallen 10 percent while Prada has declined 37 percent.
As scary as those performances look, there are several reasons to believe that the luxury market can regain pace in the next few years. According to Mario Ortelli, an analyst at Sanford C. Bernstein, 2015 should see an acceleration in luxury sales thanks to a stabilization of foreign exchange rates, a pickup in tourism, and depleted stocks of high-end watches that have clogged the supply chain in China.
Indeed, luxury tends to grow much faster than the global economy in the long run, expanding around 1.75 times the pace of GDP, Ortelli said. The reason is that economic growth tends to put more people into the luxury category and make the rich even richer.
One company that may make a good bet on luxury is Richemont. The obvious hangup is the company's exposure to watches, which account for about half of revenue. Richemont's portfolio includes brands like Vacheron Constantin and Jaeger-LeCoultre, which can cost well over $100,000 and are popular gifts among the Chinese elite.
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But after nearly two years of soft sales, stockpiles have been worn down considerably. And while government officials in China may still be cautious about conspicuous purchases, entrepreneurs are proud to wear fancy timepieces as a sign of their status.
Equally important is Richemont's crown jewel: Cartier. The jewelry brand accounted for a 69 percent of Richemont's operating profit in 2013, according to Bernstein estimates. And about 40 percent of Cartier's sales are jewelry, which has been resilient even in the face of slow watch sales.
Cartier also happens to be in one of luxury's fastest growing categories: branded jewelry. According to a recent McKinsey study, branded jewelry such as Cartier and Tiffany accounted for just 20 percent of global jewelry sales in 2011 but is likely to reach as much as 40 percent by 2020.
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Drivers of the growth include "new money" customers who are keen to flaunt their recently acquired wealth along with emerging-markets customers who want trusted brands. Younger customers are also more familiar with strong brands and will be drawn to them as they make some of their first luxury purchases.
Of course, jewelry won't be safe in the event of a serious economic slowdown such at the most recent financial crisis. Big-ticket purchases are easiest to delay in times of adversity and designs don't change as quickly as in other categories.
But investors are probably compensated for that risk with a reasonable valuation on the stock. At about 10.8 times forward earnings, before interest, taxes, depreciation, and amortization, Richemont is trading below its 10-year historical average of 13.2 times, according to FactSet.
While not flawless, Richemont may be an investment that shines for years to come.