Consumer Nation

Why China Might Not Save Luxury Retail If Europe Slows

Stacey Widlitz |Retail Consultant and Independent Analyst

This year at the Walpole China Luxury Conferencein London there were actually bears in the room — and they weren’t panda bears.

Last year attendees, still having post-traumatic stress from 2008 to 2009, asked the question could China save the U.S. in another downturn? The sentiment was a resounding yes. China was hailed as the savior that would offset weakness in the U.S. luxury market.

This year, with our fears firmly set on the European market, there is a similar question: Can China save Europe? But there is a different response.

With less positive data out of the U.S., and well let's face it, terrible data out of Europe, there is more pressure than ever on China.

Just listen to any retail conference call. It’s all about China. And when data points from Burberry and LVMH recently suggested the mainland economy might be slowing (not to mention today’s ), it became all about the Chinese traveler spending money overseas, which is holding up better than spending on the mainland).

As one attendee at the conference put it, don’t look at China as a geography, look at it as a demographic. Whether you analyze Chinese spending by region or as a group, it still won't save Europe.

Not all Brands Created Equal 

All retailers are not created equal when it comes to Europe and China. European brands including Burberry, LVMH, and Richemont, which owns Cartier and Piaget, are exposed to Europe in about 30 percent to 40 percent of their business. With about 10 percent of the revenue derived from China, a pretty meaningful acceleration would need to take place in order to offset a significant downturn in Europe.

For example, based on Burberry’s mix, a hypothetical 5-percent decline in Europe would require 20-percent growth in China as an offset. (This is just a math exercise, not a prediction.)

While the exposure of European brands are the most obvious, don’t forget U.S. retailers.

Tiffany is not in a bad position with about a 12-percent exposure to Europe. China is not far off at about 10 percent of the mix.

The names with more significant exposure include Ralph Lauren , with about 20 percent of its business from Europe and only 11 percent, Asian.  For Guess, the breakdown is about 37 percent Europe and only 8 percent Asia.

Don’t forget last week’s after cautious comments on Europe. Fossil has exposure to Europe of about 20 percent.

Guess no one was listening to the Decker’s , Crocs and Starbuck’s conference calls from the week before?

Abercrombie & Fitch has international exposure of about 25 percent, with a pedal-to-the-metal rollout strategy in Europe. The company reports its earnings next week, but same-store sales were already negative before the most recent data blitz, including a double-dip in the U.K. The company is just starting to go after China.

Coach is also worth watching, with a recent European rollout strategy. The company now has two massive flagships in London. China is estimated to be 8 percent of sales this year.

Meanwhile, the wealthy Chinese love to travel. According to KPMG, Chinese millionaires travel 2.4-times per year. They also represent 18 percent of all duty-free shopping. And why not travel to spend on luxury when Mainland prices can come at a 30-percent to 50-percent premium? Chinese tourists represent huge potential for European/U.S. luxury players. Harrod’s suggests the Chinese spend on average $5,700 per trip.

But here is the problem: Chinese tourism is already boosting European flagships (estimated at 30 percent to 50 percent of their current business.) Any Chinese slowdown will only add insult to injury as Europe continues down a bumpy road.

And let’s throw in two more wild cards.

Luxury players are leveling the pricing field, and that could hurt European sales even more.

Burberry and LVMH recently reported a slowdown on the Mainland, while Chinese tourism does not seem to be tapering off. Now many luxury players are taking a look at their cost structure in Asia and the amount of sales traveling overseas, and as a result, they are looking to raise prices in Europe.

Well the higher prices certainly aren't helpful for the locals who are already under pressure. In addition, if the Chinese decide to shop more at home, what happens to those pricey flagship store comps and productivity in the well-established brick-and-mortar network in Europe? Here is a thought: Maybe we just don’t need as many locations inside China.

Second, the Chinese government may use tariffs to keep them home. Chinese officials have declared their intent to boost domestic production. The debate continues about whether or not to cut luxury import tariffs.

Many attending the Walpole conference expressed confidence this will move forward within six months as the government wants the Chinese to shop at home.

If the pricing game changes in favor of China, we may have to ask the question: do we need so many locations in Europe?

While Chinese luxury consumption, no doubt, is leading the charge, it won't save us all.

Stacey Widlitz is the President of SW Retail Advisors Inc. She has worked at UBS, SG Cowen, Fulcrum Partners and in 2005 was one of three analysts to launch the Research Department at Pali Capital, where she covered Retail and Home Video for 5 years. Follow Stacey on Twitter @StaceyRetail.