Brexit is the last thing troubled luxury retailers needed

An employee adjusts a fine jewelry display inside a Bulgari SpA boutique.
Jason Alden | Bloomberg | Getty Images

Things are about to get even tougher for struggling luxury retailers.

The U.K. vote to exit the European Union adds yet another wave of uncertainty to sales and profits at the high end, which have already taken a beating due to a stronger dollar, slowing economic growth and a shift toward spending on experiences versus goods.

The British pound tumbled to a 30-year-low Friday, making high-end goods outside of the region more costly. Global financial markets likewise dove, putting pressure on the portfolios of wealthy shoppers, whose net worth is more directly tied to market fluctuations.

And with the euro simultaneously moving lower, the Brexit is likely to create ripples on luxury brands' U.S. flagship stores, which depend on tourists for a chunk of their sales. Foreign shoppers have already cut back on spending in the U.S. because of the stronger dollar.

Retailers based in the U.K. will face complexities and higher costs due to increased trade barriers, as they will have to pay import duties and taxes on items that are made in other European countries, said Hana Ben-Shabat, a partner in the retail and consumer practice of A.T. Kearney

"Companies will have to 'release' goods from customs, which extends lead times and delivery to stores," Ben-Shabat said. "For local designers in the U.K., there will be a cost increase for raw materials sourced in the EU."

Santelli: Emotion pounded the pound
Santelli: Emotion pounded the pound

Macquarie Research on Friday cut its earnings estimates for several retailers with exposure to the U.K., including Tiffany and Ralph Lauren. The country is Ralph Lauren's largest market in Europe, accounting for roughly $300 million of its $7.4 billion in revenue.

Because about 4 percent of the brand's revenues are generated in the British pound, which plunged to a 30-year low Friday, Macquarie estimates the Brexit could result in an additional 1.6 percent decline in the company's per share earnings this fiscal year, or an 8 cent hit.

At Tiffany, 40 percent of the brand's European sales come from the United Kingdom, representing some $202 million of its $4.1 billion in revenue. Macquarie estimates the Brexit could result in an additional 0.6 percent decrease in its current fiscal year's per-share earnings, or 2 cents a share. The company's shares fell to a three-year low on Friday.

In its latest 10-K filing, Tiffany warned that "a continued weakening of foreign currencies against the U.S. dollar would require the company to raise its retail prices in order to maintain its worldwide relative pricing structure." Such adjustments are typically put in place so that goods remain the same price across the globe to discourage shoppers from stocking up on a certain brand where it's sold on the cheap and reselling it in a pricier country.

Yet because any use of so-called "price harmonization" would make Tiffany's goods more expensive for U.K. shoppers, it could cause them to stop buying the brand's products, and result in the merchant generating lower sales and profitability.

On the other hand, London-based designers such as Burberry stand to gain from shoppers heading to the country in search of deals. The company's stock was one of the few in the green on Friday, rising more than 2 percent.

"The currency bouncing ball dictates tourism flow spend," said Stacey Widlitz, president of SW Retail Advisors. "With the new levels in the pound, London may just be the next beneficiary of tourists chasing the most favorable luxury deals. That means Burberry is a likely beneficiary."

Investors react to Brexit
Investors react to Brexit

That luxury brands tend to set up flagship stores in tourist-heavy U.S. cities adds a currency complication because it makes goods sold in the United States pricier for travelers. Tiffany, for example, generates a large chunk of its U.S. revenues from foreign tourists — an estimated 25 percent.

But Pam Danziger, founder of Unity Marketing luxury research firm, said the impact will be most visible in Europe, particularly as it relates to trade. But while she said the Brexit will no doubt cause upheaval in the short term, it will ultimately give U.K.-based brands more control over their future.

U.K. voters took back control of the economy from the European Union, she said.

The aftermath of the vote is just the latest factor weighing on the luxury sector. Bain & Company said last month that global sales of personal luxury goods grew just 1 percent on a constant currency basis last year and during the first quarter, "a trend that is expected to continue throughout the year."

"The luxury market is stuck in a holding pattern for the foreseeable future," said Claudia D'Arpizio, a Bain partner and lead author of the study — and that was before the Brexit vote. The firm attributed the soft luxury environment to a decrease in tourism across Europe, a slowdown in the U.S. and China, and instability in the Middle East.

In general, even wealthy consumers have been less willing to spend their money on high-end goods in recent years, as they favor experiences such as travel.