Diamonds in the Rough: Two Luxury Brands Ready to Shine

By Jennifer Yousfi
Managing Editor

Luxury jeweler Tiffany & Co. (TIF) yesterday (Thursday) followed in the footsteps of other high-end brands when it announced strong fiscal second quarter results.

Tiffany’s net income increased to $80.8 million, or 63 cents per share, in the second quarter, up from $40.5 million, or 29 cents, for the same period a year prior. It was enough to beat mean analyst expectations of 55 cents per share and sent Tiffany shares up 10%.

“Tiffany did a lot better than investors feared,” Schick, an analyst with Stifel Nicolaus & Co. (SF), told Bloomberg News in a telephone interview. “Luxury isn't getting a ton better, but it is hanging in there. People are going to remain concerned about what happens next, given the state of the global economy and the global equity markets.”

And there’s the rub. Luxury brands such as Tiffany, Hermes International SA (PINK: HESAF) and the Gucci Group NV (PINK: GUCG) have managed to grow sales despite a sharp slowdown in U.S. consumer spending. But growing economic troubles in Europe, traditionally the biggest market for luxury goods, are starting to weigh on the minds of high-end retailers.

And while luxury sales growth in emerging markets is on the rise, it may not be enough to offset the slowdown in the maturing markets of the United States, Europe, and Japan.

Some high-end retailers are struggling to come up with new ways of nabbing customers, while others are carefully implementing focused marketing campaigns that build on their core competencies.

Shares of luxury goods makers are no longer a sure thing, but there are still some profitable picks if you know what to look for, and just as importantly, what to avoid.

Selling Luxury

Many high-end retailers were convinced that sales of luxury goods would continue unabated despite slowing global economies. And at first, it seemed they were right. But as the fallout from the global credit crisis unfolds, the luxury market is starting to feel the pinch that its mid-level brethren are already familiar with.

The luxury industry has clocked in five straight years of strong growth that culminated with a 6.5% jump in 2007. At one time, luxury sales were expected to advance at an 8% - 10% clip over the next several years. But growth like that is no longer feasible in today’s tough markets.

Bain & Co. Inc. has ratcheted its forecast down to a 2% rate of growth for the $270 billion luxury market this year.

"I've done this for a long time, and this is one of the most volatile times I've ever experienced," Angela Ahrendts, chief executive officer of British brand Burberry Ltd. (PINK: BBRYF), told Fortune.

"The good news is that the sector is still outperforming others over the next two years," Ahrendts says. "It's just a matter of getting through the storm by focusing on the right markets, the right suppliers, and the right categories. We've got to run a tighter, smarter business."

Indeed, the future is bright for the luxury sector, particularly as demand picks up in emerging markets where rapid development has resulted in the materialization of a new client base.

Sales of luxury goods in Asia, excluding Japan, jumped 100% over the past ten years, increasing from $14.7 billion (10 billion euro) in 1997 to $29.4 billion (20 billion euro) in 2007.  But despite the rapid growth, that region only accounted for 12% of global luxury goods sales in 2007 – only slightly more than 11% in 1997.

For now, even with the impressive growth rates, emerging markets aren’t ready to pick up the slack for the wealthier West.

Stick With What Works

Luxury retailers are doing everything they can to boost flagging sales, but some just can’t get over the hurdle. A June survey by the Italian trade group Altagamma found that operating margins at many brands were flat or falling, Fortune reported. Slowing sales and shrinking margins have led some firms to try to reach out beyond their core customer base.

For many, it’s a costly error.

“The biggest mistake luxury brands make is in not sticking with their core value system and core customer,” Suzanne Hader, principal at 400twin, a New York-based consulting company that focuses on luxury goods, told Forbes.

American handbag maker, Coach Inc. (COH) has carved out success for itself by selling $300 handbags. But a recent attempt to go higher-end with its Legacy line, with handbags that retail for $1,100 was not only unpopular, it alienated the company’s core customers.

A return of focus to lower-priced items has helped Coach’s stock battle back from its record low in December 2007. The leather maker even went so far as to approve a $1 billion share buyback.

Polo Ralph Lauren Corp. (RL) is also attempting to broaden its market base with a lower-cost product line for sale in J.C. Penney Co. Inc. (JCP) department stores. But with Penney’s second quarter profits down 36%, the partnership seems unlikely to help either firm.

“I don't think you could say that by staying true, a brand is guaranteed success. However, if they don't stay true, success will be much more difficult to come by,” 400twin’s Hader said.

Luxury Stocks Worth the Price

The luxury brands that are going to be able to weather the current economic downturn have two major things in common:

  • Being innovative while remaining true to the core product lines that made them famous.
  • A smart expansion strategy designed to capitalize on growing demand in the emerging economies of China, India, Russia and the Middle East.

Two that might be worth a look include:

Hermes International SA (PINK: HESAF), maker of coveted handbags and scarves, had an impressive 24% increase in U.S. sales for the first six months of the year. Worldwide, Hermes sales jumped 12.1% in the second quarter, to $631 million ($398.1 million euros) from $564 million ($355.5 million euros) for the same period the prior year. Its European-traded shares are up over 13% year-to-date.

Hermes has been active in its expansion into China, where it currently has nine stores, as well as Russia and India where it will open a brand new location in the next three years.

Hermes has also been able to reach new business without forgetting its loyal core group of customers.

"Hermes sells the absolutely classic Birkin bags, but also bring out new styles of merchandise--[from watches to branded cars]--that show they know how to continue to interpret and apply their core values," says Hader.

LVMH Moet Hennessy Louis Vuitton SA (OTC ADR: LVMUY) has got the luxury market covered on all bases. From Veuve Clicquot champagne to Louis Vuitton leather goods and Guerlain cosmetics, LVMH’s stable of brands reads like a who’s who of luxury brands. Other well-known names include Tag Heuer, Christian Dior and Moet & Chandon.

For the first half of the year, net income climbed 7% to $1.4 billion, fueled by strong sales in Asia, where sales increased 25%. A third of LVMH’s sales come from China, where the growing middle class is gobbling up luxury goods. At the same time, sales in the U.S. have remained solid, especially in the Wine & Spirits division.

LVMH Chairman Bernard Arnault said his firm maintained “excellent” sales in the U.S. despite the slowdown in consumer spending.

We were very strong in mature countries like the U.S. France, and the rest of Europe,” Arnault said in a Bloomberg Television interview after the earnings release. “We were also extremely solid in developing countries like China, Asia as a whole, South America and the Middle East.”

“We have to find interesting opportunities with a profitability that would be interesting for our investors, which is not easy,” Arnault said. “We will adapt to opportunities, but it will have to be a high-quality, high-luxury brand.”

News and Related Story Links: