After benefiting from years of soaring Chinese consumer demand, Europe's big luxury companies now face the prospect of dented revenue and profit growth should the coronavirus outbreak continue to intensify and spread.
The scenario is reminiscent of the SARS outbreak, which lasted for more than six months and led to a decline of about 20% in the share prices of luxury goods companies between November 2002 and April 2003. One reason that a worsening coronavirus contagion could be more severe is that the more bullish economic backdrop at the time of SARS made it possible for a quicker recovery. Another reason is the luxury sector's increased dependence on China: Chinese consumers now account for 33% of luxury demand compared to just 10% during the time of SARS.
The number of coronavirus cases in China has already outstripped the total SARS cases recorded in that country. The main risk to luxury companies is the dampening effect this could have on travel and tourism. More than 40% of all luxury purchases are done by consumers when they travel overseas, so a large-scale disruption to the movement of people can have a direct impact on sales.
The travel restrictions are tightening. Last week, the Chinese government put more than a dozen cities under lockdown, restricting the movement of more than 40 million people. The U.S., U.K., Australia, Japan, South Korea and France are among the countries preparing to airlift their citizens out of Wuhan, the Chinese city at the center of the outbreak. Hong Kong is suspending cross border high-speed rail and services and limiting flights to mainland China. On Jan. 29, British Airways canceled all direct flights to and from mainland China for two days.
"The hard luxury players have a higher exposure, which means they could get more impacted by the drop in tourism from the Chinese consumer," said Zuzanna Pusz, analyst at UBS, in an emailed response to Market Intelligence. Pusz added that hard luxury items, such as watches and jewelry, could take a short-term hit because many Chinese buy them overseas, where they are slightly cheaper. Sales of "soft luxury" items, such as fashion, could be affected because of their seasonal nature. "The product may be gone next time" well-heeled Chinese travel abroad, Pusz noted.
Companies such as LVMH Moët Hennessy - Louis Vuitton Société Européenne and Gucci owner Kering SA may be best placed to ride out a coronavirus epidemic, thanks to their high operating income margins. This "gives them more flexibility to control their margins in a potential slow-down scenario, as the advertising and promotion costs are easiest to cut back on," UBS said in a research note.
Header 2Local marketing
Brands need to do be sensitive when marketing themed product during Chinese New Year, especially during a crisis. This means being respectful of their cultural codes as well as ensuring targeted messaging will reach the Chinese audience on the right social platforms.
Header 2Global crisis
The global economy is bracing itself for the impact of the virus as the world relies on China for everything from fashion and car manufacturing to mobile phone technology. Many businesses in China have closed for an extended period of time as the country deals with its biggest crisis since SARS. Major airlines have suspended or reduced carrier service to the mainland, and outgoing travel has also been restricted, with entire cities shut down.
Among the bigger luxury players, Compagnie Financière Richemont SA, Burberry Group PLC and The Swatch Group AG may be more vulnerable. "For companies that have grown somewhat slower this cycle, such as Richemont, their ability to control costs would be lower in a slow-down versus someone like LVMH, which has been over-investing and marketing, making it easier to reduce [costs] now if needed," said Pusz.
LVMH on Jan. 28 reported its full-year 2019 results, the first luxury goods company to announce earnings after the virus outbreak. In his remarks to analysts, CEO Bernard Arnault sounded a hopeful note. "Firstly, it would appear that this virus is not as aggressive [as SARS]," Arnault said. "Secondly, the Chinese government has responded very strongly, very robustly. And given the strength of the reaction, we can assume that their reaction will have consequences, very marked consequences, on the fighting of this epidemic."
As to the potential impact on LVMH's business, Arnault was more circumspect. "I mean, if it lasts a couple of months or if it's resolved over the next two, two-and-a-half months, then it won't be all that bad ... if it were to last two years, it would be a totally different matter." In addition, CFO Jean-Jacques Guiony pointed out that the variable costs were the highest proportion of costs in China, which would give the company room to adjust. "So there will be a mechanical adjustment of costs," said Guiony. "Should there be less business, there would be less costs as well."
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Source: S&P Global