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By Brian Sozzi

Shares of the world's most prominent Western luxury goods purveyors were some of the hardest hit in the consumer discretionary sector as the Great Recession wrapped its arms around equities markets and squeezed. From 2005 to 2007, there was simply an insatiable appetite by U.S. consumers for handbags, coats, wallets, watches, and sunglasses donning designer labels and fat price tags. That demand by U.S. consumers, in effect fueled by paper wealth in stocks as they went through the roof, zero savings, and equity extraction from homes was obviously unsustainable. At the time, the primary focus by luxury goods companies was to open new mall-based stores in the U.S., gain increased points of distribution at U.S. department stores, and ratchet up price points on merchandise that was as "needed" as a third head. Leveraging a luxury brand's cachet globally by extending into new product lines took a backseat to the low hanging fruit of opening new U.S. stores in non "A" rated malls to capture an irrational consumer. What about websites? Many luxury goods companies in no way boasted the enriching online experience that can now be seen at a click of the mouse on or

The wealth effect brought about by an 80% advance in the S&P 500 and other risk assets since the March 2009 nadir in fear has reawakened high-income households to spend on non-essentials. Are those luxury goods aficionados in the U.S forgetful of the lasting impacts of the Great Recession? Not really as many appear to be plunking down the loot on "investment" pieces that offer identifiable quality and that have lasting appeal rather than buying six Hermes handbags, as was the case back in 2005-2007.

That said, I believe there are important trends in luxury that can help shed light on why Polo Ralph Lauren (NYSE:RL), Coach (NYSE:COH), and Tiffany & Co. (NYSE:TIF) have share prices at 52-week highs and trading activity that suggests further gains barring a shock to the markets (one shock would be not extending the Bush era tax cuts, which many expect to be extended for two years post the Republican House rout).

Larger Themes

China: The rise of the "Me Generation" and overall ascent of the middle class is unlocking a thirst for Western luxury brands. Companies are aggressively opening new stores in the Mainland and even in second and third tier cities, and charging higher prices for their products simply because the demand has gone unabated. The earnings opportunity for luxury retailers are sizable. For example, Coach produced $100 million in revenue in its FY10 reporting period and yet the business is not profitable (market outlined to double in next four years). Once the store base is expanded materially and infrastructure investments concluded, as expected to be the case over the next three years, the earnings contribution will be quite large. Polo Ralph Lauren just assumed direct control of its Asia Pacific operations from its licensee. "Other" sales only account for 2% of Polo's annual sales currently.

New Usage Occasions: Much has been heard about luxury goods companies catering to a thriftier U.S. consumer by designing products that are cheaper up front. Some examples include Tiffany's "Keys" collection, Coach's "Poppy" collection, and Movado's (NYSE:MOV) "Series 800" line with rubber bands. However, a story that has yet to be told in its entirety is that luxury goods companies have finally become less reluctant to expand into new product lines. Tiffany's redesigned and expanded handbag collection is off to a strong start, and one can't help but to click on the sunglasses tab on the website. Coach, on the other hand, is taking its brand equity to go after men's globally. Essentially, these companies are creating new platforms for future growth.

Near-Term Considerations

In the near-term, there are reasons that explain why a Coach is able to come out of left field and handily beat consensus earnings estimates....

1. Re-stocking of U.S. department stores, which only happens if real-time sales data has stabilized and expectations of future demand have improved.
2. Willingness by high income households to engage full-price stores to purchase pieces and get the customer service not offered at wholesale points of distribution.
3. Factory store momentum driven by aspirational shoppers (those that traded up in 2007). Retailers are armed with made for factory products, which are margin favorable.


I continue to think the luxury retail sector is worthy of investor attention. Not only are U.S. comps stabilizing to surprising analyst forecast models, but international is increasing as percentage of sales and operating profits (great during a period of U.S. dollar weakness). In looking at our retail sector coverage, luxury goods stocks trade at P/E multiple of 17.7x forward earnings estimates, a five point spread over the S&P 500, but not absurdly expensive given the turn in U.S. demand, strong global volume that is offsetting higher costs, international, and U.S. business trends surprising to the upside.

Disclosure: No positions