Investing in Luxury Brands as a Chinese Consumer Play

by: China Play Stocks

As incomes raise, Chinese consumers are acquiring expensive tastes for luxury brands and high-end fashion items. You can benefit from their increased consumption of such products by investing in the companies that produce them. Be aware that, much like the products they sell, many of these company stocks are expensive (on a P/E basis) as well. But, I don't believe that the China story is fully reflected in these stock prices, lofty as they may be.

In addition to benefiting from the aspirational status-conscious nature of the increasingly prosperous Chinese consumers, foreign luxury brands also benefit from little regulation and interference from the Chinese government. There are no "national champions" in this space. The Chinese government likes the jobs that these companies create (goods are still produced in China), and the business process sophistication that these brands bring to China.

In addition, this sector is not very capital intensive and the margins are quite high. These companies are best equipped to pass on commodity costs to consumers, since the items are high-end and discretionary, and the government's inflation fight won't affect the prices for such items. The government only imposes price-caps on consumer staples like food and energy, not on luxury items.

Pundits estimate that China would surpass the United States as the world's largest luxury market within five to seven years. Piracy and counterfeiting are problems facing this sector since many buyers purchase Chinese-made inexpensive knock-offs, at steep discounts over the Internet and in Chinese stores, knowing fully well that these are not genuine; if they are only trying to impress their friends and neighbors, it won't matter much.

In addition, Chinese are becoming global travellers, and luxury shopping is high on their tourist agendas. So, on trips to Paris, New York, London, Milan, and nearby Hong Kong / Macau, Chinese tourists are loading up on these luxury products, and paying top dollar for that privilege. Taxes and import duties make these luxury goods cheaper abroad than at home; LVMH's Shanghai retail prices are apparently 35% higher than its Paris retail prices. Chinese tourists also know that they can avoid getting ripped off by knock-offs by purchasing in these reputed overseas retail outlets.

  • LVMH Moet Hennessy Louis Vuitton SA (OTCPK:LVMUY) – This French giant is the world's largest luxury goods company, and is diversified with 60 luxury brands, ranging from its signature Louis Vuitton luggage / handbags, perfumes, TAG Heuer and Zenith watches, Chaumet jewelry and fine wines/spirits.
  • Compagnie Financière Richemont (OTCPK:CFRUY) – This Swiss company makes many high-end brand-name luxury goods (jewelry, watches, apparel) including the famous French subsidiary, Cartier watches and jewelry, and the French luxury label Chloe. Cartier was the most preferred jewelry brand of Chinese millionaires.
  • Swatch Group AG (OTCPK:SWGAY) – This Swiss giant is the world's largest watch-maker and seller of the famous Omega brand watches. It has noted that Hong Kong (and by extension, China), is the single largest market for its products.

  • Hermes International (OTCPK:HESAY) – French luxury goods maker, part-owned by LVMH. Especially renowned for its premium silk scarves, ties, Kelly and Birkin handbags
  • Gucci (OTC:GUCG) – This Italian fashion and luxury goods maker, is renowned for its luxury handbags.

  • Bulgari SpA (OTC:BULIF) – This Italian maker of luxury watches, jewelry and perfumes, is the world's third-largest jeweler. LVMH recently took a controlling (51%) stake in Bulgari. Bulgari has 20 stores in China out of 286 worldwide, but trails rivals like Swatch Group in China.
  • Coach Inc. (NYSE:COH), Tiffany & Co. (NYSE:TIF), Estee Lauder (NYSE:EL), Polo Ralph Lauren (NYSE:RL) – All these American luxury and aspirational brands are doing good business in China and Hong Kong. The story is the same for all of them, more or less: expensive stocks that sell over-priced products that the status-conscious Chinese crave for.
  • L'Occitane International SA (HK:973) – This French company, a recent Hong Kong IPO, makes cosmetics and personal care products. The beauty company derives half of its sales in Asia, with an increasing share from mainland consumers.
  • Daimler AG (OTCPK:DDAIY) – Maker of Mercedes-Benz, the ubiquitous "mass luxury" brand. Globally, Mercedes has been the gold standard for decades, and China is no exception. It expects 2011 China sales to go up 60% from the 50,000 units it sold in 2010. It is off to a good start as January 2011 China deliveries were up 87% from a year earlier, to 15600 units.
  • Bayerische Motoren Werke (BMW) AG (BAMXY.PK) – In addition to the flagship BMW brand, it also owns the British Rolls-Royce luxury auto brand. It expects to continue its double-digit growth in China.
  • Volkswagen AG (OTCPK:VLKAY) – VW was early to move into China and continues to enjoy the early mover advantage both in the mass market and in the luxury market; sales in China, VW's biggest market, advanced 37% last year. It's Audi, Lamborghini, and Bentley luxury brands enjoy the same niche as BMW and Mercedes-Benz. VW is merging with Porsche SE thereby adding another marquee brand to its roster; VW already owns 50% of Porsche, which is quite popular in China.
  • Apple Inc. (NASDAQ:AAPL) – OK, Apple isn't exactly a "luxury" item, but it is a high-end discretionary and "fashion" item nevertheless. Like their counterparts elsewhere, Chinese citizens are lining up to buy Apple iPhones and iPads. This is impressive considering the countless Apple knockoffs available in China's grey markets; this is a rare instance where China's piracy and IP theft has not hurt the concerned Western company. Apple's flagship Shanghai retail store is reportedly its most profitable on a per square foot basis. More interestingly, Apple's iPhones and iPads are priced higher in China (something like 30% premium) than in the U.S. Apple delayed entering this market; so, the full effects of the China consumer play on the earnings growth for this stock may yet to be felt. Skeptics and bears may well find, to their dismay, that this stock continues to defy gravity, now thanks to new demand from China.

Of course, this list is far from exhaustive. But consider these stocks as a partial list of companies that benefit from China's increasing hunger for luxury and aspirational brands. With these names, you don't need to worry about inflation, slowdown, government price-caps etc. The rich Chinese consumers will continue to splurge on these luxury brands for years to come.

Disclosure: I am long most of the stocks mentioned.