Hugo Boss (OTCPK:BOSSY) and Burberry (OTCPK:BURBY) (OTCPK:BBRYF) reported better-than-expected results for the quarter ended December 31, confirming an improving trend in the fashion and luxury industry. Hugo Boss now expects sales and operating profits to reach the upper end of its previous forecast, while Burberry beat sales estimates and reported strong comps. Both companies benefited from a recovery in spending in Asia Pacific, thanks to Chinese consumers. These events can be seen as bullish signals for the whole industry. The reason is that the negative trend in China and other emerging markets, which was the main reason behind the weakness in fashion and luxury stocks, may be reverting, setting the stage for another uptrend in the industry.
Hugo Boss Raising Guidance
My first article on Seeking Alpha contained a suggestion to buy Hugo Boss shares. While the stock was consolidating in the €46-60 area, I published a few articles which confirmed my bullish view.
Hugo Boss, like many other companies in the fashion and luxury industry, has been affected by negative external events, such as a strong dollar and declining tourist spending. Recessions and slowdowns in emerging markets such as Russia, Brazil and China have led to capital outflows in those countries and to an appreciation of the USD against other currencies, as the USD was considered safe. The weakness of domestic currencies had a negative impact on the purchasing power of tourists. At the same time, concerns about terrorism in Europe and North America led many tourists to postpone their trips, or to choose other destinations. The negative environment has led to several quarters of negative performance and fueled a 60% correction in the stock price, which is still trading 50% below the top reached in April 2015.
On several occasions, I said that these problems were temporary and that the decline was exaggerated. Therefore, I was very happy to read that better-than-expected sales in Q4 meant 2016 operating profit would reach the upper end of the previous forecast. The company said its sales in Q4 totaled €725 million, down 3% from the corresponding period in 2015. The company also declared that full-year sales were about 2.69 billion euros ($2.85 billion), down about 4% on 2015, or 2% on a constant currency basis.
The company wrote:
In Europe, sales increased 2% on a currency-adjusted basis mainly due to robust growth in the UK. Revenues in Germany were up, too. In the Americas, sales were down 14% in local currencies. However, the Asian business was 5% above the prior level. In Mainland China, HUGO BOSS achieved comp store sales increases of close to 20% adjusted for currency effects.
We can understand that the weakness in the U.S. (due to declining tourist spending) has led to heavy discounts in the retail space. At the same time, the company is restructuring its operations in the country, reducing the number of stores and terminating its relationship with those that sell its products at excessive discounts.
While it's good to see strong performance in Europe, I think the most important developments come from China. A recession in China and declining spending from Chinese tourists were the main factors that triggered the weakness in the industry. This means that a reversal in this trend should trigger very positive results.
On one side, improved comps in mainland China suggest that growth prospects are not that bad. On the other side, a more stable currency should help a recovery in Chinese tourist spending in the U.S.
The company added:
Sales in the own retail business (including online and outlets) improved by 4% on a currency-adjusted basis in the fourth quarter. On a comparable store basis, revenues decreased by 3%. However, this represents a significantly lower rate of decline compared to earlier in the year. Sales in the wholesale business were 13% below the prior year level in local currencies. Continued efforts to clean up distribution in the US had a material impact on performance.
I think that the combination of strong retail performance and solid growth numbers in China are signals that should not be underestimated. While I can't predict growth numbers, I can see that the negative trend in revenue and sales has significantly decelerated after other companies in the fashion and luxury industry such as Hermès (OTCPK:HESAF) (OTCPK:HESAY), Tiffany (NYSE:TIF) and Brunello Cucinelli (OTC:BCUCF) (OTCPK:BCUCY) reported strong numbers thanks to the positive contribution of Chinese consumers.
I think the improved guidance is a signal that confirms both my bullish thesis on the stock, and an improving environment in the fashion and luxury industry.
Burberry Beating Estimates
Burberry published a trading update for Q3 on January 18. The company reported revenue at £735 million, up 4% on the corresponding quarter in 2015. The market was expecting a 3% gain.
Comparable sales rose 3%, aided by a recovery in the Asia-Pacific region, with an acceleration in China and an improvement in Hong Kong. Similarly to Hugo Boss, the performance in Europe was good, especially in the UK and France, while results in the Americas remained weak, but the decline was less than in 2015.
We know that the strong results in the UK (comps rising 40% y/y) were helped by the strong depreciation of the pound after the Brexit vote. The fashion and luxury industry has shown to be particularly sensitive to currency fluctuations, with tourists changing their destinations following favorable currency movements. As I said in the paragraph about Hugo Boss, the appreciation of the dollar was the main reason of the weakness in the fashion industry. Conversely, the depreciation of the pound had a positive impact on tourism and attracted customers from China and many other markets. Tourism in the UK has boomed since the Brexit vote, and we don't know whether this trend will continue, as it largely depends on currency rates.
Burberry is an iconic brand in the British fashion industry. The company has been able to maintain high margins, low debt and constant free cash flow for many years. I have no doubts that the brand will remain attractive for many years to come. But since the recent rally was helped by currency movements, which likely will have a lower impact in the future, I think we should not bet the farm on this stock.
After the weakness in the last few years, Burberry needs a catalyst to unlock earnings growth and justify the current valuation. The stock is trading at a P/E above 28 and a P/S close to 3.0, which is basically in line with peers with similar operating margins, such as Salvatore Ferragamo (OTCPK:SFRGF) (OTCPK:SFRGY) and LVMH (OTCPK:LVMHF) (OTCPK:LVMUY), but I think there is more uncertainty around its results in comparison to those peers. Nonetheless, a catalyst could be a further improvement in spending from Chinese consumers and tourists, which would act as a rising tide that lifts all the boats.
Hugo Boss raising guidance and Burberry beating estimates are signaling that the environment in the fashion and luxury industry is improving. Similarly to other players in the luxury industry such as Brunello Cucinelli, Tiffany and Richemont (OTCPK:CFRHF) (OTCPK:CFRUY), the two companies reported a good performance in China, signaling that the negative trend that has affected the industry is likely reverting.
I have already exposed my bullish view on other stocks in the industry, such as Fossil (NASDAQ:FOSL), Michael Kors (NYSE:KORS) and Ralph Lauren (NYSE:RL). While they operate in different segments, all these stocks benefit from a good macroeconomic environment in the emerging markets, especially in China. I think the positive results from companies operating in the luxury industry are valid from players in the affordable luxury segment as well. All the stocks I mentioned will benefit from a recovery in tourist spending and the positive results from Hugo Boss and Burberry are just a further confirmation that something in the industry is changing for the better.
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Disclosure: I am/we are long BOSSY, KORS, RL, FOSL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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