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HSBC Report: Scale is a Competitive Advantage in the Luxury Sector

Financial institution HSBC sees the ability to scale as a huge advantage in the luxury sector, with very few exceptions, while mergers and acquisitions can provide some benefits.

The authors of “Too Bling to Fail,” analysts Erwan Rambourg, Antoine Belge and Anne-Laure Bismouth, also concluded that a “soft landing” scenario is unfolding for the luxury sector in 2019.

Because luxury is a fragmented market, the analysts said the ability to dominate the social media conversation and win the real estate battle in shopping malls and in high street locations can be differentiating factors among brands. They note that scale in advertising impacts share of mind on social media, and general buzz in any Google search. And the bigger players can control their image online as they generate traffic at their own sites and on WeChat mini programs. The smaller players must go to a third-party platform for traffic and conversions, and therefore run the risk of “disintermediation” with their end consumers, the analysts concluded. Besides outspending the smaller players when it comes to getting the best locations, bigger brands have the wherewithal to invest in data analytics, CRM systems and other options, like concierge services, to attract new customers and keep existing ones happy.

Typically, the ability to scale is found in the larger conglomerates that are multi-branded, one understandable rationale for American firms like Tapestry Inc. and Capri Holdings Ltd. to want to have a diversified brand portfolio instead of relying solely on its original core brand. Tapestry was formerly Coach Inc. and Capri was originally Michael Kors Holdings Ltd. The only exceptions to the multi-brand versus monobrand model, HSBC said, are Hermès International S.A. and Chanel S.A. The former because in some categories demand exceeds supply, and the latter because of the perception of timeliness.

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What’s more, multi-branded firms have the ability to zero in on qualitative cost synergies, versus solely financial benefits. If one brand excels in one area, that team can become a sounding board and provide a “best practices” model for other brands.

“If a specific brand has exceptional managers, some may step up to run others in the portfolio. To that point, scale and diversity are placing larger groups ahead in terms of talent, acquisition, retention, promotion,” HSBC said. The analysts also noted that grouping brands work in businesses that are wholesale-driven, and less so for those that are more retail focused.

While the report said there’s likely not too many synergies to be garnered by acquisitions in the luxury space, deals will still get done either because a company is buying for the long-term growth prospects of the targeted firm, or because the buyer thinks it can do better than existing management at the brand that’s up for sale.

That makes M&A deals more of a secondary, or collateral, benefit to most luxury firms. With cash piling up and valuations coming down slightly, HSBC said sellers might want to do an exit before the next recession hits. The most likely buyers are LVMH Moët Hennessy Louis Vuitton SE, Compagnie Financière Richemont SA, Kering Group, Tapestry and Capri, while SMCP Group (the owners of Sandro, Maje and Claudie Pierlot), Moncler S.p.A. and Prada S.p.A. could actually become the new acquirers, the analysts predicted.

As for the soft landing scenario, HSBC forecasted continued luxury spending in China for this year. With China representing 38 percent of the sector’s sales, analysts are predicting more risk of a slowdown in spending from the U.S. and Japanese consumers this year than from their Chinese counterpart.

Given the “big outpaces small” theme, it’s no surprise that, from an investment point of view, analysts have a preference for shares of LVMH, Kering and Richemont. All three stocks have a “Buy” rating. Of the three, Richemont’s holdings in jewelry and watch brands Cartier and Van Cleef & Arpels account for the bulk of its assets, but it is growing the social media communication around its Yoox Net-A-Porter holding. Other firms that also have “Buy” ratings include Capri, Tapestry, SMCP and Hugo Boss.

HSBC analysts also have maintained their “Reduce” rating–the equivalent of “Sell”–for Tod’s S.p.A. and Salvatore Ferragamo S.p.A. Both are viewed as facing increased margin pressure due to weaker-than-expected top line growth.

They also maintained their “Hold” rating on shares of Burberry Group PLC and Hermès, but more importantly downgraded Prada and Moncler. The downgrades for both Prada and Moncler were each from a “Buy” rating. The reasoning was that Prada will likely find it harder to sustain strong top line growth with Louis Vuitton and Gucci “dominating the space,” while at Moncler, despite best-in-class execution, creative projects and a solid bench of managers, the stock valuation is now “quite high” given what the analysts said was a steep basis of comparison for the first half of 2019.