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Hong Kong Turmoil Has Wrecked Luxury Sales. When Will it Get Better?

Social unrest in Hong Kong over the past nine months has gotten progressively worse, and several luxury brands believe the sales pressure in the region will remain a headwind over the short term.

Many protesters have been on a pro-democracy push since March, and tensions have continued to escalate as anti-government demonstrations have also disrupted the Hong Kong International Airport and at local transportation hubs, as well as store closures at key luxury shopping districts. It’s also curtailed tourism in the area, a key contributor to Hong Kong’s economy.

In the latest protest, throngs of demonstrators took over Hong Kong’s Polytechnic University, culminating in a standoff with riot police for several days as troops fired teargas and rubber bullets at anyone who tried to flee. While the number of protestors encamped on the campus eventually dwindled, media reports noted that about 1,000 have been arrested by police and hundreds were treated for injuries from clashes with cops.

The social unrest has also had a significant impact on luxury retail in the sector. In a research note from October on Swiss watch exports, retail analyst Dana Telsey of Telsey Advisory Group said the “steep declines in Hong Kong, often the world’s largest Swiss watch export market (currently the third largest), have pressured the global landscape, with the [Swiss Watch] Federation estimating a 500-basis point negative impact from Hong Kong situation on worldwide exports in October.”

Asia declined 3.5 percent in October after reporting 12.0 percent growth in September, the report noted. That change reflected “significant pressure in the Hong Kong market. Hong Kong exports came in down 29.7 percent for the month (seventh consecutive monthly decline),” the report added.

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Luxury brands have been reporting quarterly earnings reports over the last few weeks, detailing the financial impact from the social unrest.

“Given the disruption, we saw significant declines, particularly in Chinese visitor spend, resulting in sales in Hong Kong falling 38 percent in Q2; down 22 percent for the half,” Julie Brown, chief operating and chief financial officer of Burberry Group plc, said during the company’s conference call on Nov. 14.

Burberry expects sales in Hong Kong to remain under pressure and impact the second half of its fiscal year, Brown said. “We do expect to have quite a significant impact because in the second quarter,” she said of what to look for in Q3, because “we’ve had two months out of the three being impacted.

“In the third quarter we’re actually expecting all three months to be fairly seriously impacted given the status we’ve got at the moment in that market,” she explained, noting that disruptions in Hong Kong will negatively impact third-quarter revenue by $10 million.

“With the impact on tourism and retail traffic, the performance of our store at IFC (Hong Kong’s International Finance Center) has been impacted significantly,” Canada Goose CEO Dani Reiss said on Nov. 13 when the company posted second-quarter results. “The same goes for our recently opened location at Ocean Center, which is the fifth of our nine openings this year.”

Reiss said the company will be monitoring the Hong Kong situation closely and begin examining options to lower costs on the ground, such as renegotiating rents with landlords. “Although we wish that the situation was different today, we are developing markets and building stores for decades, not just for the next quarter,” Reiss said, noting that “strong top-line performances in other markets offset the impact in Hong Kong.”

Jonathan Sinclair, executive vice president and chief financial officer, noted the incremental revenue the company saw from DTC operations in Greater China. Given the effects of the disruption to tourism and traffic, “we’re pleased with how DTC performed,” he said, adding that the “situation in Hong Kong has intensified, [making] the headwind on DTC revenue growth more significant.”

For the second quarter ended Sept. 28, Ralph Lauren Corp. said in November that disruption from the Hong Kong riots saw sales in the region plummet 27 percent, though Asia sales climbed 5 percent and revenue growth in the Chinese mainland was up 22 percent.

“In Hong Kong, where we have several important retail doors, heavy protest disruption drove the equivalent of 48 full days of store closures during the quarter,” Jane Nielsen, chief financial officer, said on a conference call with Wall Street analysts.

“These closures, along with significantly lower tourism, drove declines in our Hong Kong business and negatively impacted our total Asia comp by about three points,” Nielsen said. “While we expect Hong Kong to remain a near term headwind, we are encouraged by continued momentum in the rest of Asia and still expect positive fiscal 2020 comp growth for this segment as we reinvent our distribution network.”

And during an LVMH Moët Hennessy Louis Vuitton third quarter conference call to analysts on Oct. 10, company CFO Jean-Jacques Guiony said the quarter’s drop in business totaled about 25 percent. While that percentage decline in Hong Kong was a combination of the flattish month in July and a 40 percent drop in August and September, the trend has worsened throughout the quarter.

“Hong Kong will probably pay the price for the current situation, not only in terms of volume of business but also in terms of profitability,” Guiony said. “This is a profitable area and we will suffer badly due to the fact that most of the businesses are having fixed cost there and will experience much lower revenues.”

LVMH “will try to react to the situation by lowering our cost base and chiefly the rental cost, which are amongst the highest,” he added. “So there [are] concurrent discussions with landlords. But, obviously, its way too early to say whether these conversations will bear fruits or not.”

Most of the rents in Hong Kong are fixed and short-term, Guiony said, explaining that leases are three to four years with indexation clauses.

In an October report from Knight Frank, David Li, head of research and consultancy for Greater China, said the latest government report at the time of his research showed that retail sales fell for the seventh consecutive month in August. The year-over-year drop of 23 percent, representing the largest ever year-over-year decline for a single month, was “even worse than the record in September 1998 during the Asian financial crisis. An increase in the intensity and extensiveness of the social unrest has further weakened the retail sector.”

On a year-over-year basis, jewelry, watches and other luxury goods suffered the sharpest decline at 47.4 percent, while sales of apparel, footwear and accessories sales plunged 32.1 percent. “The retail environment in Hong Kong will be extremely challenging during the remainder of the year despite the upcoming festive season,” Li said.

On Nov. 1, the latest data from Hong Kong showed that retail sales volume dropped 20.4 percent year-over-year in September. The August decline in Li’s report was revised downward to 25.2 percent.

Retail sales data for October will be available on Dec. 2.