"Fitch expects 2009 to be, with the exception of a few countries, a challenging year in terms of demand for luxury goods. These concerns are only partially mitigated by the fact that the Asian region, excluding Japan, and parts of South America could remain a positive contributor to the overall performance of the European luxury goods industry," says Johnny Da Silva, Director in Fitch's Corporate Finance team.
Overall, Fitch believes the recently reported pressure on luxury goods companies' operating margins should continue through to 2010, due to the reduction of scale benefits from lower production, trading down by consumers in their choices and the need for companies to maintain momentum in product innovation and brand visibility. This pressure could be partially alleviated by a re-allocation of resources, including investments in communication, innovation, and new store openings, in favour of companies' core leading brands. Furthermore, to withstand the economic environment, large European luxury, alcoholic beverages and cosmetics groups, including LVMH, PPR, Diageo and L'Oreal have announced cost optimisation programmes.
From a credit perspective, Fitch views positively measures recently introduced to protect credit quality, which include cutting down share buyback programmes, as demonstrated by Diageo and L'Oreal, as well as higher discipline in the management of working capital. Also, as Fitch expects most of these companies to emphasize organic growth, acquisition risks should diminish. The impact of the financial crisis should, in the medium term, reinforce the dominance of the large international players and brands characterised by a wide and loyal customer base. Furthermore, with the exception of those companies that had major M&A activity in 2008 such as Pernod Ricard SA, ('BB+'/Negative/'B'), the agency notes that balanced capital structures are likely to provide support to the credit profiles of larger companies.
The agency notes that smaller, less diversified industry players, who were already suffering from thin margins and low free cashflow generation are now experiencing more difficulty. Also, availability of liquidity is now becoming, in a more credit rationed environment, a major issue for these smaller companies. As an example, these issues have been key for UK-based luxury tableware company Waterford Wedgwood, which went into administration in January 2009.
The impact of the global economic downturn highlights both geographic and product diversification as key factors of resilience. Results reported for 2008 highlight that during Q408, when the global financial crisis intensified, demand for luxury products experienced a particularly severe correction in the USA and Japan whilst already sluggish performance in western Europe was further exaggerated. However, demand remained buoyant for longer in Asia and parts of Eastern Europe and companies including L'Oreal SA, LVMH and Pernod Ricard were still able to maintain double digit revenue growth in 2008 in these regions. Sales performance also differed widely by product categories, for instance, sales of champagne were(down by 5% in 2008 and)luxury watches were also severely impacted, with Richemont for instance reporting a 11% fall in divisional sales at constant rates for the quarter ending 31 December 2008. Conversely, the most established international brands in the Fashion & Leather products category, including Hermes, LVMH's Louis Vuitton, PPR's Yves-Saint Laurent appear to be demonstrating resilience.
In 2009, Fitch also notes that companies should benefit from improved pricing on their media and communication purchasing, and that the allocation of this expenditure will most likely be shifted in terms of geography and away from past rising "stars" in favour of the already well established brands. Fitch expects most luxury companies to maintain or only slightly reduce their typically high marketing and selling costs of between 20% and 30% of sales.
