How will an Asian slowdown affect luxury firms?
Luxury firms have long been blinded by dollar signs from Asia's consumer potential, being home to 50% of the world's population who are drawn to luxury like moths to a flame. The potential comes from three areas: rising average incomes, a growing middle class and the rise of the 'mega rich'.
Which is why investors were eagerly awaiting Burberry's (BRBY) first-half results announced on Wednesday. Underlying revenue growth at 30% was better than expected, with the company flagging a 30% growth in China.
Investors have already sent Burberry's shares up 900% since its 2008 lows, before China worries sent the shares tumbling down 28% over the past two weeks.
For more on China - and its fellow BRIC nations - visit our guide to BRIC.
Money, money, money
Earlier this year, investors were left smacking their lips as they capitalised on Burberry's 30% sales exposure to Asia (China contributing towards half of that). Asia's growth may be slowing, but the region still has a burgeoning middle class with disposable income to burn.
According to management consulting firm The Boston Consulting Group, approximately 170 people join the middle class in the emerging markets every minute, with China, India and Indonesia leading the growth.
The Merrill Lynch and Capgemini World Wealth Report states that high-net worth individual (HNWI) financial wealth for the Asia Pacific region is forecast to grow at a compounded average rate of 12.8% from 2008-2013, above the expected global average of 8.1%, while a report commissioned by Julius Baer/CLSA concluded that the number of millionaires in Asia is expected to more than double by 2015.
All these factors represent discretionary spending power that is expected to drive luxury goods sales in Asia in the next decade.
And China is the jewel in the crown for this growth. The 2011 Weath Report from Hurun, China's leading luxury business magazine, stated that China had 960,000 individuals with a personal wealth of $1.5 million (c£0.95 million) in 2010.
According to McKinsey's The coming of age: China's new class of wealthy consumers, 80% of China's 'wealthy' consumers are below 45 years old, with households earning over $25,000 spending 75% of their income on discretionary consumption.
In addition, the study stated that "the 13 million households comprising China's upper middle class (incomes between 100,000 and 200,000 renminbi, or $15,000 to $30,000) offer the biggest growth opportunity... we expect to see 76 million households in this income range by 2015".
What goes up must come down
Yet it would be wrong to highlight Asian data points on the way up, and ignore them on the way back down.
Shares in Sparkle Roll and Brilliance China Automotive Holdings (distributors of luxury cars in China) plummeted 11% and 14% respectively in the past fortnight before recovering the losses. BMW and Mercedes are offering 20% discounts on selected models as demand for some luxury cars in China has "cooled". Daimler's luxury car brand Mercedes-Benz has said that the sales environment in Asia is turning "a bit more challenging". And pop went the Chateau Lafite when, for the first time in 17 years, Sotheby's failed to sell all of its wine to China's wealthy.
Does this mean that the luxury trade in China is over? Not at all. But clearly, the rate of change of demand is slowing. In fact, Sam Hart, retail analyst at Charles Stanley, says that this slowdown is inevitable; even healthy. "Burberry products are an affordable luxury, unlike luxury cars - people may be quite prepared to spend a few hundred dollars on clothing," he says.
But prospects of a China slowdown is spooking investors. Shares in Mulberry (MUL) (which have risen 225% this year) fell more than 7% on 4 October as it proclaimed that it intended to double its Asian footprint.
Fashion is made to become unfashionable
Even if China isn't slowing down, investors should remember that it only makes up around 15% of Burberry's total sales. Burberry is still very dependent on how the rest of the world behaves.
Historically, there has been a strong correlation between demand for luxury goods and global GDP growth - both of which have been softening over the last couple of months: the IMF downgraded global growth expectations in July, citing the Greek debt crisis and weak US growth, both of which have only gotten worse. The MSCI World Index is now down 15% year-to-date.
In fact, Wednesday's results show that European growth slowed 5% from the first quarter to the second quarter despite easier comparatives of 1,250 basis points. The US also only showed a slight revenue acceleration of 1% in the second quarter, again on easier comparatives of 31%.
The last time global growth slowed, Burberry's top-line sales plummeted. Organic top-line growth went from -15% in the fourth quarter of 2008 to -30.2% in the first quarter of 2009 before recovering to -14% in the third quarter of 2009. Over that period, shares in Burberry fell 65% before recovering.
Bulls are saying that it will not be as bad as 2008/09 for two reasons: global growth was in negative territory at that time, but it expected to be positive now. In addition, wholesalers have been less aggressive in re-stocking, given that the macro backdrop has remained difficult, implying that there isn't the high level of inventory sitting in the wholesale channel at a time when demand could collapse.
Still, Burberry's shares are well-owned and fully-valued, trading at a 21 times price/earnings (P/E) multiple to March 2012; in line with its luxury group peer group. "While the premium to the average retailers (who are trading on a 2012 P/E of around 10 times) is justified, Burberry is priced for perfection. Even a slight disappointment will see a sell-off in its shares," says Hart.