Trade war threatens reign of luxury stocks

LONDON/PARIS, Aug 10 (Reuters) - An escalating trade war between the United States and China could abruptly end a glittering stock market run for luxury goods firms, with some investors already put off by lofty valuations in a sector powered by shoppers in the two countries.

From pricey handbags to designer shoes, booming sales at the European companies that dominate the industry like Louis Vuitton owner LVMH and Gucci parent Kering have made them investor favorites, with shares still near record highs.

But the possible trickle-down effect of tit-for-tat tariffs hikes on consumers is adding to jitters over heady valuations, even though luxury firms are not as directly threatened by rising protectionism as carmakers and industrial companies.

RELATED: Impact of trade tensions between US and China

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Impact of trade tensions between US and China

Head chef Liang Xin poses with a piece of beef imported from the U.S. in the kitchen at Wolfgang's, a high-end steak house in East Beijing's Sanlitun district, China, April 6, 2018. Liang said U.S. beef has always been limited in China, so he doesn't know how customers would react if the restaurant has to raise prices.

(REUTERS/Thomas Peter)

Liu Anqi rolls dough in flour made from imported grain at the baking studio she runs with friends, in Beijing, China, April 12, 2018. Liu has just opened a bakery in Beijing with her friend. She also teaches customers how to make cakes with a brand of flour that uses only wheat from the United States and Canada. "Flour is one of the most important ingredients in baking and its quality varies with different brands," Liu said, adding that finding a new brand would be time-consuming and higher taxes on this wheat would force her to raise cake prices and tuition fees, which could turn customers away. 

(REUTERS/Thomas Peter)

A detail of the Harley-Davidson brand name is photographed on the motorcycle of Guo Qingshan in his village outside Beijing, China, April 7, 2018. "I love the sound of the engine and the muscle of the motor. When I ride it, I feel free and proud," Guo said. However, Guo has his limits. If prices rise, Guo said he wouldn't contemplate buying another Harley. 

(REUTERS/Thomas Peter)

Fried vegetables are seen in the kitchen of the restaurant where chef Liu Ming works, in Beijing, China, April 11, 2018. Liu said the oil that his restaurant uses is produced with soybeans imported from the United States, and the business won't change the brand even if prices rise. "We use this oil because it gives the food a bright colour and does not leave a strange smell or taste," he said. "We don't know what will happen to our dishes if we change the oil."

(REUTERS/Thomas Peter)

Xie Guoqiang, who runs the Vin Place wine and liquors store, poses for a photograph inside the shop in Beijing, China, April 10, 2018. Xie said in an interview that the tariffs would have little impact on his business, as the shop mostly imports wine and liquors from France, Chile, Austria and Argentina.

(REUTERS/Damir Sagolj)

A bottle of Jack Daniel's Tennessee whiskey is seen on a shelf at the Vin Place wine and liquors store in Beijing, China April 10, 2018. Xie Guoqiang, who runs Vin Place, said in an interview that the tariffs would have little impact on his business, as the shop mostly imports wine and liquors from France, Chile, Austria and Argentina.

(REUTERS/Damir Sagolj)

Liu Ming, a chef at a Sichuan restaurant in Beijing, poses for a picture at the back door of the kitchen where he works in Beijing, China, April 11, 2018. Liu said the oil that his restaurant uses is produced with soybeans imported from the United States, and the business won't change the brand even if prices rise. "We use this oil because it gives the food a bright colour and does not leave a strange smell or taste," he said. "We don't know what will happen to our dishes if we change the oil." 

(REUTERS/Thomas Peter)

Liu Anqi uses flour made from imported grain at the baking studio she runs with friends, in Beijing, China, April 12, 2018. Liu has just opened a bakery in Beijing with her friend. She also teaches customers how to make cakes with a brand of flour that uses only wheat from the United States and Canada. "Flour is one of the most important ingredients in baking and its quality varies with different brands," Liu said, adding that finding a new brand would be time-consuming and higher taxes on this wheat would force her to raise cake prices and tuition fees, which could turn customers away. 

(REUTERS/Thomas Peter)

A bottle of oil is seen in the kitchen of the restaurant where chef Liu Ming works, in Beijing, China, April 11, 2018. Liu said the oil that his restaurant uses is produced with soybeans imported from the United States, and the business won't change the brand even if prices rise. "We use this oil because it gives the food a bright colour and does not leave a strange smell or taste," he said. "We don't know what will happen to our dishes if we change the oil." 

(REUTERS/Thomas Peter)

Zang Yi poses for a picture as her Tesla car is charging at a charging point in Beijing, China, April 13, 2018. Zang said if the trade tensions resulted in pricier U.S. imports, she wouldn't consider American brands when the time comes to buy a new car. "With the tariff, I would have to pay tax of 100,000 yuan to 200,000 yuan if I were to buy a new Tesla," she said. 

(REUTERS/Thomas Peter)

Zang Yi charges her Tesla car at a charging point in Beijing, China, April 13, 2018. Zang said if the trade tensions resulted in pricier U.S. imports, she wouldn't consider American brands when the time comes to buy a new car. "With the tariff, I would have to pay tax of 100,000 yuan to 200,000 yuan if I were to buy a new Tesla," she said. 

(REUTERS/Thomas Peter)

A Chinese woman tastes wine during a wine seminar in Beijing, China, April 14, 2018.

(REUTERS/Thomas Peter)

Shan Yuliang, salesperson at a cigarette and wine shop, poses with a carton of Marlboro cigarettes in Beijing, China, April 8, 2018. "The moment I saw the news about the trade war on the internet, I felt something big was coming. Previously I would not think about what brand to buy. Now I will give it a second thought and avoid buying American products to defend my country," Shan said. 

(REUTERS/Thomas Peter)

Wine tasting teacher Li Yangang poses for a picture during a wine seminar in Beijing, China, April 14, 2018. Li said in an interview that reduced sales of American wine in China would not hurt the local market because of its relatively small market share. "Australian wine and French wine would have a bigger impact," he said. 

(REUTERS/Thomas Peter)

Cartons of Marlboro cigarettes are seen stacked up on a shelf between Chinese cigarettes at a cigarette and wine shop in Beijing, China, April 8, 2018. 

(REUTERS/Thomas Peter)

Student He Bingzhang lights a Marlboro cigarette in Beijing, China, April 8, 2018. "I don't think the trade war would change my behaviour. I don't smoke a lot, probably one pack a month. Even if it costs 100 yuan, I would still buy Marlboro because it is affordable," He said. 

(REUTERS/Thomas Peter)

Student He Bingzhang poses for a picture as he smokes a Marlboro cigarette in Beijing, China, April 8, 2018. "I don't think the trade war would change my behaviour. I don't smoke a lot, probably one pack a month. Even if it costs 100 yuan, I would still buy Marlboro because it is affordable," He said. 

(REUTERS/Thomas Peter)

Guo Qingshan poses on his Harley-Davidson motorcycle in his village outside Beijing, China, April 7, 2018. "I love the sound of the engine and the muscle of the motor. When I ride it, I feel free and proud," Guo said. However, Guo has his limits. If prices rise, Guo said he wouldn't contemplate buying another Harley. 

(REUTERS/Thomas Peter)

Beef imported from the U.S. is seen at Wolfgang's, a high-end steak house in East Beijing's Sanlitun district, China, April 6, 2018. A 15-kg whole cut of beef from the United States is around 20 percent more expensive than its Australian counterpart, said Daniel Sui, deputy general manager at Wolfgang's. "Customers like U.S. beef because it tastes juicy and tender, but Wolfgang's only sells around seven to eight pieces of U.S. imported beef steak each day," Sui said. "The limited supply is because the Chinese government bans feed additives and only 5 percent of U.S. beef is qualified for export." 

(REUTERS/Thomas Peter)

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The sector has an average valuation of 21 times 12-month earnings forecasts, according to Reuters data, down from its May peak, but still 23 percent above its 10-year average.

"We are not making a call that they are bad companies, we think they're great companies. But they're bad investments," said Edinburgh-based David Keir, co-manager of the Saracen Global Income and Growth fund, which dropped its LVMH holdings last year and sold out of German suit maker Hugo Boss in early July. "Now there's an incremental risk from the great unknown of trade tariffs as well."

It would not be the first demand-driven wobble the luxury industry has faced. In 2012, a Chinese crackdown on corruption caused purchases of premium cognac and other high-end goods used as gifts to fall sharply, taking the likes of LVMH and Remy Cointreau shares down with them.

This time, tariffs threaten consumers' spending power in both the United States and China – the world's two biggest consumers of European luxury goods, which make up just over half the industry's revenues.

The impact on confidence in China's markets, including the depreciation of the renminbi that would eat into Chinese tourists' budgets for shopping in Europe, is among risks that may not be fully reflected in stocks yet, analysts warn.

"We see very little priced in so far," said UBS analysts, who forecast as much as a 30 percent share price drop in the sector index in the event of a fully-fledged trade war.

Among the stocks that would be worse affected, UBS included Italy's Salvatore Ferragamo and Britain's Burberry. The two brands are in the midst of turnaround plans that have yet to fully hit their stride.

CHINA THRIVING

So far, the knock-on effect on revenues has been muted.

If anything, Chinese demand for Louis Vuitton's leather goods ticked up in the second quarter compared to the first, LVMH reported, while most firms argue their core clientele is here to stay.

"We have still an expansion of the middle and upper class in China," Kering's group managing director Jean-Francois Palus told analysts following the company's half-year results.

Sales in China have been largely driven by a young clientele unafraid of splurging on branded goods, and often financed by their parents and grandparents, with rising property prices also providing a source of wealth.

Even a moderate slowdown in the pace of revenue growth, as is expected regardless of the trade spat after two years of rebounding demand in China, is not enough to spook some drawn to the sector's underlying strengths.

"Demand is really healthy," said Andrea Gerst, co-portfolio manager of GAM's Luxury brands fund, which has stakes in many major European labels. "If comparatives get more difficult, then the absolute madness may not be as strong, but there'll still be healthy growth."

More broadly, global luxury sales are driven by some of the world's wealthiest shoppers who might shrug off any direct impact from tariffs were it to come to that.

"With luxury you've got people who are far less price-sensitive as your customers and so you ask yourself if there's a tax put on and the price goes up a bit, how much is that really going to change the demand?" said Fergus Shaw, partner and portfolio manager at Cerno Capital.

Shaw said his fund owns LVMH shares, and he has not been tempted to sell out, expecting any impact from tariffs to be much smaller than the anti-corruption drive was. https://reut.rs/2MxI3Ww

NERVES

Yet market nerves around the sector are becoming more evident, and luxury companies and industry lobbies are on alert. Even good or in-line results from luxury companies for the second quarter prompted some sharp sell-offs on results day.

Analysts at Kepler Cheuvreux downgraded the luxury sector at the start of July to "underweight," citing trade war worries.

Italy's Confindustria Moda, the national association of textile and fashion companies, said its entrepreneurs feared a possible rise in tariffs and that it was monitoring the situation in the hope of avoiding "a protectionist escalation."

It estimates goods in the sector are already subject on average to 12 percent trade tariffs, and are unlikely to be targeted for increases, however.

Though the bulk of luxury manufacturing is still anchored in Europe, some firms are also weighing whether to make changes to their supply chains should they get caught in the crossfire.

"This is an industry in which we have the capability, as we do and as we have done in the past, to switch capacity from one location to the other as is necessary," Ray-Ban maker Luxottica's finance chief Stefano Grassi told analysts following second-quarter results.

The Italian group, which makes designer sunglasses for Chanel and Versace among other labels, could for example shift more production to the United States if needed, where it has a factory. It also has three in China, while the majority of its plants are in its home base.

(Additional reporting by Giulia Segreti and Claudia Cristoferi in Milan; Editing by Mark Potter)

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