Key Takeaways
- The luxury sector is starting to look attractive, with some high quality stocks traded at a discount to their fair value.
- Profit margins came under pressure in 2024. The negative trend could continue this year due to weakness in demand.
- Inventory management is very important in order to avoid excessive discounting and to shore up balance sheets.
Luxury share valuations have had a rocky path over the past few years. During 2022-23, valuations fluctuated between attractive and overpriced as markets digested the inflation impact on demand, length of lockdowns, and pace of recovery in China, and repeatability of strong postpandemic demand in the West. Most recently, investor expectations about the sector centered on the revival or weakening of demand in the US (affected by stock market performance) and the pace and timing of improvement of demand in China.
Currently, we believe the sector is starting to look attractive again, with some pockets of overvaluation and undervaluation. We don’t see the current cyclical of weakening demand to be long-lasting because, based on the industry’s past 30 years, periods of subdued demand didn’t last more than two years. 2025 is likely to be another year of subdued demand for luxury.
Profit Margins Are Under Pressure
The luxury industry has a high share of fixed costs—selling costs such as rental and employee expenses are largely fixed. Due to this, and the need for some brands to invest more in marketing to boost brand heat (for example, Kering’s Gucci), luxury margins came under strong pressure in 2024 as sales were marginally up or declining. Most companies experienced margin declines in 2024.
Luxury margins could continue being under pressure this year due to likely continuing cyclical weakness in demand and fewer tailwinds from pricing compared with prior years, not fully offset by cost-control measures.
In the longer term, we believe a cyclical rebound and some margin tailwind from the growing scale are to be expected for most competitively advantaged luxury players.
Good inventory management is increasingly important for luxury players, given that excessive discounting and outlet presence can be damaging to brand perception, while destroying unsold goods is increasingly frowned upon or even banned from a sustainability point of view.
The downturn in sales in 2024 led to slower inventory turns for most players in the industry. Inventory turns came at the lowest level since the pandemic, which can be a worrying trend. Leather goods and apparel players were specifically hit by the slowdown, which can be dangerous if excess inventories are offloaded at a discount.
We believe companies that are best positioned to avoid excessive discounting are those with the highest control over distribution—which limits the risk of excess stock in the wholesale channel—and those with strong balance sheets without immediate liquidity needs. Slower-moving carryover items can be dealt with by limiting production until the items are sold, which helps maintain pricing integrity, but weighs on cash generation. Hence, it’s not available as a tool to weaker companies, in our view.
High-Quality Luxury Stocks That Are Still Undervalued
LVMH Moet Hennessy Louis Vuitton MC
- Fair Value Estimate: EUR 620.00
- Morningstar Rating: ★★★★
- Economic Moat: Wide
- Morningstar Uncertainty Rating: Medium
LVMH is the number one luxury group worldwide by revenue, and with its wide moat became attractive in an industrywide tariff-related selloff. Direct impact from tariffs for luxury is limited, given long-term pricing power and high gross margins. Economic fallout from tariffs is more of a danger but over the long term luxury has been resilient despite cyclicality with no technical obsolescence, strong pricing power, and high entry barriers. LVMH has some of the strongest brands in the industry and unmatched scale and financial resources.
Kering KER
- Fair Value Estimate: EUR 360.00
- Morningstar Rating: ★★★★★
- Economic Moat: Narrow
- Morningstar Uncertainty Rating: Medium
Second-largest luxury group by revenue, trading at 26 times consensus earnings (which we believe is close to trough levels), 100 percent-plus upside to our fair value estimate. Although Kering’s flagship Gucci brand is experiencing slowing momentum, with its strong brand recognition, very significant marketing resources, control over distribution (greater than 90%), and access to top managerial and creative talent, Gucci should be in a position to maintain its pricing and desirability in the long run.
Burberry Group BRBY
- Fair Value Estimate: GBX 1370.00
- Morningstar Rating: ★★★
- Economic Moat: Narrow
- Morningstar Uncertainty Rating: High
Despite recent history of sluggish growth, we believe Burberry benefits from high brand recognition, pricing power, and strong control over distribution, which supports its narrow moat. We view current weakness of performance relative to the industry cyclical and operational performance. New designer collections were launched at a price premium, which price-sensitive consumers increasingly didn’t accept. We believe performance can be improved by strengthening cheaper assortments and refocusing marketing on iconic products, which the company is doing.
The Swatch Group UHR
- Fair Value Estimate: CHF 290.00
- Morningstar Rating: ★★★★★
- Economic Moat: Narrow
- Morningstar Uncertainty Rating: Medium
Swatch benefits from a narrow moat through brand intangible assets and manufacturing scale. Its valuation is very appealing as tailwinds are not priced in. Notably, Swatch should benefit from high exposure to Chinese consumption that we expect to recover thanks to pent-up postpandemic demand and long-term income growth. Swatch should also benefit from bottoming out of lower-priced watches as smartwatches, a competitive threat, get closer to reaching maturity as well as from operating leverage through cost-cuts and automation implemented in the past.
