‘Unstoppable’ Luxury Stocks Remind Some Investors of U.S. Tech

(Bloomberg) -- The coronavirus pandemic is still raging throughout large parts of the world and China is facing a resurgence of the outbreak, yet investors keep pushing luxury-goods stocks higher, undeterred by near-record valuations.

The combination of robust Chinese spending growth and a strong start to the earnings season is seen supporting stocks such as LVMH, Hermes International and Kering SA, all of which reached record highs in the past two months. The quality of the businesses and their substantial position in the stock market are causing some investors to compare the companies to U.S. technology behemoths.

“We view European luxury companies as the European stock market equivalent of U.S. tech: businesses that are unrivaled in their global dominance,” said Giles Rothbarth, manager of the Blackrock European Dynamic Fund. Some companies in the sector with the best prospects are still attractive even after recent share price performance, he said.

Cartier owner Richemont, the first major luxury player to report sales for the last three months of 2020, set the tone on Wednesday with quarterly jewelry revenue that far exceeded expectations in spite of renewed lockdowns and no recovery in travel, fueling further gains in the sector.

French conglomerate LVMH, one of the biggest stocks in the Stoxx Europe 600 Index and a bellwether for the industry, is likely to “shoot the lights out relative to peers” when it reports results on Tuesday, given the strong momentum at its Dior and Louis Vuitton brands, said Swetha Ramachandran, the manager of GAM’s Luxury Brands Equity Fund.

While high spenders can’t splurge on travel and restaurants with many major economies under lockdown, they are choosing to buy luxury objects instead, powering sales for the best-known brands, she said.

“Mega-brands seem unstoppable,” Luca Solca, an analyst at Sanford C. Bernstein & Co., said in an interview. Growth is being fueled by Chinese consumers shopping in their home market at higher prices because of Covid-19 and snapping up “what they deem indispensable rather than nice-to-have,” which helps the top brands, he said.

Companies such as LVMH, which just acquired the U.S. jeweler Tiffany & Co., are considered high-quality, cash-generating assets that will continue benefiting from long-term structural trends such as the emergence of the Chinese middle class and from diversified, best-in-class brand portfolios that help reduce risks.

Some analysts see reason for caution, because Covid-19 restrictions will still hurt the sector this year and a return to normal could mean customers splashing out on travel and eating out rather than on the latest handbag.

The stocks are “priced for perfection,” said Francesca DiPasquantonio, a Deutsche Bank AG analyst who recommends buying only one, Richemont, among the 13 she covers. Valuations have become “complacent with no acknowledgment for risks,” she said.

Analysts at RBC Capital Markets say valuations look “stretched,” with luxury stocks as a group selling for about 40 times this year’s estimated earnings versus the 10-year average of 23 times.

That’s pricier even than many of the U.S. tech giants that have been momentum favorites in the stock market for the past year. Google parent Alphabet Inc., for example, fetches about 27 times estimated earnings, Apple Inc. is priced at 33 times and Facebook Inc. sells for 24 times profit.

Many investors are undeterred, saying the industry is benefiting from an economic recovery in China. The market is probably pricing in a much stronger rebound in earnings this year than forecast by analysts, said Cedric Ozazman, chief investment officer at Reyl & Cie. in Geneva.

“I am not afraid of lofty valuations and I’m still very bullish on the sector,” he said. “The strong appetite for luxury names is accelerating in China.”

Deutsche Bank predicts that luxury companies will report 18% sales growth, on average, this year, which is likely to drive a 95% rebound in earnings in spite of a soft beginning to the year due to Covid-19, which could potentially affect China’s Lunar New Year holidays next month.

Continued positive earnings surprises will “be essential to maintain such stock levels but we will very probably see more of those,” fueled by price increases in the industry, cost cuts and a shift to online sales, Bernstein’s Solca said.