Podcasts

07 May 2021 | Paul Dixey

Investing in Luxury and the Consumer - Part 1

In Episode 6 Part 1, we put handbags and gladrags under the microscope and the performance of luxury goods during the pandemic. Alastair McRobert, Paul Dixey and Tim Gregory discuss LVMH and Nike, along with the power of Jay-Z and Vaporfly…

 

 

 

Read the transcript below:

0:03 Paul Dixey: 

Today I'm joined by Tim again and a newbie to the podcast Alastair McRobert, who covers the luxury goods sector for us at Vermeer Partners, so he'll be super helpful in today's discussion. Today we will be discussing why the luxury sector has done so well in recent years, what competitive advantages these companies possess and what's driven their share prices to recent highs? And finally, how we at Vermeer Partners and also Tim, in his global equity fund, have been investing in the luxury space. So Tim, please kick us off with - why has the luxury sector been so good over the last few years, and also through the last few months as we've come out of the pandemic?

1:30 Tim Gregory: 

Hi guys, good to be here again. So my take on why luxury has performed well is really quite simple actually, the new consumer that the world has had from China - the Chinese middle class and wealthier classes desire to own luxury goods products - has created a whole new wave of demand for these products. And actually, to that point, one of the reasons why the sector has held up so well this year has been that actually, albeit that the Chinese tourist has been not able to travel in the way she or he had in recent years, they have still been able to continue to get product internally from China, where so many luxury goods have very cleverly set up their business models in major Chinese cities, and also online. So actually what everybody feared this time last year, as travel was getting banned and we weren't able to go anywhere, and the only way you could shop was online - in China, they've coped with that really well. And actually investment strategies that luxury goods companies like LVMH, which I know Alastair is going to come on to talk about in a minute, and Kering which owns Gucci, they have been very well positioned to cope with the epidemic and the fallout from that. So luxury goods have continued to do well I think against that against that backdrop.

3:07 Paul Dixey: 

So Alastair, Tim has teed you up nicely there into LVMH which is one of the companies luxury good companies that we've been investing in for a while now at Vermeer Partners. I wonder whether you could give us a bit of an idea as to why we like that company and it’s competitive edge that it has in the marketplace over perhaps some of its smaller rivals.

3:26 Alastair McRobert: 

First of all, a little bit of background first and LVMH which stands for Louis Vuitton Moet Hennessy, which gives you a little bit of an idea as to what it does: Louis Vuitton being fashion and leather goods, and Dior being its other large fashion and leather goods brand, and then Moet Hennessy being champagne and cognac brands. Overall it has 75 fashion or luxury brands and being French it calls them 75 maisons. And what you're starting to see there is a really diversified portfolio of brands not only cross sectors, but also across different categories: across fashion and leather goods, watches and jewellery and wines and spirits too. And one of the reasons we like a diversified approach is that whilst we see the likes of Prada and Gucci as being ever present leaders in the fashion space, Gucci is an example of one that has come in and out of fashion so LVMH, having that diversified approach, helps you to get that fantastic luxury goods exposure, which gives you high margins and as Tim's touched on, that exposure to the high growth Chinese consumer, but with some of that brand risk, diversified away.

4:57 Paul Dixey:    

One of the things that I picked up on LVMH 2020 results is it's pricing power. I think they were able to raise prices throughout that period between 4% and 7%, which is quite something given the concern consumers probably had in terms of how much disposable income they had. So, Tim, I wonder whether you have further comments on LVMH  and, and its strengths - pricing power being one of them. The other thing that I've seen is they do quite a lot of collaborations, o we've got Nike Air Jordan, collaboration with Dior, we have Burberry and Marcus Rashford. We've got Gucci and Mark Ronson. So all of these things seem to help drive, awareness and build the status of the brand and the power of the brand.

5:49 Tim Gregory: 

Well, that's, that's absolutely right. The fact is that, as you said, pricing power has been a massive driver for ever increasing margins for these companies. At the same time, that there has been great elasticity because it does not appear to have made any difference to demand whatsoever. And that is a function, I think, of a wealth effect that we're seeing in general. And indeed, of course, the pandemic has not had such a great impact on the, the wealthy generation of the population, because actually, they haven't tended to lose their jobs in the end. And governments have gone so far out of their way to bridge economies going forward, that in that respect, I think it's enabled demand to remain pretty strong for these areas, and pricing has not come under any pressure whatsoever. I think the other thing that's worth mentioning, which actually is not necessarily related to pricing, and comes back to Alastair's point about why LVMH has done so well, is that it's got to be noted they have made brilliant and timely acquisitions of the businesses they've bought to develop their franchise. Acquisition strategy to so many companies that we invest in alongside organic growth, is always the other piece of the puzzle. As companies generate lots of cash, what do they do with it? Do they make great acquisitions or terrible acquisitions? Do they just pay dividends or buy back shares or build up cash? LVMH has been able to do all those things to a degree, but its acquisition strategy has been excellent. And I think time will prove that the acquisition of Tiffany's, its most recent deal, will also be another great addition to their portfolio, and another great brand name that they've consistently added to the portfolio.

7:40 Alastair McRobert: 

Tiffany's will hopefully prove to be a fantastic investment - An interesting little story if I may, one of LVMH’s most recent acquisitions has been a champagne brand called Armand de Brignac that bought a 50% stake off Jay Z. Now Paul might remember from his youth, the rappers of the 90s in the naughties, rapping about Cristal  which is the premium brand for Louis Roederer the champagne house…

8: 07 Paul Dixey:

…never heard of them…

8:10 Alastair McRobert:   

But a Louis Roederer MD was quoted in an Economist article, basically saying that it was an issue that rappers were rapping about it, and he said something along the lines of what can we do? We can't forbid people from buying it. Quite rightly, Jay-Z thought this was disrespectful. And sure enough, his next tracks were dissing Cristal, and actually supporting patronising a new champagne brand was just so happens to be this Armand de Brignac brand - which is a fully gold bottle with an ace of spades logo. And that sure enough sales rocketed, Jay-Z bought out the company and a few years later LVMH has just bought half his stake. So certainly, Jay-Z and LVMH are having the last laugh in that little trade off.

9:02 Paul Dixey:

So in the opening remarks, we touched on these companies’ digital presence, which has obviously been incredibly important in a pandemic when everybody's been locked down. Now Alastair, one of the companies that has been making or investing a lot of money in their digital capability is Nike - give us a few thoughts on why you like Nike at the moment as an investment, again, touching on some of the competitive advantages that it might have.

9:31 Alastair McRobert:   

I'll come back to the digital strategy in a minute, but just to touch on the broader aspects first, it won't be a surprise to anyone to hear that Nike is one of the greatest brands in the world. It's somehow managed to transcend its sporting roots, which it obviously has great pedigree in, and move on to casual and street wear and somehow be popular amongst all ages, genders and classes. It truly is one of those wonderful brands. Innovation has been a fantastic part of the Nike story, to use an example if there are any runners listening, they will have seen last year the news that the new Vaporfly shoes were decreasing marathon times by something in the order of 4% to 5%. The authorities were quite rightly thinking about banning the shoes they were so good, and actually both the men's and women's marathon records tumbled. In that time, even Paula Radcliffe's long-standing record went, so the shoes completely changed the game in running. For years before that, it had been about producing the lightest shoes possible and that often meant the thinnest soles. Suddenly Nike come along with this new sole technology, and it's all about the thickest shoes, essentially the most bounce for your feet. And now we've seen every single other running shoe manufacturer trying to copy it. And I guess the point is that that innovation doesn't happen by accident. It takes a huge amount of investment - I don't have the stats for their R&D but for example, their endorsements and sponsorships totaled $10 billion a year. It's incredibly hard for a new entrant to just come in, unless they've got incredibly deep pockets to come and replicate that kind of spending. And as you said that digitalization efforts are incredibly central to the investment case here - to point out the obvious, if you can cut out a third party retailer, you could say the middleman, and also cut out the need for a shop front, your margins are going to increase. And Nike have been quoted as saying that gross margins are increasing by 10 percentage points when they sell digitally. And it's not only that effect, but once they have customers buying directly and digitally, they can control that data, they can add more personalised marketing - more targeted. And that can drive more sales and you get a sort of virtuous circle. Nike management were quoted as saying that they're in the third innings of their digitalization efforts, and for me as a cricket fan, that was quite confusing. I had to look up how many innings in a baseball match, but I can confirm there are nine. So what they're trying to say is that they're early on in their digitalization efforts.

12:33 Paul Dixey:

Before I ask Tim on his thesis on Nike as well, I just want to know whether you managed to pick up a pair of those trainers for your marathon efforts a few years ago?

12:44 Tim Gregory:    

So the honest answer is that they came too late. By the time I did my third marathon they weren't around. And to be honest with you, I very luckily was given a pair of Vaporflies as a Christmas present when they came out. And I was particularly disappointed that it did not enable me to break the world record for a half marathon, despite being 55 and 95 kilos. So I frankly think, they might be overrated, but that just might be my own poor performance. But no doubt, as Alastair said, in all seriousness, they have been another sensational innovation in Nike’s armoury of brilliant products that they developed in recent years.

13:26 Paul Dixey:   

And in terms of the investment in the women's category as well that seems to be a part of the thesis, doesn't it?

13:36 Tim Gregory:     

Very much. So I mean, we have been talking about this at Vermeer for quite a long time, because we felt that one of the areas that the company regularly talks about, that perhaps the analyst community until more recently has not really picked up on, is the strength and opportunity in women's athletic wear, and changing fashion trends of trainers being worn more day-to-day rather than just for training purposes. So we think that Nike has tremendous opportunity to grow share in the women's market, that will continue to grow faster than the overall brand. I totally agree with what Alastair has said about the strength of the digital franchise, although funnily enough, I think that the key there is kind of clicks and mortar, because Nike are launching new mono brand stores to drive traffic into their own shop fronts. And you know, to Alastair's point, that's better gross margin than having it sold by other footwear retailers who sell all types of brand or all sorts of sportswear. It’s much better for Nike to own their own brands and drive traffic through their own website. So they're investing very heavily for that. So I think a combination of the digital strategy, the strategy for the women’s market, the mono brand stores, is really giving them a strong position. I know we’re going to come on to talk about China, but obviously that's also pivotal to Nike’s success in the future.


Key Points

0:03 Paul Dixey: Thank you very much for listening. Hello, and welcome to the art of investment. I'm your host Paul Dixey. And today I'm joined by Tim again and a newbie to the podcast Alistair McRobert, who covers the luxury goods sector for us at Vermeer Partners, so he'll be super helpful in today's discussion. Today we will be discussing why the luxury sector has done so well in recent years, what competitive advantages these companies possess and what's driven their share prices to recent highs? And finally, how we at Vermeer Partners and also Tim, in his global equity fund, have been investing in the luxury space. So Tim, please kick us off with - why has the luxury sector been so good over the last few years, and also through the last few months as we've come out of the pandemic? 1:30 Tim Gregory: Hi guys, good to be here again. So my take on why luxury has performed well is really quite simple actually, the new consumer that the world has had from China - the Chinese middle class and wealthier classes desire to own luxury goods products - has created a whole new wave of demand for these products. And actually, to that point, one of the reasons why the sector has held up so well this year has been that actually, albeit that the Chinese tourist has been not able to travel in the way she or he had in recent years, they have still been able to continue to get product internally from China, where so many luxury goods have very cleverly set up their business models in major Chinese cities, and also online. So actually what everybody feared this time last year, as travel was getting banned and we weren't able to go anywhere, and the only way you could shop was online - in China, they've coped with that really well. And actually investment strategies that luxury goods companies like LVMH, which I know Alastair is going to come on to talk about in a minute, and Kering which owns Gucci, they have been very well positioned to cope with the epidemic and the fallout from that. So luxury goods have continued to do well I think against that against that backdrop. 3:07 Paul Dixey: So Alastair, Tim has teed you up nicely there into LVMH which is one of the companies luxury good companies that we've been investing in for a while now at Vermeer Partners. I wonder whether you could give us a bit of an idea as to why we like that company and it’s competitive edge that it has in the marketplace over perhaps some of its smaller rivals. 3:26 Alastair McRobert: First of all, a little bit of background first and LVMH which stands for Louis Vuitton Moet Hennessy, which gives you a little bit of an idea as to what it does: Louis Vuitton being fashion and leather goods, and Dior being its other large fashion and leather goods brand, and then Moet Hennessy being champagne and cognac brands. Overall it has 75 fashion or luxury brands and being French it calls them 75 maisons. And what you're starting to see there is a really diversified portfolio of brands not only cross sectors, but also across different categories: across fashion and leather goods, watches and jewellery and wines and spirits too. And one of the reasons we like a diversified approach is that whilst we see the likes of Prada and Gucci as being ever present leaders in the fashion space, Gucci is an example of one that has come in and out of fashion so LVMH, having that diversified approach, helps you to get that fantastic luxury goods exposure, which gives you high margins and as Tim's touched on, that exposure to the high growth Chinese consumer, but with some of that brand risk, diversified away. 4:57 Paul Dixey: One of the things that I picked up on LVMH 2020 results is it's pricing power. I think they were able to raise prices throughout that period between 4% and 7%, which is quite something given the concern consumers probably had in terms of how much disposable income they had. So, Tim, I wonder whether you have further comments on LVMH and, and its strengths - pricing power being one of them. The other thing that I've seen is they do quite a lot of collaborations, o we've got Nike Air Jordan, collaboration with Dior, we have Burberry and Marcus Rashford. We've got Gucci and Mark Ronson. So all of these things seem to help drive, awareness and build the status of the brand and the power of the brand. 5:49 Tim Gregory: Well, that's, that's absolutely right. The fact is that, as you said, pricing power has been a massive driver for ever increasing margins for these companies. At the same time, that there has been great elasticity because it does not appear to have made any difference to demand whatsoever. And that is a function, I think, of a wealth effect that we're seeing in general. And indeed, of course, the pandemic has not had such a great impact on the, the wealthy generation of the population, because actually, they haven't tended to lose their jobs in the end. And governments have gone so far out of their way to bridge economies going forward, that in that respect, I think it's enabled demand to remain pretty strong for these areas, and pricing has not come under any pressure whatsoever. I think the other thing that's worth mentioning, which actually is not necessarily related to pricing, and comes back to Alastair's point about why LVMH has done so well, is that it's got to be noted they have made brilliant and timely acquisitions of the businesses they've bought to develop their franchise. Acquisition strategy to so many companies that we invest in alongside organic growth, is always the other piece of the puzzle. As companies generate lots of cash, what do they do with it? Do they make great acquisitions or terrible acquisitions? Do they just pay dividends or buy back shares or build up cash? LVMH has been able to do all those things to a degree, but its acquisition strategy has been excellent. And I think time will prove that the acquisition of Tiffany's, its most recent deal, will also be another great addition to their portfolio, and another great brand name that they've consistently added to the portfolio. 7:40 Alastair McRobert: Tiffany's will hopefully prove to be a fantastic investment - An interesting little story if I may, one of LVMH’s most recent acquisitions has been a champagne brand called Armand de Brignac that bought a 50% stake off Jay Z. Now Paul might remember from his youth, the rappers of the 90s in the naughties, rapping about Cristal which is the premium brand for Louis Roederer the champagne house… 8: 07 Paul Dixey: …never heard of them… 8:10 Alastair McRobert: But a Louis Roederer MD was quoted in an Economist article, basically saying that it was an issue that rappers were rapping about it, and he said something along the lines of what can we do? We can't forbid people from buying it. Quite rightly, Jay-Z thought this was disrespectful. And sure enough, his next tracks were dissing Cristal, and actually supporting patronising a new champagne brand was just so happens to be this Armand de Brignac brand - which is a fully gold bottle with an ace of spades logo. And that sure enough sales rocketed, Jay-Z bought out the company and a few years later LVMH has just bought half his stake. So certainly, Jay-Z and LVMH are having the last laugh in that little trade off. 9:02 Paul Dixey: So in the opening remarks, we touched on these companies’ digital presence, which has obviously been incredibly important in a pandemic when everybody's been locked down. Now Alastair, one of the companies that has been making or investing a lot of money in their digital capability is Nike - give us a few thoughts on why you like Nike at the moment as an investment, again, touching on some of the competitive advantages that it might have. 9:31 Alastair McRobert: I'll come back to the digital strategy in a minute, but just to touch on the broader aspects first, it won't be a surprise to anyone to hear that Nike is one of the greatest brands in the world. It's somehow managed to transcend its sporting roots, which it obviously has great pedigree in, and move on to casual and street wear and somehow be popular amongst all ages, genders and classes. It truly is one of those wonderful brands. Innovation has been a fantastic part of the Nike story, to use an example if there are any runners listening, they will have seen last year the news that the new Vaporfly shoes were decreasing marathon times by something in the order of 4% to 5%. The authorities were quite rightly thinking about banning the shoes they were so good, and actually both the men's and women's marathon records tumbled. In that time, even Paula Radcliffe's long-standing record went, so the shoes completely changed the game in running. For years before that, it had been about producing the lightest shoes possible and that often meant the thinnest soles. Suddenly Nike come along with this new sole technology, and it's all about the thickest shoes, essentially the most bounce for your feet. And now we've seen every single other running shoe manufacturer trying to copy it. And I guess the point is that that innovation doesn't happen by accident. It takes a huge amount of investment - I don't have the stats for their R&D but for example, their endorsements and sponsorships totaled $10 billion a year. It's incredibly hard for a new entrant to just come in, unless they've got incredibly deep pockets to come and replicate that kind of spending. And as you said that digitalization efforts are incredibly central to the investment case here - to point out the obvious, if you can cut out a third party retailer, you could say the middleman, and also cut out the need for a shop front, your margins are going to increase. And Nike have been quoted as saying that gross margins are increasing by 10 percentage points when they sell digitally. And it's not only that effect, but once they have customers buying directly and digitally, they can control that data, they can add more personalised marketing - more targeted. And that can drive more sales and you get a sort of virtuous circle. Nike management were quoted as saying that they're in the third innings of their digitalization efforts, and for me as a cricket fan, that was quite confusing. I had to look up how many innings in a baseball match, but I can confirm there are nine. So what they're trying to say is that they're early on in their digitalization efforts. 12:33 Paul Dixey: Before I ask Tim on his thesis on Nike as well, I just want to know whether you managed to pick up a pair of those trainers for your marathon efforts a few years ago? 12:44 Tim Gregory: So the honest answer is that they came too late. By the time I did my third marathon they weren't around. And to be honest with you, I very luckily was given a pair of Vaporflies as a Christmas present when they came out. And I was particularly disappointed that it did not enable me to break the world record for a half marathon, despite being 55 and 95 kilos. So I frankly think, they might be overrated, but that just might be my own poor performance. But no doubt, as Alastair said, in all seriousness, they have been another sensational innovation in Nike’s armoury of brilliant products that they developed in recent years. 13:26 Paul Dixey: And in terms of the investment in the women's category as well that seems to be a part of the thesis, doesn't it? 13:36 Tim Gregory: Very much. So I mean, we have been talking about this at Vermeer for quite a long time, because we felt that one of the areas that the company regularly talks about, that perhaps the analyst community until more recently has not really picked up on, is the strength and opportunity in women's athletic wear, and changing fashion trends of trainers being worn more day-to-day rather than just for training purposes. So we think that Nike has tremendous opportunity to grow share in the women's market, that will continue to grow faster than the overall brand. I totally agree with what Alastair has said about the strength of the digital franchise, although funnily enough, I think that the key there is kind of clicks and mortar, because Nike are launching new mono brand stores to drive traffic into their own shop fronts. And you know, to Alastair's point, that's better gross margin than having it sold by other footwear retailers who sell all types of brand or all sorts of sportswear. It’s much better for Nike to own their own brands and drive traffic through their own website. So they're investing very heavily for that. So I think a combination of the digital strategy, the strategy for the women’s market, the mono brand stores, is really giving them a strong position. I know we’re going to come on to talk about China, but obviously that's also pivotal to Nike’s success in the future.

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