Wealth creation in GEM to boost luxury sales

While growth for luxury companies has been good, the future looks even brighter. Luxury sales are expected to increase by at least 7 to 9 per cent in 2011, driven by emerging market growth and renewed strength of high-end consumption in developed markets.

Companies’ first-quarter results showed continued strong demand for luxury products, with top brands like LVMH, Burberry and Bulgari reporting double-digit growth.

All major luxury product categories and regions did well, with the exception of Japan. The tragic events in the country, which accounts for 10 per cent of luxury sales, impacted performance in March, however luxury demand is recovering faster than most expected.

Positive sentiment was shared at the latest Basle and Geneva watch fairs. These are significant indicators for global sales, with many brands generating a large proportion of their annual turnover at these events.

Wealth creation plays a significant role in the growth of luxury sales. The number of affluent households is expected to double between 2010 and 2020, which will increase the number of consumers purchasing luxury goods.

Wealth creation in emerging markets has been particularly strong and will continue to outpace that in the developed world. Emerging markets currently purchase half of all luxury goods and account for the majority of growth.

China, the largest emerging market economy, is quickly becoming a major player in the luxury industry, with nearly a quarter of all luxury goods sold to the Chinese. This trend is set to continue, with the country now ranking fourth in the world for number of millionaires.

The average age of a Chinese millionaire is 39, 15 years lower than most developed economies. Even if there is a slowdown in the Chinese economy, the impact on luxury demand will most likely be limited due to the secular increase in the purchasing power of Chinese consumers.

Many industries and companies are suffering from rising inflation, but luxury is affected to a much lesser extent. Raw materials on average account for only 10 to 15 per cent of sale prices and most luxury products are made in Europe. They are therefore less affected by wage rises in Asia, which are increasing at a double-digit pace.

Thanks to luxury producers’ pricing power, cost increases can be passed on to consumers without any material impact on demand. In the past 30 years prices of luxury products have increased faster than inflation, and this year luxury companies have increased prices by 5 to 10 per cent already.

The luxury industry is growing and is quite profitable, with companies in good financial shape. Given high cash positions and low debt, share buy-backs, dividend increases and M&A fantasy are all probable.

Wealth creation in emerging markets will continue to be an important factor for luxury sales and in addition, high-end consumption in the US is performing above expectations. Financial recovery and lower unemployment rates of well-educated people has lifted sentiment among upper-income consumers.

As the secular trend for luxury continues, the industry is set to witness further growth due to the combination of emerging market wealth creation and pricing power.

Scilla Huang Sun is fund manager of Julius Baer Luxury Brands Fund. The views expressed here are her own.