Investors know that the luxury goods market is a cyclical industry, but this time may be different. With luxury retailers like Coach (NYSE:COH) down more than 25% since March and Tiffany (NYSE:TIF) down more than 5% in a market that's up nearly 6% over the same time period, investors are re-evaluating their confidence in a luxury market rebound.
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Even in what has become a 2012 bull market, what happens on Wall Street isn't always felt on Main Street. Unemployment is still high, wages are low, gas prices are stubbornly hanging around $4 per gallon and 20% of homeowners are still underwater on their mortgages. Luxury retailers such as Coach, Tiffany and Ralph Lauren (NYSE:RL), as well as other consumer discretionary retailers, tend to move lower during times of recession and other economic pressures. This would indicate that consumers stop purchasing luxury items during periods of economic uncertainty, but can the CEOs of these luxury brands blame the economy for their poor 2012 performances?
According to USA Today, counterfeiting of consumer goods is a multi-billion dollar industry. Knockoff luxury goods are so readily available that some consumers don't realize they're purchasing illegal merchandise. In 2010, counterfeit goods made up to 5 to 7% of all world trade, with a combined value of as much as $600 billion and even with stricter enforcement, the knockoff market still thrives. Not only does it have an impact on revenue, it also reduces the value of the brand. Consumers who think they're getting luxury items for bargain prices may not know that the items are knockoffs. When the items are found to have imperfections or short lifespans, consumers blame the company on the label.
Redefinition of Luxury
Business Insider reports that consumers are still buying luxury items, but they're paying less for them. According to studies done by Unity Marketing, a research group that studies the habits of the affluent, willingness to purchase luxury items at a premium price has continually dropped since the 2007-2009 recession. They point to luxury retailer Coach's decision to eliminate the coupons offered in connection to their discount outlets. The result was a surprisingly weak report of same-store sales for the period ending June 30.
Luxury brands embracing this changing definition of luxury have found success. Michael Kors (NYSE:KORS), the newest publically traded company in the luxury space, appeals to a wider audience with its Michael line. While still priced at a premium, it offers a lower entry point into the Michael Kors brand without the luxury prices that come with its premium products. As a result, shares of Michael Kors have almost doubled in 2012. Brands like Burberry, which cater to the most elite spenders, reported disappointing earnings, blaming the slowing economy. Analysts believe that even the most affluent of customers aren't willing to pay premium prices in a world economic environment full of uncertainty.
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Although the short-term trend has been to the downside, consumer discretionary stocks in the luxury market have outperformed the S&P 500 over the past five years. Coach has recorded gains of 20%, and Tiffany more than 10% compared to the S&P 500's losses of about 7%. As the economy improves and consumers find more money for discretionary purchasing, the short-term trend to the downside may reverse.
The Bottom Line
When economic conditions become challenging, investors become fearful. The phrase, "it's different this time" becomes a commonly-uttered refrain. It may be true that the luxury market is carving out a new normal where ultra-high end is no longer profitable, but history suggests that as the world economy improves so will the earnings of these luxury brands.
At the time of writing, Tim Parker did not own shares in any company mentioned in this article.