Discounting To Constrain Sales Growth In Luxury Fashion

BMI View: The luxury fashion industry will remain challenging over 2016-17 due to weak tourist inflows and discounting. We expect luxury fashion brands to increasingly reduce exposure to department stores in a bid to boost sales by re-establishing the value of luxury brands. We believe that the Middle East is a key growth market for luxury clothing & footwear, underpinned by high incomes and growing demand for high-end modest fashion.

Luxury clothing and footwear is experiencing a broad slowdown globally, largely due to weak tourist inflows and deep discounting. Kering, LVMH Moet Hennessy Louis Vuitton SE (LVMH) and Prada S.p.A are among the large luxury players that have cited weak tourism spend as the underlying driver of slowing sales growth. For example, Prada reported a decline in clothing and footwear sales for the six months ended July 31 2016, both coming in at -10.3% and -9.3% respectively.

Discounting in the luxury fashion segment has been depressing sales and diminishing the brand value of luxury retailers that are overly exposed to department stores. Over previous years, Ralph Lauren's profit has been affected by discounting - profits have fallen 50% since 2014 with market value around USD8bn compared to USD16bn in 2013. Department store and wholesale channel sales accounted for USD3.5bn of Ralph Lauren's revenue in 2015, around 47% of revenue.

Deep Discounting Constraining Revenue Growth
Ralph Lauren - Revenue By Selling Channel, USDbn
Source: Bloomberg Gadfly, BMI

Discounting To Constrain Sales Growth In Luxury Fashion

BMI View: The luxury fashion industry will remain challenging over 2016-17 due to weak tourist inflows and discounting. We expect luxury fashion brands to increasingly reduce exposure to department stores in a bid to boost sales by re-establishing the value of luxury brands. We believe that the Middle East is a key growth market for luxury clothing & footwear, underpinned by high incomes and growing demand for high-end modest fashion.

Luxury clothing and footwear is experiencing a broad slowdown globally, largely due to weak tourist inflows and deep discounting. Kering, LVMH Moet Hennessy Louis Vuitton SE (LVMH) and Prada S.p.A are among the large luxury players that have cited weak tourism spend as the underlying driver of slowing sales growth. For example, Prada reported a decline in clothing and footwear sales for the six months ended July 31 2016, both coming in at -10.3% and -9.3% respectively.

Discounting in the luxury fashion segment has been depressing sales and diminishing the brand value of luxury retailers that are overly exposed to department stores. Over previous years, Ralph Lauren's profit has been affected by discounting - profits have fallen 50% since 2014 with market value around USD8bn compared to USD16bn in 2013. Department store and wholesale channel sales accounted for USD3.5bn of Ralph Lauren's revenue in 2015, around 47% of revenue.

Deep Discounting Constraining Revenue Growth
Ralph Lauren - Revenue By Selling Channel, USDbn
Source: Bloomberg Gadfly, BMI

Discounting To Depress Sales

Over the coming quarters, we expect the luxury clothing and footwear segment to continue to experience slowing growth as discounting practices continue. Discounting in the sector is largely being driven by excess inventories in key retail such as department stores- which are experiencing a stark decline in footfall. Underpinning our views, department store, Macy's, same store sales have been on a sustained decline since 2015- declining by 3.9% in Q315; 4.8% in Q415 and 6.1% in Q116. Slowing sales lead to rising inventory levels which then induce department stores to offer discounts in a bid to stimulate footfall.

Furthermore, disruptive millennial consumption patterns will augment challenges for the luxury clothing and footwear market over the medium-to-long term. Millennials have disrupted the luxury sector by challenging the existing value proposition of luxury brands - effectively rejecting the high price points of the industry - which will increasingly driving discounting in the sector. This trend is underpinned by the ubiquity of discount online luxury retailers such as The Outnet, Gilt and YX Net-a-porter. For example, for Q215 YX reported sales growth of 23.2% underpinning the rising popularity of luxury online discount retailers.

Weak Luxury Clothing & Footwear Sales
Selected Companies - Clothing & Footwear Sales Growth, %
Source: Bloomberg, BMI

Luxury Fashion Industry To Implement Fundamental Changes

We hold the view that luxury fashion brands will reposition their value proposition through innovation in order to boost sales. We believe that four key strategies will be adopted by luxury fashion brands -reduce exposure to department stores; slow luxury; fast luxury and product innovation.

  • Luxury fashion brands will increasingly reduce their product offerings in department stores as continued deep discounting in these stores diminishes brand value. We believe that luxury brands will sell products through brand owned retail outlets and online channels. Underpinning our view, Ralph Lauren, Michael Kors and Coach announced in 2016 that they would pull out some of their offerings in department stores and reduce inventories.

  • We expect luxury fashion producers to reduce product turnaround time for their ready-to-wear product lines in order to effectively compete with the fast fashion sector. Luxury brands have been affected by the rapid pace at which fast fashion brands produce runway looks for retail, effectively rendering ready-to-wear luxury brands laggards in the sector. We expect this trend to play out over the near term as luxury fashion companies are already implementing the strategy for their ready-to-wear segment. Underpinning our view, Ralph Lauren is currently restructuring its business operations in the ready-to-wear segment in order to reduce product turnaround time from fifteen to nine months.

  • Producers of luxury clothing and footwear will reposition some of their high-end couture product lines to appeal to ethical consumption trends through the adoption of 'slow luxury'. Slow luxury encompasses environmentally friendly production which is socially and economically responsible throughout the supply chain. This emergent trend will appeal to the millennial demographic, justifying a higher price point for apparel to this cohort. This fashion segment emphasises craftsmanship and quality which will appeal to rising demand for authenticity among this demographic. We do note that this trend is still nascent and will gain momentum over the next ten years.

  • Luxury fashion brands will become increasingly innovative with product development, adopting avant-garde designs in order to distinguish their brands from mainstream offerings. Brands that have benefitted from this strategy include Gucci S.p.A (Gucci) and Louis Vuitton. For example, Gucci's sales rebounded over 2015 on the back of growing demand for collections produced by new creative director- Alessandro Michele. The designer introduced gender neutral designs in the 2015 fall menswear collection which resonated with the luxury fashion industry. Gucci reported that organic sales increased by 5.4% in H116 from 0.4% in 2015 and a 1% decline in 2014.

Luxury Innovators To Outperform
Share Prices- Kering Vs LVMH Moet Hennessy Louis Vuitton SE Vs S&P Global Luxury Index
Note: Share price performances as of October 10 2015 = 100; all performances in USD. Source: Bloomberg, BMI

Middle East, A Key Growth Region

The Middle East is poised to experience strong growth in the clothing and footwear segment. We forecast the growth rate for clothing and footwear spending to average 5% between 2015 and 2020, compared to -0.1% in North America; 0.3% in Europe and 3.3% globally. Furthermore, selected markets in the Middle East will experience robust growth in private consumption per capita, namely, Qatar; Saudi Arabia and the United Arab Emirates - growing at a five year compounded annual growth rate of 5.1%, 4.5% and 5.3% respectively. In comparison, key luxury markets, Hong Kong; France and the United States will grow at 4.2%; 0.9% and 3.6% over the same period.

The Middle East will present strong growth opportunities in the luxury segment over the coming years, driven by high incomes and growing demand for luxury modest fashion. Underpinning our view, Prada reported positive sales growth in the Middle East for both the clothing and footwear segments despite a 10.3% and 9.3% sales decline in the segments for the group.

We expect luxury fashion brands to increasingly invest in modest fashion lines over the coming years in a bid to appeal to Middle East consumers. Dolce & Gabbana launched a collection of high-end hijabs and abayas in January 2016, underpinning the growing importance of the Middle East for luxury fashion brands.

We hold the view that Qatar will become a regional hub for luxury fashion over the coming years due to high incomes and rising investment into the luxury fashion sector:

  • High Incomes will support consumer spending in the luxury fashion segment, enabling consumers to spend considerable amounts on luxury fashion with every fashion cycle. We forecast Qatar's GDP per capita for 2016 to be USD62,474 compared to global GDP per capita of USD10,254- underpinning the significant spending power in the country.

  • Over the past four years, we have seen rising investment from Qatar into the luxury fashion industry, indicating the profitability of the sector in the Middle East region. In June 2016, the Qatari sovereign investment fund, Mayhoola For Investments, bought luxury fashion brand Balmain for an undisclosed amount following the purchase of Valentino spA in 2012 for EUR700mn.

Middle East Luxury Fashion Poised For Growth
GDP Per Capita, USD
Source: National sources, BMI
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