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Weekly Manager Views

8 November 2019

At GAM Investments’ Weekly Investment Meeting held on 6 November, the speakers were Swetha Ramachandran, who discussed consumer demand for luxury goods, and Roberto Bottoli, who commented on the current environment for mergers and acquisitions.

Luxury equities

Swetha Ramachandran

  • The young Asian consumer and the growing middle class are, in our view, the core drivers behind the sector’s overall positive performance in 2019. By 2030, it is estimated that 80% of the world’s middle class will be in Asia. Regarding millennials, it is estimated that 450 million will be located in China and 440 million in India. When combined, these two cohorts are larger than the entire population of Europe. It has already been demonstrated that these Asian consumers have a strong appetite for the luxury sector, with China accounting for nearly a third of total industry demand – but more importantly, for two-thirds of industry growth.

  • Within this segment, the younger consumers are outspending their older counterparts. We can see the demographic shift reflected in the behaviour of luxury brands, for example LVMH’s unprecedented (and highly successful) collaboration with streetwear brand Supreme. The younger generation’s concern with sustainable fashion has also influenced the sector, seen in brands such as Gucci (now carbon neutral) and Prada (with its recently released sustainability-linked bonds).

  • A recent survey by McKinsey showed that of Chinese millennials who purchased luxury products in 2018, 50% were making their first luxury purchase. As a whole, the younger Chinese generation has more disposable resources than their non-Chinese peers. 70% own their own homes – twice the level of their counterparts in the US and Europe. Additionally, the survey said 40-50% are not concerned about their income, citing financial assistance from their parents. This lack of financial pressure allows them to spend a higher proportion of their income on luxury items.

  • The luxury goods sector is also uniquely positioned to benefit from digitalisation. For many sectors, the shift to a digital world is a threat; however, online marketplaces allow brands to tap into more consumers at a lower cost of capital.

  • Finally, the valuation premium the luxury sector has enjoyed relative to the market has been steadily compressing, despite an increase in its earnings premium since 2010. Moreover, we do not think the sector is uniformly expensive and share prices differ heavily from brand to brand. Established brand Hermès is currently valued below its prior peak valuation and Tod’s trades at a premium on the back of its founder’s goal to take the company private. Meanwhile, behemoths like LVMH have been circling smaller, specialised brands with hopes of consolidation (LVMH acquired Bulgari in 2011 and recently has attempted to purchase Tiffany). We feel that the wide dispersion of valuations within the sector lends itself well to bottom-up investing.

Merger arbitrage

Roberto Bottoli

  • Macro headwinds put the brakes on deal-making activity during the course of the previous two months; lingering detractors included unresolved US-China trade talks as well as sluggish economic growth. Conversely, further easing of monetary policy by major central banks of late is acting as a counterbalance, providing support for mergers and acquisitions (M&A) on a global basis. On a positive note, we witnessed increasing activity in October supported by low funding costs.

  • Outside the large-cap segment, we see opportunities to capture significant spreads on a risk-adjusted basis across small and mid-cap equity markets. In this area, antitrust risk is greatly reduced and funding is straightforward when compared to companies with high market values. Geographically, the US continues to be the core market in terms of deal-related activity. However, Europe, Asia and South Africa also contain interesting opportunities, in our view.

  • When looking at the UK specifically, Brexit continues to dominate political debate. Consequently, the depreciation of sterling may lead to bargain prices for foreign buyers attracted to certain UK assets. Previously announced acquisitions (such as Hong Kong-based CKA’s purchase of UK pub chain Greene King and Takeaway.com’s acquisition of rival food delivery service Just Eat) illustrate this trend.

  • Historically, it is important to note that M&A takes place in cycles. Therefore, a slowdown was logical after all-time M&A highs were experienced in 2015. Still, a sufficient number of deals are occurring and we believe it is important to be diverse and flexible in terms of geography and market capitalisation.

  • Overall, easing of monetary policy is helpful for the M&A pipeline over the medium term and sentiment surrounding US-China trade talks has recently turned positive. We therefore see scope for a greater number of companies boosting earnings through acquisitions, as opposed to growing organically.

Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or advice. Reference to a security is not a recommendation to buy or sell that security.
November 2019