Emerging market investors know the tale of the growing middle class well. Exports are no longer driving emerging economies – but domestically focussed companies cashing in on the steadily increasing disposable incomes of the masses. Urbanisation, growing wages and smaller families are leaving an increasing number of Chinese in particular able to achieve their western inspired aspirations – branded nappies, meat-rich diets and household technology.
But it is not just the middle class which are swelling in size. China has more than one million millionaires – defined as individuals with a personal wealth of 10 million yuan or $1.6 million, according to the Hurun Research Institute annual Wealth Report. And this figure is growing at a rate of 4% a year. In comparison, the US has 9.6 million households with a net worth of $1 million or more – and that number is largely due to recent stock market successes.
Despite the slow in economic growth in China the number of millionaires is expected to continue to rise. Much to the benefit of European luxury goods manufacturers; the older and the more renowned the retailer, the better. Prada – which enjoys an Italian heritage but a Hong Kong listing – gets nearly 40% of its sales in Asian countries and LVMH, who manages some of the best-known luxury brands including Louis Vuitton, De Beers and Dom Perignon.
Luxury goods appeal to emerging market millionaires because of the associated heritage – for decades, and in some cases even centuries they have been a symbol of success and excess. This heritage also means in some cases equity analysts have assigned the companies wide economic moats, meaning they have a significant advantage over their peers, as most 100-year-old luxury companies enjoy brands and businesses that are hard to copy.
What the Morningstar Equity Analysts Say
The two most significant elements suggesting that Prada has key competitive advantages are its enduring brand and its high returns on capital. As such, we rate Prada as a wide-moat company, signifying our belief in its ability to continue to achieve high returns and the difficulty competitors face to encroach on its brand. The Italian company enjoys one of the most visible luxury brands in the world and continues to have strong growth prospects.
Prada Group shows excellent margins and returns on capital, with operating margins running over 20% and returns on invested capital in the midteens, with potential improvement as the store base and operating margins grow. The company is working on narrowing and improving its distribution channels, focusing more on retail with new directly operated stores and also with the conversion of wholesale sales points to owned retail, such as through concessions operated in department stores.
LVMH Moet Hennessy Louis Vuitton (MC)
Given the high-end status associated with most of its brands, LVMH can charge premium prices and earns above-average margins. This pricing power results in around 20% operating margins and returns on invested capital in the low double digits, or higher if goodwill is excluded. Because of the brands that LVMH owns, most of which have endured for more than 100 years and represent difficult-to-replicate intangible asset moat sources, we assign the company a wide economic moat.
We believe global expansion and product innovation will continue to be the key growth drivers for LVMH.
Store openings in China have slowed, but LVMH's portfolio is large enough that other brands and segments, such as selective retailing, can grow in the Americas and as developing markets expand their middle classes. LVMH's Asia Pacific segment has held fairly steady on an organic basis despite worries about China's macroeconomy, which is growing, but at a slower pace. We believe the luxury business in China will continue to grow, but at a more moderate mid- to high-single-digit pace.
We continue to rate Burberry Group as having a wide moat and are particularly encouraged by its focus on brand and consumer engagement, with its online initiatives, in-store investments, and brand elevation. We believe that the recent management changes, including Christopher Bailey becoming CEO, are renewing and reinforcing the focus on the intangible assets of the company for the long term and serve to deepen the global perception of the Burberry brand and differentiate it from the competition.
While Bailey changed some wording in the company’s strategic pillars that may seem minor, we see such changes as critical to protecting and enhancing the brand, which is the main source of our moat rating.
The Morningstar equity analyst for these stocks is Paul Swinand
