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Investment Strategy
Sunday, January 1, 2012
Predictable disaster

The strong financial performance of several local and global luxury goods companies in recent months has re-enforced the perception that this particular industry is fairly recession proof.

However, according to Daniel Malan, Investment Director at RE:CM (a value based asset manager), this is not always the case. “With several of these companies currently trading at very inflated prices, we see the classic signs of a bubble about to burst,” he suggests.
“Since the beginning of 2010, the combined share prices of LVMH, Hermes, Richemont and Swatch relative to the market, have increased by 60%. They are currently trading much higher relative to the market than at any point since 1995. This huge popularity is probably on the back of the 12% rise in sales in 2010 in this sector and the predicted 8% rise in sales for 2011, with a further of 5% - 6% growth per annum predicted by Bain and Company until 2014.
“Their positive outlook in turn is based on a 30% sales growth in China from 2009 to 2010, with expectations of continued high growth. As usual, it seems that the market’s focus on short term results and a good story is leading to highly inflated prices, completely ignoring the lessons of history.”
He says that other common signs of a bubble are also appearing, namely acquisitions and new listings when the market is high for the industry. “LVMH paid €3.7 billion for Bulgari in March 2011, valuing the business at three times EV/Sales compared to its long term median of 2.5 times. Yet Bulgari’s earnings slumped 67% during the last three years. Furthermore, Prada exploited the excitement around luxury sales growth in the East by recently listing in Hong Kong.”
Malan says that the luxury market may be fairly recession proof with total sales dropping rarely, and then by fairly small percentages. But the share price of luxury goods companies is clearly not recession proof, sometimes dropping dramatically in response to small drops in sales.
The only two negative growth periods since 1995 were 2002/2003 where sales dropped only 0.7% and 3% respectively and then again in 2008/2009 when sales dropped 2.4% and 7.8% respectively.
“In many industries a 3% drop in sales during a recession will be considered minor, and a 8% drop once in 15 years, followed by 12% growth the very next year, a blessing. However, both these relatively small drops had a huge impact on the share price of the four biggest luxury companies.
“In 2003 LVMH lost nearly two thirds of its value, and in 2008/2009 it lost three-quarters of its value. Richemont’s value halved during both periods. Swatch lost a third and nearly two-thirds of its value respectively. Hermes proved to be the most resilient in both instances, dropping 27% in 2003 and 15% in 2008/2009. LVMH, which is bigger than the other three combined, was the worst hit in both cases,” says Malan.
“Many of the classic signs of a bubble are in place, making this a predictable disaster, as described by James Montier in the ‘The Little Black Book of Behavioural Investing’.”
RE:CM has bought Swatch and Richemont during the previous downturns when they traded at a significant discount to fair value, and sold them when they reached fair value. “We will patiently avoid this predictable disaster until an opportunity to buy these quality assets as cheaply as we did in the past arises again,” says Malan.

About RE:CM

RE:CM is a medium-sized, independent asset management company that follows a bottom-up value approach based on thorough, fundamental research. The company, with assets under management of over R18 billion, believes that a strategy of buying securities only when market prices are significantly below intrinsic value will produce superior results in the long run – protecting capital when prices and risks are high, and growing capital when prices, and thus risks, are low. The RE:CM Global Fund is five years old and was recently awarded the Personal Finance Raging Bull Award for Best Performing Global Equity Fund for the second consecutive year. Please visit www.recm.co.za for more information.

Copyright © Insurance Times and Investments® Vol:25.1 1st January, 2012
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