By The Sizemore Letter<\/u><\/p>\n
The luxury sector has been in the headlines this week, though the outlook has been muddled.\u00a0 High-end home goods retailer Williams-Sonoma <\/b>(<\/span>WSM<\/a>)<\/span> beat earnings estimates on Wednesday, initially sending shares higher.\u00a0 Unfortunately, the details were a lot less impressive.\u00a0 Overall, sales were up 12.3% and same-store sales were up 8.4%… but the retailer had to lower its prices in order to generate those sales\u2014which lowered margins\u2014and management gave guidance that suggested the rest of the year would be tepid.<\/p>\n This came just a day after luxury jeweler Tiffany<\/b> & Co<\/b> (<\/span>TIF<\/a>)<\/span> announced strong earnings and boosted its forecast for the rest of the year.\u00a0 But\u2014importantly\u2014it was a surge in Chinese sales that pushed Tiffany higher.\u00a0 U.S. growth was actually a little on the sluggish side.<\/p>\n It\u2019s never a great idea to draw firm conclusions from just two data points, but this has been a recurring theme for most of the summer. Last month, British fashion group Burberry<\/b> (<\/span>BURBY<\/a>)<\/span>, announced a knockout quarter, with sales up 21%.\u00a0 Growth in China\u2014Burberry\u2019s most important market\u2014were particularly strong. \u00a0Across the English Channel, Herm\u00e8s <\/b>(<\/span>France:RMS<\/a>)<\/span>, the French luxury group best known for its leather goods and scarves, also surprised the Street with stronger-than-expected sales for the quarter led by a strong showing in\u2026you guessed it\u2026China.<\/p>\n American sales have been decent, though far from spectacular. The real success\u2014where there has been success\u2014has been in China.<\/p>\n Between sales in Greater China and sales to Chinese travelers abroad, the Chinese consumer is the engine that drives this entire sector.\u00a0 European sales have held up fairly well, though this is in large part to aggressive buying by foreign visitors.\u00a0\u00a0 Data here is a little hard to come by, as stores generally don\u2019t track the nationality of their patrons.\u00a0 But as a telling case in point, Chinese visitors make up only about 1% of the traffic in London\u2019s Heathrow airport yet they account for nearly a quarter of all luxury goods sales<\/a>.<\/p>\n Yet not all news coming out of China is good.\u00a0 Last month, R\u00e9my Cointreau<\/b> (<\/span>REMYF<\/a>)<\/span>, the maker of high-end French cognac, announced disappointing sales stemming from a sharp decline in China.\u00a0 R\u00e9my, which makes the ultra-high-end Louis XIII cognac, gets over 40% of its sales from China.\u00a0 As goes China, as goes the company.<\/p>\n What are we to make of all this?<\/p>\n To start, despite an improving American economy, the luxury story begins and ends with China.\u00a0 This was bad news earlier this year for certain segments of the sector\u2014such as Swiss watches and super-premium wines and spirits (read: Louis XIII cognac and Chateau Lafite Rothschild wines)\u2014because of a Chinese crackdown on conspicuous consumption and on \u201cgift giving\u201d (ahem\u2026bribery) in government circles.\u00a0 This was less of a problem for handbag and fashion retailers. As the shock of the crackdown wears off, these segments should recover.\u00a0 But the short-term hit to sales will be felt in the next round of quarterly earnings releases.<\/p>\n Meanwhile, in other segments of the luxury market, it\u2019s business as usual.\u00a0 Daimler <\/b>(<\/span>DDAIF<\/a>)<\/span>, the maker of the iconic Mercedes-Benz, just announced that it was making \u20ac2 billion in new investments in China<\/a>.\u00a0 Daimler plans to double its manufacturing capacity by 2015.<\/p>\n So, with all of this said, should you invest in the luxury sector?<\/p>\n I don’t consider the sector the screaming bargain that I did a year ago, but I still see quite a bit that I like. \u00a0Daimler is one of my favorite stocks (and my choice in InvestorPlace’s Best Stocks of 2013<\/a> contest…which it happens to be winning at time of writing). \u00a0Daimler is up over 30% this year, including dividends, yet the stock still trades for a very attractive 8 times earnings. \u00a0It also sports a respectable 4.2% dividend.<\/p>\n I also like Swiss watch leader Swatch Group<\/strong> (<\/span>SWGAY<\/a>)<\/span>. \u00a0In addition to its own highly-successful brands–such as the Omega worn by James Bond<\/a>–Swatch also makes the “guts” that go into 90% of all high-end Swiss watches. Swatch trades for 17 times earnings and yields 1.24%.<\/p>\n China’s growth looks to be stabilizing at around 7.5%. \u00a0The days when Western luxury firms could count on 20% per year annual sales growth are probably over, but the “luxury story” will remain the “China story” for the foreseeable future.<\/p>\n Charles Lewis Sizemore, CFA, is the editor of the\u00a0Sizemore Investment Letter<\/a>\u00a0and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long DDAIF and SWGAY.\u00a0Click here<\/a>\u00a0to learn about his top 5 global investing trends and get your copy of \u201cThe Top 5 Million Dollar Trends of 2013.\u201d<\/em><\/p>\n This article first appeared on Sizemore Insights as What\u2019s Next for the Luxury Sector?<\/a><\/p>\n