Active Thinking: Who is buying luxury?

Flavio Cereda, Investment Manager, Luxury Equities, discusses the market segmentation of the luxury sector and explains why he prioritises growth over value.

13 November 2024

In a previous article, ‘The Luxury Sector in the Post-Covid Era – Polarisation’, I discussed how polarisation creates winners and losers. To choose the right names, it is important to identify who is buying luxury. The distinction between who buys luxury and where they buy it is also crucial.

Who buys luxury and where they buy

Chart 1: Momentum by cluster vs geography (percentage of total spend)

This year, the Chinese market is expected to decline by high teens, possibly even 20%. However, the Chinese market is different from the Chinese consumer, who is travelling and buying luxury outside of China. In 2019, 70% of Chinese luxury consumers bought their products outside of China. This year, this figure is about 30%. Many Chinese buyers travelled to Japan for significant savings due to the currency imbalance, though this has now adjusted. The Chinese cluster's total spend is holding up reasonably well, both inside and outside of China.

The Chinese Communist Party and luxury companies themselves are working to retain consumer spending in China. Brands have increased their selling space in China, offering identical products to those available in Europe with the aim of incentivising local purchases. There are also clear differences between what constitutes a VIP customer in China versus Europe which is leading Chinese consumers to favour buying locally.

The American cluster (ie American consumers) is stable, the second largest after the Chinese, with spending patterns typically influenced by the dollar's strength. Historically, American consumers spent less on luxury compared to Chinese consumers, but this has changed. Brands are expanding their presence in the US, recognising it as an emerging market for luxury, as odd as this may sound.

Europe has always been a key destination for luxury purchases due to its heritage. However, the weight of Europe in the luxury sector has still not fully recovered to pre-Covid levels. The absence of Chinese travellers, who were significant buyers, has impacted sales. The European cluster is becoming less important, with brands instead targeting visitors from the Middle East, Asia and North America. This was evident during the Olympics in Paris, where the focus was on attracting these visitors rather than European consumers.

The growing middle class

Chart 2: Luxury market segmentation based on individuals’ liquid assets

Chart 2 represents our view of the mix of luxury consumers based on data intelligence provider Altrata’s segmentation of wealth. Ultra-high-net-worth individuals (UHNWI), defined as having more than USD 30 million in liquid assets, make up 32% of buyers. Very-high-net-worth individuals (VHNWI), with assets between USD 5 million and 30 million, and high-net-worth individuals (HNWI), with assets between USD 1 million and 5 million, comprise the bulk of the rest, with the remaining 12% bought by the middle class.

If we had created the above chart 10 years ago, that 12% for the middle class would have been around 3% to 4%. I believe that 10 years from now it could be over 20%. This growth is crucial to understanding today's market: spending by the middle class is down this year compared to last year, and this segment typically drives the most significant growth.

Chart 3: The unstoppable rise of the global middle class

I believe the Asian middle class will drive 80% of new consumer spend over the next decade. The rise of the middle class, especially in emerging markets, is crucial despite being the smallest component of luxury spend. This segment drives growth, and we need recovery in this cohort, which I expect to start in 2025 and continue into 2026. While wealthier buyers maintain resilience in the sector, growth requires a return of the middle-class buyer.

Growth versus value: focus on sales momentum

What really matters in the luxury space is the quality of the customer. If these brands engage with more resilient and wealthier customers, they continue to grow, some even achieving double-digit growth this year. In such cases, the high multiple in terms of their valuation is absolutely warranted, and I am very comfortable with this.

There is a significant and broad differential at play here. Some brands trade at a significant discount to their average, while others trade at a significant premium. It is crucial to interpret this in the context of current performance and customer base. Stock picking is absolutely crucial because being in the wrong names can be problematic. Many of the more attractive stocks in terms of multiples are value traps, in my opinion. Fundamentally, they are cheap for a reason – they are not performing, and this underperformance is likely to persist into 2025.

The profitability of a brand relies on sales momentum. If we pick a brand that's not performing well at the moment, like Gucci, the impact of stuttering sales momentum on profitability can be severe. Momentum is crucial because it means that even in a year of normalisation as this year has been, following three strong years, a brand that continues to deliver and perform does so because its customers are more resilient, probably wealthier, and less volatile than those of other brands. The customers of Hermès, for example, are very different from those of Gucci. While both are luxury brands, there is a significant difference in their customer cohorts.

The game is to pick the names

2024 has been an unusual year for the sector. I expect 2025 to be less volatile, though perhaps not with a massive sector-wide recovery. It will remain key to pick and choose the right names, which will hopefully continue to outperform. These names with sales momentum behind them will, I believe, grow anywhere between mid-single to low-double digits for sales in 2025.

Flavio Cereda manages the Luxury Brands Equity strategy at GAM Investments.