In the “Are luxury stocks good value now?” section of our introduction to luxury blog, we briefly touched upon the fact that despite their recent share price rise, luxury stock valuations remain in line with their historical range. In this blog, we dive deeper into luxury valuations and what has driven luxury share prices recently.
Luxury valuations trade below their historic averages
2022 was a mixed year for the luxury sector, with strong underlying revenue growth (22%) [1] only partially reflected in share prices with the sector down -26% for the year [2] . This year has started strongly with share prices rising +22% to their 2023 peak[2], which has led investors to question sector valuations.
While industry analysts typically prefer to point to P/E [3] valuation multiples, we believe EV/EBITDA [4] is a more relevant metric given the net cash position of many luxury firms. The chart below shows the average EV/EBITDA ratio for the Tema LUX portfolio over time, currently trading at 14.9x EV/EBITDA [5] , below the 8-year average. The measures below are reflective of the fund’s current holdings.
Zooming in further on the largest four bellwether luxury companies globally (LVMH, Hermes, Richemont, Kering), we similarly see that these companies currently trade at an average 15.1x EV/EBITDA multiple [6] , below their historic 8-year average. This is captured in the below chart combining the straight average multiple of these four companies plotted over time. This underscores our view that absolute EV/EBITDA valuations in luxury today are not demanding, especially considering the business quality and growth profile.
What has really driven share prices?
When we decompose the share price performance of the LUX ETF underlying companies since 2015, we note the share price growth has primarily been driven by underlying earnings growth with minimal contribution from multiple re-rating[7], as illustrated in the below chart.
[8][9]A case in point is Hermes. The company has become renowned not only for the prices of its most desired handbags but also for the premium valuation that its share price commands. At various points in the past 15 years, the shares peaked at valuation multiples that can only be considered as high. Yet, despite this, in all these cases the share price performance over the subsequent 5-years remained strong. We believe this is attributable to its desirable brands, enviable market position and market-leading earnings growth trajectory.
Despite the sector’s positive secular growth backdrop, there is growing concern about the impact of a potential slowdown in US luxury expenditure. We share this concern which is corroborated by recent credit card data and earnings results. However, we believe this risk will, to a large extent, be managed through the reopening of much of Asia led by China, which is becoming evident in Asia leading growth in the latest earnings results.
We believe this growth balance means that increasingly the luxury goods sector has become more resilient, as it has diversified both geographically and demographically, justifying a higher run-rate valuation multiple. Asia remains the fastest growing luxury market globally and is expected to represent over 50% of global luxury consumption by 2025 [10] . We have constructed the Tema LUX portfolio with this in mind.
Bottom Line
We believe, recent valuation concerns in the luxury sector are overdone, with the sector and bellwether stocks trading at 15.1x EV/EBITDA[6] , below their historic average. Historic share price growth has predominantly come from earnings growth. Concerns of a US slowdown are genuine, but we feel that luxury’s more globally diversified customer base should make the revenue outlook of the sector more stable than in previous cycles, warranting potentially a higher run-rate multiple.
Endnotes
[1] Source: Bain & Company. (2023). Renaissance in Uncertainty: Luxury Builds on Its Rebound.
[2] Source: Bloomberg. ‘Sector’ is represented by the S&P Global Luxury Index, a market capitalization-weighted index designed to measure the performance of companies in the global luxury goods sector. The index includes companies from around the world that are involved in the production and distribution of high-end goods and services such as designer apparel, accessories, cosmetics, jewelry, automobiles, hotels, and other luxury products.
[3] P/E: price/earnings ratio
[4] EV/EBIDTA: enterprise value / earnings before interest, depreciation, tax, and amortisation
[5] Source: Bloomberg as of 05/24/2023. ‘current’ represents latest available data at the time, which is 03/10/2023, based on the latest Q1 2023 earnings.
[6] Source: Bloomberg as of 05/24/2023
[7] Re-rating: considered to have occurred when valuation multiples have changed. Re-rating in the share market means that investors are willing to pay a higher price for shares, anticipating higher earnings in the future
[8] EPS growth: Earnings per share growth – illustrates the growth of earnings per share over time.
[9] Multiple expansion: an increase in the price-earnings ratio, or multiple, of a stock or group of stocks
[10] Source: Bain & Company. (2023). Renaissance in Uncertainty: Luxury Builds on Its Rebound.
Risk Information
Before investing, carefully consider the Fund’s investment objective, risks, charges, and expenses contained in the prospectus available at www.temaetfs.com. Read carefully before investing.
Important Risks
Investing involves risk including possible loss of principal. There is no guarantee the adviser’s investment strategy will be successful.
Sector Focus Risk: The Fund may invest a significant portion of its assets in one or more sectors, including Consumer Discretionary and Consumer Staples, and thus will be more susceptible to the risks affecting those sectors than funds that have more diversified holdings across several sectors.
The success of companies that sell luxury goods and services may depend heavily on the disposable household income and consumer spending of a relatively small segment of the general population, rather than the consumer population as a whole. Changes in consumer taste among such segment of the population can also affect the demand for, and success of, luxury goods and services in the marketplace. Consumer spending on luxury goods and services can also be adversely affected as a result of declines in consumer confidence levels, even if prevailing economic conditions are favorable. In an economic downturn, consumer discretionary spending levels generally decline, often resulting in disproportionately large reductions in the sale of luxury goods and services.
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Tema Global Limited serves as the investment adviser to Tema Luxury ETF (the “Fund”), and NEOS Investments, LLC serves as a sub adviser to the Funds. The Funds are distributed by Foreside Services LLC, which is not affiliated with Tema Global Limited nor NEOS Investments, LLC. Check the background of Foreside on FINRA’s BrokerCheck.
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