PARIS — An unfavorable currency environment is not only creating strong headwinds for Europe’s high-flying luxury sector; it could compel some players to diversify their businesses further and possibly shift production toward Asia, analysts say.

This story first appeared in the December 27, 2007 issue of WWD. Subscribe Today.

Yet even as the dollar drifts to new lows against the euro and British pound, analysts trumpeted the resilience of high-end consumers, downplayed price resistance so far and pointed to booming emerging markets that are fanning sales and easing pressure on operating profits.

“I don’t think the currency dog should wag the fashion tail,” said Andy Wade, retail analyst at Seymour Pierce in London. “I think that [a company’s] pricing decision can’t be driven by currency. Customers don’t want to see prices going up and down with the currency.”

“It’s not really going to change the overall picture that much,” agreed Antoine Belge, luxury analyst at HSBC in Paris, who noted luxury players have been coping with currency gyrations for four years now. “The dollar will be a problem in 2008. ….But it will be hard to differentiate the dollar situation from the slowdown in the U.S.”

“There is no reason to tear one’s hair out. It’s simply time to fine-tune one’s strategies,” noted Tod’s Group chairman Diego Della Valle. “For the past two or three years, currency fluctuations haven’t provided us with any special gift, but luxury goods houses report strong numbers anyway. We shouldn’t sacrifice long-term strategies for our quarterly results.”

Analysts agreed currency hedging has its limits, and firms must use all tactics at their disposal to offset a widening euro-dollar divide.

“More structural measures are necessary,” said Luca Solca, senior research analyst for European apparel and specialty retailing at Sanford Bernstein in London. “European luxury brands will need to start looking at global diversity in manufacturing and [sales and general administration] costs.”

While shifting production away from Europe is considered controversial and quality concerns are paramount, analysts noted vast improvements in manufacturing ability around the world. Solca said many firms are eyeing Asia’s potential. “Prada is manufacturing and sourcing in Asia and China, and Vuitton is considering setting up shoe factories in India,” he noted.

Belge said jewelry players, whose costs have rocketed as investors seek shelter in commodities like gold, have been putting more emphasis on design and added value and less on precious materials as a way to guard margins.

Most analysts played down price resistance, except for certain products and price tiers.

Gianluca Pacini, analyst at Caboto in Milan, noted fashion purchases hinge less on economic considerations than other products.

“Does the currency really weigh on the appeal of a brand?” he asked. “Would customers stop buying Hugo Boss, for example, in favor of Ralph Lauren simply because of the weak dollar? I doubt it.”

Belge noted that most high-end consumers are still absorbing price increases, but “it’s less the case in Japan” since many leather goods have now surpassed the 100,000 yen, or $875, “psychological barrier.” Louis Vuitton addressed the situation successfully with its NeverFull monogram bag, priced around 65,000 yen, or $569, he noted.

Analysts agreed the higher up the luxury chain, the less the impact of currency.

“The most price-elastic customers are those on a medium to high level,” said Sanford Bernstein’s Solca. “The high-end customers are relatively insulated. Different brands will have different problems. Coach and Polo have had difficulty with their aspirational customers, but high-end luxury players didn’t report difficulties in the U.S.”

“In the retail products that make up our luxury market, predominantly apparel and accessories, fragrance and cosmetics, watches, jewelry and home wares, there does not appear to be a downturn,” said Maureen Hinton, lead retail analyst at Verdict Research in London, stressing resilience at the top end.

Echoing other analysts, she also highlighted that fast-growing markets like Asia, Russia and the Middle East would help offset any U.S. weakness.

“Companies that are strong today are those that have already diversified around the world and benefit from sales in other countries and currencies, emerging countries especially, such as Brazil, China, Russia and India where their brands are extremely recognizable,” echoed Pacini at Caboto.

Analysts also scoffed at the suggestion European players might scale back expansion in America because of currency concerns. Many of them are banking on growth in the U.S. to help offset the ongoing weakness of the Japanese market.

“Though the subprime [mortgage] issue is going to be far-reaching, we do not believe it will have the effect on the top end of the market as [it has had on] others — there will still be big City [financial district] bonuses paid out this year,” said Verdict’s Hinton. “However…it will probably hit sales of luxury cars, boats and the top end of the housing market.”

Might there be a tipping point for currency woes?

“If the dollar-euro exchange rate were to reach $1.60, however, it would really create some tensions,” said Caboto’s Pacini. “About 20 percent of revenues at most of the companies in the luxury goods sector is in dollars, while most of their fixed costs are in euro. The pressure on [operating profits] is heavy.”

Added Solca: “If there’s a continuation of the trend, and the U.S. economy does experience a marked slowdown in 2008 — and it’s not yet clear whether it will — then [luxury brands] would see repercussions.”

Paola Durante, analyst at Merrill Lynch in Milan, said the impact on profits will be stronger in 2008 than in 2007. “Companies bank on pricing to have less impact on margins, but we don’t know if this will continue to be possible in 2008,” she said. “Currencies have been more volatile since July and we expect they will remain so until the first quarter of 2008, but luxury will not slow down.”