While many investors had decided that Chinese consumers were done with luxury shopping, Morningstar begs to differ.
The research company issued a report that suggests that middle-class size and wage growth will lead Chinese shoppers to buy more luxury goods, albeit at the aspirational level, not the high-end side. The many negative winds swirling around the Chinese economy have caused most retail investors to assume the worst about the country’s consumers.
Export and import data have demonstrated increased volatility and declines in the Chinese economy. Debt levels for local and state governments have skyrocketed and the Shanghai Composite Index has fallen 25 percent over the past six months. However, Morningstar points out that Chinese consumers hold $9 trillion in savings and that stock ownership is less widespread than the headlines would lead some to believe.
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Morningstar thinks that China will transition from a manufacturing and production economy to one needing higher skills. More of the population will be graduating from college and expecting higher paying jobs. They project that the “lower middle class” will grow from 30 million to 130 million. The “upper middle class” is expected to increase from 13 million to 30 million.
They feel that the size and spending power of this middle class suggest 5 to 8 percent revenue growth and forecast that Chinese global luxury spending will increase 8 percent. That’s higher than the 7 percent consumption growth forecast by Morningstar over the long term. The new middle class will be buying aspirational luxury for the first time and this is what Morningstar believes will give the market growth. They see brands like Ralph Lauren, Tiffany, Burberry and Swatch as the most likely beneficiaries. The report also feels that this emerging middle class group is shifting to more athletic participation and that will boost Nike and Adidas.
Ralph Lauren is on Morningstar’s Best Ideas list and expected to be a big winner for Chinese consumers getting their first taste of upscale brands. The discount-to-fair value, plus its low market penetration, positions the company for positive results in China. Coach should also benefit from the new consumers, just not as much as Ralph Lauren.
Tiffany is also trading at a discount-to-fair value; however, Morningstar sees its potential as more gradual. The engagement ring business doesn’t lend itself to frequent purchases, but the bridal diamond business is underpenetrated in China so in the long run, it could be positive for Tiffany’s.
Swatch is also believed to be undervalued. Morningstar likes that Swatch has high-end brands, making it feel aspirational, but that it also sells lower priced products. The Swatch company has said that the brand is up 15 percent in mainland China, although the company did concede that exports to China and Hong Kong were a negative 20 percent.
Burberry has already had quite a bit of success in China and was hit hard by the declines in Hong Kong and Macau. Morningstar, though, likes that the price points are lower than some French and Italian houses, but higher than more affordable American brands. They also like that Burberry has embraced technology more aggressively than other luxury brands noting that “Burberry has the biggest and best online image and channel management.”
To be sure, China hasn’t lost its taste for luxury. Cognac sales have begun rising again and sales at company-controlled boutiques from Cartier to Swatch have seen double-digit gains. It looks as if Chinese consumers are still spending — just not as much as they used to — despite the many worries.