MILAN — Is it the beginning of the end, or the start of a new downturn?
That’s the question observers of the luxury scene are pondering after two major groups — Prada SpA and Compagnie Financière Richemont SA — last week reported muted figures following similar sluggish times at Kering and LVMH Moët Hennessy Louis Vuitton.
While the hope is that the numbers reflect a tough first half impacted by currency fluctuations, continuing softness in the European economy, the slowdown in China and the pullback on spending in Russia, and that things might pick up later this year, the fear is that the sector has entered a new phase and times will remain difficult well into 2015.
Luxury groups aren’t taking any chances either way, and are revamping their strategies as fast as they can. Prada, Kering’s Gucci and Louis Vuitton have all revealed steps to focus more on the quality of their products and less on the quantity, while many brands have slowed down their store openings to adapt to what could be a new reality.
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Prada was the last of the four major luxury groups to report figures, and on Friday revealed that profits in the first half ended July 31 dropped 20.6 percent to 244.8 million euros, or $333 million, compared with 308.2 million euros, or $400.6 million, in the same period in 2013.
Currency headwinds and slightly higher revenues “were insufficient to absorb the increase in costs” related to the group’s retail network expansion, which saw the opening of 75 stores in the past 12 months, including 41 Prada, 29 Miu Miu and five Church’s units.
The Hong Kong-listed company posted revenues of 1.75 billion euros, or $2.4 billion, up 1.3 percent compared with 1.73 billion euros, or $2.25 billion, in the same period a year earlier. At constant exchange rates, the growth in revenues was 4.5 percent.
While the Italian fashion group saw gains at its footwear and ready-to-wear divisions, as well as growth in the Americas and some regions in Asia, its bottom line was dented by the lackluster economy in Europe and a slowdown in the leather goods category. Chief financial officer Donatello Galli admitted the problem was a misreading of the market in leather goods, and said the company is moving to correct the situation. “At some point during the year, we lost connection with the market, there was a misalignment with what the market was asking,” he said. “We need to work in terms of planning, taking organizational steps to solve the problems — which are in the organization, not in the design. We need to align the flow of production with the market’s requirements, improve our planning capabilities as we are delivering a product that is much more complicated, with more craftsmanship. In a nutshell, we need to do some homework.”
Analysts took a generally downbeat view of Prada’s performance, expressing some concerns going forward. “While we see a more resilient trading momentum at Burberry and Hermès, we retain a more prudent stance on Prada — its flagship brand appearing less center stage and colder than before, as seen in these disappointing H1 figures,” said Luca Solca, managing director and sector head of global luxury goods at Exane BNP Paribas. He said that Prada is working on avoiding a “banalization” of the brand, raising entry prices of its handbags, and underscored the “difficult comparables” in light of its previous successful models, such as the Saffiano.
He concluded by describing the brand as “less hot” in terms of “brand temperature.”
Citi European luxury analyst Thomas Chauvet said Prada shares have underperformed the luxury sector year-to-date (down 26 percent versus the sector’s 4 percent) following significant underperformance in 2013 (down 7 percent versus a 15 percent gain in the sector).
In its research, Morgan Stanley expressed its belief that “price positioning is crucial to performance for all the soft luxury brands in the current consumer environment. We continue to see a risk [Prada] will find it difficult to adjust the cost base to maintain profitability in the context of its plan for new stores.”
In commenting on his group’s performance, chief executive officer Patrizio Bertelli naturally exhibited an upbeat mood, saying he remained “confident that the luxury goods market — especially the high-end segment, where the Prada Group operates with success — will continue to offer interesting growth prospects in the medium-term.”
Despite Bertelli’s optimism, during a conference call with analysts, Galli said the company would postpone the opening of stores that are not considered strategic and will pursue a cost-containment strategy to focus on prioritizing long-term growth objectives. He said he expected top-line sales in 2014 to be in line with last year’s, adding he did “not expect to change fundamentals — the market is positive.”
Chairman Carlo Mazzi underscored that, “in terms of margins, it’s very simple, we are continuing with our investment plans, and the costs are related to our new openings. Why not stop the openings? Because our strategy is long- term. The problems are short-term and there is no reason to change our strategy.”
Without providing any details, Mazzi added that the company is “changing [its] organization to face bigger complexities around the world. We are confident the next years will be very satisfying.”
Prada’s forecast indicates how rapidly the luxury scene has altered and represents a sharp downward revision of Prada’s earlier outlook. Only in April, Galli predicted sales would rise 9 percent this year and 3 percent like-for-like, and said the company would open 80 stores. It now plans to open 65.
While Bertelli was present on the call, he did not comment on the company’s performance.
Prada is heavily reliant on its own store network. The retail channel accounts for more than 83 percent of sales and was up 1.4 percent in the first half. Even though they were penalized by unfavorable exchange rates, the 566 directly operated stores generated sales of 1.44 billion euros, or $1.95 billion, in the period.
The group’s apparel sales rose 13.9 percent to 230 million euros, or $313 million, and footwear was up 18.8 percent to 208.5 million euros, or $283.5 million. “This proves the categories and their design are alive and kicking,” said Galli.
The problem lies in the group’s core leather goods division, where sales fell 4.9 percent to 975 million euros, or $1.32 billion. The company attributed the decline primarily to a decrease in tourist footfall in the main shopping destinations in Europe and Asia. Also, the company highlighted the very high comparable base of the previous year, when leather goods sales were up 22 percent.
All figures have been converted at average exchange rates for the period in question.
Sales in the Asia-Pacific area totaled 561.8 million euros, or $764 million, down 2.1 percent. At constant exchange, they would have been up 2.1 percent. Performance remains weak in Korea, Hong Kong and Singapore, while China accelerated, gaining 11.8 percent at constant exchange rates. Galli noted that the brand is “coherently positioned” in Mainland China and Japan and that he saw an acceleration in the second quarter in Mainland China. Korea is showing signs of improvement, he added.
He lamented a problem with tourist spending.
“We are not the only ones in Hong Kong seeing some tensions arising,” said Galli, echoing comments made by Richemont earlier last week. “There is a decrease of Mainlanders going to Hong Kong. There is a kind of transformation. They are less willing to spend. They stay one night or less, versus three nights in the past. There is a different pattern in consumer attitude. There are deep sociopolitical reasons. Hong Kong is important, and the level of investment is huge for all competitors.”
Galli also said that the growing complexities of the markets require a tailor-made approach to each. Responding to several questions on the leather goods performance, Mazzi said: “The company introduced top leather quality and Mainland China is very good. There are exceptions in Europe and some parts of Asia.”
Sales in the Americas were up 8 percent, lifted by domestic consumption and tourist spending, and totaled 177.2 million euros, or $241 million. Europe decreased 1 percent, totaling 481.7 million euros, or $655.1 million, penalized by weaker tourist flow and by a sputtering economy that is hurting domestic consumption.
Despite the expected slowdown in purchases after the VAT increase at the beginning of April, sales in Japan climbed 9.8 percent to 173.8 million euros, or $236.3 million. At constant exchange, they would have risen 19.5 percent. The Middle East was up 16.1 percent.
The Prada label continued to represent the group’s core business, totaling 1.2 billion euros, or $1.6 billion, around 83 percent of total sales. In the period, the brand rose 0.9 percent. At constant exchange, it would have grown 4.6 percent. The men’s wear segment, in particular, posted a 19 percent growth at constant exchange.
Miu Miu was up 2.9 percent to 217.4 million euros, or $295.6 million, but would have risen 7.1 percent at constant exchange rates. The brand performed well globally except in Europe, said the group. Church’s grew 13.8 percent and Car Shoe rose 2.7 percent.
Capital expenditures were driven by the group’s retail development and totaled 290 million euros, or $394 million. This includes 62 million euros, or $84.3 million, for the purchase of its headquarters in Milan, the company revealed.