European brands on both sides of the Channel are bracing for more exchange rate anxiety this year and next, with the pound likely to fall further against the euro, which has been gaining momentum.
A strengthening euro threatens to dampen profit for luxury brands in the second half. The European single currency peaked at $1.19 in early August, up more than 13 percent since the start of the year.
“A strengthening euro is creating a headwind for euro-based luxury goods companies down the road,” Exane BNP Paribas said in a recent research note.
Given hedges in place, this would translate into more muted top-line growth in the second half, while margin pressure should not appear before 2018, the bank added.
Speaking after LVMH Moët Hennessy Louis Vuitton reported second-quarter results in late July, LVMH chief financial officer Jean-Jacques Guiony warned that currency fluctuations could impact profitability in the second half.
“One can only be surprised by the sharp fall in the U.S. dollar that took place in the last couple of weeks, which is a useful reminder that we may not be in a strong-dollar environment forever,” the executive said. “We all know that a stronger euro has a negative impact on margins.”
Jean-Marc Duplaix, chief financial officer of rival French group Kering, said it was too soon to anticipate the impact of a strengthening euro.
“We are quite cautious regarding the evolution of the business during [the second half]. I think that our brands have still this strong momentum, but it’s clear that we will have some headwinds due to the foreign exchange. Does it imply that we are considering some price increases? Once again, I think it’s too soon to say that,” he said in late July. “Of course there will be some implications in terms of pricing, in terms of tourism flows, in terms of revenues translated into euros, in terms of margins, in terms of absorption of the cost in euros.”
The euro’s strengthening against the Swiss franc should conversely benefit companies like Swatch Group and Compagnie Financière Richemont, Exane said. “This is another reason to turn more positive on watches and hard luxury. It is a fair assumption that hard luxury may outperform soft luxury in the second half of 2017,” it forecast.
Antoine Belge, global co-head of consumer and retail at HSBC, noted the euro has strengthened 5 percent on average against other currencies since May 30. He estimated that every 5 percent increase in the euro results in an average 8 percent drop in earnings before interest and taxes, before hedging.
“This results from the fact that, on average, the euro zone accounts for 23 percent of total sales for European luxury companies, while 43 percent of their costs are denominated in euros,” he detailed in a research note.
“Luxury brands now have less power to increase prices outside euro zone and are willing to limit the gap between prices in the U.S. dollar zone relative to the euro zone in the interest of price harmonization,” according to Belge. “We thus do not expect luxury brands to increase prices outside the euro zone to mitigate this foreign exchange headwind. In addition, the stronger euro will limit the purchasing power of Asian tourists when traveling to Europe. This will affect global sales as these lost sales will only be partially compensated by purchases of Asian consumers in their home countries or at other destinations.”
Among the brands that stand to be hardest hit by a rising euro is Salvatore Ferragamo, due to its low sales exposure to Europe, followed by Tod’s and Prada, Belge predicted. Swatch and Burberry would not be significantly affected, as their reporting currencies are the Swiss franc and the British pound.
The already-weak pound is another currency that’s been falling against the mighty euro: In August, it was touching 10-month lows against the euro at 1.10, while some say the pound could reach 1.05 to 1.06 euros before the end of the year due to a variety of factors including all of the uncertainty around Brexit and the future of British trading abroad.
Morgan Stanley has said it believes the British currency could be worth less than one euro by early 2018 — which would be a psychological blow for the Brits.
British companies such as Burberry have been enjoying the post-referendum weaker pound — it’s been drawing people into shops and making them spend more. It has also been driving export growth for U.K. manufacturers.
The benefits of a weaker currency, however, are a temporary gift.
Burberry already noted earlier this year that due to new and less favorable hedging rates — and the higher cost of sourcing and manufacturing in the euro zone — it is expecting to see a 25 million-pounds drag on reported adjusted retail-wholesale profit in fiscal 2018.
The currency anxiety comes as analysts are forecasting a rebound in the luxury sector this year.
According to Bernstein’s European Luxury Goods team, the sector should see about 3.5 percent growth after a one percent decline in 2016. “On a product level, growth will be led by jewelry and shoes, both which are expected to see a 7 percent increase, and leather goods, 6 percent.
Bernstein said that in a luxury world where space growth is suppressed, “pricing power will be key to operating leverage and margin expansion in 2017.”