City cull will be no luxury

Ceri Jones

Estimates for job losses in the City seem to grow by the day. Last October the Centre for Economics and Business Research predicted that in 2008 the London financial sector would make 6,500 redundancies, but it has since raised that figure to 10,000.

Research group Experian Business Strategies has said that the cull from the City's 350,000 workforce could go as high as 20,000, nearly 20% more than the 17,000 killed off by the dotcom bubble in 2000.

Although the big groups have each already cut between 500 and 1500 jobs so far this year, there is no sense that the worse is over. As Lehman began to shed 18% of its staff last week, top job head-hunter Battalia Winston International estimated that 25-30,000 jobs will be lost in London over the next eight to 12 months.

Even those who stay in position can kiss goodbye to the bonuses they have become accustomed to. Instead of a typical structure of 70% cash and the remainder in shares, this year's bonuses will largely consist of shares.

Apart from the ramifications of this blow to corporate confidence on the wider economy, City lay-offs could have specific impact on certain stockmarket sectors. The obvious contenders are luxury goods companies and it will be interesting to see if the flotations of Prada and Salvatore Ferragamo, penciled in for the summer, still go ahead.

The 'Ultra Rich' are unlikely to be so affected by the economic downturn that they rein in their spending habits. Research by the Harrison Group estimates that the top 5% of US households now control $32,000 billion in assets, against $7,000 billion for everyone else, and this disparity is bigger in countries such as Russia, for instance, where at least 6,000 individuals are said to be worth upwards of $40 million. One indicator that the great wealth sloshing about the system - if any were needed - is the revenues still streaming into the banks' private wealth businesses, as indicated by the first quarter results of UBS and Credit Suisse.

Growth in Asia

The big growth in demand for luxury goods is coming from the new middle classes in Asia, however, and this make a real difference to the sector because these markets are so huge. Chinese social science researchers have coined the phrase 'Zhong Chan', meaning 'middle property', and talk about the growth of 'little Emperors', the thousands of singletons growing up who have come to expect the latest gizmo. Goldman Sachs predicts that China could take 29% of the global luxury goods market by 2015 - surpassing even Japan.

"The sector that traditionally does worse in cyclical downturns is watches," says Ian Ormiston, fund manager of the Resolution European Growth fund. "In the last cycle the margins of Swiss watch-maker Richemont contracted by 1000 basis points because it is highly operationally geared."

Cartier brand-owner Richemont, the third largest luxury goods firm after French giants LVMH Moët Hennessy and Gucci-owner PPR, has reported slowing demand in recent months but by contrast, Swatch, the Swiss owner of the Omega and Breguet brands, posted an 18% rise in sales last year with no apparent sign of a tail-off, partly because it has a more diversely priced product range and Omega is the IT brand for watches in China.

"I would prefer to be exposed to a luxury goods company that was sufficiently diversified in terms of geographic sales so that emerging market growth, particularly in Russia and China, could compensate for weakness elsewhere," says Catie Wearmouth, investment director at Scottish Widows Investment Partnership. "In the event of consumers trading down generally then the company I would want to own would need to have a product range that would capture that.

"The Swatch Group is an example of this, with its range of watches from the low through to mid and high end watches, LVMH is another with its highly diversified collection of luxury products. Within its accessories business and outside of its highly profitable Louis Vuitton fan base, bag lovers have brands like Marc Jacobs or Fendi to choose from. Both companies have sensible capital expenditure commitments and solid balance sheets to support their growth which will provide a structural strength in this difficult environment."

Weak dollar remains a threatLouis Vuitton is doing well in establishing its own shops and cutting out the middleman, a trail blazed by Coach which now has 500 outlets in the US. However, the brand has been somewhat overexposed and the company has just launched a TV ad campaign to try to regain its association with the height of luxury. It remains most counterfeited brand in the world with perhaps only 1% of the items bearing the LV logo now thought to be authentic.
Another threat to the European luxury goods companies trying to export to the US is the continuing weakness of the dollar, putting US homegrown brands such as Tiffany's at an advantage. It has always been said that a 10% decline in the dollar results in a 10% drop in operating profits for these companies, all else being equal, but many now hedge at least some of their currency exposures in the derivatives markets.

Other sectors that could be affected are luxury yachts makers. At the very top of this market where yachts cost £20-30 million apiece and order books for companies such as Bank of Scotland-backed Sunseeker are bulging. But in the middle market, Rodriguez, quoted in Paris, is having a tough time already; its shares have fallen by 70% since June and earnings estimates for 2008 have fallen 30%.

Spectacles in the shade

Another area of high discretionary spend that traditionally suffers when consumers trade down is spectacles, particularly designer sunglasses. Two Italian spectacle frame makers are Luxottica, which supplies Ray-Ban, and Safilo, which makes specs for top brands such as Max Mara and own label Carrera. Their shares have fallen by 45% and 58% respectively since last summer. It is difficult to find a niche top-end player in travel or leisure. Cruise specialist Carnival (CCL) addresses the middle market, for instance and was also subject to a unique take on iBall - watch the episode here.

In drink, the only sector not buoyed by growing demand from Asia is beer, but the brewers report that their leading specialist brews are enjoying growth. While high end whisky exports traditionally relied on the Japanese market, they are now being widely exported across Asia.
Companies that are ahead in foraying into China include Nasdaq's Wal-Mart, which acquired the Taiwanese big-box retail chain Trust-Mart, New York-listed Home Depot, which acquired Chinese home improvement retailer Home Way to cater for the massive growth in homeownership, the ubiquitous Tesco (TSCO) and Kingfisher's (KGF) B&Q chain. In fact, why not watch iBall's look at Tesco.

However, Kingfisher said last week it has suffered in China from government legislation to take the steam out of the property market, and had expanded too quickly opening 42 stores in China in the past three years.

Companies such as the Nasdaq-listed Estee Lauder, Christian Dior, Procter & Gamble, and Japan's largest cosmetics producer Shiseido could benefit as Chinese women start to purchase skin creams and cosmetics, a market estimated to be $5.5 billion per year and growing at an annual rate of 10-15%. Richard Hunter, head of UK equities at Hargreaves Lansdown, also likes personal care company Reckitt & Coleman (RB) on the basis that people won't cut down on basic toiletries no matter how deep the recession.