Europe’s luxury goods sector has made a strong recovery from the pandemic. Now, though, it must contend with the challenges brought by soaring inflation, particularly around energy prices. Will companies be able to adapt? And what could it mean for investors in the sector?

Taking to the skies

The European luxury goods sector derives almost 30% of its revenues from abroad, with travel a key driver of income [1]. The industry, which is at the pinnacle of the consumption pyramid, managed to exit the pandemic in a stronger position than most. It did so by significantly improving e-commerce coverage. This was especially targeted at the all-important Asian consumers, many of whom were grounded by strict travel restrictions. The pandemic also helped the industry enact much-needed efficiency measures. These included reshaping inventories and improving supply chains. Numerous firms also launched eye-catching marketing campaigns.

Now, with the worst of the pandemic over, customers – particularly from Asia – are once again travelling. And Europe’s fashion capitals remain a prime destination. Many are drawn to Italy and France’s stunning landscapes and architecture. They also prize the premium garments and accessories that the fashion houses – and their highly skilled façonisti – have to offer. The price gap differential in Europe also means Asian visitors can pick up their luxury goods at superior prices to those back home. Even the wealthy like a bargain.

Challenges ahead…

However, the industry has seen a significant de-rating in the first half of 2022. The Russian/Ukraine conflict and spiralling energy prices have sent inflation soaring. Cost pressures at many luxury firms are mounting.

As a result, we’re seeing growing concerns about what this winter might bring. Governments in Europe could face tough decisions around how to keep the lights on. There’s talk of mandatory EU-wide energy cuts during peak hours. Many in the fashion industry worry that ‘non-essential’ industries could face periods of rationing, shutdown or furlough.

The challenges don’t stop there. Transport issues could also cause further disruption. Logistics, staffing and fuel costs are all taking their toll. Some companies are reporting that products that once took 25 days to arrive are now taking up to 60 days.

And, of course, there are concerns that decades-high inflation is eating into consumers’ disposable income.

…but the industry remains durable.

Yet despite these factors, sales of luxury goods remain strong. Most notably among the highest-end companies, where the relationship between price increases and demand is highly inelastic. In the luxury watches' space, for example, demand is outpacing supply. Waiting lists for prime pieces can run to several years.

As for rising energy costs, some fashion companies have moved from natural gas to renewable sources of electricity, such as wind and solar power. This should secure more predictable energy supplies and help control costs.

Furthermore, this isn’t the first time the industry has faced economic headwinds. In the past, many luxury fashion houses were able to absorb inflationary pressures, rising freight costs and supply chain issues. They did so by introducing ‘self-help’ measures to ease the pressure. This time is no different.

Take top European brands like Brunello Cucinelli and Moncler. Over the years, they’ve adapted their sourcing cycles for raw materials – yarns (namely cashmere), woollen fabrics, cotton and feathers – to make the best of pricing volatility. Negotiations for these goods now take place ahead of the season sales. This means sourcing costs feed into price increases closer to the sales period.

By contrast, weaker mainstream fashion companies are more exposed to the negative effects of raw materials inflation, rising transportation costs and supply-chain disruptions. Shoppers in this segment tend to have less disposable income to buy discretionary goods. Retailers can only raise prices by so much before spurning customers. This can bite into margins. That said, it’s worth noting that companies offering essential ‘staples’, such as affordable trainers, jeans and workwear, continue to fair relatively well.

Final thoughts...

There’s no doubt that the current energy and inflation crisis poses a significant challenge for the fashion industry. It may even be an existential threat to some brands. But despite the gloomy outlook, the fashion industry – and especially the luxury segment – is endlessly adaptive, creative and innovative. It knows how to pivot, reinvent and create new products to meet new demands. That’s why we think many luxury goods firms will not only survive – but go on to thrive in the difficult times ahead. As for investors, recent de-ratings mean now might be an opportune time to pick up the odd bargain.

Companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance. Past performance is not a guide to future results.