Fiery Flash: Hermès

Over the past five days, shares of luxury group Hermès have taken a 10% dive. Growing concerns about (Chinese) consumer spending and analysts lowering profit expectations have driven the share price further down.

French company Hermès is renowned in the luxury goods sector. It’s not named after the Greek god of trade and commerce, but rather after its founder, Thierry Hermès. 187 years ago, he began by crafting wrought harnesses and bridles for carriages. His son and grandsons later introduced saddlery, and the company eventually expanded into other leather goods, clothing, and accessories.

Hermès is synonymous with heritage, luxury, and exclusivity. Unlike some of its peers, Hermès manufactures most of its products in-house (55%). This, along with its 7,300 skilled craftsmen, helps the company ensure the superior quality and authenticity of its products. Hermès deliberately controls supply growth, making its products even more coveted. The group’s distribution model relies on a network of 295 (mostly directly operated) stores in 45 countries and e-commerce platforms. Over the past decade, Hermès has more than tripled its sales through a combination of higher volume and regular price increases. During the same period, the group’s operating margin has risen by nearly 1000 basis points to 42%.

In recent years, China and the US have been the primary growth drivers in the luxury industry, fueled by a growing number of wealthy individuals. However, the industry is currently facing a double whammy: consumer budgets and confidence are under pressure from a weakening economy (including rising unemployment in the US and a property market slump in China), and the effects of high inflation following the COVID-19 pandemic. Additionally, the industry is experiencing a backlash from the surge in sales during the pandemic. In China, a recent trend known as 'luxury shame' is emerging, where the elite and middle class are cutting back on luxury purchases as flaunting wealth is frowned upon during a period of economic struggle.

The higher a company sits on the luxury ladder, the less it is affected by economic downturns (richer individuals are less impacted than those with lower incomes). Therefore, Hermès should be less vulnerable than its peers, though it is not immune to the industry-wide downturn.

Year-to-date, Hermès shares are still up 1%, but that represents a 20% decline from the peak earlier this year. Over the past decade, Hermès shares have delivered an impressive annual gain (including dividends) of 26.3%, significantly outperforming peers such as LVMH, Richemont, Kering, and Brunello Cucinelli, as shown in the chart above.

A positive development today is that shares of luxury goods companies are less over-owned and over-loved than in recent years. For a recovery in share prices within this industry, we need to see evidence of stabilizing demand. The worst potential scenario for the industry would be the imposition of import tariffs in China. Although unlikely, this cannot be entirely ruled out given the current geopolitical climate.