"There is a real complacency in the market today with regard to luxury companies"​



Reda Karkar, Senior Analyst for the Equity Team, Alken.


For professional investors.

Every self-respecting asset management company has its own financial analysts.

They are attentive observers of the life of companies and the dynamics of economic sectors, and they provide managers who are sometimes very busy with the markets with the necessary distance to invest in their clients' best interests.

Interview with Reda Karkar, a specialist in the retail and luxury sectors but whose vision also encompasses community services and ESG analysis.


A word about your experience to begin with ?

I have been doing financial analysis for 20 years, 10 of which have been with Alken AM. I specialise in the retail and luxury sectors, but I am also interested in utilities.

What is your view of the luxury sector on the stock market today ?

For more than 10 years, this sector has been performing exceptionally well on the stock market, with an important detail being the polarisation of performance towards "instagrammable" stocks such as Hermès and LVMH.

This good health has three drivers: firstly, the wealth effect resulting from the rise in the financial markets and the price of real estate assets. Secondly, the wallet shift by people whose ability to spend on experiences has been affected by lockdowns and travel restrictions and finally the broadening of the consumer base for this type of product. 20 years ago, fewer Chinese bought luxury goods. It’s not just nationalities, men, middle classes, and the young have also increased their spending.

So luxury has broadened its customer base beyond those usually considered affluent ?

Yes, it has. And this phenomenon has been amplified by two things. First, luxury companies have renewed themselves by launching collaborations with streetwear brands and music stars. Some of them were thus able to erase the old-fashioned image they might still have had.

On the other hand, because of the various lockdowns around the world, consumers have chosen to show themselves on social networks with their latest luxury products rather than being able to show themselves in a swimming costume on the beach.

Listening to you, one would imagine that the luxury sector is rather immune to the return of inflation and the future shocks on the markets. Is this the case ?

That's what the most enthusiastic investors think, but the reality may well disappoint them. Mostly, because we have no certainty that the Chinese clientele, which accounts for 30% of demand for luxury goods, will resume its travel to Europe. The recent confinement of the city of Shanghai is a reminder of the extent to which there are different approaches to dealing with the crisis. Besides, there is a real risk that middle class customers will be hit by the return of inflation.

Aren't all these risks weighing on the luxury sector already integrated into valuations ?

There is a real complacency in the market today with regard to luxury companies. This is understandable given the exceptional performance of certain stocks in recent years. It is also true that the most iconic brands can increase their prices by 5 to 10% each year. However, this does not make the sector immune to a correction. And this is not at all taken into account in current valuations.

Faced with the return of inflation, what are the challenges facing retail companies ?

The Ukraine crisis has exacerbated the inflationary problem, but it has started earlier as distortions appeared in the distribution chain with the covid-19 crisis. And it took six months for these to start being reflected in prices. We are only at the beginning of this phenomenon of rising prices. At the same time, the lowest wages are also rising. The inflation observed today is strong but it will tend to accelerate, especially in non discretionary expenses. It is difficult for the consumer to eat less, use less electricity and less heating.

Is the situation ahead so worrying ?

Between the rise in food prices, energy prices and the rise in certain wage categories, retailers both online and offline will have no choice but to raise their prices. Not all of them are in a position to pass on input cost rises.

Indeed, the better able to overcome this difficult period fall into three categories: those with major cost reduction programmes, those with strong brands and therefore with control over the prices they charge (the famous "pricing power") and finally the discounters.

Isn't it paradoxical to talk about "pricing power" and discounters when inflation is on the rise ?

Absolutely not. The difference between a traditional retail chain and a discounter is that the latter generally increases its prices much more than the rest of the market. And yet the customer continues to shop at Lidl because he continues to save money by going to this chain.

And what about online retailers ?

Among Internet retailers, it is possible to distinguish between two profiles: those capable of generating profits and those in the race for market share that have not yet proven that they are capable of sustainably generating profits. This distinction is crucial because if inflation is picking up, interest rates are also rising. And access to cash is going to be increasingly difficult for companies that have never turned a profit.

Could you give us two examples to fully understand what is at stake ?

One of the financially healthy companies that can generate cash is Zalando. At the other end of the spectrum are the food delivery companies that have just recently raised money at a very high cost. They will face difficult times in the coming 24 months.

What is your opinion on the Chinese company Shein, now valued at $100 billion and weighing more than Zara and H&M combined?

It's a delicate subject because it touches a broader controversy around fast fashion and the working conditions in Shein's workshops are controversial. While young people currently have no problem buying this type of product, there is no reason to believe that this trend will not be reversed as ESG concerns grow.

ESG is an important factor for Alken. How do you integrate that in your financial analysis?

ESG is critical to analysing companies. It is an integral to understanding risks and performance. All three letters, Environment, Social and Governance are all independently important. Take for example the harassment scandal uncovered within Ubisoft Canadian studios in 2020. The impact on the share price was significant. Furthermore, you cannot understand the energy sectors and Utilities without a firm grasp of the environmental issues.

How do you work ?

We keep a close eye on what is being decided in Europe. For example, the consensus on reducing carbon emissions has favoured renewable energy stocks on the stock market, but this has not solved certain concrete problems such as the intermittency of these energy sources or their profitability. With the Ukrainian conflict, we must now also integrate the issue of security of supply into our analysis.

The issue of energy transition has already favoured certain stocks at the expense of others on the stock market. Is it still possible to find opportunities ?

Today, everyone knows that the Danish company Orsted is the champion of offshore wind energy and that its share price is already very high. For a boutique specialising in discounted stocks like ours, this kind of story is no longer of much interest. We prefer to focus on companies in the process of transformation, because that's where the real opportunities lie.

For example ?

Take the German company RWE. It is a major CO2 emitter with its coal mines and lignite power plants and yet... the group that has launched a very aggressive plan to reduce its greenhouse gas emissions. Today, the stock is penalized on the stock exchange and its renewable assets are at an important discount to the sector because a large number of ESG funds still refuse to invest in it. For our part, we believe that the company’s approach, led by a fully committed management team, should be encouraged. We believe the company could get out of coal much faster than the market expects.

Do you think that the ESG analysis of specialised rating agencies is well done today ?

Most of the time, yes. And from this point of view, the rating agencies are rather on the right track. Nevertheless, their standardised analysis matrices are not always adapted to all situations. In addition, some small and medium-sized companies do not have the necessary resources to respond to the rating agencies' questionnaires on time. There is also the fact that some agencies may miss or underestimate critical issues. In the past, for example, they did not forsee the forthcoming controversies on employment for "gig economy" companies, which have brought some companies hefty fines in European courts.

So extra-financial data is still far from being a panacea, is it ?

Yes, which is why it is a potential source of differentiation from the competition. ESG reinforces stock-picking as practiced by Alken AM. These new areas of analysis, in particular E and S, are increasingly translated into risk and performance.

 

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