After targeting education companies and technology tycoons in a renewed interventionist push, will China come for the Birkin bags next?
The question has been worrying investors in the world’s biggest luxury goods groups since President Xi Jinping signalled this month that China would “regulate excessively high incomes and encourage high-income groups and enterprises to return more to society”.
While the Chinese Communist party had long allowed some to “get rich first”, it would now prioritise “common prosperity for all”, said a Xi-led commission, hinting that measures to regulate income and redistribute wealth could be on the cards.
Those few words have been enough to shave €61.7bn, or almost 10 per cent, from the collective market value of LVMH, Hermès, Kering, Richemont and Burberry since the announcement on August 17.
China has been the main growth engine of luxury, and the Covid-19 pandemic has only turbocharged its importance. Spending on high-end jewellery and clothes has been repatriated to China because travel restrictions mean Chinese can no longer jet to Milan or Paris to shop.
Led by the rising middle class of Generation Z and millennials, Chinese consumers are expected to buy 45 per cent of all the luxury goods sold globally this year, up from 37 per cent in 2019, according to Jefferies.
A small group of ultra-wealthy people — Jefferies reckons they number about 110,000 and each spend more than €100,000 a year on fashion and jewellery — account for almost a quarter of luxury sales to Chinese consumers. If they sense that flaunting their wealth is suddenly taboo in Xi’s China, then the industry may soon feel a chill.
Executives at Europe’s luxury houses are still trying to figure out what might happen and if they need to react.
Yishu Wang, a London-based consultant whose agency Half A World helps luxury brands and high-end retailers expand in China, has been fielding calls from worried clients.
“I’ve been telling them that things may not change dramatically right away, but for a time some very wealthy people, top CEOs, and high-level government officials are certainly going to be more careful about what they wear or show in public,” she said.
“It may be prudent for luxury brands to keep a lower profile for a bit. They might consider toning down the marketing campaigns they’re planning for this autumn and winter so as not to emphasise exclusivity or elitism.”
Wang added that Xi’s pronouncements could also usher in more sober clothing design that departs from the bling and loud logos that are often popular in China.
The recent sell-off of luxury shares has cut short a run-up that had sent valuations to all-time highs, with the sector trading at a 90 per cent premium to the MSCI Europe index, compared with a 50 per cent historical average, according to UBS.
The pandemic turned out to be much less of a drag than feared because affluent US and Chinese consumers have continued spending. In the past 18 months, the biggest brands such as LVMH’s Louis Vuitton, Hermès and Chanel have taken share, putting them on track to recover as early as this year, even as smaller houses continue to struggle.
But some investors have started to bet against the sector.
Short interest in Hermès ticked up to 0.9 per cent of the free float on Thursday, up from 0.7 per cent in mid-August, according to IHS Markit data, while Richemont’s rose to 1.4 per cent from 1.1 per cent in the same period. There was little change in short interest in LVMH or Kering though.
Despite the uncertainty around any regulatory crackdown and its potential impact, others are less concerned.
“The China opportunity is clearly still bigger than the risks and if it wasn’t, you wouldn’t want to be in luxury at all,” said Flavio Cereda, analyst at Jefferies. “What you have now is just a lot of new uncertainty and that’s making investors nervous.”
At a press conference in Beijing on Thursday, Han Wenxiu, a senior economic official, sought to reassure the public that the push for “common prosperity” did not mean China would “rob the rich to help the poor”.
Analysts say China may boost taxes on expensive products, crack down on influencers who flaunt on social media, impose advertising curbs, or intensify border controls on daigou, the professional shoppers who travel abroad to buy on behalf of Chinese. All these could weaken luxury demand.
Another concern is that the government may lean on companies to narrow the longstanding gap in prices. Brands often charge 25 per cent to 50 per cent more for their goods in China than Europe, which is why Chinese shoppers used to spend so much when travelling before the pandemic.
One 29-year-old professional in Chengdu who occasionally buys luxury goods said the government’s shift in tone was having “no effect” that she could see on the wealthiest consumers she knew. But policies such as a new inheritance tax or higher levies on income from investments or property would affect the wealthy.
Katie Sham, a consultant at Oliver Wyman in Hong Kong, said the wealth of the top 5 to 10 per cent of consumers in China is “likely to be impacted” which “definitely isn’t good news for the luxury players”.
Chinese policies have hit luxury before. In 2012 to 2014, the early years of Xi’s anti-corruption campaign, Beijing cracked down on gifts to civil servants in exchange for favours. Sales of luxury goods and spirits grew at slower rates during the period than before and after, according to analysts.
“If Xi says and does nothing about this again for the next few months then you’ll see some recovery in the share prices, but the derating will stay,” predicted Jefferies’ Cereda.
“If he keeps talking about it or announces specific policies, then the market could be in for a very volatile time.”
Additional reporting by Wang Xueqiao in Shanghai, Ed White in Seoul, and Adam Samson in London