Industry: Fashion stocks still in demand

Even with the euro heading north, Japanese consumers remaining skittish and valuations at lofty levels, enthusiasm for luxury fashion stocks as a medium-term investment remains undimmed among many investment professionals.

Such confidence might appear misplaced with the outlook for equities so precarious after this summer's market gyrations.

But analysts cite a number of reasons for keeping the faith: global growth is robust and wealth creation is continuing, fueled largely by emerging markets with their burgeoning and aspirational middle classes; tourism is booming; high-end home prices are holding up; and the luxury retailers listed on stock markets have largely managed to raise prices without hurting sales.

Most investors who entered the sector at the start of the year have been rewarded. An index of European textiles, apparel and luxury goods complied by Standard & Poor's was up 7.2 percent for the year to date, but down 2.03 percent in the previous three months, hit by market uncertainty.

The current upswing "will probably last for two or three more years" said René Weber, an analyst at Bank Vontobel in Zurich. "Most companies are still seeing double-digit sales growth, so there is no reason why the share prices shouldn't see double-digit growth."

Surveys are backing the theory that there are more people with more money.

A report in June by Merrill Lynch and Capgemini found the assets of high net-worth individuals - those with net assets of at least $1 million excluding primary residences and consumer goods - increased 11.4 percent to $37.2 trillion in 2006, while the number of wealthy individuals rose 8.3 percent to 9.5 million.

The research firm Mintel estimates that these factors should raise the annual sales of luxury goods by almost a third, to $128.7 billion, between 2006 and 2010.

"The fundamentals of these companies are even stronger than they were a few years ago," said Caroline Reyl, who manages the €1.5 billion, or $2.1 billion, Premium Brands Fund at Pictet Funds in Geneva. She said most of the companies's price-to-earnings ratios were around 18 or 20, making them inexpensive compared to many other sectors.

Her fund includes premium brands across the luxury sector. As of the start of August, it was up 22.7 percent on a year earlier and had gained 42.4 percent since its inception in May 2005.

LVMH is the biggest luxury player with 61,000 employees, a network of more than 1,800 stores and brands from Louis Vuitton to Loewe, Celine, Givenchy and Fendi. In July the company reported its slowest profit growth in five years after currency moves outweighed rising sales. First-half net income gained 2 percent to €834 million. Sales rose 6 percent to €7.4 billion. Weber at Bank Vontobel said the results were in line with expectations but that the company's shares have been sluggish - up just 3.60 percent this year.

PPR, another French group, is also a luxury investment, albeit more diversified. Its luxury unit, Gucci, includes Yves Saint Laurent and Balenciaga. PPR said in July that second-quarter sales rose 18 percent, lifted by the sportswear maker Puma and demand for luxury products.

Hermès International, the maker of Birkin handbags that start at $7,500, said second-quarter sales rose 4.6 percent, less than analysts estimated, as it sold fewer bags in Asia.

Weber said Richemont of Switzerland, which owns Cartier and Van Cleef & Arpels and trades at 72.5 Swiss francs, or $61, may be a better value than its peers. J.P. Morgan has a price target of 80 francs by early next year and has cited improvements in the company's supply chain; Goldman Sachs confirmed its buy rating in July, when Richemont reported a 9 percent increase in first-quarter sales.

But amid the bullishness in the sector, an increasing number of those involved are starting to sound a warning. Johann Rupert, the chairman of Richemont who is known in the trade as "Rupert the Bear," is the only senior industry figure who predicted the end of the 2000 bubble. And he is starting to argue that the sector cannot remain strong indefinitely.

For Weber of Vontobel, the outlook is linked to the overall performance of equity markets, tourism and currency moves - and the latter appears to be the most vexing.

"The weakness of the U.S. dollar and yen continues, tempering the good news on organic growth," said Melanie Flouquet, at J.P. Morgan in London, in a report in July. Since July 12, when the euro was ¥168.80, the yen has dropped 6.9 percent. And the euro's recent high was $1.3827 on July 20, which actually is only a few cents more than its average value in recent months.

The luxury sector is still dominated by European companies that largely do business in Swiss francs and euros. But about one third of their sales are linked to the yen and an average of 35 percent is linked to the dollar, said Flouquet.

Most companies use instruments like futures contracts to protect themselves against wide swings in currency values. But, Flouquet added, "this is only a temporary mitigating factor; price increases are the more lasting measure but are getting harder to pass on."

Ermenegildo Zegna, co-chief executive of the eponymous Italian menswear company, and Francesco Trapani, the chief of Bulgari, are among the European executives who have voiced concerns about the strength of the euro.

Other risks are the continued abundance of counterfeit accessories and the possibility of an economic slowdown in the West, which is being forecast by institutions like the Organization for Economic Cooperation and Development.

The Japanese economy also has been troubling. The recent revival has been business-led rather than consumption-driven and shifting demographics have left fewer core consumers of luxury goods, notably the so-called office ladies, typically unattached 20- to 30-year-olds living with parents and without financial obligations.

"Sustaining strong growth to date despite a weak Japan and rather sluggish sales to the Japanese travelers is highly commendable," Flouquet said. "Moving forward, companies are pointing to a better geographic balance that should enable them to sustain strong growth and, they argue, fair crisis and macro-cycles better."