How Does Inflation Impact the Luxury Goods Market?

There have been many debates about whether the higher inflation we've seen thus far in the U.S. is transitory or sustainable, what that means to global inflation expectations, and how that impacts a company’s ability to pass on higher costs.

As bottom-up investors, we do deep fundamental analysis of individual companies and industries. We do not look for investment ideas based solely on macro or directional plays. We may have informed views about the political, economic or fiscal market dynamics of countries in which we invest, but we are careful not to let our macro views unduly influence the portfolio.

That said, we believe our international portfolio is well positioned for rising inflation because we tend to seek out companies that have real pricing power—companies that have strong demand for their highly sought-after products, making them more defensive in a sustainable inflationary global environment, if that pans out.

LVMH, Richemont and Diageo are just a few of our portfolio holdings that possess these characteristics. LVMH is the world's largest luxury conglomerate with more than 70 brands across its portfolio— the most renowned ones being Louis Vuitton, Christian Dior, Hennessy (the cognac brand) and Sephora (the makeup cosmetics retailer). LVMH also recently completed its acquisition of high-end jeweler Tiffany’s. Our long-term investment thesis is based on the supremacy and sustainability of these brands, but also on the diversification of the brands across product categories. These brands are well diversified with products ranging from fashion to leather goods to jewelry and watches to perfume and cosmetics to liquor and wine.

To provide some perspective on the pricing power of these brands, LVMH increased prices on the Louis Vuitton brand roughly 5% across the board in 2020 despite the COVID-19 pandemic. It also made upward price adjustments on best-selling Christian Dior items. Additionally, LVMH raised prices for the Hennessy liquor brand between 3% and 4% in 2020. These price hikes did not negatively impact sales volume, again owing to the company’s pricing power as consumers’ affinity for luxury products endured.

The global luxury goods market is expected to reach nearly $300 billion by 2026 ¹

Hermes, the Paris-based brand that makes the highly sought-after Birkin and Kelly handbags, has been able to increase prices at a compound annual growth rate (CAGR) of roughly 5% over the last 40 years. Another great example of an iconic brand that possesses long-term pricing power is Rolex, the watch maker. Rolex has been able to consecutively increase prices at a CAGR of roughly 5%-6% over the past 60 years. It’s clear in the luxury goods market that the value a consumer gets out of owning a premium item is more important than price.

A company's ability to pass on cost inflation or even price ahead of inflation has to do with the level of commoditization of its product and perhaps the market structure of the industry in which it operates. If you're selling a product that is undifferentiated and commoditized, you must fiercely compete against peers that offer a near substitute of your product—it’s unlikely you will have pricing power and the ability to pass through cost inflation to your end consumer.

Luxury goods companies benefit from having more pricing power than generic products, such as consumer packaged goods or home personal care products. Consumers are willing to pay higher prices as long as the brands continue to deliver the values they desire—exclusivity, superiority, status, heritage, tradition or legacy—it’s an emotional connection that helps preserve the long-term brand equity and the desirability of these brands in the mind of a luxury consumer.