Could Coronavirus hit China's luxury boom?

Holly Black: Welcome to the Morningstar "Market Reaction." I'm Holly Black. With me is Jelena Sokolova. She is an equity analyst at Morningstar in Amsterdam.

Hello.

Jelena Sokolova: Hi, thanks for having me.

Black: So, you're here to talk to us about the coronavirus and its effect on global stock markets as it starts to spread across the world and particularly its effect on the luxury goods sector. So, what's been happening?

Sokolova: Yeah. So, the luxury goods sector has been down around 4% in January versus around flat performance of MSCI Index obviously affected by the coronavirus spreading and the restrictions that both the Chinese government but also other countries are introducing on inbound Chinese travel. The virus spreading also coincided with Chinese Lunar New Year which is an important shopping occasion and travel occasion for the Chinese. So, this news really hit the sector.

Black: And I suppose that the two key trends that were helping luxury goods is the consumer spending around the holiday season and booming tourism industry. So, is that why luxury goods are being particularly hard hit?

Sokolova: Yes, and the exposure of luxury goods to the Chinese consumer especially has grown over the past years. So, if we compare this epidemic to SARS in the early 2000s, the exposure of luxury goods to Chinese consumer was only around 2%. Now, it's 35%. And further, around 11% of Chinese luxury spending is actually done in Mainland China while all the other spending is done abroad, which should be impacted now by the travel restrictions. So, the short-term impact can be quite severe.

Black: So, we know from previous outbreaks of viruses that the impact on the market can actually be quite short term. What's your view on this sector for the long term? Does this change your opinion?

Sokolova: Yeah, I also think that the impact is mainly on the short term, that the long-term fundamentals of the sector should be sound and also driven by Chinese consumption, which is supported by increasing employment in high wage sectors. So, that does not affect my long-term view at all. That's why also my fair value estimates basically stay the same. I also think that while in the short term, there is a hit, the sector can recover pretty quickly once the epidemic is getting quieter. People have delayed their spending previously so they can come back with increased spending going forward.

Black: Is it also an argument that while obviously this affects bricks and mortar stores, it could be an opportunity for online retailers?

Sokolova: Yes, absolutely. I think in the short run that could give a boost to companies such as YNAP, YOOX NET-A-PORTER, which is owned by Richemont or Farfetch that is independent currently trading in 4-Star territory that has some operations in China as well, as well as brand's own online websites in China could benefit as people go less to malls, for example, or travel less, but prefer to buy online instead.

Black: So, what is your long-term outlook for the sector? Are there any stocks you particularly like?

Sokolova: So, for the sector, I would like to mention that most of the stocks are still trading at almost record high valuations. So, if I look at the at the industry, overall, the average price to forward earnings is around 26 times. So, definitely not a cheap sector at the moment with this near-term risk mounting. However, I do see value in some stocks. For example, wide moat Richemont, narrow moat Swatch, narrow moat Dufry which is a travel retailer, narrow moat Hugo Boss as well as no moat Farfetch, the online retailer and the no moat Pandora. All those stocks are trading currently in 4-Star territory.

Black: Jelena, thank you so much for your time.

Sokolova: Thank you.

Black: And thanks for joining us.