The stock market and overall U.S. economy appear to be moving in the right direction. Although inflation remains above the Federal Reserve's target of 2%, it has been consistently cooling (falling to 3% in June). The markets seem OK with how higher interest rates are impacting the economy and consumer demand. After all, the S&P 500 index is up 17% year to date, and the tech-heavy Nasdaq Composite is up 33%.
While big tech has dominated the headlines this year for various reasons, from mass layoffs to advances in artificial intelligence (AI), the luxury retail sector has quietly been beating the market. Oh, and it's been doing so for over a decade.
Two European powerhouses, Hermes International (HESAY 1.58%) and LVMH Moet Hennessy (LVMHF 0.94%), have been leading the charge in luxury retail for quite some time. While each has become synonymous with status-symbol accessories and products, there is much more to their underlying businesses. Namely, each company is a worldwide brand reaching consumers of all ages across the globe.
In this article, I will explore some of the catalysts fueling the boom in sales of luxury goods. While most people may not be able to afford these companies' products, their stocks are much more accessible and buying them could prove to be a savvy investing decision in the long run.
Rock-solid financials are always in style
Through June, Hermes generated 6.7 billion euros in revenue, a 25% increase year over year. That revenue growth helped fuel impressive gains to its gross margin, which rose 120 basis points from the prior-year period to 72.2%. Operating margin hit a peak of 44.0% year to date, and the expanding margins dropped right to the bottom line as net income rose 36% year over year to 2.2 billion euros.
If this weren't impressive enough, Hermes generated 1.7 billion euros in adjusted free cash flow during the period, up 21% year over year, and it paid out 1.4 billion euros in dividends.
Similarly, LVMH Moet Hennessy delivered strong financial results during the first six months of 2023. It generated 42.2 billion euros in revenue and expanded its gross margin slightly to 69.4%. Moreover, the company's net profit grew 30% year over year to 8.5 billion euros, far outpacing top-line growth of 15%.
An important metric to note is that LVMH Moet Hennessy's operating free cash flow actually declined to 1.8 billion euros -- less than half of what it was during the first six months of 2022. However, this dynamic can be traced to a significant increase in operating investments, namely in the form of real estate for its retail brands.
What is pushing luxury retail higher?
Nearly half of Hermes' revenue in the first half stemmed from the Asia/Pacific region (excluding Japan). Management commented on this growth, highlighting healthy trends in Greater China as well as Singapore, Thailand, Australia, and South Korea. Furthermore, due to the extensive and strict zero-COVID lockdowns that China was imposing in various regions as recently as last year, results in 2023 signal that region is rebounding strongly and consumers are out shopping. LVMH Moet Hennessy also had strong results in Asia (excluding Japan); nearly one-third of its sales year to date stemmed from that region.
Another notable takeaway from LVMH Moet Hennessy is that 23% of its sales came from Europe. This is interesting because Europe's economy has been in a contraction period for several months, and yet demand from luxury shoppers seems unfazed.
Data by YCharts.
Should you invest?
The chart above illustrates the performance of both Hermes and LVMH Moet Hennessy stocks and benchmarks them against the S&P 500 over the last decade.
There are some important takeaways when analyzing this chart. First and foremost, the broad market has performed well over the last 10 years. An investment in an S&P 500 exchange-traded fund would be well on its way to tripling in value, underscoring how challenging it can be to the beat the market.
That said, LVMH Moet Hennessy and Hermes have done so handily with returns approximately two to three times higher than the S&P 500. That performance makes it clear just how resilient luxury retail companies can be, even in periods of economic uncertainty, as the two stocks made their biggest gains during the global pandemic.
This dynamic tells us a few things. First, as my fellow Motley Fool contributor Neil Rozenbaum points out, a good portion of luxury buyers are already wealthy. And despite sluggish economic growth across the European continent, wealthy people have the means to shop during all sorts of economic conditions.
Perhaps more importantly, a more macro takeaway could be that the luxury retail segment is more insulated from downturns than other areas of the consumer discretionary market, making it a tempting addition to a well-diversified portfolio. The combination of strong growth, expanding profitability, and dividend income makes this pair of world-class luxury retailers a compelling investment opportunity.
