With the U.S. economy playing cat and mouse with a possible recession, common sense would dictate that luxury retailers will bear the brunt of a consumer spending slowdown as Americans hold off on big purchases.
But things may not be as bad you think.
decision to pull the plug on its planned spinoff of its luxury division
Saks Fifth Avenue
, luxury retailers are in a better position to weather this economic downturn than they've been in the past, analysts say.
Indeed, one analyst who followed Saks for years, but recently switched his coverage to the jewelry industry, questioned whether the company's decision was the best one for shareholders.
"I think it was short-sighted," says Kenneth Gassman, an analyst at
Davenport & Co.
Investors seemed to agree. Shares were off by $1.69, or 12.4%, in midday trading at $11.91.
In a statement, Saks Chairman R. Brad Martin attributed the decision to keep the luxury division and department stores together to the narrowing in valuations between traditional department stores and the luxury retail sector since the company made public its spinoff plans last July.
Valuations have narrowed, but not by much, and the luxury retail sector retains solid growth potential, even if the economy is on the cusp of a recession, says Gassman. Indeed, in sharp contrast to Saks' announcement, on the same day
Polo Ralph Lauren
released stellar earnings and said it would put more attention on its luxury items in the coming quarters.
Consider this: Since July 20, when Saks announced its decision to separate its two businesses, valuations between luxury retailers and department stores have narrowed only slightly. For example,
, perhaps the premier luxury retailer, has seen its price-to-earnings multiple slip from about 38 times trailing earnings to about 35.5 times. Another top luxury retailer,
LVMH Moet Hennessy
, has seen its P/E ratio come down more, from 57 times trailing earnings to 43 times.
Federated Department Stores'
P/E multiple has nearly doubled, though to a relatively cheap 12 times earnings;
has seen its multiple increase slightly, to 10 from 8.4; and
May Department Stores
have seen their multiples inch up only slightly.
The point of this: Despite the economic slowdown, the market still gives a healthy premium when comparing luxury retailers with traditional department stores, Gassman says.
And if the economy still has more falling to do, the performance of Tiffany stock during the 1990 to 1991 recession is instructive. For sure, the stock didn't boom, but it mostly matched the
index during the two-year span and outperformed such department store stalwarts as J.C. Penney and May.
When gauging the fate of luxury retailers in the face of a slowing economy, two arguments tend to reign: one says the rich will still be rich, and will keep buying; the other says that the first items to go when the economy slows are luxury items.
"The truth lies in between," says Gassman. "High-end consumers don't stop their expenditures, but they do spend less." He said most jewelers he has spoken with say that store traffic remains healthy, though many consumers are opting for lower-priced items.
Take a closer look at Tiffany's. While its holiday season was poor, like most retailers', analysts remain mostly bullish on the company's prospects. Although sales dipped substantially during the last recession, the company today has products in a broader range of price categories, and is much better prepared to weather a consumer spending slowdown.
"It did not do well" in the last recession, says Dorothy Lakner, an analyst at
CIBC World Markets
. "But it was a completely different company. I'm certainly not going to say Tiffany is going to perform well in a recession, but it is in a position to do better than the last one." Lakner has buy rating on Tiffany, and her firm doesn't have a banking relationship with the retailer.
And long-term, the luxury sector is poised for strong growth as the baby boom generation enjoys its last years before retirement, says Gassman, who has a buy rating on Tiffany and whose firm doesn't do underwriting. "I would focus on the luxury sector, because baby boomers are going to spend heavily on luxury goods from now until about 2009," he says. "Then they retire, and they don't have any money to spend on luxury. Then they spend it all on health care."