Deluxe Discounts Forged in the Downturn

by Charles Sizemore | May 21, 2012 8:16 am

It’s a peculiar sort of problem when your economy grows at 8.1% in the first quarter and yet talk abounds of a “hard landing.” American and Europeans haven’t seen that kind of growth in decades — and they could desperately use it today. Yet such is life is China; after years of growing at a blistering pace, growth of “only” 8.1% represents a slowdown.

The 8% mark is considered by many to be the minimum growth rate China needs to maintain high employment and to keep living standards rising. And by the government’s own calculations, Chinese growth likely will slip below that level for the full year 2012. Citing weakness in China’s European export markets and lower construction spending, the Chinese government lowered its full-year target to 7.5%.

The Chinese government doesn’t take its own GDP numbers seriously (they know the numbers are baked), and neither should we. But other trends are even more sobering:

Now that I’ve bombarded you with scare statistics, how should we react as investors?

First, step back and try to keep perspective. Yes, there is a steady stream of bad news coming out of China that signals slow growth ahead. But “slow growth” is clearly a relative term when your economy is growing at a 7%-8% clip.

China’s leaders are not fools, and they realize the model that has served them so well in recent decades — manufacturing cheaply and exporting to the West — is broken.

Realizing this, China’s leadership indicated earlier this year that “the key to solving the problems of imbalanced, uncoordinated, unsustainable development (in China) is to accelerate the transformation of the pattern of economic development. This is both a long-term task and our most pressing task at present.”

In other words, it is the stated objective of the Chinese government to de-emphasize investment and instead boost domestic consumption.

Investors wanting to profit from the reorientation of China can follow two trends:

  1. Avoid commodities and the firms that produce them or even look for opportunities to go short. China has been the overwhelming force behind the commodities bull market of the past decade, and without aggressive Chinese buying there is no bull market.
  2. Buy the companies that stand to profit from a Chinese consumer shopping spree. My preferred “fishing pond” is the luxury goods sector, defined here as everything from flashy handbags to performance automobiles.

Consider what The Economist[1] has to say about China’s demand for luxury:

“More than half of this year’s growth in luxury goods will come from China, where sales are set to soar by 24% in 2012. The country is already the largest market for jewelery after America, and for gold after India, and is gaining fast on both leaders. Prada and Gucci owe a third of their global sales to the rich in China. CTF saw same-store sales on the mainland shoot up by 45% from April to September last year.”

This week Richemont, owner of the Cartier brand (among many others) and the world’s second-largest luxury retailer by sales, announced that sales and profits rose 29% and 43%, respectively, largely on strong demand from China. Perhaps surprisingly, demand in Europe was robust, with sales up 20%. Crisis or not, it would appear well-heeled consumers are spending freely on life’s frivolities.

The crisis in Europe has made the luxury goods sector all the more interesting. Most of the biggest names in high-end luxury goods are European firms, and with the eurozone mired in crisis, we’re getting buying opportunities we might not see again for a long time.

One of my favorites is French luxury conglomerate LVMH (PINK:LVMUY[2]), the world’s largest luxury group by sales and the owner of Louis Vuitton and Fendi handbags, Dom Pérignon champagne, Hennessy cognac and Tag Heuer watches, among many other brands. Think of LVMH as a one-stop shop for gaudy baubles and expensive booze.

LVMH has been one of the rare success stories in Europe in recent years, and it’s easy enough to understand why. While the company is domiciled in Europe, its primary clients are not. Forty percent of the group’s sales come from emerging markets, led by China.

Mercedes-Benz manufacturer Daimler AG (PINK:DDAIF[3]) also is an excellent play on Chinese growth. China is the biggest market for the Mercedes S-class and the biggest engine of the company’s growth. However, I consider Daimler’s business to be riskier than that of LVMH. After all, a big spender is likely to postpone the purchase of a $100,000 car long before he postpones the purchase of a $1,000 handbag for his wife. Still, at 7 times earnings and boasting a dividend yield of 6%, Daimler is a risk worth taking.

Investors wanting to stay closer to home could consider Beam, Inc. (NYSE:BEAM[4]), the distiller of Jim Beam and Maker’s Mark bourbon whiskeys and the wildly popular Skinnygirl cocktails, among others. Beam is a smaller rival to international spirits juggernaut Diageo (NYSE:DEO[5]), and its brands lack some of Diageo’s cachet. Still, Beam is attractive as a recent spinoff from Fortune Brands, and it stands to grow at a significantly faster pace in the years ahead.

I consider both spirits stocks to be excellent holdings for the next 12 to 24 months, as they sit at the intersection of two macro themes I follow.

This first, of course, is the rise of the emerging-market consumer. Diageo gets nearly 40% of its revenues from emerging markets, and I expect that percentage to rise along with the incomes of emerging-market consumers.

Secondly, “sin stocks” tend to be highly recession-resistant, and booze companies are no exception. This has helped Diageo to become an “International Dividend Achiever,” [6]meaning that it has raised its dividend for a minimum of five consecutive years.

Diageo actually has done much better than that — it has raised its dividend every year for well over a decade. Beam still is a new company and lacks a substantial dividend history, but I expect it to reward investors for years to come with a rising cash payout.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. Disclosures: LVMUY, DDAIF, DEO and BEAM are held by Sizemore Capital clients. Sign up for a FREE copy of his new special report: “Top 3 ETFs for Dividend-Hungry Investors.”[7]

  1. The Economist:
  2. LVMUY:
  3. DDAIF:
  4. BEAM:
  5. DEO:
  6. “International Dividend Achiever,” :
  7. “Top 3 ETFs for Dividend-Hungry Investors.”:

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