Losing Hong Kong: A Catastrophe for Luxury Retail

Losing Hong Kong: A Catastrophe for Luxury Retail

Violent clashes between pro-democracy protesters and China’s government spell long-lasting damage to the local retail sector, leaving Richemont, LVMH, Kering and others exposed. What options do brands have?

 

Luxury is highly exposed to key global cities: the world’s top ten fashion capitals account for one-fifth of all luxury points of sale. Not long ago, Hong Kong alone was responsible for more than five percent of global luxury sales, according to analysts, putting its importance up there with Paris. This is unlikely to be the case this year.

Months of clashes between pro-democracy movement and the Chinese government have already put a serious dent in luxury retail. And matters came to a head earlier this week as protesters shut down Hong Kong International Airport — a gleaming symbol of the city’s long legacy of internationalism, openness and efficiency — landing the conflict on the front pages of newspapers worldwide. The latest round of protests, which kicked off ten weeks ago in response to a proposed extradition law, have since become a wider call for the government in Beijing to honour the city’s autonomy and the “One Country, Two Systems” agreement made when the island was handed back to China, in 1997, after 150 years of British rule.

Currently, Hong Kong is a special administrative region (SAR) that has its own currency, a common law legal framework and liberties not afforded to mainland citizens — such as freedom of speech and of assembly — while remaining a part of the People’s Republic of China. But the agreement that underpins the city’s special status is due to expire in 2047 with no clarity about what happens next, making locals nervous. Indeed, many fear their current rights will be revoked in far less than 28 years’ time. While Beijing sees the protests as terrorism, the Hong Kong protesters view their actions as a response to an existential crisis.

This week’s airport flare-up, which started as a peaceful sit-in, included calls for an end to alleged police brutality, particularly the use of pepper spray and rubber bullets against demonstrators. The increasingly violent confrontations between protestors and police — who have strong support from citizens in mainland China, where the government has been stoking nationalism — have pushed the situation into a dangerous new phase that, some say, could end in a military crackdown, prompting renewed consideration about the long-term impact for the luxury sector, which has long relied on Hong Kong.

Following days of disrupted and cancelled flights, the scene has calmed at the airport after a court injunction ordering the protesters to leave, but it’s far from the end of the story.

Some are comparing the fallout for luxury sales to the impact of the gilets jaunes protests in Paris, which hit the French capital in 2018 during its peak holiday spending season. Research from RBC Capital Markets found that European luxury goods groups derive about six to seven percent of their sales from France (a proportion similar to Hong Kong). Estimates suggest that sales in France fell about 10 percent (excluding currency movements) in the fourth quarter. This precedent will make luxury executives nervous about their performance in Hong Kong. The Hong Kong Retail Management Association has already revised its total retail sales projections for 2019 from single-digit growth to double-digit decline.

Even if the issue is resolved, the industry needs time to recover and tourists need to regain confidence in Hong Kong.

Unlike the gilets jaunes movement in Paris, however, Hong Kong protesters have not overtly targeted high-end retailers. But this doesn’t mean luxury hasn’t been seriously impacted as protestors moved en masse into Hong Kong’s central business district, where a great deal of luxury retail is concentrated. Stores have routinely being forced to close in the district, and more recently at the airport. The result has been a painful pinch in a market with one of the world’s highest retail rents.

According to data from UBS, Richemont is the most exposed to disruption in Hong Kong, with an estimated 11 percent of its sales coming from the market. Swatch gets about 10 percent of revenues from Hong Kong, while Burberry makes about 9 percent of total sales there. Though less exposed, UBS also cited Hermès, Moncler, Prada, Tod’s, Ferragamo, Kering and LVMH as being “at risk.”

Though analysts say the exact impact of the protests on sales at each company is “difficult to estimate,” they pointed to a potentially greater threat in the form of souring investor sentiment. The city’s large scale ‘umbrella movement’ protests in 2014 resulted in the luxury sector losing about 23 percentage points on its price-to-earnings ratio, compared to the broader MSCI Europe index.

In spite of these concerns, optimists point out that Hong Kong retailers have shown resilience in the past, bouncing back quickly from those 2014 protests, which lasted almost three months but were less confrontational. According to Annie Tse, chairwoman of the Hong Kong retail association, this time is worse as the protests are taking place over a wider area.

“Even if the issue is resolved, the industry needs time to recover and tourists need to regain confidence in Hong Kong,” she said.

Last year, tourists accounted for about 80 percent of luxury spending in Hong Kong, with the majority of that spend coming from mainland Chinese tourists, 350,000 of whom will not be travelling to Hong Kong this year due to the protests (according to estimates from HSBC).

But, it would be a mistake for brands to believe the lessening of mainland tourist spend in Hong Kong is just about the recent protests. Hong Kong tourism data shows mainland arrivals declining since January, long before the protests began, with more far-flung destinations gaining in popularity among tourists with a “been there, done that” attitude to the city.

Meanwhile, the yuan’s recent slump to an 11-year low (seen by many as a reaction to new tariffs introduced by the US as part of its ongoing trade war with China), make it even less attractive for mainland visitors to buy big ticket items in Hong Kong, where the local currency is pegged to the US dollar.

It will be very bad in the short term, but it’s too early to know what will happen long term.

Moves from Beijing have also impacted Hong Kong’s mainland tourist spend, with a government crackdown on cross-border daigou agents and a reduction in tariffs for imported luxury goods working to rapidly refocus luxury spend within mainland China.

“The only good news there is that if there are less Chinese tourists in Hong Kong, they buy more in the local market,” L’Oréal Chief Executive Jean-Paul Agon said after the company’s recent earnings report. “I think it will be more [of] a tailwind than a headwind.”

Hong Kong’s escalating protests are a problem with no immediate end in sight, but brands operating within the SAR in order to reach mainland tourists should be able to offset some of their losses by shifting resources to the massive market next door. And if Hong Kong becomes more aggressive at targeting other nationalities, some of the tourist spend loss could theoretically be recovered.

For years, Hong Kong’s proximity to the mainland has made it a valuable launchpad for those looking to enter the Chinese market. As the city’s east-meets-west culture allows companies to court a diverse global audience and gauge demand from Chinese visitors, brands from Moncler to Charlotte Tilbury have opened freestanding stores there before crossing the border. But in response to the airport shutdown, there are now murmurs of neighbouring Shenzhen becoming a mainland beneficiary of Hong Kong’s volatility.

As Mario Ortelli, managing partner of luxury advisors Ortelli & Co, points out, many luxury companies run their Chinese and even Asia-Pacific operations from tax-free Hong Kong and keep inventory there, but he believes the climate would need to get significantly worse before companies decide to relocate these operations.

“Luxury companies need to decide what is their ideal footprint in a market that clearly doesn’t have the same sales [as it did previously] … [And] how to perhaps rebalance their operations between Hong Kong and mainland China,” he said. “It will be very bad in the short term, but it’s [too] early to know what will happen long term.”

In the meantime, brands need to find ways to rebalance their footprint in Asia, and fast, but they will continue to be caught between a rock and a hard place for as long as tensions remain between officials in Beijing and protesters in Hong Kong.