China's changing tastes mean mixed fortunes for luxury brands

New mood in China For Europe's upmarket fashion and spirits brands, doing business in China in recent years has been anything but a life of luxury. Lower economic growth and a government crackdown on opulent gift-giving between businesspeople and officials have slashed sales growth and weakened profits.

But as brands ranging from Remy Martin and Martell to the likes of Gucci and Louis Vuitton try to compete in the new environment, one thing has become startlingly clear: in the face of China's newfound temperance, some groups are faring better than others.

On Thursday, Pernod Ricard revealed that like-for-like sales of wines and spirits in China in the second half of 2014 fell 6 per cent, compared with the same period a year earlier. Shares in the Paris-based group closed more than 4 per cent down as markets swallowed the news.

That same morning, however, Hermes said that sales of its luxury leather goods, silk scarves, fashion and other items in Asia excluding Japan had grown 8.9 per cent on a constant-currency basis during the past three months of 2014.

The latest figures helped push annual sales for the luxury group - famed for its Kelly and Birkin leather bags - above €4bn for the first time in its 178-year history. It also meant that Hermes' revenues overtook those of rival brand Gucci, which reports its 2014 results next week.

Luca Solca, a luxury analyst at Exane BNP Paribas, says that Hermes' resilience - a year earlier, its sales in China were growing close to 16 per cent - in such changing conditions is partly because it is a relative newcomer locally.

"Chinese consumers love novelty so Hermes's relatively recent presence should continue to benefit organic growth," explains Mr Solca.

Since entering the Chinese market in 1997, Hermes has also expanded slowly: its 22 stores in just 15 cities pale alongside the faster pace in recent years of brands such as Gucci and Louis Vuitton.

Towards the end of last year, as Hermes inaugurated a new 1,100 square metre mega-maison in a 1920s former police station in Shanghai, the group announced that it planned to open no more than one store a year in China over the next decade.

A second reason for Hermes outperformance of other French brands is the conspicuous absence of "logo" and "bling" in its range - which have made its products a better fit with the lower-profile tastes of private consumers than the heavy-logo demands of corporate gift-givers.

As Trevor Stirling, an analyst at Bernstein who follows China's consumer trends, puts it, "you can go to a restaurant with a Hermes handbag on your arm and not turn too many heads".

By contrast, many of the other higher-profile luxury brands have endured what Mr Solca of Exane BNP Paribas describes as a "locust field effect": the tendency of Chinese buyers to devour a new brand disproportionately, before quickly seeking another. "Chinese consumers now concentrate on what is new and then move on," says Mr Solca.

As a result, the big western luxury brands not only fail to capture Chinese consumers who have become more sophisticated and already moved on to smaller brands, they also miss out on the still-sophisticated consumers that have cut out gifting - and they cannot attract the aspirational consumers because these people are having to choose brands at lower price points.

For the likes of Pernod Ricard - and even more for the smaller and more specialised cognac maker Remy Cointreau - China's new sobriety has been little short of brutal. To take just one example, China today accounts for between 10 per cent and 20 per cent of Remy's operating profit. Two years ago, it accounted for up to 40 per cent.

This fall speaks volumes about the breakneck pace of the luxury goods boom in China, when sales at both Pernod Ricard, which makes Martell cognac, and Remy, which produces ultra-premium cognacs such as its $2,800-a-bottle Louis XIII, were growing at between 20 and 30 per cent a year.

So voracious was China's thirst for cognac that it went from accounting for just 13 per cent of the value of world consumption in 2003 to a staggering 45 per cent by 2013. As Mr Stirling of Bernstein says: "Everyone knew that the market had to change sooner or later".

What, then, does the future hold as Chinese tastes adapt, and wane?

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In general, however, there is growing consensus that better times lie ahead.

Ian Shackleton, beverages analyst at Nomura, points out that shipments to the country have already started to recover, falling only 6 per cent during the second half of last year compared with a 9 per cent fall during the third quarter. "The underlying trend is improving," he suggests.

In the meantime, both Remy and Pernod Ricard are scrambling to change their product mix. Remy is trying to promote 1738, a mid-tier version of its flagship cognac that sells for about $113 a bottle.

For its part, Pernod Ricard has begun to push more affordable brands of cognac in China, such as Martell Noblige - another mid-tier tipple in a modern and curvaceous bottle that retails for $75, against a typical $150 for its XO cognacs.

This new positioning is probably just as well. While Mr Stirling believes that 2015 will see a turnround in China, he also admits that it is a vastly changed world.

"We are on the tipping point of a recovery," he says. "But we are never going to get back to the kind of things that was driving growth before."

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