Structural declines at the industry level are one of the characteristics the Montaka research team looks for in identifying great opportunities on the short side. A decline that is structural means that it is not going away this quarter or the next. It is here to stay for many years at least. For companies that are exposed to such declines, there is often very little that management can do – but try to wait it out and still be alive at the other end.
In November 2012, Xi Jinping was promoted to the position of Secretary General of the Communist Party of China. It has been since this time that Beijing has genuinely cracked down Party-member corruption. A consequence of this has been that Party members are no longer allowed to be seen wearing expensive watches or carrying expensive handbags.
While it might sound trivial, the impact on luxury goods industries has been anything but, as shown by the FT’s chart of Chinese mainland luxury goods sales below. Looking at individual companies tells an even scarier story. Prada (HKEx:1913), for example, has experienced negative sales growth at the store level in nearly all regions since 2013. The global weakness reflects the fact that a significant portion of Prada’s sales are made to (many Chinese) customers that purchase goods during trips abroad.
And while this month represents the three-year anniversary of Beijing’s corruption crackdown, we are seeing no signs of it abating. In September, Prada reported 1H15 sales growth in Asia Pacific of negative 18 percent on a constant currency basis. Management added that: “Hong Kong and Macau failed to show any signs of recovery.”
This follows Burberry’s (LSE:BRBY) announcement in July that: “Asia Pacific experienced a low single-digit percentage comparable decline, impacted by the continued challenging environment in Hong Kong, which decelerated further to a double-digit percentage decline in comparable sales.” In October, Burberry added that its sales had been dented by an “increasingly challenging environment for luxury, particularly Chinese customers.”
This is a multiyear thematic that is structural, not cyclical, in nature. The chart below from the FT illustrates how the pain has been felt across all industry players. We continue to monitor this dynamic and believe that it is not going away any time soon.
Montaka has been short the shares of Prada since its inception.