Sector focus: Luxury goods firms face up to new Hong Kong reality

With Hong Kong losing its allure for Chinese tourists, what is the impact on luxury goods firms and how can they respond to changing travel preferences?

14 January 2016

Anthea Arff-Pettersen

Analyst, European & UK equities

Hong Kong used to be the prime shopping destination for Chinese tourists.

The introduction of the Individual Visit Scheme in July 2003 marked the beginning of a decade with unprecedented growth in mainland Chinese visits to Hong Kong.

Before the introduction of the scheme, a little over 7 million mainland Chinese residents visited Hong Kong on an annual basis. Ten years later that number had grown to 44 million, an astounding increase of over 500%.

Hong Kong’s attractions as a shopping destination for mainland Chinese consumers were clear: it was close and easy to access; it was cheaper (with lower taxes on goods plus favourable exchange rates); it offered a wide range of brands and product; and the risk of buying counterfeit goods was low.

What has changed?

Ten years later the situation in Hong Kong is very different.

After a decade of 11% cumulative annual growth in retail sales, 2014 marked the first year of decline, with retail sales down 0.2% year-on-year.

So far there are no signs that growth is picking up again, with retail sales down 3% year-on-year during the eleven months to November 2015.

This development is especially meaningful for luxury goods companies because the Chinese represent a significant portion of their customer base.

The decline in Chinese visits and retail sales is a consequence of a variety of factors, including the Chinese government’s anti-corruption campaign, Hong Kong residents’ hostility towards mainland visitors, currency fluctuations, changes in travel patterns and consumer preferences.

The relaxation of visa requirements coupled with higher discretionary income and a favourable exchange rate spurred exceptional growth in Chinese tourism to continental Europe, Japan and South Korea.

In many cases, these destinations can offer cheaper shopping than Hong Kong as well as more varied cultural experiences and ancient history.

How can the luxury goods sector respond?

As luxury goods companies face up to the new reality in Hong Kong, earnings disappointments might continue.

Management execution will be crucial in tackling imbalances in global pricing structures and potential rationalisation of store networks.

It is becoming increasingly apparent that the sector will have to be more agile in the future in responding to fluctuating currencies, changing travel patterns and rising online penetration.

The relative winners during this transition will be those companies that can be flexible in their inventory management and have the ability to predict the location of consumer demand and shift products accordingly.

A digital offer and omni-channel strategy will also become even more important as consumers are becoming more sophisticated, online penetration is increasing and a brand’s global pricing structure is more transparent than ever.

What are the opportunities for investors?

When facing an uncertain future, investment opportunities will arise.

We believe that identifying those companies that are prepared to tackle pricing imbalances, have the flexibility to respond to changes in the location of end demand, and have a superior digital offering to capture the growing online demand will deliver the greatest investment returns.

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.