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As glory days recede, fashion and luxury companies face a reboot challenge

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LVMH, owner of the Loius Vuitton brand, plans to review all expenses and cut overall capex by 40% in 2020 to mitigate the impact of the coronavirus pandemic.
Source: AP Photo

The global luxury and fashion industries have been dealt a massive coronavirus blow that is affecting both the demand and supply sides of their business, a historic disruption that will require them to reboot their operations once the pandemic fades.

Demand from Chinese consumers, who accounted for 90% of global luxury market growth in 2019, has fallen sharply. Many factories that employ tens of thousands of workers who make shoes, handbags and scarves in Italy, France and parts of Asia are at a standstill under government-imposed lockdowns. Thousands of stores in the U.S., Europe and Asia are temporarily shuttered. And worried consumers, faced with lost jobs and strained finances, are buying fewer luxury items online.

On April 16, LVMH Moët Hennessy - Louis Vuitton Société Européenne, the world's biggest luxury goods company and owner of Louis Vuitton and Christian Dior, was one of the first to provide a glimpse into the destruction wrought by the viral outbreak. The French company reported a 15% decline in its first-quarter revenue and said it would cut its 2019 dividend by 30%.

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LVMH noted that it had been accumulating inventory, especially in items for its ready-to-wear spring collection. The company, which plans to cut capital expenditure by 40% in 2020, acknowledged the likelihood of more financial pain ahead because of continued store closures and factory shutdowns.

"Overheads are being reviewed," said CFO Jean Jacques Guiony, in a conference call with analysts after the sales figure was released. "Selling costs are being reviewed. Marketing costs, obviously, are being reviewed. So we are taking measures, I would say, more or less everywhere."

On the call, UBS analyst Zuzanna Pusz noted that consensus estimates indicated that LVMH's second-quarter sales would decline by 27%, which she suggested was "optimistic" given that stores in the U.S. and Europe were likely to be closed for perhaps another two months. She asked if a 40% decline in revenue was, therefore, a more reasonable estimate. Guiony declined to comment.

The uncertainty has spooked investors. The average market capitalization of clothing, fashion and luxury companies fell almost 40% between January and March 24, a much steeper decline than the overall stock market, according to McKinsey. As of April 16, and on a year-to-date basis, LVMH shares were down roughly 17.7%, Kering SA's shares had fallen 19.2% and Compagnie Financière Richemont SA's shares had tumbled 30%. The shares of The Estée Lauder Cos. Inc. were lower by 23.5% and those of The Swatch Group AG had dropped 28.6%.

"Anytime you are faced with a 30% reduction in demand over a 12-24 month period, it's a shock," said Anita Balchandani, a partner at McKinsey and co-author of a new report on the fashion and luxury sector, published in April. "This requires a reset" of supply chains, cash management, inventory control and digital strategy once the crisis passes, she added.

Until recently, the best-known luxury players were riding high on quarter after quarter of robust sales and profits. In a 2019 report, Deloitte noted that the top 100 luxury goods companies had generated revenue of $247 billion in 2017, up from $217 billion in the previous year. After adjusting for currency effects, annual growth jumped to 10.8%, much higher than the 1% recorded in the previous year. Three-quarters of the companies reported growth in their luxury sales, with nearly half of these recording double-digit year-on-year growth.

But now, as a result of the COVID-19 pandemic, global revenue in 2020 for the personal luxury goods industry (including high-end watches, jewelry and beauty) is expected to decline 35%-39% compared to 2019 but will return to growth of 1%-4% in 2021, according to McKinsey. The global fashion industry, which includes clothes and shoes, is expected to contract by 27%-30% and return to 2%-4% growth in 2021. The McKinsey report was written jointly with the Business of Fashion.

A similar analysis by Bain & Co. forecast that, as of March 25, the luxury market would contract by 25%-30% year over year in the first quarter. For all of 2020, Bain's "intermediate scenario" suggests a 22%-25% contraction, amounting to a revenue decline of €60 billion to €70 billion. The hit to profits would be proportionally greater than the hit to sales, Bain added.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

The fashion industry, whose global revenues totaled $2.5 trillion before the pandemic, is reeling from multiple challenges. The outbreak started in the crucial market of China, spread to other Asian countries that host key manufacturing hubs, and then spread to Italy and France, where a large amount of specialized fashion design and production is located. The spread of the virus to the U.S. temporarily froze another important market.

McKinsey's analysis found that even in 2018, 56% of global fashion companies were not earning their cost of capital. Its recent analysis suggests that if stores remain closed for two months, about 80% of publicly listed fashion companies in the U.S. and Europe will be in financial distress. The consulting firm expects a large number of global fashion companies to go bankrupt in the next 12 to 18 months.

Given their discretionary nature, both fashion and luxury purchases are particularly susceptible in any downturn. Consumers, many of whom are quarantined at home, are being cautious. Based on data from Amazon.com Inc. and e-commerce information company Stackline, McKinsey notes that 2020 online sales so far, when compared to an equivalent baseline figure in 2019, have fallen 15%-25% in China, 5%-20% in various parts of Europe and 30%-40% in the U.S. There is already fallout: On April 16, luxury online retailer Farfetch Ltd. suspended its fiscal 2020 guidance because of the uncertainty caused by the coronavirus pandemic.

Once the dust settles, how do luxury and fashion companies readjust their vast supply chains? They have to do more of what they have already been doing, but at a much faster pace: winning more customers to their online sites, creating designs that are not overly reliant on seasonal shifts and ensuring that production and distribution are leaner and more resilient. "We expect the themes of digital acceleration, discounting, industry consolidation and corporate innovation will be prioritized once the immediate crisis subsides," concludes the McKinsey report.

Companies that have high inventory levels and long lead times for product development — something that is standard in the world of fashion — could be at a disadvantage. To succeed, businesses "will have to focus more on cash management instead of worrying about gross margin," said Balchandani. "We need more innovation in the way the fashion industry operates."