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LVMH shares drop 7% on fears of cooling luxury market in China

LVMH Moët Hennessy Louis Vuitton SE sought to soothe investor concerns about fears of a possible slowdown in the crucial Chinese luxury goods market after its shares dropped more than 7% on Oct. 10.

The share price drop came despite the company reporting robust third-quarter revenue growth the day earlier after the stock market closed. The French fashion and luxury company's shares fell 7.1% to 265.30 on Paris' Euronext stock exchange. Shares of other luxury houses including Gucci-owner Kering SA, Hermes and Burberry Group PLC also fell in the wake of a broader market sell-off.

Investors are concerned that China, which accounts for about a third of luxury goods sales, could experience a slowdown. The uncertainty has arisen as a consequence of a U.S.-China trade war as well as a loss of spending power among Chinese consumers reflecting a decline in the value of the yuan and a drop in the Chinese stock market. In addition, some analysts believe stock price valuations of many big luxury houses are at high levels and therefore offer limited upside.

In a conference call with analysts Oct. 10 to discuss third-quarter earnings in 2018, LVMH said it was not particularly worried about Chinese demand cooling. "As far as Chinese customers are concerned, there's a little slowdown that we are talking about, moving from high teens to mid-teens" in revenue growth, said Jean-Jacques Guiony, CFO of the Paris-based maker of Louis Vuitton handbags, Krug Champagne, Marc Jacobs apparel and other luxury products. "So it's nothing really noticeable."

Guiony added: "We're optimistic about the future of Chinese customers. So basically, the forecast was not particularly pessimistic or negative on China. The real numbers are not particularly bad."

The Chinese consumer is crucial to the fortunes of LVMH and other producers of high-end consumer products. In 2016, luxury consumption dropped to its lowest level since 2009, according to a report by McKinsey & Co.

But a rebound has occurred in recent months. In 2018, the luxury goods market is expected to grow by 6% to 8% to reach €276 billion to €281 billion, according to a forecast by Bain & Co. Mainland China is anticipated to account for the lion's share of that increase, growing by 20% to 22% this year, based on constant exchange rates, according to Bain.

But other concerns are giving investors pause. "Although results look solid and the market's anticipated slowdown in Chinese spending has yet to materially manifest itself, we believe investors are growing wary of the luxury sector's elevated valuations, prompting a sell-off," Morningstar Equity Analysts said in a note. "The shares are still trading at a moderate premium to our fair value estimate even after a 7% decline at the time of writing."

Earlier in October, the share prices of LVMH and Kering dropped sharply on reports that Chinese authorities were cracking down on travelers returning home after purchasing luxury items overseas, including imports that exceeded the duty-free limit. The authorities' move may be an effort to hamper a practice known as "daigou," whereby Chinese tourists sell foreign-bought luxury goods at a hefty profit domestically.

The practice of daigou is not something that LVMH welcomes or promotes, Guiony said on the conference call, adding that the company tries to fight the practice by limiting the number of products customers can buy at LVMH stores, especially in Paris.

Guiony noted that Chinese consumers tend to spend a higher proportion of their income on luxury products, compared to U.S. or European consumers. "Hence, higher volatility," said Guiony. "It has disproportionate consequences on their propensity either to purchase or not."

In the earnings call, LVMH said: "While we are pleased with our performance to date, we remain cautiously confident as we look ahead to the rest of the year in the context of monetary and geopolitical uncertainties."