Artemis Funds (Lux) – Leading Consumer Brands fund update

Source for all information: Artemis as at 30 September 2024, unless otherwise stated. 

The Artemis Funds (Lux) – Leading Consumer Brands Fund made 6.4% in the quarter to the end of September, compared with gains of 6.6% from its MSCI AC World index benchmark.

Q2 results season showed further evidence of brand bifurcation, with earnings continuing to diverge between sectors and companies: for example, Prada, which we own, saw Q2 sales increase by 18%; while Burberry, which we don’t, saw a decline of 22%. Within luxury, we retain a preference for companies at the higher end (such as Brunello Cucinelli and Hermès), where demand among customers is less elastic, as well as specific brands in an advanced stage of turnaround (Prada). We saw some signs of margin pressure at some of the larger brands on upfront investment into events such as the Olympics, but view this as temporary rather than structural.  

In sporting goods, Nike’s continued difficulties have favoured growth for niche brands such as On and Hoka, as well as adidas, which is in the early innings of a global rollout of its Terrace franchise. On Holding and adidas were two of our strongest performers during the quarter. Recent purchase Anta Sports also did well. 

Q3 reporting, about to get under way, should continue to show a significant divergence of fundamentals between ‘leading’ and ‘lagging’ brands across all subsectors. In a flatter macro backdrop, without the benefit of a rising tide, consumers are becoming more selective and focusing their spend on differentiated brands seen to offer ‘value’, irrespective of price.

We recently spent 10 days in Hong Kong and mainland China visiting companies and meeting industry experts. The timing of the trip proved fortuitous: the stimulus measures began to be announced from the second day of the trip, creating a notable shift in tone from companies as the week progressed.

Positives

Zara owner Inditex continued to gain share in a tepid market, particularly in the US. The company’s restructuring post-Covid towards larger flagship stores that highlight a broader range of products has significantly increased return on capital. 

On Holding benefited from a polarisation in the sport-shoe market, where giant incumbents such as Nike had previously de-prioritised the wholesale channel and are only now starting to re-engage after allowing smaller brands to reach escape velocity in scale. 

Ferrari’s Q2 results beat elevated expectations and led to an increase in full-year guidance. Its unique waitlist-led model helps to explain an adjusted EBITDA margin of 39.1%, which is significantly ahead of other carmakers and best-in-class luxury peers (Hermès is just behind). 

We also benefited from avoiding many of the tech giants during August’s crash, highlighting the diversification advantages of the strategy.

Negatives

Davide Campari is the only large player in wines & spirits to deliver organic volume growth so far in 2024. However, it fell heavily following the unexpected departure of its chief executive. With the shares trading at close to two standard deviations below their five-year average, we added to our position. 

Shares in Spain-listed Puig, the fourth-largest global perfumer, have fallen since its May IPO. But the company is well placed to benefit from ongoing growth in prestige fragrances as well as further roll-out in Asia, where the category is underpenetrated. It is also making inroads into skincare from its acquisition of the Charlotte Tilbury brand. 

Plans to re-list in the US failed to offset Samsonite’s weak Q2 results, blamed on a struggling competitor in India discounting its goods – it refused to get dragged into a price war, as doing so would have damaged long-term brand equity. There is also evidence of weakness in some of its ‘value’ ranges in China as consumer confidence wanes. But a 10% free cashflow (FCF) yield and sub-10x P/E for next year are compelling reasons to remain invested. 

Estée Lauder fell after competitor L’Oréal announced a softening in the beauty market to mid-single-digit growth rates. Along with the return of destocking in its travel channel, we felt this meant Estée Lauder would struggle to match consensus growth forecasts for next year, so we sold out.

The fund's objective is to increase the value of shareholders’ investments primarily through capital growth over a five year period. The fund is actively managed.

Activity

We initiated a new position in Amer Sports, whose two billion-dollar brands – Arc’teryx and Salomon – are expected to drive growth in the medium term. The company floated earlier this year, but we avoided it at the time due to its high valuation and a risk to near-term earnings that materialised through its first two reports as a public company. But since then, Q2 earnings have materially beaten expectations, with 18% growth (adjusted for currency fluctuations) in a feeble macro backdrop.

More importantly, the company raised 2024 guidance at a time when most consumer companies sound nervous on weaker-than-expected consumption trends, notably in China. Amer’s Greater China division accounts for one-fifth of group revenues, and this was up an enormous 55% in the quarter, driven by improving brand awareness. The company’s growth prospects aren’t reflected in its P/E multiple.

Prada continued to benefit from sector polarisation and market share gains, so we increased our position here, as well as to Brunello Cucinelli on its defensive revenue exposure to an inelastic income cohort.

We also added to adidas and Inditex, both of which are outperforming their respective sub-sectors and gaining market share. We added to our positions in Hugo Boss and Ralph Lauren, which are on compelling valuations – the former on a turnaround, the latter on strong operating momentum in the US and China.

Although the travel & leisure sector capitalised on the summer of European events (Euro 2024, the Olympics and Taylor Swift’s 50-city tour), we expect spending in this area to normalise as the shift towards ‘experiences’ from ‘goods’ appears to have peaked. As a result, we trimmed our positions in Hilton, Marriott and Vail Resorts, the latter of which has seen consumer resistance to price increases in ski passes, which could suggest weakness into the key winter season.

We took profits from On Holding.

Outlook

Big news from China: Why it matters

Stimulus measures announced by the Chinese government – acting as a backstop to the property market, providing aid to financial institutions and offering support for local government debt – all go a long way to addressing the source of economic malaise. The crisis in China is mainly one of consumer confidence, which can be revived by ongoing and targeted government measures to reassure consumers about the property market, in which 60% of Chinese household wealth resides. Chinese consumers drive about 25% of our holdings’ revenues.

China versus the Chinese consumer

Many company reports this year have noted weak sales in China but strong growth among Chinese consumers, as more money is spent overseas with the return of outbound travel.

Just as in other countries, there is a clear K-shaped bifurcation in Chinese consumer preferences towards ‘value’ brands on the one hand and ‘ultra high-end’ or ‘niche’ brands at the other, catering to specific consumer segments or interest groups. For example, Hermès is vastly outperforming Gucci, while premium outerwear brand Arc’teryx is doing much better than mainstream competitor Nike.

US consumer: Supported by record net-worth levels

The US consumer is supported by record-high net-worth levels (house and equity marked-led) as well as data emerging that high levels of ‘excess savings’ (the total amount of savings minus a trend level) persist – which would explain the lower-than-pandemic personal savings rate (the percentage of disposable income saved) in the US today of about 3.6%. Barclays research estimates the pool of excess savings, at about $0.8 trillion in May, could continue to prop up consumption for another 16 months.

However, we note signs of consumer resistance in the US – from staples such as Nestlé to fast-food restaurants such as McDonald’s and Starbucks – none of which we own – on cumulative price increases, or what’s been dubbed ‘greedflation’.

Impact of geopolitics on holdings

Authorities in France have imposed one-off tax increases on large corporates, which have reduced the earnings of our holdings listed there by between 2 and 4% on average.

The US elections are more consequential as they will likely drive the behaviour of both the US and Chinese consumer through government policies. These two cohorts account for more than 50% of holdings’ revenues. Companies note the looming uncertainty around the upcoming presidential election is creating a ‘wait and see’ attitude among consumers.

Precedent from 2019 suggests Donald Trump’s bark may be worse than his bite and China remains on the sidelines to counter the dampening impact of potential tariffs via fiscal stimulus. Europe may fare worse given previous tariffs on champagne and whisky, supporting our cautious outlook on the spirits sector.

Earnings inflection in sight as US and China set to re-accelerate

The dislocation between earnings, which have now stabilised after a period of downgrades, and valuation, which remains low relative to history even as the underlying companies are more profitable and of higher quality, offers an attractive opportunity in individual companies within the sector.

Fund characteristics

Our portfolio of brands compares favourably against its MSCI ACWI benchmark on quality, returns and cashflow-based valuation. Long-term EPS (earnings per share) growth is projected to be slightly behind that of the market (due to no technology exposure) with significantly higher gross margins (pricing power) and significantly lower leverage, delivering above-market returns on equity at above-market FCF yield. We believe this conveys more information than the P/E ratio due to the net-cash positive balance sheets of most fund holdings.

Sustainability spotlight

On Holding introduced LightSpray, an ultralight, one-piece upper that is sprayed onto the shoe by a robotic arm. The process, which will make its first appearance in the Cloudboom Strike LS trainer, reduces carbon emissions by 75% compared with On's other running shoes.

Cosmetics companies are adapting their sustainability efforts in China to align with local values, which are focused on health, family and community over climate change. For example, L’Occitane is collaborating with local communities to ensure the natural ingredients it uses are sustainably sourced, while L’Oréal’s 'Beauty for a Better Life' programme provides underprivileged women with education and vocational training.

Inditex announced plans to expand its 'Zara Pre Owned' offer from Europe to the US market, allowing customers to sell, donate or repair second-hand clothing.