Artemis Funds (Lux) – Leading Consumer Brands fund update

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

• The fund underperformed the MSCI ACWI during the quarter, driven by non-ownership of tech companies, stock-specific issues and political risk in France affecting our European holdings
• Q2 reporting season is likely to show growing divergence between 'leading’ and ‘lagging’ brands 
• Chinese consumption internationally is outperforming domestic spending
• US consumers continue to draw down on excess savings, which could last another year
• We exited Nike and Lululemon on worsening fundamentals, but initiated positions in Spanish perfumer Puig and Swiss chocolatier Lindt & Sprüngli
• Our approach is to stay focused on resilient businesses with inelastic demand and margin buffers as well as turnaround stories with catalysts ahead
  
   

The second quarter was another positive period for global equities, as hopes of a soft landing resurfaced while earnings remained resilient. Returns were driven primarily by growth stocks, with excitement over AI (artificial intelligence) and a strong season for US technology earnings contributing the bulk of performance.

Against this backdrop, the Artemis Funds (Lux) – Leading Consumer Brands Fund fell 7.4% compared with gains of 2.9% from its MSCI AC World index benchmark.

This was driven by:

1. A drawdown of nearly 2% on the last day of June after idiosyncratic issues affecting Nike (where we had a 3% position, which we have now sold) led to contagion across the sportswear sector. Since then, the market has started to discriminate between these companies, reflecting the brighter prospects away from Nike.
2. Elections in France, which hindered the performance of our European positions. While we are skewed towards stocks listed in Europe, we are not skewed towards European revenues. We therefore view the weak sentiment around France to be uncorrelated to business fundamentals and may use it as an opportunity to add to select names that have sold off indiscriminately.
3. Our underweight position in technology stocks.

Positives

TJX, the owner of TK Maxx and other chains, continues to disrupt US retail: the off-price category only accounts for 15% of the $30 billion apparel market, but is gaining market share, within which TJX’s positive traffic, global reach and e-commerce platform position it for strong growth.

Watches of Switzerland saw strong performance in the US (up double digits), while the market reacted favourably to a recent jewellery licensing deal with Roberto Coin.

On Holding benefited from robust Q1 results and positive momentum for footwear brand On Running. Innovation, growth outside the US and rising gross margins thanks to a focus on achieving full-price sales were rewarded in share-price performance. We also think On Holding can benefit from Nike’s problems, as can another top performer, Adidas, which raised guidance and is in the early stages of a global roll-out of its successful Terrace franchise.

Negatives

Estée Lauder and L'Oréal had a torrid month in June after the chief executive of the latter predicted the global beauty market would grow at 4.5 to 5% in 2024 versus previous expectations of “around 5%”. We believe both have overcorrected given (1) L'Oréal continues to increase its share of the global beauty market and (2) Estée Lauder is in the early stages of a recovery following the end of destocking in its travel-retail channel.

We had already reduced our exposure to Lululemon after it lowered growth expectations from the mid-teens to between 10 and 11%. Our research revealed competitive pressures in the US (responsible for 60% of sales) were more severe than we anticipated, even as international growth led by China remains robust. We sold out completely.

While LVMH and Hermès both fell during the quarter, we expect them to be long-term beneficiaries of the growing polarisation in the luxury sector.

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

Lindt & Sprüngli has been our major addition this quarter. The chocolatier is a rare consumer staple with a long runway for organic volume growth, due to under penetration in emerging markets, ongoing consumer premiumisation – even in mature developed markets – as well as sticky pricing independent of the inflationary backdrop due to the seasonal and gift-giving nature of 50% of sales.

We added to the position through the period due to peak fear over the price of cocoa. The company uses hedges to cope with volatility in the short term, while in the long term its pricing power should allow it to pass on costs to the end consumer.

Another new position is Spanish-listed Puig, the world's fourth-largest perfumer, with inroads in skincare from its acquisition of the Charlotte Tilbury brand. The company is well placed to benefit from growth in prestige fragrances and its move into Asia, where the category is underpenetrated. We believe the company’s likely delivery of annualised low double-digit earnings per share growth over 2024 to 2027 is not reflected in the share price.

We also added to Prada, which we believe will demonstrate best-in-class growth in the luxury sector at upcoming H1 results, set to be marked by a widening gap between share gainers and losers (such as Burberry and Gucci) in this area.

Nike and Lululemon were the only two positions we exited completely during the quarter. We took some profits in Deckers after a strong run driven by its Hoka footwear brand and reallocated the capital to other positions such as Brunello Cucinelli on recent weakness and Watches of Switzerland.

The second half

With the Q2 earnings season about to start, we expect to see further divergence in fundamentals by sector and company. In luxury, we prefer companies positioned at the higher end, with more inelastic demand (such as Brunello Cucinelli and Hermès) as well as specific brands in an advanced stage of recovery (such as Prada). We expect signs of margin pressure on upfront investment at some of the larger brands due to events such as the Olympics but this has been well flagged and is a temporary rather than structural issue.

We remain circumspect on wines & spirits in the near term while consumer destocking continues in the US market and believe Davide Campari is the only large player that can deliver meaningful organic volume growth for the next six-to-nine months. However, depressed valuations and sentiment are creating opportunities in some names.

The importance of travel

Travel & leisure is well positioned to capitalise from the summer of European events (such as the Euros, Olympics and Taylor Swift’s 50-city tour) which is benefiting not just our hotel investments, but our broader retail holdings, due to tourism’s positive effect on consumer spending.

Staying on this theme, data from VAT-refund operator Global Blue for June highlights an accelerating recovery for tax-free shopping across Europe and the Asia Pacific with growth of 168% in June relative to 2019 levels.

All nationalities have contributed, but of particular note is the behaviour of the Chinese consumer – while they are spending once more, they are doing so in different countries. Although sales have been weak across all categories in the mainland, Japan captured two-thirds of Chinese consumer spending in May 2024 versus one-third in May 2019. While this was aided by the weak yen, a similar pattern is evident in Europe, albeit to a smaller extent.

Over in the US, the consumer is supported by a pool of excess savings. Barclays estimated this stood at $0.8 trillion in May, which could prop up consumption for another 16 months.

Consumer elasticity

Volume growth remains elusive. Since the initial flush of post-pandemic revenge spending began to fade in 2022, luxury and other leading brands have seen little to no growth in volumes, and have instead had to rely on price and premiumisation (trading up to more expensive products).

Yet many companies seem to have pushed this to its limit, with consumer elasticity stretched to breaking point.

Among the few brands that have been able to raise prices this year without affecting volumes – Ferrari, jeweller Van Cleef & Arpels (not a holding in our fund) and hotel chains Hilton and Marriott – are those seeing undersupply relative to demand.

What we want to avoid is investing in brands that are cutting prices, as this can cause significant damage to long-term equity. Examples of this behaviour have been seen at Saint Laurent and Balenciaga (both owned by Kering, not held in the fund) and Versace (owned by Capri, not held in the fund).

The opportunity in leading consumer brands

In terms of opportunities, 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 stocks. We remain focused on companies that are benefiting from ongoing polarisation and gaining market share.

Our portfolio compares favourably to its MSCI ACWI benchmark on quality, returns and cashflow-based valuation. Long-term earnings-per-share growth is projected to lag slightly behind the market (due to the lack of technology holdings) but with significantly higher gross margins (due to pricing power) and significantly lower leverage, delivering above-average returns on equity at an above-market free cashflow yield. We believe this conveys more information than price-to-earnings ratios due to the net-cash balance sheets of most of our holdings.

Sustainability spotlight

Sustainability consultancy Positive Luxury’s report titled “The Future of Premium Drinks” highlighted the challenges and opportunities faced by this industry amid growing environmental and social pressures.

Aside from more predictable findings, such as the growing importance of sustainability to consumers and its potential benefits at an operational level, the report noted the premium drinks industry’s vulnerability to climate change due to its reliance on specific environmental conditions. Changes in temperature and weather patterns can significantly affect the quality and availability of crops such as grapes used in wine and barley used in whiskey.

Companies that actively manage their environmental impact and invest in sustainable agricultural practices are better positioned to create long-term value. For example, Diageo (not a holding in the fund) has achieved a 46% improvement in water efficiency across its operations since 2007. By 2026, it aims to replenish more water than it uses in areas where this resource is scarce.

The premium drinks industry is at a pivotal point where embracing sustainability is not just a regulatory or ethical necessity but a strategic advantage. Investor focus is warranted on companies that are addressing environmental and social challenges, as these are likely to be better positioned for future growth and resilience.

The fund's benchmark is the MSCI AC World index. The benchmark is a point of reference against which the performance of the fund may be measured. Management of the fund is not restricted by this benchmark. The deviation from the benchmark may be significant and the portfolio of the fund may at times bear little or no resemblance to its benchmark. The benchmark does not take into account environmental and/or social characteristics promoted by the fund.