Luxe Retailers in Luck

When the economy took a nosedive in 2008, most consumers retreated into hibernation and luxury retailers were first to feel the blow. Two years later, while much of America’s middle class has continued to dwell in a state of uncertainty, the high-end shopper has re-emerged, giving both retailers and investors reason to rejoice.

From an investment perspective, the comeback is hard to ignore. A number of the top luxury names are outpacing the S&P 500 year to date, with Coach (NYSE:COH) up 58%, Tiffany & Co. (NYSE:TIF) up 47% and Polo Ralph Lauren (NYSE:RL) up 38%. The broader S&P 500 is up 11%.

The rebound is of particular interest to Marie Driscoll, an equity analyst at Standard & Poor’s who currently has “strong buy” ratings on Coach and Polo Ralph Lauren and a “buy” rating on Tiffany. Driscoll says the fact that the U.S. financial markets have strengthened this year is one reason wealthy consumers have been lured back to stores.

“Luxury companies like Saks (NYSE:SKS) and Tiffany will tell you that what their sales are most closely correlated to is the stock market. There’s that positive consumer sentiment – that ‘wealth feeling’ – that people derive from the market going up.”

While luxury shoppers may be more willing to spend, they aren’t just blindly snapping up goods. According to Driscoll, the brands benefiting most right now are ones that have withstood the test of time and provide a strong value offering. She cites Gucci and Louis Vuitton as examples of brands that, through smart advertising, have positioned themselves as “heritage” or “authentic.”

“It’s just to show that this brand stands for so much more than just a handbag with initials on it,” she says.

Driscoll says the biggest catalyst propelling the luxury-retail rebound, however, has been the increasing spending power of consumers overseas. She says her strong ratings on luxury stocks are based on her belief that those brands have “lots of growing power” outside of the U.S., particularly in China, India and other emerging markets.

“We think that there are legs to these calls for luxury retailers. A lot of it has to do with expanding international markets. You don’t really want to bet against the Chinese.”

A recent study by Bain & Co. shows China’s luxury buyers upped their spending by 10% in 2009, with more than half of their luxury purchases being made outside of China itself. For luxury retailers, this means opportunity to develop not only in China, but in mature markets as well.

“Paris, France, and Europe are integral to [Coach's] global growth strategy, as much for the intrinsic opportunity, as for the marketing message and access to the Chinese consumer on his/her international travels,” Driscoll wrote in a recent note about Coach’s new shop in Paris, which marked the brand’s foray into Europe.

What China’s burgeoning class of luxury shoppers represents is the potential for a steady boost to U.S. economic growth. For all of the excitement about the return of the luxury shopper, Driscoll points out that tax increases on the state and local level are likely to negatively impact U.S. spending next year -- even if a one-year 2% payroll tax cut is passed.

She also says income levels haven’t really grown, but China will help offset that.

“If you can’t grow your income, you have to grow the number of people. And that’s why China is so important. They have a growing middle and upper class. They’re creating millionaires,” she says.