Artemis Funds (Lux) – Leading Consumer Brands fund update

Source for all information: Artemis as at 31 March 2024, unless otherwise stated.

• The fund has registered positive absolute returns in March, this quarter and since launch, but is lagging behind its MSCI AC World index benchmark over these periods.
• Q1 reporting season is expected to offer further evidence of polarisation between 'leading’ and ‘lagging’ brands across all subsectors, creating opportunities to drive returns from stockpicking.
• Consumer spending on travel and leisure as well as top-tier luxury has been resilient, while sportswear is set to benefit from innovation ramping up at larger players.
• M&A activity is set to rise, with larger companies likely to deploy surplus free cashflow to acquire smaller, fast-growing brands.

Global equities rose for the fifth consecutive month in March, as markets outside the US (specifically Europe and Japan) also started to perform well and sectors such as energy and materials rebounded on the back of higher oil prices. Developed market equities outperformed their emerging market counterparts, led by large-cap growth stocks.

Against this backdrop, the Artemis Funds (Lux) – Leading Consumer Brands fund made 7.1% during the quarter, compared with 8.2% from its MSCI AC World index benchmark.

Positives

Our luxury holdings saw Q4 results rewarded generously in terms of share price performance, which in our view was more reflective of positioning than underlying fundamentals. Sentiment towards the luxury sector had been bearish since summer 2023, due to concerns of an unpredictable deceleration from peak growth rates.

However, year-end results suggested a more orderly (but not uniform) normalisation, or what we have been referring to as a ‘slowdown, not a meltdown’, for most of our holdings.

French hotel operator Accor continued to re-rate on mounting evidence of improved capital allocation, undervalued in its 30% discount to comparable US peers.

Inditex, owner of the Zara and Massimo Dutti brands, announced a return to expansion in store space after many years of consolidation. This met with a positive market reaction as it takes Inditex back to its pre-pandemic growth model.

At a meeting with the company, management reminded investors that while competitors were battening down the hatches during Covid, Inditex was closing smaller stores and expanding its flagships with a view to exiting the crisis stronger than when it entered it.

Negatives

Underperformers for the quarter have all lowered forward guidance. Nike exceeded top-line and profit expectations from December to February, but its prediction that sales will decline by low single digits in the first half of the 2025 fiscal year (June to November) before inflecting sharply in the second half sparked fears that the company is once more promising ‘jam tomorrow’.

We believe these concerns are more than reflected in the shares’ decade-low valuation relative to the market, but the potential upside from its upcoming innovation cycle is not. As the market leader, Nike’s loss of form is likely to be temporary and we believe the shares offer compelling upside on a three-year view.

Hugo Boss was penalised after hinting that while its 2025 sales target of €5 billion a year was still in sight, it might be “a few months late”. On a P/E of less than 13x for 2024 (compared with a 15-year average of 17x), we believe the company’s repositioning efforts remain undervalued, with gross-margin recovery from the winding down of promotional intensity providing a credible floor to earnings expectations.

After a confident showing at a retail industry conference (ICR) in January, Lululemon unusually ratcheted down expectations for the first quarter, guiding to 10 to 11% growth compared with anticipated figures in the mid-teens. This caused a sell-off. While international growth remains strong (up 60% in China year-on-year in Q4 and 30% internationally), it got off to a slow start to 2024 in Europe for reasons we struggle to understand. The brand’s cautious inventory planning could have led to it ‘chasing demand’ during the quarter, while heightened competitive intensity could also be playing a part, leading us to be more vigilant on the investment thesis.

Activity

We exited our position in Puma in March. Company results and a meeting with management confirmed the road to margin recovery is likely to take longer than the market is expecting. This is particularly true in China, formerly its most profitable market, with margins above 30%.

Following the market’s punitive reaction to On Holding’s Q4 results, we added to our position. We viewed the sell-off as an opportunity to build our holding in a secular growth company with distribution-led gains and category expansion into apparel, underpinning visibility on near-term growth. We lightly trimmed our positions in Ferrari and Hermès.

Outlook

This year and beyond

While we continue to favour companies with high earnings visibility and resilience (Ferrari, Hermès, EssilorLuxottica), we recognise some valuations are beginning to reflect their relative appeal and have trimmed our holdings in favour of other names where potential upside is greater.

Luxury companies are seeing growth return to trend rates of 6 to 7% following a couple of years after the pandemic when it was above 20%. With evidence pointing to a polarised rather than uniform recovery, we have increased our weighting in our preferred names in this area, such as LVMH and Richemont, as we believe tough year-on-year comparisons they face for the next six months are priced into their undemanding valuations.

Selective pockets of pricing power

Pricing power is likely to be the preserve of fewer brands in 2024 than at any point in the past three years. As inflationary pressures subside, the ‘haves’ with secular, rather than cyclical, pricing power will come into clearer focus relative to the ‘have nots’. This is why we remain sceptical on brand ‘elevation’ investment cases, such as Kering, until the brand ‘proves itself’ to a wider group of consumers.

In some industries – such as global hotels – we remain confident that limited industry supply-growth affords the incumbents a greater degree of pricing power than has historically been seen by Accor, Marriott and Hilton, for example.

The US consumer

Although incremental growth is being led by emerging markets, the US consumer remains the engine powering most leading brands, accounting for about 35% of our holdings’ revenues.

This demographic experienced a lull in 2023 following two exceptionally strong years, but we see several signs of a recovery already in 2024. US household net worth (assets minus liabilities) ended 2023 at a record high, which will be exceeded again in Q1 2024.

A trebling of household wealth in absolute terms for the top half of households is supportive of our view that peak inflation (and interest rates) plus higher real wages should support discretionary consumption in 2024.

The shift back towards ‘experiences’ from ‘goods’, with services comprising 60% of US consumption pre-pandemic, supports several of our travel and leisure holdings.

Additionally, signs have emerged that brands with a low exposure to the entry-level consumer have withstood the normalisation of growth in this market better than those that have relied on a lower-income cohort. This has built confidence in our view that while the US will drive growth for leading consumer brands in 2024, it will do so selectively – Brunello Cucinelli should outperform Kering, for example, given it tends to have higher-spending customers with lower income elasticity.

The return of the tourist shopper

A rebound in travel should lead to growth in demand for leading consumer brands from Chinese, Middle Eastern and US consumers. Data from tax-refund provider Global Blue shows an improvement in global shopper recovery to 145% of 2019 levels as of March 2024, compared with 138% across January and February.

While the specific timing of Chinese New Year and Ramadan creates monthly variability, the underlying trends are of mainland Chinese shoppers leading the global travel recovery, with France, Spain and Italy benefiting as destination markets.

Valuations remain favourable

Our portfolio of brands compares favourably with its MSCI AC World index benchmark on quality and growth. Long-term EPS is projected to grow ahead of the market with significantly higher gross margins (pricing power) and lower leverage, delivering above-market returns on equity at sub-market enterprise value/EBITDA. We believe this conveys more information than P/E ratios due to the net-cash balance sheets of most of our holdings.

Three reasons to invest in leading consumer brands

• A balance of top-line growth and robust margins/cash generation at attractive valuations.
• Exposure to rising middle-class affluence via developed market stocks.
• Solid balance sheets – the sector’s companies are typically net cash, generating significant free cashflow, with growth fully self-funded.

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.

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.