The dual scenario for fashion on energy crisis

Fashion & luxury is showing off its weapons against the energy crisis. Analysts agree that consumer habits of high-end products have not been dented by inflation and the industry is not suffering a drop in sales. However, is this resilience offsetting the additional expenses that companies in the industry have to face due to high energy prices? The luxury sector is so far one of the few industries that has held up well to the impact of the energy crisis caused by the russian-ukrainian war and the following rise in inflation, thanks to its ability to pass on the costs of energy hikes to the end consumer. «Sales pricing power, or a company’s ability to raise prices without causing a drop in demand, is an important issue for the industry in the face of soaring inflation», Swetha Ramachandran, investment director, luxury equities at Gam, noted. Let’s just think of the annual revenues reported by luxury conglomerates like Lvmh or Kering and the positive impact of the US market and the dollar on the sector’s growth.

«Inflation now seems to be falling. However, these companies will not backtrack on the gains made», Ramachandran pointed out. «Companies in this industry avoid discounts and price reductions to maintain maximum brand value. We expect them to retain the benefits of cumulative price increases, although the increases will be more modest from now on». However, it is not the same for fashion in its broader sense, whose target consumers suffer more from the consequences of structurally higher inflation and are less resilient. «Looking ahead, we believe that macroeconomic conditions will weigh less on the sector starting in the second half of the year», Claudia Lotti and Francesco Leone, senior managing directors at Fti consulting, explained to MFF. «A milder-than-expected winter allowed less use of natural gas stocks, leading the cost of energy and inflation to stabilize, in Europe as in the US. The Federal Reserve itself gave some indications of declining inflation». Overall, the good resilience of the industry as a whole is mainly explained to the fact that fashion is not an energy-intensive sector. In fact, on average, energy weighs between 4% and 10%. However, the upper part of the value chain is certainly the one that has felt the impact of rising energy costs more than the others.

«Productions that include the use of chemicals, such as the creation of man-made and synthetic fibers, leather goods and processing of fine leathers, dyeing and finishing, are all segments where the cost of energy, especially in 2022, weighed much more heavily, with great consequences on the entire value chain, which are absorbed differently by the luxury and fashion sectors», the experts continued. Looking at the Italian value chain, composed mainly of Smes, the pressure of upstream costs related to energy, and to transportation and raw materials, is definitely a critical element, especially for fashion companies. «Companies in this sector are typically medium-sized enterprises and, under optimal conditions, with an ebitda between 8% and 10%», Lotti and Leone explained. «Pressures upstream in the supply chain could then result in shrinking margins, which are already often significantly low, reduced availability and lack of cash». Furthermore, there are the consequences that inflationary pressures will have on demand. «It has been estimated that 45% of consumers in Europe will cut their spending, mainly in apparel, footwear, accessories, and jewelry sectors, the main fashion categories», the experts said. «50% of the industry’s top management said their company will review the assortments to move towards a product mix that covers lower price ranges and thus meet the needs of consumers who have seen their purchasing power erode». According to Fti consulting, there are therefore two types of actions companies can take to change and adapt to new consumer needs. «Companies can either act on the cost structure, and 40% of the industry said it plans to move towards this direction or pass costs on to consumers by increasing prices». However, this is a lever that could pose a risk and that only segments with a target client base with limited price elasticity could afford. However, what are the prospects in the medium term? «If the crisis continues, we could see an increase in the margins of luxury companies, by virtue of the price increases already absorbed over the past years, in light of a stabilization of the cost structure». This is expected to have a positive impact on larger groups’ marginalities. «The situation in fashion is different, a sector in which smaller companies are still suffering and where margins are also compressed due to greater recourse to promotional activities», Lotti and Leone added.

In addition to working on price leverage, there are two possible areas to work on the cost side. First, building a model aiming for progressive energy independence to avoid spikes in case of shocks. Then, supply models will have to be rethought by focusing on reshoring and nearshoring where possible and sustainable in order to reduce some risk components and build a more flexible model. «Both levers require the overhaul of the business operating model, with investments that will only have an impact on economic results in the medium to long term», the experts concluded. The impact of the energy crisis has different repercussions, inevitably, and across the board trends are confirmed to differ by country and segment. In Europe, fashion expects moderate growth or a slight decline, while luxury is estimated to grow between 5%-10% due mainly to the return of American and Middle Eastern tourists. Both these regions confirm a positive and improving trend, with US-made fashion projecting increases between 2% and 6% and a luxury segment that could exceed +10%. As for China, the restart resulting from the post-lockdown recovery has already been noted, and according to the analysts it will not stop there. «By the end of the decade, we believe that three Asian economies alone, namely China, India, and Indonesia, will account for about 30% of global middle class consumption, compounded by other emerging markets such as Brazil and Mexico», Swetha Ramachandran of Gam concluded. (all rights reserved)