China luxury upturn provides relief to retailers

China's recent recovery in luxury spending may boost sales of domestic department-store operators and luxury-goods retailers, including Golden Eagle Retail Group, Hengdeli Holdings, and Parkson Retail Group, though it may not be enough to offset the effects of structural problems caused by changing spending patterns and competition from new retail formats, according to Fitch Ratings.

Reports from international brands such as Coach, Swatch Group and LVMH suggest luxury spending in China is beginning to recover after a few difficult years caused by China's anti-corruption campaign and weak consumer sentiment. Coach reported its Greater China local-currency sales rose 6% in 4Q16, while Swatch spoke of "very good growth" in mainland China sales during November and December 2016, as well as January 2017.

Fitch believes the stronger sales were driven by a wealth effect from higher property prices, narrower gaps between domestic and international prices and a curb on overseas purchases.

The previous few years have been difficult for Chinese brick-and-mortar retailers, who had to grapple with increasing competition both offline and online as well as changing spending patterns, with consumers choosing experiences over shopping.

The pick-up in luxury spending could provide some relief, particularly for mid-to-high end retailers, such as Golden Eagle and Hengdeli. The recovery in luxury spending was also partly driven by consumers bringing back some overseas spending.

For example, the press reported that Chinese visitors to France fell by more than 20% in 2016 after several terrorist attacks. In addition, a stronger yen also curbed Chinese tourist spending in Japan.

Tighter government restrictions on "daigou" - buying on behalf of a third-party for a fee - and overseas purchases since 2H16 have also made it more difficult for Chinese residents to bring in luxury products purchased abroad.

Prices of most luxury goods remain higher in China compared with the rest of the world; but this price gap has shrunk after the government cut taxes on certain product categories and major brands adjusted prices to narrow regional price differences.

Cosmetic brands such as Estee Lauder and Amorepacific, for example, announced price cuts of 2%-20% in January 2017. A weaker Chinese yuan also made overseas purchases less attractive to Chinese shoppers.