Rise of the Yummy

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Disclosures and Disclaimer This report must be read with the disclosures and analystcertifi cations in the Disclosure appendix, and with the Disclaimer, which forms part of it

By Erwan Rambourg, Antoine Belge and Cathy Chao

Luxury names have reeled from emerging market macro doubts, but we remain confi dent thatemerging market demand for luxury brands will prove more than resilient

In this report, we outline why we are optimistic: 1) Urbanisation and economic growth create more emerging client targets for luxury; 2) China is no country for old men but rather a market

that could be driven more by young women. In other markets, a metro-sexual shift is starting to move the needle, with Japan and Korea showing the way; and 3) Around the world,

purchases will increasingly be made by the digitally plugged-in youth

Our preferred stocks are Burberry, Richemont and Luxottica. We initiate coverage on EmperorWatch and Jewellery. All are OW rated

Young, Urban, Male: three reasons to rejoice

Rise of the Yummy

Consumer Brands & RetailGlobal luxury goods Equity

March 2014

*Employed by a non-US affi liate of HSBC Securities (USA) Inc, and is not registered/qualifi ed pursuant to FINRA regulations.

Erwan Rambourg*AnalystThe Hongkong and Shanghai Banking Corporation Limited+852 2996 [email protected]

Erwan Rambourg is Global Co-Head of Consumer and Retail Research and is a top ranked analyst covering the luxury and sporting goods sectors. He joined HSBC in January 2005 and in 2011 relocated from London to Hong Kong as many stocks under coverage are now Asia-driven. Before moving to HSBC, Erwan worked for eight years as Marketing Manager in the luxury industry, notably for Richemont and LVMH.

Antoine Belge*AnalystHSBC Bank plc, Paris branch+33 1 5652 [email protected]

Antoine Belge is Global Co-Head of Consumer and Retail Research and is a top ranked analyst covering the luxury and sporting goods sectors. He has been an analyst since 1998 and joined HSBC in 2003. Prior to this, he worked for seven years in the industry as a Finance Controller for Christian Dior and Chanel.

Cathy Chao*AnalystThe Hongkong and Shanghai Banking Corporation Limited+852 2996 [email protected]

Cathy Chao joined HSBC in June 2011 and is an analyst in the Asia-Pacifi c consumer research team. She began her career at a consulting company in Chicago. Following that, she worked at two major investment banks in Hong Kong where she gained experience in equity derivatives and sell-side equity research. She holds an MBA degree from the Hong Kong University of Science and Technology with a specialization in fi nance and a bachelor of arts degree in mathematics and economics from the University of Chicago.

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Consumer Brands & Retail Global Luxury Goods Equity March 2014

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Leaving aside FX, 2014 wont be that bad really 2014 sales outlook still solid Here and there, threats to travel (SARS, 9/11) and political turmoil will put pressure on markets such as Russia or Thailand. But when looking at luxurys core Chinese consumer, as well as Korea, Japan, the US and even parts of Europe, there are still reasons to believe 2014 should be at least as strong as 2013 in terms of organic sales growth for the sector (+9% vs +8%). Having spent much time recently with brand managers, watch distributors, mall operators and many other contacts in headhunting, e-commerce, brand consultancy and more in Shanghai, Hong Kong, Macau and Seoul, we believe the outlook for the industry sounds optimistic or, more importantly for this report, that investors sound too pessimistic!

Margins under pressure mostly a short-term issue FX: Most currencies have continued to deteriorate against the EUR so far this year. Therefore, both

reported sales and operating margins should now be if current spot rates prevail slightly lower than in our previous publications. Of course the RUB and the Brazilian Real are not as key for luxury players as they will be for other consumer subsectors but the citizens of these countries will see their spending power affected abroad and their spending translated into a lower amount of EUR for the brands

Cost of growth in soft luxury is a structural weakness: We still struggle with the concept of peak margins for the luxury industry, which many investors are die-hard fans of. History suggests that brands in the space will want to control their image, their distribution, and their prices so that gross margins are supported by an incremental retail (versus wholesale) exposure and a better image and inventory management. Moreover, while growth in the noughties was price and mix driven, more recent years have seen volume growth, which implies greater SG&A leverage. While all brands (except maybe Louis Vuitton) should aspire to higher operating margins, soft luxury companies (apparel, handbags, accessories) will likely find they will have to re-invest more than hard luxury companies (watches, jewellery, pens).

Summary Emerging clienteles driven by youth, economic development and, with the exception of China, men should continue to strongly support luxury demand growth for this year and beyond. Current emerging market doubts provide an opportunity to buy luxury names. We prefer Burberry, Richemont and Luxottica and initiate on Emperor Watch & Jewellery with an OW rating

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Young, Urban, Male: three reasons to rejoice Youth: benefits and issues of selling to a younger consumer Premium consumers are getting much younger. In particular, Asian ones, who are now the ones significantly moving the needle for luxury, are younger than their Western counterparts. Youth is a positive as consumers want to display social status early on, but fast-changing expectations and fashion trends put pressure on the mainstream brands. Not everyone is nimble in luxury. And, with many consumers seriously plugged into digital and social media, it might become an issue that most luxury brands leaving aside Burberry are not.

Emerging markets: better GDP growth, wealth creation and urbanisation With much travelling and many meetings in Asia lately, we have developed the sense that there is too much negativity on China. While it may sound counter-intuitive given the macro economic news, individual interviews give us the sense that, after three years of hiding (from the economic environment in 2011 and 2012, and from the anti-corruption rhetoric since September 2012), the high-end Chinese consumer is ready to make a few purchases again. Meanwhile, urbanisation powers on, and GDP growth and wealth creation are creating hordes of new luxury targets as the upper middle class swells. Beyond China, many emerging markets are starting to appear on the luxury map as wealth creation is also creating new luxury targets for the brands.

Men: starting to move the needle elsewhere than in China China is a particular market, having been dominated by male purchases from the on-set as gifting and wealth creation were structurally male dominated. This is about to change: the future of Chinese luxury consumption is female. Nothing surprising here, just Chinese spending patterns converging towards those of Japan, Korea, Western Europe and the US. Spending patterns in the latter are changing as well, with luxury consumption becoming more male now. The metro-sexual, that clich from twenty years ago, is now becoming a commercial reality, with Japan and Korea (as so often) showing the way. We warn however, that this male-driven growth could trigger new pressures on the brands.

Ranking luxury stocks Three preferred stocks: Burberry, Richemont, Luxottica We like Burberry for its digital supremacy and the misplaced pessimism of the market. Similarly, with regard to Richemont, we think fears on China are overdone, while the valuation is compelling and Cartier watches are rebounding. For Luxottica, its captain-of-industry status and retail / wholesale synergies as well as M&A opportunities should support the shares.

Soft luxury: we also like Prada, Kering, Tods, Coach, Hugo Boss Prada's de-rating has gone too far, in our view, and we think the valuation relative to peers is now very compelling. For Kering, Tod's and Coach, although we see no short-term catalysts, we are confident of an H2 rebound. We are upgrading Hugo Boss in this report following the recent sell-off. The brand is operating in a less crowded segment than most peers, should benefit from the development of male purchases and consensus expectations have now come down.

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Hard luxury: Tiffany and Emperor Watch & Jewellery stand out Tiffany's higher-end repositioning, along with lower raw material prices, should continue to support the stock. We initiate with an OW on Emperor, a great way to play the Chinese traveler.

Why we are Neutral on LVMH, Christian Dior, Herms, and Ferragamo LVMH's current valuation relative to growth is still not compelling and we believe Christian Dior also has limited upside. Herms, and Ferragamo also looked fairly valued.

Why we are Neutral on the Swatch Group and Hengdeli Sales for Swatch should be robust but limited jewellery exposure makes it less interesting than Richemont. We remain uncomfortable with recent M&A deals and communication at Hengdeli.

Key data for luxury goods

____ Rating ______ Price at __ Target price ___ Potential _________ PE __________ Implied 2015 PE Reuters New Old Currency 18/03/14 New Old return*** 2013e 2014e 2015e (based on target price)

Burberry* BRBY.L OW unchanged GBP(p) 1,442.00 1,820.00 1,850.00 26.2% 19.1 17.1 15.2 19.1Coach* COH.N OW unchanged USD 50.23 64.00 64.00 27.4% 15.0 15.7 14.5 18.5Emperor Watch 0887.HK OW NA HKD 0.59 0.80 NA 35.8% 13.5 9.7 7.8 10.6Hugo Boss BOSSn.DE OW Neutral EUR 92.19 110.00 110.00 19.3% 19.0 16.8 14.4 17.1Kering PRTP.PA OW unchanged EUR 139.95 176.00 185.00 25.8% 14.3 14.1 11.7 14.7Luxottica LUX.MI OW unchanged EUR 39.36 46.00 46.00 16.9% 28.4 25.1 21.7 25.4Prada 1913.HK OW unchanged HKD 56.45 75.00 82.00 32.9% 21.4 18.1 15.4 20.5Tiffany TIF.N OW unchanged USD 92.67 110.00 106.00 18.7% 24.1 20.1 17.2 20.5Tod's TOD.MI OW unchanged EUR 93.95 111.00 118.00 18.1% 21.5 20.5 17.4 20.6Richemont* CFR.VX OW unchanged CHF 83.50 106.00 108.00 26.9% 18.4 16.5 14.5 18.4Christian Dior* DIOR.PA N unchanged EUR 134.95 140.00 140.00 3.7% 14.1 12.6 11.4 11.8Ferragamo SFER.MI N unchanged EUR 21.38 24.00 27.50 12.3% 23.9 23.0 19.7 22.1Hengdeli 3389.HK N(V) unchanged HKD 1.51 1.66 2.30 9.9% 8.7 8.7 8.0 8.8Herms HRMS.PA N unchanged EUR 234.6 262.00 279.00 11.7% 30.4 28.4 25.4 28.4LVMH LVMH.PA N unchanged EUR 129.1 141.00 141.00 9.2% 19.0 17.2 15.6 17.1Swatch UHR.VX N unchanged CHF 560 625.00 630.00 11.6% 15.8 16.2 14.6 16.3Moncler MONC.MI UW (V) unchanged EUR 12.83 12.60 13.00 -1.8% 33.3 26.2 21.7 21.4 Average 19.3 17.4 15.1 17.7Note: *Based on calendar data, **average do not include Herms, ***Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated. Source: HSBC estimates

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Summary of HSBC sales estimates changes and comparison with Bloomberg consensus

__________________________ 2014e Sales __________________________ _____________________ 2015e Sales _______________________ ______ HSBC _______ HSBC vs _______HSBC _______ HSBC vs(m) Currency New Old Change Consensus cons. New Old Change Consensus cons.

Burberry* GBP (p) 2,315 2,330 -1% 2,330 -1% 2,505 2,550 -2% 2,539 -1%Christian Dior** EUR 31,664 31,468 1% 32,657 -3% 34,090 33,844 1% 35,701 -5%Coach** USD 4,880 4,880 0% 4,892 0% 5,110 5,110 0% 5,137 -1%Ferragamo EUR 1,320 1,350 -2% 1,354 -3% 1,440 1,540 -6% 1,480 -3%Hengdeli CNY 14,435 14,537 -1% 14,763 -2% 15,018 15,211 -1% 16,213 -7%Herms EUR 4,092 4,104 0% 4,122 -1% 4,505 4,516 0% 4,593 -2%Hugo Boss EUR 2,610 2,660 -2% 2,635 -1% 2,865 2,925 -2% 2,873 0%Kering EUR 10,105 10,285 -2% 10,174 -1% 10,943 11,149 -2% 10,920 0%Luxottica EUR 7,710 7,732 0% 7,706 0% 8,346 8,371 0% 8,290 1%LVMH EUR 31,180 31,000 1% 31,541 -1% 33,600 33,401 1% 34,129 -2%Moncler EUR 676 684 -1% 672 1% 784 795 -1% 775 1%Prada HKD 3,586 3,650 -2% 3,611 -1% 3,993 4,075 -2% 4,021 -1%Richemont* EUR 10,600 10,625 0% 10,655 -1% 11,480 11,600 -1% 11,602 -1%Swatch CHF 9,200 9,200 0% 9,299 -1% 9,920 9,920 0% 10,153 -2%Tiffany USD 4,040 4,040 0% 4,032 0% 4,430 4,419 0% 4,333 2%Tod's EUR 1,000 1,030 -3% 1,005 0% 1,100 1,131 -3% 1,076 2%*FY March n+1, ** FY June n+1 Source: HSBC estimates, Bloomberg consensus

Summary of HSBC EBIT estimates changes and comparison with Bloomberg consensus

___________________________ 2014e EBIT __________________________ ______________________2015e EBIT _______________________ ______ HSBC _______ HSBC vs _______HSBC _______ HSBC vs(m) Currency New Old Change Consensus cons. New Old Change Consensus cons.

Burberry* GBP (p) 471 473 0% 462 2% 519 529 -2% 510 2%Christian Dior** EUR 6,378 6,385 0% 6,631 -4% 6,917 6,940 0% 7,383 -6%Coach** USD 1,269 1,269 0% 1,299 -2% 1,329 1,329 0% 1,371 -3%Ferragamo EUR 238 257 -7% 245 -3% 272 314 -13% 279 -3%Hengdeli CNY 992 1,045 -5% 1,295 -23% 1,074 1,143 -6% 1,472 -27%Herms EUR 1,292 1,290 0% 1,315 -2% 1,441 1,432 1% 1,477 -2%Hugo Boss EUR 496 498 0% 512 -3% 574 580 -1% 579 -1%Kering EUR 1,795 1,921 -7% 1,830 -2% 2,095 2,209 -5% 2,046 2%Luxottica EUR 1,181 1,205 -2% 1,178 0% 1,347 1,375 -2% 1,337 1%LVMH EUR 6,384 6,418 -1% 6,564 -3% 6,992 7,019 0% 7,241 -3%Moncler EUR 202 203 -1% 195 3% 234 237 -1% 225 4%Prada HKD 959 998 -4% 973 -1% 1,100 1,172 -6% 1,095 0%Richemont* EUR 2,442 2,455 -1% 2,450 0% 2,825 2,892 -2% 2,774 2%Swatch CHF 2,290 2,300 0% 2,349 -3% 2,540 2,550 0% 2,611 -3%Tiffany USD 807 807 0% 797 1% 949 942 1% 902 5%Tod's EUR 200 213 -6% 199 0% 232 246 -6% 218 6%*FY March n+1, ** FY June n+1 Source: HSBC estimates, Bloomberg consensus

Summary of HSBC EPS estimates changes and comparison with Bloomberg consensus

___________________________ 2014e EPS ___________________________ ______________________ 2015e EPS _______________________ ______ HSBC _______ HSBC vs _______HSBC _______ HSBC vs(m) Currency New Old Change Consensus cons. New Old Change Consensus cons.

Burberry* GBP (p) 0.77 0.78 0% 0.77 1% 0.86 0.88 -2% 0.86 0%Christian Dior** EUR 9.58 9.49 1% 9.84 -3% 10.73 10.64 1% 11.45 -6%Coach** USD 3.10 3.10 0% 3.14 -1% 3.29 3.29 0% 3.41 -4%Ferragamo EUR 0.91 1.00 -9% 0.95 -4% 1.06 1.15 -8% 1.10 -3%Hengdeli CNY 0.14 0.15 -7% 0.16 -14% 0.15 0.16 -5% 0.18 -16%Herms EUR 8.25 8.24 0% 8.35 -1% 9.23 9.17 1% 9.42 -2%Hugo Boss EUR 5.38 5.41 -1% 5.46 -1% 6.28 6.36 -1% 6.20 1%Kering EUR 9.91 10.68 -7% 10.30 -4% 11.91 12.57 -5% 11.83 1%Luxottica*** EUR 1.57 1.60 -2% 1.51 4% 1.81 1.85 -2% 1.75 4%LVMH EUR 7.50 7.47 0% 7.71 -3% 8.27 8.22 1% 8.61 -4%Moncler EUR 0.49 0.50 -2% 0.47 5% 0.59 0.61 -3% 0.56 6%Prada HKD 0.25 0.26 -4% 0.26 -3% 0.29 0.31 -6% 0.29 0%Richemont* EUR 3.78 3.80 -1% 3.81 -1% 4.28 4.38 -2% 4.20 2%Swatch CHF 34.32 34.50 -1% 34.63 -1% 38.19 38.40 -1% 38.60 -1%Tiffany USD 3.85 3.85 0% 3.76 2% 4.61 4.58 1% 4.27 8%Tod's EUR 4.58 4.95 -8% 4.61 -1% 5.39 5.79 -7% 5.09 6%*FY March n+1, ** FY June n+1, *** HSBC EPS for Luxottica is before trade-mark amortisation Source: HSBC estimates, Bloomberg consensus

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Calendar of events 6

Young Urban Males could support luxury growth 7

Luxury industry outlook & valuation 16

Ranking the luxury stocks 23

Company profiles 25 Burberry (BRBY LN) 26

Christian Dior (CDI FP) 30

Coach (COH US) 34

Emperor Watch & Jewellery (887 HK) 38

Hengdeli (3389 HK) 46

Herms (RMS FP) 50

Hugo Boss (BOSS GR) 54

Kering (KER FP) 58

Luxottica (LUX IM) 62

LVMH (MC FP) 66

Moncler (MONC IM) 70

Prada (1913 HK) 74

Richemont (CFR VX) 78

Salvatore Ferragamo (SFER IM) 82

Swatch (UHR VX) 86

Tiffany (TIF US) 90

Tods (TOD IM) 94

Disclosure appendix 101

Disclaimer 104

Contents

We would like to thank Anne-Laure Jamain* (HSBC Bank Plc) and Carole Madjo (HSBC Bank plc, Paris branch for their contribution to this report. *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

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Calendar of events

Luxury goods calendar of events

Company Type of Event Date

Burberry H2 2013/2014 sales 16-Apr-14 Burberry Prelim FY2013/2014 earnings 21-May-14 Burberry Q1 2014-2015 retail sales 09-Jul-14 Burberry H1 2014/2015 Oct-14 Christian Dior FY 2014 earnings Jul-14 Coach 3Q 14 earnings release 29-Apr-14 Emperor Watch & Jewellery H1 2014 earnings Aug-14 Hengdeli Prelim FY13 earnings 24-Mar-14 Herms FY 2013 earnings 20-Mar-14 Herms 1Q 2014 sales 29-Apr-14 Herms 2Q 2014 sales 18-Jul-14 Herms H1 2014 results 29-Aug-14 Hugo Boss 1Q 2014 results 07-May-14 Hugo Boss H1 2014 results 31-Jul-14 Hugo Boss 9M 2014 results 04-Nov-14 Luxottica 1Q 2014 results 29-Apr-14 Luxottica H2 2014 results 24-Jul-14 Luxottica 9M 2014 results 29-Oct-14 LVMH Q1 2014 sales Apr-14 LVMH H1 2014 results End July 2014 Moncler Q1 2014 results 15-May-14 Moncler H1 2014 results 06-Aug-14 Moncler 9M 2014 results 11-Nov-14 Kering Q1 2014 sales 24-Apr-14 Kering H1 2014 results End July 2014 Prada FY13 earnings 02-Apr-14 Prada 1Q 14 earnings 09-Jun-14 Richemont FY 2013/2014 Results 15-May-14 Richemont 5 months sales (ending August 2014) 17-Sep-14 Richemont H1 2014/2015 results 07-Nov-14 Salvatore Ferragamo 1Q 2014 Results 13-May-14 Salvatore Ferragamo H1 2014 results 28-Aug-14 Salvatore Ferragamo Q3 2014 results 13-Nov-14 Swatch H1 2014 results End July 2014 Tiffany Q4 2013 results 21-Mar-14 Tiffany Q1 2014 results May-14 Tod's 1Q 2014 results 14-May-14 Tod's H1 2014 results 07-Aug-14 Tod's 9M 2014 results 12-Nov-14 FHS Data February period 20-Mar-14 FHS Data March period 24-Apr-14 FHS Data April period 27-May-14 FHS Data May period 24-Jun-14 FHS Data June period 22-Jul-14 FHS Data July period 21-Aug-14 FHS Data August period 18-Sep-14 FHS Data September period 21-Oct-14 FHS Data October period 20-Nov-14 FHS Data November period 18-Dec-14 FHS Data December period 03-Feb-15 Source: company data

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Youth: benefits and issues of selling to a younger consumer Premium consumers are getting younger, especially in Asia Although it may sound quite counter-intuitive, luxury goods consumers are in fact relatively young. And they are getting younger. This is driven by psychological and social trends whereby consumers prefer to display social status earlier on (while older, better-off consumers may have less to prove and will tend to buy for themselves rather than to impress others). In addition, with increasing wealth creation and affordability of travel, as well as online blogs and forums, information on brands is more readily accessible to target audiences than ever before.

In a 2012 survey published by the Bocconi University, it is said that Chinese luxury consumers are up to 14 years younger on average than their European counterparts and 25 years younger than those in America. We believe the greater

youthfulness is bound to be similar in other emerging markets, notably Brazil, Indonesia, Vietnam and many countries in Africa (eg Nigeria, Ghana). The same Bocconi report claims that the majority of luxury consumers in three to five years time will be aged between 25 and 30.

An issue for mainstream brands, an opportunity for alternative brands A brand cant complain about attracting a younger consumer. Or can it?

The issue with youth is quite obvious. Young consumers, especially those who are wealthy enough to afford luxury products, have very fast changing expectations and follow fashion trends quite quickly. If your brand is not nimble enough, there is everything to lose.

We often hear comments that Chinese luxury consumers, for instance, do not show high levels of brand loyalty. We think this is a misunderstanding.

Young Urban Males could support luxury growth The 2014 sales outlook remains solid and Greater China could

surprise positively. However, margins are still under pressure from FX, hence we are cutting estimates for most companies Longer term, urbanisation, and the shifts towards younger, and

more male, consumers should support strong sales growth; we believe fears on emerging markets are overdone Prefer Burberry in soft luxury, Richemont in hard luxury, and

Luxottica. Initiate on Emperor Watch & Jewellery at OW

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The reality is Chinese luxury consumers are young and so more demanding, and have higher expectations. They are loyal, as long as they have a reason to be so. In other words, its not so much a question of consumer loyalty but more one of brand innovation. We believe mainstream brands will find it more difficult than alternative ones to respond, simply as scale hinders speed.

Moreover, as we explained in our recent Multi-baggers? A bit of caution report published on 15 January 2014, soft luxury companies will be more under pressure than hard luxury ones because of the simple fact that barriers to entry are quite low.

The ability to respond to the desire for newness is one reason that Zara-type business models such as the flash collection approach developed by Prada offer better protection than traditional business models in soft luxury.

Consumers are seriously digitally plugged-in; what about the brands? Luxury goods companies cannot ignore digitalization. The emergence of new smart devices everywhere has led to a more and more connected world, especially among the younger generation. Burberry has been the first mover in terms of digitalization, including online streaming of runway shows as well as in-store online experiences. In addition, the company has signed an agreement with WeChat which, according to CEO Christopher Bailey opens up a huge new world of opportunity in the digital space. He added that the exciting thing is the deeper and more meaningful way that we are able to tell our stories using this platform. The digital focus truly sets Burberry apart in terms of product and service, which helps to boost the brand awareness, especially in Asia.

However, other luxury companies have reassessed the need to develop and strengthen their online platforms and are now fully embracing digital opportunities.

For instance, in October 2013, Herms introduced a new application which shows how to use a piece of silk in a fun way. Via an interactive platform, consumers can scroll down 38 pieces of silk and create for example a headband or a dress.

Kering, meanwhile, is continuing to strengthen its online channel with the integration in November 2013 of Brioni in its JV with Yoox (signed in August 2012) to manage the online stores (seven of Kerings brands are already managed by Yoox online). Note that nearly all of Kerings luxury brands are available online, with Gucci having its own website. Federico Barbieri, senior VP of e-business at Kering, has said: I cant understand why the industry has been hesitant or shy about jumping into it. In digital, if you want to keep engaging the consumer and keep positioning your brand and molding your business, you have to do it. There is no barrier, and the future is there, and you have to define what a luxury brand experience is online.

The online channel is a particularly important component when it comes to attracting, and building brand awareness among, the younger generation. As the table below shows, according to a survey conducted by Ipsos mediaCT in September 2013, US affluent consumers (household income of USD100,000+) aged 18-31 years spent an average of 53 hours a week online vs c42 or less hours for older age groups.

Weekly time spent online by US affluents*, by generation, 2011-2013 (hours)

2011 2012 2013

Millenials (18-31) 40.2 42.4 52.7 Gen X (32-48) 35.6 42.4 42.6 Baby boomers (49-67) 29.4 334 35.7 Seniors (68+) 21.8 20.3 26.0 Total 32.8 37.4 41.6 Note:* household income of USD100,000+ Source: Ipsos MediaCT, Ipsos Affluent Survey USA (Sept 19, 2013)

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The Chinese are by far the most advanced consumers in terms of digitalization. And as the table below shows, in a very short period of time, Chinese consumers have built up a large repertoire of brand knowledge.

According to KPMG Chinas chairman: The internet has become an increasingly important channel for brand positioning. Consumers will only continue to spend more online, an important point to which luxury brands need to respond.

A survey from the same firm in relation to online search frequency highlighted that 70% of potential consumers searched for luxury brands on the internet at least once a month in 2012.

The survey also showed a surge in online shopping intentions, with 40% of respondents indicating they are interested in purchasing luxury goods online in 2012, a substantial increase from 22% in 2011.

One of the main challenges relating to online business is that it accelerates the process of consumer knowledge, especially in the BRIC countries. In addition, as social media trends move very fast, it is difficult to find the right people to blog about your brand. Lastly, as online sales are not regulated, some consumers are concerned about counterfeiting.

Overall, online sales still represent only a very small proportion of the total, accounting for c4.5% of global luxury sales in FY2013, according to Altagamma.

Luxury goods: Online search frequency in China Luxury goods: Interest in purchasing online in China

Source: KPMG, TNS Source: KPMG, TNS

Brand recognition levels of middle-class Chinese (aided recall)

Clothes Bag & Shoes

Watches Jewellery

Numbers of brand list (2006)

36 15 25 9

Average number recognised (2006)

9.3 4.7 7.6 2.5

Number of brands in list (2011)

39 40 26 13

Average number recognised (2011)

13.5 15.9 8.8 5.6

Source: KPMG-TNS

China is connected: what a difference six years make

_____ 2007 ______ _____ 2013 ______ Internet

users (m) % of total Internet

users (m) % of total

National 210 15.9% 591 44.1% Beijing 7.4 46.6% 15.3 71.6% Shanghai 8.3 45.8% 16.9 75.6% Guangdong 33.4 35.9% 69.5 66.1% Source: CNNIC 2012

35%

11%

24%

19%

30%

12%

27%

12%

15%

0% 5% 10% 15% 20% 25% 30% 35% 40%

More than a week

Once 2 weeks

Once a month

Once every 3 months

Less than once 6 months

2010 2012

10%

30%

34%

19%

7%

6%

16%

34%

34%

9%

0% 5% 10% 15% 20% 25% 30% 35%

Very much interested

Somewhat interested

Neutral

Somewhat not interested

Not interested

2011 2012

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Emerging markets: stronger GDP growth, wealth creation and urbanisation Why the market is too pessimistic on China for 2014 As we highlighted recently in our Luxury post card - A slightly Greater China report published on 24 February, after meeting with many brand managers, retail operators, shop managers, head-hunters and other luxury-relevant people in Shanghai, Hong Kong and Macau, we found a shared sentiment of "cautious optimism" in the trade which doesn't seem to be shared by many investors.

In mainland China, despite the on-going anti-corruption messages being delivered by the Xi administration, there is a sense that consumer sentiment may have reached a trough. Indeed, following the poor economic environment in 2011-12 and the negative effects of the anti-corruption campaign in 2013, it seems premium consumers may slowly be starting to stage a comeback. According to the 2013 Hurun report, the HNWI (High Net Worth Individuals) of China are becoming more optimistic and more confident in the Chinese economy. For the first time in 5 years, the Hurun business confidence index rose in 2013, by 25% yoy.

Meanwhile, we have never heard so many industry contacts talk so much, and in such excited tones, about Macau. Our conversations with brand managers imply that real estate projects in Cotai are regarded as extremely attractive and current sell-through trends in luxury goods are likely to be very impressive. This seems linked to the continuous increases in minimum bets (drawing in higher- ticket consumers) as well as (more structurally) the under-penetration of luxury in Macau.

Finally, Hong Kong seems to be holding its own. While feedback from watch retailers is quite

diverse, Lunar New Year sales were likely better than expectations, especially for high-end watches. In addition, the level of discounts is not as steep as it was a few months back, and inventories are looking healthier.

While a pick-up in luxury sales growth in Greater China will sound counter-intuitive to many, we believe it is logical, notably on the watch front, as we are lapping the steep declines seen in late 2012/early 2013. The gifting market does not even need to improve for the trend to look better.

Long-term wealth creation In addition to GDP growth rates, long-term wealth creation gives us plenty of reason to be optimistic. The HNWI population grew by 3.8% in Asia in 2013, while in other emerging markets such as the Middle East and Africa, the growth was greater, at 15.3% and 9.5%, respectively.

Emerging Asia continues to outperform the world; South Korea, Hong Kong and LatAm are also firm

_______ GDP ________ 2013 2014 2015

World (nominal GDP weights) 2.1 2.7 2.9 World (PPP weights) 2.8 3.2 3.4

Developed 1.2 1.8 1.9 Emerging 4.6 4.9 5.2

North America 1.9 2.5 2.5

Asia / Pacific 4.3 4.2 4.5 China 7.7 7.4 7.7 Japan 1.7 1.3 1.3 Hong Kong SAR 2.9 3.7 4.0 Indonesia 5.6 5.0 6.0 Singapore 4.0 4.2 4.5 South Korea 2.7 3.2 3.4 Taiwan 1.7 2.8 3.4 Thailand 2.8 4.4 5.2 Vietnam 5.2 5.4 5.8

Western Europe 0.1 1.2 1.4 Eurozone -0.4 0.8 1.0 Germany 0.6 1.7 1.5 France 0.2 0.6 1.0 Italy -1.8 0.4 0.6 Spain -1.3 0.3 0.9 Other Western Europe 1.6 2.3 2.3

EMEA 2.3 2.7 3.1

Latin America 2.0 3.0 2.6 Source: HSBC estimates

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The Wealth-X and UBS report of 2013 predicts that Asia will outpace the US and Europe in the next 5 years in terms of growth in the number of HNWIs. In China, the number of HNWIs is expected to grow by 80% in the next ten years to reach 14.200 people, according to Knight Frank LLP.

According to HSBC economists, the financial wealth of the Chinese might overtake that of the Japanese by 2015 (see the report The Wealth of Asians, how rich really?). By 2020, the financial wealth of South-East Asia and India is expected to be growing faster than that of China.

The swelling middle class According to a McKinsey study, the upper middle class in China (ie the population with an income ranging from 106,000 to 229,000 renminbi) represented 5% of urban households in 2012 but should account for 15% in 2022, equating to a total upper middle class population of 54m. This growth will be the fastest of any social category, followed by that of the affluent category (income >229,000 renminbi). The mass middle class and poor categories, on the contrary, are expected to shrink by 2022, as China gets richer. The growth of the middle class will stem mainly from third-tier cities, notably in the north and west of China.

In other emerging markets, the middle class will also see strong growth. In India, the middle class is expected to account for 20% of the population by 2015 (according to McKinsey) and in Russia it is expected to reach 40% (HSBC estimate).

Our economists believe that, through to 2030, the countries with the strongest growth in their middle classes (as a % of the total population) will be China and Russia, with the middle class representing c70% of the population for both countries. In other countries, such as Brazil, Turkey, the Philippines and Egypt, the middle class will also represent a significant share of the population.

The degree of urbanisation is also increasing in emerging markets. As a consequence of urbanisation and rising incomes, the swelling middle class will quickly become more sophisticated which will lead to changes in their consumption tastes. This phenomenon will benefit luxury brands as they are often used as a way of displaying social status. Consequently, the long term CAGR (2012-2050e) of clothing and footwear should be higher in emerging markets compared to Europe and the US (see table below).

All dressed up with places to go

CAGR between 2012 and 2050 Clothing & Footwear

Philippines 5.8% Malaysia 5.3% India 4.8% China 4.6% Peru 4.5% Turkey 4.5% Egypt, Arab Rep. 4.5% Pakistan 4.1% Colombia 3.8% Mexico 3.6% Indonesia 3.6% Saudi Arabia 3.5% Poland 3.3% Thailand 3.3% Russian Federation 3.3% Argentina 3.1% Brazil 2.7% Europe 1.7% US 1.7% Source: HSBC Report Consumer in 2050, the rise of the EM middle class

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Share of middle class and upper income segments in total population in 2030 (%)

Source: HSBC Report Consumer in 2050, the rise of the EM middle class

0

20

40

60

80

100

Argentina Brazil China Colombia Egypt India Indonesia Malaysia Mexico Pakistan Peru Philippines Poland Russia Saudi ArabiaThailand Turkey

2011 Middle class share 2011 Upper income share2030 Middle class share 2030 Upper income share

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Apart from China, men to move the needle In China, the future is female Hitherto, luxury goods sales in China have been driven by men (c90% of luxury purchases in 1995 were made by men, according to a Bain report). Nowadays, however, women account for c50% of luxury goods spending, a significant shift driven by the greater financial independence of women, who keen to reward themselves with luxury products.

According to the last available list of Forbes Billionnaires, the greatest number of self-made billionaire women is to be found in China. In addition, half of the senior management jobs in China are held by women, above the global average of 24% according to a survey conducted by Grant Thornton in November 2013. Luxury brands are moving to address this shift e.g. by dedicating more floor space to womens wear. We have argued for some time now that in mainland China, the only male-driven market for luxury, the future is female and we think imported jewellery has an important role to play, as described in our report Give us a ring published in October 2013. While there is debate over the existence of a branding process in the jewellery segment (by which brands take share from non-branded jewellers), we still think that there are six relevant global brands in the space, two of which (Cartier and Van Cleef & Arpels) are part of Richemont.

The metro-sexual reality kicks in: Japan and Korea showing the way "Metro-sexual" was a term coined exactly twenty years ago to describe men who are interested in their appearance, and spend much time, effort and money on shopping. In the beginning, though, this did not translate into strong growth in purchases of luxury goods by men as "metro-sexuals" were not mainstream.

This has clearly now changed. Whether it is cosmetics, outdoor sports, fashion or accessories, male purchases have really started to impact overall growth rates. As is often the case with consumer trends, we saw the initial impulse in Japan, with Korea following close behind. In Japan, an offshoot of the metro-sexual man is the "herbivore man, defined in the late noughties by their lack of interest in relationships and their obsession with personal grooming and health. Men-specific luxury stores are one of the ways in which brands have adapted to this new type of Japanese consumer.

In Korea, a bit like in Japan and in the West, men are awakening to the luxury sector (as described in our Luxury Post Card: Seoul search report from 3 March). The trend is visible in cosmetics, watches, manbags and accessories. But why now? In the interviews we conducted, we heard various explanations, including that men already had cars and so were now moving on to other luxury categories; that they were marrying at a later age and could therefore invest on themselves instead of having to support a family; and that soap operas had started to make "metro-sexual" attitudes more acceptable socially.

The results of the trend are reflected in, for example, the COEX location at Hyundai including a lot more space for watches, even though the awareness of most watch brands aside from Rolex still being quite limited. In addition, Jaeger-LeCoultre now has four stores in Seoul, coming from none three years back, and should be opening another location soon. And Montblanc has decided to go solo in the market after having previously had the Korean operations run by a partner.

Meanwhile, from the UK to Japan, preppy-looking brands Jack Wills, Crew Clothing (not the same as J Crew), United Arrows and others are starting to gain traction. As Richard Cope, a researcher from Mintel puts it: "Taking pride and taking greater confidence from maintaining a well groomed appearance now

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defines what it is to be "a man" in today's society. Rather than being in a minority, men who buy grooming products to boost self-esteem or feel more attractive are now in the majority. We're seeing men occupy previously "feminine" space in the home spending more time on housework and parenting but also as consumers, embracing yoga, beauty goods and the act of shopping itself".

Global luxury revenue split by gender

Source: Bain

In response, Burberry is developing "travel tailoring" for active men, Hugo Boss has launched a crease-resistant, breathable travel line, Tod's has launched a "Sartorial Touch" range, Gucci has developed its own mens capsule collection with Lapo Elkann, and Ralph Lauren, Tom Ford, Berluti and others have invested heavily in flagship stores and product diversification for men.

Men: opportunities and some issues According to a 2013 Bain report, men account for 40% of the total luxury market and the demand for menswear products keeps on growing. The menswear segment is growing at a stronger pace than womenswear (2010-13 CAGR of 7% for men RTW vs. 4% for women).

As mentioned above, luxury brands are seizing this opportunity by opening men-only flagship stores throughout the world. And in order to further seduce this clientele, they are investing in a wide range of services within their men-only stores. Most of the brands offer services such as bespoke tailoring, wide

choices of the finest fabrics and personalization of products. Some brands (eg Tods and Ralph Lauren) also provide clients with the opportunity to relax and share a drink in their lounge bar.

At Burberry, menswear is already one of the biggest drivers of growth: menswear and male accessories accounted for more than half of the growth in mainline store revenue in FY2012/13. Retail sales of mens tailoring grew by nearly 70% in the same period.

However, the luxury menswear market also presents a few challenges. We believe that the main challenges are faced by longer-established menswear brands such as Ermenegildo Zegna, Corneliani and Canali as they will face tougher competition coming from newer brands such as Brioni (part of Kering) and Tom Ford. The positive for Hugo Boss is that it is not significantly established in emerging markets yet.

Another challenge, faced by luxury brands, will be to develop a more diversified product offer responding to the needs of clients.

Finally, men are less crisis-resilient as the motto cut for yourself, then for your wife, then for your kids appears to have some truth behind it, and historically watches in a downturn have been a good example of this. Hence having a greater proportion of sales to men could mean greater downside in a downturn.

Men-specific store openings in 2012-2013

Brand City Year

Burberry London 2012 Alexander McQueen London 2012 Bottega Veneta NYC 2012 Prada Milan 2013 Gucci Milan 2013 Balenciaga Manhattan 2013 Louis Vuitton Florence 2013 Tod's (Sartorial floor) Milan 2013 Lanvin NYC 2013 Ralph Lauren Hong Kong 2013 Dolce & Gabbana London 2013 Source: Company data

65% 60%

35% 40%

0%

20%

40%

60%

80%

100%

1995 2013EWomen Men

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Ralph Laurens mens store Hong Kong

Source: Company

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2014: sales growth still solid, but margins under pressure 8% constant currency industry growth in Q4 13 and 2013 Industry constant-currency sales growth was 8% yoy in Q4 2013, after 6% in Q1, 10% in Q2 and 8% in Q3, implying an 8% annual growth rate for 2013.

While the overall growth rate for Q4 2013 was in line with our expectations, the following surprises were worth noting:

Burberry continued to be the fastest growing luxury company in terms of retail lfl sales (up 12% yoy in calendar Q4 vs consensus expectations of 8-9%)

LVMH registered 8% organic growth (vs HSBCe +6%) owing to a sequential acceleration at LV (although this was mostly due to a rebound in volumes post a price increase which impacted Q3 sales in Japan)

Tods (4% sales growth at constant FX) and Coach (-3%) significantly missed expectations

Prada missed expectations as well; however, its retail sales growth rate (+15%, with lfl up 6.5%) remained one of the best in the industry.

For the full year, the relative weakness of wholesale, coupled with initiatives by some brands to close some unsuitable points of sale, weighed on the performance of companies still exposed to this channel (Swatch and Richemont in the hard luxury space; Tods, Hugo Boss, Gucci and Burberry in the soft luxury space).

In theory, H2 2013 should have benefited from a basis of comparison effect given that growth in H2 2012 was only 8% (vs 14% in H1). However, in spite of this technical effect, there was no acceleration in H2 2013 (+8%) compared to H1 2013 (+8%). This implies that underlying trends actually worsened. This was particularly notable for Louis Vuitton and Gucci, whose upward repositioning had a more severe negative impact on volumes than anticipated.

Luxury industry outlook & valuation The sales outlook remains solid for 2014: we forecast 9%

constant currency industry sales growth after 8% in 2013 Margins will be under pressure though as many currencies have

depreciated further against the EUR Key themes: underpenetrated jewellery, watches rebounding, low

barriers to entry in soft luxury

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2014e and 2015e (+9% in both years) to be broadly in line with 2013 (+8%) We forecast the luxury industry to achieve organic sales growth rates of 9% in both 2014 and 2015 (broadly in line with 2013), with:

The above-mentioned wholesale drag waning

China mainland growth picking up to 14% in 2014e (after 11% in 2013), but definitely not returning to the c30-50% growth rates prevailing until 2011.

Other regions slowing a little (tourist flows normalising in Europe, and US trends moderating after several years of robust growth).

If current spot rates prevail, reported sales growth for the industry will actually be higher in 2014e than it was in 2013. For the European companies, FX moves reduced sales growth in 2013 by 5 percentage points; the reduction in 2014e would be only c3 percentage points at current spot rates. In other words, reported sales growth in 2013 was c3% whereas reported growth in 2014e should be c6%.

Trends by geographic region Asia ex-Japan In mainland China, we expect trends to continue to differ depending on categories and/or brands:

The watch category has been the most affected by the slowdown in economic growth and, probably more importantly, the change in administration in China at the end of 2012, which put political pressure on consumers spending habits, and caused a collapse in gifting. However, we believe there are signs of stabilisation: inventory levels are improving, and end demand is moving sideways rather than down in China (and is still robust in Hong Kong and Macau). We also see average selling prices rising slightly.

The jewellery category has continued to be strong, as the category is far less driven by gifting; we expect robust growth in jewellery, boosted by the emergence of financially independent women.

Louis Vuitton and Gucci should, in our view, see better growth, but still under-perform as

Luxury goods: contribution of each geographic region to organic sales growth

2007a 2008a 2009a 2010a 2011a H1 2012a H2 2012a 2012a H1 2013a H2 2013a 2013a 2014e 2015e

Geographic breakdown Europe 42% 42% 39% 36% 34% 32% 32% 32% 33% 33% 31% 30% 29%Japan 12% 12% 11% 9% 8% 8% 8% 8% 7% 7% 8% 8% 8%US 20% 19% 18% 18% 18% 18% 18% 18% 19% 19% 19% 19% 19%China 3% 5% 6% 8% 10% 10% 10% 10% 10% 10% 10% 11% 12%Rest of Asia & other 22% 23% 25% 28% 29% 31% 31% 31% 31% 31% 32% 32% 33%Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%Organic sales growth rate Europe 13% 5% -7% 9% 12% 9% 5% 7% 3% 4% 4% 6% 5%Japan 6% -9% -15% -4% 4% 5% 1% 3% 11% 9% 10% 6% 3%US 16% 2% -14% 14% 24% 17% 11% 14% 13% 11% 12% 10% 9%China 40% 45% 30% 45% 47% 28% 10% 19% 11% 11% 11% 14% 17%Rest of Asia & other 22% 13% 8% 23% 27% 17% 11% 14% 10% 10% 10% 11% 12%Total 15% 6% -4% 15% 20% 14% 8% 11% 8% 8% 8% 9% 9%Contribution to growth Europe 5% 2% -3% 3% 4% 3% 1% 2% 1% 1% 1% 2% 1%Japan 1% -1% -2% -1% 0% 0% 0% 0% 1% 1% 1% 0% 0%US 3% 0% -3% 2% 4% 3% 2% 3% 2% 2% 2% 2% 2%China 1% 2% 1% 3% 4% 3% 1% 2% 1% 1% 1% 2% 2%Rest of Asia & other 5% 3% 2% 6% 8% 5% 3% 4% 3% 3% 3% 4% 4%Total 15% 6% -4% 15% 20% 14% 8% 11% 8% 8% 8% 9% 9%Source: Company data, HSBC estimates

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their brand repositioning is a long-term process.

Smaller or more niche brands should continue to enjoy strong growth rates (even though rates are normalising as these brands become bigger in China) as long as they are perceived as having a distinctive positioning.

In Asia ex-Japan, there is a growing Chinese influence on the luxury markets of Hong Kong, Korea, Taiwan and Singapore, which benefit from ever-increasing Chinese tourist numbers. For more on this, please refer to our The Bling Dynasty thematic report dated 28 March 2013.

Europe In Europe, despite the economic uncertainties, business was stronger than expected in 2013. For 2014:

Tourism flows (mostly, but not only, Chinese visitors) should again be supportive, even though the emergence of the US as a new destination for Chinese travellers could mean moderating trends

We expect a modest resumption of European consumer spending after two and a half years of holding back (as we have already seen for companies in other consumer sub-sectors Samsonite and Nike, for instance). Domestic demand, although sluggish, did not collapse in 2013 as affluent customers proved more resilient than most people thought. We forecast 6% growth in 2014, and 5% in 2015, after 4% in 2013.

US The US was where luxury demand was hit the most by the psychological shock of the Lehman collapse in September 2008. However, since then, luxury consumption in the US has outperformed overall luxury consumption growth. Demographic trends remain supportive (notably the increasing weight of non-Caucasians in the total US population as US

citizens of Hispanic and Asian origins have a higher propensity to buy luxury goods).

We forecast y-o-y sales growth of 10% in 2014, and 9% in 2015, after 12% in 2013, but it is worth noting that the US consistently exceeded our forecasts in the 2010-13e period.

As we highlighted a while ago in our West Side Stories thematic report, the US remains, to a certain extent, an under-developed market for luxury for social and cultural reasons. But domestic demand is growing fast in this sector and the recent easing of travel constraints including, notably, steps taken by the Obama administration to facilitate Chinese outbound travel to the US means that tourism-related sales are giving the market an extra boost.

Japan After years of decline or sluggish growth, Japan was the positive surprise in 2013. In addition to Abenomics boosting consumer confidence, the weaker yen limited the appetite of Japanese customers for buying abroad. We believe our growth estimates (6% in 2014, and 3% in 2015, after 10% in 2013) are prudent for Japan, which is one of the few luxury markets we would call truly mature. Note that in 2013e and 2014e, most of the growth will be driven by the significant price increases implemented to offset the yen weakness (eg 23% in the case of Louis Vuitton over the course of 2013).

Margins under pressure in 2014 We believe the combination of further depreciation of currencies vs the EUR and increases in the cost of growth for many players (notably in soft luxury, as we have highlighted as a key industry theme), will lead to margin pressures in 2014.

As a consequence, few companies will see significant EBIT margin expansion according to our estimates.

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The notable exceptions should be:

Luxottica: we believe Luxottica's "rule of thumb" which is to grow sales (at constant FX) at a high single digit pace, and EBIT twice as fast is realistic due to continued leverage of fixed costs in Wholesale and increased store productivity in Retail.

Richemont: the EBIT margin should be boosted by lower raw material prices. Meanwhile, the fading of FX hedging won't affect EBIT since hedging gains are booked in the financial result line

Tiffany: the EBIT margin should benefit from lower raw material prices and renewed SG&A leverage as US sales pick up

Burberry: the overall reported EBIT margin will decrease y-o-y to the decline in Licensing revenues but the Wholesale and Retail margin should continue to increase due to higher sales productivity and leverage on past investments

Prada: the company is guiding towards a flat margin y-o-y but our analysis shows that most margin drivers will be positively oriented, thus offsetting the effect of the planned rise in retail investment

Currency remains key for this sector with European- listed companies benefiting when the EUR (and the CHF) are weak against the USD-denominated currencies and the JPY.

In 2013, FX became a headwind: the JPY was extremely weak (c20% depreciation against the EUR) and, more recently, the USD and several other currencies have also trended lower. However, most of the companies in the luxury goods space had hedged much of their bigger currency exposures (notably JPY and USD against the EUR). Hence, while reported top-line growth took a hit from currency in 2013e, margins will have been protected by the hedging policies in place. Much of the

hedging will roll off in 2014, however, and the margin effects will be sizeable.

EUR to USD since 1 January 2005

Source: Thomson Reuters Datastream

EUR to JPY since 1 January 2005


EUR to CHF since 1 January 2005


1.11.151.2

1.251.3

1.351.4

1.451.5

1.551.6

Jan-05Jan-06Jan-07Jan-08Jan-09Jan-10Jan-11Jan-12Jan-13Jan-14

90100110120130140150160170180

Jan-05

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1

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1.3

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EBIT margin evolution by group 2011-2015e

% 2011a 2012a 2013a 2014e 2015e

Herms 31.2 32.1 32.3 31.6 32.0 Luxottica 13.0 13.9 14.4 15.3 16.1 Tiffany*** 20.6 18.4 20.2 21.4 22.4 Burberry* 20.3 21.4 20.3 20.7 20.2 Tod's 21.8 21.7 20.0 20.0 21.0 LVMH 22.2 21.1 20.6 20.5 20.8 Kering Luxury 25.7 25.9 26.0 25.7 26.4 Gucci brand 30.2 31.0 31.8 31.3 32.0 Hugo Boss 19.2 18.5 18.8 19.0 20.0 Ferragamo 15.9 16.9 17.4 18.0 18.9 Swatch Group 23.9 25.4 27.4 24.9 25.6 Richemont* 23.0 23.9 23.0 24.6 25.7 Coach** 31.7 30.0 26.0 26.0 26.5 Hengdeli 10.2 10.3 7.5 6.9 7.2 Prada*** 24.6 27.0 26.8 27.6 28.5 Moncler 28.7 29.8 29.7 29.8 29.9 Average 23.5 23.8 23.6 23.8 24.4 *year ending March n+1 **year ending June n+1 *** year ending January n+1 Note that the average does not include Hengdeli. Source : Companies, HSBC estimates Key industry themes Underpenetrated jewellery We have argued for some time now that in mainland China, the only male-driven market for luxury, the future is female and we think imported jewellery has an important role to play.

While there is a debate on the existence of a branding process in the jewellery segment, by which brands take share from non-branded jewellers, we think that there are six relevant global brands in the space, two of which (Cartier and Van Cleef & Arpels) are part of Richemont. The other four are Tiffany (listed, independent), Chopard (non-listed, independent), Bulgari (part of LVMH) and Harry Winston (acquired by the Swatch Group in early 2013). Richemonts Piaget could well develop into a global jewellery brand too.

While we believe the Harry Winston acquisition is a good one at a fair price, and the brand has potential, we expect it to represent only 5% of Swatch Group sales in 2015 and to remain margin dilutive for a while.

Watches rebounding After the slowdown in economic growth and, probably more importantly, the change in administration in China in late 2012, which put

political pressure on consumers spending habits, and led to a collapse in gifting, we believe there are now signs of stabilisation in the Chinese watch market.

Indeed, inventory levels are improving, and end demand is now going sideways rather than down in China, and is still booming in Hong Kong and Macau. As we believe ASPs are also rising slightly, we see potential for a rebound in the short term.

Low barriers to entry in soft luxury Our updated view on soft luxury goods is that unlike for watches and jewellery barriers to entry are much lower than most investors believe. This is a positive for up-and-coming brands but a negative for the sub-sector as a whole as it implies that the cost of growth (the amount of investment (retail, advertising etc) that has to be incurred to ensure similar growth as in the past) is higher.

Louis Vuitton is operating with a stable number of stores globally (around 470 units) but with bigger stores replacing smaller ones. This means that much space is allocated to lower-margin products linked to the lifestyle diversification of the brand (apparel, footwear, hard luxury, eyewear etc). This is the global equivalent of what Coach is doing in the US (although, of course, the two brands are not positioned similarly in terms of price points).

Some brands looking to emerge will have to invest strongly in advertising and retail (eg Miu Miu within Prada). Others, while well-known already, may have under-invested in recent years and will need to make up for this if they want to maintain, or win, share (typically Hugo Boss in the Asian region). However, we still dont believe in the idea that there is a fundamental cap to how high margins can go in the soft luxury space. Louis Vuitton has an EBIT margin in the low 40s, so if thats a theoretical cap, all other brands are very far from it. Having said that, in 2014, reinvestments (notably in stores and communication) on top of unfavourable FX movements will weigh on margin expansion possibilities for the space.

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Sales growth at constant forex and perimeter

% FY 98a

FY 99a

FY 00a

FY 01a

FY 02a

FY 03a

FY 04a

FY 05a

FY 06a

FY 07a

FY 08a

FY 09a

FY 10a

FY 11a

FY12a

Q1 13a

Q2 13a

Q3 13a

Q4 13a

FY 13a

FY 14e

FY 15e

Herms 6 15 14 8 6 8 12 7 8 11 9 4 19 18 16 13 16 13 11 13 11 10LVMH -9 10 8 4 4 4 11 11 12 13 7 -3 14 14 9 7 9 8 8 8 7 8o/w Louis Vuitton 2 25 20 12 7 14 13 12 11 14 12 7 15 15 6 2 4 1 5 3 5 6Richemont** 8 14 13 0 0 0 13 17 16 16 2 -5 19 30 9 7 9 10 9 9 10 9Swatch Group 9 7 12 1 1 1 6 8 12 17 4 -8 22 22 12 5 5 6 6 6 8 8Burberry** na na 40 14 12 15 10 3 15 19 7 1 15 21 8 9 9 10 12 10 11 11Kering Luxury na na na na na 5 13 0 0 0 0 0 12 0 15 6 9 6 7 7 8 9Gucci brand 7 14 24 1 -8 4 13 18 17 11 4 0 11 19 9 4 4 1 0 2 5 8Hengdeli na na na na na na na na na na 20 7 39 38 7 9 9 14 14 12 6 4Prada na na na na na na na na na na na -6 24 25 23 16 14 13 11 13 13 10Tod's na na 15 27 13 8 15 20 0 0 0 0 0 0 5 -6 10 0 4 2 5 10Luxottica na na na na 3 -2 11 11 14 10 -1 -4 7 9 6 5 9 7 7 7 8 8Tiffany na na 13 0 4 14 8 9 11 13 -4 -5 12 15 5 13 8 11 7 9 10 9Coach*** 12 21 32 37 29 26 29 20 -1 9 14 14 10 10 9 2 -3 -1 5 8Hugo Boss na na na na na na 13 12 14 12 6 -8 5 19 10 -2 11 5 11 6 9 10Ferragamo na na na na na na na na na na na -10 17 24 13 10 13 10 9 11 8 9Moncler 22 31 25 19 16*half-year **year ending March n+1 ***year ending June n+1 Source : Companies, HSBC estimates

Sales by nationality 2013

LVMH LV brand Gucci brand Burberry* Herms Prada Richemont Swatch Ferragamo Tod's Moncler

Western Europe 17% 12% 14% 12% 15% 11% 11% 9% 11% 38% 33%Eastern Europe 5% 5% 5% 4% 6% 3% 3% 4% 4% 5% 9%Middle East 6% 8% 3% 5% 7% 5% 8% 7% 4% 5% 3%North America 18% 16% 17% 21% 13% 10% 10% 5% 18% 11% 12%Latam 4% 5% 3% 3% 5% 2% 4% 3% 7% 2% 1%Rest of Asia 11% 8% 11% 15% 12% 19% 14% 12% 14% 7% 3%China Mainland 22% 28% 30% 30% 22% 35% 34% 50% 22% 21% 21%HK+Taiwan+Macau 6% 5% 4% 6% 7% 3% 6% 7% 10% 6% 2%Japan 10% 15% 16% 5% 13% 10% 10% 3% 11% 5% 18%Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%* For Burberry, figures are based on sales at retail equivalent Source: HSBC estimates

Luxury goods companies 2013 geographical sales breakdown

% of sales Europe Americas Japan Asia & others Mainland China HK + Taiwan + Macau Rest of Asia & others

Herms 36% 17% 12% 35% 9% 10% 16%Richemont* 31% 15% 8% 45% 9% 20% 16%LVMH 30% 22% 7% 42% 10% 10% 21%of which Louis Vuitton 29% 22% 14% 36% 11% 9% 20%Kering*** 33% 19% 10% 38% 11% 9% 23%of which Gucci Brand 28% 20% 10% 42% 13% 10% 21%Burberry* 31% 25% 2% 42% 14% 9% 19%Tod's 55% 9% 4% 32% 12% 12% 8%The Swatch Group 34% 8% 2% 56% 18% 20% 18%Luxottica 20% 69% 1% 10% 2% 1% 7%Ferragamo 26% 28% 9% 37% 11% 11% 14%Hugo Boss 60% 23% 2% 15% 7% 2% 6%Moncler**** 57% 12% 16% 15% 9% 4% 2%European average 38% 22% 7% 33% 10% 10% 14%Coach** 3% 69% 13% 15% 4% 7% 4%Tiffany*** 11% 48% 14% 26% 3% 12% 11%Emperor Watch and Jewellery 0% 0% 0% 100% 8% 90% 2%Hengdeli 0% 0% 0% 100% 65% 35% 0%Prada*** 37% 15% 9% 39% 10% 15% 14%Total average 29% 24% 7% 40% 13% 17% 11%This average includes PPR and LVMH (rather than the Gucci Group and Louis Vuitton) *FY March 2013 **FY June2013 ***FY Jan2013 ****HK + Taiwan only Source: company data, HSBC calculation

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Sector valuation While the luxury goods sector overall out-performed markets and re-rated in 2013, most luxury stocks under-performed in Q4 2013 and Q1 2014 (see table below). Unfavourable FX movements, volatile underlying trends and unabated China fears, led to earnings downgrades over the recent period.

We continue to believe that comparing the sector average multiple relative to its history remains quasi-irrelevant for the time being, notably because of the number of IPOs since 2011. From a share price standpoint, the most noticeable trend is the sharp correction of Italian mid-caps Tods, Ferragamo and Moncler, down 19-23% y-t-d. However, these three stocks are still trading at a premium, notably relative to the larger cap stocks.

Sector valuation history (forward PE) *

Note: * Non-weighted average of LVMH, Richemont, Swatch, Tiffany (other companies do not have the necessary history, own non-luxury assets, or their valuations have been distorted by speculation) Source: Factset, HSBC

Share prices performances - Luxury goods

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 Q1 13 Q2 13 Q3 13 Q4 13 FY13 Q1 14TD

LVMH -35 -14 47 -2 33 7 3 -42 64 57 -11 27 -4 -7 17 -9 -4 -3Herms 15 -24 17 -4 44 35 -9 16 -7 68 47 -2 20 -8 7 -1 16 -11Richemont -29 -16 15 27 52 24 10 -74 71 58 -14 51 4 12 8 -2 24 -6The Swatch Group -26 -23 29 12 17 37 27 -57 80 59 -17 33 20 -6 13 2 29 -6Christian Dior -32 -7 50 4 50 8 11 -55 78 49 -14 40 1 -4 17 -5 7 -2Burberry nm -2 63 10 5 54 -12 -61 170 88 6 3 8 2 21 -7 24 -5Tod's 6 -34 13 1 63 7 -22 -37 72 42 -15 52 17 -3 28 -12 27 -23Kering -37 -52 9 -4 29 19 -3 -58 81 41 -7 27 22 -9 6 -7 9 -9Luxottica 20 -32 9 9 43 9 -7 -42 42 26 -5 43 26 -1 1 -1 25 1Hugo Boss 90 -58 59 54 21 31 0 -58 70 130 1 45 10 -3 13 8 30 -11Ferragamo** nm nm nm nm nm nm nm nm nm nm 13 63 30 11 7 8 66 -23Moncler*** nm nm nm nm nm nm nm nm nm nm nm nm nm nm nm 55 55 -19Average -6 -28 34 12 33 22 -1 -47 68 60 -1 35 14 -2 13 -2 23 -10Eurotop 300 -18 -32 12 9 22 16 2 -45 26 7 -11 13 5 -2 7 6 16 -1 Prada* nm nm nm nm nm nm nm nm nm nm -12 112 6 -11 4 -6 -7 -18Hengdeli nm nm nm nm nm 220 37 -73 268 57 -46 14 -31 -10 5 -2 -36 -17Emperor Watch & Jewellery

nm nm nm nm nm nm nm nm 82 141 -13 -2 -17 -19 8 -14 -38 0

Hang Seng Index -24 -18 35 13 5 34 39 -48 52 5 -20 23 -2 -7 10 2 3 -7 Tiffany -1 -24 89 -29 20 2 17 -42 61 45 8 -14 21 5 5 21 62 0Coach 36 69 129 49 18 29 -29 -32 76 52 11 -9 -10 14 -4 3 1 -11S&P 500 -13 -23 26 9 3 14 4 -38 23 13 0 13 10 2 5 10 30 1Share prices at 18th March 2014 * Prada's IPO on 23 June 2011, **Ferragamo's IPO on the 18 June 2011, ***Moncler's IPO on the 11 December 2013 Source: Thomson Reuters Datastream

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Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

Asian financial crisis

2000 bubble

09/11 attacks

SARSepidemic China starts

to matter 2007 market peak

Post-Lehman collapse

Average since 01/01/2003: 17.0x

PE as of 18/03/14: 17.6x

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Three preferred stocks: Burberry, Richemont, Luxottica We think concerns on Burberry following the announcement of the change in CEO have been overdone and the brand remains comfortably ahead of the pack in terms of digital marketing and its capacity to recruit consumers. In addition, the execution risks for the integration of "Beauty" and Japan will likely prove to be overstated. Meanwhile, a pick-up in Cartier watch sales, strong exposure to the fast growing jewellery category and a compelling valuation make Richemont a good investment opportunity, with fears on China providing a good entry point. Luxottica doesnt look cheap but there are good reasons for that: vertical integration, captain-of-industry status and possible M&A opportunities are reasons to be enthused.

Soft luxury Overweights: Prada, Kering, Tods, Coach, Hugo Boss Prada's de-rating makes the stock very attractive, in our opinion, as we do not believe in the concept of peak margins for luxury companies nor in the idea of a collapse in sales growth for Prada. For Tod's, the short-term remains challenging but the transformation story towards more retail, more Asia, and more leather goods remains valid, in

our view. Coach will be unlikely to see a strong sales pick-up in the short term, but its valuation is compelling and calendar H2 2014 could confirm a brand revival.

We upgrade Hugo Boss as we now believe it is time to become more constructive again as consensus expectations have been revised down and the share price is 6% lower

Hard luxury Overweights: Tiffany, Emperor Watch & Jewellery Tiffany should do well as bolder management initiatives kick in and soft raw material prices support further margin improvement. We initiate on Emperor with an OW rating. The stock should be a great way to play Chinese travellers propensity to purchase watches abroad. In addition, the fact that Emperor is seeing initial success in its jewellery ranges bodes well for margins.

Why we are Neutral on LVMH, Christian Dior, Herms, and Ferragamo LVMH may have underperformed the sector, but we do not see the current valuation as compelling. The stock is trading in line with its historical average, but earnings growth is much lower than it used to be. This is also why, by extension, we

Ranking the luxury stocks Best of hard Richemont, best of soft Burberry and best of

other Luxottica are our favourite stocks We have several other OW ratings on a 12-month view, but which

lack short-term catalysts Our Neutral ratings are mostly due to unsupportive valuations

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see no compelling buy case on the holding company, Christian Dior. Elsewhere, Herms remains exceptionally resilient but that is already well-reflected in its valuation for now. Ferragamo and Moncler continue to trade at valuation levels which are difficult to justify, in our opinion.

Why we are Neutral on the Swatch Group and Hengdeli Unlike Richemont or Emperor, who have relied more on high-end brands that took a big hit during 2013 in China, Swatch and Hengdeli did not suffer as much due to their more accessible price points. In turn, this implies that the pick-up in sales momentum at the latter two will likely not be as remarkable. Furthermore, as explained earlier, we are uncomfortable with the recent M&A deals and communication at Hengdeli and feel that relying on the domestic China market (rather than trying to capture spending by travelling Chinese) could put a cap on growth. Similarly, for the Swatch Group, we believe many of its brands have become quite China-driven as they do not have sufficient clout and awareness globally, which could also limit growth.

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Company profiles

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Theme implication: positive Burberry enjoys one of the best brand momentum stories in the luxury industry, which is translating into superior retail same store sales growth (SSSG). We believe the main reasons behind this outperformance are:

The brand distinctive positioning (unique sizeable luxury brand with a British heritage, strong outerwear offering) makes Burberry a different proposition from the crowd of French and Italian brands primarily focusing on handbags.

The fact that Burberry is the only digitally relevant brand, ie savvy on digital luxury and using this as a competitive advantage, in our luxury coverage; this means it can continue to recruit a younger, savvier clientele base at a faster rate than others.

The fact that most legacy issues have been addressed, especially the clean-out of licences (the last one, in Japan, soon going to be tackled) and of products (notably the Nova check canvas line made in China).

The companys operational excellence (much better grip on its supply chain, with inventories in check and SAP roll-out done).

A lot of negativity on the stock In our recent discussions with investors, Burberry is the Overweight stock on which we faced the most pushback, notably about the sustainability of above-average SSSG, the future of the Japan business post 2015, profitability improvement, the Beauty business and last but not least the change in CEO. On all these subjects, we believe that investors fears are overdone, and that their comfort levels regarding these issues will increase progressively:

SSSG: double-digit SSSG in Q1, Q2 and Q3 are not sustainable in our view; we forecast 7% in Q4 March 14 and 6% in FY March 15

Japan: the income loss linked to the strategically-sound decision to discontinue local lines is now fully factored into consensus estimates

Profitability: many investors have the impression there is no leverage at Burberry, but the reality is that Burberry's Wholesale & Retail EBIT margin rose 80bp in FY March 12 and 70bp in FY March 13, adjusted for the one-off reduction in performance-related pay charge)

Beauty: the integration in-house of the Beauty business should enable Burberry to establish a few brand pillars and leverage the overall digital marketing budget

Burberry (BRBY LN) One of the strongest brand momentum stories in luxury We believe investors comfort on several issues should increase

progressively, thus reducing the negativity on the stock Remain Overweight, lower target price to 1,820p (from 1,850p) on

FX estimate cuts; Burberry is an HSBC Europe Super Ten stock

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Christopher Bailey: he replaced Angela Ahrendts as CEO on top of his existing Chief Creative Officer role but this is not a concern for us; he has a strong business acumen and has worked alongside the previous CEO for eight years, which can only help.

Earnings, valuation and risks On 15 January, Burberry issued a trading statement which only included the Retail performance during the Q3 period (Oct-Dec 2013). Retail growth at constant FX was 14% (12% SSSG).

We cut our FY March 15e-16e EBIT estimates by 2% on the back of less favourable FX.

For FY March 14e, we forecast 16% reported sales growth (10% organic sales growth, 6% technical impact from integrating the Beauty licence, 0% FX impact). We expect the Wholesale & Retail EBIT margin to increase to 18% (ie a 90bp improvement vs the 17.1% adjusted for the one-off reduction in performance-related pay charge).

For FY March 15e, we forecast 8% reported sales growth (11% organic sales growth, -3% FX impact). We expect the Wholesale & Retail EBIT margin to increase 80bp to 18.8%.

We lower our target price to 1,820p (from 1,850p) on the back of the above-mentioned estimates cut. Our DCF assumptions are outlined on page 29. Under our research model, the Neutral band for non-volatile UK stocks is 5ppt above and below the hurdle rate of 8.0%. Our target price implies a 26.2% potential return, which is above the Neutral range; therefore we retain our Overweight rating. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

The main downside risks to our rating include a failure to execute properly on the expiry of the Japanese licence in 2015 and FX (GBP becoming stronger). In addition, as the brand has attracted outside talent in recent years, there is a risk that this talent may prove difficult to retain.

An HSBC Super Ten stock We believe Burberry offers a long-term growth story, combining both above-industry top line growth and EBIT margin gains. On top of the above-mentioned brand strengths, we believe many markets are still under-penetrated for the brand, which drives a significant contribution to sales from new selling surfaces without cannibalising SSSG. In terms of valuation, the 2010-2012 bubble has burst, and Burberry is now trading at 16.7x14e and 14.6x15e calendar PE, which we find compelling given the projected 13% EPS growth CAGR we see over the next three years.

Sales breakdown by channel (%) FY ending March 2013

Source: Company data

Retail/wholesale sales breakdown by product category (%) FY ending March 2013

Source: Company data

Retail71%

Wholesale24%

Licenses5%

Womens33%

Mens24%

Large Leather Goods19%

Soft5%

Small Leather Goods10%

Shoes5%

Childrenswear4%

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Burberry P&L - Full Year ending March

GBPm 2009a % 2010a % 2011a % 2012a % 2013a % 2014e % 2015e % 2016e %

Sales 1,202 21 1,280 7 1,501 17 1,857 24 1,999 8 2,315 16 2,505 8 2,870 15Gross profit 666 8 804 21 1010 26 1299 29 1442 11 1681 17 1832 9 2095 14Gross profit margin 55.4% 62.8% 67.3% 69.9% 72.1% 72.6% 73.1% 73.0%Operating expenses 485 17 584 20 709 21 922 30 1,014 10 1,210 19 1,313 8 1,514 15As a % of sales 40.4% 45.6% 47.2% 49.6% 50.7% 52.3% 52.4% 0.0%Adjusted EBIT 181 -12 220 22 301 37 377 25 428 14 471 10 519 10 581 12EBIT margin 15.0% 17.2% 20.1% 20.3% 21.4% 20.3% 20.7% 20.2%Reported EBIT -10 -105 171 -1,828 302 77 367 21 351 -4 456 30 504 11 566 12EBIT margin -0.8% 13.4% 20.1% 19.7% 17.6% 19.7% 20.1% 19.7%Pre-tax profit -16 -108 166 -1,131 296 78 366 24 351 -4 460 31 511 11 576 13Reported net profit -6 -104 81 -1,456 208 156 263 26 254 -3 345 36 386 12 438 13Clean net profit 132 -6 155 17 217 40 274 26 312 14 356 14 397 11 449 13EPS (clean diluted) 30.2 -5 35.1 16 48.8 39 61.6 26 70.0 14 79.8 14 88.9 11 100.6 13Source: Company data, HSBC estimates

Burberry Sales by geography - Full Year ending March

GBPm 2009a YOY% chg

2010a YOY% chg

2011a YOY% chg

2012a YOY% chg

2013a YOY% chg

2014e YOY% chg

2015e YOY% chg

2016e YOY% chg

Europe 524 16 515 -2 475 7 553 16 560 1 679 21 723 7 774 7North America 305 30 321 5 387 35 435 12 463 7 538 16 574 7 628 9Asia Pacific 240 27 283 18 457 131 653 43 745 14 873 17 978 12 1,267 30Rest of the world 50 50 64 28 85 71 109 29 120 10 144 19 157 9 176 12Licensing 83 -3 97 18 98 11 109 10 109 1 81 -26 73 -10 25 -65Total sales 1,202 21 1,280 7 1,501 17 1,857 24 1,999 8 2,315 16 2,505 8 2,870 15Source: Company data, HSBC estimates

Burberry Sales and EBIT by distribution channel - Full Year ending March

GBPm 2009a YOY% chg

2010a YOY% chg

2011a YOY% chg

2012a YOY% chg

2013a YOY% chg

2014e YOY% chg

2015e YOY% chg

2016e YOY% ch

Retail sales 630 30 749 19 962 29 1,270 32 1,417 12 1,620 14 1,749 8 1,992 14Wholesale sales 489 15 434 -11 441 2 478 9 473 -1 614 30 683 11 851 25License Sales 83 -3 97 18 98 1 109 10 109 1 81 -26 73 -10 27 -62Total sales 1,202 21 1,280 7 1,501 17 1,857 24 1,999 8 2,315 16 2,505 8 2,870 15 Retail & Wholesale EBIT 110 -19 138 25 220 59 287 31 336 17 403 20 458 14 558 22Retail & Wholesale EBIT margin 9.8% 11.6% 15.6% 16.4% 17.8% 18.0% 18.8% 19.6%License EBIT 71 0 82 16 82 -1 90 10 93 3 68 -26 61 -10 23 -62License EBIT margin 85.6% 84.3% 82.9% 82.9% 84.6% 84.0% 84.0% 84.0%Total EBIT 181 -12 220 22 301 37 377 25 428 14 471 10 519 10 581 12EBIT margin 15.0% 17.2% 20.1% 20.3% 21.4% 20.3% 20.7% 20.2%Source: Company data, HSBC estimates

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Financials & valuation: Burberry Group Overweight Financial statements

Year to 03/2013a 03/2014e 03/2015e 03/2016e

Profit & loss summary (GBPm)

Revenue 1,999 2,315 2,505 2,870EBITDA 462 596 658 743Depreciation & amortisation -111 -140 -154 -177Operating profit/EBIT 428 471 519 581Net interest 0 4 7 10PBT 351 460 511 576HSBC PBT 351 460 511 576Taxation -92 -115 -125 -138Net profit 254 345 386 438HSBC net profit 312 356 397 449

Cash flow summary (GBPm)

Cash flow from operations 346 458 520 593Capex -320 -200 -200 -200Cash flow from investment -320 -200 -200 -200Dividends -114 -126 -139 -155Change in net debt 42 -131 -181 -238FCF equity 8 258 320 393

Balance sheet summary (GBPm)

Intangible fixed assets 210 210 210 210Tangible fixed assets 409 469 515 538Current assets 937 1,150 1,390 1,693Cash & others 426 558 738 976Total assets 1,746 2,019 2,305 2,631Operating liabilities 542 596 635 679Gross debt 130 130 130 130Net debt -297 -428 -609 -846Shareholders funds 1,017 1,235 1,482 1,765Invested capital 588 676 741 786

Ratio, growth and per share analysis

Year to 03/2013a 03/2014e 03/2015e 03/2016e

Y-o-y % change

Revenue 7.6 15.8 8.2 14.6EBITDA 1.7 28.9 10.4 12.9Operating profit 13.6 10.0 10.2 12.0PBT -4.2 31.2 11.1 12.7HSBC EPS 13.5 14.0 11.5 13.1

Ratios (%)

Revenue/IC (x) 3.9 3.7 3.5 3.8ROIC 51.2 54.1 53.7 56.3ROE 33.2 31.6 29.2 27.7ROA 15.4 18.3 17.8 17.7EBITDA margin 23.1 25.7 26.3 25.9Operating profit margin 21.4 20.3 20.7 20.2EBITDA/net interest (x) 1540.7 Net debt/equity -28.2 -33.7 -40.1 -47.0Net debt/EBITDA (x) -0.6 -0.7 -0.9 -1.1CF from operations/net debt

Per share data (GBPp)

EPS Rep (fully diluted) 56.95 77.26 86.39 98.03HSBC EPS (fully diluted) 69.97 79.78 88.92 100.59DPS 29.00 31.91 35.57 40.23Book value 233.58 283.77 340.38 405.28

DCF analysis

HSBC assumptions DCF, comprising

Risk-free rate (%) 3.50 EBIT growth FY2014-24e CAGR (%) 8.1Equity premium (%) 4.50 EBIT growth FY2024-44e CAGR (%) 3.7Sector beta 1.10 Fade period FY2044-52e Specific beta 1.10 WACC (%) 8.95

Sensitivity and valuation range

Cost of capital vs fade period 4 years 8 years 12 years

8.0% 20.25 20.75 21.148.5% 18.98 19.41 19.769.0% 17.84 18.20 18.529.5% 16.81 17.12 17.4010.0% 15.88 16.14 16.39

Issuer information

Share price (GBPp) 1,442 Target price (GBPp) 1,820

Reuters (Equity) BRBY.L Bloomberg (Equity) BRBY LNMarket cap (USDm) 10,602 Market cap (GBPm) 6,397Free float (%) 100 Enterprise value (GBPm) 5809Country United Kingdom Sector TEXTILES, APPAREL &

LUXURY GOODSAnalyst Erwan Rambourg Contact 852 2996 6572

Antoine Belge Contact 33 1 5652 4347

Price relative

Source: HSBC Note: price at close of 18 Mar 2014

84794710471147124713471447154716471747

847947

10471147124713471447154716471747

2012 2013 2014 2015Burberry Group Rel to FTSE ALL-SHARE

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Another strong performance for Dior Couture in H1 13-14 Dior Couture has adopted a more premium strategy in the last five years, which has brought benefits as the group has delivered consistent and solid performances quarter after quarter. Logo products are now very limited in the group sales mix. Although Dior Couture has reduced logo-products for non-logo products, the group has successfully managed to keep product clearly recognisable by customers.

The group has now moved to a FY July-June format to match its reporting with LVMHs half-year reporting period.

On 28 February 2014, Christian Dior reported H1 2013-2014 (June-December).Dior Couture sales were up 14% reported and 20% at constant FX, and accelerated to 21% in Q2 (October-December) from the 19% posted in Q1 (July-Sept). Management mentioned a good performance of leather goods, mens/womens read-to-wear and accessories. EBIT was EUR108m, up 31% y-o-y. The EBIT margin was 14%, up 190bps. For FY ending June 2014, we expect 18% organic sales growth, implying 16% in H2 owing to a tougher basis of comparison. We expect an EBIT margin of 12%. For FY ending June 2015-16e, we forecast 13% and 12% organic sales growth respectively, and EBIT margins of 13.5% and 14.5%.

Earnings, valuation and risks 16% discount to RNAV Christian Dior is the main holding company for LVMH, controlling 40.9% of the shares and 57.5% of the voting rights. As well as its stake in LVMH (89% of assets), Diors only operational entity is the Dior Couture brand (10%).

In 2013, Dior shares gained 7% vs -4% for LVMH shares, and Dior shares are down 2% vs. -3% for LVMH shares y-t-d 2014. Diors discount to restated net asset value (RNAV) is 16%, below its 20% historical average.

There is nothing surprising here as conglomerate/ holding discounts to RNAV tend to fall during bull market phases and vice versa.

As evidenced by the chart on page 31, the discount to RNAV has moved within a 6%-34% range (average 20%) since 2005.

Note that higher levels of discounts were witnessed in 1995-2005, but we do not consider them relevant to our analysis since the LVMH control structure at the time was much more complicated, and the French tax regime back then was less favourable (taxation on capital gains).

Christian Dior (CDI FP) Diors discount to our estimated restated net asset value (RNAV)

is 16% (vs 20% on historical average) Unchanged target price of EUR140 on the back of an unchanged

value for LVMH (TP EUR141) We have a Neutral rating and a EUR140 target price

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We continue to value Christian Dior using a sum of parts valuation based on LVMH (89% of RNAV) unchanged target price of EUR141 and a Dior-targeted discount to RNAV of 20% (unchanged and in line with past history as highlighted on the previous page.)

As a result of our unchanged target price of LVMH, our Christian Dior valuation and our target price are unchanged at EUR140 (see details on following page).

Under our research model, for stocks without a volatility indicator, the Neutral band is 5 ppt above and below the hurdle rate for eurozone stocks of 9.5%. At the time we set our target price for Christian Dior it implied a potential return of which was within the Neutral band of our model; therefore, we have Neutral rating on Christian Dior stock. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

The main downside/(upside) risks to our rating on Dior would be a negative/(positive) development in LVMHs share price. Another risk would be a change in the markets view of the discount to apply to holding companies (positive or negative).

Since Diors IPO in 1995, there has been recurring press speculation about a potential streamlining of the current LVMH control structure (notably an article in The Independent dated 25 November 2012 elaborated on several scenarios).

In theory, any expectations or announcements about such a simplification (for example, an LVMH/Dior merger or a Dior minority buy-out as mentioned in the press) provided it benefited Diors minority shareholders could trigger a sharp narrowing in the companys discount to RNAV. We think this could be a potential upside catalyst for Dior.

Dior discount to our estimated net asset value

Source: Thomson Reuters Datastream, using share price close at 18 March 2014 -60%

-50%

-40%

-30%

-20%

-10%

0%

16% on 18/03/2014

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Dior Couture sales & EBIT evolution

EURm 1995a 1996a 1997a 1998a 1999a 2000a 2001a 2002a 2003a 2004a 2005a 2006a 2007a 2008a 2009a 2010a 2011a 2012/ 13a*

2013/14e**

2014/15e**

2015/16e**

Sales 157 187 200 200 220 296 350 492 523 595 663 731 787 765 717 826 1,000 1,289 1,500 1,700 1,900EBIT 24 24 11 -1 9 14 -5 33 40 50 53 56 74 9 13 35 85 131 180 229 275EBIT margin 15.1 13.1 5.6 -0.3 3.9 4.7 -1.5 6.7 7.7 8.4 8.0 7.7 9.4 1.2 1.8 4.2 8.5 10.2 12.0 13.5 14.5 YoY evolution (%) Sales 15 19 7 0 10 35 18 41 6 14 11 10 8 -3 -6 15 21 29 16 13 12EBIT 8 3 -54 nm nm 64 nm nm 21 25 6 6 32 -88 44 nm 143 54 37 27 20Notes: * FY ending April N+1, ** FY ending June N+1 Source: Company data, HSBC estimates

Dior target price calculation based on HSBC's LVMH target price

EURm % stake Restated NAV Method % of RNAV

LVMH 40.89% 29,303 HSBC target price EUR141 89%Dior Couture 100.00% 3,166 2x 2014e sales 10%Property 100.00% 108 90,000m2 at EUR12000/m2 0%Treasury stocks 1.24% 304 Share price 1%Restated NAV 32,881 100%Parent co. debt -1,065 RNAV (EURm) 31,817 Targeted discount to RNAV (%) -20% HSBC Dior target price (EUR per share) 140 Source: HSBC estimates

Dior restated net asset value

EURm % stake Restated NAV Method % of RNAV

LVMH 40.89% 26,830 Share price EUR129.10 89%Dior Couture 100.00% 3,166 2x 2014e calendar sales 10%Property 100.00% 108 90,000m2 at EUR12,000/m2 0%Treasury stocks 1.24% 304 Share price EUR133.80 1%Restated NAV 30,408 100%Parent co.debt -1,065 RNAV (EURm) 29,343 RNAV per share (EUR) 161.48 Share price 134.95 Discount (%) -16% Source: HSBC estimates

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Financials & valuation: Christian Dior Neutral Financial statements

Year to 04/2013a 06/2014e 06/2015e 06/2016e

Profit & loss summary (EURm)

Revenue 29,881 31,664 34,090 36,819EBITDA 7,084 8,045 8,677 9,438Depreciation & amortisation -994 -1,667 -1,759 -1,857Operating profit/EBIT 6,090 6,378 6,917 7,581Net interest -129 -146 -20 23PBT 5,847 6,137 6,827 7,536HSBC PBT 5,847 6,137 6,827 7,536Taxation -1,916 -1,911 -2,145 -2,367Net profit 1,431 1,715 1,919 2,125HSBC net profit 1,431 1,715 1,919 2,125

Cash flow summary (EURm)

Cash flow from operations 4,226 5,372 6,114 6,621Capex -1,702 -1,663 -1,763 -1,863Cash flow from investment -2,048 -4,130 -1,763 -1,863Dividends -498 -572 -658 -757Change in net debt 213 -452 -1,953 -2,153FCF equity 2,524 3,709 4,351 4,758

Balance sheet summary (EURm)

Intangible fixed assets 23,208 24,716 24,716 24,716Tangible fixed assets 9,286 10,074 10,322 10,592Current assets 14,651 16,919 17,883 18,978Cash & others 1,925 3,331 3,331 3,331Total assets 55,555 60,469 61,912 63,509Operating liabilities 6,586 7,473 8,001 8,601Gross debt 8,534 9,488 7,535 5,382Net debt 6,609 6,157 4,204 2,051Shareholders funds 10,964 14,962 17,244 19,750Invested capital 38,634 40,905 41,589 42,354

Ratio, growth and per share analysis

Year to 04/2013a 06/2014e 06/2015e 06/2016e

Y-o-y % change

Revenue 21.3 6.0 7.7 8.0EBITDA 10.8 13.6 7.8 8.8Operating profit 14.4 4.7 8.5 9.6PBT 19.1 5.0 11.2 10.4HSBC EPS 11.9 19.8 11.9 10.7

Ratios (%)

Revenue/IC (x) 0.8 0.8 0.8 0.9ROIC 11.2 11.0 11.5 12.4ROE 13.9 13.2 11.9 11.5ROA 7.5 7.5 7.7 8.2EBITDA margin 23.7 25.4 25.5 25.6Operating profit margin 20.4 20.1 20.3 20.6EBITDA/net interest (x) 54.9 55.2 424.9 Net debt/equity 23.6 20.2 12.6 5.6Net debt/EBITDA (x) 0.9 0.8 0.5 0.2CF

Rise of the Yummy

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