It’s time to look at watches from Switzerland
Amid a cost of living crisis that seems to be getting worse by the day, many retailers seem quite exposed. As their disposable income declines, consumers tighten their belts and reduce their spending. But one retail category, at the more exclusive end of the market, has a customer base and product mix that should weather well the headwinds hitting the global economy.
- Pricing power
- Strong returns on equity
- American expansion
- UK market leader
- D2C risk
- Poor share price momentum
This category is that of luxury watches. For those willing to drop a multiple of the average UK annual salary on a Girard-Perregaux, for example, fluctuating household energy costs or weekly groceries are unlikely to deter them from taking the plunge.
Swiss Watches (WOSG) is a key player in this space. The company is the UK leader with around 40% of the luxury watch market and has over 170 stores in the UK and US with over 50 mono-brand boutiques in addition to its online presence. It operates under five brands, including Goldsmiths in the UK and Mayors in the US. The company also sells luxury jewelry, although that only accounted for 12% of sales last quarter.
The stock has been volatile lately. After hitting an all-time high of £16 at the end of 2021, the share price has nearly halved amid a deteriorating economy and an indiscriminate hammering of highly valued sectors. But with significant growth potential in the US and an impressive long-term plan through April 2026, the stock’s recent decline could very well represent an attractive entry point for investors looking for a solid option. long term in the luxury retail space.
After posting record sales and profits in its last financial year, Watches of Switzerland (WoS) entered the recent period of turmoil from a position of strength. Recent evidence suggests that this form has continued. In the nine months to January (the group’s fiscal year ends in April), revenues increased by 38%. Even in the third quarter – a tougher comparison than the first half – luxury watch sales rose by a fifth, and demand consistently outstripped supply.
Investors can expect a fourth quarter update on May 18, although the company has already confirmed that full-year trading is in line with expectations. Consensus forecasts call for sales of around £1.2bn for the year and £1.5bn for 2023, which would represent a jump of 67% in just two years. Not too shabby, although of course the update will confirm the fine print.
The fundamentals also look good. WoS posted a free cash flow conversion rate of 104% in 2021, compared to 66% in the previous pandemic-hit period. Return on capital employed, meanwhile, was over 25% in 2021 and Barclays expects it to reach 36% in FY22. scale: between 2017 and 2021, the gross margin increased steadily from 8.6 to 13.3%. Without being mind-blowing, it all suggests that the company knows how to grow sustainably.
supply and demandn/a
The company’s strong revenue performance is underpinned by a favorable supply-demand relationship. Well over half of sales come from the “very high demand” Rolex, Patek Philippe and Audemars Piguet brands, for which levels of customer demand are significantly higher than existing inventory.
This imbalance is a key reason why Katen Patel, co-manager of JPMorgan Mid-Cap Investment Trust (JMF), is bullish on the company. “Two-thirds of [the company’s] sales come from brands that have always been limited in supply, operating with long waiting lists for an exclusive product, which translates to a much less price-sensitive customer,” he told us.
The momentum, which has been intensified by the pandemic and supply chain headwinds, means the company enjoys robust pricing power and has a very good idea of future revenue streams.
Long waiting lists could be seen as a problem if they cause customers to give up and spend their money on other things. But exclusivity confers its own value and is a big part of why luxury buyers are willing to pay. WoS’s market-leading position and initiatives such as the sale of second-hand watches also mean that any threat from impatient customers should be manageable.
Revenues are currently dominated by the UK. In the past financial year, the UK accounted for 67% of sales, with the remainder going to the US. This distribution is set to change. WoS recently announced its expansion into Europe, with the launch of six single-brand stores later this year, but it is in America that the price could be most significant for shareholder profits. The company first entered the US watch market in 2017, and further expansion could be transformative for future growth.
Indeed, Bank of America analysts believe the potential for consolidation in the United States is the biggest opportunity for the company. The bank talks of a £2.7bn ‘blue sky opportunity in the US’ and thinks it could claim a 10% market share in the country by the end of this calendar year . The potential to replicate its level of dominance in the UK soon, BoA believes, is underestimated by the market.
The US watch market is underdeveloped and fragmented compared to the UK. Luxury watch sales are 40% lower per capita and retailers have fewer stores. Again, US store rents are generally lower, while the lack of competition for scale means there are good opportunities for the company to consolidate and take advantage of M&A options. As Bank of America points out, “competition in the United States is low because often individual jewelers cannot invest as much as WoS.” Big market, low competition, what’s not to like?
The company’s forecast of a 25-30% compound annual growth rate for U.S. revenues through 2026 certainly suggests they are optimistic that things are already moving in the right direction. Within four years, management expects UK and US revenues to be roughly evenly split. If the company succeeds in this push, we wouldn’t rule out WoS itself becoming a target for mergers and acquisitions.
One of the biggest concerns facing all investors in retailers is the risk of brands cutting out the middleman and opting to sell direct to consumer (D2C). The luxury watch world has not really embraced e-commerce, with many brands having extremely limited online capacity and some offering no online sales at all. Selling is not the strong point of the sector.
But if the market changes, could a change in distribution ownership hurt WoS?
JP Morgan’s Patel isn’t convinced this poses a significant threat.
“The Swiss luxury watch market has an extensive wholesale distribution network and although there are examples of producers going into retail, this is usually where the distribution partner has gone wrong. – it’s not a category we would place WOSG in,” he explains.
Nevertheless, it is important to note that the online offer of WoS is growing. Online sales grew 121% in 2021, helped by the pandemic, and are expected to continue to account for a larger share of total sales in years to come. The BoA expects online sales to reach 10% of all by fiscal 2027, which would help alleviate concerns about digital risks.
A luxury valueation?
Continuing with the stock’s potential declines, some investors will likely view the valuation as a bit too expensive, especially given the risks associated with the quality of earnings forecasts at this time. Some analysts say growth expectations are already priced into the rating.
Shares have indeed looked expensive at times – analysts at Barclays, for example, had shares trading at 28 times 2023 forward earnings in a February research note. After dropping to 16 times consensus earnings, the rating no longer seems excessive given the growth ahead. This valuation is below the five-year average of 20 times and is more in line with consensus valuations of other luxury companies such as Burberry (BRBY) at 14 times future earnings and LVMH Moet Hennessy Louis Vuitton (FR:MC) to 19 times future earnings.
All in all, and with little reason to bet against the lure of WoS’s premium products, now seems like the best time to buy.
Last seen IC: Hold, 1,487p, Dec 9, 2021
|Company details||name||Market cap||Price||52 weeks high/low|
|Swiss Watches (WOSG)||£2.23 billion||931p||1600p / 648p|
|Size/debt||NAV per share*||Net Cash / Debt(-)||Net debt / Ebitda||Operating cash/EBITDA|
|VEvaluation||PE before (+12 months)||JJ (+12 months)||P/V||P/Sales|
|Quality/ Growth||EBIT margin||ROCE||CAGR of sales over 5 years||CAGR EPS 5 years|
|Forecast / Momentum||Fwd EPS grth NTM||Fwd EPS grth STM||Mom of 3 months||% change in EPS before over 3 months|
|Year-end April 30||Sales (in billions of pounds sterling)||Profit before tax (millions of pounds sterling)||EPS (p)||DPS(p)|
|Source: FactSet, adjusted PTP and EPS figures|
|NTM = next 12 months|
|STM = second 12 months (i.e. in a year)|
|*Includes intangibles of £151 million or 63 pence per share|