Time to check out Watches of Switzerland
In the midst of a livelihood crisis that seems to be getting worse by the day, many retailers are looking pretty exposed. As their disposable incomes fall, consumers are tightening their belts and cutting spending. But a retail category that sits at the more exclusive end of the market has a customer base and product range that should weather the economic headwinds rocking the global economy.
bull points
- pricing power
- Strong returns on equity
- American expansion
- Market leader in Great Britain
bear points
- D2C risk
- Weak share price momentum
This category is luxury watches. For those willing to pay many times the average UK annual salary for a Girard-Perregaux, for example, fluctuations in home energy costs or weekly grocery shopping are unlikely to stop them from taking the plunge.
Watches of Switzerland (WOSG) is a major player in this field. The company is the leader in the UK with around 40 per cent 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 trades under five brands including Goldsmiths in the UK and Mayors in the US. The company also sells luxury jewelry, but that made up just 12 percent of its sales last quarter.
The stock has been volatile lately. After soaring to an all-time high of £16 in late 2021, the share price has nearly halved amid a deteriorating economic backdrop and an indiscriminate beating of highly valued sectors. But with significant growth potential in the U.S. and an impressive long-term plan through April 2026, the stock’s recent drop could well present an attractive entry point for investors looking for a solid long-term option in luxury retail.
Real-time growth
After record sales and profits in the last financial year, Watches of Switzerland (WoS) entered the recent turbulent phase from a position of strength. Recent evidence suggests that this form continued. In the nine months to January (the group’s fiscal year ends in April), revenue rose 38 percent. Even in the third quarter — a tougher comparable quarter than the first half — luxury watch sales rose by a fifth and demand consistently exceeded supply.
Investors can expect an update on the fourth quarter on May 18, although the company has already confirmed that full-year trading is in line with expectations. Consensus forecasts place sales at around £1.2bn for the year and £1.5bn in 2023, which would represent a 67 per cent jump in just two years. Not too shabby, although of course the update will confirm the fine print.
The fundamentals also look good. WoS recorded a free cash flow conversion rate of 104 percent in 2021, up from 66 percent in the previous pandemic-hit period. Return on capital employed, meanwhile, was over 25 percent in 2021, and Barclays expects that to reach 36 percent in fiscal 2022. The greater operational reach has also brought economies of scale: between 2017 and 2021, the gross margin rose continuously from 8.6 to 13.3 percent. While it’s not mind-blowing, everything indicates that the company knows how to sustainably expand.
offer and demand
The company’s strong sales development is underpinned by a favorable supply-demand ratio. Well over half of the sales come from the “super high demand” brands Rolex, Patek Philippe and Audemars Piguet, for which customer demand is well above existing stock.
That imbalance is one of the main reasons JPMorgan Mid-Cap Investment Trust (JMF) co-manager Katen Patel is bullish on the company. “Two thirds of [the company’s] Sales come from brands that have historically had limited availability and operate with long waiting lists for an exclusive product, resulting in a much less price-conscious customer,” he told us.
The momentum, fueled by the pandemic and supply chain headwinds, means the company has 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 lends its own value and is a big part of the reason luxury buyers are willing to pay for it. WoS’ market-leading position and initiatives such as offering pre-owned watches for sale also mean that any threat from impatient customers should be manageable.
expansion time
Revenue is currently UK dominated. In the last fiscal year, 67 percent of sales came from Great Britain, the rest went to the USA. This division should change. WoS recently announced its expansion into Europe with the opening of six mono-brand boutiques later this year, but it’s America where the price could be most meaningful to shareholder gains. The company first entered the US watch market in 2017, and further expansion there could transform future growth.
In fact, Bank of America analysts see the potential for consolidation in the US as the company’s biggest opportunity. The bank is talking about a £2.7 billion “US blue sky opportunity” and believes it could capture a 10 per cent market share in the country by the end of this calendar year. The market is underestimating the potential to soon repeat its dominance in the UK, according to the BoA.
The US watch market is underdeveloped and fragmented compared to the UK. Luxury watch sales per capita are 40 percent lower and retailers have fewer stores. On the other hand, store rents in the US are typically lower, while the lack of competition for scale means there are good opportunities for the company to consolidate and pursue M&A options. As Bank of America points out, “Competition in the US is weak as individual jewelers often cannot invest as much as WoS”. Big market, weak competition, what don’t you like?
The company’s forecast of a 25 to 30 percent compound annual growth rate for U.S. sales through 2026 certainly suggests that it’s bullish and that things are already moving in the right direction. Within four years, management expects revenue to be fairly evenly split between the UK and US. If the company succeeds in this push, we wouldn’t rule out WoS itself becoming an M&A target.
D2C risk
A key concern for all investors in retailers is the risk of brands cutting out the middleman and opting for direct selling (D2C). The world of luxury watches hasn’t exactly embraced e-commerce, with many brands having extremely limited online capacity and some not offering online sales. Selling is not the forte of the industry.
But as the market shifts, could a shift in distribution ownership hurt WoS?
JP Morgan’s Patel isn’t convinced it poses a significant threat.
“The Swiss luxury watch market has a large wholesale distribution network and while there are examples of manufacturers expanding into retail, this has usually been the case where the distributor has done a poor job – not a category in which we would place WOSG” , he argues.
Still, it’s important to note that WoS’s online offering is picking up steam. Online sales grew 121 percent in 2021, helped by the pandemic, and are projected to continue to account for a larger share of total sales for years to come. BoA expects online sales to reach 10 percent of total sales by fiscal 2027, which would help alleviate concerns about digital risk.
A luxury valuenation?
Continuing with the stock’s potential downsides, some investors will likely see the valuation as a little too expensive, especially given the risks associated with the quality of earnings forecasts right now. Some analysts argue that growth expectations are already burned into the rating.
Shares did indeed look expensive at certain points — analysts at Barclays, for example, had traded the shares at 28 times forward 2023 earnings in a February research note. Having dropped to 16x consensus earnings, the rating no longer looks exaggerated given the growth ahead. That rating is 20 times below the five-year average and is more in line with consensus ratings from other luxury companies such as Burberry (BRBY) at 14 times expected profit and LVMH Moët Hennessy Louis Vuitton (FR:MC) at 19 times the expected profit.
All in all, and with little reason to bet against the lure of WoS’ high-end products, now looks like a good time to stock up.
IC last accessed: Hold, 1,487p, Dec 9, 2021
Company Details | Surname | Mkt.Cap | Price | 52-week Hi/Lo |
Watches of Switzerland (WOSG) | £2.23 billion | 931p | 1600p / 648p | |
size/debt | NAV per share* | Net Cash / Debt(-) | Net Debt / Ebitda | Op Cash/Ebitda |
104p | – £271m | 2.2x | 87% |
vvaluation | Fwd PE (+12 months) | Fwd DY (+12 months) | P/BV | P/Sale |
17 | – | 6.7 | 2.1 | |
quality/growth | EBIT margin | ROCE | 5 year sales CAGR | 5 year EPS CAGR |
11.1% | 13.4% | 17.1% | – | |
Forecasts/ Momentum | Fwd EPS Grth NTM | Fwd EPS grth STM | 3 month mother | 3 Month Fwd EPS Change % |
30% | 13% | 30% | 2.8% |
Year end Apr 30 | Turnover (£bn) | Profit Before Tax (£m) | EPS(p) | DPS (p) |
2019 | 0.80 | 26 | 20.9 | zero |
2020 | 0.82 | 9 | 16.3 | zero |
2021 | 0.91 | 66 | 23.8 | zero |
for cst 2022 | 1.21 | 123 | 40.8 | zero |
for cst 2023 | 1.51 | 164 | 53.2 | zero |
Modification (%) | +25 | +33 | +30 | – |
Source: FactSet, adjusted PTP and EPS figures | ||||
NTM = Next 12 months | ||||
STM = Second 12 months (i.e. one year from now) | ||||
*Includes intangible assets of £151m or 63p per share |