The “Watch series”: Swatch Group (UHR.VX)

This is the 4th post in what developed into a kind of “Watch series”, see Fossil part 1 and part 2 plus Movado.

Swatch is the largest wrist watch producer in the world. The company is the brainchild of legendary founder Nicholas Hayek who turned around the whole Swiss Watch industry and created Swatch out of insolvent Swiss watch makers.

null

Many people identify Swatch only with the relatively cheap plastic watches, but over time Swatch also collected a pretty impressive line up of luxury brands such as:

Prestige & Luxury Range: Breguet, Harry Winston, Blancpain, Glashütte Original, Jaquet Droz, Léon Hatot, Omega
High Range: Longines, Rado, Union Glashütte
Middle Range: Hamilton, Certina, Mido, Tissot

This Breguet Watch for instance sells for around 120.000 EUR:

The currently heavily promotes Omega Seamaster “James Bond” at around 7.000 EUR:

According to some estimates, Swatch has 50% of its sales in the High Range or higher, another 40% in the middle range and ~10-15% in th cheap range with the actual Swatch watches. Most probably, the share of profits in “Prestige & Luxury” range is much more than 50%. Their biggest brand is clearly Omega which, according to some estimates, alone stands for up to 30% of total sales and a potentially higher share of profits.

So despite the general opinion, Swatch is clearly much more a luxury company than a low-end consumer fashion brand.

Comparison to Fossil (before the drop) & Movado:

Movado Fossil Swatch
Market cap 629 2.605 20.600
Sales (2014) 580 3.510 9.524
P/E (2015) 13,1 10,3 16,4
EV/EBITDA 5,9 5,2 9,1
P/B 1,4 3,15 2
P/S 1,1 0,7 2,4
Operating margin 10y avg 6,2% 14,8% 21,9%
Operating margin 3y avg 11,2% 16,8% 24,3%
ROE 10y avg 5,1% 23,1% 13,9%
ROE 3y avg 12,1% 33,0% 18,1%

So we see something interesting here: Swatch has the best margins but is not as good as Fossil (used to be) with regard to ROE.

However we can have a quick look how much capital they use to run their business. Again we compare against Movado and Fossil:

Swatch   Fossil   Movado  
    In% of sales   In% of sales   In% of sales
Sales 9.210   3.509   587  
             
Inventories 5.934 64% 597 17% 181 31%
Receivables 1.198 13% 430 12% 68 12%
payables -371 -4% -428 -12% -58 -10%
Net working cvap 6.761 73% 599 17% 191 33%
             
PPE 3.010 33% 345 10% 46 8%
             
Capital employed 9.771 106% 944 27% 237 40%

What a difference. Swatch ties up a lot of capital to do business. This is not totally surprising as they are vertically integrated. As a “real” manufacturer they have slower inventory turns than someone who just order in China. Clearly also the higher value of raw material (gold, diamonds) plays a role. Last but not least they also seem to be more friendly to their suppliers and seem to pay them quickly. It looks like that working capital is not full optimized at Swatch.

The fixed assets also seem to include some “non-production” assets like this recently acquired house in Zurich.

Comparison to other luxury companies

Name Mkt Cap (CHF) EV/EBITDA P/E P/FCF EV/EBIT 5Yr Avg Adj ROE
             
SWATCH GROUP AG/THE-BR 19.399 8,9 15,4 29,4 11,0 17,5
LVMH MOET HENNESSY LOUIS VUI 88.056 10,8 14,1 21,5 13,5 15,2
CIE FINANCIERE RICHEMONT-REG 44.242 11,8 17,4 31,3 14,1 17,8
HERMES INTERNATIONAL 37.393 19,8 36,9 43,0 22,0 27,9
KERING 22.368 13,0 22,8 88,5 15,7 10,3
             
Avg ex Swatch   13,8 22,8 46,1 16,3 17,8
Theoretical upside Swatch   35,4% 32,2% 36,1% 32,8%

Based on most valuation multiples, Swatch would have a theoretical upside of around 30-35% if it would trade in line with the big luxury Groups.-

Why are they (relatively) cheap ?

If we accept that Swatch is actually a luxury products company, we have to ask us two questions:

1. Why are luxury companies in general so expensive ?
2. Why then is Swatch relatively cheap ?

re 1:
Almost all luxury companies earn high margins which indicates that the brands represent something like a moat and are not easily copied. An its pretty logical: You can try to do it but a real luxury brand with global reach cannot be created over night. Sometimes old brands can be ressurected but it is a long way to be a Cartie, Tiffany, Louis Vuitton or Hermes. On the other hand it is clearly possible to destroy a luxury brand by either going downmarket or extending it too much, so having a brand is not enough. Significant ongoing investments in brand maintenance are reuqired.

A second reason for the high valuations is also the recent growth driven mostly by Asian consumers who seem to be crazy for luxury rands.

re 2:
So why then is Swatch so significantly cheaper than the others ? I can think of 3 main reasons:

a) Many investors don’t automatically put them into the luxury bucket
b) The increase of the Swiss Franc creates issues for a Swiss based manufacturer
c) They are depending to a very large extent on China/Asia (50% of sales directly, more indirectly)
d) Again, the Smart Watch or more specifically the Apple Watch could be a problem. Other luxury companies (LVMH; Richemont etc.) are better diversified

I think the first point is actually a clear opportunity. the second point is something Swatch has managed to overcome before. The third one to some extent is a problem for other luxury companies as well but also for instance for the German car industry. The last point is the most interesting one. If the Apple Watch turns out not to be such a thread then Swatch could really really be interesting.

If we look for instance at the closest competitor, Swiss based Richemont (Cartier) which has less watch exposure (more Jewelry) but is also Swiss based and exposed to Asia, we can clearly see that since beginning of 2014, the Swatch stock price clearly underperformed:

Maybe it is coincidence but in early 2014 the rumours started that Apple will come out with the apple Smart Watch.

So let’s stop at this stage and summarize:

So far, Swatch, the dominant producer of Swiss watches seems like an interesting candidate. Although not cheap on an absolute level, Swatch looks cheap relatively to luxury peers.

The company currently is clearly suffering from a high Swiss Franc which is an issue that they have overcome in the past. Aditionaly, the company is significantly exposed to China, more than other luxury companies. Finally, if the Apple Watch turns out to be a “Swiss Watch Killer” then they clearly have a strategic problem. If not, the stock would be very interesting and maybe a chance to get a very good company at a very reasonable price. (To be continued……)

31 comments

  • Nicolas Hayek the father was a genius, he also had part in the concept of the Smart car. Unfortunately he passed away. Is his son also a proven genius already?

    • No – I met both when I used to live in Switzerland (I am of Lebanese origins as well).

      Even if he was, I can only wonder what he can do in a failing industry. Possibly move upstream (rather than downstream as sales are now mostly done online rather than instore).

      But then Asian entrepreneurs (think Xiaomi) are better suited for this task in my view.

  • Why not looking at Fitbit Inc in that case?

    It is a comp in my view, just a couple of years ahead in R&D.

    • #Tony, yes, Fitbit is clearly something to look at in the future. The “Watch series” is not over yet. It’s an interesting company.

      • There is a lot of ink (and blood) on seekingalpha about FIT.

        The argument that insiders were awarded shares between $0.5 and $1.48 may hit hard when the 180 day IPO lock-up expires

        Nonetheless, I find it a much more interesting play (at the right price) than Swatch

        • to be honest, I don’t look at something to “Play” short term but for a long term investment. Fitbit is interesting because it is much more a potential “disruptor” than Apple with the Iwatch. Disruption always comes from the cheap end and this could be one of the cases. I think Fitbit could actually eat into Aplle’s sales quite quickly if they execute their strategy well.

          on the other hand it could alos turn out to be some kind of GoPro. Let’s wait and see.

        • In that case have a look at Xiaomi, the disruptor par excellence. Bullet proof management and no-BS strategy.

          It is privately held but one could gain partial exposure via Qualcom (which is falling like a rock).

          Think owning Yahoo (at the time) for their stake in Alibaba and Paypal…

  • Swiss watch exports sharply declined in October (http://www.fhs.ch/scripts/getstat.php?file=comm_151010_a.pdf). The luxury segment is hit the most. It seems to be too early to call a bottom in Swiss watch exports especially to China+HK+JP.

    I would like to ask all followers the following question:
    How do you think about the deteriorating exports to the U.S. since the summer of 2015?
    Is it the result of Apple’s smartwatch or just cyclically?

    The statistics for exports to the U.S. from January until October gave me no big glue, because after 10 months the market is still slightly positive compared with 2014 and compared with 2013 it’s remarkably growing. I still doubt Apple’s gadget is a problem for Swatch and think that tourists travel less to the U.S. travel and spend less in the U.S. on luxury goods since the USD has risen against all currencies by a wide margin since 2013. Therefore I conclude Swiss watches in the U.S. are nowadays primarily sold to Americans.

    Joe

  • Thanks mmi for keeping the watch series going ;)) Really like that! I also like what Hayek is saying in general too 🙂
    Having read the comments above and before I still do not share or understand the view that the iWatch is much of a thread to high end watches. In my very personal opinion luxurious watches are a basic business gadget that belong to a business man’s outfit and are a symbol of status. This could be kind of a moat for the industries major brands. Not sure yet about the latter, however, these watches are more exclusive than the electronic watches and do not require updates and all that stuff. What I find very interesting is that despite temporarily being diving into the start-up scene in Berlin I have trouble to see anyone wearing an iWatch. Therefore, I guess the major thread it is likely to be sought somewhere else.

    • I totally agree with you: “luxurious watches are a basic business gadget that belong to a business man’s outfit” I dont need to spend 5.000 Euro to know the time 😉

  • Hello,

    Thanks for the writeup. 😉

    As I haven’t seen the sector details in their annual reports, could you tell us where did you get the estimates of % of sales for Low, middle and high range markets ?

    Thanks

  • I like this watch series!
    Two quick comments:
    1. In terms of moat, I believe that Cartier (Richemont) and Hermes are way ahead of the rest of the pack re exclusiveness, brand value etc.
    2. I wish LVMH was trading at a P/E of 14x like in your table. On an adjusted basis, the P/E stands at around 20x.

  • Everybody investing into Swatch Group should know that the company is controlled by the powerful Hayek Family (approx. 41%). CEO is the Cigar chain smoking Nicolas Hayek. He, and as well other family members, are very long-term thinking. They don’t care about 1 or 2 year stock market trends and what financial analyst have to say (this point is very similar to Berkshire Hathaway). This very long-term approach is also visible with the acquisition of Harry Winston or a large office and retail building in the middle of Zurich. Not only with Harry Winston, they bought a brand name with a huge multi decade potential, and I am sure they have the power of endurance to develop it over that time frame. I was once a shareholder of the company in the 90s, but this year engaged again below 400 chf. Holding period: forever.

    • mikegu,

      thanks for the comment. There will be more about Swatch Group soon. I do like family run businesses with long time horizons, my portfolio has several of them (e.g. Miko, Hornbach, TFF). It is not a guarantee for success but I think it improves the probabilities for long term value to a certain extent.
      mmi

      mmi

    • Unfortunately this seems to lead to poor decisions in areas outside their circle of competence. Ask any expert in Zurich real-estate: they got screwed royally by the seller or rather willingly threw away millions and millions of shareholder money to outbid other potential buyers by a wide margin in order to acquire an asset that will not be able to generate any (measurable) returns. But maybe in times of a general real-estate bubble analysts are willing to overlook such poor capital allocation.

  • Take a look at the very first chart: http://www.fhs.ch/eng/statistics.html

    I know, it’s looking backwards … but it’s certainly not encouraging.

  • Swatch has also been a supplier of moving parts to other watch manufacturers. The have secured a court ruling allowing them to cut supply to competitors in 2011.
    –> In addition to the brands, there is an intangible asset for the technological capabilitites. Difficult to handycap. This is a difference to the other watch companies you looked at.

  • As always thank you for your great work! I love your “Watch series”

    Pi multiplied by thumb 🙂 i think Swatches Market Cap schould be near RICHEMONTs (or vice versa).

    Are you planning to take a closer lock into Rolls Royce these days?

  • Hi and thank you for your fantastic blog!

    I think Swatch:s weakness relative to Richemont may be because of a combination of Swatch being a pure watchmaker (uncertainty from Apples product and overall trends of young rich tech-oriented people maybe not seeing luxury watches as a status symbol anymore) and the ongoing effect of the chinese anti-corruption campaign given they have more exposure there than Richemont.
    Also recently a few luxury goods companies have reported a big slowdown in sales in Hong Kong where if i understand correctly a lot of wealthy chinese go to have holidays and do their shopping.

  • Nice write up of a true Swiss blue chip. It is true, Apple watch and the likes are hard to estimate in their outcomes, but I would like to also focus on the currency issue, but not from the point of view of the exporting company. If the Swiss Frank gets weaker again – maybe like it was a year ago – this offers a downside to your investment of something like 30% if you operate from a Euro basis. I find this hard to predict.

    • I think Swatch is one of the viw Swiss based companies that have a “natural hedge” implied: If the Swiss Franc goes down, their Profit goas automatically up because they actually produce in Switzerland.

  • http://www.fuw.ch/article/nick-hayek-selten-so-viele-chancen-wie-heute/
    There was an interview with Hayek in ‘Finanz und Wirtschaft’ a few days ago, this is the link.

    I have never invested in watches but find the field to be interesting because manufacturers have some pricing power, if the brand is well protected (not going downmarket, as you call ist, is very important. I guess going downmarket is what happened to Michael Kors).

    For the LT investor the China-problem is, as you write, maybe not that worrisome, and could create an entry point. You have to find an acceptable price-value-ratio in the stock considering a downturn in China.

    I would guess that the real issue one has to have an opinion on is the iWatch issue. People buy (expensive) watches because of the brand, ‘Liebhaberei’, hobby, and whatnot, maybe even with some regards to hoarding/inflation protection. Now Swatch can add technical features to its watches (which they do for some models – for example NFC, see the interview), but since technical features lose value over time relatively fast, this could affect these buying patterns.

    So in my opinion the real question is: what drives watch-buyers? I am not having a clear answer to this and I am looking forward to the next part of this watch series.

    Tom

    • Thanky for the link. Depsite his appearance, I like what Hayek is saying in general….

    • I think watch buyers only buy the brand. Nobody knows the difference between a Longines, a Breitling or a Rolex. But if you walk through the Bahnhofstrasse you can see the most people always in front of the same jewellers Windows.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s