The return of the “Watch series”: Richemont (ISIN CH0210483332) – Better than Swatch ?
Within my “Watch series” last year (Swatch part 1, Swatch part 2, Hengdeli, Fossil part 1, Fossil part 2, Movado) I left out one company which also is one of the major players in the Watch space: Richemont.
Some might ask: Why didn’t you already buy Swatch ? I argued that 300 CHF would be a good entry point and the stock is now at 292. Well, at the time of writing the Swatch post, I implicitly assumed that 2015 would be the low point. As we can see now, this is most likely not the case. Sentiment at Swatch is clearly more negative than for Richemont but still not rock bottom.
Additionally, I think one should not overestimate the moat of expensive Watch brands. One example is a (German) article 2 weeks ago in Handelsblatt about luxury watch brand Richard Mille. Founded in the early 2000’s they went from zero to almost 600 mn EUR in sales of super luxury watches with a new brand. So the market entry seems to be possible, at least at the very top.
Originally founded in South Africa by Anton Rupert, Richemont has a quite colorful history.The Group among other activities was into Tobacco, Pay TV and jewelery. Then, in the early 2000s, they focused on luxury and increased their exposure to watches.
The founder Anton Rupert died in 2006 but he seems to have been a quite interesting biography, starting his business with 10 GBP in 1941. His son Johann was CEO from 2010-2013, since then an “external” CEO has been appointed. The Rupert family also controls South African based Remgro, a listed company with ~7 bn EUR market cap.
Today their most well-known brands are Cartier, IWC, Van Cleef, Mont Blanc just to name the most important ones. Around 50% of sales are watches, the rest is jewelery and others (leather, clothes, pens).
One could argue that Richemont has been a good capital allocator, over the last 17 years for instance, Richemont has clearly outperformed its competition with an annual shareholder return (in EUR) of +13,9% p.a. compared to Swatch (11,3% p.a.), LVMH (10,6%), Kering (1,8%). only super-exclusive Hermes has done better with 16,9% p.a. over that time period.
Market cap: 33 bn CHF (share price 57 CHF)
P/E (2015): 17,3
EV/EBIT: 13,3 (Bloomberg)
What I like:
+ The luxury business itself is a very good business to be in
+ Strong brands, especially Cartier is clearly a “Mega brand”
+ less Watch focused than Swatch
+ little exposure to lower priced watches (less risk of “disruption” via Apple Watch & Co)
+ conservatively run (net cash, little Goodwill)
+ underlying results often better than stated results
+ luxury sector seems getting attractive as contrarian opportunity
+ good capital allocation track record
What I didn’t like:
-non core brands (Dunhill, Chloé etc.) add little value
-relatively “hard to understand” numbers, lots of “one offs”
-clearly negative momentum, especially in watches & other (Diamond prices)
-A/B share structure with voting right control of founding family
-EM > 50% of sales (indirectly more likely much higher)
-Very highly compensated management, alignment with shareholders ?
-management change required (Co-CEO retired at age 69, CEO age 65)
-analyst sentiment still relatively positive
The stock price has held up better than Swatch over the last 5 years if we look at the comparison chart:
Early warning signs:
John Hempton pointed out the problems of Richemont (too) early in 2012. However I do think he indirectly made one mistake: You should never project your preferences (I hate expensive watches) on other people or even other people from other cultures. Jewelery for women for instance is a very old concept which has survived for thousands of years and will most likely survive a few more.
Also many succesful men want to show their wealth and expensive watches (or several of them) is a pretty good way to do so. Especially “new money” likes to show off and there is a lot of new money in Asia.
My personal experience tells me that especially value investors are mostly pretty “immune” against the lure of luxury brands as status symbols. However one should not confuse as I mentioned above personal preferences with the analysis of a company
Luckily I didn’t short Richemont back then but I tried my luck with Prada. Again too early.
Comparison to Swatch
Compared to Swatch, I do think that Richemont is both, better run and better strategically placed. With Harry Winston, Swatch seems to imitate Richemont, but I think it will take a very long time before they can even get into the vicinity of the Cartier brand which nowadays is even exhibited in museums around the world. Jewelry is good business but not a guarantee for sucess. Tiffany’s for instance just came out with pretty negative numbers:
Tiffany & Co’s quarterly sales fell 7.4 percent, the sixth straight quarter of decline, as a strong dollar discouraged tourists from buying its high-end jewelry and ate into revenue from markets outside the United States.
Sales at the jeweler’s stores open for more than a year fell 10 percent in the Americas region in the first quarter. Analysts on average had expected a 9.1 percent decline, according to research firm Consensus Metrix.
The Swatch brand itself is a lifestyle brand which I personally think has seen its best days long ago and a lot of the cheaper Swatch brands (Tissot, Rado; Hamilton) are not that strong in my opinion.
Within the watch sector, I guess that Richemont is missing a really “monster” brand like Omega. They do have very good brands but I think only IWC and Jaeger come close to the leaders Omega, Rolex and Patek Philipe. Interestingly, they bought their main brands from German conglomerate Mannesmann in 2000 for around 3 bn CHF. Back then, the acquisition multiples looked very expensive:
Over the three years to 31 December 1999, LMH’s sales have grown at a compound annual rate of 19 per cent to CHF 349.4 million. Operating profit before depreciation and amortisation (EBITDA) in 1999 amounted to CHF 80.4 million. Operating profit (EBIT) amounted to CHF 70.8 million.
For companies like Richemont or Swatch with high margins and high free cash flows, capital allocation is important. The historic track record of the Rupert family is very good, they were active capital allocators with a very long-term perspective. Within Richemont, capital allocation looks smart as well.
For instance Net-a-porter, the fast growing online luxury retailer. According to this article, Richemont bought the company in 2010 for 392 mn EUR. Last year, the merged the company with Italian company YOOX and received a 50% stake in the combined listed entity which, at the time of writing is worth 1,6 bn EUR. So the quadrupled their money within 4 years which is not bad and turned an unlisted stake into a listed one. However a “behind the scenes” story I found indicates that they could have sold at an ever higher price.
At the moment they seem to be on the hunt for more Jewelery acquisitions , the timing looks relatively smart from the outside.
In 2008, Richemont made an interesting spin-off with the company Reinet Investments, which effectively was the Tobacco assets held by Richemont. At the time of the spin-off, the stock was worth 2,30 EUR, right now it trades around 17 EUR. For Richemont investors who kept the shares (for instance the Rupert family….) this clearly has been unlocking a lot of value.
One weakness in my opinion is that they carry a couple of brands which make no profit or losses. Accrding to the last annual report, acually 1.8 bn of sales (or 17% of total) contributed negatively for the second year in a row (adjusted for special charges).
I would subjectively judge that Richemont overall allocates capital significantly better than Swatch which is buying real estate in Zurich instead.
Management / founding family
The Rupert founding family owns all the unlisted B shares which gives them a 50% vote although they only own ~9% of the total capital. I do like to invest alongside families but all other things equal I prefer a “pari passu” structure.
Executive compensation looks very rich (fitting the name). The total compensation of the board (including non-executives) has been 50 mn CHF both in 2013/14 and 2014/2015. Swatch has similar levels of compensation (47 mn CHF in 2014, 42 mn CHF in 2015) but at least compensation went down with lower profits.
Johann Rupert pays himself “Only” ~1 mn CHF as Non-executive president of the board, this looks OK. Johann Rupert itself seems to be an interesting character. For instance here he gave a talk at FT conference. Also the Q&A of the 2015 results is quite interesting.
One of the issues is clearly that he turns 66 in June and no apparent heir from the family side is available at least for his role at Richemont. As a rule of thumb, for family businesses the jump from 2nd to 3rd generation always seems to be the hardest. I have no hard statistics on that but there is German saying which basically says: The fist generation creates, the second maintains and the third spends. Some family companies have solved this by bringing in external talent early and institutionalizing the ownership like Henkel, others have failed miserably.
Momentum (fundamental / stock analysts)
As I mentioned above, the underlying business, especially watches shows strong negative momentum. Clearly there are some special effects (terrorist attacks Paris) but for me it is not clear where the bottom is, both in sales and profit margins. When I looked at watch companies last year, everyone thought that this is the bottom, now however it seems to be 2016. But who knows ?
The question is clearly: What is priced into the stock ?
One indication for this is analyst consensus. Personally, I think it is very hard to gain any informational advantages on large and well researched stocks. The only but important advantage that I have vs. “the market” is that I can afford longer time horizons and that I can go against consensus for longer period of times.
Analyst consensus for Richemont is still surprisingly positive. From the 39 analysts that are covering Richemont, 18 still have buy recommendations. Overall consensus score is 3,65 (out of a max. 5) which puts it exactly into the middle of the Stoxx 600 index. So sell side analysts have not yet thrown in the towel. This could be an indication that the market still prices in too much optimism.
Richemont clearly has experienced a boom from 2011 to 2015 which will be hard to repeat. One therefore should look at longer historic periods in time to estimate underlying margins.
If I look at the 17 year (1998-2014) average operating margin, this would be around 18%. Assuming (wild guess !!) 20% tax on a Group basis, this would mean 14,4% profit margin in the long run, across cycles (which, compared to many other industries is fantastic !!)
Based on current 11 bn EUR sales, this would mean ~1,6 bn EUR in average after tax profits. At a current market cap of 30 bn EUR (33 bn CHF) and and 5.8 bn cash and investments, Richemont trades at an implicit P/E of 15 over the cycle without growth.
Theoretically one could adjust further for the Yoox-Net-a-porter stake (1.5 bn EUR), then we would end up at around 14,2. Not bad but also not super attractive. For the inherent cyclicality I would require at least 10% return p.a. Within the next 2-3 years I don’t think profits will go up much, so this would be clearly a speculation on a multiple expansion.
For Swatch I thought a P/E of 16 would be fair, Richemont in comparison to Swatch clearly justifies a higher multiple. But even if we use 17 or 18, the stock doesn’t look like a bargain.
I do think it is a good company and in direct comparison “better” than Swatch. On the other hand it is also more expensive and there are a couple of smaller issues like management change etc. which increase the risk.
Still I do think that there is a decent chance that one could buy the stock at some point in the future at a more attractive valuation, most likely when analysts as a whole more negative.
So for the time being I will do nothing. I don’t have a direct price where I would buy but I guess I would be more motivated (and take an even deeper look into) at prices around 50 CHF.