Swatch

 

Watch Industry

  • Swiss watch exports have been on a persistent decline for the last 6 years
  • 2016 was a bad year for watch retailers. Swiss watch exports dropped by 10% as big markets like HK and US began to shrink
  • Strong Swiss Franc
  • And smart watch threat an additional risk but that has lost credibility in some people’s view due to apple watch failing
  • Chinese clamping down on people using luxury items as a gift in black market transaction, so there’s been a crackdown on corruption and tax evasion.
  • Last year the Chinese government doubled the import tariff on luxury watches to 60 per cent to promote domestic consumption.
  • Still too much inventory in the channel (especially in Hong Kong) as watch prices have increased significantly since the downturn and this inflation has been even more compounded by relative strength in the Swiss Franc. People are just finding watches generally too expensive
  • There is also a risk to long term watch demand as millennials don’t wear watches as much / appetite to spend that much has decreased
  • Only bright spot was the cheap pound that helped lift sales in the uk

Upsides: higher oil prices leading to emerging market opportunities that have not yet been exploited eg. Russia.

 

Since 2014, Swatch has shown significantly declining revenues and profits with the sales declining by 10% last year and net income decreasing by nearly 50%.

Still, the CEO, Nick Hayek (with family controlling 40% of the Swatch Group), targets the firm will make 7-9% growth this year and that there is no need to change the company’s strategy and that the firm can grow organically without having to do any acquisitions.

All this is based on the last three months of trading in 2016 where evidence of a turnround has started to emerge as brands such as LVMH (tag Haeur, Bulgari) and Richemont reported watch sales rises of 8 percent and 5 percent higher in the final three months of 2016 compared with a year earlier.

He explained 2015’s sales declines by referring to a strong CHF, whilst this year massive decline was explained by combination of strong CHF, poor Asian demand but also terrorist activity in Europe and regional shifts due to new regulation, but then again we see comparable companies like Richemont that haven’t been seeing the same declines.

So its seems very much like he is seeming to have to make excuses for the brand and Hayek is famous for giving very optimistic interviews both in the good and bad times. He is refusing to take on board the structural challenges in the industry and the firm seems to be behind on the curve with regards digital innovation and experience based spending. This is not a good strategic move because the only way to bring growth in mature markets such as the watch industry through innovation and creativity.

Second of all corporate governance and the principal-agent relationship at Swatch is questionable. Since his family own the majority 40% shareholding, the street believes that the firm is treated like a family-run private company with its main directors being family members and others with no real experience in the watch or luxury goods industry like an ex-astronaut and George Clooney even sits on the board of one its subsidiaries that deal with clean power (Belenos).

Swatch is also vulnerable because swatch got into some regulatory arrangement with the Swiss Competition commission which results in them having to hold excess inventory on their books even though the watch industry is suffering a downturn.

The share bottomed out in mid-2016 at 248CHF whilst now the shares are on 365 CHF so that’s a 47% price rise and this on the back of the back of investors feel that the worst has happened in the watch industry and the industry is now returning to growth.

I don’t think the market, therefore, has priced in all the above correctly and at the next stock update, Hayek will be making more excuses for the brand and the sector’s weak growth prospects.

At a PE of 35x, the market is pricing in an ambitious margin recovery when to get there you need MSD-HSD comps every year which given there is no pricing power at the minute, is hard to achieve on volumes alone. There has been no volume growth in the last 15 years and swatch’s failure to innovate is going to cost them in the long-run.

I think the stock is way too expensive at the minute and there are far better comparable luxury brands out there such as Richemont trading sat slightly more at 40x PE, but posting much better results and seem to be far more resilient the current trends.

Investors and analysts made a valid point that Swatch was still “cheaper” than most of its peers such as Richemont (OTCPK:CFRHF) or LVMH (OTCPK:LVMUY), but in my opinion, future growth prospects still mean that the stock is still overpriced.

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