Stock Pitch - Watches of Switzerland Group (LON:WOSG)

Rolex, Patek Phillipe, Omega… Watches Of Switzerland (LON:WOSG) is associated with some powerhouse Swiss Luxury Watch brands. It is the leading luxury watch retailer in the UK but can this group create enduring value in the manner of these stalwart brands, or will it forever answer to their beck and call?

That’s a big question for prospective shareholders to answer. WOSG can trace its lineage back to the 18th century, but that doesn’t change the fact that watch sellers don’t hold the power here. Brand owners do.

They set the prices, and it is up to Watches of Switzerland to market and sell the product.

But these brand owners need routes to market and in this regard, WOSG has been a faithful servant to them over many decades. That counts for something. It has been a partner of Rolex for a century and it hasn’t lost a partner in over ten years. You can find the rest of the group’s brand partners here.

The luxury watch market is underpinned by strong long term fundamentals and is well positioned for continued growth. It is supply constrained with customer demand remaining significantly higher than availability. The brands have the power, for sure, but can Watches use its scale and sense of history to carve out a similarly significant position in the market?

And shares, since listing in 2019, have nearly doubled - not bad given the group has had to navigate a global pandemic early on in public life.

WOSG was pitched to the Stockopedia Investment Club on the 23rd of March at 658p per share.

Summary

Bull points: UK market leader expanding into larger US market; high QM stock with double-digit revenue and operating profit CAGRs; cash-generative operations with global top decile return on equity; strong partnerships with supply-driven iconic watch brands (has not lost a partner in 10 years).

Bear points: investment case relies on successful US expansion; lack of bargaining power with premium watch suppliers; tough competition, grey market selling, and newer online operators could threaten business model; recent insider sales.

Profile

Watches of Switzerland Group is a Specialty Retailer in the Consumer Cyclicals sector. It is the UK’s leading luxury watch specialist, with over 35% market share (including nearly 50% of the online market) and accounts for half of Rolex’s sales in the UK.

The group is using this leading UK market position to build out a fast-growing US operation.

It has more than 2,000 colleagues across 138 physical and five online stores. Of the physical stores, 116 are in the UK and the remaining 22 are in the USA.

Luxury watch sales make up 84% of group revenue (with the remainder coming from jewellery sales). Sales of its top five luxury watch brands of Rolex, Patek Philippe, Omega, Breitling and TAG Heuer made up 70% of the group’s revenue in FY19.

The share price today is 684p, making for a market cap of £1.64bn and this mid cap status means liquidity should not be an issue for retail investors.

Stockopedia views it as Speculative and Style Neutral but a Quality Rank of 73 and a Momentum Rank of 93 give Watches Of Switzerland a QM Rank of 91.

We can also see that the StockRank has gapped up three times over the past year and a half.

Business & Model

What is the company history & what does it do?

The group’s lineage stretches back over more than two centuries.

The Mappin & Webb brand story began in 1775, when Jonathan Mappin opened a silver workshop in Sheffield. Three years later in 1778, the Goldsmiths brand story began with the first store located in Blackett Street, Newcastle, trading as Reids & Sons.

The Mayors brand (US acquisition) can be traced back to 1910, when it was founded by Irving Mayor Getz in Cincinnati, Ohio.

And in 1919, Watches of Switzerland’s partnership with Rolex began when Northern Goldsmiths in Newcastle was appointed a stockist of Rolex watches.

Today, WOSG is made up of four retail brands:

• Watches of Switzerland - leading retailer of luxury watch brands.
• Mono-brands - WOSG operates mono-brand boutiques on behalf of brand owners, allowing them to showcase products in a more tailored environment.
• Mappin & Webb - relaunched in 2016 as a luxury watch and jewellery retailer.
• Goldsmiths - luxury watch retailer complemented by a luxury jewellery offer which includes brands such as FOPE, Messika, Gucci, Jenny Packham and Mappin & Webb.
• Mayors - US watch and jewellery retailer with a portfolio of stores in Florida and Georgia.

What are the key business segments?

The group has two operating segments: UK watch & jewellery and US watch & jewellery.

The US segment is growing fast, with year-on-year revenue growth of 106%. This is impressive, and we can see from the group’s store opening costs that capital is currently being allocated to the US operations.

This investment into US operations is particularly promising given that US stores are twice as productive, generating £10.5m per door vs. £4.3m per door in the UK.

Market & Competition

What is the state & size of the company's market?

The value of global swiss watch exports grew by 7.9% to some £17.2bn in 2019, according to the group.

Morgan Stanley research shows that, after applying a retail markup and adding sales generated in Switzerland, global retail sales of Swiss watches reached approximately £42.6bn in 2019.

The luxury Swiss watch market is resilient and driven by long term price increases and volume growth. It is dominated by a few key powerful brands and is characterised by a structural imbalance between supply and demand.

The UK is the fifth largest market globally, with £1bn during 2019, up 12.6% vs the prior year and by a CAGR of 10.8% since 2010.

The US is the second largest market, with a value of £1.9bn during 2019, up 11.6% relative to the prior year. Since 2010, the US market has recorded a CAGR of 5.1%.

According to GFK data, the total market for online sales of luxury watches increased by 10.2% to £54.3m during 2019, excluding brands’ own online sales and fashion retailers’ sales.

Who are the company's key competitors?

The group faces competition from other established retailers, newer online specialists, and the grey market, where unauthorised dealers offer significant discounts.

There are numerous specialty-branded retail shops and department stores in the UK and US, as well as specialist watch retailers that carry distribution rights to select watch brands.

Online retail companies and digital marketplaces such as Chronext, and including emerging start-ups, might present a threat in future.

What is the company's strategy?

The group currently boasts a ~40% share of the UK Swiss luxury watch market (SLWM) (including nearly 50% of the online market), and is currently set to leverage that position to expand into the US market - the 2nd biggest SLWM in the world.

The current management team started a transformation program in 2015-2016 to prepare the group for US expansion, during which time revenues have increased from £410m to £811m, and operating profit has increased from £13m to £64m.

YoY growth continued through the pandemic, and revenue is predicted to exceed £1bn by 2022.

In terms of more concrete initiatives, the group wants to:

• Grow revenue, profit, and return on capital employed,
• Drive customer awareness and brand image through multimedia and digital advertising,
• Expand multi-channel leadership.

How does it derive its competitive advantage (if any), is it durable and is there evidence of one in the financials?

The group lists a few competitive advantages:

• Brand partnerships - Long-standing, collaborative partnerships with the most prestigious Swiss luxury watch brands and luxury jewellery brands. It has not lost a single one in the last 10 years, and celebrated its 100-year anniversary with Rolex in 2019.
• Multi-Channel - Market presence across store network and leading ecommerce platform.
• Operational excellence - including leading-edge IT systems; dynamic inventory management optimises stock availability and enhances store productivity.
• Scale - national coverage in the UK with a portfolio of 116 stores and a growing presence in the US with 22 stores.

The above might make Watches competitive, and possibly even best in class, but they are not necessarily durable competitive advantages in and of themselves.

That said, combining the above characteristics makes for a potentially attractive competitive profile. Its longstanding relationships with brand owners is the trickiest aspect for others to replicate. Watches’ operational excellence, scale, and multi-channel presence make it an attractive steward and route to market for these brands.

We can see some evidence of this in the group’s improving operating margins.

Financials & Ownership

What is the record of growth & profitability?

Revenue growth has been impressively consistent, with a compound annual growth rate of 18.6%, and sales are forecast to exceed £1bn by FY22E.

Diluted normalised earnings per share has been patchier, but forecasts indicate this is expected to improve in the years ahead, and the group’s cash flows per share have been more robust.

Profitability metrics are good on a trailing twelve month basis but trends over time show volatility.

What is the state of the balance sheet? (debt/cash etc)

The group’s Financial Health scores are somewhere between solid and strong.

WOSG’s gearing ratios are uncomfortably high, however, and the liquidity ratios are tight. Net debt has increased recently, so financial health trends are worth monitoring in the years ahead.

Is there evidence of historic share dilution or buy backs?

There are signs of slightly declining shares in issue, which can be taken as a positive for shareholders.

What is the ownership structure of the company and do management have stakes?

Watches of Switzerland has an impressive institutional shareholder base, with some big names buying into the investment case.

Director dealings have been mixed recently, with Romberg selling some £7.2m of shares but other directors buying. On balance, there has been more selling than buying due to two large transactions.

Valuation

It is important to note that Watches does not own the brands it sells. It is a route to market for the real value. That can still make for a great business, but it does also have valuation implications.

After a strong run up in share price, Watches is expensive against its industry group and the wider market across almost all relative valuation metrics:

A 22.6x forecast PE ratio and a forecast PEG of 1.1 can be justified by the group’s strong position in the UK and its US growth potential, but we must also take into account a competitive environment and the fact that Watches does not own the brands itself.

Risks, Threats & Hurdles

What are the biggest risks, threats or hurdles that the business may face?

• Dependence on a few luxury watch brands - The group’s success is largely dependent on its sales of luxury watches, in particular Rolex watches, and has no control over the pricing strategies of these third-party brands.
• Leadership change - The current CEO has been in charge since 2014, and was given a substantial IPO bonus that was contingent on him staying until June 2021. He recently sold 1m shares - could this be a sign of him leaving?
• Competition - Watches is constantly under competitive pressure that both constrains pricing and requires extensive merchandising and marketing efforts in order for it to remain competitive.
• Debt and execution risk - The group has taken on more debt as it ramps up US expansion, which itself is subject to execution risk.

Conclusion

Watches of Switzerland Group has a long history, a strong UK market position, and a clear growth strategy. This has attracted a number of well known institutions to the investor base.

But the fact is that Watches does not own the brands it sells and its share price is already up by more than 210% over the past twelve months. With that in mind, more than two-thirds of members voted against the inclusion of Watches of Switzerland.

There’s no doubt the company is good at what it does though, and its expansion into the US could drive earnings higher. Has the Club missed out on a promising quality growth candidate here, or are there better opportunities to consider?