Watches of Switzerland Group (WOSG) is the UK based retailer of high end luxury watches and jewellery, which it sells through its portfolio of retail locations in the UK and US as well as through its online websites. WOSG listed on the London Stock Exchange in 2019 and has performed fantastically for investors since its initial public offering, from which it is up over 220% to date. With the coronavirus lockdowns of 2020 behind us and the seemingly insatiable demand for luxury watches continuing, does WOSG pertain to being a good investment?
The group’s history dates back to the 1700s where one of their future retail brands Mappin and Webb was created as a purveyor of silverware in Sheffield. In 1897, Her Majesty Queen Victoria first granted a Royal Warrant to Mappin and Webb. The Mayors retail brand started its first stores in Cincinnati Ohio in 1910 and subsequently opened a flagship store in Miami in 1937. The namesake Watches of Switzerland brand started in 1924, selling watches via mail order before setting up its first store in Ludgate Hill, London.
In the 1970s, Watches of Switzerland opened its first Rolex mono-brand retail store in London, which marked a significant milestone in strengthening the business' partnerships with key retailers. Over the next 30 years, Watches of Switzerland grew independently before merging with Mappin and Webb and Mayors in the 2000s.
The group has had many different owners over its history, changing hands from privately held jewellers to private equity companies. Eventually, the group was listed in 2019.
The group engages in the retail of luxury watches and jewellery in the UK and US through its 148 (core) branded stores Goldsmiths, Watches of Switzerland, Mayors, Mappin and Webb and its mono-brand partnership stores under the brand banners of Rolex, Patek Philippe and Audemars Piguet.
Revenue is highly weighted to the UK. With UK sales of £600 million in 2021, the group has a share of roughly 27% of the £2.2 billion UK luxury watch market. In the US, the group has revenues of £300 million, which is the equivalent to 6% of the £5 billion luxury watch market in the world’s second largest watch market.
As you can see from below, the group’s business is almost exclusively weighted to the sale of watches with only a 6.7% inclusion from jewellery. The ‘other’ segment relates largely to the sales of service and maintenance to existing watch owners.
Reading into the group's annual report, you do begin to understand some of the important characteristics of the business model. The luxury watch category is almost exclusively dominated by a handful of private, some family owned, Swiss companies. Rolex, Patek Philippe, Audemars Piguet and Hublot are all examples of this private structure, which typically produce less watches in a year than there is demand for.
As written by Bloomberg, ‘Brands including Hermés, Rolex and Audemars Piguet temporarily halted production last year (2020) amid the pandemic, which helped ease a supply glut’. By having control over exclusive brands, supply and pricing, the industry largely works together to maintain prosperity. I would expect that, given the geographic proximity and watchmaking tradition in Switzerland going back many years, this stronghold on the market is likely set to continue.
The group recently released its Q1 2022 results on the 10th of August. Sales were buoyant to say the least. Revenue for the quarter was up 102% versus the prior year and 45% versus the year before that, showing spectacular levels of growth even compared to pre-pandemic levels. The group's results as they exit the pandemic have been largely buoyed by strength in domestic spending in the UK and US, with the additional boost from mono-brand store roll-outs in both markets.
Looking a little further back at performance in the last five years, the group has averaged a growth rate of 15% per annum, with especially good years of +20% growth in 2017 and 2018.
Performance over these years has been largely underpinned by strong levels of demand for luxury watches, noted by the rising percentage of exports from Switzerland coming from the luxury end of the market as opposed to mid range. As the company notes in its annual report:
‘Watches at the luxury end of the market have outperformed lower priced segments and represent 91.6% of the value of global Swiss watch exports in 2019; note in 2000, luxury watches represented 38.7% of the value of all Swiss watch exports. [...] Luxury watches have continued to be supported by long term increases in prices, with average selling prices of Swiss watch exports (wholesale) generating a 20-year CAGR of +3.4% (2020 vs 2000).’
Long Term Outlook/Growth Drivers
WOSG Annual Report
Demand for luxury Swiss watches has grown at resilient levels for a long period of time. Since 1970, compound annual growth for exports has averaged 3.3%. Whilst there has been some corrections in the level of exports (notably in the great financial crisis, a slowdown in purchasing in China in 2016 and also due to the Covid-19 impact) over the long term, export numbers have been rising. Important to recognise is that some of the above impacts will not have been felt by WOSG as the company has no exposure to China, thus it has likely performed in a more stable fashion than the total market.
Whilst we cannot guarantee that this historic tailwind of demand for premium watches will continue into the future, the overall trend is positive, and as economies produce more wealth, it is likely that aspirational purchases of luxury items will continue, in addition to the small number of watchmakers raising prices steadily over time.
WOSG Annual Report
Looking specifically at WOSG, its big opportunity is in the US market. Somewhat surprisingly given that the US is the consumer capital of the world, US luxury watch ownership per capita is much smaller than the UK, where 3.5x as much revenue per capita is generated compared to the US. Compared to other luxury goods, watches seem to be a clear underspend for American wealthy individuals, where the market is only 1.8x as big as the UK versus 7.6x for luxury leather goods. With key retail stores such as Mayors and mono-brand locations at popular luxury shopping venues such as the Wynn casino in Vegas, WOSG aims to grow into this opportunity.
Lastly, WOSG reference the burgeoning resale market as a potential opportunity in their financial reports considering that the emergence of more resale venues creates liquidity and provides strong price realisation for watch owners. This allows people to think of a watch as more of an asset rather than a depreciating purchase, therefore justifying more purchasing behaviour.
As with any investment, risks are present. For WOSG, the main risks I see are the fine balance between demand and supply for the Swiss manufacturers. In order for WOSG to continue growing, it needs to source an ever higher quantity of time-pieces from an industry that requires scarcity to protect its brand value. In 2021, Hermés sounded the alarm that Swiss producers were flooding the market with too much supply, as bonus incentives for distributors incentivised more inventory from the leading makers. However, WOSG has truly preferential partnerships with the watchmakers and the relationships are on parity given the need for key brand manufacturers to ensure their products are seen in impeccable quality showrooms. Given the time WOSG has been operating in this market, it is likely the group has the experience and relationships to navigate supply issues.
Another potential risk would also present itself in a slowdown of demand due to economic circumstances. Watch exports fell from 15.9 billion CHF in 2008 to 12.3 billion CHF in 2009 during the financial crisis. However, given that UK exports were up 0.1% during the period and many high end luxury customers have the ability to spend even in bad economic environments, it looks as though WOSG is partially insulated from this too.
All Twenties Trader financials are sourced directly from company annual reports and prospectus documents.
Looking at the financials, WOSG has been improving over the years on many fronts. Despite growth slowing down from 2017 to 2021, gross margins have improved greatly to 13.3% and operating margins have doubled to 9%. Debt has also fallen considerably, with a key ratio debt to equity (total liabilities:equity) dropping from 6.86 to 2.30 in 2021 as WOSG went from a privately held entity to being capitalised on the London Stock Exchange.
The company reports ROCE of 19.7% for 2021 on an adjusted average pre IFRS basis (essentially using the average number of assets employed throughout the year compared to adjusted profit). This measure slightly flatters results, with the real ROCE sitting at 12.8% using their year end figures. For extra detail, many companies report ROCE in this way, but WOSG didn’t exactly make it easy to find the real figure.
Profit margins at WOSG don’t look incredible compared to the typical company I review. However, we have to be mindful of the products they sell having a high ticket value, thus the margins aren’t likely to be massive. In summary of these financial metrics, the last five years has seen WOSG go from mediocre to good. Only time will tell if these results can turn into ‘great’.
Summary and Valuation
In summary, I think WOSG has a unique opportunity, considering a large portion of the luxury watch market is either owned by private families or by large fashion houses (typically lower end watch brands). Therefore, the group allows investors to get luxury watch exposure where they may not otherwise be able to.
Very importantly, the luxury stocks available to investors such as Kering, LVMH, Richemont and Burberry all have large exposures to the Chinese market, which has recently created lots of trouble for investors given the communist party clamping down on the wealthy, amongst other regulatory concerns. With WOSG exclusively operating in the US and UK, it is one of the only ways to participate in the luxury sector without this risk from China.
The dynamics currently at play by the Swiss manufacturers and the strong relationships with a trusted retailer such as WOSG largely ensure supply is prioritised through this channel, but oversupply and future growth could be a concern.
In terms of valuation, WOSG trades on approximately 30x this year's earnings falling to 25x earnings the year after. This isn’t overly expensive for a decent quality company such as this. I have no position in WOSG and no immediate plans to purchase the stock, but I shall be keeping my eye out for a potential pullback given the underlying opportunity and strength of the business.
At the time of writing, The Twenties Trader did not own shares in Watches of Switzerland Group.
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