The Watches of Switzerland Group operates in the luxury watch market, which has a strong track record of growth, and the branded jewelry market, which is expected to perform well in the future as branded jewelry continues to gain market share from non-branded jewelry. But is this enough to make the company a compelling investment? This is what I will investigate in this analysis.
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Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
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The Business
The Watches of Switzerland Group PLC is a British company that operates as a retailer of luxury watches and jewelry in the United Kingdom, Europe, and the United States. The company manages showrooms under the Watches of Switzerland, Mappin & Webb, Goldsmiths, Mayors, Betteridge, and Analog brands. Additionally, it oversees mono-brand boutiques on behalf of prestigious names such as Rolex, OMEGA, Tag Heuer, Breitling, TUDOR, Grand Seiko, BVLGARI, and Fope, and also operates e-commerce platforms. The company specializes in the sale of fashion and classic watches, as well as jewelry, and offers services including servicing, repairs, and product insurance. The Watches of Switzerland Group boasts a total of 223 showrooms: 158 in the UK, 56 in the U.S., and the remainder across other European countries. The company generates 55% of its sales from the UK and Europe, and 45% from the U.S. Its largest segment is luxury watches, contributing 87% of its sales, followed by luxury jewelry at 7%, with services making up the remaining 6%. The Watches of Switzerland Group has a strong competitive advantage, or moat, stemming from its long-standing and collaborative partnerships with the most prestigious and recognized luxury watch and jewelry brands—relationships that take years to establish. The distribution of luxury watches is governed by Selective Distribution Agreements, which are strict, legally binding contracts with brands on a point-of-sale basis. These agreements, typically limited by geography, ensure that retailers maintain rigorous presentation standards. Selective Distribution Agreements enable brands to control the number of points of sale and set qualitative criteria for retailer approval. As a result, product presentation and client experience are closely monitored by brand owners, creating high barriers to entry in the sector. Another key element contributing to the company’s moat is its scale. Thanks to its scale, the company benefits from dynamic inventory management, optimizing stock availability, enhancing showroom productivity, and in the UK, providing nationwide coverage—advantages that smaller companies cannot match. Therefore, the Watches of Switzerland Group secures its moat through strong partnerships and significant scale.
Management
Brian Duffy is the CEO of the Watches of Switzerland Group, a position he has held since joining the company in 2014. He is an ICAS Chartered Accountant and holds an Honorary Doctorate from Glasgow Caledonian University. Prior to his role at Watches of Switzerland, Brian Duffy served as Group President of Polo Ralph Lauren Europe and the Middle East for nine years, based in Geneva, Switzerland. Brian Duffy began his career at Playtex, where he rose to the position of CFO at the age of 33. Following the acquisition of Playtex by the Sara Lee Corporation, new opportunities emerged for Brian Duffy, and his career shifted towards marketing and branding. His first major marketing success was the launch of the Wonderbra brand, which was a phenomenal achievement. Unconventionally, Brian Duffy decided to take a break from his corporate career to pursue a degree in contemporary music, until he was offered the opportunity to become President of Ralph Lauren. According to an analysis by Jefferies, CEO Brian Duffy is a significant asset to the Watches of Switzerland Group. He is recognized as a strong communicator and executor, highly valued by investors. I believe that Brian Duffy’s extensive retail and international experience, financial acumen, proven track record, and deep understanding of the global luxury watch and jewelry sector make him the ideal leader to guide the Watches of Switzerland Group forward.
The Numbers
The first metric to investigate is the return on invested capital (ROIC). Our criterion requires a 10-year history with all figures exceeding 10% annually. However, the Watches of Switzerland Group made their IPO in June 2019, so we only have data from the past five years. It's also important to note that the Watches of Switzerland Group's fiscal year runs from the start of May to the end of April, which means the numbers from 2020 do not cover a full year. Despite this, the Watches of Switzerland Group has managed to deliver a ROIC above 10% in all five years for which we have data, which is very impressive. It is particularly noteworthy that the company achieved a ROIC above 10% during the fiscal year 2021, which was impacted by the pandemic, and in fiscal year 2024, which faced challenges from macroeconomic factors. These figures are encouraging, and I believe that the Watches of Switzerland Group will continue to deliver a ROIC above 10% in the future.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Since the Watches of Switzerland Group made their IPO in June 2019, we only have data for the past five years. It is encouraging to see that the company has managed to grow its equity every year since its IPO. This is particularly noteworthy given that fiscal 2024 was impacted by macroeconomic factors, which may explain why the year-over-year growth rate wasn’t as high as in previous years. Nonetheless, the Watches of Switzerland Group is a textbook example of how you would like to see equity growth, as it has consistently grown by more than 10% annually since its IPO.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is encouraging to see that the Watches of Switzerland Group has managed to generate positive free cash flow every year since its IPO. Free cash flow peaked in fiscal year 2021 but has since decreased, with the company delivering its lowest full-year free cash flow in fiscal year 2024 (noting that fiscal year 2020 doesn't cover a full year). Similarly, the levered free cash flow margin has declined since fiscal year 2021, reaching its lowest point in fiscal year 2024. While the last couple of years have been impacted by macroeconomic headwinds, it is slightly concerning that the levered free cash flow margin continues to decline. I would like to see an improvement in this metric moving forward. On a positive note, the free cash flow yield is at its highest level ever, indicating that the shares may be trading at an attractive valuation—though we will revisit this point later in the analysis.
Debt
Another important aspect to consider is debt. It is crucial to assess whether a business has a manageable level of debt that can be repaid within a period of three years, determined by dividing the total long-term debt by earnings. Upon analyzing the Watches of Switzerland Group's financials, it is evident that the company has 1,88 years of earnings in debt. This figure is well below the three-year threshold, indicating that debt is not a concern for me if I were to invest in the Watches of Switzerland Group. Additionally, it is worth noting that long-term debt is at its lowest point since the IPO.
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Risks
Based on my findings so far, I believe that the Watches of Switzerland Group is an intriguing company. However, no investment is without risk, and the Watches of Switzerland Group faces its fair share of challenges. One significant risk is the macroeconomic environment, particularly in the UK and Europe. The company's recent performance has already been impacted by these factors, as evidenced by a 5% year-on-year decline in sales within these regions. This decline reflects broader economic challenges, including high inflation and rising interest rates, which have put substantial pressure on consumer spending power. Management has also noted that the UK luxury watch market is undergoing a period of normalization following the COVID boom, during which consumers had more disposable income to spend on watches and jewelry. Additionally, significant price increases for Swiss watches, driven by the strength of the Swiss Franc, have further squeezed aspirational customers who may have previously considered purchasing these high-end products. If these macroeconomic challenges persist or worsen, the company could face prolonged pressure on its sales and profit margins. The combination of reduced consumer spending, increased costs, and the ongoing normalization of the luxury watch market could lead to more challenging years ahead for the Watches of Switzerland Group.
Another risk is the withdrawal of VAT-free shopping for tourists following Brexit. This change presents a significant challenge for the Watches of Switzerland Group, particularly in the context of its UK operations. Historically, VAT-free shopping has been a strong incentive for international tourists to purchase luxury goods, including high-end watches, during their visits to the UK. The ability to reclaim VAT made the UK an attractive destination for luxury shopping, allowing tourists to buy expensive items at a lower effective price compared to their home countries. However, with the withdrawal of VAT-free shopping, this cost advantage for international shoppers has disappeared, leading to a notable decline in the number of overseas shoppers in the UK. Consequently, the UK market has become increasingly reliant on domestic consumers, who may not have the same level of spending power or inclination to purchase luxury items as international tourists. The withdrawal of VAT-free shopping for tourists thus represents a significant risk for the Watches of Switzerland Group. The company must navigate this new landscape carefully, finding ways to mitigate the impact of reduced international spending while ensuring continued growth and profitability in the UK market.
Another risk is the need for the Watches of Switzerland Group to maintain strong relationships with luxury watchmakers. These relationships are a critical aspect of its business model and represent a significant risk if they were to deteriorate. Some of the company’s distribution agreements include clauses that allow luxury watch brands to terminate the agreement in the event of a change in control or management within the Watches of Switzerland Group. This creates a vulnerability, as any significant corporate restructuring, acquisition, or management turnover could trigger the termination of these crucial agreements. Even without a change of control, there is always a risk that luxury watch brands might choose not to renew their agreements with the Watches of Switzerland Group when they expire. Brands might also reduce the number of agencies granted to the company, limiting its ability to offer a full range of products. This could happen if brands seek to diversify their distribution channels or if they perceive that the Watches of Switzerland Group is no longer the best partner to represent their products. Moreover, the luxury watch industry, like many others, is experiencing a shift towards direct-to-consumer sales, where brands sell their products directly through their own boutiques or online platforms, bypassing third-party retailers. If luxury watchmakers increasingly adopt this model, the Watches of Switzerland Group could face substantial pressure.
Reasons to invest
There are numerous reasons to consider investing in The Watches of Switzerland Group. One compelling reason is the strong track record of growth in the luxury watch market. The luxury watch industry is well-protected by high barriers to entry and has a history of consistent long-term growth, driven by sustained investment and elevated innovation. Luxury watches attract a diverse range of shoppers who often become repeat clients, spanning various age groups, income levels, and genders. The internet has also had an increasingly positive impact over the years, with digital and social media appealing to a younger market. Additionally, demand for luxury watches has outpaced production, a trend that luxury watchmakers are keen to maintain. According to various earnings transcripts that I have read, luxury watchmakers learned from previous years (2015-2018) when they flooded the market with luxury watches, which led to decreased margins. Even if luxury watchmakers decide to ramp up production, they are constrained by the labor-intensive nature of watchmaking and the shortage of highly skilled watchmakers.
Another reason to consider investing in the Watches of Switzerland Group is that the company is among the first to offer the Rolex Certified Pre-Owned program. This program provides customers with the opportunity to purchase pre-owned Rolex watches from official authorized dealers, with each watch certified as authentic and accompanied by a Rolex-backed two-year international guarantee. This initiative has made the pre-owned market more accessible to customers who may have previously been hesitant about purchasing pre-owned items. Management has reported that trading within this program has been very encouraging, and it has introduced a new client base to this product segment. They have high hopes for the pre-owned watch business (not limited to Rolex), as they believe it will continue to grow. This growth is driven by the fact that the supply of certain products in the first-hand market is inadequate to meet demand, and for collectors, nearly 95% of watches are no longer in production.
Another reason to consider investing in the Watches of Switzerland Group is its branded jewelry business. The global luxury jewelry market has been shifting towards branded jewelry, with the market share of branded jewelry compared to non-branded jewelry increasing from 17% in 2019 to 25% in 2023, and it is expected to reach 34% by 2027. Luxury branded jewelry typically has a higher average selling price and purchase frequency, along with higher levels of self-purchase, making it less promotional and less cyclical than non-branded jewelry. Management has identified this as a significant growth area for the Group moving forward, where they can leverage their expertise gained in luxury watches to expand into the luxury branded jewelry sector. To boost this part of their business, the Watches of Switzerland Group has acquired Roberto Coin Inc., a globally renowned brand with a particularly strong presence in the North American market, where it is the sixth largest luxury jewelry brand.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 0,25, which is from fiscal year 2024. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 22,9% a year in the next five years, but 15% is the highest I use. Additionally, I have selected a projected future P/E ratio of 30, which is twice the growth rate. This decision is based on the Watches of Switzerland's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be £7,50. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy the Watches of Switzerland Group at a price of £3,75 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 191, and capital expenditures were 82. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 57 in our calculations. The tax provision was 33. We have 239,6 outstanding shares. Hence, the calculation will be as follows: (191 – 57 + 33) / 239,6 x 10 = £6,97 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With the Watches of Switzerland Group's Free Cash Flow Per Share at £0,46 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is £7,26.
Conclusion
I believe that the Watches of Switzerland Group is an intriguing company with strong management. The company has a moat through its strategic partnerships and scale. It has consistently delivered a high ROIC since its IPO, but it's worth noting that free cash flow and the levered free cash flow margin have decreased over the past few years. The company faces some short-term risks due to macroeconomic factors. High inflation and rising interest rates have put substantial pressure on consumer spending power, while the strength of the Swiss Franc has increased prices for Swiss-made watches. Although macroeconomic conditions should eventually improve, they pose a risk for the Watches of Switzerland Group in the near term. The withdrawal of VAT-free shopping for tourists following Brexit presents another risk, as the company will increasingly depend on domestic consumption. It remains uncertain whether domestic consumption can fully compensate for the loss of tourist spending. Maintaining strong relationships with luxury watchmakers is essential for the Watches of Switzerland Group, as this is a critical aspect of its business model. Any deterioration in these relationships could represent a significant risk. The Watches of Switzerland Group operates in an attractive industry, as the luxury watch market is well-protected with high barriers to entry and a history of consistent long-term growth, which should benefit the company in the long run. The Rolex Certified Pre-Owned programme is also likely to benefit the company over time, as it has made the pre-owned market more accessible to customers who may have previously been hesitant about purchasing pre-owned items. Additionally, the company stands to gain from the growing trend towards branded jewelry, where it can apply its expertise from the luxury watch sector to the luxury branded jewelry market. While I find the company appealing, I would personally like to see an improvement in free cash flow and levered free cash flow margin before investing. However, I understand if someone were to open a small position below the margin of safety price at £3,75.
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