Luxury goods stocks are to Europe what technology stocks are to the US. The performance of European luxury stocks may not be as spectacular as US tech stocks’ but they have nonetheless generated solid and consistent returns. That is why Bernard Arnault, owner of LVMH (MC:FP), briefly surpassed Elon Musk as the richest man on the planet and is still the world’s second-richest entrepreneur.
Global appetite for European luxury products seems insatiable. Italian fashion, French brandy or Swiss watches are all in high demand and benefit from low price elasticity. Rich people are able and willing to pay high prices for the best quality. Nor do they change their consumption habits much in a downturn. That is why stocks of the strongest luxury brands like Hermès (RMS:FP) or Brunello Cucinelli (BC:MI) tend to trade consistently at a substantial premium to the market. Investors pay up for these companies’ high profit margins, pricing power and low sensitivity to economic cycles.
Why, then, has the stock of the largest distributor of Rolex, British company Watches of Switzerland Group (WOSG:LN), (OTCPK:WOSGF) done so poorly? The company is performing remarkably well. Revenues have nearly doubled in three years. Having conquered the British market, this luxury retailer has just begun its international growth. Its recent expansion into the US market is nothing short of spectacular. With sales up 52% over twelve months (albeit 35% at constant currency), North America already accounts for more than 40% of the group’s revenues. Management still sees plenty of scope to grow by acquisition of retailers in the fragmented US market. Next is Europe. A little over a year ago, the Group decided to apply their successful formula to the Old Continent where retail of expensive watches is also dominated by small family-owned shops.
Swiss watchmakers are small companies with a laser-sharp focus on quality. Their focus is on the product, not so much on distribution. As a result, Swiss watches have historically been distributed through a myriad of mom-and-pop stores around the world, which makes it hard to keep proper quality controls over their sales channels. Some of these family-owned shops may be appropriate, others may not. How to keep track from Geneva? Here is where the Watches of Switzerland Group comes in as a consolidator. Rolex or Patek Philippe can trust the Group to provide a uniform quality service anywhere in the world.
Why is the stock so cheap?
Watches is growing rapidly, has great visibility, and is very profitable. Despite this, it is trading at just a little over 11 times earnings. It boasts an EV to EBITDA under 8 and an enterprise value to revenues of only 1.3. The stock is down 22% over the past year and is trading at a big discount to its peers.
In contrast, LVMH, the uncontested standard of luxury stocks, is up 35% over the last 12 months and trades at an EV/EBITDA multiple of 16 and at 5.5 times revenues. The Swiss Company Financière Richemont (CFR:SW), which owns major jewelry brands and high-end watchmakers like Cartier, Piaget, and Van Cleef & Arpels, has seen its stock price go up 50% over the last year. It trades at 12 times EBITDA and 4 times revenues.
The fundamentals of business don’t seem to justify such underperformance. Management has a very strong track record and a clear strategy. Their plans for expansion in Europe and the US point to visible multi-year growth. They are adding new partnerships with prestigious watchmakers, including TAG Heuer, Audemars Piguet and TUDOR. They are also in the process of launching a very promising Rolex-certified pre-owned product service online.
Visibility
For something to be special, it has to be rare. Luxury brands are very careful in managing their supply. Expensive watches would not be special if they were mass produced. Customers of stores in Watches’ network typically have to order exquisite watches in advance. Popular items thus have long waitlists which gives the stores great visibility in future revenues.
The company’s track record is strong. Management is credible. The guidance is conservative. What are we missing?
Watches Of Switzerland probably doesn’t deserve a LVMH-like valuation because it does not own the brands. It is merely a retailer of high-end products, operating multi-brand stores as well as mono-brand stores. However, having secured unique long-term business relationships with the best brands in the industry, they benefit from many of the same dynamics.
On the other hand, in more bullish times, a company with such excellent growth prospects would have traded at a premium to its more mature counterparts. The business is expanding more rapidly than the more mature companies LVMH or Richemont. This should justify a higher, not a lower multiple on revenues. Since WOSGF is still investing heavily in its growth at the expense of short-term profit margins, the stock needs to be valued relative to the top line rather than the bottom line. With an EV to revenues of only 1.3, WOSGF is trading at less than one-third of LVMH (5.5X) and less than half the Swiss group Richemont (4X). The ultra-luxury group Hermès is in a league of its own at an enterprise value to sales of 16!
There may another, more short-term explanation for the stock’s undervaluation. Delays in product deliveries caused management to warn of a small decline in sales in the first quarter of their fiscal year ending in March. “More than half of our business is driven by supply, and you can never predict the exact timing,” CEO Brian Duffy said, per Bloomberg, adding that it would be “misleading if people are focusing on that as any indication of the market or business overall.”
This seems fair. What matters in the long run is the order book, which gives strong confidence in second half demand. The expected rebound in product supply explains why full year guidance for double-digit growth remains unchanged. The stock has suffered a very hefty correction for what looks like a small timing issue that will be quickly remedied and quickly forgotten. The market chose to ignore the headline of an impressive 25% revenue increase for the past fiscal year and a reiteration of double-digit growth for the full year ahead.
Another cloud hanging over the stock may be the correction of the second hand index for watches. This index exploded at the outset of the pandemic but has since given back half of its gains. Aggressive fiscal and monetary policies during the pandemic resulted in an abundance of liquidity chasing all kinds of assets. Used watches got caught in this frenzy. Now prices are trending lower again, albeit still at a substantial premium to pre-COVID prices. This may have affected sentiment, but then why did Richemont’s stock not behave accordingly? In any case, Watches of Switzerland is not in the market for pricey second hand watches.
PS. As we go to press, Watches of Switzerland just released a 25% increase in their year-on-year sales as of the end of the recent quarter. This is much better than expected by most analysts. Management spooked investors by being overly conservative three months ago. We think they continue to be too conservative with their guidance of 8 o 11% revenue growth for the full year. According to Yahoo Finance, Watches trades at 12 times projected earnings. This, we believe, is a bargain considering the flawless execution of their strategy, the double-digit revenue growth and the future expansion of profit margins that will come with economies of scale.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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