Friday, July 13, 2012

The Swatch Group

Largest watchmaker in the world.  Provides a 'ladder of brands', from low end to high end:
  • Swatch and Flick Flak: $30 to $100+
  • Hamilton and Tissot: Around $300 to $1500
  • Longines: 1.5 to 3.5K per steel watch
  • Omega: 3K to 8K: per steel watch
  • Breguet, Blancpain, Glashuette Original: starting at 15K
Competes with Citizen/Seiko/Casio and many others at the low end, Rolex and Richemont in the luxury range, Richemont, LVMH and Independents in high end luxury.

Segment breakdown

How much of their sales are from high end watches vs low end?  Swatch gives no breakdown: 70 color pages of rubbish in their Annual Report without a single number!  Have to guess from online snippets.  Out of 2011 revenue of CHF 1.27b, from high end to low:
Estimated 2010 revenue (from HSBC Research) is:

Revenue accounted for seems to be spread between low, mid and high end.  Based on the above, and the list of Swatch brands, my guess is: 15% high end luxury (Blancpain, Breguet, Glashuette Original), 30% luxury (Omega), 15% high end (Longines, Rado), 25% basic watches (Hamilton, Tissot, Certina), 5% for kids (swatch, flick flak).  Remainder for ETA and electronics.

Swatch Branding

All swatch brands are neatly categorized into a specific price range with certain characteristics.  For example, a Hamilton or Tissot will never release a watch at a Longines price range.  Only Rado will make ceramic watches.  It follows 100% a textbook strategy on price segmentation by branding.

This is a different approach from Richemont, whose brands compete a little, and do sometimes their own thing by releasing watches that are 'out of character'.  For example, up-market JLC released a Navy Seal watch.  Panerai, a sports brand with large luminous dials, made a  torbillion watch.


Has a rich history and tradition. After dying and being resurrected by The Swatch Group, is now a shell of its former self.

Gained fame in the 19th century as a railroad watch.  Official watch of the American Expeditionary Forces in WWI.  In the 20s and 30s, was used by explorers: Commander Richard E. Byrd f;ying over the North Pole in 1926,  Roy Chapman Andrews  in three years' exploration of the Gobi Desert, First Byrd Antarctic Expedition to the South Pole.  Produced a maritime chronometer in WWII: from zero they produced 10,000+ pieces by the end of the war - considered the 'most accurate portable mechanical timepiece ever made'.  Produced the worlds first electric watch in 1957, the Ventura, worn by Elvis Presley in 'Blue Hawaii'.  Went out of business in 1964.

Brand sold to Swatch Group in 1974; production moved to Switzerland in 2003.  Hamilton watches feature in many Hollywood movies.  Still marketed as an 'American' brand, is pigeon-holed at the lower end of the swatch range (U$300 onwards).

Profit breakdown

Personnel costs usually increase steadily (1% down in 03, 4% down in 04, increased all other years).  'Rent, maintenance and Energy' is also probably fixed.  The other costs seem variable, especially Materials, and Marketing/Sales/Admin:

Profit margin (before tax) recently is between 15% in bad years and 23% in good years, similar to Richemont.  But if we look further back:

Richemont is far more cyclical than swatch - Richemont's profit margins are lower in bad times and higher in good times.  As expected, since Swatch also sells lower end products.

Balance Sheet

Quite clean, 1.6bn CHF net cash.

600m contingent liabilities.  700m leases over the next 5 years. 

Comparison to Richemont

Transcripts: In 2011, Swatch tried to sue Bloomberg for secretly recording a conference call with Securities Analysts and selling it to their clients.  Apparently Swatch has never heard of immediate disclosure of public information.  Switzerland is ranked 3 out of 10 in the world bank ranking for investor protection, on par with countries such as Mali, Chad and Iraq.

Richemont has the potential to branch out into other luxury products (leather goods, jewellery).  Swatch will forever sell watches.

Swatch has many competitors in the sub USD 1000 range.   Some of them make excellent watches (e.g.: Seiko), but have not been able to brand their products to successfully move above that range.  Richemont has fewer potential competitors: in the luxury segment (e.g.: Omega/Rolex/Cartier), branding builds most of the product's value, and only large companies can bankroll this.  LVMH is a threat to both companies (Tag Heur competes directly with Omega....I don't think it has the same type of image as Cartier...achievement vs luxury).

Cannot fault the numbers from Swatch, they are profitable in good times and bad, and less cyclical that Richemont.  They are also financially conservative and don't like debt.

But it seems easier to get a feel for how Richemont develops its businesses, and they have greater potential to expand.  Subjectively, I would choose Richemont.

Thursday, July 12, 2012


Second or third largest luxury goods company in the world, after LVMH and PPR.  Sell mostly watches and jewelery.  Owns Cartier, Van Cleef and Arpels, IWC, Panerai, Jaeger-LeCoultre, A Lange & Sohne, Montblanc, Shanghai Tang and others.

Its a holding company for the South African Rupert family's Luxury goods companies.  The CEO, Johann Rupert, owns 10% of the stock but has majority voting rights.

Some Brand History

Some scattered bits and pieces about their get a feel for the business they are in.


In 2000, Richemont sold their media business and bought LMH (Lange & Söhne, Jaeger LeCoultre and IWC), paying 3b Swiss Francs, at the peak of the economic and watchmaking cycle. They were widely considered to have overpaid - LMC sold 91000 watches in 1999 though 15000 retailers, giving a price tag of U$1.2m per retail outlet, none of them exclusive.  Rupert later admitted they overpaid, but said if they could go back, they would do it again, only overpay by less.  It led Richemont to become one of the largest players in the luxury watch industry.


The Cartier brand has gone through many transformations, from being 'Jeweller to the Kings' to 'appealing to American secretaries'.  In the 70s and 80s, their 'Les Must de Cartier' line aimed to be affordable to a younger audience, and sold cigarette lighters, perfume, watches, scarves and sunglasses. In 2000, Cartier began to a costly exercise to reposition itself as an exclusive watch and jewelry brand, removing cheaper items in the $1000 to $4000 range, and turning into the brand known today.

Luxury brands may be ephemeral.  It takes a constant effort to build and maintain them, and they can be devalued if they branch into cheaper or inappropriate product lines.  Johan Rupert has said that they do not want to "pick the low hanging fruit".  I think, like what Pierre Cardin did in the 80s and what Armani Exchange is doing now.

Profit Breakdown

  • Operating Margins below approximate PBT in the period shown, they differ only by (negligible) finance costs.
  • Using PBT allows us to ignore BAT associate (divested Nov 08)

The dip in 2010 seems to trail the stock market by one or two years: hard luxury is historically more cyclical than soft luxury.  Operating margins are between 15% (bad times) to 23% (a stellar 2012).

As a percentage of sales:
What costs are fixed and variable?  Looking at the absolute amounts (not percentages):
  • Only their Administrative costs seem to be fixed (Only dipped once in the past 7 years, and that was less than 1%).  
  • Other costs seem to be variable: Advertising declined 21% in 2010 (its not obvious on the chart) but rose every other year.  
  • It takes a fixed investment in staff and equipment to produce and jewelery and watches, but Cartier cut about half their production staff in the last downturn.  Variable....I guess.


Balance Sheet

Very clean. Negligible long term debt.  3b Euros cash.

Minimum operating lease less than 600m Euros.  Interesting that about 40% of this is contingent, the real minimum (if they don't sell anything) is under 350m.  They get their landlord to share in their success - first time I have see this in a listed company.

Non-cancellable leases are 900m for the next 5 years.

FCF and Capex

First, looking at CFO and Profits: since COGS is their largest cost. their CFO is most influenced by inventory:  (All charts below exclude BAT)

There is a clear pattern: CFO is usually slightly lower than profits, the difference being mainly inventories and depreciation.  Except for the past two recessions, where they work off inventory (2004 and 2010 were the only 2 years where inventories added to CFO), resulting in CFO being higher than profits.

They have generated free cashflow for the past 10 years (2002 was negative due to high CFI):

Majority of CFI was spent on PPE (mostly) and acquisitions (approximately 1/3rd of it).  Can't determine how much of the PPE was replacement and how much was expansion.

In the 2011 AR, they said they will keep expanding: "Our capital investments are therefore likely to range between 6 % and 8 % of sales in the next two years".

Business Model:

Buy troubled brands on the cheap, then take 5 or 10 years, using cashflow from their existing successful brands, to turn them around.  Examples of troubled brands acquired include Cartier in 1979, Panerai in 1999  - LMC was the exception (...not cheap).  They take time and effort to build their brands.  They mention that their businesses need to reach a critical mass: "it’s a lot harder to get from zero, or from €100 million to €200 million, than it is from €200 million to €600 million. From €500 million to €1 billion is a lot easier than from €100 million to €200 million".  Some of their brands are still loss making (Baume and Mercier) - Richemont did not break down the sales/profits of individual brands.

They are financially conservative.  No debt for the past 10 years.  Cashflow from their successful businesses is used to turnaround the troubled ones, and overall they have been profitable, and generating free cashflow for 10 years.  The CEO has stated that they prefer to build their current brands rather than acquire new ones ("Our job is to create goodwill, and not to pay other people for goodwill").  And that they will not use equity for acquisitions

I think they need to be financially conservative to handle bad times in a highly cyclical industry:
  • They prefer, as much as possible, variable costs instead of fixed costs.  e.g.: have a turnover clause when leasing from landlords.
  • In 2011, retail sales grew to match wholesale, for the first time.  The CEO previously mentioned that there is no fixed target to increase the percentage of retail.
  • CEO previously mentioned that they are one of the fastest in scaling back production when bad times occur. 
Each brand has separate manufacturing facilities: "Our philosophy is based on verticalisation, i.e. each maison has its dedicated manufacturing facilities to guarantee authenticity."  This is important, because serious watch-people care about the components inside their watches.  So they don't try to get 'synergies' or economies-of-scale from combining (the manufacture of) different brands.

The transcripts of the results presentations are very informative. And even entertaining - especially the Q&A sessions.  Really get a feel for how management runs the business.


Like this company: Its long term approach to building brands, clean balance sheet, free cashflows, and financially conservative nature.

And my wife likes their brands.

  • LVMH. With 3X the revenue and profits of Richemont, and its Bvulgari acquisition - LVMH is moving further into the luxury watch industry.  The barriers to entry are not strong enough to stop a monster like LVMH.
  • China.  A downturn would affect everyone else too.  With its cash, the company will survive.
High beta stock, we see it roughly drop and rise 4X from peak to trough (stock price in Swiss Francs):

(Note the chart's y-axis does not start at zero, so looks a little worse than it is).

Dangerous game, playing with highly cyclical stocks.  I don't think I could bear seeing my stock drop 4X....Wait for a recession to buy.