This article was taken from the
June 2023 issue of Market Insight. To subscribe to our investment publications, please visit
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We thought we might mix things up a little and turn away from the titans of industry that tend to dominate our Stock Focus pieces and instead take a look at the small and mid-cap space. Watches of Switzerland group (WOSG) is one company in this sector that has achieved a great deal of success since its IPO in June 2019. The company has built excellent relationships with luxury watch brands, particularly Rolex, and it has played a key role in shifting the industry towards a retail model where shops stock products from only one manufacturer. The company has its eyes set on expansion, with both Europe and the US firmly in its sights. However, it has not all been plain sailing. The removal of the VAT Retail Export Scheme and the tax-free shopping concession has hit it hard. Tourists in the UK were responsible for almost one third of its domestic revenue in 2019 compared to just 4% now. Given this backdrop, its expansion plans are particularly important. Other luxury goods companies have experienced stellar years so far, but WOSG’s share price has dropped by over 25%. While analysts seem broadly positive about the company’s long-term prospects, the short to mid-term horizon has produced some real challenges that bear consideration.
The first and most prominent of these hurdles has been the removal of the VAT Retail Export Scheme and the tax-free shopping concessions previously mentioned. This legislation has allowed tourists to avoid paying VAT on goods purchased in the UK. Given how important the domestic market is to the groups’ bottom line, the loss in revenue from this group has been detrimental to both the company’s balance sheet and its share price. The government in the UK is under pressure to reverse this change, however, given the scale of the UK’s budget deficit, and the current chancellors previous opposition to such a move, it would be unwise to assume that a reversal in this sector was a sure thing. This makes the UK one of the countries in Europe not to offer duty free shopping and makes it near impossible for the UK to compete with the likes of Italy and France as international shopping destinations. Given that WOSG is only just starting to penetrate the European market and over 60% of its revenue is generated from within the UK, this loss of international business is no small matter.
That said, the company does have plans to expand outward into both the European and US markets. These new frontiers offer promising growth prospects, but also some serious challenges. While Watches of Switzerland has an excellent relationship with Rolex in the UK, where it operates almost 50% of its locations, on the continent it has several competitors who have long-standing relationships with a variety of brands. The opportunity for WOSG comes from its existing size. In Europe, retailers tend to be small and operate on a regional basis. One of its main competitors in Europe is Bucherer, a luxury watch retailer that operates 38 showrooms across the continent. For perspective, WOSG operates more Rolex stores than this in the UK alone. The economies of scale that come with its size means that WOSG could offer a more attractive package to top luxury brands when compared to its regional rivals. This theory has been tested in Berlin where Tag Heuer recently chose to open one shop with the group and shut several other local venders in the vicinity in order to accommodate this new relationship. The trust that WOSG has built with luxury watchmakers in the UK should serve it well as it looks to expand into the European market.
In the US, the story is a little different. The country is the largest market for luxury watches worldwide and there are many established retailers in operation. WOSG has predicted that by 2027 US sales will account for more than 50% of its revenue. Watchmakers are seeking to consolidate the number of retailers they do business with in the states and, given WOSG’s affinity with Rolex, it appears it is likely to benefit from this in the short term as many smaller players are forced out of the market.
That said, the primary driver of growth for luxury goods in 2023 has been the reopening of China’s economy and the increased demand for luxury items in the region. As of time of publishing in June 2023, WOSG has no exposure to China or the wider Asia Pacific region and as such is set to miss out on a large portion of the total revenue generated by luxury watches globally. While WOSG is targeting the largest markets globally for its own development, it is very possible that these will not be the fastest growing regions, and as such will not provide the best opportunities for new players hoping to disrupt the market.
On top of this, while inflation in the US is starting to come down, in the UK it has remained exceptionally high. The Bank of England has signalled it is likely to raise interest rates further in an attempt to get this back under control. Further rises are likely to worsen the cost-of-living crisis that we are all feeling and put more pressure on household budgets which could in turn lead to decreasing demand for luxury items, such as watches. The UK labour market has remained tight to date and as such consumers have been willing to take out debt to finance spending on the assumption that they will have the future income required to pay it off. If this continues, then perhaps WOSG will see some recovery in its domestic market, but should unemployment start to tick up, it could well experience a further decline in revenue.
An additional area of concern is the possibility for watchmakers to abandon retailers all together and move their distribution networks in-house, as Audemars Piguet (AP) are doing. Should this model prove profitable and sustainable for AP, it is likely that the additional level of control and long-term cost saving opportunities would appear enticing to other manufacturers. While the shift away from the current model would take a long time and would likely be staggered, WOSG would be exceptionally vulnerable to such a shift. Luckily for WOSG, Rolex has expressed no interest in pursuing this model and, due to the charitable requirements of the foundation that owns Rolex, it is unlikely that it will be willing to provide the capital expenditure required for such a shift.
However, if we take a look at WOSG at a more granular level, things get interesting. Following its recent crash in share price down to £6.24 (in 2022 it had been as high as £14.70), its expected revenue growth rate of 10% starts to look more appropriate. A price to earnings ratio of 12.5 seems remarkably low for a company with such strong growth prospects. On top of this, around half of all its revenue is generated from waiting lists, such is the demand in the luxury watch market at the moment, and this provides the company with a good deal of downside protection should the economy take a turn for the worse. It generates a free cash flow of a little under £126m a year and as such has a strong financial cushion to absorb any unexpected shortfalls. This type of story is becoming typical across the small and midcap space. On a mere valuations basis there appear to be a number of exciting opportunities that are presenting themselves to those who know where to look.
All in all, WOSG has left us torn. The share price seems to be heavily discounted given its strong fundamentals, and the length of the waiting list for almost all Rolex watches provides it with real downside protection in the short-term. It has strong relationships with luxury watch manufacturers that it can leverage to grow into promising new markets, and it is the partner of choice for arguably the most prominent watch maker in the world, Rolex. That said, it has no exposure to the Asia-Pacific market, it remains to be seen if watchmakers will continue to use retailers in the future, and a deep recession could impact people’s desires to spend exuberant amounts of money on watches. The move towards more exclusive mono-brand showrooms seems to indicate a desire for brand recognition and exclusivity that could perhaps be better managed by manufacturers in-house. While WOSG has done an excellent job at promoting this very business model, AP’s expansion into the retail sector could be seen as something of a canary in the coal mine for retailers in the luxury watch market - if it succeeds, other manufacturers may follow.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.