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Morningstar | Little to Cheer at Swatch’s Full-Year Results but Shares Still Attractive

We are maintaining our fair value estimate of CHF 376 per share for narrow-moat Swatch as the company reported full-year results that were weaker than our and consensus expectations. Sales for the full-year at constant exchange rates increased by 5.7% versus the 8% we expected, while operating margin grew to 13.6% from the 12.5% versus 15% we expected. Excluding the production bottlenecks brands in the second half of the year, revenue would come approximately in line with our expectations while operating profit would be mid-single-digit percentage points weaker.

Revenue in the second half of the year declined by 0.8%, versus 14.8% growth in the first half, with business slowing significantly in the last three months and December particularly slow.

Some production companies in the Habillage sector (cases, dials, watch hands) worked at or above capacity, resulting in delivery delays for Omega and Longines. Although the company added employees in 2018 (employee expenses rose 9.6% versus 6% revenue increase with a 5% total workforce increase), productivity in the Habillage unit was not up to speed, creating the bottleneck. Around CHF 200 million-CHF 300 million for the Omega and Longines brands was lost as a result and will be recuperated in 2019 at a strong margin.

Nonetheless, workforce increase and disappointing operating leverage goes against our thesis that with revenue still practically at 2015 levels, the company should be comfortable growing off the same productive capacity. According to the company, management is being increasingly prudent about new hires and is focusing on the productivity of the existing workforce. However, since manufacturing is brand-specific a mix of over- and under-performing brands could create inefficiencies in manufacturing capacity utilization that could hinder operating leverage going forward. So far, we don’t see a reason to make significant changes to our assumptions of gradually improving operating leverage.

Inventories increased by 9.5%, growing faster than revenue, however, excluding Omega and Longines inventory related to the bottlenecks and acquisition of Pink Legacy Diamond for Harry Winston, inventory growth was practically in line with sales growth.

Prestige and luxury watch ranges, such as Blancpain, Omega, and Longines continue to outperform at Swatch and elsewhere in the industry. While Swatch doesn’t breakout growth rates by brand, Swiss watches priced over CHF 500 at export value delivered high-single-digit growth in the year, while those priced below CHF 200 experienced declines for the third year in a row. According to Swatch, volume brands of the middle and basic range performed well in the retail segment, however, wholesale accounts, especially in China, curtailed purchases massively, fearing online competition.