EUR 850.00 For Business Accounts Only

Morningstar | Swatch's Margins Should Improve Through Operating Leverage and Cost Discipline

Swatch is the biggest vertically integrated Swiss watch manufacturer with 20 brands covering all price ranges, from entry to ultraluxury. Swatch-owned brands account for around 35% of Swiss watch exports, and the company supplies competitors with watch movements. Swatch Group’s luxury brands boast 100- to 200-year histories, iconic collections, and deep cultural heritage. The group’s more affordable brands (at price points below $10,000) benefit from cost advantage through scale and a higher degree of production automation.Swatch’s diversification in terms of brands and price points helps it to avoid the pitfalls that come with extending brands into categories where they don’t strategically belong, and to potentially capture positive mix as consumers trade up. However, we see a lack of control over distribution (70% of sales are wholesale) as a weak spot for the company. Distributors are more likely to engage in discounting to maintain cash flows when demand sours, which we believe can be damaging for brands with long-shelf-life products.The recent strong supply response from Swatch and its competitors to Chinese demand points to a lack of supply discipline. We believe supply discipline is one of the important moat-supporting factors for luxury brands, as it helps to preserve the brand exclusivity perception and ensure high returns on capital. We expect Swatch Group’s sales to grow at a 3%-4% pace over the long term (versus 7% over the prior decade), with growth driven by an increase in the number of high-net-worth individuals globally, some increase of own retail in the mix, and scaling-up of the Harry Winston brand acquired in 2013. We anticipate that this slower growth will be accompanied by decreased investment, as demand grows into capacity built out during the cycle peak. We expect Swatch to take some market share thanks to countercyclical marketing investments and as uncommitted and weaker players exit the market in downturns. Returns on invested capital should increase to 10%-11% over time from 5.6% in 2018 as growth picks up, operating leverage plays out, and investments moderate.