Watches of Switzerland: A Contrarian Bet (OTCMKTS:WOSGF)

Watches of Switzerland Group or “WOSG” (OTCPK:WOSGF) is among the world’s largest luxury watch dealers (mainly Rolex, but also Audemars, Patek Philippe, Cartier etc.) with a clear lead in the UK market , as well as a rapidly growing US present. WOSG’s economics have long been very attractive, combining best-in-class returns >20% with consistent earnings growth over cycles. That perception has changed drastically in the past year, however, mainly due to concerns about Rolex going downhill. post purchase of its Swiss distributor Bucherer. A string of poor trading updates and a big profit warning earlier this year didn’t help either.

However, if more recent data points are any indication, the worst may finally be over for WOSG. However, the market has kept WOSG stock firmly in the penalty box, and at the current P/E before ~10x, Rolex disintermediation risk is likely over-priced. Also, in my view, WOSG’s “plan” value is not properly established as a Bucherer-type M&A target (probably the most logical vertical integration path for Rolex).

All of this simultaneously leaves WOSG investors with a healthy dose of safety margin against future execution crashes and plenty of upside if the company moves closer to its ambitious “long-term growth plan” (or “LRP”). Bottom line, a favorable risk/reward here.

Another online trading update

WOSG has had its fair share of earnings disappointments; the most recent being a massive profit warning earlier this year citing “challenging macroeconomic conditions” which caused the stock to drop >30%. However, since the big reset, trading updates have been largely in line with management expectations.

Post-AGM commentary earlier this month was more of the same. To recap, the company reiterated the outlook for FY25 (pre-IFRS 16) that it initially set out in its FY24 results. For P&L, key targets remain a top line of 1.67-1, £73 billion (9%-12% implied constant currency growth) and +0.2 to +0.6 percentage points of EBIT margin expansion. Elsewhere, conversion targets of £60-70m and ~70% free cash flow are intact. Also positive was the fact that the integration of Roberto Coin Inc., for which the company now holds distribution rights in the US/Canada/Central America, is “progress to plan”.

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Source: Watches of Switzerland

Promising signs from Swiss export data

The other big plus that came out of this month’s AGM was the upbeat outlook of management “demand for our key luxury brands… remains strong in both the UK and US markets, outstripping supply.” In support of this view, monthly data from the Swiss watch industry shows promising growth.

Overall, watch exports rose +1.4% in July – reversing consecutive monthly declines through June.

By geography, WOSG’s key UK market was relatively resilient (+0.9%), tracking a gradually improving macro context. Meanwhile, the company’s other key area, the US, continues to outperform at +11.3% month-on-month.

However, the even more positive reading is that the very premium end watches, the “bread and butter” for WOSG, performed better. Of note, wristwatches over CHF 3,000 (up +5.4%) and made of precious metals (up +12.6%) led the way in July.

To be clear, setting guidance will not be straightforward this fiscal year, particularly in the US, where the upcoming election could introduce some sales volatility. Further complicating matters is a half-weighted element behind FY25 guidance. However, given the renewed pace of Swiss exports, especially for WOSG’s key categories, there is still a good chance that the company will surprise on the upside from here.

Based on M&A with Roberto Coin

Beyond this fiscal year’s guidance, there are also ambitious “LRP” targets. “More than double sales and adjusted EBIT by end of FY28” to think Getting there involves mergers and acquisitions – one leverage management has already started using by purchasing the exclusive rights to import and distribute Roberto Coin Inc. (a Roberto Coin SpA associate) in the North, Central and Caribbean markets.

Strategically, the business is a direct fit given that WOSG has been retailing Roberto Coin for years. The only major change after the deal is that WOSG also gets wholesale margin in exchange for $130 million in debt-financed consideration (including ~$10 million related to post-deal milestones). However, at ~0.8x net debt/adjusted EBITDA, the company will retain ample pro-forma balance sheet capacity for more M&A. Current guidelines also require that acquisition be immediate “Margin Improvement and EPS Growth,” which seems about right in the context of a cheap ~4.3x trailing EBIT multiple.

The key to growing more inorganic for LRP

Management’s move to diversify into branded jewelry, almost immediately after Rolex acquired a distributor, doesn’t quite send the right message. However, more attractive offers such as Roberto Coin Inc. they certainly won’t hurt.

Yes, the expansion adds complexity and doesn’t help WOSG’s value as a potential M&A target if Rolex decides to expand downstream. That said, if management can scale their acquisitions fairly quickly and efficiently (as they have done in the past), that won’t matter as seemingly ambitious “LRP” targets could suddenly be within reach. And given that the market is still very skeptical, getting anywhere close would revalue the stock quite significantly.

In this regard, progress on the integration of Roberto Coin Inc., as well as the broader M&A pipeline, will be key monitors in the next few trading updates.

Final note on risks and summary

It hasn’t been an easy ride for existing WOSG investors, but for new money, the stock is worth dumping now, in my opinion, after a >70% discount from peak to trough. Of course, there are still risks here, the most notable being key brands like Rolex leaving or going direct to consumer. And with management now turning to acquisitions to drive growth, there’s always the risk of capital misallocation (somewhat mitigated by management’s track record).

Still, at around 10x earnings for a company poised to grow earnings in the high-teens while maintaining best-in-class ROE, the risk/reward looks favorable enough to warrant a contrarian bet.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.