In the new interest rate world, Watches of Switzerland’s ambition is not being rewarded. The FTSE 250 group’s shares have more than halved over the past 18 months, in expectation that the Rolex seller would be hit by the same slowdown in demand as retailers operating downmarket.
The latest annual trading figures are an indication of why the company deserves more credit. Strip out acquisitions, and revenue rose by just over a quarter last year, as its expansion stateside and into Europe helped to push the top line forward. Adjusted margins were bumped higher, partly by greater scale, and pre-tax profit rose just over a fifth. A step up in cash generation pushed the retailer into a net cash position of £16 million.
Higher sales prices and customers trading up, including buying more gold watches in an attempt to hedge against inflation, accounted for the bulk of revenue growth. But unlike many retailers, volumes were positive, up 7 per cent last year.
True, the luxury watches market has not floated entirely above darker macroeconomic clouds. Pricing in the second-hand market has started to come off and the extraordinary demand over the past two years from consumers flush with cash has started to slow. Sales growth is expected to slow this year to between 8 and 11 per cent at constant currency rates, or £1.65 billion and £1.70 billion, excluding any bolt-on deals, from £1.54 billion last year.
Analysts at HSBC think M&A will contribute about £70 million to sales this year, or 5 per cent of the £1.7 billion annual figure it forecasts. WOSG has a degree of visibility over demand that most retailers do not. Waiting lists typically run for years for the high-end watches it sells, where demand vastly outstrips supply.
The retailer has been valued with a doomsday scenario in mind, which explains a near 11 per cent lift in the price on results day. Even so, the shares trade at just 13 times forward earnings, about half that at the start of last year and among the cheapest since the 2019 IPO, pandemic crash aside. It is also a steep discount to other luxury retailers such as the French fashion house LVMH and Swiss-based Richemont.
That ignores the upside that could come from pushing harder into overseas markets. The Leicestershire-based group is looking towards the US to propel sales. That is a market that is highly fragmented and underinvested by retailers that operate no more than three stores.
The US store estate has grown to 47 since the group entered the arena in 2017 and accounts for 42 per cent of revenue. Lower rents make US sales higher margin and stores are profitable within a year of opening. Six mono-brand shops were opened last year in America, with six in continental Europe and 14 at home.
If the price of luxury watches continues to head north, even at a slower pace, there’s scope for margins to follow suit, as the watch seller’s supply agreements include a fixed formula between wholesale costs and the retail price.
Capital expenditure is set to step up again this year, to £80 million from £68 million last year, which will be directed towards opening new stores and refurbishing existing ones to get more shoppers through the door.
But high cash generation and a steely balance sheet mean WOSG can afford the outlay. It delivered £146 million in free cash last year, up from £112 million the year before. It has proven to be a canny allocator of capital too, generating a return on cash deployed of almost 28 per cent last year, enviable by most retailers’ standards.
For that reason shareholders shouldn’t bank on surplus cash being returned via special dividends or share buybacks. Or any dividend at all for that matter, any time soon. But what Watches of Switzerland lacks in income, it could well deliver in capital growth for shareholders.
ADVICE Buy
WHY The shares look too cheap given the earnings growth potential on offer
Barratt Developments
At least Barratt Developments isn’t banking on any pick-up in sales rates this year. With more interest rate rises and more volatility in mortgage rates on the cards, it pays for investors to be cautious towards Britain’s housebuilders, too.
The FTSE 100 group is cutting back the volume of new homes it builds, guiding towards completions of between 13,250 and 14,250 this year, markedly lower than just over 17,000 for the 12 months to the end of June. Sales rates over the first six months of the year were running at a weekly rate of 0.49 per sales outlet, almost half the rate over the same period last year.
It’s not just the quantity of sales where Barratt is feeling the squeeze. The average selling price in its order book at the end of June was almost 9 per cent lower than the same point last year, in part a function of higher reservations from private rental landlords, as well as fewer houses being built in the capital.
But it’s also the result of higher incentives, which are now being offered to around 5 per cent of customers compared with 2 per cent last year. Build cost inflation is due to halve this year, to about 5 per cent, Barratt reckons. Housebuilders need sales prices to rise at just half the rate of costs to hold margins steady. Even that could be a stretch.
It all points towards thinner margins this year, which analysts at Peel Hunt think will come in at 13.5 per cent, down from the 15.9 per cent it expects this year.
The shares have been justifiably marked down. They trade at a 27 per cent discount to the company’s forecast book value.
Barratt has net cash of more than £1 billion. But it also has a policy of targeting a dividend that is twice covered by earnings, which means investors can expect a step down in the amount returned.
A strong balance sheet might be enough to convince shareholders not to sell and crystallise a loss, but a depleted share price doesn’t constitute an opportunity for the uninvested.
ADVICE Hold
WHY A further rise in borrowing costs could weaken demand further
