As Luxury Flies Off the Shelves, Swatch Group Is Still Attractive

In an increasingly expensive luxury sector, we view narrow-moat Swatch Group as one of the few remaining attractive investment opportunities with its solid, cash and precious metal/gem-backed balance sheet and underappreciated opportunities for profitability improvement. We believe that Swatch’s profitability should benefit from continued mix shift toward luxury and high-range watch brands, including Omega and Longines, which we believe to be the most profitable in the group. While we expect basic and mid-range brands (21% of revenue, we estimate) to continue suffering from smartwatch competition over the next 4-5 years before stabilizing at lower levels as smartwatches reach maturity, we think that cost-control measures, such as shift to e-commerce and store closures, should mitigate the impact of those brand revenue declines. Further, investments in automation should help achieve higher profitability even with lower volumes. We believe that Harry Winston brand (8% of revenue) could grow revenue at a low-teens pace over the next 10 years, helped by fundamental drivers for branded jewellery demand (share gains from non-branded alternatives, female self-purchasing, growth in wealth) and strong brand (supported by auction successes, very high end positioning, and control over distribution). We believe Harry Winston’s operating margin could reach mid-teens by 2025 and low-20s by 2030 from below 10% in 2019 thanks to fixed retail cost scaling. Finally, Swatch Group’s balance sheet is strong, precious gem and metal-backed, and delivered free cash flow of almost CHF 700 million even in the 2020 crisis year (representing a 4.9% free cash flow yield).