2007 will be no exception to Swatch Group's record run - Economy - Echoes

Economy

2007 will be no exception to Swatch Group’s record run

Quentin Simonet - The future looks bright for the Swatch Group: a record financial year, impressive share prices, growth opportunities from the Olympic Games in Beijing and the benefits for its production wing of the reinforced Swiss-Made criteria. The group is in a state of grace.

Sources : Swatch Group / Société Générale

The future looks bright for the Swatch Group: a record financial year, impressive share prices, growth opportunities from the Olympic Games in Beijing and the benefits for its production wing of the reinforced Swiss-Made criteria. The group is in a state of grace.

Quentin Simonet

Unlike other publicly-floated luxury groups, Swatch Group doesn’t publish quarterly results. The last officially published figures are for the first half of 2007. From then until annual results are made public (by January 31st 2008 at the latest), mum’s the word at the group’s head office in Biel. The men at the top of the world’s leading watch group may occasionally slip some information into interviews, but the tendency is more towards general reflections than specific details.

Another record year

One thing is for sure: 2007 will be a milestone year. First-half figures prompted the group itself to report "a highly promising outlook for the full year" while Goldman Sachs predicts that Nick Hayek’s company is on course for yet another record year. Despite major and persistent problems surrounding production capacity, results for the first semester have exceeded expectations, with gross sales gaining 16.7% to reach CHF 2.74 billion. The group has even outperformed watch exports for the same period, with its watches and jewellery segment reporting a 20% rise in gross sales.

This core segment once again demonstrated its position as a powerful growth engine for the Swatch Group. With 18 brands in all price categories (from Breguet to Swatch) the company continues to benefit from uninterrupted worldwide demand for watches and jewellery and, according to the group’s half-year report, gained significant market shares. As in the branch as a whole, the luxury segment and notably the Breguet, Blancpain and Omega brands once again had a particular impact on the group’s growth.

The Swatch Group has opted for a wider product mix than its competitors and for this reason the incredibly strong demand for luxury watches is, to a certain extent, less evident in its sales. On the other hand, this balance will cushion the impact should demand for luxury items slow down. The Swatch Group also draws on a strong production segment that covers the full range of watch components, says Merrill Lynch. Few, if any, can do without Swatch Group subsidiaries. In the current euphoric climate, this branch of the group is reaping the benefits of growth across international markets. Gross sales for Production climbed 23.7% to CHF 857 million in the first half.

An impressive rise in share price

In contrast, it has been a more difficult six months for the group’s Electronic Systems segment. While gross sales climbed slightly (2.7%) to CHF 306 million, operating profit fell 16.1% to CHF 47 million. This drop reflects a shift in the market towards lower-priced mobile phones. The group’s Micro Crystal subsidiary, which supplies quartz, has been hardest-hit by this trend. Not that this should dent the group’s morale. Far from it. Operating profit shot up by 27.1% from CHF 402 million to CHF 511 million. This gave an operating margin of 19.6% versus 18% the previous year. And with net income growing a more than proportional 39.4% to CHF 460 million, the group looks set for a smooth ride ahead.

However, some clouds have gathered on this sunny horizon over recent months. No one can say for sure what repercussions the US subprimes crisis will have on the economy, although any damage should be pretty limited for the Swatch Group given its relatively low exposure on the American market. Even so, a 10% drop in sales in the US could shave 5.6% off the group’s EBIT (earnings before interest and tax). The dollar’s continued depreciation is also putting on the pressure. For this reason, Société Générale forecasts that the luxury market will slacken off in 2008. The bank notes that exchange rate effects and a less buoyant macroeconomic climate make it difficult to compare performances from year to year.

In a word, the group’s red-hot share price could cool down, although it is expected to consolidate at a more than respectable level. This is no cause for alarm, given the impressive rise of late. A month ago, at end October before the market correction, the Swatch share had gained 39% in one year versus an average of 8% for the sector.

Christmas comes twice with the Beijing Olympics

Anyone who thinks the price has peaked can always sell their stake back to Swatch itself. Indeed, the world’s number-one watch group is being especially kind to its shareholders: the group recently bought back shares for CHF 400 million and is preparing to launch another share repurchase programme for at least the same amount. As a reminder, the group had already repurchased own shares for CHF 300 million in 2006.

Swatch Group has already announced its intention to cancel these shares, which reflects a rise in earnings per share (EPS). Vontobel Bank has calculated that EPS for 2007 could reach CHF 18.40 and CHF 20.30 the following year versus CHF 14.90 in 2006. These forecasts could be revised upward as the group is banking heavily on the 2008 Beijing Olympic Games of which Omega is one of the main sponsors. For Nick Hayek, Chairman of the group, it could be Christmas all over again for Swatch.

In the longer term, the multinational could also be one of the main beneficiaries of the revised "Swiss Made" ordinance, even though the Swiss Federal Council has asked that the proposed changes be reviewed. A UBS survey published last July estimated that once the new criteria come into force, they could generate additional sales worth some CHF 650 million for Swiss watch component suppliers, including CHF 500 million for the Swatch Group alone. At this stage it’s not sure whether all the analysts have incorporated this information into their forecasts. ■

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