Tuesday, September 24, 2013

Swatch's Financials

Now, in this post, we get into the really nitty gritty details of investing: financials and revenue and margins and numbers and ratios. This is really the bread and butter of stock analysis which is also perhaps the most difficult part for most laypeople. As alluded to in the previous posts, I would usually like to pick up a few important numbers and ratios out of the financial statements. Most of the time, it would give a really good sense of how the company is doing. I have posted in details what all these numbers meant like a million years ago. You can find the old descriptions in the labels: Financial Statement Analysis and Financial Ratios. For your convenience, I have also added hyperlinks at the relevant paragraphs below. But for Swatch today, I would just do a quick commentary on what’s interesting.

Here’s an updated version of the cheat sheet that I would normally use. As you might be able to tell, I have added some colours and made it look prettier in order to compete with Serina Wee. I hope our beloved media will take some pics here too!

Swatch's Cheatsheet

First, let’s explain the structure. I have divided this table into a few parts, the titles for these parts are in red and underlined. The pure financials are PL, BS, CF. If you do not know what they stand for, I suggest you message Serina Wee on Facebook for a crash course, she would be able to help since she is a certified accountant and a devoted Christian. Of course, you should also make known to her that you will be joining City Harvest tomorrow and pledge 50% of your household income to support her wardrobe.

Well, short of pledging 50% of your income to support Serina Wee’s wardrobe, which isn’t really a bad thing since you will be doing a big favour to all Singaporean guys watching her strut down Supreme Court, you can read the posts I wrote a million years ago under the in the labels: Financial Statement Analysis and Financial Ratios. I just need a Like for my Facebook page on the right of this post.

You are most welcome :) Ok, jokes aside. So the financials are PL, BS and CF. The other segments are:

Stock related: which relates to stock information and the numbers used to calculate its valuation and the all important target price (TP) or intrinsic value.
Stakeholders: who are the big owners and managers of this company.
Comps: how does it compare with industry peers in terms of valuation.

So we see a bunch of no.s all over. I guess it would be easiest to focus on those numbers in blue. Basically these are derived numbers ie they are formulas in Excel rather than hard coded. What does it mean? Take dividend yield which is at 1.4%. It is simply DPS or dividend per share of CHF (Swiss Franc) 8 divided by its share price of CHF 587, ie no.s in blue are derived from other no.s in the spreadsheet.

So as you can see, Swatch is pretty much a top notch business. GPM or gross margin at 80% and OPM or operating margin of over 20%, these are some of the highest margins in any industry. Essentially, when you pay $10,000 for an Omega watch, the cost to produce it in the Swiss watch factory would only be $2,000. *Gasp!* That’s why the gross margin is 80%. Well, since OPM is 20%, it then means that the cost to do marketing like getting James Bond to wear it, putting it in a fancy retail store on Orchard Road and finally packaging it nicely in a wooden oak box, these add up to another $6,000, which is the difference between the gross profit and the operating profit. So Swatch only makes $2,000 at the operating level for every $10,000 Omega watch that it sells.

Then there’s the ROE or Return on Equity, which measures the growth rate of the business. For Swatch it’s 21%, another world-class number. How’s your salary increment this year? If I read the published stats, it’s about 5%? For every year that passes, the capital base in Swatch grows 4x faster than our salaries. So if your savings pool is large enough, you have to think really hard if you should work or you should just put all your money in Swatch. Well, that’s another topic. But even when compared to peers like Tiffany (ROE 16%) and Richemont (20%), Swatch’s ROE is still superior.

The other measure I like to look at is the FCF yield which stands for free cash flow yield. This is basically cash the business churns out after it has re-invested back in the business, divided by the market cap. So it means that if you buy Swatch now, it churns out 3% cash for you, in theory. In reality, it pays out 1.4% as dividends to shareholders. This two no.s then compares whether the dividend is sustainable. If you see a dividend yield higher than the FCF yield, it means dividend cut akan datang (or coming soon).

FCF yield of 3% is actually considered low in most circumstances which means that the stock is expensive. Cheap stocks give close to 10% FCF yield, like Microsoft or Apple, the maker of iPhone 5S, which stands for Same and 5C for which stands for Cheap. Even Singaporeans’ infatuation with the 5C dream would not save Apple. Tim Cook probably needs to seek divine help from Serina Wee.

So Apple 10% FCF yield vs Swatch 3% FCF yield? Shouldn’t we buy Apple? Things are cheap for a reason. Just comparing the plain FCF yields ignores the growth angle. Swatch has a sustainable ROE of 21% while Microsoft or Apple would probably see its ROE decline over time. This means that whatever cash Swatch’s business can churn out, that amount should grow at 21% per annum. For Microsoft or Apple, the cash churned out would decline over time. Hence it’s not really an apples-to-apples comparison (no pun intended :).

Now growing at 21% is powerful. Remember compound interest is the Eighth Wonder. This means that in 2 to 3 years, Swatch’s FCF yield based on today’s price is then 6%. And in 4 to 6 years, it would be 9%. That is not far from the 10% for the 2 loser techland dinosaurs described above. And Swatch's free cash flow will continue to grow after six years, into perpetuity as long as people don't stop buying luxury watches and diamonds.

Finally, we should talk about how we get to Swatch’s target price or intrinsic value of CHF 650. There’s no rocket science here. I simply used the EPS or earnings per share of CHF 36 multiplied by 18x. Why 18x? This is actually at the high end of what I would pay for. (I have advocated paying not more than 18x PE) But 18x should be justifiable for such a great franchise with strong growth, brand recognition and all the business moats we have discussed.

Now do take note that intrinsic value is just a number. The most important point about investing is the margin of safety. At CHF 587, the margin of safety is a mere 10%. Ben Graham, the father of value investing, would want 30%, so this is definitely not enough for him. But Warren Buffett also did say that if the business is great, not just good but great, then it’s ok to buy even with no margin of safety.

Investing is an art and I would leave it to you and your artistic talent to determine what is a good entry price for Swatch. For me, although I started the analysis and bought it way cheaper, I believe Swatch still offers upside at today’s price. I would advocate buying a toehold for now and if it falls, it’s a chance to load the truck! Hopefully we would make enough to fund Serina’s wardrobe in time!

PS: For those who have no idea who’s Serina Wee, where have you been dude? Here’s her pic below.
Singapore's hottest accused criminal

Saturday, September 14, 2013

Swatch's Management

Swatch Group came about via a series of mergers around the time of the near death experience of the Swiss watch industry in the early 1980s and was finally helmed by this legendary guy called Nicolas Hayek, a Lebanese who later became a Swiss. His kids, Nick Junior and Nayla Hayek - a brother and sister tag-team, run the Swatch Group today. Nick Senior passed away in 2010 but he created a lasting legacy by rescuing and reinventing the whole Swiss watch industry.

Nick started his own management consulting firm called Hayek Engineering in the early 1960s and became very successful in consulting and helping to turn around ailing companies all over Europe. Hayek Engineering corporate philosophy embodies Nick’s belief that an entrepreneur is essentially an artist. This is not different with investing which is also an art. Also, an investor should also manage his portfolio with an almost artistic creativity to make outsized returns.

In Nick's own words,

An entrepreneur is first of all an artist, full of fantasy and inventions. He or she needs to be able to communicate, be open to new ideas and able to question everything. – Not only our society but also oneself. An entrepreneur ought to be captured by the beauty of and sensitive to the outcome of our planet. This attitude does not only allow him or her to create new products and more jobs, it also allows for the creation of true values and riches for all people. It is also necessary if one wants to overcome all obstacles using courage and fantasy…

This is how Nicolas Hayek approached entrepreneurship and by 1979, Hayek Engineering had 300 clients in 30 countries and Nick was well regarded as a true entrepreneur and on top of that, a teacher to other entrepreneurs. Today the company still exists as a niche consulting firm headed by Nayla Hayek, Nick’s daughter.

So that was all before Nick got involved in Swatch. Then, in the early 1980s, the onslaught of the cheap Japanese quartz watches drove the mechanical Swiss watch industry to the brink of bankruptcy. A lot of watchmakers and their movement companies were going bankrupt. At age 52, Nick was roped in to oversee the liquidation of two of these companies: ASUAG and SSIH but he thought and decided there could be a way out for the Swiss watch industry.

At the same time, Swatch was created by a group of entrepreneurs led by another guy called Ernst Thomke who was also trying to rescue ETA, a very important Swiss watch movement company. Nick then joined hands with Ernst and a group of investors to form a Swiss watch giant called SMH, which later changed its name to Swatch Group.

Swatch Group today is an integrated watchmaker producing 50% of the world's high end mechanical watch movements and owns a slew of brands including Breguet, Harry Winston, Blancpain, Glashütte Original, Jaquet Droz, Léon Hatot, Omega, Tiffany & Co. (watches), Longines, Rado, Union Glashütte, Tissot, Calvin Klein watches and jewellery, Balmain, Certina, Mido, Hamilton and needless to say, Swatch.

On its website, Swatch also lists all its production companies. Some of which are critical to the development of the human race. Like Nivarox-FAR, one of Swatch Group companies that produced the world's smallest springs and gears for impeccably accurate time-keeping in mechanical watches.

Swatch Group production companies
ETA, Nivarox-FAR, François Golay, Comadur, Rubattel et Weyermann, MOM Le Prélet, Universo, Manufacture Ruedin, Simon Et Membrez, Lascor, Novi, Swatch Group Assembly, DYB, EM Microelectronic, Renata, Micro Crystal, Oscilloquartz and Swiss Timing.

We already know the turnaround story. Swatch was driven by innovation: funky, fashion styled cheap watches that managed to beat the Japanese in their own game. Nick’s masterstroke came with the re-positioning mechanical watches as luxury products. The Swiss mechanical watch became a symbol of art, a reflection of the owner’s appreciation of craftsmanship, a mark of personal achievement, a family heirloom and everything else (including a status symbol, a wealth flaunt and a bragging right). It worked. Swiss watches became the luxury item of choice for successful men and now women as well. A multi-billion dollar industry was born.

Today Nick Jr is the CEO and Nayla is the Chairwoman of Swatch Group. While lacking the larger-than-life charisma of their father, both brother and sister are respectable business people in their own right and have created value for shareholders. Nick Jr seemed to be very interested in movies and his profile says nothing about his achievement in the company. But as CEO of the Group, he holds his own ground and his views on the watch industry and the Chinese consumer are highly sought after. Nayla appears to be the more serious and capable of the two and she recently took on an additional role as the CEO of Harry Winston, the newly acquired diamond ring and jewellery specialist.

The following is a picture of the Chairwoman of Swatch Group and CEO of Harry Winston.

After she became the CEO of Harry Winston, she decided to help a Singapore church pastor and his tone-deaf wife launch a Hollywood music career by siphoning some money from the church fund. Since she was an accomplished accountant, this was child's play to her. She successfully did so for seven years until the whole scheme was found out by the authorities. This picture was taken as she attended court hearings.

Ok just kidding. For the un-initiated, that's Singapore's hottest criminal-in-question Serina Wee who is currently involved in the City Harvest saga. Apparently, she is so hot she singled-handled converted the courtroom to Christianity.

So much for jokes. Let's get back to Swatch. The following is a real picture of Nayla Hayek.

Nayla Hayek, Chairwoman of Swatch Group

Well, she would have rivalled Serina in her younger days. At 62 today, she and her brother are diligently continuing their father's legacy. They have managed to surround themselves with very capable people: PhDs, lawyers, engineers and MBAs to help them run the Swatch Group. It suffices to note that they have not done anything drastically detrimental to shareholders and should continue to help us grow the company in the foreseeable future. Together the Hayek family still owns 20% of Swatch and their interests are aligned with the minority shareholders.

Friday, September 06, 2013


"Patience is a Virtue."

I was googling around for this topic and as usual, Wikipedia came to the rescue. Sadly, it's still loss-making because donation somehow doesn't work on the internet. Google should just buy them out.

So what did Wiki says about Patience? It's actually part of the seven heavenly virtues which are counterparts of the more famous seven deadly sins, protrayed in the cult movie starring Brad Pitt and promoted Kevin Spacy and Gwyneth Paltrow to stardom. Patience is described in more context than our current world usage: usually like waiting patiently for someone or for the MRT to actually move smoothly. Accordingly, it is about endurance, moderation, grace and forgiveness. The counterpart in the sins is wrath.

In investing, the masters have talked about this over and over. And this is the Nth time I am re-learning this lesson as well. Baseball is the favourite analogy. It is known that the best baseball players do not anyhow swing. They wait for the perfect pitch. When the pitcher screws up and throws a slow ball, in the right zone, they swing the bat and hit that sayonara home run. In buying stocks, it's the same. You don't just buy when Singtel drops 10%. You wait for something to happen or some crisis for the stock to fall really, really cheap. Actually it's sort of happening now with some of our Indonesia exposed names like Jardine Cycle and Carriage.

And you swing when the slow fat pitch comes. Like when Jardine drops to $30, when it's PE hits 8x and its dividend yield goes up to like 6%. Imagine! 8x and 6% for the No.1 auto and motorcycle distributor in Indonesia where both auto and motorcycle market would likely be in the Top 5 globally in the next few years. 

These opportunities do not come often. Usually once every few years. The last time Jardine was this cheap was 2011 when the Greek tragedy hit. As for Singtel, the No.1 stock in market cap in Singapore, the last time it was cheap enough was Lehman, that's half a decade ago. So as patient value investors, most of the time we should really just do nothing. It's called "sit-on-your-ass investing" according to Buffett. To deploy capital over mediocre opportunities simply just doesn't cut it, especially if we are trying to hit 8%pa kind of return.

Ok, that's patience in investing, but what about patience in life?

I think this could be the more important lesson. Patience in life could work in various circumstances:

1. When we are preparing to do something bigger. Hence needing the patience to remain in the current situation for longer, allowing more time for training and mastery.

2. In facing our adversaries, one of the best weapon is patience. Wait for them to commit mistakes. But we need to do our part in maintaining our best. The wait would usually take months if not years. Although sometimes we ought to leave the mud-house especially when the bosses are not on the right side. Choose not to wrestle pigs, if possible.

3. To garner support for change, sometimes it take years for things to move. Like the changes in our education system. Together with others (more prominent opinion leaders and education specialists), I have discussed about revamping PSLE a few years ago in a few series of posts on Education. Finally, something would be done. Well, at least, PM Lee promised.

Being patient in situations is not about admitting defeat. It is taking a step back to leap forward. It is taking time to strategize, recognizing that the time to act is not now. Recall the old battle scenes before machine guns were invented. The army needs time to reload their guns. So you cannot fire when the enemy is coming until they get near enough. Patience makes the difference.

Of course, there is a spectrum to everything. Pulling patience past its limit is cowardice. Unwilling to act after waiting and the opportune moment passed. That would also be a grave mistake. How do we know when is the right moment then?

Oh, we know. We ALL know. When the stock hits 6% dividend but we fail to act even though we already decided we must buy when it hits that price. We didn't because our balls shrunk and we say let's wait. It's the same feeling as seeing the girl leaving and our balls shrunk and we say, "next time I'll ask for her number."

To sum up, we need a suitable amount of patience to succeed in investing and in life. Train up and be prepared. Focus and wait for the opportune moment. Then seize the day! George Savile, an English statesman who lived 400 years ago also summed it up pretty nicely, "A man who is a Master of Patience, is a Master of Everything Else."