Smartwatches and luxury watches battle for your wrist

-- | 29/06/2020 Text size Decrease

Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Jelena Sokolova. She is an analyst at Morningstar in Amsterdam. Hello. Jelena Sokolova: Hi, thanks for having me. Black: So, you've been looking at the smartwatch and luxury-watch sectors. Can you tell us a bit about the growth of the smartwatch in recent years? Sokolova: Yeah. So, the smartwatch has started off in 2013 and since that moment the growth, of course, has been quite strong. In 2015, the smartwatch volume sold were a bit less than 20 million pieces, and now it was above 70 million in 2019. So, that's quite a spectacular growth over recent years. Black: And some people think obviously, with our reliance on technology, this smartwatch could make the luxury watch obsolete. Do you think it's a threat? Sokolova: We clearly see that as a threat on the lower-end side of the Swiss watch industry. The Swiss watch is priced below $1000 at retail value. They have been down by around 20% since 2015 when Apple Watch was launched. The high-end part of the watch industry fared much better. But still, it was flat since 2015. But I think that is not due to smartwatch competition but to rather other factors such as, for example, Chinese graft demand, which still contributed a meaningful part of sales in 2015, plus the development of the parallel channel, such as gray-market channels, where excess watch inventory post Chinese bubble was channeled to, as well as preowned watches on platforms such as Watchfinder or Chrono24. So, I think if those channels and Chinese graft were to be excluded, the growth of luxury watches could be comparable to 3% to 4% growth in luxury industry overall since 2015. Black: It's interesting you say the higher end of the luxury-watch space is a bit safer. But one of your top stocks in this sector is Swatch, which I don't typically think of as being at that end of things. What is it you like about Swatch? Sokolova: Yeah. So, Swatch actually—the name is a bit misleading. The Swatch brand itself contributes just a mid-single-digit percentage of the revenue of the group, and it's earnings dilutive by our estimates. So, generally, the majority of sales is still generated by higher watch brands such as Omega, Longines, also very high end Blancpain, Breguet. We think that the watches priced below $1000 at retail value contribute around 24% of revenue of Swatch and a bit less than that also of the profits. So, we think that the high end should still be well positioned, protected by the competition by the conspicuous value and investment value of luxury watches. However, there could be a silver lining for the low end as well, because we expect smartwatches to reach maturity sometime in the next five years, during which the low-end Swiss watches are expected to have still high-single-digit revenue declines per year. However, they may stabilise thereafter at a sort of low-single-digit growth rate after five years that is consistent with history when mobile phones were adopted as an alternative to time telling. Black: And are there any other stocks that you still like in the luxury-watch space? Sokolova: Richemont is actually my top pick. It generates around 36% from luxury-watch business. It also has important jewelry business with brands like Cartier and Van Cleef. And for the watchmaking, I think, the good thing about Richemont's brands that they have cleared up their distributions channels. They are much less present on the secondary channels with lower discounting at the moment compared to other listed peers. So, I think, once the growth returns, they should be well positioned. However, that's also important to say that current crisis is impacting the industry obviously as well, and both companies have plentiful liquidity to weather the negative sales developments currently. Black: Jelena, thank you so much for your time. For Morningstar, I'm Holly Black.  <img src="https://im.morningstar.com/im/premIcon.gif" alt="" /> Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list <a href="https://premium.morningstar.com.au/#/investments/screener/ST/global-equity-best-ideas" target="_blank">here</a>.