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Richemont's repurchase of unsold watches could pay off in time

Compagnie Financière Richemont SA's move to repurchase unsold watches from retail partners could help the luxury fashion group to refresh its product line-up to respond to rapidly changing trends and gain market share, analysts say.

It is a strategy that has hurt the Geneva-based company in the short term, contributing to a drag on sales and profit in the fiscal year ended March 31. But analysts say it could pay off in the long run.

"Going forward, Richemont may gain some market shares nearby the wholesalers they have helped in this context," said Arnaud Cadart, an analyst with CM-CIC Market Solutions SA. Richemont's brands include IWC Schaffhausen, Cartier and Piaget.

Richemont's initiative comes at a time when the value of Swiss watch industry exports is at its lowest level since 2011. The total export value of Swiss watches totaled CHF19.41 billion in 2016, the lowest since CHF19.30 billion in 2011, according to the Federation of the Swiss Watch Industry.

Johann Rupert, Richemont's CEO, said in Geneva on May 12 that while the company's own inventory was healthy, it decided to act to combat overstocking in the wholesale network, caused partly by the slowing Chinese economy. The company focused on repurchasing stock from multibrand retailers. The buy-back program, which began at the beginning of 2016, was "mostly over," Rupert said May 12.

Swiss rival Swatch Group Ltd. is not following Richemont's lead. CEO Nick Hayek Jr. has indicated in recent months that he was opposed to disrupting the flow of goods that took up to two years to produce and did not have expiry dates. Biel-based Swatch was not in the yogurt business, Hayek has been quoted as saying in the Financial Times.

Swatch declined to comment to S&P Global Market Intelligence.

The long-term cycle that Hayek highlights may not be in tune with changes in customer demand and the wider economy, one analyst said.

"As the lead times in [the] watch industry are quite long (longer than jewellery and apparel) and distribution is largely wholesale, it is hard to manage inventory to the rapid shifts in demand," said Jelena Sokolova, an equity analyst with Morningstar Inc. "The industry (both producers and distributors) have become excessively optimistic about Chinese demand and over-invested in both capacities and inventory."

This has left distributors with excess stock, some of which has been unloaded in grey markets where watches are sold for deep discounts — a strategy that can hurt brands, Sokolova said.

"In this sense, I see Richemont's actions to buy back and destroy excess inventory as a right and brand-protective measure," Sokolova added.

Richemont has either reallocated the watches it bought back from retailers to other regions or dismantled them, recycling some components and materials. It booked the cost from the buy-back program as a one-time charge.

The rapid change in trends can partly be seen in a March survey by RBC Capital Markets of affluent Chinese consumers who intended to buy watches priced over 5,000 Chinese yuan in the next 12 months.

The survey shows changes in reasons for buying luxury watches from June 2015, with more people pointing to "beautiful design" and "reasonable price," and fewer to "famous brand" and "brand history & technical reputation."

That survey also shows that in the same period, Cartier, Longines, Bulgari, Chanel, and Patek Philippe climbed up the rankings of watches Chinese customers intended to buy, while Omega, Rolex, Tissot and Vacheron Constantin fell.

RBC Capital Markets analysts Rogerio Fujimori, Piral Dadhania and Richard Chamberlain said the survey result was positive for Richemont, highlighting the focus of Cartier's new CEO on R&D spending for female and dress watches, among other efforts, as well as increasing buyer interest for IWC, Jaeger LeCoultre, Montblanc and Piaget. Meanwhile, the outlook was mixed for Swatch, the analysts said, with Longines and Blancpain its only brands gaining popularity.

Weaker momentum in Chinese consumption is another factor the watch makers need to consider when managing inventories. While Chinese customers have continued to represent the largest group of buyers since about 2010, momentum is waning.

Hong Kong and China combined represented the largest export destination of Swiss watches in 2016, accounting for 19%, according to the Federation of the Swiss Watch Industry. That is down from 27% in 2010.

Richemont is in a strong position to implement a buy-back program. It held €5.8 billion in net cash at the end of fiscal 2017. That compares with about CHF1.3 billion for Swatch.

"I would expect Richemont's watch wholesales to pick up faster than those of Swatch Group's," said Jon Cox, head of European consumer equities at Kepler Cheuvreux, who noted that while the luxury watch industry is seeing demand rising at the retail level, wholesales remain sluggish.

Richemont's sales in the wholesale channel dropped 14% in fiscal 2017, mainly due to the buy-backs, wiping out the 4% growth booked for retail sales.

Exane BNP Paribas analyst Luca Solca said he agreed with Rupert that the wholesale channel was still suffering from inventory overhang and added that Richemont's move should help it gain an edge over Swatch. Richemont "should be experiencing stronger top-line growth — all else being equal — as the credits they have extended in exchange for returns transform into new orders," Solca said.

As of May 11, US$1 was equivalent to 6.90 Chinese yuan.