The Swatch Group Ltd (SWX: UHRN)

Intro

Having written about a few smaller companies recently, this blog entry talks about a major firm – a Swiss blue chip. Swatch is the number one producer of watches in the world and produces nearly all of the components for its 18 watch brands in house. The brands include names in different price segments such as Harry Winston, Swatch, Breguet, Omega, Longines and Rado.

Some uncertainty in Hong Kong (political turmoil, protests), the spreading of a new virus (COVID-19), provisional measures adopted by the Competition Commission and possible risk of smartwatches have weighted heavily on the stock price, which trades on the lowest levels since 2009 – albeit the operational performance has been very acceptable.

Valuation

In the last four years, Swatch was able to increase its sales from CHF 7.5 billion to more than CHF 8.2 billion; operating profit (margins between 10.7-13.6%) and net income have seen even bigger boosts. For 2019, net income is around CHF 750 million, which reflects a currently depressed P/E of approx. 14x.

The balance sheet is just pristine: as of 2019, Swatch shows financial debt of only CHF 120 million, while total assets are worth more than CHF 13.6 billion. It is fair to say that this company would be in a position to absorb a potential market downturn easily, even for an extended time horizon. Buying a pretty much debt free company like Swatch at a P/B of 0.93x with a long term track record is rather cheap and provides a fair margin of safety.

What’s next?

For 2020, Swatch initially expected healthy growth in all markets in local currency, except in Hong Kong – we’ll see if that is still possible after COVID-19. Many things are quite negative when looking at Swatch at the moment – as always, times will change and Swatch will still be around to hopefully receive the full valuation as it deserves.

Current Price

CHF 40.16 per registered share

Alaris Royalty Corp. (Debenture Symbol: AD.DB)

Intro

This entry constitutes a novelty – so far, all entries have been about a specific stock, while this post is about an attractively priced bond with an excellent risk reward situation (and why not profit from it?). The Canadian company that issued this bond is Alaris Royalty, a highly diversified royalty firm with the majority of its assets in the US. Alaris’ business model is to advance money to companies and in return receives a percentage of the investees revenues – in other words, Alaris sits in the capital structure between the equity holders and banks, a form of hybrid capital. Hence, companies requiring money usually have one of the following needs: growth capital, partial liquidity, recapitalisation or for a management buyout (MBO). Alaris has been public since 2008 and currently holds royalty interests in 16 partners.

 

Valuation

Alaris is only as strong as the weakest link in the chain, its royalty partners – if they are able to make their royalty payments to Alaris then Alaris will do fine and generates a significant amount of cash flow. However, by having a meaningful portfolio, sooner or later some of the investees will face difficulties; the crucial thing is to make sure the losses and gains will balance out within the broad portfolio. Looking at the balance sheet as of end of March, Alaris has total investments (its royalty investments) of approx. C$740 million and cash as well as promissory notes of around C$50 million. On the other side of the balance sheet, the liabilities, loans amount to roughly C$150 million and the aforementioned bond is with C$92 million in the books. As a result, assets are close to C$800 million while interest-bearing liabilities amount to C$242 million – at least as of March a wide margin of safety.

By now, you may ask yourself: what is this bond exactly? The Alaris bond is actually a subordinated convertible debenture that pays annual interest at 5.50%, can currently be bought at 85% and will be repaid at 100% in June 2024. This translates into a yield of approx. 10.1% p.a. – not too shabby in the current interest rate environment. As always though, the devil is in the detail: The bond is subordinated, meaning if Alaris goes belly up, proceeds will be received ahead of the shareholders but after other loans and borrowings are fully paid back. Furthermore, according to its prospectus, Alaris can choose to repay the bond with its own shares, at the then prevailing price and a discount of 5%. In short, if worst comes to worst, bondholders might end up as shareholders – a scenario the company and the bondholders want to avoid under any circumstances and as of now only has a low probability.

What’s next?

Luckily, Alaris sold its biggest investment ‘Sales Benchmark Index SBI’ in February 2020 for roughly US$91 million and its proceeds were used to repay its credit line. It is evident that the timing was superb, and a potential later sale would have resulted in lower proceeds. From a total portfolio point of view, Q1 2020 was still alright and most partners showed sufficient coverage ratios. It won’t come as a surprise though, that Q2 will look much worse and that Alaris might have to either postpone or even waive some of the royalty payments from its partners, followed by potential write offs of some of its investments. However, this shouldn’t worry bondholders yet and Alaris still has a lot of wiggle room in case it needs to preserve liquidity, be this either through the complete suspension of the dividend or making use of further drawings of its credit line.

Current Price

C$85.00 (i.e. 85%), listed on the Toronto Stock Exchange under symbol ‘AD.DB’