SINGAPORE (May 7): Although jewellers are further down the gold value chain, jewellery accounts for 52.6% of gold demand. There are some well-known international brands such as Tiffany & Co and Pandora, while others such as Poh Kong Holdings and Chow Tai Fook Jewellery Group are better known within their respective markets. What they have in common is selling precious metals, which often include gold.
One style of investing recommended by Peter Lynch in his book One Up on Wall Street is investing in things you see and understand. He recommends constantly exploring, going on walks and venturing into the unknown to discover hidden gems. Although the internet has made more information freely available, there still is merit in this style of investing.
For example, you could be walking down Bond Street or Oxford Street while holidaying in London when you see a long queue outside Tiffany and Pandora.
Some might be drawn to join the queue while others might just walk past. A savvy investor, however, would see this as a demonstration of strong domestic consumption, bullish animal spirits, higher disposable income, increased jewellery-store sales and strong revenue growth. Therefore, theoretically and all things being equal, it is an opportunity to buy a great jewellery company.
Looking at a jeweller is different from looking at a gold-mining stock. It is essentially a retail business model versus a resource/mining model. Let’s look at a large household name such as Tiffany. It actually fared quite poorly on our screening (see Charts 1 and 2). Earnings growth is very modest and net profit growth was negative on a five-year compound annual growth rate (CAGR) basis. Yet, valuations are relatively rich.
To be sure, Tiffany has been a name of renown since Audrey Hepburn as Holly Golightly ate a pastry while window shopping there in the movie Breakfast at Tiffany’s. The company, which is listed on the New York Stock Exchange, is synonymous with discretionary spending and is probably a proxy to consumer spending and wealth growth. No surprise then that for its FY2018 (the company has a January year-end), the highest growth in sales was in the Asia-Pacific region where total net sales increased 10% y-o-y to US$1.1 billion ($1.5 billion) for the full year and 13% y-o-y to US$320 million in 4Q. The strong sales growth in mainland China was offset by lower sales in most other countries, Tiffany said. Sales in the US rose 2% and sales in Europe, 6%.
Net earnings for the year to Jan 31 more than doubled to US$370.1 million, up sharply from US$146.2 million, owing to a tax write-back of US$390.4 million attributed to a change in the US tax law. This translates into earnings per share of US$2.96. The US tax impact is probably a one-time charge. Earnings from operations fell to US$256.5 for FY2018, down significantly from US$721 million a year ago.
Pandora sees China as the world’s largest market
Since entering China in 2010, Danish jeweller Pandora has delivered double-digit growth in sales y-o-y as it opens more stores, enters new cities, expands its online presence and increases brand awareness across the country. China is the world’s largest jewellery market, worth an estimated DKK637 billion ($137 billion) in 2017, and is expected to grow to DKK775 billion by 2022. Pandora currently has less than 1% of market share, giving it a huge opportunity over the coming years.
Pandora showed up on our screen, with its five-year earnings before interest, taxes, depreciation and amortisation (Ebitda) CAGR ranking and five-year net profit growth ranking the highest among jewellery stocks. Its five-year Ebitda CAGR was 41.9% and it had double-digit annual growth rates from 2014 to 2016. Despite gross profit decreasing in 2017, it still maintained a double-digit Ebitda growth from 2013 to 2017.
Pandora is the world’s largest branded manufacturer of jewellery and has a full value chain. When a collection is launched, it is available in every store across more than 100 countries. In 2017, 117 million pieces of jewellery were crafted, and 88% of pieces were produced at their own facilities.
More than 50% of Pandora’s concept store openings in 2017 were owned by the company. Pandora acquired 200 concept stores, including 79 as part of the acquisition of a distribution company in Spain, Belgium and South Africa last year. Going forward, the company expects to add a further 200 predominantly Pandora-owned concept stores annually, while at the same time refining its network of other points of sale to showcase the brand in a more effective manner.
Sales from Pandora’s eSTOREs increased 61% for FY2017 compared with last year, and now make up 7% of revenue. The company says it will continue to focus on eSTOREs as it seeks to strengthen the link between physical and online stores. The aim is to increase the share of revenue from eSTOREs to more than 10% within five years.
On the other hand, a lack of newness in its product assortment turned out to be a challenge in 2017. This was most evident in the more developed markets such as the US and the UK. As such, Pandora says it is updating innovation and product development processes to make it consumer-centric and ensure that it delivers more new jewellery concepts in the future.
In 2018, Pandora plans to continue to expand its store network and expects to add around 200 concept stores (net, including closures) during the year, of which roughly 50% are expected to be in Europe, the Middle East and Africa; 25% in the Americas, and 25% in Asia-Pacific. The company expects revenue growth in 1QFY2018 to be slightly below the guided range of 7% to 10%. The main reason is the dependency on newness in the product assortment, which is expected to gradually improve throughout the year. Additionally, the currency headwind for 1QFY2018 is expected to be around five percentage points.
In January, IHS Market said Pandora was the most shorted European consumer durables stock; short sellers increased bets against Pandora tenfold in the last 12 months. Short demand was unchanged despite the CEO’s message to shareholders in January, IHS Markit said. Another company that appeared in our screening, Signet Jewelers, was also subject to a short attack by hedge funds last year.
Poh Kong part of Malaysia’s national psyche
Poh Kong is Malaysia’s largest jewellery retail chain store with almost 100 outlets nationwide. It promotes and develops its own brand in addition to being the sole distributor for many international brands. Its in-house brands include Tranz, Happy Love and Anggun. Poh Kong is also the licensee for Disney Collection, the sole distributor for Schoeffel luxury pearls from Germany, Luca Carati and Moraglione from Italy, Angel Diamond and Hemera Diamond.
Poh Kong had a sterling 2017 (the company has a July year-end). Net profit rose 168% to RM29.5 million ($10 million). Almost 90% of its FY2017 revenue of RM877 million came from its retailing business. It is essentially the market leader in Malaysia and resonates well with local Chinese Malaysian buyers. For the six months to Jan 31, 2018, net profit eased RM4.8 million y-o-y from RM6 million. Its cash flow ended 1HFY2018 in the red. This was partially due to a RM63 million cash outflow of inventories, owing to an increase in inventories held on the balance sheet. The company’s inventories rose to RM603 million as at end-January versus RM540 million on July 31, 2017.
Chow Tai Fook: Rebound at hand
Chow Tai Fook is the largest jeweller in the Chinese territories by market value. Partly as a result of the restructuring of China’s economy, the company’s revenue numbers had been falling since 2014. However, for the nine months to Dec 31, 2017 (the company has a March year-end), total revenue rebounded by 12.7% y-o-y to HK$41.13 billion ($10 billion). China comprised 60% of revenue, rebounding 15.3% y-o-y. Hong Kong and Macau accounted for 40% of revenue, rising 8.9% y-o-y. Managing director Kent Wong said the company would add new names to attract the younger generation and add stores in lower-tier Chinese cities, according to a Bloomberg report.
Founded in 1929, Chow Tai Fook employs a vertically integrated business model, from raw material procurement and rough diamond cutting and polishing to midstream product development, manufacturing, logistics and distribution, all the way through downstream to retail and ecommerce. Gold products constituted 57.8% of revenue in 1HFY2018.
The company is a proxy to China’s restructuring away from an investment-led economy to a services and consumption-led economy. It is also likely to reflect China’s rise as a global economic power. The Chinese are getting wealthier, and as China breaks above the ranks of middle-income countries into the rich world, Chow Tai Fook could be a good representation of discretionary spending.
