Pandora A/S DCF-Valuation after 2019-Q3

~ searching4value

Pandora, a Danish Company producing and Selling Mid-Priced Jewelry, most known for their charms concept, reported Q3 2019 results. Time to update my valuation. The Companys Management is trying to turn around sales trends, currently highly negative. If the turnaround will be successful is very uncertain, thus the Company trades at a Forward P/E of below 10 and out of 20 analysts only 3 give a buy rating. If it is successful there is a much higher valuation to be realized, …

This is not investment advise. Do your own research. I currently have a long position in the discussed Stock (Pandora A/S). Please read the disclaimer.

This post includes

Q3 Reporting

I wrote a recap of Pandoras Q3 results, pls watch for overview and point of reference. Q3 materials: Report (link), Presentation (link), Appendix, xls (link), Transcript (link). Last available Annual Report: FY 2018 (link)

Key Metrics reported for 2019-Q3

My Valuation Concept

Since Pandora A/S is right at the beginning of a Turnaround, performing a robust DCF-valuation of the Company is hardly possible. This is because the fair value depends on a few key assumptions such as underlying revenue growth and profit margins. I am going to tackle this problem modeling Pandoras financial performance derived from a few key-drivers. These key-inputs are being modeled depending on the assumed scenario.

  1. The Base Scenario will assume a modestly successful turnaround with stabilizing growth and profit margins.
  2. Bear Case will assume that the turnaround takes longer and profitability is slightly lower.
  3. Bull Case will assume a more successful turnaround with slightly higher growth rates and margins.
  4. The Adverse Case will assume the Canpora will struggle going fowrward and basically never return to former financial performance.
  5. As a rather unlikely event, I will model a very successful turnaround with further positive growth momenturm in the future. The Favorable Case could materialize if Pandora invents a new blockbuster product.

Turnaround Initiatives

It is very early in the initiatives, and probably too early to predict any trends with a high certainty. Nevertheless there are some early signs to spot, i.e. results in refurbished stores look encouraging, higher online engagement and new online store.

Sales

Reported numbers were less than stellar with overall like-for-like growth at -10%, and with disappointing performance in China. But more important than reported sales trends are future underlying growth trends. Marketing spend is aimed at reviving like-for-like sakes growth.

Costs

The most obvious positive sign on the cost side is the record gross margin at 78.6% on an adjusted basis, indicating that costs initiatives are working. Targets for cost savings were increased. Retail expenses are kept in check, despite deleverage through negative like-for-like growth at O&O Concept Stores.

Capital Expenditures

  1. Maintenance CapEx should consist of (i) reinvestment needs into O&O stores, modeled as a dollar amount per store per year times the remodels stores per year and (ii) overhead invest in IT infrastructure, production facilities in Thailand,…
  2. Growth CapEx will be needed for opening up new stores, being modeled as opened stores times invest per store.
  3. Transformation Capex should mostly consist of implementing the new concept store design. If it proves to be successful, rollout should happen faster. Costs per store redesigned should slighlty fall over time and it should partly substitute Maintenance reinvestment needs per store during this phase (mid term)
  4. Special Factor CapEx is rather limited, with business acquisitions (forward integration) being mostly done.

Financial Model

Sales

Total Revenue is modeled summing up Revenue per Channels

  • Owned and Operated (O&O) Concept Stores. Base Case assumes improving underlying sales trends with Sales Growth per Store turning poistive in FY 2022 and turn out at 3% in 2025 with Number of Stores slightly increasing over time.
  • Non-O&O Concept Stores. Base Case assumes underlying sales trends to be 1%p vs O&O and Number of Stores decreases until 2021, stable thereafter.
  • Online Store Revenue is assumed to grow above average through an optimized Website, with Online Sales almost doubling from 2018 until 2025, supporting Profit Margins.
  • Other Channels is forecasted to grow weaker than Non-O&O Stores.

Gross Profit

Is modeled by estimating a Gross Margin going forward. Efficiency measures seem to be already in place, thus reporting a record high adjusted gross margin of 78.6% in Q3. Assumption is that gross margin will be slightly above that level in the future, being at 80% in FY 2025.

Operating Expenses

OpEx is modeled to be higher in coming years, both in total amounts and relative to Sales. OpEx is modeled in the reported three categories.

  • Sales and distribution expenses are partly linked to Number of O&O Stores operated with Costs per Store assumed to be lower (about -20% vs 2018).
  • Marketing expenses will be much higher to support the brand perception, generating traffic and ultimately reviving sales growth.
  • Administrative expenses are assumed to be a bit lower, driven though cost initiatives, that should show some effect.

Scenarios

Base Case

As my Base Case (30%), I assume a turnaround that will be mildly successful in the sense that, underlying growth is stabilizing next year and will be back in positive territory a few years into the future. Gross Margin will stay high due to successful implemented efficiency measures. Marketing will be higher compared to historical levels. Sales and Distribution expenses per O&O store will only be lower marginally compared to 2019 Q3. Online store will develop much better than O&O concept stores, being another lever in the long term for driving the costs/revenue ratio lower in retail segment. Wholesale and other Points of Sale will develop weaker.

Other Cases

Bear Case (40%) will assume that turning around Pandora will take longer, with more pain short term, in the long run. However, in the long run it develops about the same as in base case, with both growth and margins being a bit lower.

My Bull Case (10%) assumes slightly higher growth and margins in the long run. Globally rising middle classes should provide higher demand for Mid-priced jewelry, a focussing on China should help as well.

The Adverse Case (15%) basically assumes the turning around Pandora will not be successful. That means growth is not revived, remodeling O&O stores is not taking place and costs/revenue ratio per store is deteriorating. Margins will fall off a cliff in a few years.

Against that, the Favorable Case (5%) assumes a much more successful but very unlikely transition, with stronger growth and margins in the future. Reason could be a much desired (new) product from Pandora, as was the charms business a few years back.

Valuation

When perfoming a DCF Valuation it is critical to get the Valuation Parameters about right. Since I am already invested in Pandora — I bought in Jul, Aug 2018; Feb 2019 — I might be biased and just want to get the result that Panora is undervalued. With this in mind, I hope that writing down my reasoning helps setting the Parameters about realistically.

Inputs and Parameters

Number of Oustanding Shares (Float) is 100m, according to 2019-Q3 presentation slide #42. Since Pandora buys back shares at a high rate, it had 4,917,649 Treasury Shares as of Sept 30, 2019 according to their Announcement, representing “4.92% of the Company’s share capital”. Some Shares will be given to employees as performance linked pay. I calculated Effective Number of Shares Outstanding in Thousands as 95,355.

Current Financial Net Debt is 11,288 mDKK consisting of Short-Term Debt of 5,191 and LT Debt of 6,963 and Cash of 866. Further Items to be taken into account when assessing debt metrics:

  • Lease Obligations of 4,196 mDKK as of end of Q3 (mostly from property) which I will not include in Net Debt, and
  • Pension Liabilities, which are currently immaterial as of end of FY2018.

WACC or Weighted Average Cost of Capital is used as a discount factor for future cash flows, it is an important parameter. Most of the time it is based on Share Price Volatility, which I will not use. I will go with 7%. My calculated blended interest rate for Pandora is rather low, but as far as I know they do not provide much information about debt. In AR 2018, Note 4.3 Net Interest Bearing Debt is all I found. Maybe it is mostly short term debt, thus I add 1%p to Pre-Tax Cost of Debt. Further reasoning for my WACC estimate below.

own spreadsheet

Terminal growth rate or TGR, is assumed to 3% for the Base Case. If the turnaround is successful as my Base Case assumes, this number is reasonable I guess, since globally rising middle classes should provide support for mid-priced jewelry. In other Scenarios it is: 0.1% bear, 4% bull, – 5.6% adverse, 5% favorable.

Margin of Safety should be a function of Quality and Growth. Since Quality of Pandora appears to be on the lower side and Growth currently is negative and has a high amount of uncertainty going forward, the MoS has to be high. I will go with 45%.

Fair Value

Using my Base Case I get a Fair Value per Share of DKK 1286 (172 EUR, 190 USD) and a buy price of DKK 707 (95 EUR, 105 USD) for my base case. [Estimated Fair Falue for the ADR (US 698 341 2031) would be 48 USD, since 4 ADRs : 1 ordinary share].

My Fair Value Estimate is rahter sensitive to both used discount rate and assumed terminal growth rate. Using Base Case indicates a clear Buy. Current Share Price is pretty in line with my Bear Case Valuation, if using slightly higher WACC and a negative TGR.

Below are my Fair Value per Share estimates for all Scenarios, as well as a probability weighted FVpS estimate. Based on this evaluation Pandora is a buy currently as well.

Final Conclusion, Decision

I will (probably) buy more Pandora Shares within the next few days for my usual investing amount. I need to get the OK from compliance department first. UPDATE: I have bought as planned.

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