Pandora A/S Valuation Update after AR 2019

Pandora A/S released its Q4 and FY 2019 Annual Report on 4th February, 2020. The market reacted negatively with Pandora down 2.5%, presumably to the FY 2020 guidance, with sales guidance meeting expectations but expeted margin falling below expectations. I read through the material and updated my former Valuation-post of Pandora.

This is not investment advice. Please read the disclaimer.
I do currently own Pandora Shares!

Resources

Key Topics

Key Figures

Below are Pandoras reported Key Figures for the past 5 years (2019 – 2015):

Underlying sales trends (like-for-like) are improving, with the three key markets Germany, Italy, France at the centre. These key markets in Europe could serve as indication that Pandoras turnaround program NOW is up to the task to deliver once again underlying sales growth in the future. Overall lfl in Q4 improved to negative lfl of -4% from -8% for the frist nine months of 2019. But it is …

…too early to say if the company could return to [reported] sales growth in 2021.

Alexander Lacik, CEO of Pandora
  • Like expected, Pandora owned Retail, especially Online Stores, show above average sales trends
  • Asia is lagging; with China being a Problem in general, but tackled
  • Revenue mix was about unchanged, Charms still responsible for +50% of Sales

Like-for-Like Momentum in Q4 2019

Alexander Lacik (CEO) said about the underlying sales trends for Q4 2019

With 2019 behind us, we have completed the first year of our 2-year turnaround. We have made significant changes in a very short time, and the results in Q4 give us confidence. Consumers are responding positively to our commercial initiatives. Like-for-like is improving, and we have built a healthier foundation for the business. In 2020, we will continue to invest significantly to drive the topline, strengthen our organisational capabilities and pursue further cost reductions to fund our growth initiatives. Our priority remains to do what is right for the company in the long-term.

Interim Report Q4 2019
  • Like-for-like (adj. for HK) was -4% in Q4 2019 vs -7% in Q4 2018, showing positive momentum in underlying growth on broader basis.
    • Total lfl was positive for the three European key markets Italy, France and Germany, representing 22% of total Sales in Q4.
    • This is a very positive development, indicating that the turnaround could be successful, leading to stronger lfl growth in the future.
  • Adj. EBIT Margin was 35.3% in Q4 2019 vs 32.0% in Q4 2018.

Margins Pressured

Adj. EBIT Margin (excl. Restructuring costs) for the full year was at 26.8% (down -1.4%p YoY), mainly driven by increased marketing expenses and deleverage, and supported by a strong fourth quarter with an Adj. EBIT Margin at 35.3%.

Gross Margin

Adj. Gross margin was 77.4% compared with 74.3% in 2018, showing some parts of Programme NOW are working.

OpEx

Total operating expenses for 2019 were DKK 11,065 million excluding restructuring
costs, equivalent to an Adj. OpEx ratio of 50.6% compared to 46.1% in 2018. The OpEx increase was driven by deleverage (as a result of declining revenue) and increased marketing investments.

AR 2019, p 49

Restructuring Costs

Restructuring costs are 2 bn DKK as expected, with about 1 bn mostly for inventory buy-backs at the level of COGS and a similar amount mostly consultancy fees and costs for implementing Program NOW cost savings. These costs seem to be a worthwhile short term pain to strengthen the longterm business.

China Business

The performance in China in 2019 was disappointing with like-for-like of -11%. The negative development was driven by significant decline in traffic into physical stores. Physical store sales declined significantly, which was only partly offset by continued good growth in Tmall – the main online sales channel in China. Q4 included Singles’ Day (11/11), which is the most important annual trading event and was characterised by significant promotional discounting activity from competitors, reflecting the challenges in the retail environment. Pandora has initiated a workstream called “Win-in-China”, which will be the foundation for the upcoming commercial initiatives, including brand positioning and media spend optimisation.

AR 2019, p 47

The underlying weakness in China is one thing. Another thing are the special situations in there, representing significant risk factors to regional performance in APAC. The protests in Hong Kong are ongoing and the Corona virus could be potentially have very negative effects on Chinas Q1 performance (or even longer-term?). Right now physical retails sales are next to none, with many shops closed.

Cash Generation

Cash Generation in 2019 was very strong, even at unsustainable high levels. Pandora generated reported FCF excl. IFRS 16 of 5.1 bn DKK compared to 5.6 in 2018. Efficient (low) levels of CapEx of only 822 mn DKK as well as strongly favorable Working Capital measures both provided an uplift to Cash Genration in 2019, which will not be repeatable in 2020. In 2020, there should be a material negative WC effect to FCF generation.

Capital Allocation

Pandora proposes a new Capital Allocation, returning 3 bn DKK to Shareholders in Cash in FY 2020 vs. 4 in FY 2019 (both proposed).

  • Indicating a Cash yield of c. 8.5% based on a current Market Capitalization of about 35 bn DKK
  • Proposed dividend Payments being halved, both
    • per Share (9 DKK vs 18) and
    • in total (0.9 bn DKK vs 1.8).
  • Share Buy Backs (SBBs) shall only decrease slightly (2.1 bn DKK vs 3.0)
AR 2019, p 43

Opinion

The distribution in 2020 (and beyond?) is skewed from dividends towards share buybacks. Pandoras shares are currently trading at a potentially cheap valuation (low P/E) vs estimated fair value resulting from my updated valuation. At current prices the buybacks therefore reward long-term shareholders.

Guidance for 2020

It seemed the Guidance disappointed, since Pandora traded lower after releasing the Q4 figures. In later days, Pandora traded above pre Q4 levels, however.

Revenue

Pandora expects total lfl sales growth “negative mid single-digit”, driven by further reduction of promotions and ongoing weak performance in China (excl. additional effects of the Corona virus). Net store openings (some openings & closings) and net inventory changes in wholesale channel as well as Forward Integration (M&A) are expected to be of minor importance in the bigger growth picture for 2020. Organic Sales Growth in 2020 is expected to be between negative 3 to 6%; roughly in line with lfl.

Profitability

Pandora guides for an Adj EBIT Margin (excl. restructuring expenses) above 23% (vs 26.8% in 2019, down about 3.5%p). Cost reduction target is again increased giving an uplift to margin, but deleverage and further investments in brand equity have a negative effect. Restructuring costs are expected to be c. 1.1 bn DKK (vs 1.0 bn initial expectation). CapEx is exp. to be between 1.0 and 1.2 bn DKK.

Valuation Update

FY 2019

  • Actual Revenue for FY 2019 came in at 21,868 mn DKK (I modeled 21,788 in my base case)
    • O&O Concept stores (EoP 1,397 stores) generated 10,619 vs my estimate of 10,893 (1,390)
  • Adj. Gross Margin came in at 77.4% vs my model calculated with 78.6%
    (error in my model: I wanted to use 78.6% for Q4, same as in Q3, which had been very close to the actual value. Instead I used 78.6% for FY 2019.)
  • Adj. OpEx (excl. restructuring costs) came in at 11,065 mn DKK vs my modeled value was 11,280.
  • Reported EBIT was 3,829,I modeled 3,839
    • incl. of restructuring costs of 2,000 vs actual 2,025
  • Income tax expense was 884 mn vs my estimate of 909
  • Pandora reported 2,945 mn Net Profit, I modeled 2,958

Updating Estimates

I incorporated Pandoras new guidance in my model and adjusted underlying like-for-like growth a bit downwards as well as lowering the number of owned and operated concept stores. Additionally, Profit margin is expected to be slightly lower. Key Assumptions for my base case are:

  • Reported sales growth will be back to positive values in 2021 (+2%), driven by
    • continued strong total online sales growth (15%) and
    • a successfull stabilization in lfl growth for O&O Concept Stores (0%), with number of Stores almost flat.
    • Both, Non-O&O Concept Stores (-1.5% lfl) and other Points of Sale (-2.5%) are expected to show a lower lfl performance.
  • Profitability is pressured for some years to come, increased marketing spend to build higher brand equity is outweighing costs savings initiatives.
    • Adj. EBIT margin for FY 2020 is modeled according to guidance (23.5%). Assumptions for 2021 is 25.4% and growing slightly until 2025 (27.1%).
  • Special Factors in 2020 will probably show a significant drag to reported numbers.
    • a negative cashflow-effect as inventory needs to be build up to sustainable levels again (8.5% ov Sales) and
    • further impacts from Program NOW (1.1 bn)

Compared to my former valuation, my estimated Fair Value per Share (base case) came down, resulting in a FVpS of 907 DKK (121 EUR, 133 USD or 33 USD per ADR). On the same time, I believe the base case (successful turnaround) became more likely.

Based on the current Price per Share of 373 DKK, and the discount being higher than my applied Margin of Safety (35%), Pandora is still a buy for me. But, my Pandora position is still quite high, so I am not going to purchase more share currently.

Outlook

I hope you enjoyed this blog post about Pandora A/S. Please feel free to comment below with general feedback or any questions about the valuation!
Best, s4v

2 thoughts on “Pandora A/S Valuation Update after AR 2019

  1. Hi Jose. Thank your very much for your comment.
    I also bought Pandora several times, each time lower than before. But my purchases were always based on a DCF Valuation resulting in a FVpS much higher than the then current PpS, indicating a strong undervaluation. Did you also value Pandora or did you just buy more shares when the price was lower?
    Very interested in your reasoning!
    Best, s4v

    Like

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