Oriental Watch Holding Ltd. (Oriental Watch, OW) is a holding company that is listed in Hong Kong (398 HK) since 1993. It is active as a luxury watch retailer in greater China with stores in Hong Kong, Mainland China, Macau and Taiwan. I got the initial idea from a blog I highly recommend you to follow! …
This is not investment advice. Please read the disclaimer.
Where did I got the Idea from?
The stock caught my initial attention because of a blog post from Forager Funds in Oct 2019* (btw this is one of the blogs I like to follow really much). Since I regard their blog as a high quality value blog and I like Hong Kong very much after spending there three months during an internship some years ago, I had to read the article with special detail.
Prior to the post, Hong Kong Stock Index was one of the worst performing indexes (protests, less tourists, retail sales slump), leading Forager up to taking a look at attractive buying opportunities in HK. One of the mentioned stock ideas was Oriental Watch, with the main points being:
- OW was founded in 1961 and proved to be resilient during former crises.
- Current market capitalization or M Cap
iswas less then Net Cash!
At first sight, Oriental Watch seemed to be a compelling investment idea in Hong Kong, that is not too complicated. So in the end of 2019, I started to look at OW in more detail …
*) Since Oct 2019, I was looking at the Company and trying to analyse it. But in the end, uncertainty remeained too high for me, with ever more factors, potentially increasing the range of Outcomes, trends during months not yet reportd. More on that issue later.
The Company in more Detail
As of March 31, 2019, Oriental Watch operates 61 stores. According to the AR 2019 (p4) the majority is located in Mainland China (46) and Hong Kong (11) and the remain in Taiwan (3) and Macau (1).
Attention: Revenues and operating profits are skewed to Hong Kong.
Financial reporting: Oriental Watch does report its financial results in a sufficient way, but explanations on fundamental developments are somewhat missing, at least that’s my current view.
- The Financial Year ends March 31st
- (preliminary) annual reports are usually released in mid/late (June) July
- Last available annual report is AR 2019
- for the 12 months ending March 31, 2019
- Semi-annual reports for the 6 months ending Sept 30, are usually released in mid/end November
- latest is for the first 6 months of FY 2020 (H1 2020)
- ending Sept 30, 2020
- latest is for the first 6 months of FY 2020 (H1 2020)
Annual Report 2019
To get a better idea of the companys financials I a had a look at their latest AR , ending March 31, 2019 (2019 AR). These financial numbers were already 6 months old at the time of Foragers post, thus bringing sustantial uncertainty with it, because
- the economy slowed quite a bit, especially in China, and
- protests in HK were ongoing for almost these exact 6 Months.
Since Oriental Watch is a luxury retailer, I guessed both developments will lead to and/or already resulted in (a) much lower retail purchases of luxury items (watches) of people living in the Greater China Region in general and (b) much lower numbers of both international and Chinese tourists visiting HK, again driving down luxury purchases.
I read the 2019 AR anyway to get a better understanding of the underlying business and to confirm the numbers stated by forager. I was in HK for 3 Months for a banking internship in 2016 — which I still love to remember very much by the way — and I know that the people there want to ‘show what they earn‘. So I can imagine that the business could be very profitable during (normal) times. My main findings were
- confirmation of the above net asset value presentation of Forager Funds indicating that a liquidation of the business could create much value for current shareholders besides a positive going concern.
- Both gross and operating margins are quite high indicating a profitable business could be had for a low P/E multiple.
- Margins are only that high since FY 2018, more on that below.
After studying Oriental Watchs 2019 AR, I still had relevant open questions (if applicable with answer or ‘solution’):
- Why is revenue down since 2017 but gross margin up?
- I believe it has to do with (partially) eliminating the wholesale business, but I do not find any numbers supporting this notion anymore! I dropped OW an email and wait for a reply…
- Net income was much higher in 2018/19 vs 2016/17, why?
- It is purely dependent on the operating financial performance (see picture above). higher gross marging and lower OpEx
- Is uncertainty about the companys performance since April 2019 based on the above stated issues (weaker economy, protests) too high?
- I decided in Oct 2019 to wait for the interim report
2019 Interim Report
OW released its 2019 Interim Report for H1 2020 in the middle of Dec 2019. To my surprise, in Hong Kong revenues were steadier than I expected. Revenues for the first 6 months in the FY 2019, ending Sept 30, 2019. For HK it came in at HK$ 621m vs 689m in 2018 (-10%). Amazingly enough and to keep in mind, HK is still responsible for almost all (88%) of the so called segment profit.
So I liked the performance in the first ix months of FY 2020 very much. Revenues kept up pretty well. But, then came the …
In the beginning of 2020 the corona virus is responsible for many headlines and news driving anxiety among global investors (or the other way around?). Everybody is worried about serious economic consequences, potentially further driving down general economic activity, consumer confidence and sales trends in greater China.
A few months into 2020, it was apparent that the corona crisis will be a global issue with very severe economic fallout. And obviously, it was very hard to predict when life is getting back to (almost) normal, maybe it is better to say to a ‘new normal’. At this time, it was again too risky for me.
Now in April 2020, I still/again have the feeling that Oriental Watch is too risky (for me), and I want to know how Oriental fared during corona in HK and Greater China — after all, it is only two months until the preliminary AR for 2020 should be released.
My approach: Currently uncertainty is too high one again, for me (personally). But I want to be readily prepared, when OW releases its next annual report in June / July. So I think about preparing a Sum-of-the-Parts valuation (SOTP) and/or a DCF Model, that needed to be rather easy to upade, once the (prelim.) financial results are released.
How to value Oriental Watch?
For valueing OW one needs to decide how to value the business or what valuation method to use. An SOTP is much easier to update, once the the financials are released. Problem with comparing OWs M Cap to Net Assets basically (implicitly) assumes to wind down the company and paying out the liquidation value to shareholders. But, a liquidation of Oriental Watch is highly unlikely I believe! Thus, it is not the perfect valuation approach. But, the company pays high dividends to shareholders.
Using a DCF Valuation one discounts future cashflows with an appropriate risk based discount factor to get todays present value of the cashflows, minus net debt and some other items indicates the equite value. In general, I strongly prefer DCFs.
In this case, I am inclined to do the following:
- Assessing the current value position of OW rather quickly and easy, based on an SOTP valuation with preliminary financial results released soon (probably in June), taking into account the following balance sheet items
- current assets, including
- cash and equivalents; inventories, applying a haircut; A/R; others
- minus total debt, including
- borrowings, short-term and long-term; lease liabilities
- current assets, including
- Further, if the underlying financial performance in FY 2020 (ending March 2020) was not to bad, considering the adverse market condition, I am going to assume that the business will be profitable going forward. The expected earnings stream for years to come should sufficiently rely on a few basic assumptions
- total organic revenue growth
- operating margin
If the first approach (SOTP valuation) indicates an attractive opportunity is to be had at an attractive discount, I will calculate the present value of the somewhat simplified future earnings stream, using a discount rate of 10%.
- Currently it seems, there are 28.56m share options outstanding with exercise prices above HK$ 3.40 as of Sept 2019, which have to be taken into account valueing the company.
My Decision and Answer
To answer the above question from the title of this post: I decided against buying Oriental Watch since uncertainty is too high, currently. Instead, I will wait further until the preliminary results are released.
What do you think about Oriental Watch? Is OW an interesting company to revisit (in June) when preliminary figures for the twelve months ending March 2020 are released?