Hour Glass Limited
April 2014
Price target (2018) $2.64 Highlights - Hour Glass Ltd:
Price, 1st Jan 2014: $1.68 Only the best for the top. It implies a 56.9% Upside: 56.9% upside potential till 2018. Hour Glass is also the largest luxury watch redistributor in Singapore.
Outstanding growth level, healthy cash level, Key Information low debt, sound margin. Historical revenue compounding annual growth rate is at 6.7%. 52 week range: 1.560-2.000 Return on Equity at 16% median since 2010 Market Cap: 393.6m annually. Median EBITDA margin at 10.86% since 2010. We forecast CAPEX to be at 2.7m Shares outstanding: 235.0 or 0.4% of revenue till 2018 due to necessary yet conservative expansionary plan. 87.1 Float (m shares) Major Shareholders: Gamechanger for a champion: China’s officials are tightening measures to clamp down Dr. Henry Tay (CEO) 57% corruption of luxury goods gift giving by state Bloomberg Ticker: SSG: HG owned companies to civil servants. Luxury watches sales levels are also slowing down in Reuters: HRGS.SI Singapore. We forecast a slow declining revenue growth of -1.5%. However, that has Avg Daily Volume: 16.5 (000) been mitigated with conservative and Analysts: Zai Wei and team prospectable expansion plans in Thailand.
Hour Glass Ltd 3
2.5 56.4% upside
potential 2
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Hour Glass Limited
Overview Established since 1979, The Hour Glass Limited (HG) is a leading specialist luxury watch retailer in Asia. It is the most geographically diverse, multi-brand specialist luxury watch retailer in the region, representing a stable of over 50 brands across 38 boutiques in six cities throughout Asia Pacific. The company retails and distributes watches and jewels. The products that the company offers are sold under key brands including A. Lange & Sohne, Alain Silberstein, AudemarsPiguet, Baume & Mercier, Blancpain, Breguet, Breitling, Bulgari, Hanhart, and Graham. It also invests in properties. The company is the leading cultural retailer that develops and promotes the culture in Asia. Its key operating regions include Singapore, Malaysia, Hong Kong, Japan, Australia and Thailand. The company is headquartered in Singapore. Solely in Singapore alone, it owns 17 boutiques shop where all of it are placed in prime location. In April 2013, French luxury bakery and sweets, Ladurée, opened for business in Singapore in collaboration with HG. The French bakery is known for its double-decker macaroons. The success of the two point-of-sales in Takashimaya shopping centre has prompted HG to look overseas for opportunities to open an outlet and Malaysia is a possibility.
Number of Outlets Australia, 5
Thailand, 6 Singapore, 17
Malaysia, 5
Japan, 2 Hong Kong, 3 Singapore Hong Kong Japan Malaysia Thailand Australia
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2 Industry overview
Weak consumer sentiment for luxury goods
Bad macroeconomic condition and slowing Asian economy have contributed to weak consumer sentiment with Singapore being the weakest among the ASEAN countries. In the region, the luxury sector is facing increasing challenges. For example, China’s efforts to weed out official corruption has resulted in a drop in Swiss watch export levels to Asia (Singapore’s -2.6%, Hong Kong’s -11.1% and China’s -18.7% in 1H13.)
Rising operating cost Rising business costs in Singapore in recent times have negatively affected one of its core customers, namely, SME owners. Higher staff costs and rental expenses have also eroded HG profit.
Potential entry of new competitor (Singapore)
There is also talk of new competitors entering Singapore, eg, Emperor Watches & Jewellery. But we think newcomers would find it difficult to take market share with HG as they already have firmly entrenched in prime retail spaces on Orchard Road. Management pointed out that once the company secures a retail space, it is usually there for good.
A people business
The specialty and luxury watch retail trade is an emotional business that requires a lot of trust in handling the specialised brands and products. The watch business is also a trans- generational business where credibility and reputation can be very difficult to reclaim once damaged. HG places tremendous emphasis on the building of character and credibility, a key competitive advantage that is hard to duplicate.
Revenue drivers HG generate profits of $613,867 in the Asia Pacific regions. The chart below shows that most of the revenue were from South East Asia and Australia. This results evidently shows that there were high spending power and disposable income in that region.
2013 REVENUE DRIVERS ($'000)
Sales to external customers Inter-segment Sales Interext Income Other Income 512,848
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89,088
5,455
5,159
851
97 765 111
SOUTH EAST ASIA AND AUSTRALIA NORTH EAST ASIA
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3 Macroeconomic Overview
Figure 3
Improved Luxury Goods demand in 2014. According to Euromonitor international 27/11/2013 and Bloomberg Industries analyst (Luxury Goods Team) Deborah Aitken, global luxury sales is expected to increase by 3.6% in 2014. Asia Sales is also forecasted to expand by 5.8%. It is also projected that Asia will surpass the western countries as leading world luxury goods purchaser by 2018.
Figure 4
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| Luxury Jewellery and Timepieces to grow in 2014. According to Deborah Aitken, Jewelry and watch sales both may hit almost 5% growth in 2014, outpacing the market’s growth rate of 3.6%. There are also a wide range of brands and it is fueled further by lower entry and exit price points.
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Figure 5
Increase in Disposable Income of Chinese families. There has been a significant increase in wealth of Chinese families. In 2014, 169,000 Chinese households will move into above $200,000 disposable income category. By 2017, it is forecasted to have an increase to 2.44 million.
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Figure 6
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5 Increased in number of Chinese Tourist-Usual trend of Chinese to buy Luxury Watches Overseas. There has been an increased in Chinese tourist for past decade. This is fueled by the additional increase in income by the middle income group. The Chinese are expected to surpass the Germans by 2017, for the highest source of outbound travelers. Over the next 5 years, regional destinations such as Hong Kong, Macau and Thailand will benefit the most. This will benefit overseas luxury watches businesses as long as China’s consumption tax on luxury goods remain at 20%.
Boost in Australia and Thailand. With a growing interest in Thai culture, more Chinese tourist has turned their vacation points to Thailand. It is reported in Euromonitor International that there has been a 62.2% growth in number of Chinese tourist visiting Thailand, making it the 4th largest destination point. In 2012, China has also became the second largest source market for Australia, with a reported 15% increase in tourist growth.
Figure 7 Despite Hong Kong, China being the top forecasted destinations, we believed that HG main revenue driver comes from South East Asia. Hence it avoids unnecessary competition from other big competitors such as Hengdeli and Emperor Watch who are based in China, Hong Kong and Macau.
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Figure 8 Yellow: HG stock price Pink: Hengdeli stock price Black: Singapore retail sales for Jewellery and Watches Green: Hong Kong retail sales for Jewellery and Watches As we can see, both Hong Kong and Singapore retail sales for jewellery and watches have taken a slower down in demand for recent months in this 2 year chart. Yet HG historical stock price has not been tumbling and it has also be fueled with optimistic macro trends in future.
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Figure 9 Green: Thailand special goods and non-supermarket retail stores Blue: Thailand supermarket and departmental stores
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7 As Hourglass as some exposure in Thailand, we can observe that there are more openings of special goods and non-retail supermarket stores recently. This could signify increase in demand but also increase competition.
SWOT Analysis Strength Strong intangibles – reputation, credibility and brand power as a retailer as well as strong partnership with existing manufactures Impeccable service – Personal touch, service and excellence Secured limited supply of prime retail space in Singapore
Weakness Family-run business Concentration of risk in Singapore Most of its purchases are done in CHF and this would result in more costly purchases and bear a negative impact on gross margin in the event that the CHF appreciates against SGD
Opportunities . Overseas presence, especially in China (Double-edged sword) and Thailand . Expanding and refreshing of network locally
Threats
. Rising rental rates could add stress to its operating margins . Global economic slowdown would affect global consumer spending and likely slowing down demand for luxury items . Risks exist in the event that brand principals terminate distribution agreement
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8 Competitive Positioning Listed Competitors
1.1 SINGAPORE . CORTINA HOLDINGS (CTN SP Equity) . SINCERE WATCH LTD (SIN SP Equity)
1.2 HONG KONG . ORIENTAL WATCH HOLDINGS (398 HK Equity) . EMPEROR WATCH & JEWELLERY (887 HK Equity) . HENGDELI HOLDINGS LTD (3389 HK Equity) . DICKSON CONCEPTS INTL LTD (113 HK Equity)
o Peer Group Analysis . We have chosen to conduct a peer group analysis only with companies currently and used to be listed on the Singapore Exchange (SGX), namely, Cortina Holdings Ltd and Sincere Watch Ltd. Cortina Holdings Ltd
The Company is focused in the retail and distribution of luxury watches. The Company's retail customers comprise of repeat customers and referrals, tourists and walk-in customers. It markets a variety of watches, carrying over 50 different brands and over 3,000 models in its product range. Its incorporation date was December 15, 1972, in Singapore.
SINCERE WATCH LTD
Established in 1954, Sincere Watch
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brands in the region of Asia, with a networking spanning Singapore, Malaysia, Thailand, Hong Kong, China, India, Australia, South Korea, Indonesia & other countries in both south-east and north-east Asia. Its businesses include brand management, fine watch retailing, travel watch retailing and lifestyle watch retailing. Sincere Watch is listed on the mainboard of the Singapore Exchange in 1993 but has been delisted since 2008,
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9 and as of 2005, its subsidiary known as Sincere Watch (Hong Kong) Ltd is listed on the mainboard of the Hong Kong Stock Exchange.
Analysis A brief look at the competitive positioning (Market share) of the 3 companies in the general category of Leisure and Personal Goods:
Leisure and Personal Goods Specialist Retailers Company Shares: % Value 2008-2012 % retail value rsp excl sales tax 2008 2009 2010 2011 2012 Hour Glass Ltd, The 3.5 4.1 4.3 4.4 4.6 Cortina Holdings Ltd 2.0 2.7 3.2 3.3 3.5 Sincere Watch Ltd 2.8 2.6 3.0 3.1 3.3
Figure 10
The Hour Glass Ltd is still able to maintain a relatively higher market share as compared to its direct competitors.
ANALYSIS - FUNDAMENTALS Focusing on the companies’ fundamentals, some of the key highlights include:
Figure 11
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| As can be seen, HG market capitalisation is way bigger than its competitors, which implies the relatively higher growth potential albeit with a higher level of risk. All three companies has a P/BV of above 1, indicating that the companies are earning good return on its assets, and further comparing it alongside with its respective ROE figures, the companies are relatively efficient in generating profits.
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10 However, HG has a relatively higher ROE, implying that it has a relatively superior profitability.
Figure 13 HG is turning its inventory faster than its competitors at 1.7x as compared to 1.4x (Cortina) and 1.2x (Sincere). The key to its better-than-peer inventory turns are: 1) excellent store locations that drive traffic; and 2) management’s skill in inventory selection. Essentially, like any other retail store, carrying the models that consumers want will help to move inventory.
Figure 14
1/18/2014 We like HG’s conservative yet fundamentally strong balance sheet, even if it means
| sacrificing a few percentage points of ROE. The company has no long-term debt and short-term debt is used to fund inventory needs, thus its net gearing ratios are much lower as compared to its competitors. This is important for a luxury retailer given that its revenues are susceptible to economic downturns. The 2009 global financial crisis was a prime example where several of the oldest watch businesses in Japan which survived wars and recessions declared bankruptcy. Hour GlassHour Limited
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Figure 15 HG Ltd has higher P/E than Sincere (7.8x as to 6.4x), which implies that investors are expecting higher earnings growth for the former as compared to the latter company. In comparison, it has similar level of P/E with Cortina.
Financial Analysis After 3 years of consecutive growth, there was a slight dip in 2013 revenues, profit margins as well as ROE and ROCE. A temporary decline in earnings could be attributed to 2 factors, a sombre south east asian outlook and the impact of policies in China.
Revenue (S$million) Net profit margin 9.02% 8.78% 607.009 601.936 8.19% 487.638 483.662 517.617 439.916 6.26% 6.79%
2.91%
2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013
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12 ROCE ROE
17.84% 17.37% 18.02% 16.46% 16.02% 15.59% 15.53% 14.66% 13.79% 13.85%
6.24% 6.75%
2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013
Figure 17
Rising global financial markets and domestic property prices in 2012 did little in the way of injecting confidence into the shoppers from South-East Asia. Economic deceleration aggravated by regional currencies, runaway real estate values and rising business costs associated with a tight Singaporean labour market have all contributed to luxury retail sales losing momentum. Also, the luxury watch market in China witnessed a sharp retrenchment in demand, suffering its severest slowdown since the global recession hit in September 2008.
There is an increase in net debt as money is re-invested into the construction of new stores and the renovation of existing ones and the increase in our working capital of which $36.6 million was deployed primarily into inventories to match our planned network expansion. However, these are all short term borrowings and the company continues to not have long term borrowings
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13 Net Debt Ratio ST borrowing (S$million) 9.57% 41.198
6.41% 6.54% 5.16% 4.54% 14.884 15.511 14.186 14.292
0.86% 3.069
2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 Figure 18 The rise in short term borrowings to finance the above mentioned expansion plans also explains the declining current ratio. The quick ratio is reflected to show the proportion of the company’s current assets being inventory.
Inventory days Stock turnover 2.57 212 2.37 2.43 183 173 2.10 1.99 142 154 150 1.72
2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013
Figure 19
By August 2012, the management had determined the fundamentals of the luxury watch market was deteriorating and took immediate rightsizing action, reducing the number of
inventory days from 236 days to 211 days by the financial year end. This translated into 1/18/2014
| a stock turnover of 1.7 times. With fewer new multi-brand store openings on the horizon and a reversion to a more cautious posture, especially with regard to the inventory pool, the management is confident of convalescing their capabilities to generate more free cash in the coming year.
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14 Valuation
We have decided to use the Discounted Cash Flow (DCF) model: Free Cash Flow To Firm to value The Hour Glass Limited. The stated factors below are most sensitive to our model:
Revenue Growth: Forecast of growth in sales is based on two pillars. Room for domestic growth as well as foreign macro factors that affect choice of destination of Chinese particularly Thailand due to latest Phuket expansion. Due to a slow in demand in domestic sales but bullish views on Thailand outlets, we have conservatively set a median decline of -1.5% revenue growth till 2018. Operating costs are expected to increase at a median of +0.01% of revenue and will be eroding profits.
Figure 20
Cost of Debt: at 3.9% based on historical median interest expenses.
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Figure 21
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Figure 22
Near zero debt: Hour Glass has incurred near zero long term debt. Its only liability for debt is a short term borrowing (to be repaid within a year) Using the revolver concept, we have projected Hour Glass to have no debts to be repaid or use to finance current capital expenditure till 2018 (assuming no new debt has been undertaken)
Cost of Equity is calculated using the CAPM model: Risk free rate is taken at Singapore Government 10 year bond at 2.6%. Target Beta is taken at 0.73 after un- levering it from Industrial Beta. Market Risk Premium is valued at 6.8% and cost of equity is at 7.6%. Total WACC is at 6.9%
Conservative Terminal Growth Rate, minimum CAPEX: Terminal Growth rate is taken as an increase of 1% annually and CAPEX is to increase at an increasing of 0.1% of revenue over the next 5 years. We believe that HG will not undertake any aggressive expansionary plans towards supporting future growth.
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Figure 23
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16 Despite slow in growth last year, we are still bullish about sales to rebound back in 2014 However due to overall slow in demand and China political clamping down of corruption, we have conservatively set remaining 5 year forecast sales to be in decline. Decline for 5 year sales is only about 1.5% as we believe tourism in China is picking up and there is also a rise in middle class income group from China, resulting to reasonably optimistic view for global sales for luxury watches and also to negate the decline growth. Hence we arrived at a target value of $2.64, a 56.9% upside from current price with other stable increase in expenses and capital expenditure.
Figure 12
Investment Risk
Increased labour cost. Since July 2012, when the dependency ratio for foreign workers was reduced from 50 to 45%, business have had to rely more on attracting local workers to fill these positions and it is becoming progressively more challenging. The situation will only get tougher as the dependency ratio is reduce further to 40 per cent from July this year(2013) and S pass holders from 20 to 15 per cent. Foreign worker levies will also be going up. All these measures will further exacerbate the labour situation and raise the cost of doing business. HG has the most number of boutiques stores in Singapore than in any other countries it operates (shown in the below diagram), with a further expansion of two more mono -brand boutique here at The Shoppes at Marina Bay Sands next year. A rise in labour costs would
most likely affect its profits considerably.
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Figure 24 Mitigation: In 2012 Chairman Statement, Mr Henry Tay said, "that the average tenure of Hour GlassHour Limited employment at The Hour Glass is nine years. We aim to be a model employer. It's a people
17 business”. Hence they are employing its staff base on a long term perspective rather than to fill the temporary labour shortage like most retail outlets. The Hour Glass places tremendous emphasis on the building of character and credibility, a key competitive advantage that is hard to duplicate. Its staff needs to have specialised knowledgeable in its luxury watches and being able to interact with its customers are crucial in providing a good experience to its customers. Since most of the boutiques are in Orchard speaking good English is paramount in engaging the customers. HG spares no effort in hiring the best people in its sales floor even if it is higher than hiring a cheaper foreigner. Slowdown in China Luxury Goods Market Management is seeing a slowdown in luxury demand. Although Asian consumers are propelling the growth in watch demand worldwide, sentiment is nevertheless affected by the global economic slowdown. HG observes that the luxury watch industry thrives in societies where there are high levels of income disparity.
Today, besides Singapore, few countries can match China’s income disparity. HG management does not believe that it has to open retail stores in China to gain exposure to Chinese spending. Management said that being physically in China exposes the company to unstable business policies, and it will need to grapple with identifying reputable mall operators. It estimates that 50% of luxury spending by Chinese is done overseas and that its stores in Singapore and Hong Kong and Thailand are well placed to benefit as Chinese tourists often buy luxury goods during their overseas trips.
Figure 25
In August 2012, the luxury watch market in China witnessed a sharp retrenchment in demand, 1/18/2014
| suffering its severest slowdown since the global recession hit in September 2008.By the end of 2012, Swiss watch exports to the mainland only resulted in a 0.6% growth versus a 49.2% increase in 2011.
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Figure 26 Reasons for the slowdown: The central government introduced tightening measures, which included more diligent airport customs checks on returning Chinese travellers and a ban on the advertisement of luxury products on state-owned media. These actions were instituted in an effort to reduce conspicuous consumption by civil servants and state owned enterprises and to clampdown on the practice of gift giving.
The biggest cause of slowdown on China Luxury goods comes from its Anti-Corruption efforts. Since becoming Communist Party chief in November 2012, President Xi Jinping has led wide- ranging efforts to curb the culture of extravagance and excess of the ruling elite—putting at least a temporary dent in the country officials’ enjoyment of alcohol-fueled, multicourse banquets, showy and unnecessary motorcades, and expensive gifts, such as gold watches and luxury mooncake confections.
Mitigation: Exploring untapped markets to mitigate slowdown at China.
HG needs to look elsewhere to offset the slowdown in China. For example in 2012, its foray into
Phuket turned out to be a positive surprise as the store became a popular tourist destination, attracting a minimum of 1,500 visitors a day during the low season and as many as 4,000 visitors during the high season. Inbound tourism to Phuket is expected to hit 5.7 million visitors by 2015. With a new airport underway, an increasing frequency of direct scheduled and 1/18/2014 chartered flights from key Chinese cities, an average 5-day stay, Phuket is the 3rd most popular
| destination after Hong Kong and Seoul for the Chinese during their spring golden week vacation.
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19 Top 5 International tourist arrivals to Phuket in 2012 by nationality
China 409,988 Russia 224,889 Australia 198,492 South Korea 173,184 Malaysia 83,011
Figure 27 Total number of Tourist who visited Phuket: 7.4 million. Out of which 86% are international tourists Through a collaboration with a local partner who owns and controls over a hundred tour buses that operate on Phuket island, ensuring a reliable daily pipeline of visitors to its complex. Fully optimised, HG believes Royal Paragon Watch should have the capacity to receive more than 600,000 visitors a year.
Low Barriers to Entry In any industry with high profit margins attracts new competition HG is no exception. According to CIMB analysts report there is already talk of new competitors entering Singapore, eg, Emperor Watches & Jewellery. An interesting development is the entrance of Malaysia-based Valiram group. The new competitor’s retail presence can be felt at Singapore’s Resort World Sentosa where it has secured sizable retail space. It has brought in brands like Omega, Rolex and Tag Heuer. But we think newcomers would find it difficult to take market share with Hour Glass already firmly entrenched in prime retail spaces on Orchard Road relative to its other competitors.(Figure 17) Management pointed out that once the company secures a retail space, it is usually there for good.
Mitigation: Making the first move is the key. Retailers who are not first movers will find it difficult to convince brand manufacturers (e.g. Rolex, Omega etc.) to allow them to carry their watches in a mall where there is one other multi brand retailer. It is in the interest of the
brand manufacturers to restrict points of sales to maintain the exclusivity of their product. We observe that the earlier part of the last decade was about breaking into new markets with maiden The Hour Glass stores sprouting up in Australia, Japan and Thailand. Given the
importance of being a first mover in securing retail space and ‘blocking’ your competitors, 1/18/2014
| management was clearly laying the foundations for the future.
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Figure 28
HG will focus on driving the productivity of the company’s five new retail stores. As luxury demand slows, management has turned more cautious on its expansion plan. Any expansion at all will likely be focussed on luxury-themed and mono-brand stores. Management has decided that it has pretty much capped out the Orchard space.
Figure 29
Risk Matrix
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