Description

Company Detail

They are a jewelry producer and retailer based in Denmark. They key product is their charms bracelet, which is a product where you buy a bracelet and then you can customize it with any of a variety of the charms, which include their own in-house designed offerings, as well as collaborations with other brands including Disney and Marvel (collabs are a low double digit percentage of revenues). The price points start at about £20 and range all the way up to £500, however the vast majority (95%) of the price points are in the £25-£100 range, with more of a skew towards the £25-£50 range. Aside from charms, they also offer other jewelry such as rings, necklaces and earrings, but charms are still over 70% of the business, I believe. The company are vertically integrated, with production facilities in Thailand and Vietnam, while the distribution model is mixed, with about 75%-80% retail and most of the balance wholesale, a mix which has shifted to this level from basically the opposite 10 years ago. Aside from the above, they have a nascent lab-grown diamonds business that they’re rolling out across markets at the moment. 

In terms of their customer base, it’s overwhelmingly women (or men buying for women), while on age demographics the product skews younger, with ~45% of customers 18-34, and it does skew a bit to relatively lower incomes – in the UK for example, only 42% of customers have an income above £45k, while in the US just 22% have an income above $100k. In terms of key markets for them, the ones that are the most important are the US (30% of revenues), the UK (14%), and then Italy, Germany, France and Australia are 4%-9% each. The markets where they have very strong share are Ital (11%), Spain (11%), the UK (10%), and then in Australia and Mexico the have about 9% of each of those markets. 

The vertically-integrated nature of the business allows them to generate very attractive gross margins, which are in the high 70’s, while operating margins are in the mid-20’s, while return on invested capital is in the mid-30’s:

 It is often perceived as a bit of a low quality company, which is an understandable view when one looks at the variability in the like-for-like profile of the business (and when looking at the share price over the years), but I think that it’s quite interesting that when one just purely looks at the numbers, it tells a slightly different story. I have included some detail on the LfL below (disclosure has changed over the years and it’s a bit harder to get it on a consistent basis back further than 2017, but the cliff notes would be that there was strong LfL growth prior to the meltdown).

In terms of where the LfL comes from, they are pretty clear that most of the growth is going to come from volume, however they did take 3% price increases last year and were still able to grow volume. A meaningful part of the top line growth story will come from forward integrations, which is just where they buy in franchisees who want out of the business, which should continue to add a low single digit percentage to revenue growth, affords them more control over the product, and is I think slightly margin accretive (they suggest that network expansion comes with 35%-40% EBIT margins vs group margin of 25%). 

The company’s balance sheet is quite strong – they have about DKK 10bn of net debt (against operating income of about 7bn last year), while it’s also a really cash generative business, generating about 5bn (and growing)  in FCF per annum against a market cap of 88bn, so a 5.6% FCF yield. If you have a Bloomberg terminal, you’ll see FCF higher last year, at 6.3bn for a backward-looking yield of 7.2% which looks amazing, however I think the “true” yield is a bit lower as 1) they probably spend on average 500m per annum buying in the franchisees, which is basically ongoing capex, IMHO; 2) they classify the capital repayment part of the leases under IFRS 16 as CFF, both of which are excluded from the consensus calculation. This stuff is a matter of opinion, of course, but for me I think it’s right to include the outflows in FCF – I’ve provided some detail below just for the sake of completeness:

The company are quite shareholder friendly – whether you use the 4.8bn of the 6.3bn definition for 2023, clearly they don’t need all of the cash that they generate to reinvest into the business. They pay out 18/share in dividends (so a yield of about 1.7%) and then they have bought back quite a lot of stock, something that I think they will continue to do. Over the course of 2019 (when the new CEO took over) to 2023, they’ve bought back around 20% of the shares. The buybacks will continue to juice EPS growth, but not to the extent that they have done in prior years, just because the valuation of the stock is a bit different now. 

In terms of the outlook from here, the company provided a lot of colour at a CMD last year which is worth spending an afternoon watching, but the summary is that they are targeting revenue CAGR out to 2026 of 8%-10%, with about 4%-6% coming from LfL (average over the last 4 years including covid is 4.5%, think they did nearer to 6% last year), while they believe they can expand operating margins out to 26%, with the majority of that to be driven by the margin accretion from the owned network expansion. I think that the combination of these factors, together with some share buybacks, ought to drive EPS growth from 55 DKK in 2023 to just under 85 DKK in 2026:

Before getting onto valuation, I will delve a little bit into their markets and the history of the company: 

Markets 

The market size is enormous at 2.5trn DKK (not USD) per annum (with annualized growth in the 3%-4% range), which gives Pandora a tiny market share at 1.3%, looking at the largest regional markets, it’s China at 35%m US at 25%, and then the five biggest European markets are a mid-single digit percentage, and then beyond that a large tail. In terms of products, neckwear is 40%), earrings are 23%), wristwear (their bread and butter) is 17% (and they own 6% of this market), and rings are 14%. Outside of wristwear they have shares mostly below 1%, but the are growing that offering. They claim to be the largest single player and that this speaks to the fragmentation of the market. I think that this is a matter of definition – LVMH for instance reported 10.8bn EUR of revenues from watches and jewelry in 2023, however presumably Pandora are excluding watches in their category definition. I think that the point to take away from this is just that there is a lot of white space into which they can grow, and that one should not infer from them growing revenues from ~7bn at IPO to ~28bn last year that the growth is over for them. One other general observation that I’d make is that compared to other “luxury” categories, i.e. spirits, perfumes, watches and so on, only about 1/3 of jewelry is branded. The company talk about that quite positively in that they cite a KPMG report arguing that brands grow at 3x the speed of non-branded, so the fact that they’re a brand and that branded share can grow in their categories could be a driver. I think it’s fair to point out, but the other side of it is just that something like Pandora is just going to be an inferior business to an LVMH or an Hermes or even a Diageo purely through the lens of pricing power. I think that this is true from a pricing perspective and a revenue stability perspective (less so from a gross margin/ROIC perspective specifically for Pandora), and certainly on just through a brand quality lens, I’d pay a higher valuation for LVMH than I would for Pandora. Fortunately, I think it’s a moot point as I think you can buy Pandora on just under 13x 2026 EPS – there’s definitely an argument around “why not just buy LVMH (which I like as well), but I like the risk/reward in going down the quality spectrum a bit on Pandora. 

Company History

In terms of the history of the company, it became public in the early 2010’s and it has been a bit of a rollercoaster ride since then. After some initial ups and downs, the shares went on a bit of a roll, but there was always some concern around the product in that the charms were seen as potentially a faddy product. On top of that, in terms of distribution, the company was pretty far from, say, an Hermes (which I won’t bother trying to compare Pandora with) given that the better luxury brands tend to control all of their distribution (and never discount), whereas Pandora was, at one point, over 1/3 wholesale distribution, where obviously one doesn’t control the product as closely which can cause problems with display and promotion, among other things (something like Burberry would be an example here as they’re currently going through this; Hugo Boss in the mid-teens would be another example). On top of that, the group grew points of sale at a rapid clip in the early 2010’s (most of it wholesale and third party distribution, though those points of sale aren’t a great proxy for revenue share as they tend to be much smaller) and I think that the concern was that if the wheels ever came off on the LfL, then that in combination with a lot of space growth would potentially be a recipe for disaster. 

Those fears looked like they were being validated starting from about 2017, or possibly even before that. In the run up to the carnage from 2017 to 2020 (covid obviously didn’t help), inventories did grow (which made sense as sales were still growing), but what I think concerned people more was that sell in to the distribution partners seemed to be exceeding the pace of revenue growth (not helped here by quite confusing disclosure) which set some alarm bells ringing over what the pace of real demand growth was, what the wholesale partners were trying to achieve by ordering in so much inventory, what would happen if there was a rapid rate of returns, and so on. From 2017 onwards, the 5h1t hit the fan as the company reported negative LfL on a FY basis. It got worse from there on out with -4% LfL overall in 2018, -9% in 2019, -12% in 2020 (and this is at the group level – it was worse in the wholesale channel). Though it was (is) only a marginal market for them, it also didn’t help that at the CMD, they put out some fairly punchy guidance for tripling their revenue in China – as a point of reference, in 2017 they did 1.6bn DKK of revenue in China – as of last year they were at ~600m I think – guess someone in the spreadsheet department there was multiplying by three when they meant to divide by three. In terms of what exactly went wrong, I think there was a lack of innovation and newness in the products and there was just bad execution in terms of: 

·         Racing for growth which meant picking out poor retail locations

·         Lack of selectiveness over retail partners (not enough control over the distribution)

·         Poor cost control - just a random example but marketing expenses went from 1.1bn in 2014 to 2.7bn in 2019 at a time when LfL was getting crushed, and they were (rightly) getting asked what exactly they were spending the money on

·         Overconfidence that they would simply be able to replicate the market share they have in places like the UK, Italy and Australia (around 10%) in places like the US (about 2%) and China (about 0%) 

As LfL backed into negative territory, the company suffered bigly from negative operating leverage, with operating income declining from ~8bn in 2017 to ~2.6bn in 2020 (albeit in the midst of covid), with the share price -80% peak to trough (you don’t get this 5h1t with LVMH). It ultimately led to the management team getting kicked out, and the new guy, Alexander Lacik, taking over in April 2019. Lacik was able to address the issues that he saw with Pandora via the so-called Phoenix strategy, which entailed: 

·         Revitalising the product, which entailed more newness in the product, a new design team, slightly less discounting, along with more scope for personalization (for instance installing etching machines into man of the stores, as one example)

·         Continuing to fix the distribution, which was on the journey to more owned but still over 30% wholesale, so this involved buying in more franchisees, investing capex in updating the store network, and so on

·         Diversifying the manufacturing footprint

·         Fixing their digital offering – I met the company face to face many years ago and was impressed by their infrastructure, but the had fallen behind. It included things which now seem fairly basic such as rolling out My Pandora to get better information on who their customers are, informing the design process 

As part of the plan, he set out targets for 2023 at the 2021 CMD which included 5-7% organic CAGR and EBIT margin expansion to 25-27%, targets that they more or less hit in 2023, which I think lends some credibility to the 2026 targets that have been set out. 

Valuation 

As I lay out in my numbers above, I have them getting to 84 DKK of EPS in 2026. The stock has traded in a very wide P/E range over the years (between 6x and 20x in the earlier years when there was excitement over the growth prospects). Given the financial profile that they enjoy (~80% gross margin, mid-30’s ROIC), I think I would be willing to pay 16x those 2026 earnings, which with the dividends gets me to about 1400 DKK as a price target, which is 30% upside from here by December 2025. I would stress that the margin targets they have set out are not particularly aggressive within a historical context, so I’d say that in the out years, there is room for continued double-digit EPS growth beyond 2026. Another way of framing the buy case is that I think ~13x P/E with a fairly clean balance sheet more than compensates one for the volatility one has seen in the top line historically.

Catalyst

Delivery on the targets set out in the CMD and the market gaining confidence from that, which should support a higher multiple. Beyond the 2026 targets, I think they can continue to deliver double-digit earnings growth. FCF should further improve beyond 2026 as well as capex to support the current extension of the Phoenix plan normalises from the current ~7% of revenues to nearer to 5%