Description

Started in 1961, Oriental Watch is a luxury watch retailer operating 14 retail shops in Hong Kong and 72 point-of-sales in China, 3 in Macau and 3 in Taiwan. It is one of Hong Kong’s largest watch retailers, selling prestigious global brands such as Rolex, Tudor, Piaget, Vacheron Constantin, Audemars Piguet, IWC, Laeger-LeCoultre, Longines, and Omega. It generates approximately 70% of its revenue from Hong Kong.

The stock declined from more than 6 HK dollars in 2011 to 1.36 currently. The negatives are obvious. Its business has been facing significant headwinds in the past couple years. The Anti-Graft push by Chinese government weighed on the sales of luxury goods. The 2015 luxury Macau watch show is canceled the event due to poor expected turnout. The auction market of high end watch in Hongkong also fell victim to the push. Top auction houses saw sales during their flagship spring sales plunge this year. Sotheby's sale declined 20% this year at an auction. The export of Swiss watch to China also fell year over year for the first time in more than a decade. In 2014, the sales of luxury watch and jewelry in Hongkong declined 14.7%. Although gaining market share from smaller competitors, sales of Oriental Watch  still declined by 10.4% in the 2h of 2014. Meaning while, the company’s margin is also squeezed by high rental cost. Retnal cost rose by 3% in 2014 and accounted for 42% of operational cost. Its gross margin declined from 18.1% to 16.9%.

I think Oriental Watch is the victim of the factors not in its control and its business is not broken. It is still the most respected luxury watch retailers in HK. At current price I think the value of the equity is floored by its asset value. Market is giving the buyers of the equity cheap optionality of the business turn around.

The company has 1.78 billion worth of inventory of luxury watches. The average value of its watch is around 200k HK dollar. 67% of these inventory are liquid cash like rolex watches. It has 425M in cash and 123.5M in receivable. On the liability side, it has 145M payable and 289M short term borrowing and 202M long term debt. Even we conservatively give its inventory a 30% haircut. Its net current asset worth 1360M.

The company owns retail properties that are very liquid and almost cash like. It is willing divest its property to strengthen balance sheet. In fiscal 2013, Oriental Watch disposed of one of its self-owned retail shops for a net gain of HK$76 million. The rest of the 4 of the company owned properties is estimated to worth 532M currently.

The per share value of net current asset plus property is 3.32, 144% higher than the current stock price.

The management owns about 33% of the company showed good stewardship of share hold value. They reduced inventory by 9% in 2014 as sales declined. Further deleveraging is likely to prompt more network consolidation. Several of its shops face a 30-40% rental hike, when the leases expire this year. The company is likely to close those shops, if the sales do not recover. The store closures should further allow the company to reduce inventory and foucs better-performing stores, with an aim to yield a better sell-through and achieve better margin.

Although the luxury watch market can be further pressured by the anti-graft move in the short term, I am still optimistic on the long term and think there is decent chance for the business turn around.  The company also has stronger balance sheet than its smaller competitors and allows it to further gain the market share during the downturn, while waiting for the market to recover. The loss of demand from gifting/corruption is mostly in in the rearview. Most government officials that are fear of buying/gifting a piece of luxury watch most likely did not make that purchase last year, when the anti-graft move was at its peak. The demand from the growing middle class will continue to increase the demand for luxury goods. In the near term, the wealth effect of the bubbling Chinese equity market also increases spending on luxury goods.  The appreciation of Swiss Franc will also help the company to deleverage its operational cost due to higher price per watch.

Catalyst

Disposal of company owned real estate.

The turnatound of HK luxury watch market.