Oriental Watch, founded in 1961, is a Hong Kong listed watch retailer with 12 shops in Hong Kong, 2 shops in Macau, 37 shops in China, and 2 associate shops in Taiwan. The Company focuses on retailing high end watch brands such as Rolex, Tudor, Piaget, IWC, Audemars Piguet, Jaeger-LeCoultre, etc. I am recommending a buy in this company given its downside protection (trading below value of its liquid assets, or current assets less all liabilities) and hidden asset value in its undervalued property assets (marked at book value of ~US$10.5mn on the balance sheet, but likely to have a market value north of US$60mn). My current target price is HK$2.8/share, or the value of its net working capital, which represents 30% upside to current trading levels. Upside case is HK$3.7/share, which is the net working capital + market value of property assets, which represents 70% upside to current trading levels.
Based in Hong Kong with long operating track record, Oriental Watch is an authorized dealer of more than 100 international watch brands and an assortment of other luxury products. Mix of both wholesale (2/3 of revenue) and retail business (1/3 of revenue). Wholesale generates 5% margin, whereas retail 15 – 25%.
In the last several years, Oriental Watch has been shifting its business strategy to focus more on higher margin retail businesses by opening up new stores. Rolexes are the key product, and has contributed up to 90% of revenue in China for Oriental Watch. The Company has over 52 outlets and a wholesale customer network of 36 point of sales.
Oriental Watch signs dealership contracts with the watch manufacturers, and in-turn sells the timepieces to wholesalers and end-customers directly. The watch manufacturers have control over what models are sold at each store. They also have a say on the range of retail and wholesale prices‚ as well as credit terms.
High end retail spend is expected to slow down in the coming 12 months, but Oriental Watch has the balance sheet strength to weather the storm. Sales of high-end luxury has slowed, but Hong Kong and key Tier-1 cities in China continue to be prime shopping destinations for the ultra-wealthy in China. Much of the downward SSS momentum has been priced into the stock. Management has indicated low SSS growth expectations in 2012, but does not believe there’s much pressure to discount.
Share price = HK$2.2/share
Market cap = US$160mn
Debt = US$35mn
Cash = US$48mn
Enterprise Value = US$147mn
6 month daily average trading volume = US$1.5mn / day
Balance sheet (as of Sept 2011)
Cash = US$48mn
A/R = US$19mn
Inventory = US$212mn
Total Liabilities = US$74mn
Current assets minus total liabilities = US$200mn vs market cap of US$160mn
Property assets (book value) = US$10.5mn
Property assets (market value) = US$60mn
Current assets plus market value of property assets minus total liabilities = US$270mn vs market cap of US$160mn. Implied 40% discount
Current Trading Valuation
P/E: 5.0x (FY12E), 7.5x (FY13E)
EV / EBITDA: 3.3x (FY12E), 4.7x (FY13E)
What is the value of the inventory?
Mostly comprised of mid-high end watches. Given that 75% of sales is Rolex and Tudor, value of existing inventory is relatively high and risk of large write-down is relatively low. High end watches are able to retain value over the years and have a relatively liquid and transparent market price should the inventory be liquidated. For example, Rolex has historically raised their prices 3 – 5% p.a., with the old watches retaining good value (and in some cases, increasing in value)
What are the property assets worth?
The property book is mainly retail stores that operate out of Hong Kong and China which were mostly acquired 25 years ago and recorded on the balance sheet at historical cost + depreciation. The location of the assets are as follows:
Hong Kong: 8 properties all purchased prior to 2000 (earliest being 1966), located in prime locations and recorded at a net book value of HK$65mn
- 133 Des Voeux Road Central: acquired 1981. HK$11mn (net book value), HK$120mn (est. market value)
- 160 Des Vouex Road Central: acquired 1988. HK$10mn (net book value), HK$40mn (est. market value)
- Rm 312-320 China Insurance Group building: acquired 1997. HK$31mn (net book value), HK$50mn (est market value)
- 15/F, Shing Lee Building: acquired 1993. HK$5mn (net book value), HK$7mn (est market value)
- Shop B G/F, & M/F., 719 Nathan Road: acquired 1980. HK$6mn (net book value). HK$33mn (est market value)
- Unit 2, 7/F, 33 Mongkok Road: HK$2mn (net book value). HK$4mn (est market value)
Mainland China: 2 in Shanghai, purchased in 2003 and 2007, with estimated net book value of HK$19mn (vs. estimated market value of HK$40mn)
The shop locations are all prime location. I've seen the store front for some of the locations in Hong Kong, and can confirm that the book valuation of the assets do not fully reflect market valuation.
Management has indicated that they may sell and lease back some of the properties to generate cash. Given the weak transaction volumes in the property market, we conservatively assume this does not occur.
High insider ownership. Founding family owns 27% of the shares in the Company
Cheap valuation. Trading below net working capital providing full downside protection
Stock liquidity is low to build a significant position
Retail sales highly levered to Mainland tourist demand