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Oriental Watch is one of the largest luxury watch retailer in the world with an extensive retail network in the Great China area. As at 31 March 2019, the Group operates 61 retail and wholesale points (including associate retail stores) in the Greater China region. Breakdown by geographic region is as follows: HK:11. Macau:1, China:46, Taiwan:3.
In 1961, Dr. Yeung Ming Biu, Chairman of the Group, and his shareholders founded the first store at Des Voeux Road Central. Since then, the Group has been progressively expanding. Through the acquisition of La Suisse Watch Company in 1973, the Group successfully acquired the distribution rights of a number of top-tier international brands. This translate to eight legacy properties all purchased prior to 2000(earliest being 1965). Located in prime locations and recorded at a cost less depreciation. These are goldmines for them, as the market value are currently many times their cost of acquisition.
Oriental Watch is a net net company with high dividend payout that is free cash flow sustainable. Current asset net off total liabilities equals to 1.4 billion hkd vis a vis a 958mil hkd market cap and a 231mil enterprise value. Cash net off total debt equals to 1.1bil hkd, net cash itself is currently more than its own market cap. This means, at current price base on sum of parts, their luxury watch inventory, financial assets and legacy property assets are free. On a per share basis:
Current asset net off total liabilities per share: 2.45
Net cash per share: 1.92
Share price: 1.68
Here is the breakdown of their dividend and free cash flow over the years. Do note in 2018 they had a 21% rental reduction due to aggressive negotiation and in 2016 the Chinese stock market and OPEC oil crisis happened.
2016 Div: 0.0035(0.2%) FCF:0.31(18%) OCF:0.35
2017 Div: 0.036(2.1%) FCF:0.46(27%) OCF:0.47
2018 Div: 0.25(14.9%) FCF:0.84(50%) OCF:0.88
2019 Div: 0.33(19.6%) FCF:0.43(26%) OCF:0.50
1H20 Div: 0.115(6.8%) FCF:0.37(22%) OCF:0.40
Their capex is low hence their FCF is quite close to its OCF. Its high free cash flow yield is due to two drivers – strong operating cash flow and material reduction in inventory level. This is also the reason why they have being paying out double digit yields for the last three years.
Luxury watch business has undergone multiple years of headwind especially if one is exposed to the Greater China area. String of events happened that consistently decrease their turnover. From China's corruption crack down, US-China trade war, Hong Kong social unrest and now the global covid pandemic. Management has aggressively tried to streamline cost internally from rental reduction, close down of high-rent yet non-performing stores and inventory optimization.
"Oriental Watch will continue to deploy appropriate strategies to elevate the productivity of existing stores, strengthen cost management and optimize its inventory profile, as well as enrich its product portfolio to capture opportunities within this particular consumer threshold"
2016 Inven: 1.57bil Rev: 3.03bil GPM: 16%
2017 Inven: 1.28bil Rev: 3.14bil GPM: 16.2%
2018 Inven: 1.00bil Rev: 2.89bil GPM: 21%
2019 Inven: 824mil Rev: 2.43bil GPM: 24.7%
1H20 Inven: 704mil Rev: 1.17bil GPM: 27.3%
They have parred down more than half of their inventory since 2016. Gross profit margin increased due to the Group’s positioning at high-end luxurious market where their long-term clients maintain strong purchasing power. This divergence together with lower rental cost have helped them maintained consistent high profitability despite decreasing demand.
"With the hard work and determination from all staff, the Group’s inventory level has successfully been maintained at a reasonable level."
Above was a comment made by the management in 1H 2020 which states that their inventory level is now reasonable. This mean free cash flow going forward will be more dependent on operating cash flow and less on inventory reduction.
Approximately 75% of sales consist of Rolex and Tudor. This means the value of existing inventory is relatively high and liquid. Risk of large write-down is relatively low. Inventory is usually a scorn for most business, but not for them, as Rolex watches tend to appreciate in value over time. This is because Rolex historically raised their prices 3 to 5% p.a, with vintage watches retaining good value.
This is a deep value, high yield investment that is meant to be kept long term. Good management and balance sheet amidst a tough macro business outlook.
Risk
1) Continued decrease in turnover due to decrease spending power from recent global spike in unemployment.
2) Covid19 pandemic impact may give management a reason to stop dividend payment
3) Continued social unrest in Hong Kong after Covid19 is resolved, extending the bleak outlook
Catalyst
1) Rising economic clout of the middle class in China
2) Management unlocking value via privatization
3) Dividend recapitalization. They can payout HK$1.92 per share to shareholders if they want to, without taking on debt while continuing to be listed and operating.
Disclosure: At the time of this posting, I own shares in this company.
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