The Hour Glass (HG) is a luxury watch retailer group founded in 1979 in Singapore. It has presence with over 40 boutiques in 9 cities in Asia Pacific region, including Singapore, Malaysia, Australia, Thailand, Japan and Hong Kong. More than 20 boutiques are located in Singapore, which is also its headquarter. It sells luxury watches from more than 50 of the world’s finest watch brands, such as Patek Philipe, Audemars Piguet, Hublot, IWC, Richard Mille, Rolex, TAG Heuer and the likes.
HG just released its FY16 financial results two days ago. Revenue fell by 4% yoy and net profit was down by 10% yoy. The FY16 net profit was 5.6m lower yoy mainly due to 5m donation for charity purpose. So, without this donation, the net profit was pretty much flat. The Company achieved higher gross margin to partly offset the lower revenue. Overall, this result exceeded my expectation on the back of substantial drop in Switzerland’s watches export to Singapore.
Source: Company’s FY16 Financial results
Why I bought it?
Look at the 5-year performance below. It was able to grow its revenue and earnings steadily in the past 5 years while maintaining the margins. It also had a strong balance sheet with net cash. The free cash flow fell to negative in FY15 mainly because of the acquisition of Watches of Switzerland for 13.3m and purchase of two Australian properties for 43.5m. The free cash flow fell to 1.5m in FY13 mainly because of 48m investment in the construction of new stores and the renovation of existing ones, the start-up of Laduree franchise – a French luxury bakery, and the acquisition of a warehouse facility in Singapore. So, the free cash flow dropped significantly because the Company was investing for growth, not just to maintain existing business.
Source: Company’s FY15 Annual Report
If we look further back for past 10 years, we will see even better performance. From 2006 to 2015, revenue grew at 8.42% CAGR while net income grew at 18% CAGR. The earnings grew faster than the revenue because of improving net margin from 3.51% in FY06 to 7.88 in FY15. During the same period, the Company was doing a bigger business but still managed to achieve even higher return on equity. ROE grew from 9.3% in FY06 to 15% in FY15.
Luxury watch retail is a discretionary business. The customer base is from the upper middle class to the rich. During the GFC 2008 – 2009, which was among the worst recession in the history, HG remained profitable. Both the revenue and net profit recovered in the following year and continued to grow even through the European debt crisis in 2011. The management has demonstrated its resilience to guide the Company through several tough time.
The solid performance was awarded with the share price rising nearly 12x from 2006’s level to current price of 0.785. If we measure the performance from the start of 2000, the share price rose nearly 20x. This has been an outstanding return over the years. I do not have the price history before 2000.
Source: Yahoo Finance
From 2010 until 2015, it was valued at an average of 7.4x P/E with the range from the low of 5.4x to high of 9.6x. That valuation multiple is quite low for a Company with such solid performance.
The share price reached the peak of 0.91 per share in July 2015, but fell to 0.69 during the August market sell-off. I thought that was a good opportunity to buy despite that the P/E was at the higher end of the range. I bought it at 0.72 per share in September 2015 and intended to hold for longer time as HG is a good company and undervalued.
Why I sold it?
After seeing 15.3% yoy drop in Swiss watch export value (in CHF) to Singapore for first three months in 2016, I need to adjust my earlier BUY decision based on this new information. I don’t have special insights in how long this downturn in Swiss watch export can last. So, I analyzed it this way.
In 2015, the total value of Swiss watch export to the whole world, in CHF, fell for the first time since 2009. The export value was lower by 3.2% compared to the year before. Export to Hong Kong suffered the most with nearly 23% yoy drop, and many HK retailers faced sharp declines in both sales and profitability. Export to Singapore held up well with 1% increase, and HG was able to grow its revenue and earnings modestly during that period. Export to Singapore actually started to show substantial drop in second half, but it was offset by the strong export in first half.
Things got worse in 2016. For first three months of 2016, export value of Swiss watch to the whole world fell nearly 9%. Export to Hong Kong, again, topped the chart in terms of decline among the 10 biggest markets, with 31.6% fall. Singapore is not spared this time round. Export to Singapore fell by 15.3%, and I don’t see the overall luxury watch business to turnaround any time soon.
If the value of watch export to Singapore falls by double digit percentage points in 2016, the watch players in Singapore will have less to sell. Eventually, their revenue, in aggregate, will fall. HG, being the largest luxury watch retailer in Singapore, is likely to experience meaningful fall in revenue this year despite its past demonstration to navigate through difficult times.
In the past 5 years, it was trading at P/E multiples from 5.4x to 9.6x. As current share price is near the high-end range, and near-term earnings are likely to fall, I decided to sell out my position. I figured that it’s likely that I could buy back at lower price in near future. Therefore, I sold it at 0.745 per share in April. Deducting all the expenses, I got nearly 2.5% return while holding it for 7 months.
The headline FY16 earnings fell by 10%, which might sound bad. However, without the 5m donation, the earnings were quite flat for FY16. This is actually a good performance considering that revenue fell by 4% and overall luxury watch industry was getting worse. The share price rose from 0.75 to 0.785 after the earnings release, giving 4.7% return, which I missed out.
My view on the near-term outlook of this industry remains negative. The Swiss watch export figure for April was out two days ago. For first four months of 2016, the export to the whole world fell by 9.5%, and the export to Singapore declined by 14.6%. You can access the report from this website: http://www.fhs.ch/eng/statistics.html.
The export figure could swing widely from month to month. So, don’t try to predict the figure for the following month. We should, however, treat this export figure as leading indicator for this industry. What the data has been telling us is that luxury watch business in Singapore has turned from ok to bad since late last year until now. The effect is likely to flow through to the financials of the players in this industry, probably, in their next financial reporting. I will continue to monitor the development in this industry and hope I can buy back the shares in HG at more attractive price.