The Hour Glass

Not forgetting THG used $34.68m or 4.9cts per share to pay down debts to a minimal level.

With $180m cash, $560m equity and little leverage, THG's balance sheet is pristine and robust, with enough firepower to do M&A should any opportunities come along.

The major risk is privatisation and I certainly hope Dr Henry Tay do not give up on a public listing. Private equity should certainly be interested too...

Boss Tay definitely up for M&A, powder are dried and plenty for a reason! 💪💪💪

The valuation of THG shares can be easily understood by first understanding its business.

Here are some key characteristics:

THG holds its inventory for 6-7 months, which is a long period. THG is not an exclusive distributor of particularly well-selling brands/models. THG does not produce its own brand of watch. The products that THG sells is not expected to require scheduled servicing, if at all. So there is no after sales revenue from this as well. Most of its assets are in inventory and cash.

So what is THG? It is simply a (luxury commodity) trader/distributor.

This does not mean that THG has not produced a satisfactory track record of capital appreciation and dividends for its shareholders. It has.

But why does it not trade at a higher P/E? Sheng Siong is also a trader (albeit with some house brand products), but it trades at a much higher P/E valuation. Perhaps the difference in valuation between THG and SS is the stability of earnings. Can THG continue to perform well during periods of recession? Perhaps not as well as SS.

Given the lower stability of earnings, and large proportion of inventory and cash on its books, P/B may be more useful to measure THG.

Since THG's equity is mostly a bunch of inventory and cash, anyone willing to pay prices higher than THG's book value for its shares is hoping that the value of inventory and cash will appreciate, more than what he/she has paid. In normal circumstances -- as it has been for the past years -- the value of inventory will be realised at 'appreciated' values, since they are marked at cost on the books, and then sold to customers at a mark-up margin. In effect, when anyone is paying at higher than book value, he/she is paying for future earnings/dividends. And this is why THG seldom trade above book value, and those that do buy THG shares at above book value prices seldom see satisfactory returns.

The implication of this is that there is a low likelihood of THG being privatised at a satisfactory premium over book value. Unless there is an expectation of a material change in business -- say THG will be the exclusive Rolex dealer in Asia Pacific for the next 20 years -- there are few compelling economic reasons for the Tays to pay above book value. Assuming the Tays are smart/shrewd business people, what is more likely to happen is for them to pay below value. Since THG often trade close to book value, it is difficult for the Tays to make an offer that is both compelling (i.e. large premium to last traded price) to the shareholder, and that makes economic sense (not overpaying too much above book value) to the Tays. And so from the economic angle, privatisation is unlikely for THG.

And as for the large cash balance, it is working capital to grow the business, since cash is needed to finance the inventory. This is also why the payout ratio has only been about a third over the long-term. The implication of this is that a bumper special dividend is unlikely, but if it so happens, it means that THG has decided to stop/slow its growth. Which of these is ideal? If the latter does happen the shares should trade at a higher yield.

Nevertheless, an alternative -- and probably more appropriate -- valuation tool to measure THG is its dividend yield. A payout of 3 cents a year gives a 4% yield at current prices. Given its track record of growth, this seems to be pretty fair.

For shareholders who wonder why the market is not buying up THG shares in spite of its 'good results,' perhaps a useful exercise will be for such shareholders will be to ask themselves if they are buyers of THG at current prices. And if not, why?

As for M&A of other watch traders, why pay a premium to buy the inventory of others, when you can purchase your own inventory without?

(02-06-2019, 12:07 PM)karlmarx Wrote: The valuation of THG shares can be easily understood by first understanding its business.

........

As for M&A of other watch traders, why pay a premium to buy the inventory of others, when you can purchase your own inventory without?

Thanks karlmarx for the post. As I have not vested into watch companies, your insights make a good basis for my understanding. 

The takeway for me - this type of co is more suited for a dividend yield play than capital appreciation. A quick look into the EPS 5 yr growth of THG & Cortina (https://www2.sgx.com/securities/equities/AGS & https://www2.sgx.com/securities/equities/C41) seems to indicate stability over fast growth. Even THG's share price seem to hover +- 10% over the years, although Cortina's share price has a larger range.

Profit wise, this also seems to be the case for HK listed Emperor Watch(EW) http://aastocks.com/en/stocks/analysis/c...mbol=00887.

My high level analysis may be flawed because I simply use statistics from web sites, rather than reading through the various years' AR(& examining various factors e.g. company restructuring) and notwithstanding the small sample size of watch companies used. Nevertheless, I am inclined to think of THG as a stable low growth business and M&A may not be a good use of its cash holdings unless it can somehow find another high profit growth competitor business at a reasonable price.

Thanks for sharing. A Lot to learn from

(02-06-2019, 12:07 PM)karlmarx Wrote: The valuation of THG shares can be easily understood by first understanding its business.

Here are some key characteristics:

THG holds its inventory for 6-7 months, which is a long period. THG is not an exclusive distributor of particularly well-selling brands/models. THG does not produce its own brand of watch. The products that THG sells is not expected to require scheduled servicing, if at all. So there is no after sales revenue from this as well. Most of its assets are in inventory and cash.

So what is THG? It is simply a (luxury commodity) trader/distributor.

This does not mean that THG has not produced a satisfactory track record of capital appreciation and dividends for its shareholders. It has.

But why does it not trade at a higher P/E? Sheng Siong is also a trader (albeit with some house brand products), but it trades at a much higher P/E valuation. Perhaps the difference in valuation between THG and SS is the stability of earnings. Can THG continue to perform well during periods of recession? Perhaps not as well as SS.

Given the lower stability of earnings, and large proportion of inventory and cash on its books, P/B may be more useful to measure THG.

Since THG's equity is mostly a bunch of inventory and cash, anyone willing to pay prices higher than THG's book value for its shares is hoping that the value of inventory and cash will appreciate, more than what he/she has paid. In normal circumstances -- as it has been for the past years -- the value of inventory will be realised at 'appreciated' values, since they are marked at cost on the books, and then sold to customers at a mark-up margin. In effect, when anyone is paying at higher than book value, he/she is paying for future earnings/dividends. And this is why THG seldom trade above book value, and those that do buy THG shares at above book value prices seldom see satisfactory returns.

The implication of this is that there is a low likelihood of THG being privatised at a satisfactory premium over book value. Unless there is an expectation of a material change in business -- say THG will be the exclusive Rolex dealer in Asia Pacific for the next 20 years -- there are few compelling economic reasons for the Tays to pay above book value. Assuming the Tays are smart/shrewd business people, what is more likely to happen is for them to pay below value. Since THG often trade close to book value, it is difficult for the Tays to make an offer that is both compelling (i.e. large premium to last traded price) to the shareholder, and that makes economic sense (not overpaying too much above book value) to the Tays. And so from the economic angle, privatisation is unlikely for THG.

And as for the large cash balance, it is working capital to grow the business, since cash is needed to finance the inventory. This is also why the payout ratio has only been about a third over the long-term. The implication of this is that a bumper special dividend is unlikely, but if it so happens, it means that THG has decided to stop/slow its growth. Which of these is ideal? If the latter does happen the shares should trade at a higher yield.

Nevertheless, an alternative -- and probably more appropriate -- valuation tool to measure THG is its dividend yield. A payout of 3 cents a year gives a 4% yield at current prices. Given its track record of growth, this seems to be pretty fair.

For shareholders who wonder why the market is not buying up THG shares in spite of its 'good results,' perhaps a useful exercise will be for such shareholders will be to ask themselves if they are buyers of THG at current prices. And if not, why?

As for M&A of other watch traders, why pay a premium to buy the inventory of others, when you can purchase your own inventory without?

To add on to the comparison between THG and Sheng Shiong.

There is also a case of inventory risk and inventory holding cost.
I am not a watch expert but it would be safe to assume that not all inventory will be able to generate a good profit when sold.
In fact, the best sellers usually have low margin. Some inventory will have to be sold off below cost as the brand/model falls out of favor.
Keeping watch inventory is non productive. It does not generate any revenue while sitting there and you would still need a controlled environment to keep them in pristine condition. THG runs the additional risk of the brand owners dropping them due to one reason or another. Relationship with the brand owners are important.

In the case of Sheng Shiong, there is little inventory risk. Except for perishable food(which has much higher margins to cover the ones that are unsold and written off), most of the goods can be returned to suppliers. So inventory risk is extremely low. That is one reason why you can see a supermarket go out of business but not have any sale before it closes. And in terms of revenue, the variance in Sheng Shiong is extremely low and profit is very predictable. SS has little problems with suppliers and they have the upper hand in negotiations. They are big enough to have their own house brands or import direct bypassing the official distributors.

While valuations for SS are quite fair at the moment and THG can be said to be is low. SS is a generally a better stock to hold for the longer term. Its moats are generally much wider compared to THG. One can also sleep better at night knowing trade wars and recession has very little effect on SS's revenue and profits. Cant say the same for THG. But this is not saying that THG is not a good company, it has done very well for itself. But economics of its business is not great. It may very well outperform for a long stretch of time during the boom years. Different strokes for different folks. Not vested in either companies.

(02-06-2019, 02:48 PM)dreamybear Wrote: The takeway for me - this type of co is more suited for a dividend yield play than capital appreciation.

A shareholder of THG who held the shares for the past 10 years have actually enjoyed good returns, from both dividends and capital appreciation.

Assuming that THG can continue to grow at its past rate, it is likely that present shareholders will enjoy even higher dividends, and hence, even more capital appreciation.

So the real question that THG shareholder should be asking is, 'Will THG be able to earn higher profits in the future?'

I am of the opinion that spending on luxury consumption will continue to grow in Asia. But whether THG is a beneficiary of such a trend requires a separate analysis.

(02-06-2019, 03:28 PM)Big Toe Wrote: To add on to the comparison between THG and Sheng Shiong.

There is also a case of inventory risk and inventory holding cost.

This is perhaps the gulf that separates THG from SS. And also the reason why SS' payout ratio is about 75%, while THG's payout ratio is 30%. 

When THG purchase inventory, it is sold to customers in about 6 months. But it pays suppliers in 1 month. So working capital is needed to hold the inventory for 5 months. You pay your supplier first before you eventually sell the inventory and get paid by your customer. Most trading businesses are like this. 

When SS purchase inventory, it is sold to customers in about a month. But it only pays suppliers in about 2 months. So no working capital is required. In other words, SS makes sells goods and get paid by customers, but only pay their supplier 1 month later. Very few businesses are like this. Those that are, must possess certain strengths to negotiate such purchasing terms. Which then says something about those businesses that are not like this.

In terms of long-term business prospects, I believe it is positive for both SS and THG. But whether THG will make a more profitable investment as compared to SS is a separate matter. After all, the valuation of SS shares is rather high.

Granted Mr Market has been pricing THG conservatively for quite a while now, we must not forget that the real achievable value for a high-quality, well-managed business with a solid track record in steady business growth and superior profitability, is in a trade sale of the entire business to a willing and right external suitor. In such an event, the transaction price for the THG share will be what the Tay Family finds compelling - or at least attractive enough - to cede their controlling stake. This price cannot be the latest NAV/share of $0.79! My wild guess is that it could well be closer to 2x of that.

One can say THG is very much undervalued but it is not a business that would be a attractive target for take over. I might be wrong of course but the people that are most willing to take it private are probably the people running it because they know best what it is worth.
THG is a trader, while they maybe good at adapting to changing taste of their high net worth clients, they ultimately do not own any brands and there is nothing stopping the brand owners from selling direct or offer the brand to another dealer/distributor. Of course they sell many prestigious brands and that would help mitigate this risk.

In an extreme example, consider how apple went direct and caused the downfall of Epicentre. In any case, at its peak, Epi centre was earning an extremely low margin. People buy the brand/product, not the dealer who sells it. Also consider the example of investors/speculators making a windfall on Best World. The returns from best world are huge but it is a company that would have never made it in my portfolio which favored earnings visibility over the longer term. THG may well be a multi bagger over the next few years, but as with a number of other businesses, I dont have enough knowledge of its watch business or is confident enough to make a bet on it. As an investor I think it's good practice to define what one has deep knowledge of and what one has little or no knowledge of.