Pandora A/S - Part 2

Main competitors

There is not another player on the affordable jewellery market comparable to Pandora. They are either too small (the affordable luxury industry is fragmented), their target market is not the affordable jewellery or not only they are focused on jewellery but also other premium and luxury accessories like bags, sunglasses or watches. Some of those players are Tiffany´s & Co. (acquired by LVMH in 2021), Swarovski (private) or Tous (private).

However, there are some peers the company compares with, in terms on return to shareholders, on their 2022 Remuneration Report. The only ones which are only dedicated to jewellery are Chow Tai Fook Group Limited (1929.HK) and Signet Jewelers Limited (SIG). Although, both of them are focused on diamond jewelry. From figure below it can be observed Pandora has the best margins by far from its competitors.

Figure 2 shows Pandora uses more leverage than competitors because it can be payed with the cash generated - Net Debt/EBITDA is conservative.

On figure 3 we can see Pandora’s return exceeds the one of it competitors. In terms of ROE it is expected due to the larger leverage used as mentioned before. Pandora’s OCF/net income ratio is the lowest compared to peers but shows most of net income from the business is generated by operating activities.

There are other players which are more preent in Europe to the ones previously presented but they are private so I decided to search their websites to see their affordable jewellery catalogue offer. On the table below a comparison between some of the mentioned players is shown:

From Table 1, it can be observed that Pandora offers the widest affordable selection of jewelry at affordable prices, no matter the size of the competitor. This a good indicator of their dominion of this sector of the jewellery market through its economies of scale competitive advantage.

On a year when the jewellery market is expected to contract, Pandora’s guidance it’s grow revenue on low single digit. On Alexander Lacik’s (CEO) words 2023 will be a sucess if revenue stays flat because on a market which decreases it means Pandora has stolen market share from competitors. This market share increase on a difficult macroeconomic status its possible thanks to the extense affordable jewellery offer Pandora offers in comparison to its competitors.

Key financials

Let's now have a look at some of the financial data provided by the company, looking at period span of last 10 years.

• Margins

They are stable and high. Gross margin is expected to slightly increase as franchises are acquired while the Operating and net margins are compressed. Reduction of these last two during Covid-19 was caused by Pandora stores closed down while employees were not fired.

• Income Statement

Revenue has increased in the low double digits during the last decade which is impressive. However, due to the uncertainty in terms of macroeconomic growth there is no certain guidance for the following year.

The objective for this year was an organic growth of -3% to 3% (updated on Q1 report to -2% to 4%) and an EBIT margin of 25%. Hence, management expects a flat year. However, they point out that that specific case scenario would imply a contraction of their TAM so Pandora will end-up stealing market share from other players.

Moreover, due to the transition to a capital intensive business model it can be observed the disconnection betwee EBITDA and EBIT.

• Balance Sheet

The company has a large debt on the balance which it is able to maintain as it is a cash generating machine. Where some key point should be mentioned:

1. The business shows excellent return in terms of ROE (> 50%), business ROCE ( range of 70% to 80 excluding goodwill), ROIC (45% - 55%) and ROA (approximately 20%). These extraordinary ratios are due to the large amount of debt Pandora uses to finance its operations (right now Total Debt/Equity ratio is 2).

2. Company’s target is to have a debt level between 0.5 and 1.5 Net Interest Bearing Debt/EBITDA. Right now it is currently at 0.8.

3. Interest coverage ratio is around 20. All loans are at floating rates and the company estimates that by each 1% increase on interest rates 49 DKK million (7.8 million USD) of additional interest expenses will be added. Net income is 707.2DKK million and approximately 70% of that debt due date is within a year. Hence a temporary decrease in net income during 2023 will be expected.

4. Goodwill represents between 20% and 25% of total assets. Pandora does not acquire other players but the companies running its franchises so the goodwill comes from those acquisitions.

• Cash Flow Statement
  Pandora its a money-making machine with a CAPEX which oscillates between 3.5% and 5.5% of revenue. Moreover, Pandora its close to complete its new manufacturing facility in Vietnam what will probably reduce the CAPEX investment needed for the following years.
  FCF% margin was over 20% before Covid-19, reporting 12.3% margin last year due to the opening of a over 80 new concept stores and the payment of 1 more billion DKK in taxes (part of them deferred from 2021).

Competitive advantages

I can only identify two as pure moats:

1. Economies of scale.

The capacity to offer high quality jewels at very low prices in comparison to competitors is the scale. Pandora production activities are mostly established in Thailand, enabling the company to produce goods at lower cost.

Pandora’s assets and distribution network are not easy to replicate so it is not likely for another competitor to scale-up and replicate Pandora’s value proposition overnight.

2. “Owning a piece” of customers mind

In Western markets, specially in Europe, when someone needs to make a gift and they think on the possibility of buying a jewel, Pandora is the company that easily comes to customer’s mind. Their outstanding locations on the towns and malls favor reinforces that perception.

Valuation

I don´t like to do very thorough or detailed valuations because its difficult to predict the future as accurately as a numeric valuation model allows but more importantly because it is about making an educated guess of the price based on all the previous research than performing a detailed engineering exercise.

For the valuation it will be assumed:

1. Revenue growth of the core business to be 6% (in line with analysts expectations for following years). On 2023, Pandora expects -1% to 4% according to Aide memory for 2023 Q2.

2. China recovers and grows conservatively. Recent China GDP data suggests slower recovery. Let´s say full recovery by 2024 and double the revenue by 2026.

3. EBITDA margin is maintained around 30%.

4. EV/EBITDA used due to transition to more capital intensive model. Current EV/EBITDA around 7.6 while historically the median value has been 10.7. EV/EBITDA of 10 used for calculation.

5. Repurchase programme maintained around 3% of shares outstanding every year.

By 2026 the share price is expected to reach 1390.5 DKK, resulting on roughly 21% CAGR from today´s price.

Running a DCF model, depending the assumption taken, you will get a price range of 600DKK - 700DKK so we can conclude its fairly priced right now.

Risks

Some risks I have identified are:

• Supply chain disruptions and geopolitical risk in Thailand.

Thailand has internal political tensions and in the recent past has been under civil unrest situations. Pandora is diversiying its manufacturing facilities by building a new plant in Vietnam, starting production is planned at the end of 2024.

• Fashion fad

Pandora’s revenue is highly dependent on charms and bracelets (accounting for around 72% as shown on Part 1). However, the concept is still highly profitable after being released for more than 20 years. During that time have coexisted and expanded in that environment so it does not lo important transformations on fashion have occurred and charms ok like things will change at least in the mid-term. Moreover, partnerships with other brands have the ability to bring back charms to the spotlight.

For me its more likely a scenario where customer sentiment towards the brand changes because it became too mainstream to express each customer character and individualism.

• Management

As previously shown their ownership of the company and incentives are not the best ones. However, they have been succesfully executing since 2019 and I can’t see why they should not continue doing the same apart from erros not related to being aligned with shareholders.

Opportunities

Some of the opportunities for Pandora in the following years are:

• China expansion

Before Covid-19, management estimated revenue in China to triple by 2025. Under the current uncertainty management has not provided guidance for the following years, nor for China’s expansion. Market is short minded so it is not discounting this possibility.

• Artificial diamonds collection

It currently accounts for less than 1% of the company's total revenue. New collection of jewellery which Pandora started 2 years ago. It is growing at a good pace as the baseline was 0. Artificial diamonds are identical to natural ones and around 50% cheaper. If Pandora’s outperforms industry peers on margins also on this product line it can be an interesting growth driver in the coming years

• Boarding of new customer segments

There are growth potential on 2 groups:

1. Men.

   Men jewellery market is expected to grow at least CAGR of 8.25% until 2030 according to Globe Newswire. The company does not report revenue from men jewellery separately but they only offers 81 products out of 1230.

2. Gen Z

   Pandora Me is the collection focused on atracting Gen Z customer. It corresponds to 3% of the total revenue currently, growing at a approximately 44% CAGR since 2020.

Conclusion

Pandora is a jewellery market leader, with no competitor on bottom price range. It still has market to grow through new collections and product which are working well. However, its dependency on its charms collection its still quite remarkable.

Management is not specially aligned with shareholders but have performed satisfactorily since taking over. They show focus on long-term thorugh their priority on stregthening the brand and use brick and mortar to build a relationship with customers.

It constitutes an opportunity in terms of industry leadership and cash generation at a fair valuation.

DISCLAIMER: This article is not a recommendation to buy or sell any financial instrument, the content is educational and my personal opinion. Each person has to make his own analysis. Any action or decision you take as a result of viewing this article is your sole responsibility.