Pandora - 2023 Earnings Review

During the end of 2022 and first half of 2023 I built my position in Pandora turning into the 2nd bagger of my portfolio during this month as 2023 earnings were presented last 7th of February of 2024. Since then, the stock has surged ↑10.6% up to 1134 DKK per share.

The Danish jewellery brand reported a full year revenue growth of 6.3% when first 2023 guidance was estimating earnings growth of -3% to 3%. If this gap between guidance and actual year performance has not awakened the curiosity about how 2023 was for the company don’t worry, in today’s newsletter we will cover much more.

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.

Executive summary

• Revenue YoY growth equal to 6.3% in DKK (9% at CER, Constant Exchange Rate) impulsed by Germany and Rest of the World countries. Net income: DKK 4.74 billion (down -5.75% YoY).

• Large debt increase, both short and long term used to return cash to shareholders in the form of a large share repurchase programme.

• Dividend of 18 DKK per share announced (vs 16 DKK in 2022, 12.5% YoY increase). Additionally, additional DKK 3.7 billion to be allocated to shares repurchase.

• 2024 guidance expected 6% to 9% revenue growth driven by like-for-like revenue growth and network expansion.

Income statement

Pandora’s performance during 2023 has exceeded the set expectations with a strong revenue growth of 6.3% in DKK (9% at CER). See figure 1 below.

Simultaneously, gross margin reached an all time record high of 78.6% while the EBIT margin hold at 25% (see figure 2).

This is great news considering Pandora is transitioning from a business model focused on quick expansion through partnerships (wholesalers and franchises which accounted for 50% of the revenue in 2018) to a business model in which the own their stores to have more control over customer experience. This business model change implies an increase of the gross margin (trend already observed) but a reduction of the operating one, which has been at 25% for the last 3 years.

Geographical revenue distribution

Geographically, Pandora’s revenue is coming from Western countries where Pandora market share is approximately 10%. In those markets the revenue remains flat (what constitutes a decrease in real value). The exceptions are Germany and the USA where some low double-digit steady growth has been observed.

Revenue is then fueled by countries from the rest of the world (under “Others” category) with strong performance in countries like Spain and Mexico where the revenue generated is comparable to the one in Australia or France.

During the CMD held last October, Pandora placed its focus in the growth opportunities that Canada in the West and India, South Korea and Japan in the East, offer as well as the relaunch of the brand in China - which sales still are far from showing any sign of reverse and start of recovery - so I expect traditional Pandora markets to represent a lower share of revenue in the following years.

Product revenue distribution

If we split the revenue per product line, it can be observed Charms are still the greatest contributor to the revenue (65%). However, its growth slowed down in 2023.

On the other hand, Timeless is the segment with the strongest momentum. During the call they commented that during the Q4 it experienced a 31% LFL growth and they experience this trend of Timeless outpacing Core segment although they do not provide a guideline on it.

Regarding the lab-grown diamonds segment, it reported sales of 265 DKK million (+24% YoY) corresponding to 1% of the total revenue. The company expects this segment will generate 1 DKK billion sales by 2026. Finally, the new jewellery segment - Pandora Essence - was launched in the Netherlands during 2023 and reported sales of 5 DKK million. The collection is expected to be rolled-out in more countries during 2024.

Balance sheet

If the income statement was a positive surprise, the balance sheet is weakening and makes some doubts arise.

Pandora boosted its leverage during 2023 by increasing its loans & borrowings by 3.7 DKK billion. Current loans & borrowings were reduced by 3 DKK billion while non-current ones increased by 6.6 DKK billion. The effective interest rates of the loans are remarkable is it can be observed from figure 6.

Some relevant financial ratios to evaluate this leveraged financial structure would be:

• Assets/Equity ratio → 4.4 (2023) vs 3.1 (2022).

• Net Debt/EBITDA → 1.2 (2023) vs 0.8 (2022).

• Long-term debt/Net Income → 1.7 (2023) vs 0.6 (2022).

As you can see, the income generated by the company justifies the use of leverage to boost returns. We will discuss later if this capital allocation its appropriate.

Cash flow statement

Free cash flow (calculated as FCF= NOPAT + D&A - CAPEX - ΔWC) was DKK 5.27 billion (an outstanding 55.4% YoY growth) with a FCF margin of 18.7%, up from 12.8% in 2022.

This was driven by a normalization of inventories, and hence of the working capital, and maintenance of the CAPEX at the same level of 2022 - DKK 3.88 billion in 2023 vs DKK 3.76 billion in 2022.

Capital allocation

Pandora’s new Vietnam factory is currently under construction, explaining the expenses in “PPE” and “Assets under construction” reported in 2023 annual report. The expenses in Purchased Plant & Equipment (Purchased PPE) have increased 34.7% from 2022, DKK 1.1 billion in the 2023 vs DKK 838 million in 2022, which includes also the network expansion. Acquisitions of partner stores accounted for DKK 356 million expense.

The company will pay a dividend of 18 DKK per share (vs 16 DKK in 2022, 12.5% YoY increase) maintaining a payout ratio of around 30%. Additionally, DKK 3.7 billion to be allocated to shares repurchase, which in combination with the remaining, 1.3 billion from the previous repurchase programme, makes a total of DKK 5.0 billion to shares repurchase equivalent to 5% of the company’s market cap.

And here is where the increase of loans & borrowings in the balance sheet comes into play. Increase & loans & borrowings has two reasons: refinanciation/repayment of loans & borrowings which are maturing and increase of cash return to shareholders over the earned income.

Capital efficiency

Pandora shows extraordinary performance in terms of capital returns measured using any of the usual ratios. See figure 9.

Note: As the company is a fashion brand, which needs to be appealing to customers and provide a great buying experience at the shops, I considered it more appropriate to not exclude goodwill on ROCE calculation because it’s difficult to establish the contribution of any acquired asset to the brand appealing. E.g. an iconic shop in a specific location part of an acquired franchisee assets.

ROE extended Dupont analysis

The outstanding ROE values shown in figure 8 are due to the leverage employed by the company. ROE improvement since 2020 has been driven by an improvement of the net margin but leverage has been the main contributor as shown in figure 10.

Management

The most remarkable news regarding management is the sale of shares by CEO and CFO last 9th of February. Both of them sold 15% of their total shares. These shares are part of the 2019 remuneration package and the sale coincides with the vested date so they probably wanted to cash out some of them.

In connection with the call, very in line to what was presented in the CMD back in October 2023: existence of under-penetrated markets where the company expansion will drive revenue growth, network expansion plans, and customer experience focus.

The most interesting insight was the possibility to continue gross margins expansion, specially once when buy backs of partners stores in the coming years.

Guidance was also provided, forecasting a revenue growth between 7-9% and EBIT margin of approximately 25%. In line with the announced outlook and strategy for 2026 at the CMD.

Conclusion

Overall, Pandora showed great execution through 2023, specially compared to the guidance given one year ago. Charms collection maintained a certain level of growth and other collections like Timeless accelerated driving growth in markets out of the traditional Western ones. Furthermore, the company continues executing its playbook to transform the shops’s network and concept, expanding gross margin while maintaining the operating one.

However, I got left with some concerns:

1. Suboptimal capital allocation.

   Executive management remuneration is based on target yearly revenue growth, EPS growth and total shareholder return (TSR). While revenue grows steadily at a moderate pace, share repurchases will accelerate EPS growth. Moreover, continue to pay a rising dividend will favorably impact TSR metric.

   Repurchasing shares during 2022 and 2023 was a great way to create shareholders value. However, I don’t think taking debt at 5 - 6% interest rate to repurchase shares with a FCF yield of 5.4% (growing at 7 - 9% annually) is the best alternative to allocate capital and might be biased due to remuneration incentives. Instead, expanding the brick-and-mortar part of the business as a counter-cyclical move might be more interesting in my opinion.

2. Impact of a potential recession in already saturated markets.

   I have concerns on how a recession would impact sales in already saturated markets where the brand is struggling to appeal to customers and grow.

Hope you enjoyed this newsletter. This will be the last earnings I will cover from the companies of my portfolio (if no surprise arises and makes me change my plans). Now I will go on a short ski holiday and I hope to write about my latest portfolio addition in my next newsletter in a couple of weeks.

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