Back in July 2023 I made two newsletter breaking down Pandora’s business and the investment opportunity it was in my opinion.

During the last month Pandora hosted two remarkable events: Capital Markets Day, back on 2023.10.05, and the Q3 2023 earnings report, on 2023.11.09. Since the first of both events the stock is up 25% in roughly 6 weeks.

In today’s newsletter I will go through the most remarkable points of both events and update the investment case exposed back in July.

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.

Capital Markets Day

In the Capital Markets Day, celebrated in London back in 2023.10.05, the company updated investors on the execution of Phoenix strategy and announced the start of a new phase, focused on brand transformation and growth.

Brand

Efforts and investments on transforming brand perception and increasing awareness will continue through different initiatives. The company also pointed to the low unaided awareness of Pandora non-owners - which I thought to be larger back in previous newsletters.

This spending should be then capitalized as it consists of a continuous effort to enhance brand name recognition and appeal. Hence, if executed correctly, it will be reflected on company terminal value.

One thing I didn’t like among brand enhancing strategies was linking the brand to ambassadors (influential/famous people who will promote the products). If any of these ambassadors are part of any scandal it might end-up impacting Pandora too. In fact, one of the ambassadors is Pamela Anderson, whose private live controversies have opened headlines in the past. Other initiatives like the sponsorship of exclusive and luxury events I think can have a larger impact on increasing brand perception to an aspirational brand.

Customers

The company has a good understanding of its customers and their segmentation. Surprisingly for me, the share of high income customers is quite remarkable. In combination with the large economic assortment of jewels offered reduces the potential impact of economic downturns, supported by the strong performance observed during 2023.

Effort on purchase experience enhancement is also being made. Pandora has a large set of available data and is focused on how to impact customer behavior more than making a flawless product (even though they do not compromise in quality).

Products and collection

The aim is to expand the product/collection portfolio, so Pandora is not only a charms and bracelets brand but also a full jewelry brand. To achieve so the following initiatives are being carried:

1. Lab-grown diamonds collection roll-out in Mexico, Brazil and Australia. Currently, it is only available in the USA, UK and Canada. New lab-grown collection will also be released.

2. New Pandora Essence collection. It is based on gold and pearls jewelry. A pilot test in the Netherlands will be carried out.

3. Expand offers for necklaces and earrings.

4. Relaunch of Pandora Me collection.

5. Customization of products by personalization services roll-out (online and in store) and installation of engraving machines on group’s stores.

Pandora is also offering refurbishment and cleaning services, as well as loyalty programmes to increase customer retention.

Markets

The company confirms the existence of some saturated markets like the UK, Australia and Italy where stable growth is expected. However, they see growth potential in markets where the brand is already established like he USA, Germany or Canada.

Western markets are already exploited so Pandora expansion will be focused on Asian markets:

1. Relaunch of the brand in China due to the company traction loss after covid-19. Pilot relaunch in Shanghai is promising.

2. Expansion to India, Japan and South Korea where the company presence is testimonial. See figure 5.

Stores network

The concept stores are the preferred channel due to their potential to express the brand and the insights workers who talk and interact with the customer every day can provide. In this regard, development of store managers is set to be a priority as shop performance is correlated with the length of their tenancy. I like this approach as it has been demonstrated quite successfully in analogue companies like Inditex.

It is expected 75% of the network in 2026 to be O&O concept stores. Forward integration will benefit brand recognition, customer experience and optimize performance (1% revenue per year estimated).

E-commerce sales were reported to represent 21% of total sales.

Q3 2023 earnings report

Released back on Wednesday this week, the earnings report was again better than estimations (same happened with Q2 2023 earnings report). In the report, the company points out that there was an unexpected pick-up in demand driven by tourists which is not expected to repeat in Q3 2024.

Products highlights

All product categories experienced LFL growth, with the exception of Pandora Signature collection.

Engraving service has been rolled out in 350 stores and is planned to reach 850 stores by the end of 2023

Geographical highlights

Pandora growth mainly comes from Rest of the world markets (22% LFL YoY revenue growth). LFL growth in Latin America is quite remarkable, Mexico experienced 9% LFL growth while Peru, Argentina and Colombia are growing at mid-double digits.

In the Western markets QoQ revenue growth is observed in USA, France, and Germany, although only Germany shows positive trend 9M 2023.

Stores network highlights

During the third quarter of 2023, Pandora has advanced with its strategic network expansion, opening a net of 27 concept stores and 16 Pandora owned shop-in-shops

Financial highlights

1. Record gross margin, an outstanding 79%. Historically >75%.

2. NIBD/EBITDA increase to 1.5. Pandora decided to increase leverage to the midpoint of its capital structure policy.

3. EBIT margin worse on YoY basis (16.5% vs 18.6%). Expecting a Q4 margin larger than target 25% which will balance lower EBIT margin on previous quarters, pattern observed on previous years.

4. Strong cash conversion, 65%, a vast improvement from 0% in Q3 2022. The improvement is mostly resulting from last year’s deliberate inventory build-up starting to lapse. Free cash flow including lease payments was DKK 597 million. CAPEX was 6.7% of revenue as investments into growth and in particular the physical store network continues

5. FY2023 guidance raised. Expected 5-6% LFL revenue growth.

Thesis update

Due to the new information available and the strategy shift after the announcement on the 2023 Capital Markets Day it is reasonable to revise the initial thesis and update it.

Pandora defines its market as an intersection between fast fashion and aspirational brands (I think an analogy again could be Zara and Massimo Dutti current positioning in the fashion industry). Pandora has a unique business model within the jewelry industry, thanks to its recurring nature. Instead of buying an expensive crafted jewelry piece, customers get captive by purchasing a bracelet to which charms are added (10 million bracelets and 50 million charms are sold per year).

During the 2023 Capital Markets Day the company emphasized sales volume to be the key growth driver as well as scale and vertical integration to be its main competitive advantages. Stores forward integration makes so much sense IMO.

Another thing Pandora has achieved is to make their jewels especially meaningful to their customers by allowing customization. High-end luxury pieces are special due to its exclusivity and aspirational appeal. Pandora is able to achieve special meaning by enabling customers personalization.

On the negative side, firstly, the low unaided brand awareness makes me think the brand is not as present in customers’ minds when it comes to buying jewelry.

Secondly, the expansion focus until 2026 has been placed in Asian markets. Recent experience in China suggests the brand struggles more than in Western markets (expansion in Latin America is also suceeding) to position the brand.

Thirdly, the capital allocation plan establishes the return of the excess capital to shareholders in the form of balanced dividend and repurchase programmes, so we could expect a less aggressive repurchase programme than the current one. With ROIC > 40% I would like to see further reinvestment into the core business or deleverage now that interest rates to take new debt are high.

Having established the strengths and risks of the business I have run a DCF model on the following conservative assumptions:

1. Revenue growth → 5% (guidance: 7-9% until 2026).

2. FCF margin → 20% (historically, over 25%). Larger CAPEX spending as sales percentage, 6-7%, due to Phoenix strategy.

3. WACC → 15%. 6% risk-free rate + 3% inflation + 6% risk premium.

4. Terminal growth → 2.5%. Jewellery industry is a well-established industry which will grow at the same pace as global GDP.

Closing remarks

After successfully executing the first part of its Phoenix strategy Pandora has announced its new growth path towards 2026, which in combination with a better 2023 than originally estimated thanks to markets in emerging markets and the recovery of the German one, has triggered a positive reaction of the market.

Brand development is in line with my expectations, with some emerging doubts regarding future expansion in Asian markets and the risks which linking a brand to a public figure impose.

DCF model with conservative assumptions shows Pandora is currently overpriced right now. IMO the market is more optimistic and values the comapny on Phoenix guidance metrics presented on the Capital Market Day. Although, I believe it is plausible and possible to get a 12-15% CAGR return from current price considering Pandora is the biggest player (1.3% market share) of the highly fragmented jewelry industry which is consolidating.