the Oriental Watch Group operates a total of 14 shops, including 11 Oriental Watch Companies, 2 La Suisse Watch Companies and a Rolex Boutique, in Hong Kong and Macau. OW has started the watch retail business in Mainland China since 2004. Now OW operates more than 40 outlets and brand boutiques in over 20 cities. Recently, the company has expanded the business to Taiwan.
Is It Cheap?
- Trading at 0.63x P/NTA, a 15% discount to its five-year average P/NTA of 0.74
- P/NTA for OW hit a high of 1.4x in 2007 and 2010; and a low of 0.2x during the 2008 GFC
- ROE (trailing 12 months) was 8.3% and ROE (five-year average) was 10.5%
- Dividend yield 3.4%
- Book Value Growth (five years) 9.4%; Book Value Growth (10 years) 9.1%
Is It Safe?
- The total debt to equity ratio is 24.20%, while net gearing is 14.3%
- Over-dependence on Rolex brand limits new distributor opportunities with other brands. Rolex and Tudor account for more than 70% of OW’s sales. As the largest Rolex wholesaler in Hong Kong, OW’s strong relationship with Rolex is at the expense of other international watch brands.
- Rising Rental Costs: HK retailers need to pay bigger rental bills once their leases expire. With the high cost of rent in Hong Kong, retailers are effectively working for their landlords. OW's policy on self-owned stores will affect its vulnerability to rental hikes. Rental expenses impact is comparatively lower. In fiscal year 2011, rental costs accounts for only 3.41% of OW’s total revenue. This is because 4 out of 12 OW retail outlets in Hong Kong are self-owned properties, thus lowering the average impact of escalating rental rates.
- Share Options Risk: In April 2011, OW granted 32.3 million share options at HK$4.13 per share, 12.1 million shares to directors, 12 million shares to employees and 8.2 million shares to consultants. The closing price at the date of the grant was HK$4.13. As of Sept. 30, 2011, only the consultants exercised the share options; while both directors and employees did not exercise any stock options. The periodic issuance of share options could be an area for concern. Furthermore, share options vest immediately and some share options are even issued to consultants in lieu of cash. Although share options will potentially dilute existing shareholders' interests, we like the fact that (1) the exercise period of 10 years is long enough to discourage short-term behavior, although I will have preferred that the stock options do not vest immediately; (2) OW's top management does not monopolize stock options, but offers stock options to other employees as well (50-50 ratio of share options granted to directors and other employees).
Is It Quality?
- Oriental Watch accounts for over 20% and 30% of total Rolex sales in HK and China, respectively. On average, Rolex adopts a conservative production schedule as it only increases production volume by 10% each year to keep the brand premium, and avoids over-supply in the market and dragging down prices. This can explain why Oriental Watch was still profitable during the financial crisis in 2008.
- OW has owner-operators at the helm with large stock ownership, with significant portion of compensation tied to profit sharing. Oriental Watch's share options is a negative in terms of equity dilution and also whether directors need additional share options to motivate them given they already have significant share ownership. This is partly mitigated by long exercise period of options and the fact that management does not monopolize options.
- Oriental Watch's dividend payout ratio has varied from 16% to 22% of EPS from fiscal year 2008 to 2011.
Oriental Watch, as a proxy for Chinese luxury demand, is relatively cheap, but safety and quality of stock is compromised by the manner of share options issuance.
Disclosure: Not vested.