Emperor Watch – In my previous musings on investing and life, one of the topics which I wrote about was the idea on valuation. While one can do fancy valuation on a company, it is an extremely subjective exercise at times that can be fraught with inaccuracies. The reason why Buffet does it so darned well in my opinion is because his mental models allow him to validate the value that he is putting on the company. If you are up to Buffet’s level of genius, sure, by all means do and invest in what he does. But if you feel that you may be lacking in that department, it may be wise to take another approach. Which is to look at companies through the lens of statistical cut off points. The frequentist in me looks for value through those very filters. And then, the deep dive into the annual reports before puling the trigger.
Emperor Watch is one of those companies which I pulled the trigger on, that is to say, we have initiated long positions into the company. It’s stock code is 887 and is a company listed on the mainboard of the Hong Kong Stock Exchange. If you find Emperor Watch and Jewellery to be a familiar name, you must have seen it in the malls and on the streets of Hong Kong. Like Oriental Watch, Emperor Watch is in the business of selling luxury big ticket watches and Jewellery to its customers.
A little history of how Emperor Watch evolved may be necessary for one to appreciate the company. And then later, the numbers.
Emperor Watch and Jewellery had some humble beginnings starting out as aclock retailer. In the 1960’s, the company took a strategic leap towards selling luxury watches as they saw that there was tremendous potential in Hong Kong and the mainland market. Their thesis was right. It proved to be profitable throughout the years. In fact, most of their 100 odd stores are in mainland China.
With a history that spans nearly 7 decades, it makes sense to think that the company, at the least, has done some things right, surviving the vagaries of time. So much so that when one wants to purchase a Patek Phillipe or a Rolex, one is inclined to think of Emperor Watch and Jewellery. I am not a marketing expert but I believe that they do have some ‘mindshare’ of the market. This is evident in good times.
For one, the bet to expand into China proved to be a good decision. The company also has other overseas branches in Singapore. In terms of revenue, the bulk of it comes from the sale of watches.
Insider ownership is clear cut. The founding family of Emperor Watch and Jewellery own 52% of the company. The founding family’s vested interest within the company is high. The only thing is that its chairman, Albert Yeung, is reputed to be a member of the triads. If you are interested, read this article. But to me, this is of a minor concern. I have said it before, people are generally dishonest. As long as they are not outright fraudulent, I think I can live with it.
Diluted earnings per share from 2011 to 2015 was 0.10, 0.06, 0.04, 0.02, -0.02. Year to date, its diluted earnings per share is also negative. The capital structure of Emperor Watch and Jewellery looks very similar to that of Oriental Watch. It is heavy on current assets due to the inventory which they hold, large ticket items of watches and Jewellery. So one of the reasons why the price of Emperor Watch has fallen to such a low degree is really the declining earnings over the years. And what exacerbated this is the fact they have been expanding nonetheless, increasing their number of stores from from 80 to 100 in 2015. Oriental Watch, a company in the same space opted to react to the market in an opposite manner to Emperor Watch. Oriental Watch opted to reduce the number of stores over the years. There is merit in both strategies I believe. On one hand, the reduction of stores reduces operating costs and results in savings. On the other hand, increasing the number of stores adds to brand awareness but increases costs. But to me, it all boils down to capital structure. I think both companies will do well if the conditions of the industry takes a change for the better.
On a price to book basis, investors have nothing to worry about. Emperor Watch is cheap. It trades at 0.5 on a price to book basis.
The China Growth Story
I am not at all an economics guy. I don’t know which way the economy is headed at any given point in time. But I do have some simplistic views on this matter. While China used to grow at 10% per annum, its growth has slowed considerably to 6-7% per annum. And I think it is not unreasonable to expect China to continue growing, albeit a slower rate. So if China is still going to continue to grow, wouldn’t Emperor’s footprint within the country benefit it? Considering the cyclicality of Emperor Watch, I believe that it has a fair chance of doing well again.
But with regards to the time frame, I can’t put a performance timeframe on it. Neither can I see any catalyst on the horizon here. But what I do see is if an investor is willing to wait, one may be able to see better days. When better days arrive, one may see increased earnings and increased dividends along the way. For now, its dividends paid in 2015 is 13.7 million hkd, a far cry from 149 million hkd paid in 2011.
I consider Emperor Watch a suitable candidate for a diversified portfolio. An overconcentrated bet in this company would not make sense.
So the question is are you willing to wait for mean reversion to take place? Would you?
Oriental Watch Holdings – This article talks about a similar company with the same business model, mercilessly beaten down by the markets.
Qian Hu Reversion To Mean – Reversion to mean is an interesting statistical phenomenon. For a quick read, read the article on Qian Hu, a down and out fish breeder.