If you are in Asia and you consider yourself a value investor, Hong Kong is a great place to find bargain companies at more than fair prices. And that hunt begins in Hang Seng Index. Although the index, a representative of market performance has held its ground at 23700 levels with respect to global indices, our screens have begun to show a number of candidates worth considering.
And one of those companies which we have found is Oriental Watch. If some of you have been to Hong Kong, you will find that Oriental Watch has a presence that lines the busy streets and malls of the metropolitan city. Its business involves the sale of luxury watches and jewellery. Already, because the nature of the company is that of retail, I hear the naysayers cringing at the thought of investing in a retail company. That is the first conclusion bias permeating our consciousness. Why? That is because value investors such as Warren Buffet, Edward Lampert and less well known Guy Spier has had less than pleasant experiences with retailers. Folks like us take the narrative fallacy of thinking : Since those investors say that retail is bad, all of retail must be bad. How true is that may I ask? I have mentioned before that there is always a subset of of events that spurn the truth of a generalised set of observations. For example, portfolios of glamourous stocks with financial metrics such as a high past growth rate and return on equity experience a market return of underperformance when compared to its respective benchmarks but subsets of this portfolio are evident outliers. Think Coca Cola, Disney and others. With regards to Disney, read my article on how Lucas Films Star Wars was a brilliant acquisition. Also do read my take on FJ Benjamin and Eddie Lampert’s Sears Holdings. The latest update on Sears Holdings is this : the company has gone on an offensive in asset stripping with headlines emblazoned across the media, ” Sears May Sell Land, Cuts Jobs To Save $1 billion…” There are investors who are sticking to their guns on Sears though, perhaps coattailing on an asset stripping opportunity. But I think there is an enormous amount of execution risk on the part of management here and too many things can go wrong. And to add to that, the numbers don’t look right to me.
Coming back to Oriental Watch. The company has been beaten down mercilessly.
I do not claim to know all the reasons why but one of the reasons is that tourism receipts in Hong Kong have fallen. Why? The clamp down on corruption in China, the political turmoil between mainland and Hong Kong all have a part to play I suppose, and of course, can I say that we are living in very uncertain times with the world economy and the geopolitical events of our era. We have got Trump, a hard headed republican as an American president and a tough Xi Jinping staking his claim on the South China Sea, the conflicts in the middle east, a possible trade war and more. I just hope with all my heart that this would not break out into an all out war as history suggests.
I remember vaguely also listening to what Jim Rogers had to say about this. He said that Trump’s proposed policies and more could lead to bankruptcies and war. Considering that this man worked for a fund that compounded money at 40% per annum, his words should perhaps be taken as a possibility of things that could occur in our lifetime. I sure hope as hell that he is wrong. I will cease my speculation regarding the future now for I know not what will happen.
However interesting times may get, in an uncertain world lies opportunities. And as I mentioned earlier, Oriental Watch appears to be one. On the idea that all of retail is dead, i hacked at the idea that that is true for “all of retail”. I spoke to my wife recently on the possibility that the sale of jewellery and luxury watches goes online. And we had a lively discussion regarding the topic. I have no scholarly explanation for this but I can buy a pair of jeans online but if it is a big ticket item such as a car or a luxury watch, I want that experience of feeling the product and buying it. And I believe that many others do as well. This is perhaps an extension of our tendencies for self inflation.
I have seen what management is doing. And I can emphatise with their values. The company has systematically reduced the number of stores from 106 stores a few years ago to 87 stores in 2015. The reduction in stores will obviously reduce operating expenditures and produce savings going forward. The savings will aid the company if the downturn is a prolonged one.
Oriental Watch is also watching inventory levels, raising levels of cash and renegotiating rentals over the last couple of years. At the least, the management is reacting to the market by playing it conservative. Speaking of inventory alone, the value of the inventory is 1.438 billion hkd.
The company has also maintained very low debt levels of between 10% to 20% of equity. These levels of debt relative to equity is conservative. Perhaps when things start to improve , this number would go up. It always makes sense to leverage up if management sees that things would turn for the better. Of course,this is a matter of judgement to be reserved for management. As a point of observation, just a few years ago, debt levels were higher than currently.
At the time of assessing the opportunity, the market capitalisation was 970 million hkd. It has gone up a bit since then. So comparing its value of inventory to the market capitalisation alone showed its undervaluation. And we are talking about luxury watches here. 5 years down the road, it is my belief that luxury watches will still be a thing amongst the rich. So we should have less to worry about regarding inventory obsolescence.
Just one last thing though. To those considering its purchase, do not bet the farm as not all stars are aligned on this one. But as a matter of risk and reward, I would consider this a suitable candidate for a diversified portfolio. At the end of the day, we are talking about a company with a 55 year history. While it is loss making now, it has survived the 1997 Asian Financial Crisis, the SARS outbreak, the internet bubble and the 2008/2009 subprime crisis. And personally I think it has a more than fair chance of surviving the next 5 years and become profitable again. So we are really talking about probabilities here. As they say : “Life is a school of probabilities.” And so is investing.
