PANDY - Pandora: An Undervalued Gem With Hints Of Value Investing

2024-01-04 13:37:57 ET

Summary

• Pandora, a Danish jewelry brand, offers a compelling investment opportunity with robust fundamentals, sustained growth, and market dominance.
• Positioned between luxury and affordability, Pandora caters to consumers seeking quality and personalization without compromising affordability.
• The company's growth strategy focuses on core business priorities, branding, alternative revenue streams, and expanding its store network, especially in the US and China.
• Despite an EV/EBITDA premium, Pandora's potential upside hinges on meeting guidance, including consistent EBIT margin, revenue growth, and free cash flow accumulation.
• A discounted cash flow analysis suggests Pandora's shares are trading at a 33% discount, making it an attractive prospect for value investors.

The investment thesis for Danish jeweler Pandora ( PANDY ) is primarily anchored in the company's robust and enduring fundamentals, cultivated over the past few decades. With an impressive track record of profitability, exceptional retail resilience, and enviable margins, Pandora stands out. The company's remarkable Return on Equity ("ROE") further contributes to its investment appeal.

Furthermore, Pandora's strategic market position between luxury and affordability offers a competitive edge. This positioning caters to consumers seeking quality and personalization without compromising affordability.

Pandora has implemented a growth strategy based on solid pillars, prioritizing its core business, making substantial investments in branding, exploring alternative revenue streams, and expanding its store network, particularly in the lucrative markets of the US and China.

In considering Pandora as a stock suitable for value investors, my discounted cash flow ("DCF") analysis, incorporating the company's financial guidance up to 2026, indicates that Pandora is currently trading at a noteworthy discount to its present share price.

This amalgamation of robust fundamentals and favorable technical factors strengthens Pandora's investment thesis, presenting an enticing opportunity in the jewelry sector.

Pandora’s Business Model and Strategy

Pandora is a premium jewelry brand and market leader in charm bracelets. It originated in Denmark in the 1980s and has since expanded globally. The company boasts over 2,500 concept stores worldwide, including 1,600 owned and operated, with the remaining managed by franchise partners, alongside multi-brand locations and stores-in-stores. The company's market cap is currently at $11.29 billion.

Pandora's business model revolves around producing affordable jewelry, particularly customizable bracelets and charms, differentiating itself by offering more accessible prices than luxury brands. The business is divided into two segments: Moments incl. Collabs (representing 73% of revenue) and Style, covering Timeless, Signature, ME, and Diamonds by Pandora.

Retail accounts for 51% of Pandora's sales, own online channels contribute 21%, and the rest comes from wholesale. Almost three-quarters of sales are attributed to charms and bracelets. The firm primarily produces in-house in two jewelry-crafting facilities in Thailand.

The US is Pandora's primary market, accounting for 30% of revenues, followed by the UK and Italy with 14% and 10%, respectively.

Launched in 2021, Pandora executes the Phoenix growth strategy, focusing on building a solid foundation and tapping into significant untapped opportunities. Key pillars of this strategy include:

1. Brand: Pandora possesses substantial brand equity and a loyal customer base, ranking number one in five out of seven key markets. By October 2023, there were 164 million searches for Pandora on Google, three times more than any other jewelry brand.

2. Design: With three clear design priorities, Pandora aims to drive the core (Moments), fuel the brand with more platforms in the Style segment (considered a low-risk opportunity built on existing infrastructure), and establish dedicated support models for each platform, including strategic collaborations such as the Marvel collection.

3. Personalization: Pandora focuses on increasing revenues through online and in-store engraving, allowing customers to customize their jewelry. Approximately 850 stores provided this service in 2023, with plans for 1,450 in 2024.

4. Core Markets: Identifying the US and China as markets with the highest growth potential due to underpenetrated network footprints, Pandora aims to drive revenue growth by enhancing brand awareness.

In summary, Pandora's growth plans hinge on new store openings and increased same-store sales resulting from the renewal of shop formats. Between 2024 and 2026, the company targets 225-275 concept store net openings and 175-225 shop-in-shop net openings, forecasting incremental revenue of $370 million and $146 million in EBIT, reflecting its network expansion.

Pandora's Fundamentals: A Value Investing Choice

Pandora has consistently demonstrated resilience and positioned itself as a top-value investment in recent years, earning recognition as a long-term option in line with Warren Buffett's criteria for quality in my opinion. The company's strong fundamentals, underpinned by a proven management team, set it apart.

First and foremost, Pandora boasts a commendable 10-year track record of Earnings Per Share ("EPS"), without any negative earnings years, even in 2020 during the pandemic when it reported $0.74 per share. This achievement signifies the company's ability to maintain stable profitability, navigate economic challenges effectively, and showcase strong management practices.

Pandora's moderate approach to long-term debt relative to annual earnings is noteworthy. The current financial net interest-bearing debt to EBITDA ratio is 1.5x, indicating that Pandora’s EBITDA may reasonably cover its total long-term debt.

Examining efficiency ratios, Pandora’s biggest strength lies here. The key selling point of Pandora is its fantastic margins, which contribute to higher profitability at the gross level. The company boasts an EBIT margin of 17% and a gross margin of 77%.

Therefore, solid returns are generated for its shareholders. Pandora has consistently demonstrated solid ROE and ROIC over the past decade. The company reported an outstanding ROE of 88% throughout 2023, and in the last decade, only in 2014 and 2020 did it report an ROE below 55%, at 44% and 26.2%, respectively, still robust figures. The same can be attributed to the ROIC, which finished 2023 at 36%.

The robust ROIC underscores the company's adeptness in efficiently deploying equity and debt capital to generate positive returns. Concurrently, the elevated ROE indicates that Pandora consistently delivers significant returns on shareholders' equity, showcasing effective utilization of equity financing.

In conclusion, Pandora currently boasts an attractive earnings yield. With an earnings yield of 5.5%, higher than the long-term Treasury yield of 3.88%, the company presents an appealing opportunity for investors seeking more substantial returns compared to less risky investments, such as government bonds. This suggests a more generous compensation, highlighting Pandora’s capacity to generate significant gains relative to its share price.

Risks to Be Aware Of

In my perspective, aside from macroeconomic risks such as elevated global inflation and high-interest rates worldwide, which pose significant threats to the execution of Pandora's projects for expanding the store network and enhancing same-store sales, the primary risks intrinsic to Pandora's business within the current investment thesis revolve around four primary and two secondary factors. These are:

1. Consumer Preferences and Fashion Trends: The demand for jewelry is often influenced by changing consumer preferences and fashion trends. If Pandora fails to adapt to evolving tastes or cannot introduce new and appealing designs, it may face challenges in maintaining or growing its market share.

2. Competition: The jewelry industry is highly competitive, and Pandora competes with both traditional jewelry retailers and other fashion accessory brands. Increased competition, pricing pressure, or the entry of new players could impact Pandora's market position and profitability.

3. Supply Chain and Production Risks: As Pandora produces most of its jewelry in-house in facilities in Thailand, any disruptions to its supply chain, such as logistical challenges, geopolitical issues, or natural disasters, could impact production, leading to inventory shortages and potential revenue losses.

4. Currency Exchange Rate Fluctuations: Pandora is exposed to currency exchange rate fluctuations in the Danish Krone since it operates globally. Changes in exchange rates can impact the company's revenues and costs, affecting its financial performance.

Secondary risks, which should not be disregarded in my view, include:

1. Regulatory and Compliance Risks: The jewelry industry is subject to various regulations related to product safety, materials sourcing, and labor practices. Non-compliance with these regulations could lead to legal and reputational issues, negatively impacting Pandora's business.

2. Brand and Reputation Risks: Any negative publicity, product recalls, or controversies related to Pandora's products could harm its brand image and reputation. Maintaining a positive brand perception is crucial for consumer trust and loyalty.

Valuation: The Icing on the Cake

Pandora's current EV/EBITDA of 12.5x, following a more than 90% increase in share valuation in 2023, gives it a premium rating compared to the sector average of 11.1x and approximately 37% above its average over the last five years.

However, this doesn't necessarily imply a lack of further upside potential for the Danish jewelry retailer, especially if the company meets its guidance . To achieve this, Pandora would need to report an EBIT margin of 26% by 2026 consistently, maintain revenue growth between 7% and 9% over the same period, and accumulate a free cash flow of $730 million by fiscal 2023, along with an additional $2.5 billion between 2024 and 2026.

Collating these figures and constructing a DCF model, I estimated a relatively low WACC of 6.5%, which I attributed to a low cost of equity considering Denmark's long-term interest rates and the country's low equity risk premium. This is balanced by an average cost of debt of 7.7%, accounting for an effective tax rate of 23% and interest expenses totaling around $193 million. These considerations and total shareholders' equity of $449.1 million and total debt of $1.92 billion brought the present value to an estimated equity value of $15.01 billion for Pandora.

When divided by the 82.4 million outstanding shares and incorporating a 4:1 ratio for ADRs per ordinary share, this calculation resulted in an implied value of $45.56 for Pandora, representing a 33.3% increase above the January 3 share price of $34.17.

The Bottom Line

Pandora exhibits several attributes that align with the criteria valued by a value investor when selecting a company to invest in. It presents a compelling case with a longstanding history of sustained growth and profitability, a commanding market position, elevated profit margins, and impressive ROE and ROIC. Furthermore, its current valuation is perceived as discounted.

If Pandora reports figures in line with its financial guidance until 2026, my analysis suggests that its shares are trading at a 33% discount compared to the current market price. This assessment considers a low discount rate, given the company's capital structure characterized by a low cost of debt, even in an environment marked by high-interest rates.

For further details see: