ORIENTAL WATCH: "Why I consider it a small-cap gem"

Lotustpsll, who contributed this article to NextInsight, worked 32 years with a global banking group before he retired.

ORIENTAL WATCH HOLDINGS – a small cap gem

"...it is expected that the Group’s profit for such period will be higher than that for the six months ended 30th September, 2017 mainly as a result of sales of products with higher profit margin, as well as the decrease in rental payment during the period."

-- Oriental Watch,
Positive alert announcement

Oriental Watch Holdings (OW), a luxury watch retailer, was established in 1961 in Hong Kong by the Yueng family and was listed on HKSE (stock code 398) in 1993.

The family is still managing this business diligently.

Oriental Watch has recently issued a profit alert for its half year reporting to be released on 20 Nov.

Key reasons why I have invested in Oriental Watch:

• Deep Net Net
• High FCF and High Operating CF
• High Dividend Yield over 10%
• Net Cash that matches Market Capitalisation
• Strong Financial Position
• About 60 Years Operating History

(All financial data below are based on the Annual Report for the year ended March 2018)

"Whether the investing thesis is “deep value, net-net, high yield or for Margin Of Safety”, Oriental Watch satisfies all. In my view, it is a unique small-cap play for the long haul."
-- Lotustpsll (photo)

Deep Net Net

Net current asset value (NCAV) was HKD 3.50. Current price/NCAV is 54%.

I would categorise Oriental Watch as a deep Net-Net stock.

Over the years, the company has taken in various luxury brands but I believe Rolex is the dominant brand driving its business.

The bulk of the inventory, a big component of current assets, should comprise of Rolex timepieces. Hence, the inventory value should hold its value.

OrientalWatch rolex Photo: Company

Exceptionally Strong Balance Sheet

For the past 3 FYs, in addition to paying down its debts significantly, the Management decided to build up its cash balance aggressively.

	FY 3/16	FY 3/17	FY 3/18
Borrowings	217m	110m	75m
Cash Balance	451m	690m	1,110m

Strong Recurrent free cash flow (FCF)

In the last FY, Oriental Watch recorded huge FCF of HKD 482m, HKD 84 cents ps and registered an exceptional FCF yield of 44% (based on current price). Operational CF yield was at 18%.

There are 2 huge FCF drivers – strong operating CF and material reduction in inventory level.

	FY 3/16	FY 3/17	FY 3/18
Inventory	1570m	1276m	1001m
FCF	183m	256m	482m

Management is proactive in managing its inventory level and has done exceptionally well for the past 3 FYs.

I believe inventory level is close to reaching optimal level and unlikely to drop much further. In future, FCF will be dependent more on operating CF.

High Dividend Yield

Driven by strong profits (EPS at 24.3 cents), Oriental Watch paid total dividends of HKD 25 cents, of which 15 cents were special dividends. Based on share price of HKD 1.90, this gives a yield of 13.2%.

Record profits for last FY were driven by improved GPM and lower rental costs.

Management has implemented a 2-pronged strategy to close marginal profitable outlets and to cut rental costs (biggest component of operating expenses) - that have led to a strong turnaround of its business profitability.

	FY 3/16	FY 3/17	FY 3/18
Outlets	80	64	62
GPM %	16.0	16.2	21.0
Rental	226m	214m	169m

Net Cash = Market Capitalisation

Net cash at last FY was HKD 1035 million. Market cap is currently at HKD 1085m.

So you literally get other assets for free if you invest in Oriental Watch at the current level -- at the time of writing -- of HK$1.90 per share.

I think Oriental Watch owns 4 to 5 retail properties, acquired years back, in Hong Kong that are accounted for at book values.

Not much information can be gleaned from the accounting notes. So there are significant hidden values in these properties.

Business Outlook

Stock price	HK$1.97
52-week range	HK$1.54 – HK$2.72
PE (ttm)	8.1
Market cap	HK$1.12 b
Shares outstanding	570 m
Dividend yield (ttm)	8.1%
1-year return	30%
Source: Bloomberg

I am sanguine over the future of Oriental Watch.

The experienced management has a firm handle on its business model. Its varied strategies to progressively monitor and manage its branch performance standards, rental expenses and imposing stringent inventory control have led to record performance for the last FY.

Strong FCF generated over the past 3 FYs were judiciously applied to reduce its borrowings and to build up cash reserves are right decisions undertaken by Management.

I expect Management to continue to reward shareholders with high pay-outs, similar to last FY.

Watch retailing is not as sexy a business as it used to be. However, given the rising affluence and economic clout of the middle class in China, I figure that this Hong Kong luxury watch retailer will be around for a long time.

Whether the investing thesis is “deep value, net-net, high yield or for Margin Of Safety”, Oriental Watch satisfies all. In my view, it is a unique small-cap play for the long haul.

Comments

#2 lotustpsll 2018-11-21 13:19

Strong 1H results with EPS up 39%. Strategies to raise GPM, reduce inventory and rental expenses have contributed to the stronger performance.

Dividends declared were hefty and kinda expected. Since last FY, management has raised dividend pay-out aggressively, almost equivalent to full EPS. OW can well afford it in view of its strong financial position.

Trailing dividends of 34.5 cents provide a yield of 17% pa. Amazing small cap.

#1 Watchy 2018-11-20 22:23

1HFY2018 results are out:
... the Board has resolved to recommend an interim dividend of 2.8 HK cents per share (2017: 2 HK cents) and a special dividend of 8.7 HK cents (2017: Nil) for the Period.

Group’s net profit attributable to owners of the Company recorded a year on year (“yoy”) growth of 39.1% to HK$64.0 million (2017:HK$46 million),

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ORIENTAL WATCH: "Why I consider it a small-cap gem"

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