At Farnam we are constantly looking for businesses that display the following characteristics: great fundamentals (high ROE, solid growth trajectory, low debt levels etc.), a shareholder friendly management team and a purchase price that gives our assumptions considerable margin for error. Pandora is one such opportunity that we believe displays these characteristics.
Pandora is a Danish jewelry maker listed on the Copenhagen Stock Exchange that, over the last three years has consistently rewarded shareholders, both in terms of business performance and share price appreciation. Now, share price performance is not generally the best reason to invest in a company, but it can often be the flag that brings it to your attention for further analysis.
The company demonstrates above average economics, shareholder friendly management, and a price that we think provides greater upside than downside. For this blog post we thought we would run you through what we like about Pandora and what the risks are with such an investment. Hopefully it’ll give you a bit of an insight into our own investment process.
Here is the high level view on the Pandora fundamentals:
|Net Profit Margin||24%||26%||22%|
Source: Pandora Company Reports
At first glance we liked the look of Pandora’s financials but we didn’t love them. The raw numbers show that free cash flow (FCF) margin had fallen dramatically, as had net profit margin. However, a company with such impressive numbers (the profit growth and ROE for two) is worth investigating despite one or two flaws, especially we understand that no company is perfect.
When we looked deeper into the numbers we found that Net Profit margin had fallen entirely due to a one-time tax settlement with Danish authorities. This took their average tax rate up to 31% from 21% where it had been historically. This one off was confirmed by the company in their market announcements and will be much closer to 21% for 2016.
FCF margin had decreased due to two reasons: the fall in Net Income as explained above; and because of the company’s new strategy of store rollouts which requires capital expenditure. While this capital expenditure will reduce cash available in the short term, we expect it to reward shareholders over the medium to longer term.
Apart from these two factors, we generally liked what we saw. In short, we saw a management team that is consistently growing profits while reducing the company’s shares outstanding; two very good signals in competent management. Importantly, this growth is also mostly fueled by retained profits.
However, for every investment case, there is always a downside case. We no doubt had to consider the risks that Pandora presented:
- Global economic downturn – Pandora is still heavily reliant on the Western consumer, and jewelry, especially jewelry targeted to the middle income consumer, is very much a discretionary item subject to disposable income.
- Execution Risk – The Company is closing down third party stores and rolling out their own retail network. This brings with it some execution risk.
- Product execution – Though they have increased their product launches from two to seven per year, there is still a risk that the consumer doesn’t like their products.
- One trick pony – Around 70% of sales come from charms and bracelets, which are subject to changing consumer tastes and preferences.
- Commodity prices – Pandora are reliant on spot gold and silver prices to get the raw materials for jewelry production. This risk has been falling and now a 10% move up or down in these spot prices would result in a gross margin move of 1% up or down.
After looking at the current market price, we thought Pandora represented good value and the upside outweighed the downside. We the decided Pandora was worthy of inclusion in the Farnam International Opportunities Portfolio, but you should always decide independently if it is a good fit with your own portfolio, investment style, and risk profile.
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This document has been prepared by Farnam Investment Management Pty Ltd (Farnam) ABN 15 149 971 808 AFS Licence 430574. Australian Unity Funds Management Limited ABN 60 071 497 115 AFS Licence 234454 is the responsible entity of Farnam Managed Accounts. While every care has been taken in the preparation of this document it does not contain any recommendations to buy or sell any particular stock(s) noted. Farnam makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation and needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek their own professional advice. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.