This week's casual valuation is Movado Group, a company with a fairly small market cap (just under $750m)
As always, this post is not financial/investment advice, it is purely for educational/entertainment purposes. It is divided into a few segments:
- Understanding the business
- Understanding the historical financial performance
- Laying down some assumptions to value the company
- Valuing the company based on assumptions significantly different than mine
What is Movado Group?
It is a company that is involved in designing, sourcing, marketing, and distributing quality watches.
Manufacturing isn't part of the sentence above as that is being outsourced to companies in Switzerland and Asia (mostly China). Is outsourcing better than having this process in-house? There are pros and cons to each decision. If the company has this process in-house, they would have higher margins (as there's no 3rd party that will take a cut), but in times when the demand for their product declines, the fixed costs regarding the factories will still be there. With the decision to outsource, the company has more flexibility in bad times to adjust the contract according to the demand.
They own 5 brands (Movado, Concord, Ebel, Olivia Burton, and MVMT), and in addition, they have contracts to sell products for 6 licensed brands (Coach, Tommy Hilfiger, Hugo Boss, Lacoste, Calvin Klein, and Scuderia Ferrari).
The difference between the two is, with the licensed brands, every time they make a sale, Movado Group pays a royalty to the company that actually owns the brand.
Depending on the price, some of these products can be classified as luxury products. However, I'll argue that the products that they sell are fashion accessories.
Unlike the smartwatches, the watches that Movado is involved in are old-school (in terms of functionality). Therefore the person who wears one only gets the benefit of knowing the time, not the steps made, or whether the last night's sleep was good.
Based on their annual report, there are two major selling seasons, the spring season (around school graduation) and the Christmas/holiday season at the end of the year.
They also disclose that the success of the sales depends on 4 factors:
- General economic conditions
- New product introductions
- Level and effectiveness of advertising/marketing
- Product pricing decisions
The company can control all except the first factor. This was reflected in its share price which was relatively volatile over the last 5 years, ranging from $50/share prior to the pandemic, to $9/share as the pandemic has begun to $33/share today.
How are they selling these products?
Around 77% of their sales are through wholesale (3rd parties who take a cut) and 23% are direct to consumers (through their own stores and websites).
Over the last 5 years, the # of stores increased from 37 in the US to 47 in the US and 4 in Canada.
Historical financial performance
The company's year-end is January 31st, hence when I refer to a certain year, I am referring to the 12 months ending January 31st of that year. (Example, 2022 is the 12 months ending January 31st, 2022).
The last twelve months (“LTM”) represent the 12 months ending July 31st, 2022 (the last available quarterly report).
Since 2019, the company's revenue grew an average of 3%/year and this indicates that we're looking at a fairly mature company, so it would be unreasonable to expect high growth rates in the future (organically).
The revenue increased from $680m (in 2019) to $770m (LTM) and the gross margin improved from 54% to 58%.
All of the other operating expenses are reported as one bucket of Selling, general, and administrative (“SG&A”) and it decreased from 45% of revenue back in 2019 to 41% for the LTM.
This means the company's operating margin improved from 9% to 17%.
The company impaired goodwill and intangible assets during 2021, however, as this isn't a cash expense and the company is acquiring other companies often, I am ignoring it for the purpose of the valuation.
During the pandemic, if we exclude the goodwill impairment, the company was still profitable (although, the operating margin was only 2%). This shows that it has the strength to go through difficult times without losing (significant amounts of) money.
Let's move to the balance sheet:
The company has a cash position of roughly $200m (over 1/4 of its market cap) and no debt (except for leases). This balance is similar to what it was 5 years ago, so the question is since the company was profitable throughout this period and was generating cash, where did it go?
- Dividends – Current yield is slightly over 4% (takes about $20m/year)
- Share buybacks – The management is authorized to use $30m more on buybacks (which isn't a significant amount compared to its cash position and market cap)
- Paying down debt – Although it is debt-free today, it had debt in the past
- Inventory increase – The company was holding a reasonably stable amount of inventory over time(around $160m). In the last quarter, this amount increased to $215m, which ties an additional $50m of capital and it comes with no explanation. If I am to invest in this company, this is something that I will closely monitor.
Overall, the company is in a good financial position, without any risk of bankruptcy.
The management does a great job not only in managing the business but also making sure that the risk is at the lowest level possible.
Assumptions about the future & valuation
As this is a small-cap company, there's only one analyst who's providing forecasts for the future. However, I find these assumptions a bit too optimistic as the forecasts include revenue growth of 7.7% for 2023 and 6.1% for 2024 while keeping the margins at the same level as today around 17%.
The reason why I find these assumptions too high is due to a few factors:
- Historically, the growth was 3% per year.
- The company benefited from the favorable FX rate to improve the margins to some extent (this might not be sustainable).
- Inflation will also impact their costs in the coming period (which will reflect in lower margins)
- The economic conditions are not favorable.
Hence, my assumptions are as follows:
My assumptions:
– Revenue growth of 2%/year in perpetuity – Yes, it is lower than the current level of inflation, but I am always trying to be more conservative in my assumptions.
– Operating margin of 10% (much lower than the current margin of 17%) – This is more in line with their margin prior to the pandemic.
– A discount rate of 10.52% (WACC-based), decreasing to 9.72% over time.
One more thing to keep in mind, I am applying a 15% discount for lack of control as there are two types of shares and the ones available won't give control (even if someone bought all).
Based on these assumptions, the fair value is $$635m ($28.13/share)
The current market cap is $743m ($33.17/share)
Based on my assumptions, the IRR is close to 10%.
Note: I have taken into account the cash, debt, and deferred taxes on their balance sheet as well as the outstanding equity options.
What if my assumptions are significantly wrong?
Based on the assumptions above, the revenue will grow by 22% to $939m in 10 years and the operating margin will be 10%. I am aware that my assumptions could be significantly wrong. So, let's take a look at how the value of the company (per share) will change based on different assumptions regarding the revenue 10 years from now and the operating margin:
| Revenue / Op. margin | 7% | 10% | 13% | 16% |
|---|---|---|---|---|
| 0% ($770m) | $18.9 | $25.6 | $32.2 | $38.8 |
| 22% ($939m) | $19.8 | $28.1 | $36.9 | $45.4 |
| 50% ($1,15b) | $21.1 | $33.0 | $44.9 | $56.7 |
| 70% ($1,3b) | $21.6 | $34.8 | $48.0 | $61.2 |
In my opinion, the 16% operating margin isn't sustainable in the long run. If we take a look at the share price over the last 5 years, it is quite clear that when it was around $50, it was on high-end.
However, in hindsight, the pandemic numbers of $9/share were quite low. If someone bought at that price, the dividend yield is around 15%.
I do not own any shares of Movado, but I will open a position if the price drops to around $20/share.
What are your thoughts on Movado Group and its valuation?
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