What would you pay for a well-regarded, branded business that is expected to grow revenues and net income around 10% CAGR for the next 3-5 years with industry leading margins, high returns on capital, and low capital intensity?
And better yet, given that this business has low capital intensity, the company generates and distributes high free cash flows back to shareholders in the form of dividends and share buybacks, bringing total shareholder returns to 15%+ per year?
That’s Pandora (the jeweler) in a nutshell.
And unusually, Pandora trades at just 12.5x trailing P/E (~10.5x 1yr forward P/E) and 10x trailing EV/EBITDA (~8.5x 1yr forward) based on analyst estimates.
Were the multiple to revert closer to branded peers or the index as a whole, that would potentially add another 40-50% return. Realizing that over a 3-5 year period would add an additional 10-13% return per year, bringing total returns to 25%-30% CAGR.
Of course the natural question to ask is why the market doesn’t see or believe the story? It all comes down to durability of the core product.
A Brief History of Pandora
Pandora is a Danish jeweler that was established in the 1980s. Although it’s been around for quite a long time, the company’s modern formula for success did not come about until the early 2000s when Pandora launched the charm and bracelet product.
The bracelet forms the core of the product, but the charms is where the magic lies. Through the selection of charms, Pandora customers (almost exclusively female) can personalize their bracelets and switch it up depending on the occasion. Today, Pandora carries a catalogue of more than 700 different charms, covering nearly every occasion and personal taste imaginable.
Through this product, Pandora embarked on a fantastic journey of growth with revenues expanding >12x between 2008 and 2016.
Today, charms makes up ~60% of revenues with another ~20% coming from bracelets. The remaining 20% is composed of rings, earrings, and necklaces – categories that were mostly launched after 2013 in order to expand Pandora’s portfolio.
Pandora sells through 3 formats – concept stores, shop-in-shops, and multi-branded. Concept stores are standalone Pandora stores where the customer experience is designed and tightly-controlled by the company. Over the past few years, Pandora has been shifting the mix from predominantly shop-in-shop and multi-branded towards concept stores.
And layered on top of the channels, Pandora either runs the stores themselves or acts as a franchisor. Currently, 38% of revenues are generated through Pandora owned concept stores while the remainder is generated by franchisees or 3rd party distributors. In owned stores, Pandora captures the full retail price, while in franchise/3rd party stores, Pandora sells into those channels at a wholesale price. The difference is 2.4x (i.e. $100 worth of wholesale goods would fetch $240 if sold within owned stores).
Charmed or Cursed?
So far, the charms business has performed exceptionally well. Not only has it attracted a large customer base, it is also distinctly Pandora, which is an unusual feat of differentiation in the jewelry business. Jewelry tends to be a fairly commoditized industry (the inputs are commodities and final products are usually not distinguishable across brands) so product differentiation is usually non-existent except perhaps in ultra-high-end jewelry.
But that is exactly the paradox here – Pandora is not an ultra-high-end jeweler (Pandora’s price points are $25-$200), and the company sells a product that is quite non-traditional for a jeweler.
The prevailing thinking is that Pandora charms are a fad. One day customers will get over it, and sales will plummet.
This fear has percolated for a decade, but over the past 12 months, the fear seems to have materialized. Reported like-for-like sales slowed across all regions with the most recent numbers in North America turning negative (this was partially compounded by confusing metric calculations, but I’ll refrain from discussing the nuances to avoid complexity). As a result, the stock has declined approx. 1/3 over the last 12 months.
In essence, the market appears to assume that Pandora is cursed, and one day investors will wake up to find that the charms business has been nothing more than a passing illusion.
What Makes a Fad?
I challenge that view. Certainly there will come a day in which the charms business will be fully mature, but the performance of the charms business does not carry the usual characteristics of a fad.
For one, Pandora has been selling charms since 2000. If charms were a fad, the customer base would have likely moved on many years ago, yet the charms business still exists 17 years later. If this were a fad, it would certainly be the longest living fad.
Pandora recently conducted a survey of former customers and discovered that many customers remain interested in the brand and would consider buying Pandora products even after 6+ years.
In addition, fads usually tend to develop within certain groups (e.g. teens) or geographies. Yet, neither of these are observable within the Pandora customer base. Pandora charms and bracelets are worn across the age spectrum, and Pandora’s products are finding success across the world from the US to Latin America to the UK to continental Europe to Australia and to Asia. The global success of the product suggests broad appeal, and such broad appeal does not suggest a fad.
A Fast Fashion Business Model
Rather than getting hung-up on whether the product is a fad or not, I think it’s more instructive to think about the business model and how the company operates.
At its core, Pandora is a fast fashion jeweler. Unlike traditional jewelers that have inventory cycles longer than a year and glacial lead times, Pandora’s inventory cycle is less than a year and lead time is only ~100 days. The company is targeting lead times of just several weeks by the end of this decade. Like Zara, the fast fashion retailer, Pandora can respond relatively quickly to customer preferences and adjust the product mix as the data prescribes. No one worries that Zara can’t sell fashion because when they do have a fashion miss on their hands, they can respond and fix the issue within weeks. Pandora is positioned similarly in the jewelry world.
Pandora sells fashion and newness, not “forever”. Diamonds are forever. Pandora doesn’t do diamonds. What Pandora does do is drop 7 collections a year. Every season and holiday brings a new collection, a new reason for customers to pop in and see what else they can add to their collection, in effect creating a recurring customer/revenue streams. Given the low prices, charms are priced to be impulse purchases.
In addition, Pandora is a branded affordable jeweler. Investors and pundits seem to have a tendency to compare Pandora to other branded jewelers, which tend to be higher end. Pandora is no Tiffany. Pandora’s true competitors are mom & pop jewelers. Pandora offers customers a good brand, attractive products at an affordable price, and fashion – everything that mom & pops do not have the scale to offer.
If we consider the business model, it seems more than likely that if charms truly were declining, Pandora has the right business model to quickly adjust and adapt to whatever is next.
What If I’m Wrong
Pandora is already priced as if the business will cease to exist in 10 years. That’s a fairly large margin of safety given that analysts expect the business to continue to grow at 10% CAGR for the next few years, but a couple of other things offer additional comfort:
- Jewelry as a category is growing ~5% per year. If Pandora’s above-average growth simply normalized to industry growth, you would still have an okay business for the share price available today.
- Pandora’s newer categories are growing >50% per year. In just about 3 years, Pandora has launched and grown non-charms/bracelet categories that now represent 20% of total revenues. Within a few years, these categories could represent 40-50% of total revenues, significantly reducing the dependence and fear of charms.
- If worst comes to worst, Pandora’s continued conversion of franchise stores to owned stores would keep revenues unchanged even if the entire charms business goes away since owned stores generated 2.4x more revenues on an apples-to-apples basis compared to the wholesale channel.
So the risk/reward looks pretty good to me.
Disclosure: I have no direct beneficial interest in PNDORA DC as of publishing date but I may initiate a position within the next 48 hours.