KDDL (Ethos Watches) - Scalable business model at an inflection point?

Stock Opportunities
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This story seems very interesting to me.

@mikaarun - Your numbers for FY15 matched the actual numbers almost eerily and also the pics/graphs in the KDDL investor presentation and yours. I’m assuming you just pulled the data from their investor presentation from last year. Started having integrity doubts there for a second!

So I was going through the results PDF of KDDL which also has the investor presentation slides. Need help from you guys to understand a couple of aspects :-

  1. EBITDA margins for ETHOS have been alternating up & down every year - 9.2%,8.8%,9.6%,8.9%,9.6% from FY11-15.
    Since the rate of branch expansion will be a lot lesser going forward, I’m assuming the EBITDA margins should start moving in only one direction from next year - up that is! Your thoughts???

  2. Looking at Ethos P&L - There is a line item for Cash PAT!

What is Cash Profit after Tax? How is it calculated? Cash PAT was 6.1 crores and PAT is 2.4 crores?

Ethos 1.jpg733×511 69.6 KB

  1. Looking at Consolidated P&L - There is a line item for PAT after MI and Cash PAT!

Can anyone explain what is the difference between PAT and PAT MI? How is Cash PAT being calculated?

KDDL 1.jpg718×485 58.7 KB
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Ok - so moving to a couple of things discussed earlier in the thread.

  1. Future Outlook of luxury watches -
    With India’s every growing upper middle class and HNIs, Ethos should be best positioned (offline/online model) to capture their share of wallet every time they look to buy an expensive watch. Owing to the current market size (I dare say which will grow handsomely in the next few years), growth in luxury watch sales over the next few years should not be much of a concern. Whether KDDL is best positioned to capture this is the bigger question that needs to be answered?

  2. The threat of smart watches - my opinion
    Simple question - Which phone do the elite or ultra rich generally use? Which phone does their entire family use? Most affluent HNIs would be using the iPhone and upgrading it every year / 2 years. (Offtrack but important to stress the point - Our PM used an iPhone to take his selfie with the Chinese PM). My thinking is there will be a mad rush for people to get their hands on the 1st iWatch as a status symbol.

And then… there will be disappointment. It usually takes a couple of iterations (years) before Apple starts getting the product right based on new technology, innovations and customer feedback.

But sooner rather than later - a lot of these people will be buying an Apple watch as it would make their lives easier with the same eco-system and usefulness of these devices.

Just yesterday, Google presented a host of new stuff for Android Wear and the future looks very exciting for smart watches. However, that time is still a few years away according to me.

So if the rich start buying the smart watches, where does it leave KDDL? The smart watches would ideally be their day-to-day/fitness tracking/swimming/fun events watch where they don’t need to be wearing a luxury watch worth > Rs 1-2 lacs. They will always be showing off their Rolex/Omegas/Cartiers at major functions/parties.

But it would start eating away at the wallet share for KDDL. If they’re going to upgrade to a new iWatch every year as well, they may not buy those <50k watches they used to buy earlier.

Don’t know but smart watches may just divide the market into 2 distinct segments

  1. Smart watches ( <60 k) As these devices may be a lot more useful for the middle class going forward. How much will that hurt KDDL? How much market share will they lose?
  2. Luxury watches (> 1 Lakh)

It may take some time, 1/2/3 years but smart watches are here to stay and there’s no denying that!

However, my take is there is still a tremendous scope for growth in the luxury segment watches in India which can be compared with jewellery for women (diamonds, gold) and these may never go out of fashion.

1 Main Question - How much share of the luxury watch pie can KDDL garner over the next 5 years? Assuming honest management and effective operations.

  • Initiated tracking position .7% of portfolio (Looking to add a lot more)
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PAT after MI means - PAT after Minority Interest. This is because KDDL doesn’t has 100% ownership of ETHOS so the PAT to the extent of their ownership is being considered.

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Ethos has closed 3 stores (7%) out of the 46.

2 of them at International Airports (Delhi and Ahmedabad) and 1 in Bangalore (Forum Mall, Whitefield).

Not sure about the Delhi Airport closure as it says Ethos Kiosk - which doesn’t sound like a full fledged store.

However, this is a concern for me as International Airports means duty free watches which should ideally be doing some of the best business for Ethos.

High operating costs (rent, staff, promotion, etc) may be a factor but airports business should ideally be a good pointer for demand.

Having read through the investor presentation earlier - it mentions the pace of opening new stores is going to be slower in the future.

Another worrying signal - Shouldn’t the management mention about the possibility of store closures which are not doing well or shifting them to other locations, etc?

Awaiting your thoughts.

PS: Subject of letter is even more interesting which says “Intimation of Store opening!”

Irony - Increased my holding today after the fall!

27AFE0E5_A475_4669_89E3_C945435777DB_174006.pdf (328.7 KB)

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Sharing some links to read about the current size and future growth of luxury watch market in India

http://www.gems2jewellery.com/?p=3192

The live mint article has a very good picture showing the growth/consumption of luxury products in India along with the rate of increase in HNIs.

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Any reason behind recent fall of more than 20% in last 5 days?

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Good time to accumulate, if you believe in the story

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Arun,

Very well crafted report … Just read the entire thread. Please participate here more often… Your flow of reasoning is nice.

First let me confess, I didn’t look into the financials of KDDL …

The market will grow and may grow very rapidly and substantially with rising income / aspiration etc. Mens’ jewellery as category has very limited options apart from watches. Women have gold / diamond jewelry; handbag; footwear, watch etc but till now men fortunately or unfortunately have only one piece of portable item to show wealth; to show a badge of success or to give a signal of his personal status. Luxury Mobile Vertu till date is a disastrous failure. Also purchase of these costly trivia thrives in the early stages of Capitalism development. If you see the US market, sales of these trivia is almost flat over the years. India, China, Brazil, Mexico are the new market for these products.

I am visiting the Ethos shop since it opened in Delhi and a member of their Loyalty Program for long time. I get calls every now and then telling some or the other brand has some special discounted price (ranging from 10% to 35%); also they have a program (if I recollect correctly) to buy any brand at flat special discount on birthday, anniversary etc (they also make call / send card / token gift etc). Also, they arrange some Summit or Conclave or something or other from time to time either all by themselves or in collaboration with one or two specific brands.

All are fine but a bit banal to me. There is a sameness and mechanicality in the process. In reality, it can’t be otherwise but mechanical as there is a hidden agenda for these “good wishes”… What I mean is, these marketing techniques are very short lived and possibly don’t have as much pay off as being tomtomed by marketing experts. Hasten, to add, it is my gut feel … have no strong data to support it.

They have done a wonderful website and have established an image of trust and genuineness.

I also don’t think smartwatch etc would be a threat to this conspicuous trivia consumption segment. But yes, I guess the Mid Market category “half way wannabe” brands (Tissot / Rado / Tag Heuer etc) may face some heat as there may be a premium category of Smart Watch (even Omega is planning to produce smart watch I guess)

Having said that I have doubts about the investment thesis for long term (short term anything may happen) for the following reasons…

  1. A distributor margin for an established brand is always a function of volume. There is very very little scope of Margin Improvement apart from cost control. Here Margin means “Sales Price - Purchase Price” … You have said it is 26% but if you take just for Ethos then I won’t be surprised if it is in the range of 35% to 40%. Consolidated Figure minus Standalone Figure of Sales and Cost Price would give you a rough indication.

  2. People come to buy a Rolex / Omega / Patek Philippe NOT to buy Ethos. These are market access / entry margin and as markets grow the Principals start exerting pressure on distributors — Even a very large distributor has very limited traction on a Principal. And since there are only 4 - 5 large players and the Category / Brand which are the “puller” ---- they can always join hands to put pressure on the Distributor. So, the Supplier Bargaining Power which you said is “Medium” is something which you may rethink. I feel it is high, very very high. Distributor can make money only through volume growth.

  3. Non exclusive distributorship will always remain an overhang on these businesses. I have just seen on Rolex website store locator in Mumbai ---- Ethos is not mentioned there. But Ethos has quite a few shops in Mumbai. Does it mean these distributor agreements are geography / location specific? Please check. Omega / Rolex etc have their exclusive boutique in most cities … Apart from the types of Kapoors / Johnsons of Delhi. They have great locations and can always upgrade if they sense an opportunity.

  4. If there is no brand fatigue, there would be shop fatigue / shop environment fatigue which they need to fight with constantly. So regular fixed big expense every 4 - 5 years to shop overhaul would be there. Also, promotions / discounts are always from their margin, if the shop supervisor is to be believed. I asked this few years back. But he may be wrong.

  5. I have seen in many cases, these brand owners, after initial success, wants to ramp up fast which is sometime difficult for one distributor to keep pace with. And it results in multiple distributorship which makes the brand owner happy / market growing but distributors falling short in margin / profitability. Upfront cost / location / rent is so critical that many time, in spite of category / brand’s grand success the distributorship is not profitable for long term. See the margin and profitability of Ingram Micro / Redington vis a vis that of HP / Cisco./ Microsoft. So success of Luxury watch category doesn’t necessarily mean grand success of Ethos. Here lies the supremacy of a brand.

  6. If market grows with multiple distributors, own boutique shops, price points may drop … So, per unit realization may come down even if margin is constant. Same store sale is very seasonal and no one likes a crowded luxury store !!!.. So, per shop sales volume may not grow beyond a certain point putting pressure on overall profitability. Per store cost structure is very fixed hence this point needs critical scrutiny if you are looking for long term multibagger opportunity here.

  7. Chanel / Dior / Hermes are also planning to get into Mens’ Expensive Trivia segment … How they change the rule of the game, if at all would be something interesting to watch. Also, a shift in focus / self image from Macho Man to Metro Man may change the luxury consumption nature, And these changes happen fast and sudden not slow and gradual. So, a newcomer may be better of to notice a shift than an incumbent. But it is just a hypothesis.

Lastly, their after sales service needs improvement … They very nicely and warmly entertains and tries to solve problems but if the problem is not as simple as changing battery they falter in diagnosing. And then takes a very long time to return the watch. Once even without repairing with a big “sorry” smile :smile: to one of my friend! Also, the repair costs are quite high. But I guess, once business matures, these problems can be resolved.

Overall I feel there are too many moving parts beyond control of Ethos. Ethos can remain profitable as a cost plus type business but expecting something beyond that may be adventurous.

I have no interest in other standalone part of KDDL.

Your informed opinion on these issues are welcome.

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I was following up on the OP regarding the group Hengdeli, the Chinese luxury watch retailer that is supposed to be the world’s largest. Came across an article and excerpts from it:

Source: http://www.bloomberg.com/news/articles/2013-01-30/hengdeli-plunges-after-report-some-exclusive-watch-licenses-lost

Shareholders

Swatch Group owns 9.1 percent of Hengdeli, according to data compiled by Bloomberg. LVMH Moet Hennessy Louis Vuitton SA, whose brands include Fendi, holds 5.9 percent, the data show.

“We are shareholders and it’s going very well — there is no change,” Hayek said of Swatch’s relationship with Hengdeli. “The development is very good. There is no irritation in our collaboration.”

Competing watchmakers having stakes in the same watch retailer! Found it interesting. Now the question is, while India does have the potential to be as large a market for luxury watches as China, does Ethos have in it to attract investment from the big 4 watchmakers?

Don’t have an answer and not invested as of now.

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If the raison d’etre for ethos is to promote the principal brands, soon enough, once market becomes big enough these watches will start having EBO’s - most luxury brands prefer EBO’s as they have better control over the experience and can squeeze out more margins. Look at what happened to guys like shoppers stop and lifestyle - in teh 1990s, shoppers stop was like a dream destination but they are strugglign with growth - hit at the low end by ecom and at the high end by brand’s own EBOs.

  1. across the world, there are no scaled up luxury retail models (non brand owners). Draw our the porter’s five forces and you will know what I mean - customers are discerning and your suppliers are very powerful - eventually you will get squeezed.

  2. last but not he least, as a first mover and possibly the only one in this space in india, if KDDL cannot make profits, it will only get worse once new competition comes in and “creative destruction” starts happening.

  3. retail is a tough business and as buffet said “it is like running a marathon at sprint speed”.

One of the basic tenets of investing is to understand where pricing power lies - most of these luxury watch brands are 200-300 years old and have massive brand and operating leverage and ethos is just a convenient marriage - look around you everywhere and right from auto (where honda broke up with hero and went solo) to ford (broke up with mahindra and went solo) to luxury brands (where louis vuitton always goes alone), I have seen these to be medium term, convenient marriages.

Think black swan - think of what would happen if say mont blanc decided not to supply to ethos once they become big enough - footfalls will plummet. And what’s the guarantee such a black swan won’t happen - think of what happened with HCL info and nokia - overnight, the latter cancelled the distribution arrangement and got another partner and HCL never recovered after.

To summarize, KDDL needs a mont blanc but mont blanc does not need a KDDL.

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Once a brand sees enough business, it will definitely take the EBO route. But if you look at a bouquet of a luxury watch brands, only 3-4 will be able to take the EBO route. and even then they would only have EBOs in a few cities. (3-4 Top Brands across 3-4 Top cities could well be the bulk of the business though)

I am not quite sure if KDDL Ethos is the only player in the Luxury watches space. Zimson stores (Mostly in South) offer a range of luxury watches and they have been in the business for a reasonable period of time. So there could be other local biggies in the space.

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Hi Vardha, always find your comments very practical and generally backed up by solid discussions with industry people. I always enjoy reading them so thanks for your insights on various threads.

I have been thinking on similar lines. However there are 2 reasons why I decided to go ahead and invest anyway. Please share your thoughts

  1. There is a working model in the form of Hengdeli which has scaled up from exactly where KDDL was about 10 years back to where it is now. Look how it has grown in the last 10 years. I will be extremely happy if KDDL in 10 years is where hengdeli is today and there is little reason why it shouldnt be given its current position.

With disposable incomes to rise disproportionately over the next 10 years I dont see why this business cant grow atleast 25% for a decade. Think about a low income white collar professional just entering the workforce who possibly earns 30k a month. After deducting rent expenses, food, transport, taxes etc. (all non-discretionary expenses) he barely has 2-3k left. Now imagine he does well at his job and has a hike of 10-12% (conservative I feel) He has added about 3-4k to his income, expenses might increase by 2k in a year but he saves 2-3k more. Now while his salary has only increased 10-12% his disposable income has gone up by more than 40%-50% which is huge. This is exactly what Raamdeoji Agarwal refers to the next trillion dollar opportunity!

  1. I think we need not look at KDDL as a buffet type strong moat buy and hold, rather hold it with a close watch and sell at the nearest sign of another strong competition emerging which as of now is none (and doesnt look like anyone is approaching). This means that operating leverage should come into play soon and while that competitor doesnt emerge, brands have that much less of bargaining power as they really dont have much of a choice until then. If they want to reach cities outside Bangalore, Chennai, Mumbai and Delhi, they really dont have a choice outside of Ethos and noone seems close to them as of now.

There is one issue however (which may look like an opportunity to the optimists of the world). I was at Mumbai airport today and saw about 4 sales people tending to an area of barely 200sq ft of store. There was no customer at the store at that point and it seemed like a sheer waste of money hiring 4 idle salespeople when such a small store could have easily been run by 1 person, 2 at the max. I am sure this is the case at other stores too and sooner rather than later, KDDL should be able to get its act together and cut costs too.

Regards,

Abhishek.

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The KDDL story is indeed very interesting. There are definite signs that discretionary spending will increase and KDDL will be the beneficiary. But I do have one major concern. The rise of E-comm players like Flipkart, Amazon and Snapdeal have severely impacted retail outlets. There is a clear shift in buying behaviour wherein people are prefering to buy online due to convenience and discounts.

I think the burgeoning e-commerce story will be a major impediment for retail stores like Ethos.

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Please read the detailed writeup by Arun(first post in the thread). KDDL is a quasi-ecommerce play as the customers can see the watches on www.ethoswatches.com but they are directed to the stores for purchase as most luxury watch makers do not allow online sales.

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Hi Raj,

Thanks for the insight. Post your comment, I checked Flipkart, Amazon and Snapdeal. I could not find a decent collection of Luxury watches at Flipkart and Amazon. But, Snapdeal was an exception. It’s collection included brands like TAG Heuer, Rado, Bernard Richard, Seiko, Tissot etc. With regards to Variety, there were 50 results for watches above Rs. 1 Lakh and around 400 results for watches worth above Rs. 30,000.

I believe this shows that e-commerce channel is open for luxury watch brands and its a matter of time before the other biggies like Flipkart and Amazon catch up with Snapdeal. And looking from the perspective of luxury brands, e-commerce channel of distribution will have advantages like reach, accessibility and convenience. It seems like a logical option for them to eventually opt for this channel unless I am missing something here.

Thanks.

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Hi Smiran,

Even Ethos sells the watches you found online. Luxury watches are generally 2 lakhs and above. That is where distinction comes.

Please listen to the last 2-3 conference calls on researchbytes. Mr. Saboo has explained very well about the business in Q&A.

Regards,
Raj

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Hi Guys,

What is the achievable EBITDA margins for ETHOS in the next 2-3 years? That is the key question in my view in the puzzle. I believe growth will be there but they have ~20 odd stores that are not doing well. Their best stores are doing an EBITDA of 10% before corporate expenses. and currently @ a corporate level they are doing 5%.

Their target is to reach 10% at a corporate level over the next 2-3 years. Isn’t that a steep ask? What potential levers do we think they have?

If the growth comes, but it isn’t profitable then its not very exciting, especially given the current valuations.

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Their targeted EBITDA margin will come only after couple of years provided economy picks up and luxury spends starts growing faster. There are other triggers like de-merger Ethos(quasi e-commerce play) from KDDL which will unlock the value, but that too is 2-3 years away.
In my opinion, this is more of a concept stock whose numbers will fluctuate for some more time before coming to a stable growth trajectory.

Disc: I am holding since last 6 month and fine with the bumpy ride.

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KDDL came out with a decent result. Story is unfolding slowly. The result and investor presentation provided a decent overview of the trend.

http://corporates.bseindia.com/xml-data/corpfiling/AttachLive/3A61D3DB_D757_4A19_BC27_44A1680F95BE_202804.pdf

http://corporates.bseindia.com/xml-data/corpfiling/AttachLive/3A61D3DB_D757_4A19_BC27_44A1680F95BE_202804.pdf

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Maybe interesting news w.r.t Ethos

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Thanks for sharing. This is one of the worries what KDDL investors have, but personally I would not take it much seriously. I am not sure how many of the mid level executives will replace their Omega or any other such brand with apple watch and go to work.

Also, if at all there is a trend change(highly unlikely in my view) then it won’t take much for switch watch maker to acquire a digital watch company and redesign the whole stuff. Let us see how the things unfold in next few quarters. As long as there is healthy sales growth in KDDL, I will stay put.

Regards,
Raj