Value Investors Club / Phu Nhuan Jewelry (PNJ VN)

Description

Phu Nhuan Jewelry (PNJ) is Vietnam's leading jewelry retailer with an estimated 30-50% market share of organised retail. While most jewellers have not turned out to be successful investments, I believe that PNJ is at the sweet spot in terms of management capability, Vietnamese affinity towards gold, and sufficiently large and growing middle class population.

The bull case is quite straightforward - i) unfocused/inefficient competition in the branded space, ii) best in class management, designers and production capability, iii) large unbranded market that accounts for 60-70% of jewelry market (depending on sources) with over 6k stores vs PNJ's 405 stores as of June 2024, iv) plus the usual EM story of low consumption of gold per capita and rising middle class tailwind

On the other hand, there are also a number of issues with PNJ - i) Very poor cash generation, mainly stemming from increasing inventory days (increased from 119 in 2015 to averaging 169 days in the past 5 years), ii) DongA Bank scandal (PNJ and founder were both cleared but that will always be an overhang), iii) possibility that PNJ is at the ceiling among their target customer segment

Investment Summary:

PNJ is the dominant player in the branded jewelry segment (~30-50% market share from various expert estimates). During covid, the company said they gained a few percentage points in market share as consumers preferred to stick to the most trusted brand
There are 3 big competitors in the jewelry space - SJC, Doji and Ben Thanh Jewelry (BTJ).
- SJC is a SOE with 200 stores that focuses on gold bars (~1% GPM). Although ~20% of their sales come from jewelry, they mainly play in the 24k gold segment and don't put in any effort because they are so dominant in gold bars and since they're owned by the government, they don't have any incentive or investor pressure to change
- Doji is the closest competitor with ~200 stores but has the rare stone label and has no unique identity. Doji's parent company has much larger businesses in financial services, banks and real estate under Bamboo Capital (BCG) and Tien Phong Bank (TPB)
- BTJ was a very promising challenger with 18 stores in 2019 which targeted segments which were not captured by PNJ yet, but the ex-CEO said they were struggling with capital and it was majority acquired by a PE, they decided to change direction and focus on manufacturing for exports and gold trading instead of jewelry as they didn't want to compete with PNJ
Unit economics of a store is $60k capex and $600k in WC (mainly inventory), giving a total cost of VND 15.3bn per store. Steady state stores generate ~VND 50bn per year with 8-12% EBIT margin = 5bn EBIT per year, giving them a 3-yr payback period
Margins have had 2 large step ups in 2012 (stopped focusing on gold bars which have 1% GPM and fierce competition with SJC and Doji) and 2015 (sold off fuel trading business which had ~3% GPM in 2014). Going forward, I do not expect another drastic improvement, but it should gradually improve as mix changes to more jewelleries (gold jewelry GPM 28%, silver jewelry is 65% and accessories are ~30%). PNJ also has the only private gem grading lab in Vietnam (also gives them the highest trust factor as jewelries from PNJ come with 2 certificates) which is small but 70% GPM

Importance of gold in Vietnam

According to this thesis (discount because it was written by a student?), gold was widely accepted to pay transactions until the mid-1990s even real estate, furniture and garments. This led to a deep rooted habit of hoarding gold as a method of saving, and banks even offer gold saving services with interest. It is also seen as way to preserve capital in the face of VND devaluation, even more popular than hoarding USD
Interestingly, the study showed that the correlation between gold prices and inflation in Vietnam were not statistically significant while interest rates had the strongest influence on gold prices in Vietnam. Crude oil had a negative correlation with gold, but only in the long run
Looking at general demand in the country, Vietnam (13.3t) has the 4th highest demand for investment gold in Asia behind China (71.2t), India (33.6t) and Thailand (21.3t) in Q1 2019. On the other hand, jewellery demand tells a very different story - China (184.1t), India (125.4t) and Vietnam (5.4t). Although there wasn't data for Thailand, if we go by previous quarters, both Vietnam and Thailand seem to have jewellery demand less than investment, therefore I would hypothesize that as Vietnam progresses, this gap should close or maybe even emulate China since their cultures are pretty similar

But what if Vietnamese consumers see gold as an investment not an accessory?

This will probably be a very gradual process of changing the consumer mindset, but I think PNJ has been doing a good job in educating consumers that their jewellery can be used for investment purposes as well by offering to buyback PNJ branded pieces at a very small discount (~1%) while according to a Third Bridge expert, their competitors will take a $10-15 cut for a $200 piece (5-7.5%)
Alternatively, when you want to upgrade your jewellery, PNJ allows you to trade in your current PNJ piece to deduct from price (similar to Tiffany's but they said the new piece had to be 2x the value when I did a channel check last month). While this practice is widely done in Vietnam, PNJ has the widest store network, so a consumer could buy in HCMC and later upgrade in Hanoi

Why do I think that Vietnam's demand for jewelry will increase?

According to Brookings, Vietnam's consumer class (population able to spend $11/day) will increase from #26 to #18 by 2030, adding 23.2m incremental consumers. In a separate study by AT Kearney, as a population's wealth, measured by GDP per capita, increases over the years, the wallet share allocated to jewelry will gradually increase, transitioning from a store of value to a status symbol. While the exact GDP per capita varies, reports have figures ranging from $2k to $4k as an inflection point for jewelry consumption vs Vietnam's current level of $2.8k.

Ratio of Jewellery vs investment demand (Tonnes)
	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019	2020
India	1.9	1.7	1.9	1.8	3.0	3.4	3.1	3.6	3.7	3.7	2.4
Greater China	2.7	2.3	2.5	2.5	4.2	3.5	2.4	2.3	2.4	3.1	2.1
China, P.R.: Mainland	2.5	2.2	2.3	2.3	4.1	3.4	2.3	2.2	2.2	3.0	2.1
Hong Kong SAR	19.3	27.5	23.7	28.3	43.2	34.5	29.1	25.9	34.3	31.0	6.3
Taiwan Province of China	-5.5	1.2	1.4	1.1	1.0	1.1	1.1	1.1	1.0	1.0	0.6
Japan	-0.5	-0.3	-1.5	4.3	-6.0	1.0	1.0	-5.1	1.3	-0.8	-1.5
Indonesia	1.9	1.2	1.3	0.9	1.4	1.9	1.8	1.9	1.9	2.8	1.2
Malaysia	2.1	1.1	1.7	1.8	2.3	2.3	2.7	2.3	2.2	2.3	2.3
Singapore	6.3	2.1	1.9	2.2	2.2	2.1	2.4	2.5	2.4	2.4	1.5
Korea, Republic of	13.5	2.4	1.5	1.3	1.4	1.3	1.6	1.2	1.1	1.0	0.9
Thailand	0.1	0.1	0.1	0.1	0.1	0.2	0.2	0.2	0.2	0.3	-0.1
Vietnam	0.2	0.1	0.1	0.1	0.2	0.3	0.4	0.4	0.4	0.4	0.4

Using data on jewellery and physical investment (bars & coins) from Gold.org, I computed the table above to give us some base rates in Asia. The key observations were

Japan has been a net seller of physical gold (negative years are when the population is selling physical gold) over the last 10 years, presumably to raise cash for retirement but we cannot rule out switching to gold ETFs, especially if the country should be quite financially savvy. In the same vein, Thailand also sold gold during the pandemic in 2020
For the countries with a culture of investing in gold (China, India, Thailand and Vietnam), the trend has been declining, even if we strip out 2020 as investing was likely not the top priority.
On the other hand, the ratio of jewelry vs investment has increased for all these countries. For some reason, India's absolute demand decreased since 2010, but at a slower rate than the decline in gold investment, while the other 3 countries grew jewelry demand - China +38%, Thailand +57% and Vietnam +22% over 9 years
My hypothesis is that Vietnam's ratio should converge towards 1x in the next 8-10 years, thus a meaningful shift from investment to jewelry will occur

Now that we have high confidence that Vietnam's jewelry market will grow, how will PNJ benefit?

I will approach this from 2 angles - top down and bottom up.

Top-down assumptions: If we assume the i) entire jewelry market grows by 20% over the next 5 years, ii) PNJ has 50% of the organised market, and iii) the unorganised market is 60% of the industry

For PNJ to reach my FY25 sales target of 51% growth compared to FY20, either
- The organised market gains 10ppts from 40% to 50% of the jewelry industry, or
- PNJ increases its market share by 12.5ppts from 50% to 62.5% of the organised market, or
- An amalgamation of the 2 scenarios

Bottom-up assumptions: Base case target of i) Reaching 460 stores by 2025 (management is targeting 500 stores), ii) SSSG of 4%

Presently, each store does ~VND 50bn of sales with historical SSSG of 10-12% according to the IR and from 2014-2019, they opened 181 stores or 30 per year
460 stores with 0% SSSG = VND 23tn (11% upside) vs my forecast of 26.5tn
460 stores with 4% SSSG from 2022-2025 (lockdown in 2021) = VND 26.9tn (25% upside)
500 stores with 6% SSSG = VND 31.6tn (39% upside)

Is there something inherently different or worse about PNJ that inhibits them from generating FCF?

This is something I have been spending a lot of thought on as well, and I will say I don't know for sure, but my best guess right now is that their inventory days have not reached the optimal level
It has been increasing inventory days every year from 47 in 2012 to 190 in 2019, causing a drag on their OCF. On the other hand, Titan has been fluctuating between 134-190 for over the same period
The question is whether PNJ can keep it similar to Titan or it will reach the median level of 250 inventory days. In my model, I forecast that inventory days stabilise around 145 days

DongA Bank scandal - Bad corporate governance and will it distract the founder?

One of the key pushbacks from investors when they consider PNJ is their close ties with Dong A bank and how the CEO of the bank was able to misappropriate hundreds of millions of the bank's funds. Even worse, the CEO is the husband of PNJ's founder (additional info)
In 2016, the company took a full provision of their stake in the bank worth VND 395bn which is now carried at zero value on their balance sheet. While I don't think they'll ever recover it, there is a possibility that some could be reversed, but it'll still be quite insignificant to their current valuation (~2% of market cap)
The investigation that lasted 4-5 years finally wrapped up last year with the husband getting sentenced to life in jail but the courts concluded that PNJ and its chairwoman had no involvement. Seems like quite a heavy handed punishment, but since Vietnam is a communist country, I don't think the government would've allowed her off the hook if she was complicit in any way (I could definitely be wrong here)
Employees said during the whole ordeal, the chairwoman continued to be focused on the business, plus it has been 5 years, so I don't think this incident will have any future impact on her running the business

PNJ is able to cover the mass to premium market through their various brands:

PNJ Gold Jewelry - Since 1988, the brand has produced hundreds of signature collections, primarily made with gold
PNJ Silver & Accessories - Launched in 2001, PNJ Silver targets the younger female audience, utilising dynamic colours like pink and purple
CAO Fine Jewellery - Born in 2005, CAO's products are made from 18K gold, diamonds and other precious stones. The brand appeals to the high-end niche, competing with Cartier, Tiffany's and Hermes (all are present in Vietnam). The differentiating factor for CAO vs international brands is the ability to customise designs and get larger carat diamonds as their prices are 2/3rd that of the big brands
Jemma - Their newest jewelry line, launched in 2009, to cater to the high-end customers that want a modern twist
PNJ Watch - Started in 2012 and has been making steady progress against the popular mass luxury watch brands like Longines, Michael Kors and Tissot. The company thinks that they can win in this fragmented market

Design capabilities and international recognition:

In the 2019 Gold Hand Jewelry competition, PNJ won 13 of the 27 awards. As the premier jewelry fashion show in the country, PNJ said this helps them attract and retain promising talent who want to learn from their goldsmiths
They were chosen by the government to design and manufacture a gift for Kim Jong Un of North Korea (maybe not so good for ESG purposes...)
In JNA Awards, the most prestigious award in Asia (by Informa), PNJ has consistently been either the finalist or winner of the "Manufacturer of the Year", "Outstanding Enterprise of the Year - APAC" and "Sustainability Initiative of the Year" awards.
How do they manage to retain talent in Vietnam?
- Founder knew that this industry the most important aspect is the skills and techniques, this was traditionally done by small independent workshops
- In Vietnam, the skill was taught by goldsmiths to their apprentices
- Thus, from the beginning, she gathered all the best goldsmiths and gave them ownership stakes in the company and helped them achieve scale, making them loyal to the company
- Nevertheless, competitors know that PNJ has the best expertise and poach their staff every year, but the company said time answers everything, and people who come back after 10 years tell them that the corporate culture and working environment is very different in Doji
- PNJ has a huge factory that is able to produce 4m products annually and they give their craftsmen the freedom to experiment and design new products, this is why they have unique lines while Doji usually copies their popular products
In 2019, they signed an official partnership with Disney to produce accessories that carry their IP

Incorporating technology and outside help to further distance themselves from the competition:

Since April 2019, they implemented SAP's S4 HANA as an ERP tool to manage and maximise raw materials, helping PNJ in their production capacity, supply chain management and inventory optimisation
They also use AI to turn tools which were traditionally costs centers like security cameras to read customer and employee behaviours, making adjustments to the arrangement of counters and shelves to optimise the flow of customers and their service staff
They have also shown willingness to seek outside help for advice, which is something quite rare in Asian companies, hiring Value Partners Consulting in 2011 to help with its transition from gold bars to jewelry.
They followed that up in 2012 with Cowan to assist in rebranding the firm to align with its business plans and aspirations, Hays for consulting on HR, IT and retail projects

Valuation - not cheap but good play to tap into Vietnamese consumers

End Dec (VND bn)	2018	2019	2020	2021	2022	2023	2024E	2025E	2026E
Sales	14,571	17,001	17,511	19,547	33,876	33,137	41,331	47,567	53,290
EBIT	1,265	1,624	1,505	1,381	2,399	2,534	2,704	3,221	4,090
% margin	8.7%	9.6%	8.6%	7.1%	7.1%	7.6%	6.5%	6.8%	7.7%
Net profit	889	1,110	980	965	1,693	1,833	1,954	2,333	2,972
EPS	4,611	4,896	4,308	3,184	5,222	5,590	5,450	6,508	8,289
ND/EBITDA	1.0x	1.5x	0.9x	1.6x	0.6x	0.3x	0.3x	0.2x	-0.2x
ROCE (pretax)	29%	27%	27%	19%	27%	27%	23%	24%	27%
ROE	24%	24%	19%	16%	20%	19%	17%	17%	17%
EV/Sales	1.5x	1.5x	1.4x	1.7x	1.1x	1.1x	0.9x	0.8x	0.7x
EV/EBIT	17.1x	16.2x	16.8x	24.8x	14.9x	13.9x	14.3x	11.9x	9.0x
P/E	22.8x	21.4x	24.4x	33.0x	20.1x	18.8x	19.3x	16.1x	12.7x
FCF/ Mkt Cap	-3.1%	-3.7%	5.9%	-2.4%	0.1%	4.2%	-0.7%	1.1%	3.2%
Div yield	1.9%	1.0%	1.5%	1.0%	1.4%	1.9%	0.0%	0.0%	0.0%

If the company can execute their store expansion strategy while maintaining similar levels of sales per store, PNJ gives us ~50% upside from current levels. If we believe they can grow SSSG by 5% per annum (10% guidance and take off 5% growth for inflation), the upside is ~90%.

On a relative valuation basis, PNJ seems to be dramatically undervalued compared to its peers, even those in China who do not have such a strong competitive position in their market compared to PNJ.

Major shareholders:

Chairwoman and her family owns 21% of the capital, so should be quite incentivised for the company to succeed
VinaCapital is the second largest shareholder with 7% stake, they are one of the first private investment companies in Vietnam with a strong track record. Capital IQ states that PNJ is their number 1 position with 26% of their fund invested in the company, but I think this is an error as their website has many funds and manages $3bn. Nevertheless, PNJ is in their top 5 in a few funds
Dragon Capital is the third largest with 6% stake, another pretty good fund who has been around for many years

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Quicker than expected consumption recovery in Vietnam

Partnerships with other brands gaining traction like watches with Titan and Seiko

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			2024	2025
Price:	105,000.00	EPS	5450	6508
Shares Out. (in M):	359	P/E	19.3	16.1
Market Cap (in $M):	1,510	P/FCF	0	0
Net Debt (in $M):	-51	EBIT	0	0
TEV (in $M):	1,459	TEV/EBIT	0	0