Vietnam Foreign Trade University - Ho Chi Minh City Campus PDF

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CFA Institute Research Challenge Hosted by

CFA Society Vietnam Foreign Trade University Ho Chi Minh City Campus

This report is published for educational purposes only by students competing in The CFA Institute Research Challenge

Retail Sector, Consumer Discretionary Industry Ho Chi Minh Stock Exchange (HOSE)

PHU NHUAN JEWELRY JOINT STOCK COMPANY Date: 04 – Nov – 2016 Ticker: PNJ VN Equity (Bloomberg)

Closing price: VND69,000 (USD3.09) USD/VND = 22,300

Recommendation: BUY (16.9% Upside ) Target price: VND80,630 (USD3.61)

PNJ: The Queen Conquers The Dwarfs Executive Summary Phu Nhuan Jewelry Joint Stock Company (“PNJ” or “the Company”) is a Vietnamese producer and retailer of jewelry. PNJ’s Revenue streams come from 5 sources: Retail, Wholesale and Export Jewelry, Gold Bar and Inspection Service.

INVESTMENT RECOMMENDATION We issue a BUY recommendation on Phu Nhuan Jewelry Company (PNJ) with a one – year target price of VND80,630 using the Discounted Free Cash Flow to Firm Method and Multiple Valuation Method. This offers a 16.9% upside from its closing price of VND69,000 on November 04th, 2016. PNJ is able to capitalize on the favorable economic and demographic conditions to further maximize firm value through its proper core business strategy, strong dominance in the jewelry market and solid business growth. Jewelry Industry Growth Is Endorsed By Favorable Economic Outlook Over the medium term, Vietnam is expected to remain a strong economic performance with a CAGR of 6.2% of GDP in 2016 – 2021. Proliferation of wealth presenting in an annual growth of 6.5% of GDP per capita will lead to a rise in spending on luxury items, such as fine jewelry and luxury products. The society of Vietnamese MAC will enjoy the fastest growth in South East Asia region, with a CAGR of 12.25% until 2021. Riding on the rising wealth of the Country and coupled with the robust growth of middle – income population, we strongly believe that the jewelry industry could achieve better sales momentum over medium term.

Source: Stoxplus, Team estimates

Solid Core Business Fosters Rising Revenue Growth And Gross Margin The core operation of retailing in-house jewelry is well positioned for sustainable growth by discretely strategic expansion of store system. With the justifiable two-digit growth derived from effectively controlled operation of stores and the impression of PNJ’s dominance over the market, the Company’s distribution channel is extensively widened to scale up the revenue, especially from gold jewelry. A robust growth of core business reporting in a CAGR of 28% in 2012 – 2015 is reasonably followed by the feasibly continuous increase from 45.0% in 2015 to 69.9% in 2021 as we estimate. The Company’s emphasis on jewelry business is translated into more lucrative gross margin of above 20% and is expected to sustain this favorable trend to 2021.

Source: Team estimates

Hostile Expansion Strategy Promises Potentially Vast Gain Of Market share PNJ would seize 10% more market share from the unorganized jewelry players, increasing its total market share to over 20% and substantiating its leading position in the industry. This goal is specified by a range of intangibles including prestigious national iconic brand with thorough and comprehensive marketing plan backed by strong financial foundation, profound experience and visionary Board of Directors; PNJ has created a widening gap for its competitors to regain market share. Thanks to PNJ’s sustainable competitive advantages over time, the Company will not only gain market share from unbranded competitors to maintain its market dominance but also fend off declines in the market growth to outperform the industry. Vertically Integrated Value Chain Guarantees Cost Efficiency And Quality PNJ’s competitive advantage also lies in its strong self- production capability generated by amalgamation of comprehensive value chain with the exclusive resources: most highly equipped factory and most advanced artisan team nationwide. These two resources along with large scale business offer quality assurance and cost efficiency due to human expertise and technologies application. Ancillary operation continues to maintain and widen to new customer spectrum whereas non-core business is diminished for amendment in resources ore operations. luation: Using both DCF and Relative Valuation methods (including EV/EBITDA, P/E and P/S came up with one-year target price of VND80,630 (USD3.62), implying an 16.9% upside from its f VND69,000 (USD3.09) on 06-Nov-2016. isks: Including market, regulatory, business and operational risks. The biggest risk of this e economic downturn (GDP growth contribute 70% of the Monte Carlo results). Monte Carlo 00,000 trials) outcomes confirmed our Buy recommendation with 56.9%.

SELL

Source: Team estimates

HOLD

BUY

KEY METRICS & RATIOS Total Revenue Core Revenue Gross Profit Margin Operating Margin Net Profit Margin Return On Equity ST Debt to Total Asset

2014A 7,306 5,287 10% 4% 3% 19% 40%

2015A 7,718 6,186 15% 3% 2% 11% 40%

2016F 8,772 7,210 15% 6% 5% 29% 42%

2017F 9,877 8,353 16% 8% 6% 34% 39%

2018F 11,064 9,576 18% 9% 7% 35% 36%

2019F 12,367 10,917 19% 10% 8% 37% 35%

2020F 13,687 12,272 19% 11% 9% 39% 31%

2021F 15,023 13,641 20% 11% 9% 41% 30%

Figure 1: Sales Breakdown 2015

Business Description Founded in 1988, PNJ is the largest jewelry producer and retailer in Vietnam. The Company and its subsidiaries manufacture, wholesale, retail and export jewelry. PNJ also retails gold bars, distributes watches and provides jewelry inspection service. In the long-term plan 2012-2022, PNJ planned to divest all non-core businesses to focus on the competence of jewelry sales, especially jewelry retail which constitutes 45% of total revenue in 2015 (Figure 1). PNJ offers a broad jewelry product portfolio made from diverse materials, available at varying price levels and suitable for different generations and customers’ life stages.

Source: Company filings Figure 2: Gross Profit Breakdown 2015

Gold Jewelry Is The Key Driver Of Revenue And Profit PNJ has placed heavy emphasis on gold jewelry thanks to its relatively high margin and bright prospect. Gold jewelry segment (with the successful brand “PNJ Gold”) contributed 78% of revenue and 88% of gross profit in 2015 (Figure 2). It has witnessed an impressive growth with a CAGR of 20.2% per annum, far higher than the 4.65% growth of the Company’s total revenue. PNJ Gold has diverse offerings at mediu m and high price level, catering mainly for event-driven demand - the major demand in Vietnam. Effective Vertically – Integrated Business Model PNJ has steady and reliable supply of raw materials, an award-winning design team, the biggest national artisans team, the largest jewelry factory and an extensive distribution network (Figure 3 and Appendix R). Vertically-integrated model helps PNJ control product quality, increase cost effciencies and market responsiveness which translate into more competitive pricing yet higher margin. PNJ has cooperated with professional consultants (Value Partners) and dominant global industry players (Swarovski) to upgrade the value chain. Leveraging the value chain, PNJ’s gold jewelry is made of quality-assured gold with comparatively sophisticated and fashionable design.

Source: Company filings Figure 3: PNJ’s vertically integrated business model

Source: Team estimates Figure 4: PNJ’s total number of stores in 2012 – 2016

The Leading Jewelry Retail Chain PNJ reported significant expansion from 151 to 194 retail stores in 2012-2015 (Figure 4), higher than three closest competitors (SJC, Doji and BTMC) combined. PNJ’s chain is the leader in terms of market share and store coverage. It comprises 11.46% share of jewelry retail market and covers 45 out of 63 cities and provinces. PNJ’s stores are self-operated and locate in high-traffic areas to maximize customer convenience and brand exposure. 54% of the stores are placed in South East area- the wealthiest region in Vietnam. PNJ’s store formats are divided into three types, determined by product range, area size and location. Grade 2 stores, characterized by medium size, have scored the greatest number, fastest expansion and highest revenue contribution. Grade 1 stores (flagship stores) mark the biggest size and grade 3 stores are the smallest ones.

COMPANY STRATEGIES A fragmented industry with 80% share of traditional jewelry stores opens up huge opportunities for PNJ to seize additional share. To realize the target of reaching 20% market share, PNJ focuses on 3 main strategies: Expand And Optimize The Jewelry Retail Chain To Broaden Customer Base PNJ planned to rapidly expand the retail chain in the next five years to capture rising demand, achieve greater penetration and mitigate location war thanks to the absence of international players and other branded jewelers. The expansion is backed by strong financial base, skilled personnel and effective management. PNJ aims to achieve 300 retail stores before 2020, mostly in densely-populated and wealthy regions. Grade 2 stores will continue their impressive expansion. To optimize the retail network, PNJ conducts thorough market research before stores opening and close underperforming stores.

Source: Company filings Figure 5: Omni - Marketing mix

Build A Prestigious Brand Of Reliability And Authenticity To Captivate Modern Customers To differentiate from unbranded competitors whose product quality is highly un-assured, PNJ has established reputation for providing reliable and authentic jewelry. To deliver brand values and maximize brand visibility, the Company pursues an omni-channel marketing strategy (Figure 5). Brand messages and channels are specialized for each customer segment to optimize brand awareness and widen customer base. PNJ’s flagship stores at prime locations, strategic partnership with Swarovski and the authorized jewelry inspection service also add critical dimensions to brand equity. Enhance Customer Experience and Design To Facilitate Purchasing Decision PNJ has enhanced customer satisfaction by service standardization with PNJ Standards, from store layout, product, promotion and after-sales service to sales staffs - the success determining factor of the process. PNJ’s sale staffs, better known as “advisors”, must undergo careful recruitment and 6-month tailored training before officially joining sales team. Moreover, given the ambitious expansion, the Company introduced PNJ Standards based on international standard and appropriate KPIs for better control of service quality. Besides, to stimulate customers’ buying interests, PNJ has focused on product design by launching around 10 new grand collections and 200 separate items yearly, keeping up with fast-changing preferences of modern customers.

Source: Team’s collection

Figure 7: PNJ’s sales from jewelry retail –

Source: Team estimates Figure 8: Shareholder structure

CORPORATE MANAGEMENT Comprehensive Corporate Management Has Been Guaranteed (Appendix K) Management panel entails five executives of at least 18 - year tenure with a variety of expertise: 2 member expert in strategy management, 1 in sale and marketing, 1 in finance and accounting, 1 in gem valua committing to deliver comprehensive control and have a panoramic view on both internal and ext activities. Growth Strategy Has Been Upheld By Pro-Active And Visionary Experts Positively disproportionate increment in retail sales with CARG of 28% (2012-2015) (Figure 7) results from the effective implementation of strategy focusing on core business. Two important decisions: divesting from non-core businesses and contracting with Value Partner (leading retailer strategy consultancy) for br building not only align with growth strategy but also add great values to core operation.

SHAREHOLDER STRUCTURE The concentrated shareholder structure with 60% ownership of institutional and internal members (Figure 8 and Appendix J) guarantees the stability of management decisions. The involvement of institutional shareholders has positive impact on enhancing the efficiency of corporate governance supervision by the improvement of information accessibility and expert valuation.

Corporate Governance Source: Company filings Figure 9: Distribution of CG Score of top listed companies PNJ

Source: Team’s analysis

PNJ Delivers One Of The Best Practices Corporate Governance In Vietnam The effectiveness of the well-structured corporate governance (CG) is built on three main components w independent and cross check mechanism: (1) General Shareholders Meeting (GSM): the GSM possesses th ultimate decision power with one share one vote policy, (2) Board: the Board assists the decision of GSM wit established governance supervisory and (3) Audit and oversight: the internal auditor oversees complia regulation annually and external audit are employed by contracting with highly reliable experts (restricted t the 4 biggest audit companies) to have a better grasp of possible risks the Company may encounter. To analyze PNJ governance quality, we apply Five Principles of Corporate Governance published by Organization for Economic Co-operation and Development (OECD) as the main benchmark with the adjustment derived from ASEAN corporate governance scorecard country report composed by Asian Development Bank (ADB) 2014. The use of two levels of scoring is designed to better capture the actual implementation of the substance of go corporate governance. Based on the team valuation, the CG operation of PNJ falls to the range of g company, bearing the characteristics of efficient and effective governance, guaranteeing 3 main expectations integrity, transparency and independence. Compared to the average corporate governance score (averaged out at 35 over 2012 to 2015) (Figure 9) for Vietnamese listed companies, PNJ is among the top companies delivering best practices.

Industry Overview and Competitive Positioning INDUSTRY OVERVIEW Macroeconomic Analysis: Economic and demographic outlook support demand Strong Economic Prospect Enhances Purchasing Power And Expenditure Vietnam is considered as a rare bright light in the dismal picture of global economy. Vietnam’s GDP CAGR in 2010-2015 scored 5.88%, far surpassing the global rate of 2.3%. Vietnam’s outlook remains positive with GDP’s robust and consistent growth of 6.2% until 2020, far outperforming its regional peers (Figure 10). Strong economic growth has driven prosperity and expenditure. Indeed, in 2010 -2015, disposable income increased (in real terms) by 32% while consumer spending reported 33% growth. Due to the nature of high income elasticity of demand, luxury goods in Vietnam are expected to experience radical growth. Source: International Monetary Fund, 2016

Figure 11: Population projection

The Burgeoning Middle And Affluent Class Drives Jewelry Demand Vietnam‘s middle and affluent class (MAC) will double in size from 12 million in 2012 to 33 million in 2022, reporting a CAGR of 12.25% per annum (Figure 11). They are described as modern customers with show strong willingness for self-expression and conspicuous consumption. MAC is the dominant force of growing demand for luxury goods, including jewelry. Vietnam’s MAC customers are youthful, knowledgeable and fashionable. They have stricter requirement for quality and demonstrate strong desire for branded products with both superior quality a nd design.

Industry Analysis: Promising industry for branded players

Source: BCG, Team estimates

A Relatively Untapped Market Suggests Strong Prospect The luxury goods market in Vietnam is at its infancy with the absence of many international brands (Euromonitor, 2016). Despite ranking in top 15 largest countries regarding gold consumption, Vietnam’s gold jewelry per capita was just around 6.2 USD in 2015. Gold jewelry consumption contributed only 25% to total gold consumption, far lower than the minimum ratio of 50% scored by other regional countries (Figure 12). Rising purchasing power and living standard lead to the Vietnamese’s strong tendency to switch from buying

Figure 12: 2015 jewelry value per capita

gold bars for investment purpose to gold jewelry for consumption purpose. Trust Has Been The Chief Attribute In Purchasing Decision Due to jewelry’s extreme value, customers are highly prudent when making purchasing decision; however, they generally lack of expertise to inspect the quality. That makes jewelry purchasing behavior highly dependent on trust. Consequently, all players in the market have paid meticulous attention to gain trust from customers. While nationwide traditional jewelers have built trust by intimate relationship over generations, branded companies have mainly earned trust by brand. However, because personal relationship has been, for long, the most valued virtues of the Vietnamese, branded companies are far left behind the game. Quality Concern And Trust Deterioration Rise To Peak Local media has recently reported that most 18-karat jewelry sold in traditional stores was only 58-68% gold. That means many traditional players are making illegal profit margin by retailing fraudulent jewelry that is falsely advertised as real and authentic. The released information has raised serious concerns over the public on the authenticity and quality of jewelry of traditional stores. As a result, customers are turning their back on these micro vendors due to deteriorating trust. This has signaled great opportunities for branded players.

Source: Euromonitor, 2016 Figure 13: Industry structure

Government Jumps In To Stabilize The Market Given the opaqueness of the industry, Circular No.22, taking effect in June 2014, was introduced to enhance transparency and sustainability of the jewelry industry. The Circular stipulated that all gold jewelry traded in the market must be coded with the exact quality standard and measurement, namely gold content. Government’s intervention has again alarmed the widespread concern and posed enormous challenges to micro players, some even decided to close their stores due to the burden of fraudulent inventory compilation. The Fragmented 80% Market Share Of Small Vendors Waits To Be Tackled Over 6,000 trusted countrywide traditional jewelers account for 80% market share (Figure 13). These players usually self-manufacture with high cost (due to low craftsmanship, high gold-loss rate and limited scale) or purchase from wholesalers at high price (owing to modest purchase orders). Lack of control over supply also results in low quality-assurance. All of the above factors lead to inferior-quality products yet offered at less attractive price. Hence, to compete with branded companies, most traditional stores just sell basic and simpledesigned jewelry or even try to deceive customers with products of lower gold content than actually advertised. Besides, these unorganized players show some common critical weaknesses of limited brand name, unprofessional service, and notably small business mindset that impedes their business scale’s expansion and accordingly, locks them in this vicious cycle.

Source: Company filings, Team estimates Figure 14: Market segment positioning

Source: Team estimates Figure 15: Retail stores of big organized players Year

2012

2013

2014

SJC

175

158

132

135

PNJ

153

145

174

178

Doji

24

35

35

33

2015

Source: Team estimates Figure 16: Assessment of players in mass luxury segment Dimension Number of store Location

BTMC

PNJ

94

215...