connect with the hour glass
Annual Report2022Download Annual Report 2022 PDF
DEAR FELLOW SHAREHOLDERS,
For the financial year ended 31 March 2022, the Group recorded a robust 39% increase in sales to $1.03 billion. This has resulted in our after-tax profit rising by 86% to $157.0 million. The flourishing interest in mechanical watches aside, this accomplishment was only possible because all members in the Group were aligned, and motivated to meet the series of qualitative business goals we set for ourselves 5 years ago.
Cash and bank balances rose to $323.4 million. Loans undertaken exclusively for our portfolio of long-term property assets stood at $111.0 million, giving the organisation a net cash position of $212.4 million. Throughout our operating history, we have injected moderate leverage into our balance sheet and are only persuaded to do so in periods where we are certain of the inherent stability of our operations and consequently, a low probability that this leverage will threaten the financial soundness of the Company.
Our business has been built organically with our earnings. The last time we tapped the capital markets for funding was more than 35 years ago. As the Group continues to build its cash generative capabilities and bolster its equity base, it is important that shareholders have an appreciation of the principles by which we deploy our financial resources. The following is the cascading capital allocation priorities that have remained largely unchanged since the turn of the millennium.
A key financial objective of the Board and management is to constantly seek ways to improve The Hour Glass’ long-term earnings power. At the first instance, we do so by deploying capital into elevating our corporate brand equity as a means to broaden our client base, investing in multiple mid to long-term organisational development initiatives, deepening our inventory base, augmenting our watch related businesses through a combination of nett new boutique openings and, expanding our boutique network by way of entry into new markets.
As there is little management desire, nor compelling push factors for us to enter non-watch related businesses, our next priority is to acquire prime commercial retail properties, always with an eye for our own future use. With this in mind, we have placed an emphasis on Australian and New Zealand assets, for good reason.
Firstly, we have a team who have a thorough understanding of the retail dynamics in these markets and have the necessary local relationships to generate strong deal flow. Secondly, legislation governing property ownership in these two countries are stable and not discriminatory to Singaporean ownership. Moreover, the properties we seek to acquire are all freehold in tenure. From a risk standpoint, our view is that of all the markets we operate in, Australia and New Zealand are where we have been able to uncover compelling investment cases and opportunities. The deal sizes are within our range, capitalisation rates are reasonable, and we still produce a positive carry despite assuming some debt. And as our intention is not to sell these properties, capital gains taxes are a moot point. Unless we are prepared to buy entire shopping malls, we are less able to apply a similar strategy to real estate acquisitions in South-East Asia and Hong Kong.
The Hour Glass acquired its first building in Australia thirty years ago and over the ensuing decades, have continued to channel capital towards building a portfolio of high-quality, high street retail assets in its key cities. As our business further develops in the two markets of Australia and New Zealand, we are confident of utilising the properties we have acquired. It had been the case in a couple of instances where our tenants vacated the property at their own volition or, as we had experienced during COVID-19, requested to pre-terminate their lease. In these cases, we have always opted to occupy the retail tenancy for our own business operations.
There is however a caveat to this strategy. Should a qualitative long-term tenant be in place when we purchase the property and, at the point in time when the lease is concluding and we do not have an immediate need for the retail tenancy, we may opt to extend the lease for the tenant.
Following from that, in the rare instance we are unable to find attractive opportunities in the real estate sector, we may decide to allocate capital to both private and public equities.
Finally, we have a mandate to return capital to shareholders via share buybacks and ordinary dividends. Throughout this financial year, the Group repurchased $34.1 million of our ordinary shares and remain on an opportunistic footing with our share re-purchases.
On a consolidated net asset basis, The Hour Glass increased its corporate net worth by $71.6 million to $751.6 million or $1.10 per share. During the financial year, an interim dividend of 2 cents per ordinary share, amounting to $13.7 million was paid. Considering the improved operating performance across all our business units, the Board of Directors are pleased to recommend a final dividend of 6 cents per ordinary share. Together with the interim dividend, the total dividend for FY2022 is $54.5 million.
The two-and-a-half years since the COVID-19 pandemic began have been a spectacular boom for the specialty luxury watch sector. My long-term business partners, including several who have been involved in the trade since before the Quartz Crisis of the 1970s, describe the current period as the biggest expansionary phase they have witnessed occurring in this industry. I concur.
Export numbers for the Swiss watch industry – typically a proxy for the global luxury-watch industry – illustrate the macro trends well. These are published on a monthly and annual basis by trade body – Federation of the Swiss Watch Industry. Overall watch exports from Switzerland stood at CHF20.5 billion in value and 20.6 million units in 2019. After a precipitous decline in 2020 due to lockdowns, the numbers recovered with a vengeance. The value of Swiss watch exports in 2021 was CHF21.2 billion. But the volume of exports was a mere 15.7 million units, or a decline of 25%. From 2019 to 2021, Swiss watches in every category of export value declined in both volume and value – except for those over CHF3,000.
These numbers illustrate exactly what is happening in the watch industry – demand for high-end watches is so voracious that supply cannot keep up, while low-end watches are being decimated by connected watches. As an example, the aggregate demand for the watches of a prestige brand we represent rose from 3.2 times of our annual allocation in 2019 to 7.0 times in 2021 – rising even further to an annualised 12.6 times by the middle of 2022. This level of overall interest is unprecedented and has been further exacerbated by supply shortages. That in turn has driven up secondary-market prices for watches, pulling more new people into the hobby.
Reflecting a trend seen in other categories of luxury goods, the genesis of the current market lies in the various lockdowns of 2020 that happened one after another across the world – and the accompanying quantitative easing unleashed by central banks was the rocket that the industry rode into the stratosphere. While the severity of national lockdowns varied substantially, they generally meant that people were cooped up at home, leaving them plenty of time to pursue old hobbies and take up new ones. Social media and online resources functioned as a gateway into hobbies, providing both information and “hype”, a platform to “flex”, and occasionally a sense of community. The ample spare time during lockdowns is also a crucial reason behind the rise in demand for independent artisanal watchmakers. Historically, such brands required acquiring a depth of knowledge to appreciate their virtues, which was doable during the lengthy downtime over the two years when the pandemic was its most severe.
And besides time, there’s the money.
The immense quantities of money injected into economies by national governments put cash into the hands of consumers as intended, but the consequent spike in luxury-goods demand was certainly unforeseen and continues to rise across Asia despite the war in Ukraine and the recent decline in global equities and cryptocurrencies.
Unsurprisingly, one key segment of the industry that continues to struggle is travel retail. Even though travel has resumed with a good degree of normalcy in most of the world, it appears that the recovery of travel retail will be long tailed. For one, brands have realised that it is safer to sell to native clients domestically, for whatever happens in the future, the local buyers will likely be stuck in-country. Some brands got here earlier than others, with Patek Philippe sounding the trumpet as far back as 2016. At the same time, most of the industry expects that Chinese travellers will not leave the country’s borders until at least 2024. Before the pandemic, the high-spending Chinese traveller accounted for as much as 85% of the global specialty travel retail turnover. That spend is now being redirected to Hainan Island, a duty-free paradise that was booming just before the recent 2022 lockdowns in China.
Watch brands however are not overly concerned, because most have developed a strong base of local clients in the last two years. Even in Hong Kong, perhaps the world’s most battered watch market, signs of life have resolutely taken hold. Though the overall market size in Hong Kong has consolidated, the spend of local clients has risen dramatically. And my conversations with prominent property developers in the territory reveal strong optimism on their part – they all hold an unshakable belief in the future of the city post-pandemic, and we share a similar view.
The same holds true for China, where despite the pandemic, this group of former globetrotters were shopping with gusto before the lockdowns. Watches that would have been sent to Hong Kong or Paris in the past – to be purchased by Chinese tourists – were instead directed to the mainland. However, the closure of large swathes of the Chinese economy in 2022 has dented demand with Swiss watch exports to China falling almost 28% on a month-on-month basis. And with Chinese buyers in Mainland China and Hong Kong responsible for up to 25% of global watch sales in the years before 2020, many brands are now trying to gently reduce their dependence on these markets.
FINANCIALISATION OF WATCHES
The wave of interest and accompanying escalation in values have led to a newfound perception of watches as more than objects of historical and cultural value, but financial assets in themselves. The proof of this, as they say, is in the pudding. Professional investors, namely venture capital and private equity, have invested several hundred million dollars over the last two years in pre-owned watch merchants and aggregated online selling platforms. The growth of the secondary market also inadvertently constrains supply, since the watches sitting in pre-owned dealer inventories are not on the wrists of consumers. Outside investors have also nudged the pre-owned watch industry towards greater financialisation, leading to the adoption of instruments like “buy-now-pay-later” schemes, loans against purchases, and guaranteed buybacks, which are essentially put options. Established auction houses such as Sotheby’s have also spearheaded similar services for their clients to increase business flow.
THE NEW CLIENT
An article in The New York Times that was published at the time of writing this letter captured the zeitgeist perfectly. Titled ‘The World’s a Mess. So They’ve Stopped Saving for Tomorrow.’, the article went on to describe how “many adults under 35 have stopped playing it safe… they’re saving less, spending more and pursuing passion projects or risky careers.” Much of the new demand comes from ever-younger buyers who are pursuing ever more expensive timepieces, a phenomenon echoed in other “hype” collectible categories like sneakers and contemporary art. Our average client is now about 30% younger than before the pandemic. Youth, as we all know, brings with it impatience and the desire for immediate gratification. The wealth created during the pandemic has made all those youthful ambitions a reality. “Crypto bro” is a cliché, but to an extent it rings true for a good number of watch buyers at the top end of the market.
Herein lies an opportunity for The Hour Glass to cultivate our next generation of clients. The pace of acquisition by many new buyers means that they often have not yet developed the experience or acquired the knowledge to be true connoisseurs. This therefore allows us to educate and inform, and in doing so, build client loyalty. Given the youth of many new clients, this demographic will be able to consume for decades to come and it is our intent to ensure their interest in watches holds up.
Watchmakers have, predictably, responded to this surge in purchasing desire by attempting to increase supply. The ambitions to boost production are especially pronounced with high-end independent brands – mostly those with an average retail price of six figures – but those ambitions have collided with reality.
As with producers in other sectors, supply chain disruptions for watch components are hampering the ability to create product in watchmaking. Lead times for the average manufacturer have lengthened from 6 months or so to 12-18 months. That is oftentimes a consequence of a shortage for seemingly trivial parts: a chief executive of one of the top ten largest brands revealed to me in May 2022 that they had 20,000 watches that could not be shipped that month simply due to an insufficient supply of buckles for their watch straps!
WHERE DO WE GO FROM HERE?
Notwithstanding the industry’s outperformance over the past two years, the outlook is now clouded, most prominently by runaway inflation and the possibility of aggressive hikes in interest rates by central bankers the world over. Much of how it unfolds will depend on central bankers keeping their promises to raise rates, or perhaps they were just talking inflation down with the prospect of drastic rate hikes. Barring any major, unexpected events, we believe the scenario with the highest probability is moderated growth, but still growth. This is especially so given that we represent the most important names in Swiss watchmaking, with partnerships that go back decades.
We believe that the prudent expansion plans advocated by our key partners is the way to sustainable growth. Measured increases in production will help meet demand – already diminished by recent geopolitical events – and tamper down secondary market prices. And if there is a bust, the overhang of production will be manageable.
THE SECRET TO SUCCESS IS CONSTANCY TO PURPOSE
More than once, I have expressed to our team the fortune we have in being a part of this incredible industry, and even more so during the pandemic and this subsequent period of grave global geopolitical and macro-economic upheaval. Save for a troubling 2 years in the aftermath of the 1997 Asian financial crisis where The Hour Glass experienced operating losses from our ownership of two Swiss watchmaking brands – Gerald Genta and Daniel Roth – since inception, our specialty watch retail business has always remained profitable.
I harken back to a conversation I had with Philippe Stern in the year 2000 when he was still the President of Patek Philippe. Philippe advised me that if one wished to secure a leadership position in this industry, the pre-requisite was that one had to focus singularly on seeking excellence in whatever our “metier” was. He taught me that each one of us in the watch industry value chain had one purpose. Patek Philippe’s is to make the world’s best watches and then distribute them to the best watch retailers in the world. In that same vein, The Hour Glass’ focus should be striving for excellence in the field of specialty watch retailing and cultivating and caring for its clients. I took his advice to heart and acted on it. We subsequently divested our two Swiss watch manufacturers and redirected all our resources to enhance our core business of watch retailing, a position we continue to maintain.
Today, The Hour Glass has not just built the brick and mortar network we need to further grow our business, we have also developed the critical mental, cultural and technological infrastructures of the organisation. Pouring capital into opening retail stores is a simple exercise. What is challenging to replicate and to sustain at the highest level, is the operational excellence required in managing a boutique’s daily operations. To run our business well, we also need a strong and ever-growing pool of managerial talent who have accumulated sufficient wisdom to navigate the cyclicality of demand and harness a growth mindset.
The current team will not be leading this business forever and so, I am delighted that our inaugural platoon sized cohort of prospective managerial candidates recently completed their three-year skills and management training programme, graduating with glowing results. They have been tasked with three objectives. To serve the needs of our brand partners and the watch industry, to continue growing communities of enthusiasts and to advance the understanding and passion of these beautiful timekeeping objects. These graduates give me great comfort that The Hour Glass’ future is in safe hands.
I wish to extend my sincere gratitude to the board, management, and team at The Hour Glass. The team had persevered in the most challenging of times. We are also privileged because of the confidence and support afforded by our historic brand partners – Rolex, Patek Philippe and Hublot. It is because of them that we could attain this set of strong financial results.
We often hear the word “relationship” bandied about in this business. Human connectivity in any business context is important and in the watch business, plays a salient role in the longevity of brand and retailer partnerships. But one would be remiss to presume that these intangible tethers are absolute. Relationships are important in so far that the counter party has demonstrated qualifications to privilege from that relationship. For a specialist watch retailer, the pre-conditions for any enduring business relationship are integrity, competence, enduring positive qualitative and quantitative performance and, the ability to understand and anticipate the needs of both our partners and clients.
In my 2016 Chairman’s statement, I had identified that the industry was undergoing transformational shifts that were fracturing historic distribution networks, with brands rationalising their distribution in mature markets whilst marginally expanding their footprint in new and emerging watch markets. This development has continued to gather momentum. If The Hour Glass is to overcome this period of transition, we must truly shine at what we do. And if that isn’t enough, then at least we can appreciate that it is not because of the quality of our people and performance but the strategic impulses of our brand partners.
In closing, I wish to commend Jean-Frederic Dufour, in his capacity as President of the Watches and Wonders 2022 exhibiting committee and our other key partners for ensuring that the collegial spirit within the industry was fortified and produced a most successful, first of its kind watch fair. All brands played a role in this historic event and even though it was the most intense fair I had ever attended, I left Geneva satiated and optimistic for the future of this industry.
HENRY TAY YUN CHWAN
31 May 2022