How Investors Can Understand 1 Crucial Aspect Of Hour Glass Ltd’s Business: Inventory Management

Hour Glass Ltd (SGX: AGS) is a retailer of luxury watches with over 40 boutiques scattered across six regions in Asia Pacific, namely, Singapore, Australia, Hong Kong, Thailand, Japan, and Malaysia.

The company carries over 50 high end watch brands in its boutiques, some of which are Audemars Piguet, Patek Philippe, Richard Mille, and IWC Schaffhausen.

Inventory management

As a retailer, Hour Glass is required to hold a significant amount of inventory. This requirement is further exacerbated by the nature of luxury watch retail – the watches sold are high value, but slow-moving. As of 30 September 2016, 56% of Hour Glass’s total assets of S$557.3 million is in the form of inventory.

Thus, it is important that the company manages its inventory properly. But, how can investors judge how well the company is doing in this aspect?

We can look at two things: (1) Changes in the company’s inventory value compared to changes in revenue; and (2) Day sales of inventory.

Changes in inventory value

The ideal case here to see is inventory levels that decline while revenue increases. If not, we’d want to see inventory levels ebb and flow along with revenue.

Here’s a chart showing Hour Glass’s revenue and inventory over its last five fiscal years:

Hour Glass revenue and inventory
Source: Hour Glass’s annual reports

From its fiscal year ended 31 March 2012 (FY2012) to FY2016, Hour Glass has seen its revenue and inventory grow by 17% and 39%, respectively. In other words, the rate of growth of inventory has outstripped that of revenue.

Day sales of inventory

Put simply, day sales of inventory indicates the average number of days a retailer takes to clear its inventory. For example, a day sales of inventory of 50 means there’s an average of 50 days between a retailer buying inventory from its supplier and selling the inventory to customers. Ideally, what we want to see is a stable or declining day sales of inventory.

The metric is calculated with the following formula:

(Closing inventory) / (Cost of sales) x (365 days)

The chart below plots Hour Glass’s day sales of inventory from FY2012 to FY2016:

Hour Glass inventory days
Source: Hour Glass’s annual reports

We can see that Hour Glass’s day sales of inventory had declined from FY2013 to FY2015, only to then spike sharply in FY2016. In fact, FY2016 was the year with the highest day sales of inventory for Hour Glass in its last five completed fiscal years.

A Foolish conclusion

Given what we’ve seen – inventory value growth that outstripped revenue growth and a higher day sales of inventory – Hour Glass’s inventory management appears to have weakened during the period FY2012 to FY2016.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.