For Investors: A Quick Overview Of The Cost Structure Of Hour Glass Ltd

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.

Given the recent weakness in the consumer discretionary market, Hour Glass’s business has been under pressure. In the quarter ended 31 December 2016, the company’s profit attributable to shareholders fell by 8% despite revenue growing by 5%. This is a sign that the company’s cost efficiency is dropping.

I thus thought it would be interesting if I took a look at Hour Glass’s cost structure. Here’s a table showing a breakdown of the company’s income statement for its fiscal year ended 31 March 2016 (FY2016):

Source: Hour Glass FY2016 annual report

There are a few observations we can draw:

1. Cost of goods sold represented 76% of Hour Glass’s revenue in FY2016. This also means that Hour Glass had a gross profit margin of 24% in that year.

2. Of the remaining 24% of Hour Glass’s revenue that’s not eaten up by cost of goods sold, 15 percentage points go toward various expenditures such as labour costs, rental, selling and promotion, depreciation, and others. This leaves 9% of Hour Glass’s revenue as profit before tax and share of results from associates.

3. With the exception of cost of goods sold, the majority of Hour Glass’s costs are fixed in nature. In other words, there is some operating leverage in the copmany’s business. As such, a significant downturn in sales volume will have an outsized impact on the bottom-line.

4. The large amount of cost of goods sold indicates that Hour Glass requires a high level of investment in inventory to sustain its business. As such, it is important that investors monitor the risk of the company’s inventory becoming obsolete.

By understanding Hour Glass’s cost structure, investors can gain a clearer perspective on the company’s future profitability. This will allow investors to form a better opinion on the attractiveness of the company as a long-term investment.

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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.