Initiation on Jewelry and Watch Sector

Transcription

CONSUMER DISCRETIONARY
20 April 2012
Watch this space
Though the long-term outlook for China’s jewelry and watch industry is
Analysts
Forrest Chan, CFA
unambiguously bright, 2012 is shaping up to be a year of normalized, gradual
growth. Year-to-date, share prices of Chow Tai Fook Jewellery (1929 HK)
and Luk Fook (590 HK) have corrected around 20% and underperformed the
market by 30%, reflecting investor concerns about a slowdown in sales.
While long-term value has emerged even on cautious 2012 same-store sales
growth (SSSG) assumptions, near-term share price volatility and downside
(852) 2532 6743
[email protected]
Claudia Ching
(852) 2532 2528
[email protected]
Timothy Sun
(852) 2532 6746
[email protected]
persist as SSSG is likely to see another major leg down in 2HCY12,
providing an opportunity for accumulation. We initiate coverage on both
names with a Neutral rating. Despite their strong share price performance
year-to-date, we favor watch retailers as we believe their sales will be more
resilient and their valuations are attractive. We maintain our Outperform
rating on Hengdeli (3389 HK) and initiate on Emperor Watch & Jewellery
(887 HK), which we also rate Outperform.
Please read the analyst certification and other important disclosures on last page
20 April 2012
Table of Contents
Watch this space.......................................................................................................................... 3
A year of slower growth................................................................................................................ 4
More resilient sales from the watch segment ............................................................................. 10
Finding the right valuation .......................................................................................................... 12
Key investment risks .................................................................................................................. 18
Porter and SWOT analysis......................................................................................................... 22
Chow Tai Fook Jewellery (1929 HK) .......................................................................................... 24
Emperor Watch & Jewellery (887 HK)........................................................................................ 43
Hengdeli Holdings (3389 HK)..................................................................................................... 59
Luk Fook Holdings (590 HK) ...................................................................................................... 75
Appendix : Peer comparison ...................................................................................................... 92
2
20 April 2012
Watch this space


A year of slower growth. Though the long-term outlook for
China’s jewelry and watch industry is unambiguously bright,
2012 will be a year of normalized, slower growth as a result
of the more challenging macro environment as well as
volatility of gold price.
CCBIS jewelry and watch universe
Chow Tai Fook 1929 HK 11.90
12.50
N
15.6
12.4
Long-term value has emerged in jewelers…
Year-to-date, share prices of Chow Tai Fook (1929 HK) and
Luk Fook (590 HK) have corrected about 20% and
underperformed the market by 30%, reflecting material
investor concerns about a considerable sales slowdown in
jewelry. Yet long-term value has emerged: Chow Tai Fook
and Luk Fook trade on 12x and 8x CY13F P/E, respectively,
even if we cautiously assume low-teen SSSG in FY13F
(year-to-March 2013) and mid-teen SSSG in FY14F
(year-to-March 2014), compared with 35%+ SSSG in
FY12F (year-to-March 2012).
Emperor
887 HK
1.20
1.40
O
9.4
7.2
Hengdeli
3389 HK
3.43
4.15
O
12.3
9.9
Luk Fook
590 HK
20.90
21.80
N
9.5
8.1

…but the worst is yet to come. Nevertheless, we expect
share price volatility and/or downside to persist in the near
term as SSSG is likely to see another major leg down into
2HCY12. The price of gold reached its high in September
2011 and has since entered a period of consolidation,
ending its rally that began in late 2008. Gold price has risen
20% YoY since the beginning of 2011. CCBIS’ gold price
forecast of US$1,850/oz, equivalent to an 18% rise in the
annual average price, also implies less positive trends will
be seen over the remainder of 2012 as compared with 2010
and 2011. The absence of a clear uptrend in gold price will
cause a worse-than-expected slump in Chinese jeweler
SSSG due to the correlation of gold price with both prices of
gold jewelry products and volume demand for gold jewelry.
Most critically, 3QCY12 is likely to be a quarter of
year-on-year gold price decline.

Accumulate Chow Tai Fook and Luk Fook in 2HCY12.
We initiate coverage of both Chow Tai Fook and Luk Fook
with a Neutral rating, and view 2HCY12 as the best
opportunity to accumulate the stocks. Of the two, we
consider Chow Tai Fook, Greater China’s largest and most
recognized jeweler, as the best-quality proxy for the
long-term boom in jewelry consumption in China.

Favor Hengdeli (3389 HK) and Emperor Watch &
Jewellery (887 HK). We have a clear near-term preference
for watch retailers despite their strong share price
performance year-to-date. Watch sales will remain resilient
in the more challenging retail environment. We maintain our
Outperform rating on Hengdeli, China’s largest mid-to-high
end watch retailer. We also initiate coverage on Emperor, a
leading Hong Kong-based retail name with an exceptional
franchise carrying exclusive European-made ultra-luxury
watch labels. Valuations are undemanding, with Hengdeli
and Emperor trading on 10x and 7x CY13F P/E, respectively.
3
Share
Company
P/E (x)
Stock
price
TP
CCBIS
code
(HK$)*
(HK$)
Rating†
CY12F CY13F
† Ratings: O = Outperform; N = Neutral; U = Underperform
* Prices as at close on 18 April 2012;
Forrest Chan, CFA
(852) 2532 6743
[email protected]
Claudia Ching
(852) 2532 2528
[email protected]
Timothy Sun
(852) 2532 6746
[email protected]
20 April 2012
A year of slower growth
Phenomenal growth in jewelry
and watch sales between 2009
and 2011
China’s jewelry and watch sales have exhibited unprecedented strength since 2009.
The retail market in the country was buoyant and there was a gush of liquidity amidst
negative real interest rates which fueled demand for luxury items. Gold product sales
saw the biggest increase as the undisrupted uptrend from 2009 to 2011 in gold price
stimulated demand from consumers seeking wealth protection. Operators with
substantial exposure to Hong Kong benefited materially as the influx of mainland
tourists into the city brought about an exceptional surge in their business.
China retail sales – jewelry and watches vs. non-jewelry and watches (YoY)
60%
55%
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
(5)%
2001
2002
2003
2004
2005
2006
2007
Overall retail sales
Jewelry and watch
2008
2009
2010
Non-jewelry and watch
2011
Source: CEIC, CCBIS research
Hong Kong retail sales – jewelry and watches vs. non-jewelry and watches
(YoY)
50%
40%
30%
20%
10%
0%
(10)%
2001
2002
2003
2004
2005
2006
2007
Overall retail sales
Jewelry and watch
4
2008
2009
2010
Non-jewelry and watch
2011
20 April 2012
Swiss watch export value to Hong Kong
CHFm
4,500
47%
4,086
4,000
3,500
3,186
3,000
25%
2,500
2,000
5%
1,508
1,433
1,500
1,549
1,420
1,642
2,697
2,433
16%
1,768
8%
1,946
28%
2,168
11%
10%
3%
1,000
(8)%
500
(20)%
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Total sales value (LHS)
Total sales value (RHS)
2010
YoY
55%
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
(5)%
(10)%
(15)%
(20)%
(25)%
2011
Source: Swiss Watch Federation
While many of the structural drivers of luxury consumption growth over the long run
remain intact, the near-term outlook for jewelry and watch retailers has deteriorated as
the latent impact of the economic slowdown and credit tightening is beginning to
discourage big-ticket item purchases. Consumers are more reluctant to purchase gold
jewelry now that the price of gold has begun to consolidate from its high of
US$1,900/oz in September 2011 while China’s negative real interest rates have
begun to narrow.
Long-term structural drivers
intact
Sales of Swiss watches per 1,000 people
10
Austria
Italy
China Taiwan
5
Saudi Arabia
Spain
Greece
Portugal
2
UK
Germany
Japan
USA
Australia
Belgium
Holland
Thailand
Turkey South Korea
1
Russia
Sales of Swiss watches in
pieces
Mexico
0.5
Canada
Market penetration of
Swiss watches in China
is low and there is huge
growth potential
Malaysia
China 2018: 0.59/’000 people
China 2013: 0.34/’000 people
0.2
China 2008: 0.23/’000 people
Ukraine
(Swiss watches worth
over RMB10K)
0.1
0
100
200
Source: Hengdeli, Bain & Company, Euromonitor, Watch Association of Switzerland
5
300
20 April 2012
China jewelry consumption
RMB b
1,300
1,170
1,040
Hong Kong jewelry consumption
HK$b
330
2010-2015F CAGR:
Gold products = 40%
Platinum/karat gold products = 39%
Gem-set jewelry = 35%
322
240
780
266
2010-2015F CAGR:
Gold products = 40%
Platinum/karat gold products = 40%
Gem-set jewelry = 38%
100
210
66
180
650
178
520
132
390
260
0
270
240
910
130
300
45
35
28
30
23 77
45 18 59
2006
2007 2008
Gold products
54
37
94
72
50
130
98
71
184
150
504
0
Source: Frost & Sullivan
Further downside to jeweler
SSSG
23
2
2006
2009 2010 2011F 2012F 2013F 2014F 2015F
Platinum/karat gold products
Gem-set jewellery
168
19
60
30
224
29
90
703
361
43
120
138
99
258
192
6
34
8
36
2008
2009
3
30
2007
12
50
93
68
126
2010 2011F 2012F 2013F 2014F 2015F
Hong Kong
Macau
We forecast a material slowdown in the SSSG of jewelry and watch retailers in 2012 in
comparison with2011. We expect a more pronounced slowdown from jewelry
operators. Our forecast is supported by empirical evidence: During the last two
consolidation cycles in gold price (2006 and 2008), retail sales volume growth of
jewelry and watches underperformed that of the overall Hong Kong market. Although
there is no separate data available for jewelry, we believe the overall weakness was
more attributable to reduced consumer appetite for jewelry products during the period.
Same-store sales growth (%) of listed jewelry or watch plays
Jan – Jun
Jul – Sep
Oct – Dec
2010
2011
2011
2011
2012F**
2013F**
Chow Tai Fook – Hong Kong
32
Over 70s
Over 70s
c.30
12
16
Chow Tai Fook – China
35
Over 40s
Over 40s
c.30
10
15
Emperor – Hong Kong
49
36
c.30
c.30
16
21
Emperor – China
17
19
Teens
teens
Luk Fook – Hong Kong
30
over 40s
over 40s
27
10
12
Luk Fook – China
33
over 30s
over 30s
35
13
15
Oriental Watch – group
–
–
–
>20
–
–
Hengdeli – Hong Kong*
41
39
mid 20s
mid 20s
24
19
Hengdeli – China*
38
46
mid 30s
mid 20s
27
23
* Denotes total sales growth
** 2012F = FY13F, 2013F = FY14F for Chow Tai Fook and Luk Fook
Source: Chow Tai Fook, Emperor, Hengdeli and Luk Fook data, CCBIS estimates
6
high single digit high single digit
20 April 2012
China’s real interest rate trend
5%
3%
2%
0%
(2)%
(3)%
(5)%
Mar-08
Jul-08
Nov-08
Mar-09
Jul-09
Nov-09
Mar-10
Jul-10
Nov-10 Mar-11
Jul-11
Nov-11
Mar-12
Source: Bloomberg, CEIC
Weak jewelry and watch sales in
Hong Kong during the last two
consolidations in gold price
Retail sales volume growth of jewelry and watches vs. Hong Kong’s overall
retail sales volume growth
50%
25%
0%
(25)%
Jan-Feb Jul-06 Dec-06 Jun-07 Nov-07 May-08 Oct-08 Apr-09 Sep-09 Mar-10 Aug-10 Jan-Feb Jul-11 Dec-11
2006
2011
Retail sales volume index
Retail sales volume: jewelry, watches, clocks & valuable fift
3QCY12 has the highest
comparison base for gold price
year-on-year trends
7
As shown in the following chart, gold price reached its high in September 2011 and
has since entered a period of consolidation, ending its rally that began in late 2008.
The significance is that increased volatility in gold price is likely to result in contracted
purchases of jewelry products, in our view. CCBIS’ gold price forecast of US$1,850/oz,
equivalent to an 18% rise in annual average price, implies less positive trends will be
seen over the remainder of 2012 compared with 2010 and 2011. The price of gold has
risen 20% YoY since the beginning of 2011. Most critically, given that the price of gold
peaked in September 2011 at US$1,900/oz, 3QCY11 is most likely to see a
year-on-year decline in gold price.
20 April 2012
Gold price – consolidation
US$/oz
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
4-Jan-00
17-Jul-01
28-Jan-03
10-Aug-04
21-Feb-06
4-Sep-07
17-Mar-09
28-Sep-10
10-Apr-12
Source: Bloomberg, CCBIS research
Historical and forecast average annual gold price
75%
US$/oz
2,200
2,000
2,000
1,800
872
1,000
800
Source: Bloomberg
Slowing mainland tourist
spending in Hong Kong
18%
445
12%
200
0
Gold price (LHS)
2010
6%
2008
27-Jun-08
23-Sep-09
20-Dec-10
Gold price (LHS)
YoY (RHS)
410
24%
974
697
2007
1-Apr-07
(15)%
17-Mar-12
364
2005
0%
400
2004
790
600
2003
15%
605
2006
30%
8
1,227
1,200
1,080
500
3-Jan-06
1,400
2009
45%
1,370
30%
1,565
1,600
2011
60%
1,660
36%
1,850
YoY (RHS)
2013F
US$/oz
1,950
2012F
Gold price
Source: Bloomberg, CCBIS estimates
For companies with a large presence in Hong Kong, slowing mainland tourist arrivals
into the city could be another negative factor. After several years of high growth in the
number of mainland tourists, we have begun to note a slight deceleration, which we
attribute to the higher base and competition from other travel destinations.
20 April 2012
Mainland tourist arrivals into Hong Kong (YoY)
80%
70%
60%
50%
40%
30%
20%
10%
0%
(10)%
(20)%
Jan-Feb
2005
Source: CEIC
9
Sep-05
May-06
Dec-06
Aug-07
Apr-08
Nov-08
Jul-09
Mar-10
Oct-10
Jun-11
Jan-Feb
2012
20 April 2012
More resilient sales from the watch segment
Demand for gold jewelry is
correlated with gold price trends,
in our view
In the current cycle we expect watch sales to be more resilient than jewelry sales.
Consumer sentiment has soured because of eroding macro conditions. Demand for
gold jewelry in volume terms is likely to be dented by much slower rises in gold price
than what was seen in 2009-2011. Meanwhile, increases in product prices will be
considerably lower than in past years due to less favorable gold price trends.
Worsening consumer sentiment and the absence of a clear uptrend in gold price is a
double whammy jewelry retailers are hoping to avoid.
The crux of our argument is that demand for gold products is positively correlated with
the medium-to-long-term gold price expectations of consumers. We base our claim on
the premise that gold jewelry is no ordinary discretionary consumer product in the
eyes of Chinese consumers and as a result, purchase patterns pertaining to gold
jewelry do not fit those of other discretionary consumer goods. The following features
of gold jewelry explain why it is treated differently than other goods.
Event-driven demand is
adjustable
10

An accessory. In its role as a decorative accessory, gold jewelry can be
considered a normal luxury good. Like many other luxury products, gold jewelry
serves the cultural function of signaling wealth and social status. In this respect,
there is a long-term, structural growth component to the demand for gold jewelry.
As the disposable income of Chinese consumers grows, so too does their
desire to own luxury items to communicate their wealth and social standing.
This long-term trend aside, in the short term, gold demand will fluctuate
according to China’s general macro health in the same way that other luxury
goods tend to do.

Event-driven demand. Gold holds considerable symbolic meaning in many
cultures, including the Chinese culture. It is often presented as a gift on various
Chinese ceremonial occasions and festive events, including Chinese New Year,
birthday celebrations, the arrival of a newborn and most notably, at weddings.
Frost & Sullivan estimates that over 12m marriages were registered in China in
2010, a year when over 30% of the Chinese population was at the marriageable
age of 20 to 39. In spite of the global financial crisis, the number of marriage
registrations continued to increase at a CAGR of 9.8% from 2007 to 2009.
Looking ahead, the number is forecasted to grow at a CAGR of 9.2% between
2010 and 2015. While such event-driven demand is usually steady over the
long run and less affected by short-term changes in the economy, what is often
overlooked is that consumers sometimes adjust their purchases according to
their expectations of medium-term gold price movements. When consumers
anticipate downside to current gold prices or else are uncertain about gold price
trends, they tend to defer their purchases. Vice versa, purchases may take
place earlier when consumers believe that the price of gold will continue to rise.
A common counter argument to this purchasing behavior is that jewelers often
see short-term increases in sales volume when gold prices begin to retreat or
fluctuate. In our view, such a scenario is usually driven by purchases by
consumers who look upon near-term dips as an opportunity to accumulate gold
ornaments on the grounds that their gold price uptrend expectations in the
medium-to-long term remain unchanged. However, event-driven demand can
be delayed in periods when consumers become less certain about what
direction the price of gold price is taking in the medium term.
20 April 2012
Number of marriages in Hong Kong
'000
70
60
50
50
47
47
7.7%
51
10.5%
58
52
10.5%
58
51
47
47
51
7.7%
40
(0.3)%
52
2.8%
(0.3)%
2.8%
30
(7.0)%
20
(5.7)%
10
(11.9)%
0
2000
2001
2002
2003
2004
2005
2006
No. of marriages (LHS)
2007
2008
YoY (RHS)
2009
2010
14%
12%
10%
8%
6%
4%
2%
0%
(2)%
(4)%
(6)%
(8)%
(10)%
(12)%
(14)%
2011
Source: CEIC
Gold jewelry provides a tangible
way to preserve wealth
11

Wealth protection. In our view, the market has failed to fully appreciate the
importance of gold jewelry as a store of wealth and therefore underestimated its
importance as an element in the extraordinary sales growth of gold jewelry in
China between 2009 and 2011. To many Chinese consumers, gold jewelry
products provide them with a tangible way to preserve wealth while at the same
time serving the cultural functions of providing decoration and displaying wealth.
Indeed, one can easily draw an analogy between the many ways Chinese value
jewelry and the pragmatic and sentimental value they attribute to real estate as
both a residence and as a means of preserving and transferring wealth across
generations. This goes a long way to explaining why the dire condition of the
Chinese property market (and to a lesser extent, the stock market) is behind the
shift in wealth-protection demand to gold-related products, including direct
holdings of gold and purchases of pure gold jewelry. It follows naturally that
such wealth-protection demand is, again, correlated with expectations of
medium-to-long-term gold price movements versus those of the property and
stock markets. Similar to the aforementioned event-driven demand, near-term
demand could contract when gold price trends become unclear.
20 April 2012
Finding the right valuation
Except Chow Tai Fook, companies we analyze in this report have a reasonably long
history as public companies, but the watch and jewelry space has become liquid and
investible only since 2010, thanks to valuation and earnings expansion of listed watch
and jewelry players. The listing of Chow Tai Fook in Hong Kong also put this segment
under the spotlight.
Peer comparison is our primary
valuation metric
When determining the fair valuation of watch and jewelry companies, historical
valuations may not be the best reference given the many structural changes that have
taken place in the industry, the impact of mainland spending on Hong Kong retail
sales being the most critical.
We do not resort to the discounted cash flow (DCF) model as most investors converse
in P/E terms and the results from the DCF methodology can change materially even
with only small changes in assumptions. This leaves us with peer comparison as the
most reliable primary valuation metric. In valuing the companies in our China watch
and jewelry universe, we take into account the following factors.
Cyclicality and near-term earnings momentum
Our analysis has already indicated that watch and jewelry demand faces greater
cyclicality than ordinary discretionary items due to the “big ticket” prices involved and
correlation with commodity prices and the changing need of Chinese consumers to
protect their wealth depending on macro economic environment. We project 2012 to
be a challenging year for watch and jewelry retailers as we forecast much slower gold
price movement and a mixed macro outlook that will affect consumer sentiment and
lead to much slower SSSG. Earnings momentum will, in turn, be significantly
weakened, possibly capping valuations for the entire segment.
Momentum weakens in 2012
Revenue growth (YoY)
65%
Earnings growth (YoY)
105%
59
53 52
52%
84
50
46
43
36
39%
39
26%
63
52
38
31
24
35%
25
24
16
13%
65 66
70%
43
30
25
96
93
20 19
21
24
16
4749
2323 21
27
32
21
24
13
19
2123
14
20
0%
(1)
7
(16)
(21)
(35)%
0%
2009
2010
2011
2012F
Chow Tai Fook
Emperor
Hengdeli
2013F
Luk Fook
2014F
12
2009
2010
2011
2012F
2013F
Chow Tai Fook
Emperor
Hengdeli
Luk Fook
2014F
20 April 2012
Comparison with Chinese specialty and branded retailers
Different consumption patterns
Throughout this report we have repeatedly argued that the “big ticket” nature of watch
and jewelry sales makes them inherently more volatile than those of other
discretionary consumer items, such as apparel and footwear. Wealth-protection needs
play a significant role in creating demand for jewelry and, hence, complicate the
nature of purchases. Jewelry sales are additionally correlated with gold price trends.
More importantly, working capital requirements are extremely demanding in watch and
jewelry retailing.
In conclusion, watch and jewelry retailers have a riskier business model and generally
deserve to trade at a discount to specialty and branded retailers selling ordinary
discretionary items through a comparable business franchise, other factors being
equal. Chow Tai Fook and Hengdeli are widely recognized national leaders in their
respective sub-segments and we therefore benchmark their fair valuations at a
discount to Belle (1880 HK, Outperform).
Comparison with department stores
Premium valuations justified for
department store operators
Despite the vastly different business models of department store operators and watch
and jewelry retailers, an accurate valuation of the latter should include a comparison
with department stores because department stores remain among the best
representations of China’s structural consumption growth, barring the growing
challenges from oversupply within the retail space and alternative retail formats, such
as online shopping. In our view, department stores are a balanced and diversified
proxy for China’s mid-to-high-end discretionary consumption, whereas watch and
jewelry purchases mainly reflect sentiment towards luxury consumption and prevailing
wealth protection needs of Chinese consumers. Department stores, in theory, also
have greater sales resilience and more favorable working capital requirements than
jewelry and watch retailers. On a positive note, the degree of industry consolidation is
higher for watch and jewelry retailing where leading operators enjoy strong market
positioning and substantial market share at the national level. We therefore believe
the best-quality watch and jewelry retailers deserve a small discount to department
store operators.
Watch versus jewelry retailers
Jewelry retailers deserve a
premium
13
Watch retailers are focused mainly on distributing Swiss watch labels and do not have
their own watch brands, while branded jewelry retailers are engaged in brand
management, raw material sourcing, product design, production and distribution. A
lack of brand ownership and pricing flexibility implies watch retailers rely heavily on
differentiated merchandizing to compete, although at times strong relationships with
selected suppliers can prove to be a crucial competitive advantage. The extent of
involvement in the value chain will result in different valuations. As established earlier,
jewelry demand is sensitive to gold price movements while watch demand is not. Yet,
demand for luxury watches and jewelry share some similarities. For example, they
both represent luxury consumption that also meets the wealth protection needs of
consumers. Overall, we believe the watch retailing business deserves a small
valuation discount versus branded jewelry retailing.
20 April 2012
Comparison with global watch and jewelry companies
Comparable global peers include some of the most widely internationally recognized
luxury labels that come with long and distinguished histories. They are not
single-market players and their diversified geographic exposure provides them with a
stable yet generally slower growth profiles than those of China-focused operators.
The Chinese market offers strong, structural long-term growth potential, albeit with
significantly higher volatility as Chinese consumer sentiment swings with consumer
investment needs and views on commodity prices – a feature of the Chinese watch
and jewelry market that is not found elsewhere in the world. Despite their less
attractive growth prospects, we believe global luxury watch and jewelry companies
deserve a valuation premium over their Chinese counterparts to reflect their stronger
brand equity.
Leader premium
Within the same sub-segment, it is clear that the leader defined as having higher
market share and larger scale should trade at a premium to its smaller, niche
competitors. In deciding appropriate valuation discounts for Emperor and Luk Fook to
Hengdeli and Chow Tai Fook, respectively, we refer to the trading history of Belle
versus Daphne (210 HK, Not Rated). Daphne has been trading at an average
discount of 32% to Belle since Belle was listed in 2007. The historical average
discount of Emperor to Hengdeli is larger at 46%.
P/E trends of Belle vs. Daphne
48x
44x
40x
36x
32x
28x
24x
20x
16x
12x
8x
4x
May-07
May-08
Daphne (LHS)
64%
60%
56%
52%
48%
44%
40%
36%
Average discount = 32%
32%
28%
24%
20%
16%
12%
8%
4%
0%
(4)%
May-09
Apr-10
Apr-11
Apr-12
Belle (LHS)
Daphne's P/E discount to Belle (RHS)
14
P/E trends of Hengdeli vs. Emperor
29x
72%
64%
24x
56%
48%
Average discount = 46%
19x
40%
32%
14x
24%
16%
9x
8%
0%
4x
Jan-09
Emperor
Feb-10
Hengdeli
(8)%
Mar-11
Apr-12
Emperor's P/E discount to Hengdeli
20 April 2012
Stock recommendations
The following table summarizes our target valuations for the listed jewelry and watch
retailers covered in this report.
CCBI jewelry and watch universe
Implied share price
Target
Stock Share price price* CY12F EPS CY13F EPS
Company
upside
CCBIS rating
(%)
Implied target
P/E (x)
P/E (x)
code
(HK$)
(HK$)
(YoY, %)
(YoY, %)
CY12F CY13F CY12F CY13F
Chow Tai Fook
1929 HK
11.90
12.50
32
26
Neutral (initiation)
5
15.6
12.4
16.4
Emperor
887 HK
1.20
1.40
31
32
Outperform (initiation)
17
9.4
7.2
11.0
8.4
Hengdeli
3389 HK
3.43
4.15
21
21
Outperform (maintained)
21
12.3
9.9
14.9
12.0
Luk Fook
590 HK
20.90
21.80
3
17
Neutral (initiation)
4
9.5
8.1
9.9
8.5
13.0
* Price as at close on 18 April 2012
Source: CCBIS estimates
Justifications for our valuations are as follows:
15

We value Chow Tai Fook at 13.0x CY13F earnings, compared with current
CY13F P/E of 16.7x for Golden Eagle (3308 HK, Not Rated), 17.7x for Belle and
12.6x for Parkson (3368 HK, Not Rated). The discount of Chow Tai Fook to
Golden Eagle and Belle that we assign echoes our earlier conclusion that watch
and jewelry retailers generally deserve to trade at a discount to specialty and
branded retailers as well as department store operators with comparable
business franchises. We also hold the view that non-jewelry specialty retailers
and department store operators are beginning to see a sales recovery that
gives them stronger near-term revenue and earnings momentum than Chow Tai
Fook.

Our target CY13F P/E for Luk Fook is 8.5x, implying a 35% discount to our
target for Chow Tai Fook. It was set after consulting the historical trading history
of Belle and Daphne which revealed an average discount of 32%. Chow Tai
Fook’s earnings outlook is also stronger than that of Luk Fook thanks to Chow
Tai Fook’s active gold price hedging activities which have availed it of better
gross margin stability during the recent period of gold price volatility. We project
a 23% rise in Chow Tai Fook’s FY13F (year-to-March) earnings, and a 1%
decline for Luk Fook.

Hengdeli is valued at 12x CY13F P/E versus 13x CY12F P/E previously. As
established earlier, we believe a valuation discount is justified for watch retailers
versus jewelry retailers to reflect the lack of brand ownership of watch retailers.
When we compare Hengdeli and Chow Tai Fook, the discount should not be
material since Chow Tai Fook is forecast to see greater earnings deceleration in
CY12F as a result of the decline in SSSG.

Our target for Emperor is pegged at 8.4x, equivalent to a 30% discount to our
target for Hengdeli and an average discount of 46% in the past. We anticipate
the valuation discount between the two companies will narrow over time as
Emperor continues to build its business franchise and lengthens its track record
as a listed company.
20 April 2012
Valuation summary
Company
Share price
Market cap
3M average value traded
Stock code
(local currency)†
EPS growth (%)#
(US$m)
(US$m)
CY12
CY13
CY12
P/E (x)
CY13
PE/G (x)
Yield (%)
P/B (x)
ROAE (%)
CY12
CY12
CY12
CY12
Net cash/
Net
share (%) gearing (%)
Jewelry and watch retailers
Chow Tai Fook*
1929 HK
11.90
15,271
19
32
26
15.6
12.4
0.5
1.9
3.5
26.8
5
Hengdeli*
3389 HK
3.43
1,829
6
22
24
11.6
9.4
0.5
3.0
2.3
18.1
Net debt
6
Chow Sang Sang
116 HK
19.76
1,722
3
19
19
10.3
8.6
0.5
3.4
1.8
17.9
Net debt
27
Luk Fook*
590 HK
20.90
1,585
20
3
16
9.5
8.1
3.7
4.4
1.9
22.1
17
Net cash
Emperor Watch*
887 HK
1.20
1,038
6
31
31
9.4
7.2
0.3
3.0
1.8
18.7
6
Net cash
Oriental Watch
398 HK
3.40
250
2
15
14
5.8
5.1
0.4
4.3
3.8
15.2
15
Net cash
20
22
10.4
8.5
1.0
3.3
2.5
19.8
Average
Net cash
Department stores
Golden Eagle
3308 HK
19.70
4,923
10
20
28
21.4
16.7
0.6
1.4
5.7
28.2
7
Net cash
Parkson
3368 HK
8.62
3,119
8
15
20
15.2
12.6
0.6
2.9
3.2
22.7
13
Net cash
Intime Dept Store
1833 HK
9.59
2,462
8
17
19
15.4
13.0
0.7
2.6
2.2
14.6
Net debt
32
Springland*
1700 HK
5.51
1,774
1
24
22
15.5
12.7
0.6
2.9
2.4
16.5
11
Net cash
Maoye
848 HK
1.83
1,265
4
13
27
11.0
8.7
0.3
3.1
1.2
13.3
Net debt
38
NWDS
825 HK
5.24
1,138
1
(10)
15
13.1
11.4
0.8
3.0
3.0
11.5
47
Net cash
PCD Stores
331 HK
0.99
539
3
21
28
8.9
7.0
0.3
3.8
1.3
15.1
9
Net cash
Shirble Dept Stores
312 HK
0.72
231
2
16
18
5.8
4.9
0.3
5.5
0.8
15.1
125
Net cash
14
22
13.3
10.9
0.5
3.1
2.5
17.1
Average
Sportswear brands
ANTA*
2020 HK
7.85
2,521
8
(7)
7
9.9
9.2
NA
6.4
2.3
23.9
28
Net cash
Li Ning*
2331 HK
7.89
1,073
7
9
100
16.0
8.0
1.9
1.9
1.7
11.4
6
Net cash
Xtep*
1368 HK
3.58
1,003
1
2
7
6.4
6.0
2.9
7.8
1.4
23.4
33
Net cash
China Dongxiang*
3818 HK
1.00
726
4
66
64
8.1
4.9
0.1
8.7
0.6
8.0
106
Net cash
361 Degrees*
1361 HK
2.29
610
3
(29)
6
4.8
4.5
NA
8.4
0.8
17.6
13
Net cash
Peak*
1968 HK
1.86
502
2
(33)
16
6.1
5.3
NA
4.9
0.7
12.3
78
Net cash
1
33
8.5
6.3
1.6
6.3
1.3
16.1
Average
(continued on next page)
16
20 April 2012
Valuation summary (continued from previous page)
Company
Stock code
Share price
Market cap
3M average value traded
(local currency)†
(US$m)
(US$m)
EPS growth (%)#
PE/G (x)
Yield (%)
P/B (x)
ROAE (%)
CY12
CY13
CY12
P/E (x)
CY13
CY12
CY12
CY12
CY12
Net cash/
Net
share (%) gearing (%)
Supermarkets
Sun Art Retail
6808 HK
10.08
12,381
10
28
27
31.9
25.2
0.9
1.1
4.9
15.5
9
Net cash
CRE
291 HK
28.05
8,666
17
(1)
21
24.0
19.9
1.0
1.9
1.9
8.1
4
Net cash
Wumart
1025 HK
16.96
2,798
2
35
21
22.1
18.2
0.9
2.0
4.5
21.6
6
Net cash
Lianhua
980 HK
8.24
1,188
4
12
5
10.6
10.1
1.9
3.2
2.0
18.6
94
Net cash
Beijing Jingkelong
814 HK
6.97
370
0
15
23
9.6
7.8
0.3
4.2
1.3
13.5
Net debt
97
18
19
19.7
16.2
1.0
2.5
2.9
15.5
Average
HK retailers
Lifestyle
1212 HK
18.92
4,066
5
4
16
16.1
13.9
0.9
2.5
3.3
21.7
6
Net cash
Sa Sa*
178 HK
4.72
1,711
4
22
20
18.1
15.2
0.8
5.5
7.8
45.8
5
Net cash
Texwinca
321 HK
9.45
1,656
2
10
14
9.9
8.6
0.6
6.3
9.1
22.6
Net debt
3
Giordano
709 HK
6.26
1,232
3
13
14
11.5
10.1
0.7
6.7
3.2
29.5
13
Net cash
I.T*
999 HK
4.38
693
2
20
29
9.7
7.5
0.5
3.6
2.0
18.2
9
4
Bonjour*
653 HK
1.13
438
1
25
27
11.3
8.9
0.5
7.2
9.9
93.4
8
Net cash
16
20
12.8
10.7
0.7
5.3
5.9
38.5
Average
China specialty retailers / other brands
Belle*
1880 HK
14.96
16,246
36
11
21
21.6
17.8
1.9
1.4
4.4
22.3
Net debt
20
Gome*
493 HK
1.59
3,455
50
(24)
47
15.4
10.5
NA
2.0
1.3
8.5
18
Net cash
Bosideng
3998 HK
2.28
2,351
4
11
13
9.4
8.3
0.6
8.3
8.2
21.0
25
Net cash
Daphne
210 HK
10.98
2,329
7
21
22
16.0
13.1
0.6
1.9
3.8
25.7
7
Net cash
Trinity*
891 HK
6.67
1,470
4
23
23
17.9
14.6
0.8
4.0
3.3
19.1
4
Net cash
Lilang*
1234 HK
7.19
1,112
2
17
18
9.6
8.1
0.6
6.1
2.8
30.9
18
Net cash
Net cash
Ports
589 HK
11.40
835
2
14
22
10.0
8.2
0.4
6.0
2.5
26.6
3
Pou Sheng
3813 HK
0.88
483
0
7
30
8.5
6.6
0.2
NA
0.7
6.0
1
Net cash
Evergreen
238 HK
2.24
274
1
18
22
7.8
6.4
0.3
6.5
1.1
14.5
66
Net cash
Sparkle Roll*
970 HK
0.70
269
1
32
27
6.2
4.9
0.2
3.2
1.2
19.6
14
Net cash
Huiyin
1280 HK
0.49
65
2
236
23
7.8
6.4
0.3
NA
0.4
5.0
Net debt
34
33
24
11.8
9.5
0.6
4.4
2.7
18.1
Average
†
Prices as at close on 18 April 2012; # Calculated in Hong Kong dollar terms; * Denotes CCBIS estimates
17
20 April 2012
Key investment risks
Macro risk
High-end consumption is often sensitive to short-term fluctuations in macro conditions
and, hence, shows greater volatility than mass-market or low-end consumption.
During retail slowdowns due to macro-economic changes, it is not uncommon to see a
decline in big-ticket item purchases. Such correlation is due to the discretionary
nature of big-ticket consumption. In the case of jewelry retailers, as repeatedly
elaborated, their sales are additionally correlated with gold price trends which drive
ASP as well as sales volume.
A macro-driven segment
Competition risk
The jewelry retail market in both Hong Kong and China is generally fragmented and
competitive. According to Frost & Sullivan, Chow Tai Fook, the No. 1 jeweler in China,
had 12.6% market share in 2010. In the same year, the top-five jewelry brands
collectively commanded 42.0% market share. In Hong Kong, Chow Tai Fook
dominated the market with 20.1% share in 2010, and together with the No. 2-4 players,
had a combined market share of 42.8%. Although major players are expected to
increase their market share going forward leading to higher industry concentration, we
believe competition will remain intense. Key areas of competition include brand
reputation, product offerings, product design, marketing, in-store service, and store
network (in terms of number of stores and store locations). Watch retailers, on the
other hand, face a slightly different form of competition insofar as they compete mainly
on brand portfolio and product offerings rather than product design. Overall,
competition is most keen in the jewelry arena, as brand and product differentiation is
limited.
Limited differentiation
POS for Chow Tai Fook
POS for Emperor
2,600
2,378
2,400
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
821
69
965
70
600
400
752
895
1,183
85
1,098
1,361
84
1,277
1,620
92
1,528
1,879
100
2,123
106
150
110
124
120
90
1,779
2,017
2,268
30
0
FY10
FY11
China POS
Source: Chow Tai Fook, CCBIS estimates
Note: Year to March
18
FY12F FY13F
Hong Kong POS
33
FY14F
FY15F
31
28
23
60
40
0
FY09
80
61
200
FY08
110
95
19
21
16
57
67
79
91
40
15
4
24
FY08
FY09
FY10
China POS
Source: Emperor, CCBIS estimates
FY11
FY12F
FY13F
Hong Kong & Macau POS
FY14F
20 April 2012
POS for Hengdeli
POS for Luk Fook
640
1,300
560
496
453
480
405
400
350
320
240
1,170
82
1,040
79
910
76
780
73
650
64
237
204
13
7
160
80
539
197
224
286
332
457
417
377
520
456
37
385
34
390
260
419
351
130
817
45
699
42
557
38
772
657
519
1,045
46
927
45
1,116
999
882
1,163
47
0
0
FY08
FY09
FY10
FY11
FY12F
FY13F
China POS
Hong Kong, Macau & Overseas POS
FY08
FY14F
Source: Hengdeli data, CCBIS estimates
FY09
FY10
China POS
FY11
FY12F FY13F FY14F
FY15F
Source: Luk Fook data, CCBIS estimates
Note: Year to March
Intensive working capital requirements
Working capital most related to
new openings
Watch and jewelry retailing involves heavy working capital stemming mainly from
inventory requirements. In particular, companies expanding their self-operated store
network quickly usually see rapid growth in inventory turnover. For instance, each new
directly-managed outlet of Chow Tai Fook would require start-up inventory of up to
HK$9m. In Chow Tai Fook’s case, inventory cycle was 214, 194 and 192 days as at
the end of FY09-FY11, respectively. However, Luk Fook has less exposure to direct
retail to warrant faster turnover in inventory but its inventory cycle is still well above
100 days on average (146, 132 and 129 as at the end of FY09-FY11). Start-up
inventory requirements can be even higher for watch companies carrying ultra-luxury
labels.
Working capital cycle of companies*
250
259
251
243
219
165
180
159
143
115
110
40
(30)
14
25
12
4
(6)
(32)
(35)
(75)
(100)
Chow Tai Fook
Average inventory days
Emperor
Average receivable days
Hengdeli
Average payable days
* Latest balance sheet date
19
Luk Fook
Cash conversion cycle (days)
20 April 2012
Rising operating costs, especially rental
All companies covered in this report have directly-run operations of meaningful scale
in Hong Kong, exposing them to the risk of sharply rising rents. A key difference
between the Hong Kong and China operations of these companies is that
turnover-linked rental arrangements are less common in Hong Kong than in China.
Retail rental has and is expected to continue to grow rapidly in Hong Kong. Any failure
to produce high enough SSSG to offset the increases in rents can result in operating
margin squeeze. Pressure stemming from rising staff costs in both China and Hong
Kong is another concern though it is likely to be mitigated by flexible compensation
structures commonly adopted by jewelry and watch companies that link a significant
proportion of staff compensation to the performance of individual stores and staff
members.
Rental risk
Concentration risk
The following charts show the contribution of Hong Kong to turnover and EBIT of the
four companies under our coverage. Companies with a strong and extensive
presence in the Hong Kong market are highly vulnerable to any adverse changes in
Hong Kong’s retail environment, which in turn is highly dependent on spending by
mainland tourists. To this end, we note that any adjustments to China’s import tariff
and tax policies on imported luxury products would at least marginally affect mainland
consumers’ desire to shop in Hong Kong. In addition, any tightening, while unlikely, in
the current individual visit scheme for mainland travelers would affect tourist traffic into
Hong Kong. If these events were to take place, companies with solid establishment in
China would be better off as they would benefit from increased domestic sales in
China. In our view, Emperor and Luk Fook have the highest net exposure to the Hong
Kong market.
Exposure to Hong Kong
Percentage of revenue from Hong Kong
90%
Percentage of EBIT from Hong Kong
90%
83%
76%
80%
70%
70%
60%
60%
50%
50%
44%
58%
49%
40%
40%
28%
30%
30%
20%
20%
10%
10%
25%
0%
0%
Chow Tai Fook
Emperor
Hengdeli
Source: Chow Tai Fook, Emperor, Hengdeli and Luk Fook data
20
83%
80%
Luk Fook
Chow Tai Fook
Emperor
Hengdeli
Luk Fook
20 April 2012
Commodity price risk
Gold exposure can be hedged
21
Jewelers are vulnerable to fluctuations in the price of raw materials, including gold,
platinum, diamonds and gemstones, which could cause margin volatility. Some
operators actively hedge their gold price exposure through derivatives and/or gold
loans but they remain subject to movements in the price of other raw materials, such
as diamonds, for which there are no established hedging instruments. On the other
hand, there are jewelers which choose not to aggressively hedge the risk of price
changes in their gold inventory. Luk Fook, for instance, hedges only 20% of its gold
price risk.
20 April 2012
Porter and SWOT analysis
Porter
Supplier's
bargaining
power
Threat of
substitutes
Watches
Jewelry
High
Supplier concentration is relatively high as the core watch suppliers are from
Switzerland. ASPs and supply quantity are determined by the Swiss watch
suppliers, and distributors are not allowed to grant discounts to customers.
Hengdeli and Emperor are therefore price takers and source watches locally
from Swiss watch suppliers. This policy is the same for all exported Swiss
watches. Therefore, there is no differentiation between distributors.
Low to moderate
Watches can be viewed as a necessity in daily life for timekeeping purpose,
although they have gradually turned into a popular accessory. The watch
market is enormous and fragmented in China; however, there are only few
sizable and reputable luxury watch retailers and Hengdeli and Emperor are
leaders among them. Hengdeli also owns the largest luxury watch retail
network in China and has a large clientele. Buyer inclination to substitute
foreign brand watches with local brand watches is minimal, given heightening
brand consciousness in China.
Moderate
Jewelers purchase their gold at market prices. For diamonds and gemstones,
sizeable operators with good trade reputations, such as Chow Tai Fook, may
enjoy sourcing benefits by having access to quality materials at competitive
prices.
Rivalry among Low to moderate
existing
Many retailers hope for a share in the rapidly growing luxury watch industry in
companies
China, yet it is quite difficult to establish a scale comparable to Hengdeli.
Likewise, Emperor's network already occupies some of the best locations in
prime tourist districts in Hong Kong. It would be difficult for peers to build a
strategic alliance with top Swiss watch suppliers as they are very cautious in
screening distributors. Hengdeli is one of the few that has been able to
maintain a solid bond with these top Swiss watch companies, and is therefore
given priority in watch supply and deliveries. Emperor's relationships with its
suppliers are similarly strong. Moreover, many customers prefer to shop at
Hengdeli’s stores, which offer a diversified brand portfolio of mid-to-high end
watches covering all major consumer segments while others have a limited
product mix. Emperor, meanwhile, attracts customers seeking top luxury
labels. Customers are confident that Hengdeli and Emperor products are
authentic with high quality.
Threat of new Low
entrants
It is very difficult for new players to secure distribution rights or access to
Swiss watch suppliers. As Swiss watch suppliers are extremely strict in terms
of sourcing, they may only supply a limited range of products to local watch
retailers. Moreover, brand identity is exceptionally important for luxury watch
retailers, since their brand reputation signifies the assurance of quality and
authenticity. The creation of brand identity requires a long period of operation
in the market where new players may struggle.
Low
Unlike in western countries, event-driven purchases are an important driver of
jewelry sales in Greater China. It is a Chinese tradition to present gold jewelry
as a gift at ceremonial and festive events such as weddings, Mid-autumn
Festival, Chinese New Year, birthday celebrations and to celebrate the arrival
of newborns. As an accessory, gold jewelry can be substituted by gem-sets,
pearls or other metal accessories through jewelry retailers have the flexibility
to adjust and expand their product offerings to meet changing consumer
needs. Consumers seeking wealth protection, however, may switch to
alternative investment options such as real estate or equity when and if the
property and stock markets in China start to improve.
Moderate to high
Mass luxury jewelry retailers compete on branding, product offerings, product
designs, marketing, in-store services, and store network (in terms of number
of stores and location). At the individual product level, differentiation tends to
be limited and design differences subtle. Competition has intensified in recent
years following rapid store network expansion of existing operators. For
example, the Hong Kong market and the department store channel in
higher-tier cities are generally perceived as reasonably crowded. As a result,
we expect leading companies to accelerate expansion into lower-tier cities to
take advantage of growth opportunities.
Moderate
In theory, entry barriers to jewelry retailing are not formidably high. However,
new player entry has become difficult due to heavy working capital
requirements and escalating rental levels in both Hong Kong and China. It
can take a long time for a new brand to build a franchise comparable with that
of the leading existing brands as consumer recognition and trust do not
develop overnight. The growing presence of foreign brands is a valid concern
but they are more concentrated in the luxury segment whereas Chow Tai
Fook and Luk Fook target the mass segment.
Low
Buyer's
Low
bargaining
Since all Swiss watches have a unified ASP, there is little room for buyers to Jewelers price their products based on raw material costs plus a mark up. As
power
bargain for discounts across the board. Buyers of luxury items are relatively a reflection of the mark up, gross margin has been largely stable for the
less price sensitive since they have high spending power, and a minor price companies we track. Generally speaking, room for price negotiation is small,
increment will not affect their purchasing decisions.
especially at times of strong demand. Small discounts may be offered when
the market is slow.
Source: CCBIS research
22
20 April 2012
SWOT
Hengdeli, Emperor
Strengths
Chow Tai Fook, Luk Fook
Good and long relationships with key watch brands
Direct retail model, with multi-store format
Key suppliers as strategic investors
Leading players in their respective market segment, with strong customer recognition
Extensive and rapidly growing store network occupying favorable locations in Hong Kong and China
Weaknesses
Lack of pricing flexibility
 Limited brand differentiation
 Use of franchising business model
 Heavy working capital requirements
Opportunities
 Attractive industry growth supported by disposable income growth of Chinese consumers as well as other favorable macro developments
 On-going industry consolidation as mom-and-pop stores and regional chains lose market share to leading national operators. This process can be driven
by two forces: (1) local retailers with poor operations and/or branding offer acquisition opportunities; and (2) aggressive expansion plans of the national
leaders to capture further market share
 Opportunities in lower-tier cities
Threats
 Possibility of losing distribution licenses to competing chains upon expiry  Entry of foreign jewelry labels
 Possibility of China lowering import tariffs and taxes on luxury items could reduce mainland customers’ desire to shop in Hong Kong
Source: CCBIS research
23






20 April 2012
Chow Tai Fook Jewellery (1929 HK)
Company Rating: Neutral
Diamonds are forever
(initiation)
Chow Tai Fook Jewellery is Greater China’s largest and most
recognized jewelry brand and retailer with over 80 years of
history. It has a strong business franchise and an extensive
store presence, among other positives. We view the company
as the best-quality proxy for the long-term boom in China’s
jewelry consumption. Nevertheless, we believe the stock is
fairly valued on 16x CY12F P/E against a notable SSSG
deceleration ahead. We initiate coverage with a Neutral rating
on the stock.


Strong franchise. Chow Tai Fook is the No. 1 jeweler in
terms of retail sales in both Hong Kong (20%) and China
(13%). According to various surveys, Chow Tai Fook
enjoys the highest customer recognition in both
markets. Its extensive yet still rapidly-growing store
network comprising over 1,500 POS is among the
largest in Greater China. More importantly, the company
has strong coverage in China’s lower-tier cities where
consumption is booming.
High-quality operator. We see several major
advantages in Chow Tai Fook. It has an effective
vertically-integrated business model that provides major
cost and product quality benefits. Its exposure to
franchising is limited. Active hedging of gold price
reduces volatility of its gross margin.
Price:
HK$11.90
Target:
HK$12.50
(initiation)
Trading data
52-week range
HK$11.66 – 15.16
Market capitalization (m)
Shares outstanding (m)
Free float (%)
HK$119,000/US$15,331
10,000
11
3M average daily T/O (m share)
10.9
3M average daily T/O (US$m)
18.9
Expected return (%) – 1 year
7.3
Closing price on 18 April 2012
Stock price vs. HSI
HK$
18.0
16.7
15.4
14.1
12.8

Initiate with Neutral. Our earnings projection for FY13F
is 6% below consensus estimate. In addition, share
price performance is likely to be restricted as SSSG is
set to slow materially in the coming months. We initiate
coverage with a Neutral rating and our target price
implies CY12F and CY13F P/E of 16x and 13x,
respectively.
11.5
14-Dec-11 1-Jan-12
19-Jan-12 6-Feb-12 24-Feb-12 13-Mar-12 31-Mar-12 18-Apr-12
Chow Tai Fook
HSI (rebased)
Source: Bloomberg
Financial forecast
Year to 31 March
FY10
FY11
FY12F
FY13F
FY14F
Revenue (HK$m)
22,934
35,043
55,615
68,937
86,205
Net profit (HK$m)
2,139
3,538
6,516
7,998
10,127
EPS (HK$)
0.214
0.354
0.652
0.800
1.013
–
65
84
23
27
55.6
33.6
18.3
14.9
11.8
–
–
0.7
2.3
2.9
0.4
0.7
(2.0)
(1.5)
5.8
ROAE (%)
29.5
36.4
32.5
24.9
25.6
P/B (x)
14.3
10.2
4.0
3.3
2.6
2.9
10.3
Net cash
Net cash
Net cash
EPS (YoY, %)
P/E (x)
Yield (%)
FCF yield (%)
Net gearing (%)
Source: Company data, CCBIS estimates
24
Forrest Chan, CFA
(852) 2532 6743
[email protected]
Claudia Ching
(852) 2532 2528
[email protected]
Timothy Sun
(852) 2532 6746
[email protected]
20 April 2012
Investment highlights
Number one player, mass-market
focus
Chow Tai Fook is Greater China’s largest and most recognized jewelry brand and
retailer with over 80 years of history. The company focuses on the mass-luxury end of
the jewelry market, which is the key segment accounting for 57% of the overall jewelry
market of China in 2010. Its leading yet growing scale, market leadership and strong
customer recognition make it the best proxy for attractive long-term growth in China’s
jewelry consumption. In addition, Chow Tai Fook has a favourable vertically integrated
business model featuring balanced exposure to both the China and Hong Kong
markets as well as limited franchising.
Market position of jewelers
Luxury
Van Cleef & Arpels
Cartier
Bulgari
Tiffany
Tesiro
Chow Sang Sang
3D-Gold
Emperor Watch
& Jewellery
CHJ Jewellery
Jovan
Limited
geographic
coverage
Daimengde
Fuhui
Fuqi
Jewelry
Lukfook
TSL
Kimberlite
Diamond
Ming
Jewelry
Laofengxiang
Chow Tai Seng
Extensive
geographic
coverage
Laomiao
First Asia Jewellery
Batar Jewellery
Affordable
Retail value of jewelry market in China with breakdown by price range (2010)
Low-end
(price less than
HK$2,000)
10%
High-end
(price greater than
HK$100,000)
33%
25
Mass luxury
(price ranging
from HK$2,000
to HK$100,000)
57%
20 April 2012
Leader with strong customer recognition and a reputation for
quality
A clear market leadership,
well-recognized by customers
Chow Tai Fook was the No.1 jewelry retailer in value terms in both China and Hong
Kong/Macau in 2010, based on Frost & Sullivan’s estimates. The Chow Tai Fook (周
大福) brand was ranked along with Tiffany and Cartier as the top-three brands most
likely to be purchased in 2010 in China according to consulting firm Bain & Company.
Frost & Sullivan ranked Chow Tai Fook first in jewelry brand awareness in China,
Hong Kong and Macau. These rankings are strong evidence of the company’s
branding and market position.
Jewelry market share by retail value in China (2010)
14%
13%
12%
10%
9%
8%
7%
7%
6%
6%
4%
4%
4%
3%
3%
2%
2%
2%
0%
Chow Tai Lao Feng Chow Tai Lao Miao Beijing First Asia Zhe Jiang
Fook
Xiang
Seng
Caishikou
Ming
Cartier
Luk Fook Kimberlite
Diamond
Chow
Sang
Sang
Jewelry market share by retail value in Hong Kong and Macau (2010)
22%
20%
20%
18%
16%
14%
12%
10%
9%
7%
8%
6%
4%
4%
3%
2%
2%
2%
2%
2%
2%
Qeelin
CSS
0%
Chow Tai Chow Sang Luk Fook
Fook
Sang
26
MaBelle
Cartier
Tiffany &
Co
King Fook Seng Feng
20 April 2012
Unaided brand awareness on total market – China (2011)
80%
Unaided brand awareness on total market – Hong Kong
and Macau (2011)
80%
74%
70%
70%
60%
60%
50%
50%
40%
35%
74%
58%
49%
40%
34%
30%
30%
20%
20%
10%
10%
0%
0%
Chow Tai Fook
Lao Feng Xiang
Chow Tai Fook
Chow Sang Sang
Tsw Sui Luen
Chow Sang Sang
Extensive and fast growing store network with strong access to
lower-tier cities
Solid presence in lower-tier cities
Chow Tai Fook has an extensive store network of over 1,500 self-operated and
franchised point of sales (POS) as of end-September 2011 covering over 320 cities in
China, Hong Kong, Macau, Taiwan and selected countries in Southeast Asia. The
majority of its stores are jewelry specialty stores with the balance being watch POS.
Its network is growing fast, achieving a store count CAGR of 18% between March
2008 and March 2011, or an average 179 new POS per annum. Chow Tai Fook
intends to maintain a rapid pace of expansion, as it looks to add about 200 net new
jewelry POS annually going forward, targeting a total store count of over 2,000 jewelry
POS per year.
Chow Tai Fook – number of POS
2,600
2,378
2,400
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
821
69
965
70
600
400
752
895
1,183
85
1,098
1,361
84
1,277
1,620
92
1,528
1,879
100
1,779
2,123
106
2,017
110
2,268
200
0
FY08
FY09
FY10
27
FY11
China POS
FY12F
FY13F
Hong Kong POS
FY14F
FY15F
20 April 2012
Chow Tai Fook made an early move into lower-tier cities where market growth is
phenomenal. It entered tier-3 and tier-4 cities as early as 2000 and 2002, respectively,
and has already established a strong presence. 34% and 18% of its jewelry and watch
POS are located in tier-3 or below cities, based on its September 2011 store count.
Frost & Sullivan forecasts impressive jewelry market CAGR of 45% in lower-tier cities,
versus only 32% and 37% for tier-one and tier-two cities.
A first mover into lower-tier cities
Retail value of jewelry market in China with breakdown
by city tier
RMB b
1,300
1,170
1,040
100%
90%
2010-2015F CAGR:
Tier-1 cities = 32%
Tier-2 cities = 37%
Tier-3 cities = 45%
551
382
C
520
264
124
260
0
35
26
36
37 28 46
2006
2007
58
61
65
2008
85
82
85
115
113
401
215
150
338
259
35%
37%
39%
41%
43%
31%
32%
33%
33%
33%
32%
32%
31%
31%
40%
39%
38%
36%
31%
29%
28%
26%
34%
32%
0%
2006
2007
2008
2009 2010 2011F 2012F 2013F 2014F 2015F
Tier-1
Tier-2
Tier-3
Contribution from Hong Kong not
excessive
Chow Tai Fook’s solid presence in China means it can be less dependent on the Hong
Kong market. As shown in the following chart, Chow Tai Fook derives a smaller
proportion of its sales and EBIT from Hong Kong than Luk Fook or Chow Sang Sang,
which suggests smaller concentration risk.
Chow Tai Fook sales from Hong Kong vs. peers
Chow Tai Fook EBIT from Hong Kong vs. peers
90%
83%
76%
80%
34%
10%
2009 2010 2011F 2012F 2013F 2014F 2015F
Tier-1
Tier-2
Tier-3
90%
31%
40%
20%
158
197
30%
30%
294
181
390
31%
50%
650
30%
70%
60%
780
46
48
57
29%
80%
910
130
Retail value of jewelry market in China with breakdown
by city tier
73%
70%
70%
60%
60%
50%
83%
80%
44%
49%
50%
40%
28%
30%
58%
40%
30%
20%
25%
20%
10%
10%
0%
Emperor Watch
Luk Fook
Chow Sang
Sang
Chow Tai Fook
Hengdeli
Source: Chow Sang Sang, Chow Tai Fook, Emperor, Hengdeli and Luk Fook data
28
0%
Emperor Watch
Luk Fook
Chow Tai Fook
Hengdeli
20 April 2012
Sourcing advantages and vertical integration
Extensive involvement in every
stage of supply chain
Chow Tai Fook has an effective vertically integrated business model that allows it to
exert significant control over procurement, design, production, marketing and sales
processes. The group therefore enjoys high efficiency and cost benefits, and has
ability to ensure stable and quality supplies. Key aspects of Chow Tai Fook’s vertically
integrated business model and procurement strengths are worth further discussion:

In-house diamond processing capacity. 40% of its diamond requirement is
met by its three diamond cutting and polishing facilities in South Africa and
Shunde, China, where rough diamonds are cut and polished.

Strong relationships with DTC and Rio Tinto. Chow Tai Fook is a sightholder
of the Diamond Trading Company (DTC) through Zlotowski’s, one of its
wholly-owned subsidiaries. Another of its subsidiary, Chow Tai Fook Hong Kong,
is also a DTC Sightholder. In 2009, the group became a Rio Tinto Select
Diamantaire. Under the agreements with DTC and Rio Tinto, Chow Tai Fook is
supplied with rough diamonds meeting pre-agreed specifications up to a
stipulated value and for a specified period. DTC and Rio Tinto account for a
significant portion of Chow Tai Fook’s demand for rough diamonds.

Access to rare stones. Thanks to its reputation, Chow Tai Fook is often invited
to auctions to bid for rare and unique diamonds. In 2010, Zlotowski successfully
won the bid for the 507-carat Cullinan Heritage rough diamond for US$35.3m,
the highest sale price on record for a rough diamond. Successful bidding in rare
diamonds or gemstones enhances Chow Tai Fook’s global exposure and media
publicity.

In-house production. As at 30 September 2011, Chow Tai Fook operated a
total of 12 factories consisting of nine jewelry factories and three diamond
cutting and polishing facilities. The nine jewelry factories together hire over
3,500 employees, occupying a total area of over 42,000 sqm. Since 2008, the
group has produced 80% of its gem-set jewelry products in-house, or about
50% if other products are included. The basic rationale behind its outsourcing is
to keep its own production capacities focused on gem-set jewelry products,
while using external producers for simple or low value products.
Chow Tai Fook’s production facilities
Location
Number of factories
Specialization
Hong Kong
1
Gem-set jewelry
Shenzhen, China
4
Gem-set jewelry, karat gold and gold products
Shunde, China
4
Gem-set jewelry, platinum/karat gold and gold products
Shunde, China
1
Diamond cutting and polishing
South Africa
2
Diamond cutting and polishing
Source: Company data
29
20 April 2012
Limited franchising
Unlike the majority of its key competitors, Chow Tai Fook has a relatively low ratio of
franchised stores in its store base. All of its outlets in Hong Kong and Macau are
self-operated, whereas franchised stores, selling products exclusively supplied by
Chow Tai Fook, only account for 32% of its store count in mainland China. Its
franchising model is mainly employed in tier-three and tier-four cities. Chow Tai Fook
has good control over its franchised stores, and does not often grant any credit terms
while setting the same operational standards as its self-managed stores. We regard
Chow Tai Fook’s limited franchising as a positive. Chow Tai Fook is also in the
process of converting some of its franchised stores to joint-venture POS.
More use of direct retail
Chow Tai Fook – franchised POS as % of China total
China’s jewelry POS by operation model 2010
100%
90%
27%
29%
28%
31%
31%
32%
33%
34%
73%
71%
72%
69%
69%
68%
67%
66%
80%
Self-operated
32%
70%
60%
50%
40%
30%
20%
10%
Franchsied
68%
0%
FY08
FY09
FY10
FY11
FY12F FY13F
Self-owned
Franchised
FY14F
FY15F
Active hedging of gold price exposure
90% of gold inventory hedged
Chow Tai Fook manages commodity price risks mainly by hedging gold price
fluctuations through gold loans and bullion forward contracts. Changes in the fair
value of gold loans and bullion forward contracts are reflected in the company’s
COGS to offset price changes in its gold inventory and, hence, provide stability to the
gross margin of Chow Tai Fook’s gold products. We understand that Chow Tai Fook
has one of the most active hedging policies of its peers as it hedges nearly c.90% of
its exposure to gold price. For the remainder of its product mix, the company looks to
pass on price increases to its customers.
Strong presence in department store channel
As oat end-September 2011, 778 out of Chow Tai Fook’s 884 self-operated POS in
China were concessionaire counters located within department stores paying
turnover-linked commission (i.e. rent). While alternative retail formats such as
shopping malls are developing quickly in China, the department store format remains
the major channel where mid-to-high end consumption takes place. Chow Tai Fook’s
significant presence within department stores ensures that it maximizes its exposure
to target customer segments. It also reduces operating leverage, providing greater
margin stability.
30
20 April 2012
China's jewelry sales breakdown by retail channel (2010)
Others
(including the Internet)
2%
Specialised markets
10%
Stores in shopping malls
14%
Department stores
44%
Stand-alone
branded stores
30%
31
20 April 2012
Key earnings drivers
We forecast 25% earnings CAGR for Chow Tai Fook in FY12F-14F to be driven by the
following factors:
New openings and SSSG
We estimate c.250 net new openings to be achieved per annum going forward,
implying a mid-teen rate of POS growth. Our understanding is that locations have
been secured or confirmed via MOU for a majority of Chow Tai Fook’s planned
openings in FY13F. SSSG of 10-12% and 15-16% is assumed for FY13F and FY14F,
respectively.
Chow Tai Fook – revenue projections
Year to March (HK$m)
Total revenue
2009
2010
2011
2012F
2013F
2014F
2015F
18,411
22,934
35,043
55,615
68,937
86,205
104,726
25
53
59
24
25
21
YoY (%)
Revenue by market
Retail, China
6,758
9,355
14,595
22,327
28,424
36,075
45,061
Retail, Hong Kong, Macau and others
8,168
10,168
15,438
24,111
28,791
35,004
41,710
Wholesale, China
3,247
3,274
4,877
8,945
11,455
14,819
17,602
238
137
133
232
267
307
353
Retail, China
–
38
56
53
27
27
25
–
24
52
56
19
22
19
Wholesale, China
–
1
49
83
28
29
19
Wholesale, Hong Kong, Macau and others
–
(42)
(3)
75
15
15
15
Retail, China
36.7
40.8
41.6
40.1
41.2
41.8
43.0
44.4
44.3
44.1
43.4
41.8
40.6
39.8
Wholesale, China
17.6
14.3
13.9
16.1
16.6
17.2
16.8
1.3
0.6
0.4
0.4
0.4
0.4
0.3
14,926
19,523
30,033
46,438
57,215
71,079
86,771
3,485
3,410
5,009
9,177
11,722
15,126
17,955
Retail
31
54
55
23
24
22
Wholesale
(2)
47
83
28
29
19
Revenue growth by market (%)
Revenue mix by market (%)
Revenue by sales channel
Retail
Wholesale
Revenue growth by sales channel (%)
Revenue mix by sales channel (%)
Retail
81.1
85.1
85.7
83.5
83.0
82.5
82.9
Wholesale
18.9
14.9
14.3
16.5
17.0
17.5
17.1
32
20 April 2012
Stable gross margin
Chow Tai Fook actively hedges its gold price exposure using forward contracts and
gold loans, and prices its gold products on a daily basis according to prevailing gold
price. As a result, its gold products carry a stable gross margin of 10% in Hong Kong
and 20-22% in China. Gem-set products are usually priced at a mark-up to their cost
of purchase and have higher margin at 35%+. Hence, we believe Chow Tai Fook’s
overall gross margin is broadly driven by product mix changes, and to a lesser extent,
retail discounting level. Share of gold products in Chow Tai Fook’s sales mix has
increased since FY09 which we attributed to rising gold price, which lifted ASPs and in
turn stimulated demand. However, the company’s long-term strategic intention is to
gradually increase the share of gem-set products in its sales mix since there is better
room for consumer to trade-up within the gem-set segment. In the meantime, the mix
between direct retail and wholesale in Chow Tai Fook’s sales mix is another factor
determining Chow Tai Fook’s gross margin given the higher gross margin of sales of
its directly-managed stores. However, we foresee the mix to be fairly stable in the
foreseeable future.
Upside from business mix
improvements
Chow Tai Fook – sales mix by product
100%
6%
Chow Tai Fook – sales mix by channel
7%
7%
100%
90%
80%
19%
15%
14%
17%
17%
18%
17%
81%
85%
86%
83%
83%
82%
83%
FY09
FY10
FY11
FY12F
FY13F
Direct retail
Wholesale
FY14F
FY15F
80%
70%
64%
60%
64%
67%
60%
50%
40%
40%
30%
20%
20%
30%
29%
26%
0%
10%
0%
FY09
FY10
Gem-set jewelry
Gold items
FY11
Watches
Chow Tai Fook – gross margin by product
Chow Tai Fook – gross margin trend
52%
47%
30.0%
45%
29.6%
39%
29.7%
29.8%
29.5%
29.5%
27%
26%
29.0%
28.9%
15%
13%
28.6%
28.5%
28.3%
0%
Gem-set jewelry
Platinum/karat
gold products
33
Watches
Gold products
28.0%
FY09
FY10
FY11
FY12F
FY13F
FY14F
FY15F
20 April 2012
SG&A expenses
Staff cost is modelled as an assumed percentage of turnover. Like most peers, Chow
Tai Fook has a compensation scheme linking a substantial portion of staff
compensation to individual store and individual member performance. Staff cost
expense ratio is expected to decline in years of extremely high SSSG such as FY11
and FY12F, whereas a slower sales environment may see a stable or modestly higher
ratio due to structural growth in China’s wage level.
In FY11, concessionaire fees accounted for up to 75% of Chow Tai Fook’s total rental
and commission expense. This ratio should continue to increase as its China unit,
which employs predominantly the department store counter store format, increases
contribution to the overall business mix. We project that the average effective
commission rate applicable to Chow Tai Fook’s concessionaire counters will decrease
over time as a result of more openings in lower-tier markets where commission rates
are lower. We therefore project slower increases in concessionaire fee per counter
than SSSG in China.
Tax rate
The group’s effective tax rate is largely as function of changes in its geographic
exposure. Most of its subsidiaries based in China are subject to the standard income
tax rate of 25%. In Hong Kong, its businesses face a lower profit tax rate of 25.8%.
From FY13F and onwards, we expect China’s business to grow faster aided by more
rapid store expansion and we forecast Chow Tai Fook’s effective tax rate will rise
steadily.
34
20 April 2012
Chow Tai Fook – key assumptions
2009
2010
2011
2012F
2013F
2014F
2015F
Total POS
965
1,183
1,361
1,620
1,879
2,123
2,378
China – sub-total
895
1,098
1,277
1,528
1,779
2,017
2,268
China – self-operated jewelry POS
634
732
815
962
1,107
1,238
1,373
China – franchised jewelry POS
261
302
391
474
570
667
772
0
64
71
92
102
112
123
70
85
84
92
100
106
110
Hong Kong/Macau – jewelry POS
70
81
81
88
95
100
103
Hong Kong/Macau – watch POS
0
4
3
4
5
6
7
Total POS – YoY change
144
218
178
259
259
244
255
China – sub-total
143
203
179
251
251
238
251
87
98
83
147
145
131
134
0
64
7
21
9
10
11
56
41
89
83
97
97
105
China – watch POS
Hong Kong/Macau – sub-total
China – watch POS
1
15
(1)
8
8
6
4
1
11
0
7
7
5
3
0
4
(1)
1
1
1
1
Total POS – YoY change (%)
18
23
15
19
16
13
12
China – sub-total
19
23
16
20
16
13
12
16
15
11
18
15
12
11
27
16
29
21
20
17
16
China – watch POS
–
–
11
30
10
10
10
1
21
(1)
10
9
6
4
1
16
0
9
8
5
3
0
0
(25)
33
25
20
17
China
–
15.2
35.2
33.5
10.2
15.0
14.7
Hong Kong/Macau
–
16.0
32.4
53.5
11.6
16.1
15.9
12.3
10.2
12.1
17.0
17.5
18.7
18.7
–
(17)
19
40
3
7
0
28.9
28.6
28.3
29.5
29.6
29.7
29.8
7.2
6.8
6.1
5.8
5.8
5.9
5.8
Rental per retail store (HK$m)
–
2.3
2.8
3.1
3.4
3.8
4.2
YoY (%)
–
–
21.1
12.0
10.0
11.0
10.0
Commission per concessionaire POS (HK$m)
–
1.6
2.0
2.5
2.6
2.8
3.1
YoY (%)
–
–
26.7
26.6
3.2
6.2
13.0
4.5
4.7
4.2
3.9
3.8
3.7
3.6
SSSG (%)
Average revenue per franchised store (RMB m)
YoY (%)
Gross margin (%)
Total staff cost as % of retail sales
Other expenses as % of retail revenue
35
20 April 2012
Chow Tai Fook – profit and loss projections
2009
18,411
–
2010
22,934
25
2011
35,043
53
2012F
55,615
59
2013F
68,937
24
2014F
86,205
25
2015F
104,726
21
1H11
13,315
–
2H11
21,728
–
1H12
23,875
79
2H12F
31,741
46
(13,085)
–
(16,379)
25
(25,115)
53
(39,209)
56
(48,531)
24
(60,602)
25
(73,518)
21
(9,614)
–
(15,501)
–
(16,734)
74
(22,475)
45
5,326
28.9
6,555
23
28.6
9,928
51
28.3
16,406
65
29.5
20,405
24
29.6
25,603
25
29.7
31,208
22
29.8
3,701
–
27.8
6,226
–
28.7
7,141
93
29.9
9,266
49
29.2
72
98
164
260
233
273
305
66
98
166
93
Staff costs
YoY (%)
As % of turnover
(1,076)
(1,320)
23
5.8
(1,821)
38
5.2
(2,693)
48
4.8
(3,318)
23
4.8
(4,194)
26
4.9
(5,033)
20
4.8
(752)
–
5.6
(1,069)
–
4.9
(1,370)
82
5.7
(1,324)
24
4.2
Depreciation
YoY (%)
As % of turnover
(161)
(226)
41
1.0
(247)
9
0.7
(377)
53
0.7
(527)
40
0.8
(676)
28
0.8
(802)
19
0.8
(113)
–
0.8
(134)
–
0.6
(154)
36
0.6
(224)
67
0.7
Donation
YoY (%)
As % of turnover
(164)
(117)
(29)
0.5
(122)
4
0.3
(120)
(2)
0.2
(140)
17
0.2
(160)
14
0.2
(180)
13
0.2
(21)
–
0.2
(101)
–
0.5
(8)
(63)
0.0
(112)
11
0.4
(1,370)
32
6.0
(1,996)
46
5.7
(2,803)
40
5.0
(3,403)
21
4.9
(4,111)
21
4.8
(5,107)
24
4.9
(832)
–
6.3
(1,164)
–
5.4
(1,235)
48
5.2
(1,568)
35
4.9
(926)
38
4.0
(1,249)
35
3.6
(1,811)
45
3.3
(2,174)
20
3.2
(2,630)
21
3.1
(3,124)
19
3.0
(492)
–
3.7
(757)
–
3.5
(844)
72
3.5
(967)
28
3.0
16.9
2,291
–
12.4
(3,958)
27
17.3
2,695
18
11.8
(5,435)
37
15.5
4,656
73
13.3
(7,805)
44
14.0
8,861
90
15.9
(9,562)
23
13.9
11,076
25
16.1
(11,770)
23
13.7
14,106
27
16.4
(14,245)
21
13.6
17,268
22
16.5
(2,210)
–
16.6
1,557
–
11.7
(3,225)
–
14.8
3,099
–
14.3
(3,610)
63
15.1
3,697
137
15.5
(4,195)
30
13.2
5,164
67
16.3
161
226
255
385
534
684
810
–
–
–
–
EBITDA
YoY (%)
EBITDA margin (%)
2,130
11.6
2,469
16
10.8
4,402
78
12.6
8,475
93
15.2
10,541
24
15.3
13,422
27
15.6
16,458
23
15.7
–
–
–
–
–
–
–
–
–
–
–
–
Interest income
Interest expense
Share of results of an associate
89
(157)
1
77
(62)
9
70
(102)
(5)
96
(274)
0
149
(335)
0
176
(246)
0
215
(228)
0
35
(30)
0
36
73
(5)
38
(117)
0
58
158
0
Profit before tax
YoY (%)
As % of turnover
Tax
Effective tax rate (%)
2,224
12.1
(309)
13.9
2,719
22
11.9
(512)
18.8
4,620
70
13.2
(947)
20.5
8,683
88
15.6
(1,884)
21.7
10,890
25
15.8
(2,472)
22.7
14,036
29
16.3
(3,326)
23.7
17,255
23
16.5
(4,193)
24.3
1,562
0
11.7
(339)
21.7
3,203
0
14.7
(609)
19.0
3,618
132
15.2
(797)
22.0
5,380
68
16.9
(1,087)
20.2
(18)
(68)
(135)
(282)
(420)
(583)
(795)
(48)
(87)
(129)
(153)
Net profit
1,897
YoY (%)
Net margin (%)
10.3
2,139
13
9.3
3,538
65
10.1
6,516
84
11.7
7,998
23
11.6
10,127
27
11.7
12,267
21
11.7
1,176
–
8.8
2,507
–
11.5
2,692
129
11.3
4,140
65
13.0
Total revenue
YoY (%)
COGS
YoY (%)
Gross profit
YoY (%)
Gross margin (%)
Other income and gains
Rental cost and concessionaire fees
YoY (%)
As % of turnover
Other expenses
YoY (%)
As % of turnover
Total SG&A and other expenses
YoY (%)
As % of total turnover
EBIT
YoY (%)
EBIT margin (%)
Depreciation and amortization
included in SG&A
Minority interest
36
5.8
0.9
0.9
(1,036)
5.6
(671)
3.6
(3,107)
20 April 2012
Balance sheet and cash flow
Chow Tai Fook’s balance sheet has been significantly enhanced by its listing. We
estimate its net cash position will exceed HK$8b by end-FY12F.
The company’s cash flow health is closely related to its expansion pace and the
prevailing gold price. Store fitout cost is usually around HK$1-2m per new opening but
working capital requirement for each opening can be as high as HK$8-10m at the
current gold price. Working capital needs of existing stores also rise in tandem with
higher gold price. Sharp rises in gold price during 2010 and 2011 have led to negative
operating cash for Chow Tai Fook in FY11 and 1HFY12. Given our assumption of
slower gold price growth in FY13 and onwards, we estimate that positive operating
cash flow will resume to finance estimated capex of HK$0.9-1.2b per annum.
Chow Tai Fook – cash flow projections
2009
2010
2011
2012F
2013F
2014F
2015F
EBIT
EBITDA
Adjustments for other non-cash items
Working capital changes:
Inventory
Receivables
Payables
Defined benefits paid
Gold loans
Pledged deposit
Tax paid
Interest paid
Interest received
Operating cash flow
Capex
Free cash flow
Other investment cash flows
Contribution from minority shareholders
Share issue
Dividend paid
Advance/repayment to/from minority shareholders
Net cash flow
2,291
161
2,451
54
2,695
226
2,921
473
4,656
255
4,911
720
8,861
385
9,246
900
11,076
534
11,610
1,050
14,106
684
14,789
1,200
17,268
810
18,078
1,300
(822)
177
(385)
(7)
323
(390)
(366)
(157)
89
968
(485)
483
8
6
5
0
25
526
(1,186)
(1,069)
490
(7)
(355)
242
(399)
(62)
77
1,125
(320)
806
7
14
5
(7)
56
881
(7,508)
(675)
677
(7)
984
68
(730)
(102)
70
(1,592)
(824)
(2,416)
24
21
2
(9)
75
(2,304)
(10,915)
(1,037)
1,362
(7)
1,268
(39)
(1,535)
(274)
96
(935)
(900)
(1,835)
(19)
0
15,500
(4,500)
135
9,281
(2,471)
(741)
622
(7)
350
(15)
(2,253)
(335)
149
7,959
(1,050)
6,909
1
0
0
(1,308)
70
5,672
(6,767)
(771)
1,166
(7)
300
(10)
(3,008)
(246)
176
6,822
(1,200)
5,622
1
0
0
(1,727)
80
3,976
(5,253)
(1,178)
1,183
(7)
700
(20)
(3,870)
(228)
215
10,919
(1,200)
9,719
0
0
0
(2,154)
60
7,626
37
20 April 2012
Chow Tai Fook – balance sheet projections
2009
2010
2011
2012F
2013F
2014F
2015F
1H12
Property, plant and equipment
Prepaid lease payments
Deposits
Interest in an associate
Amounts due from related companies
Loan receivables
Non-current assets – total
715
0
86
39
30
35
905
835
0
51
48
80
35
1,049
1,165
87
232
45
0
16
1,546
1,740
99
150
45
0
15
2,049
2,313
80
100
45
0
14
2,552
2,887
62
50
45
0
13
3,057
3,285
43
50
45
0
13
3,437
1,619
102
211
49
0
16
1,996
Inventories
Trade receivables
Other receivables
Amounts due from related companies
Loan receivables
Convertible bonds
Derivative financial instruments
Taxation recoverable
Pledged deposit
Cash
Current assets – total
8,094
540
826
2,135
136
0
0
16
468
1,290
13,504
9,275
1,054
1,382
1,782
136
0
0
0
226
2,107
15,962
17,101
1,632
1,595
1,278
135
0
0
0
156
5,605
27,503
28,016
2,329
1,947
50
130
25
0
0
195
21,400
54,092
30,488
2,959
2,068
0
130
25
0
0
210
26,122
62,002
37,254
3,654
2,155
0
130
25
0
0
220
30,598
74,036
42,508
4,380
2,618
0
130
25
0
0
240
39,224
89,124
28,878
1,956
1,549
88
134
25
165
0
187
3,205
36,187
Trade payables
Other payables
Amounts due to related companies
Amounts due to minority shareholders
Taxation payable
Bank borrowings
Gold loans
Current liabilities – total
212
603
4,727
28
39
114
2,061
7,784
381
926
4,640
84
131
160
2,189
8,511
384
1,666
7,833
165
353
2,881
3,932
17,213
798
2,614
9,000
300
702
7,000
6,100
26,514
931
3,102
11,000
370
921
4,000
7,500
27,824
1,061
4,138
12,500
450
1,240
3,000
9,000
31,389
1,356
5,027
13,500
510
1,562
3,000
11,000
35,955
755
2,383
8,459
239
757
9,022
4,961
26,575
184
164
163
200
220
240
260
191
6,343
99
6,442
8,157
179
8,335
11,307
366
11,673
28,779
648
29,427
35,442
1,068
36,510
43,814
1,650
45,465
53,901
2,445
56,346
10,927
490
11,417
14,410
14,410
17,010
17,010
29,049
29,049
56,140
56,140
64,554
64,554
77,094
77,094
92,561
92,561
38,183
38,183
2,174
885
14
2,350
243
3
6,813
1,208
10
13,100
(8,300)
Net cash
11,500
(14,622)
Net cash
12,000
(18,598)
Net cash
14,000
(25,224)
Net cash
13,983
10,777
94
Retirement benefit obligations
Shareholders’ equity
Minority interest
Total equity
Total assets
Total liabilities and equities
Gross debt
Net debt
Net gearing (%)
38
20 April 2012
Chow Tai Fook – cash conversion cycle and working capital days
250
200
200
194
192
218
210
200
228
220
212
204
206
198
150
100
50
14
13
14
13
14
14
0
(6)
(7)
(6)
(6)
(7)
(6)
(50)
FY10
FY11
FY12F
FY13F
FY14F
FY15F
Chow Tai Fook – operating cash flow, free cash flow and net cash flow
projections
HK$m
13,000
10,919
11,000
9,719
9,281
7,959
6,909
9,000
7,000
5,672
5,000
3,000
1,000
7,626
6,822
5,622
3,976
968
483526
1,125806 881
(1,000)
(1,592)
(2,304)
(2,416)
(3,000)
(935)
(1,835)
(5,000)
FY09
FY10
FY11
Operating cash flow
FY12F
FY13F
FY14F
Free cash flow
Net cash flow
FY15F
Chow Tai Fook – key financial ratios
Year to March
2009
2010
2011
2012F
2013F
2014F
2015F
ROAE (%)
ROAA (%)
ROIC (%)
Net gearing (%)
Gross gearing (%)
–
–
–
–
–
–
–
13.7
33.8
29.5
14.0
21.2
194
13
7
200
2.9
28.2
36.4
15.9
24.3
192
14
6
200
10.3
58.4
32.5
16.0
28.1
210
13
6
218
Net cash
44.5
24.9
13.9
27.2
220
14
7
228
Net cash
31.5
25.6
15.1
29.7
204
14
6
212
Net cash
26.4
25.1
15.4
30.9
198
14
6
206
Net cash
24.8
39
20 April 2012
Senior management and shareholding structure
Dato’ Dr. Cheng Yu-Tung – Honorary chairman and non-executive
director
Dato’ Dr. Cheng Yu-Tung, age 85, is responsible for advising on overall strategic
planning and management of the group. Dr. Cheng joined the group in January 1947
as a trainee and was eventually promoted to become the permanent chairman of
Chow Tai Fook Hong Kong in March 1961. Dr. Cheng is the permanent chairman of
Chow Tai Fook Enterprise, a sister company of Chow Tai Fook, and a director of CYT
Family Holdings, CYT Family Holdings II, Chow Tai Fook Capital and Chow Tai Fook
Holding.
Dr. Cheng is also the chairman and non-executive director of NWD; non-executive
director of Shun Tak Holdings Limited; non-executive director of SJM Holdings Limited;
chairman and executive director of Melbourne Enterprises Limited; and chairman and
non-executive director of Lifestyle International.
Dr. Cheng is the father of Dr. Cheng Kar-Shun, Henry, the grandfather of Mr. Cheng
Chi-Kong, Adrian and Mr. Cheng Chi-Heng, Conroy, an uncle of Mr. Cheng Kam-Biu,
Wilson and Mr. Cheng Sek- Hung, Timothy and the elder brother of Mr. Cheng Yu-Wai.
Dr. Cheng Kar-Shun, Henry – Chairman and executive director
Dr. Cheng Kar-Shun, Henry, age 64, is the chairman and executive director and a
member of the company’s Nomination Committee and Remuneration Committee. Dr.
Cheng is responsible for the strategic direction and overall performance of Chow Tai
Fook.
He joined the company in 1971 and has served as a director of Chow Tai Fook Hong
Kong since May 1971 and as vice-chairman since March 2007. Dr. Cheng is also a
director of CYT Family Holdings and Chow Tai Fook Holding and is the vice chairman
of Chow Tai Fook Enterprise. He also holds the following positions in other companies
including managing director of NWD; chairman and managing director of NWCL;
chairman and executive director of NWS; chairman and non-executive director of
NWDS; chairman and executive director of International Entertainment Corporation,
independent non-executive director of HKR International Limited, and non-executive
director of Lifestyle International. In addition, Dr. Cheng was also the chairman and
executive director of Taifook Securities Group Limited up to his resignation in 2010.
Dr. Henry Cheng is the eldest son of Dato’ Dr. Chen Yu-Tung, the father of Mr. Cheng
Chi Kong, Adrian, an uncle of Mr. Cheng Chi-Heng, Conroy, a cousin of Mr. Cheng
Kam-Biu, Wilson, and Mr. Cheng Sek Hung, Timothy and a nephew of Mr. Cheng
Yu-Wai.
40
20 April 2012
Mr. Wong Siu-Kee, Kent – Managing director
Mr. Wong Siu-Kee, Kent, age 55, is responsible for the overall management of the
group. He is a member of the company’s Nomination Committee and Remuneration
Committee. He joined the group in 1977, working initially as a trainee. Mr. Wong’s
diverse experience in both operations and management led to his appointment as the
general manager of the PRC business of the group in 1999, where he was
responsible for developing the group’s market in mainland China. Since 2002, Mr.
Wong has taken the position of director of Chow Tai Fook Hong Kong and Chow Tai
Fook Enterprise, and in 2008 he was promoted to managing director of Chow Tai
Fook Hong Kong.
Mr. Wong is a member of HKTDC Watches and Clocks Advisory Committee, director
of welfare of the HK Jewellers’ & Goldsmiths’ Association, chairman of the supervising
committee of the HK & Kowloon Jewellers’ & Goldsmiths’ Employees’ Association Ltd.
Mr. Cheng Chi-Kong, Adrian – Executive director
Mr. Cheng Chi-Kong, Adrian, age 31, is responsible for the marketing of the group as
well as customer relationship management and branding and e-commerce operations.
Adrian joined the group in 2007 as a director of Chow Tai Fook Hong Kong. Prior to
joining the group in April 2007, Mr. Cheng worked at UBS AG in the Corporate
Finance group from 2003 to 2006. Mr. Cheng also holds the following positions in
companies listed on the Main Board of the Stock Exchange, including executive
director of NWD; executive director of NWCL; executive director of NWDS; and
executive director of International Entertainment Corporation. He is a director of Chow
Tai Fook Holding and Chow Tai Fook Enterprise.
Mr. Cheng is a grandson of Dato’ Dr. Cheng Yu-Tung, a son of Dr. Cheng Kar-Shun,
Henry, a cousin of Mr. Cheng Chi-Heng, Conroy, a nephew of Mr. Cheng Kam-Biu,
Wilson and Mr. Cheng Sek-Hung, Timothy and a grandnephew of Mr. Cheng Yu-Wai.
Mr. Cheng Chi-Heng, Conroy – Executive director
Mr. Cheng Chi-Heng, Conroy, age 33, is responsible for the procurement and
production of diamonds and gemstones. He has been a director of Chow Tai Fook Hong
Kong since 2007. He is also an executive director of NWD and a director of Chow Tai
Fook Enterprise and Chow Tai Fook Holding.
Conroy worked at Yu Ming Investment Management Ltd. from 1999 to 2000 as a
corporate finance executive. He is a grandson of Dato’ Dr. Cheng Yu-Tung, a nephew
of Dr. Cheng Kar-Shun, Henry, Mr. Cheng Kam-Biu, Wilson and Mr. Cheng Sek-Hung,
Timothy, a cousin of Mr. Cheng Chi-Kong, Adrian and a grandnephew of Mr. Cheng
Yu-Wai.
Mr. Chan Sai-Cheong – Executive director
Mr. Chan Sai-Cheong, age 49, is responsible for the group’s PRC and overseas
operations. He joined the group in 1985 as a salesman and was appointed director of
Chow Tai Fook Hong Kong in July 2005. Mr. Chan has over 31 years of working
experience in the jewelry industry.
41
20 April 2012
Mr. Chan Hiu-Sang, Albert – Executive director
Mr. Chan Hiu-Sang, Albert, age 60, is responsible for the group’s diamond
procurement and operations of the diamond department. Mr. Chan joined the group in
1977 as a member of the diamond procurement team and was appointed a director of
Chow Tai Fook Hong Kong since January 2006.
Mr. Cheng Ping-Hei, Hamilton – Executive director
Mr. Cheng Ping-Hei, Hamilton, age 36, is the finance director responsible for the
group’s financial management and overseeing the group’s company secretarial
functions. He joined the group in 2004 as a finance manager and subsequently
became the Head of Financial Management of the group in February 2011.
Mr. Suen Chi-Keung, Peter – Executive director
Mr. Suen Chi-Keung, Peter, age 46, is responsible for the Hong Kong and Macau
operations. Mr. Suen joined the group in 1985 as a trainee and was appointed as the
administrative manager in 2010. He served as a general manager of the Hong Kong
and Macau operations since February 2011.
Chow Tai Fook’s shareholding structure
Chow Tai Fook (Holdings) Ltd.
89.5%
Public
10.5%
Chow Tai Fook
(1929 HK)
Source: HKEx, CCBIS research
42
20 April 2012
Emperor Watch & Jewellery (887 HK)
Company Rating: Outperform
Veni, vidi, vici
(initiation)
Emperor Watch & Jewellery (Emperor) is a leading Greater China
retail name carrying European-made ultra-luxury watch labels.
Known for stocking classic brands, the company has an
exceptional franchise. Its stores have become a must-go
destination for affluent Chinese shoppers coming to Hong Kong,
while its unique investment story is being further enriched by its
growing exposure to the mainland market and to jewelry
products. We initiate coverage on the stock with an Outperform
rating.




Strong ties with suppliers. Emperor has a long-standing
partnership with key Swiss watch brand owners which
allows it to source a wide range of internationally renowned
watches. This avails it of a comprehensive product and
brand portfolio. Emperor’s solid sales track record has
helped it gain the confidence and support of brand owners.
Jewelry business offers synergies and upside. Emperor
has built a strong franchise by offering premium quality
jewelry under its own brand. While Emperor’s jewelry
business only accounts for 18% of sales, we believe this
high margin business and the cross-selling potential it
entails has not been tapped. Emperor has shifted focus to
expanding this segment by opening more jewelry stores
and through additional marketing.
Synergies with sister companies and L Capital.
Emperor enjoys significant synergies availed to it by its
relationship with Emperor Group and its partnership with L
Capital, especially when it comes to negotiating with
suppliers and landlords. These relationships make
cross-promotional and marketing activities possible.
Initiate with Outperform. Our target price of HK$1.40,
based on CY13F P/E of 8x, represents a 30% discount to
Hengdeli.
Price:
HK$1.20
Target:
HK$1.40
(initiation)
Trading data
52-week range
HK$0.72 – 1.84
Free float (%)
FY10
FY11
FY12F
FY13F
FY14F
Revenue (HK$m)
4,095
5,862
7,607
9,987
12,355
Core net profit (HK$m)
6.0
20.6
Stock price vs. HSI
HK$
1.85
1.62
1.39
1.16
0.93
0.70
19-Apr-11
1-Jul-11
12-Sep-11
24-Nov-11
5-Feb-12
Emperor Watch & Jewellery
HSI (rebased)
Source: Bloomberg
325
636
784
1,031
1,266
Claudia Ching
0.097
0.128
0.168
0.206
23
82
31
31
23
(852) 2532 2528
[email protected]
22.5
12.3
9.4
7.2
5.8
1.5
2.3
3.0
3.9
4.8
(5.0)
(8.3)
1.8
3.5
6.8
ROAE (%)
6.6
20.5
18.7
20.7
21.2
P/B (x)
5.7
5.2
3.6
2.1
1.8
Net cash
Net cash
Net cash
Net cash
Net cash
EPS (YoY, %)
P/E (x)
Yield (%)
FCF yield (%)
Net gearing (%)
43
42.0
0.053
EPS (HK$)
6,719
45
Financial forecast
Year to 31 December
HK$8,062/US$1,039
Forrest Chan, CFA
(852) 2532 6743
[email protected]
Timothy Sun
(852) 2532 6746
[email protected]
18-Apr-12
20 April 2012
Emperor is a leading Greater China name in watches and jewelry, known especially
for its European-made luxury watches and in-house designed fine jewelry. The
company has shops in Hong Kong, Macau and China and targets middle-to-high
income earners. Having built its brand over the last 70 years, the company is now a
well recognised name, known for stocking classic luxury brands in Hong Kong.
Emperor has become one of the must-visit watch and jewelry shops for affluent
Chinese shoppers.
Offers the finest collection of
top-notch European-made luxury
watches and premium fine
jewelry
Besides its wide range of prestigious and luxury European watches, Emperor offers
in-housed designed fine jewelry products made of diamonds, jade, pearl, 999.9K fine
gold and other precious stones. These are sold under its “Emperor” brand. Luxury
watch sales accounted for 82% of sales in FY11, while the contribution from the
jewelry segment is growing.
Emperor has the necessary qualities to capture long-term growth in China’s luxury
watch segment, with store network expansion underpinning its market share gains. It
operates a direct-retail business model and a dual-format store network of both
multi-brand and mono-brand outlets, which we view as a vital to in its long-term
success. Over the years, the company has earned strong customer recognition and
loyalty, and it now enjoys long-standing relationships with renowned international
watch suppliers.
Long-standing relationships with top international brands
Extensive brand mix supported
by its long-standing partnership
with top Swiss watch brand
suppliers
Established in 1942, Emperor can claim over 70 years of experience in the watch and
jewelry business. During that time, Emperor developed long-term partnerships with
major watch brands which now allow it to offer a wide range of internationally
renowned Swiss watches. The group has a diversified brand mix, with 19 international
watch labels in Hong Kong and Macau, and 32 watch brands. The business
relationships with some of these watch suppliers began decades ago. For certain
watch labels, the group strategically establishes boutique outlets in order to curry
favour with those brands.
Emperor’s watch brand portfolio for its Hong Kong & Macau shops
A. Lange & Sohne
Audemars Piguet
Baume & Mercier
Blancpain
Breguet
Cartier
Chopard
Frank Muller
IWC
Jaeger-LeCoultre
Omega
Panerai
Parmigian
Patek Philippe
Piaget
Rolex
Tudor
Vacheron Constantin
Zenith
Source: Company
44
20 April 2012
Emperor’s watch brand portfolio for its China shops
A. Lange & Sohne
Audemars Piguet
Baume & Mercier
Blancpain
BULGARI
Carl F. Bucherer
Certina
Corum
Cyma
Girard Perregaux
Glashütte Original
Gucci
Hamilton
IWC
Jaeger-LeCoultre
Longines
Maurice Lacroix
Mido
Movado
Omega
Oris
Panerai
Piaget
Rado
Raymond Weil
Rolex
Tag Heuer
Tiffany & Co.
Tissot
Tudor
Vacheron Constantin
Zenith
Source: Company
Emperor has a well-earned positive reputation among Swiss brand suppliers and has
close partnership with many of them. To cite just a few examples, it is cooperating on
advertising campaigns with Tudor, Patek Philippe, Cartier, Audesmars Piguet, Piaget,
Breguet, Panerai and Jaeger-LeCoultre. These partnerships give Emperor access to
the very latest items, including limited editions and exclusive collections.
Extensive and diversified store network in prime locations
Emperor owns an extensive network of 82 retail outlets in prime locations throughout
Hong Kong, Macau and China.
Retail network located in prime
locations throughout Hong Kong,
Macau and China
In its core markets of Hong Kong and Macau, Emperor operates 25 outlets occupying
total floor area of over 70,686 sq ft. The majority of these stores are located in prime
shopping locations that are easily accessible and have heavy customer traffic. Most of
its shops in Hong Kong are located in Central, Wanchai, Causeway Bay and Tsim Sha
Tsui, all major shopping zones for tourists. Chinese visitors currently account for over
85% of Emperor’s retail sales in Hong Kong and Macau.
China is a key region of growth for the company, which established its PRC
headquarters in Beijing in 2008. The group currently manages a total of 57 outlets
occupying total floor area of 76,914 sq ft in first- and second-tier cities, including
Beijing, Shanghai, Guangzhou, Chongqing and Tianjin.
Multi-store formats to capture a
wider range of clientele
45
Emperor outlets operate various store formats depending on local conditions. The
primary format is that of a multi-brand watch and jewelry POS offering a
comprehensive Swiss watch portfolio that caters to the different price sensitivities and
brand preferences of its customers. There is also an increasing number of
jewelry-only POS that specialize in the finest in-house designed Emperor-branded
accessories. In addition to the store formats just mentioned, mono-brand watch
boutiques were established to provide comprehensive and exclusive coverage of
selective brands. These mono-brand POS enhance the company’s synergies with its
respective international watch suppliers and foster customer loyalty with the featured
brands. For example, the group operates the largest Rolex-Tudor boutique in the
world and operates a Patek Philippe and Cartier boutique in Hong Kong and a Cartier
and Rolex mono-brand store in Macau.
20 April 2012
Emperor’s multi-brand store
Emperor’s multi-brand store
Emperor’s mono-brand store
Emperor’s mono-brand store
Source: Company
Direct-retail operation
Eschewing the franchising model
to sustain Emperor’s high-end
positioning and to minimize the
risk of brand dilution
46
Emperor directly operates all of its stores. Management foresees no changes to this
business model. Given its position as a top luxury or high-end watch and jewelry
retailer, Emperor believes that its long-term success depends on how well it sustains
its brand name and the image of the brands it carries. Management is well aware of
the potential dangers to its reputation and the operation risks that could arise from
franchising.
20 April 2012
Upside from jewelry exposure
Expand jewelry business to
enhance overall profit margin
performance
Targets 50% of overall sales from
jewelry in the medium to long
term
Emperor is accelerating expansion of its jewelry operation. Emperor’s jewelry
business covers a full range of luxury jewelry products including diamonds, jade, pearl,
ruby and gold with a special emphasis on diamond and jade products. The company
is known for its stylish designs, high quality and detailed craftsmanship. All jewelry
products sold from Emperor are done so under the Emperor label. The group does not
carry other jewelry brands or items in its stores. We believe the move to increase
exposure to jewelry products presents Emperor with considerable growth
opportunities. It aims to raise its jewelry sales contribution from 18% of total sales at
present to 50% in three-to-five years. In the long term, we expect Emperor’s jewelry
business to play a more central role in driving the company’s overall earnings growth.
We think it will eventually enhance Emperor’s reputation as one of the leading luxury
goods distributors in China.
We see four major positives in Emperor’s jewelry business:
Cross-selling potential

Emperor’s jewelry segment enjoys considerable synergies with the company’s
existing watch business. There are major cross-selling opportunities to be
seized by leveraging off the existing customer base of Emperor’s watch
business.
Focus on non-gold jewelry items
to avoid competition from the
gold-jewelry market

Emperor has made the decision to focus on diamond and jade products in order
to differentiate itself from the over-crowded gold-jewelry market, and thereby
avoid direct competition with the likes of Chow Tai Fook, Luk Fook, Chow Sang
Sang, and Tse Sui Luen, which already have high market shares and long
histories within the gold-jewelry trade. Jewelry products tend to provide higher
gross margins than watches or gold products. It is therefore more sensible for
Emperor to concentrate on high-end diamond, pearl and jade products.

The additional offering of jewelry products will provide an avenue for Emperor to
increase its presence in China since consumption of very high-end luxury
watches still tends to take place overseas. Jewelry is a more personalized
product than watches and so customers are less reluctant to purchase
domestically.

The jewelry segment provides higher gross profit margin than watches, with a
minimum of 10ppt difference between the two segments. Greater sales of
jewelry will enhance Emperor’s overall profitability.
Enhance Emperor’s jewelry
brand recognition through the
use of different marketing
campaigns
47
The group is planning to enhance its Emperor jewelry brand by launching direct
marketing events and rolling out different collections on a regular basis. The company
is committed to maintaining a high profile at jewelry shows held each year in Hong
Kong, Macau and China each year.
20 April 2012
Emperor’s jewelry store in Hong Kong
Emperor’s jewelry store in China
Emperor’s jewelry products
Emperor’s jewelry products
Source: Company
Strategic partnership with L Capital
Unique relationship with the
world-renowned LVMH group
Emperor introduced L Capital Asia, an affiliate of the LVMH group (LVMH IM,
Not Rated), as a passive investor as well as a strategic partner in 2010 by issuing
HK$140m worth of CBs and HK$100m in warrants to L Capital with an exercise price
of HK$0.54 and conversion price of about HK$1.00 for the CB. L Capital converted the
CBs it held in February 2011 while the warrants are still outstanding. L Capital is now
holding around 2% of Emperor’s stake, which would further increase to about 4%
upon full exercise of the warrants.
Synergies
Given LVMH’s established reputation and L Capital’s expertise in investing in
consumer companies in Asia’s emerging markets, particularly China and India, we
believe the involvement in L Capital has major positive implications for Emperor’s
operation, business developments and valuations. Indeed, an MOU was signed at the
time of L Capital’s investment. The agreement set out the framework for future
co-operation between the two parties, stipulating that L Capital would extend
professional advice to Emperor regarding sales expansion, brand building, advertising,
marketing, retail operations, human resources, distribution and costs management.
More specifically, L Capital would: (1) assist Emperor in establishing retail stores in
China; (2) assist Emperor in expanding its product portfolio; (3) allow Emperor to
launch joint promotions and marketing events with leading LVMH brands; and
(4) ensure a stable and competitive diamond supply to Emperor with the support of
leading LVMH brands. Most importantly, the support of L Capital stands to enhance
Emperor’s creditability and, hence, its bargaining power when it comes to acquiring
watch and diamond resources.
48
20 April 2012
Synergies with the Emperor Group of companies
Emperor enjoys synergies from its membership in the Emperor Group of companies.
Obvious benefits include joint marketing events, the sharing of the VIP database as
well as access to favourable shop locations and competitive rental rates with sister
companies.
Synergies
Group
with
the
Emperor
One-third of Emperor’s shops in Hong Kong and all stores in Macau are leased from
properties owned by Emperor Group (163 HK, Not Rated). We believe Emperor
enjoys more competitive rental rates than peers, as reflected by its rental expense to
sales ratios of under 8% in FY07-10. Most importantly, the relationship with Emperor
Group’s property arm provides it with access to prime retail locations.
Emperor has access to the VIP database of Emperor Entertainment Hotel (296 HK,
Not Rated), which includes casino “high-rollers” and key business associates. Having
these names in Emperor’s Rolodex presents tremendous cross-selling opportunities.
In addition, the entertainment businesses of Emperor Motion Pictures (EMP) and the
Emperor Entertainment Group (EEG) provide strong support to Emperor’s advertising
and marketing efforts, especially in China. Emperor benefits from free celebrity
endorsements and media coverage of EMP/EEG’s promotional campaigns. From time
to time, Emperor Watch & Jewellery sponsors various local concerts, art shows, and
movies showing in Hong Kong and China. It invariably invites VIPs and other
luminaries to these events. During the past few years, Emperor’s marketing cost ratio
has been running at under 1% of total sales.
We forecast a strong earnings CAGR of 27% between FY11 and FY13F.
Hong Kong and Macau
Steady SSSG
Business growth in Hong Kong and Macau is expected to be underpinned by a mix of
modest store openings and solid SSSG. In Hong Kong, the group has plans to add
three-to-four outlets in FY12F, and one-to-two new stores in FY13F. Coupled with our
SSSG estimates of 16% in FY12F and 21% in FY13F, we project annual turnover
growth to be 30% in FY12F and 32% in FY13F in Hong Kong.
Macau is forecast to have a steady uptrend with turnover growth estimated at 52% in
FY12F and 38% in FY13F. There are two drivers unique to Macau, namely (1) the
influx of Chinese gamblers whose demand for luxury accessories is particularly high,
and (2) growing cross-selling opportunities thanks to the sharing of the Emperor
Entertainment Hotel’s casino VIP database. For Macau, we assume two openings in
FY12F followed by one addition in FY13F.
49
20 April 2012
China
Despite the on-going trend of mainland consumers preferring to purchase luxury items
abroad due to price and product offering differences, we see additional room for
Emperor to develop its domestic business as its current operations in China are small.
We also believe having a presence in China is critical for marketing purposes and,
perhaps more importantly, for positioning the company as the price differential
between China and Hong Kong narrows in the long run. We project turnover growth of
17% in FY12F and 19% in FY13F in China.
Healthy sales growth in China
supported
by
increased
penetration and store expansion
The pace of Emperor’s network growth in China is forecast to be rapid and we
estimate 10-12 new openings per annum in FY12F-13F. As we discussed earlier, we
expect more of the openings to be for its jewelry business. Of the planned new stores,
there will be openings of three mono-brand watch POS in Shanghai and Shandong in
FY12F. The group will also construct a flagship store in Beijing, expected to
commence in 2015.
Steady gross margin uptrend
Emperor has limited control over the gross margins it earns from selling for the Swiss
watch brands as gross margins are watched over and carefully controlled by the
Swiss watch suppliers. The implication is that watch gross margins have and will
remain largely stable within the range of 23 to 25% going forward. The gemstone
jewelry business earns a higher gross margin of about 34% to 35%. Critically, there is
upside to jewelry’s gross margin in the long run as Emperor’s brand ownership within
this segment provides flexibility for product mix upgrades and ASP increases.
Gross
margin
improvement
mainly driven by increased
contribution from jewelry sales
Due to jewelry’s higher profitability, Emperor is planning to increase the segment’s
contribution from 18% currently to a target of 50% in the medium-to-long term. That
said, the change is not likely to be substantial in the coming three years. That said, we
believe the group’s gross profit margin is set to grow steadily, factoring in a gradual
increase in sales contribution from gemstone jewelry and gross margin improvement
within the jewelry segment.
Emperor – sales mix by product
Emperor – gross profit margin trend
31%
100%
12%
14%
15%
18%
29.9%
30%
80%
28.8%
29%
28%
60%
40%
88%
86%
85%
29.1%
29.5%
27.9%
27%
82%
25.8%
26%
25.6%
25%
20%
24%
0%
FY08
50
FY09
Watches
FY10
Gem-set jewelry
FY11
23%
FY08
FY09
FY10
FY11
FY12F
FY13F
FY14F
20 April 2012
SG&A not a key concern
We see the following factors lending stability to Emperor’s key SG&A expense ratios.
No material pressure from key
costs in the medium term

Synergies with the Emperor group of companies. Emperor has access to
attractive retail locations at competitive rates as one-third of its stores in Hong
Kong and Macau are leased from Emperor Group. We forecast rental costs to
remain under 7% of total sales in FY12F and FY13F. Our earlier discussion also
indicated that Emperor enjoys advertising and marketing synergies with the
activities of EMP and EEG. Marketing cost ratio remained under 1% of total
sales for the past few years and should remain below 1% of sales in the
foreseeable future

Turnover-linked staff compensation. A common practice of watch and jewelry
retailers is to link a substantial part of their staff compensation to individual store
and staff member performance. We expect staff costs to sustain at 4% of total
sales in FY12F-13F.

High SSSG. High sales growth on a same-store basis tends to offset rising
costs.
Emperor – key assumptions
Year to December (HK$m)
2008
2009
2010
2011
2012F
2013F
2014F
Total POS
19
40
61
80
95
110
124
Hong Kong
11
12
17
18
21
23
24
Macau
4
4
4
5
7
8
9
China
4
24
40
57
67
79
91
10
24
18
19
15
15
14
Hong Kong
3
4
2
1
3
2
1
Macau
3
0
0
1
2
1
1
China
4
20
16
17
10
12
12
111
111
53
31
19
16
13
38
9
42
6
17
10
4
Macau
300
0
0
25
40
14
13
China
NA
500
67
43
18
18
15
20
15
49
32
16
21
18
Hong Kong
16
29
51
44
30
32
25
Macau
31
75
49
42
52
39
24
China
NA
1393
66
35
17
19
15
27.9
25.8
25.6
28.8
29.1
29.5
29.9
Total staff cost as % of total sales
4.4
4.3
3.8
3.9
4.2
4.3
4.4
Total lease costs as % of total sales
5.3
8.0
6.7
6.9
7.2
7.3
7.5
Other expenses as % of total sales
(0.4)
0.3
1.1
1.2
1.3
1.4
1.5
Hong Kong
SSSG (%)
HK/Macau
Sales growth – YoY (%)
Gross margin (%)
51
20 April 2012
Emperor – revenue projections
2008
2009
2010
2011
2012F
2013F
2014F
Total revenue
1,842
2,686
4,095
5,862
7,607
9,987
12,355
18
46
52
43
30
31
24
YoY (%)
Revenue by market
Hong Kong
1,722
2,230
3,366
4,863
6,305
8,325
10,376
Macau
102
179
267
377
574
796
983
China
19
278
462
622
728
866
996
Hong Kong
16
29
51
44
30
32
25
Macau
31
75
49
42
52
39
24
China
NA
1,393
66
35
17
19
15
Hong Kong
93
83
82
83
83
83
84
Macau
6
7
7
6
8
8
8
China
1
10
11
11
10
9
8
Emperor – profit and loss projections
2008
2009
2010
2011
2012F
2013F
2014F
Total revenue
YoY (%)
1,842
18
2,686
46
4,095
52
5,862
43
7,607
30
9,987
31
12,355
24
(1,328)
10
(1,993)
50
(3,048)
53
(4,177)
37
(5,397)
29
(7,045)
31
(8,666)
23
514
47
27.9
694
35
25.8
1,048
51
25.6
1,686
61
28.8
2,210
31
29.1
2,942
33
29.5
3,688
25
29.9
0
5
10
8
8
10
12
Staff costs
YoY (%)
As % of turnover
(81)
13
4.4
(116)
43
4.3
(156)
35
3.8
(227)
46
3.9
(319)
41
4.2
(429)
34
4.3
(544)
27
4.4
YoY (%)
As % of turnover
(14)
49
0.8
(22)
62
0.8
(42)
85
1.0
(66)
60
1.1
(73)
9
1.0
(59)
(18)
0.6
(55)
(7)
0.4
Rental costs
YoY (%)
As % of turnover
(97)
96
5.3
(215)
122
8.0
(273)
27
6.7
(407)
49
6.9
(548)
34
7.2
(729)
33
7.3
(927)
27
7.5
Other costs
YoY (%)
As % of turnover
8
48
(0.4)
(7)
(184)
0.3
(44)
542
1.1
(71)
62
1.2
(99)
39
1.3
(140)
41
1.4
(185)
33
1.5
YoY
(170)
47
9.2
(338)
99
12.6
(472)
40
11.5
(705)
49
12.0
(966)
37
12.7
(1,298)
34
13.0
(1,656)
28
13.4
280
44
15.2
245
(12)
9.1
413
68
10.1
764
85
13.0
955
25
12.6
COGS
YoY (%)
Gross profit
YoY (%)
Gross margin
EBIT
YoY (%)
EBIT margin (%)
52
1,254
1,539
31
23
12.6
12.5
(Continued on next page)
20 April 2012
Emperor – profit and loss projections (continued from previous page)
2008
2009
2010
2011
2012F
2013F
2014F
14
22
42
66
73
59
55
EBITDA
YoY (%)
EBITDA margin (%)
294
44
15.9
268
(9)
10.0
454
70
11.1
831
83
14.2
1,027
24
13.5
1,313
28
13.1
1,593
21
12.9
Interest income
Interest expense
Extraordinary items
1
(3)
(9)
0
(2)
0
2
(11)
(199)
4
(2)
(9)
4
(3)
0
5
(3)
0
7
(3)
0
Profit before tax
YoY (%)
As % of turnover
269
40
14.6
243
(10)
9.1
204
(16)
5.0
757
271
12.9
956
26
12.6
1,256
31
12.6
1,542
23
12.5
Tax
(47)
17.5
(43)
17.7
(70)
34.5
(130)
17.2
(167)
17.5
(220)
17.5
(270)
17.5
Minority interest
(0)
5
8
(0)
4
5
6
Net profit
YoY (%)
Net margin (%)
223
40
12.1
196
(10)
7.3
126
(33)
3.1
627
368
10.7
784
26
10.3
1,031
31
10.3
1,266
23
10.2
Core net profit
YoY (%)
Core net margin (%)
232
46
12.6
196
(16)
7.3
325
66
7.9
636
96
10.9
784
23
10.3
1,031
31
10.3
1,266
23
10.2
Depreciation and amortization included in SG&A
Lowest inventory turnover days
for Swiss watches in the industry
Emperor’s inventory largely consists of finished watches and gem-set inventory,
including raw materials and finished goods. Inventory turnover days for Emperor
surged from 207 days in FY10 to 243 days in FY11, mainly caused by the Lunar New
Year stock building, and the increased proportion for jewelry stocks. Emperor has the
lowest inventory turnover days for its watch segment compared with peers, with only
130-150 days by end-2011. Jewelry inventory was at over 400 days in the same
period.
Going forward, with the tight control on inventory management, we believe Emperor’s
inventory turnover days to maintain under 260 days level, with an average of 16-24%
YoY increase p.a. Receivable and payable days were relatively stable in FY08-11 and
we believe both will remain constant in FY12F-13F.
Capex spending is mainly being put towards retail network expansion, IT system
upgrade and regular maintenance. We expect a sum of HK$54-56m on capex in
FY12F-13F. Our estimates included an average of HK$2-2.3m starting costs for stores
in Hong Kong and Macau, and HK$0.8m capex budget for China openings.
Emperor is in a net cash position (HK$464m as at end-December 2011). It is also
forecast to generate annual EBITDA of over HK$1b in FY12F-13F. On top of that,
Emperor had HK$340m in short-term borrowings at end-2011 to support its heavy
working capital requirements. We hence expect the group to have sufficient financial
and cash flow strength to support its store openings pipeline, without the immediate
funding needs from capital markets in the short term.
53
20 April 2012
Emperor – cash conversion cycle and working capital days
320
276
280
269
257
243
230
240
220
235
219
207
239
216
228
205
184
200
160
120
80
40
23
17
17
12
11
11
11
0
(40)
(24)
(34)
(40)
(80)
FY08
FY09
(33)
(35)
FY10
FY11
FY12F
(34)
(33)
FY13F
FY14F
Emperor – operating cash flow, free cash flow and net cash flow projections
HK$m
800
604
600
334
400
200
149
198
135
201
92
550
379
278
155
146
47
0
(80)
(200)
(400)
(248)(272)
(346)
(403)
(600)
(592)
(669)
(800)
FY08
FY09
FY10
Operating cash flow
54
(63)
FY11
FY12F
FY13F
Free cash flow
Net cash flow
FY14F
20 April 2012
Emperor – balance sheet projections
2008
2009
2010
2011
2012F
2013F
2014F
34
75
85
97
80
75
74
Deferred tax assets
0
0
4
6
6
6
6
Others
0
0
102
157
155
155
155
34
75
191
260
240
236
234
1,205
1,308
2,152
3,404
4,209
5,002
5,806
133
205
171
199
251
330
408
0
7
0
0
0
0
0
168
252
601
804
828
979
1,335
1,506
1,771
2,925
4,407
5,288
6,311
7,549
Inventories
Trade receivables and other receivables
Tax recoverable
Bank balance and cash
Total current assets
Payables, deposits received and accrued charges
102
264
405
396
594
705
867
Amount due to immediate holding company
0
0
0
0
0
0
0
Amounts due to related companies
0
3
4
4
1
1
1
Amount due to a related party
0
0
45
0
0
0
0
Dividend payable
0
0
0
0
0
0
0
Taxation payable
16
6
35
68
70
70
70
Obligation under a finance lease – due within a year
0
0
0
0
0
0
0
Short-term bank loans
4
4
67
340
320
320
300
123
277
556
809
985
1,096
1,238
Total current liabilities
Bank borrowings – due after one year
13
9
0
0
0
0
0
Deferred taxation
1
0
0
0
0
0
0
Derivative financial instruments
0
0
180
0
0
0
0
Liability component of convertible bond
0
0
110
0
0
0
0
14
10
290
0
0
0
0
1,398
1,549
2,268
3,859
4,540
5,442
6,530
5
10
3
0
4
9
15
Total equity
1,403
1,559
2,270
3,859
4,544
5,451
6,545
Total assets
1,540
1,846
3,116
4,667
5,529
6,546
7,783
1,540
1,846
3,116
4,667
5,529
6,546
7,783
Total non-current liabilities
Shareholders’ equity
Minority interest
Gross debt
Net debt
Net gearing (%)
55
17
14
67
340
320
320
300
(150)
(239)
(534)
(464)
(508)
(659)
(1,035)
Net cash
Net cash
Net cash
Net cash
Net cash
Net cash
Net cash
20 April 2012
Emperor – cash flow projections
2008
2009
2010
2011
2012F
2013F
2014F
280
245
413
764
955
1,254
1,539
14
22
42
66
73
59
55
EBITDA
294
268
454
831
1,027
1,313
1,593
(10)
1
(2)
22
2
3
5
EBIT
Inventory
(403)
(105)
(842)
(1,255)
(805)
(793)
(804)
Receivables
(44)
(71)
(68)
(81)
(52)
(79)
(78)
Payables
(32)
162
141
(8)
197
111
162
(1)
3
1
0
(3)
0
0
(53)
(60)
(40)
(99)
(165)
(220)
(270)
Amount due to fellow subsidiary and related companies
Tax paid
Interest paid
3
2
11
2
3
3
3
(1)
(0)
(2)
(4)
(4)
(5)
(7)
(248)
198
(346)
(592)
201
334
604
(25)
(63)
(57)
(77)
(54)
(55)
(54)
(272)
135
(403)
(669)
146
278
550
15
0
2
4
4
5
7
0
0
0
(3)
0
0
0
581
0
372
800
0
0
0
(318)
(43)
(83)
(149)
(103)
(129)
(178)
143
(1)
33
(45)
0
0
0
Net cash flow
149
92
(80)
(63)
47
155
379
Year to December
2008
2009
2010
2011
2012F
2013F
2014F
ROAE (%)
25.3
13.3
6.6
20.5
18.7
20.7
21.2
ROAA (%)
18.2
11.6
5.1
16.1
15.4
17.1
17.7
ROIC (%)
26.2
15.7
20.8
24.4
22.2
24.3
25.4
276
230
207
243
257
239
228
17
23
17
12
11
11
11
(24)
(34)
(40)
(35)
(33)
(34)
(33)
Interest received
Operating cash flow
Capex
Free cash flow
Share issue
Dividend paid
Emperor – key financial ratios
Net gearing (%)
Gross gearing (%)
56
269
220
184
219
235
216
205
Net cash
Net cash
Net cash
Net cash
Net cash
Net cash
Net cash
1.2
0.9
3.0
8.8
7.0
5.9
4.6
20 April 2012
Company specific risks
Connected-party transactions
Although we acknowledge that Emperor’s working relationship with sister companies
under the Emperor Group brings operational advantages, the market tends to have a
negative perception of any form of connected-party transactions.
Frequent fund-raising activities
Emperor has raised money from the market several times in the past three years as
shown in the following table. Not all of these activities were absolutely necessary, in
our view. Frequent capital market activities can be a share price overhang and EPS
dilutive.
Emperor – past capital raising activities
Conversion/
Issue date
Amount/principal amount
completion date
Type
No. of shares issued
(HK$m)
January 2010
N/A
Placement
450,000,000
230
0.51
March 2010
N/A
Top-up placement
264,810,000
143
0.54
August 2010
12 April 2013
Convertible bond to L Capital
259,300,000
140
0.54
August 2010
12 April 2013
Convertible bond to D.E.Shaw
444,400,000
240
0.54
September 2010
12 April 2013
Warrants
N/A
100
0.62
April 2011
Top-up placement
800,000,000
787
1
April 2011
HK$/share
Ms. Cindy Yeung – Executive director and Managing director
Ms Yeung joined the group in 1990. She is responsible for the group’s strategic
planning, business growth and development and for overseeing different operations
within the group. She became a director of Emperor Watch & Jewellery (HK)
Company Limited, an operating arm of the retail outlets of the group in Hong Kong, in
April 1999. The Group has been under her management since then. She obtained the
qualification of Graduate Gemologist of GIA in 1988 and since then has accumulated
over 20 years of experience within watch and jewelry industry. Prior to joining the
group in 1990, she joined the sales department of Anju Jewelry Ltd, a US-based
company engaging in trading of jewelry products. Ms. Yeung is the daughter of Dr.
Yeung Sau Shing, Albert who is deemed to be a controlling shareholder of the
company.
Mr. Chan Hung Ming – Executive director
Mr. Chan joined the Group in July 2005 and is now responsible for overseeing the
retail outlet operations in Macau and Hong Kong. He has over 30 years of experience
within the watch and jewelry industry. Prior to joining the group, he acted as general
manager in charge of the retail and watch boutique outlets in Hong Kong and the PRC
in the Dickson Watch & Jewellery division under Dickson Concepts (International)
Limited (113 HK, Not Rated) for over 20 years.
57
20 April 2012
Mr. Wong Chi Fai – Executive director
Mr. Wong has been involved in the management of the company since November
1998. He is the Chairman of the Remuneration Committee of the company. Mr. Wong
is an associate of the HKICPA. He is also a director of Emperor International Holdings
Limited (163 HK, Not Rated), Emperor Entertainment Hotel Limited (296 HK,
Not Rated) and New Media Group Holdings Limited (708 HK, Not Rated). Having over
20 years of management experience, Mr. Wong has diversified his experience by
working in different businesses ranging from manufacturing to watch and jewelry
retailing, property investment and development, hotel and hospitality as well as media
and publication.
Ms. Fan Man Seung, Vanessa – Executive director
Ms. Fan has been involved in the management of the company since late-1998. She
is also a director of Emperor International Holdings Limited, Emperor Entertainment
Hotel Limited and New Media Group Holdings Limited. Besides having over 21 years
of corporate management experience, she possesses diversified experience in
different businesses, including watch and jewelry retailing, property investment and
development, hotel and hospitality, financial and securities operations as well as
media and publication.
Mr. Hanji Huang – Non-executive director
Mr. Huang was appointed as non-executive director of the company in August 2010.
He is a member of the company’s audit committee of the company and has held
senior positions in various global investments. He has over 10 years of experience in
the equity capital market, particularly in private equity investment.
Emperor shareholding structure
Yeung’s Family Trust
53.2%
Emperor Watch & Jewellery Limited
(887 HK)
Source: Company, HKEx
58
Public
46.8%
20 April 2012
Hengdeli Holdings (3389 HK)
Company Rating: Outperform
Still a timeless preposition
(maintained)
Hengdeli is China’s largest mid-to-high end watch retailer and
wholesaler with 35% market share. Increased penetration of the
mid-market segment through aggressive network expansion into
the second- and third-tier cities will be the company’s core
earnings driver in the coming years. Given the company’s
favorable earnings outlook as well as its strengthening financial
position, we maintain our Outperform rating on the stock.



Market leader. As the leading national mid-to-high end
watch retailer with strong store brand recognition in China,
Hengdeli is well positioned to tap the country’s burgeoning
watch market. The company outshines its peers by virtue of
its strategic alliances with major Swiss watch suppliers, that
allow Hengdeli to secure and source a wider range of
products. We see limited competition risk for the
foreseeable future as peers have weaker sales channels
and insufficient financial strength to adopt Hengdeli’s
multi-brand strategy or keep up with its aggressive
expansion.
Tapping the potential of second- and third-tier cities.
The booming Chinese economy has spurred the country’s
urbanization rate, leading to the emergence of a wealthy
middle-class. Hengdeli has moved ahead of its competitors
in aggressively expanding into second- and third-tier cities,
and is therefore well-positioned to benefit from the
favorable market development.
Reiterate Outperform. We fine-tune our estimates and
slightly lower our EPS estimates by 3% for FY12F-13F. Our
target price is raised from HK$3.95 to HK$4.15, now based
on CY13F P/E of 12x instead of CY12F P/E of 14x. Despite
the near-term hiccup of moderating sales growth, we
believe that the long-term prospects for the industry will
remain promising. Hengdeli’s market leadership and
FY11-13F earnings CAGR of 21% should support share
price performance in the medium-term.
Price:
HK$3.43
Target:
HK$4.15
(up from HK$3.95)
Trading data
52-week range
HK$2.14 – 5.15
HK$15,085/US$1,944
4,398
Free float (%)
48
6.1
22.8
Stock price vs. HSI
HK$
5.0
4.6
4.2
3.8
3.4
3.0
2.6
2.2
19-Apr-11
1-Jul-11
12-Sep-11
Hengdeli
Source: Bloomberg
Financial forecast
Year to 31 December
FY10
FY11
FY12F
FY13F
FY14F
Revenue (RMB m)
8,216
11,375
14,155
17,019
19,729
Rev forecast change (%)
Net profit (RMB m)
NP forecast change (%)
EPS (RMB)
EPS (YoY, %)
–
–
0.2
(1.3)
–
554
815
985
1,192
1,356
–
–
(3.4)
(3.0)
–
0.133
0.185
0.224
0.271
0.309
41
40
21
21
14
25.9
18.5
15.3
12.6
11.1
1.1
1.6
1.8
2.2
2.5
FCF yield (%)
(4.3)
(0.6)
12.7
3.4
11.4
ROAE (%)
14.9
16.9
18.1
19.2
19.1
Net cash
6
Net cash
Net cash
Net cash
P/E (x)
Yield (%)
Net gearing (%)
59
14.4
Claudia Ching
(852) 2532 2528
[email protected]
Forrest Chan, CFA
(852) 2532 6743
[email protected]
Timothy Sun
(852) 2532 6746
[email protected]
24-Nov-11
5-Feb-12
HSI (rebased)
18-Apr-12
20 April 2012
end
Hengdeli is the largest watch retailer in China with 35% market share and the
country’s most extensive retail network with close to 405 stores at end-2011. These
feature put it in good position to capture growing demand for affordable-luxury
watches .in China. Hengdeli’s strong brand recognition, well-established relationships
with key suppliers, multi-brand strategy, and diverse customer base are key
competitive advantages that keep the company ahead of its peers. By expanding its
strong network in the affluent mid-market segment, Hengdeli stands to strengthen its
strong network presence across the second- and third-tier cities.
Strategic tie-ups with world
renowned luxury brand owners
Thanks to its long standing co-operation with major Swiss watch makers over the
years, Hengdeli now has close relationships with top Swiss watch suppliers. The
Swatch Group (UHR VX, Not Rated) and LVMH Moet Hennessy Group are substantial
shareholders of Hengdeli. The company’s strategic alliance with major suppliers
provides unique advantages, including a more diversified and wide ranging supply of
product, an extended credit line, and priority in watch supply and delivery which no
other industry player in China can compare with.
Leader in
watches
mid-to-high
Supported by its nationally recognized brand name, Hengdeli is a rare luxury watch
retailer that has the financial ability and bargaining leverage to operate a multi-brand
approach. With its three main brands targeting different customer segments, we
believe the company is well positioned to fortify its sales channels and expand its
customer pool.
Focus on developing tier two-tothree markets in China
Eyeing the large market potential for entry-level luxury watches, Hengdeli will
accelerate its expansion plans by adding 40-60 stores per annum in FY12F-13F in
second- and third-tier cities, from a total store count of 405 at end-2011. Hengdeli is
among the few luxury watch chains expanding at such a rapid pace; moreover, it is
doing so in regions outside of tier-one cities. We are confident of Hengdeli’s ability to
seize the opportunity to capture additional market share.
Solid sales performance over the
past
six
months
despite
weakening consumer sentiment
In 4QCY11-1QCY12, when the overall retail environment in China began to soften,
Hengdeli saw some slowdown in its sales of ultra-luxury goods (over RMB50,000). In
contrast, mid-end watch sales at Prime Time and With Time stores held up well.
Overall, the quarter still saw SSSG in the mid-to-high teens. At the latest results
announcement presentation, management indicated a relatively cautious sales target
of over 20% YoY growth for FY12F, which we believe is achievable. Despite the
near-term hiccup of moderating sales growth, we believe that the long-term prospects
for the industry remain promising. Hengdeli’s market leadership and earnings CAGR
of 21% between FY11-13F should support share price performance in the
medium-term. Hengdeli offers an attractive investment case that will sustain over the
long-term.
Market leader with exceptionally strong store brand recognition
Hengdeli was ranked first in Greater China in terms of retail sales of affordable-luxury
watches, topping RMB11b in sales in FY11. As the largest player in the luxury watch
segment in China with 35% market share, Hengdeli is strongly leveraged to the
country’s rapidly growing demand for luxury goods, especially in the wake of rising
income levels and its penetration into second- and third-tier cities. On the back of its
aggressive expansion plans across China, we anticipate Hengdeli’s market share will
continue to grow.
60
20 April 2012
Unmatched competitive advantages to sustain dominance
Besides being a dominant player in China, Hengdeli is the most scalable retailer
among China’s national luxury watch retail chain operators. Hengdeli’s successful
business model is extremely difficult for other industry players to replicate and, hence,
it is unlikely others will overtake Hengdeli’s market leadership in the foreseeable
future. The success of Hengdeli is supported by the following factors:
Four distinctive competitive
advantages

A well-established household name within China’s luxury watch market

Strategic tie-ups with suppliers and comprehensive product offerings

Extensive customer coverage through effective brand building

Room to scale up through aggressive store openings
A well-established household name within China’s luxury watch
market
Wide recognition nationwide
One of the first national luxury watch retailers in China, Hengdeli has established
sound and exclusive working relationships with various internationally renowned
brand owners. Tracing back to 1949 when it became a state-owned enterprise,
Hengdeli began distributing Swiss watches in China. The close cooperation over the
years has been unrivaled.
Experienced management team
Hengdeli’s extensive history distributing luxury watches in China has given it
considerable industry know-how. Run by an experienced management team
(Chairman Zhang Yupin has over 25 years of experience in the high-end consumable
distribution industry in China), we believe Hengdeli will continue to benefit from its
management team’s expertise and experience retailing luxury watches in China.
Hengdeli is consistently viewed as a symbol of authenticity and quality assurance.
With the rising awareness of product quality and originality among Chinese
consumers, Hengdeli is likely to become a preferred and trusted watch retailer. Its
long established reputation in China will help it gain access to more strategic shop
locations, and will give it strong bargaining power when negotiating for rental rates.
Strategic tie-ups and wide ranging product offerings
In order to minimize brand image risk, international luxury brand suppliers have
become extremely stringent when selecting distribution partners, especially in China.
On the strength of its exclusive product offerings and years of cooperation, Hengdeli
has managed to win over the trust of world-class Swiss watch brands, including the
world’s largest watch distributors – Swatch Group and LVMH. Hengdeli currently
distributes over 50 internationally renowned brands. Its strong ties with suppliers
mean Hengdeli is able to secure a wider range of model collections as well as more
favourable credit terms compared with local peers. In many cases, Hengdeli is also
given priority in watch supply and delivery.
Unique shareholding structure
with suppliers as major
shareholders
61
While non-exclusive, distribution partnerships with Swatch Group and LVMH remain
guarded in our view, given the ownership status of the major suppliers within
Hengdeli’s shareholding structure. Swatch Group owns a 9.1% stake in the company
and is currently the second-largest shareholder, while LVMH is the third-largest
shareholder with a 5.9% interest. Such shareholding structures clearly suggest that
Hengdeli has a strong vote of confidence from its suppliers; moreover its strategic ties
provide it a distinctive competitive advantage.
20 April 2012
Hengdeli’s shareholding structure
Best Growth
34.6%
Swatch Group (UHR VX)
9.1%
LVMH
5.9%
Public
50.4%
Hengdeli Holdings
(3389 HK)
Source: Bloomberg
Hengdeli and Swatch Group have established a 50:50 JV to wholesale and retail
certain watch brands in China since 2003. The JV, which plans to open and operate
boutiques that focus on watches, jewelry, and other accessories of the Swatch Group,
has already opened an Omega flagship shop on Huaihai Road, Shanghai and a
Swatch boutique in Harbin and Qingdao.
Providing the hottest brands
Leveraging its strong links with various brand owners, Hengdeli has managed to
secured exclusive distribution rights for over 18 brands, including those owned by
Swatch Group, LVMH, and Richemont. Its close relationship with Swatch Group and
LVMH are of particular importance given that these brands are among the top-five
best-selling watch brands in China (50% of the market).
Hengdeli’s brand portfolio
Exclusive brands
Swatch Group Tissot, Calvin Klein, Certina, Hamilton,
Mido, Breguet, Longines
Rolex Group
Non-exclusive brands
Omega, Rado, Blancpain, Glashutte,
Jaquet Droz
Rolex, Tudor
LVMH
TAG Heuer, Zenith, Christian Dior, Fendi
Richemont
Jaeger-Lecoultre, Baume & Mercier
Alfred Dunhill, Panerai, Cartier,
Independent
Maurice Lacroix, Carl. F. Bucherer,
Edox, Enicar, Carven, Ball, Gucci, Oris, Raymond Well,
brands
Claude Bernard
Frank Muller, Hermes, Girard Perregaux, Grand Seiko,
Vacheron Constantin, IWC
Jean Richard, MONTBLANC, Parmigiani, Ulysse Nardin,
Cyma
Source: Company
Extensive customer coverage through effective brand building
Three distinct store brands to
capture different consumer
segments and expand sales
channels
Rare among luxury brand retailers, Hengdeli possesses sufficient scale to handle a
multi-brand strategy that allows it to maximize customer exposure. Its retail network
can be classified under three main categories of multi-brand shops, namely: Elegant,
Prime Time, and With Time. The company also operates several mono-brand
boutiques.
The multi-brand business model is unparalleled and is a function of Hengdeli’s
leadership within China’s mid-to-high end watch market. Hengdeli’s ability to source
an extensive range of watch products avails it of a diverse clientele base while
supporting the multi-brand operation. Most industry peers operate under single store
brand due to network scale restrictions.
62
20 April 2012
Hengdeli’s store brands
Elegant
 Showcases the most luxurious, internationally renowned brands of top-class watches
 ASP: RMB50,000 in Mainland; HK$100,000+ in Hong Kong
 21 Elegant outlets, with 14 in China, six in Hong Kong and one in Taiwan
Prime Time
 Offers a full range of watch brands under an extensive number of internationally renowned brands targeting middle-to-high end customers
 Provides one-stop-shop services to customers
 Selective expansion in tier-two and tier-three cities
 ASP: RMB15,000
 245 Prime Time stores, with 207 in China and 38 in Taiwan
With Time
 The trend setter of watches, bringing fashionable and niche yet classy watches to the youngsters
 ASP: RMB5,000
 63 stores in China
Mono-brand boutique  Jointly established brand boutiques with brand owners to demonstrate the style of brands, and providing the most comprehensive and rare portfolio.
stores
 74 brand image boutiques, with 48 in China, 12 in Hong Kong, one in Macau and 13 in Taiwan under various renowned brands, namely Rolex,
Tissot, TAG Heuer and Cartier etc.
Source: Company, CCBIS Research
Hengdeli’s Elegant store
Hengdeli’s Prime Time store
Source: Company website
Hengdeli has committed considerable resources improving sales of its middle-to-high
end brands. More than 75% of its retail outlets in China are Prime Time shops, which
are positioned to sell mid-to-high end watches. Prime Time and With Time contribute
nearly 80% of the company’s total retail sales in China and will remain the company’s
leading store brand in the coming years. Given increasing demand for mid-to-high end
watches, Hengdeli will continue to consolidate and expand its retail network in
second- and third-tier cities under the Prime Time label.
Leadership by scale
An industry leader for several
years
63
With its good reputation and wide product coverage, Hengdeli dominates the other
two major Hong Kong-listed luxury watch competitors in terms of sales size and
market share. In FY11, Hengdeli’s sales revenue exceeded Oriental and Emperor by
2.1x and 1.9x, respectively. Its presence in China also over shadows that of its peers,
with a network of approximately 332 stores compared with 57 for Emperor and 86 for
Oriental at end-2011. The three players target different markets, with Hengdeli
focusing on China’s second- and third-tier cities, Oriental targeting Hong Kong and
Emperor focusing on China’s first-tier cities.
20 April 2012
Hengdeli dominates China’s luxury watch industry on the strength of its reputable
brand name, long history, large network, and overall sales and profitability. Given their
lower sales and smaller market share, other players have insufficient finance ability to
ramp up their expansion plans. Thus the threat to Hengdeli from its peers is minimal.
Faster expansion compared to peers
In view of the growing spending propensity of the expanding middle class, Hengdeli is
accelerating its store rollout plan to capture fast growing demand. Already with 332
stores in China, 18 in Hong Kong, 1 in Macau, and 54 in Taiwan at end-2011,
management aims to add 40-60 annually in FY12F-13F. Hengdeli’s store portfolio
should reach over 400 outlets, far exceeding other competitors.
Captures the affluent
middle-income customers
Hengdeli – number of stores
600
539
496
500
453
405
400
350
82
79
76
73
64
300
237
204
100
13
7
200
197
224
FY08
FY09
286
332
417
377
457
0
FY10
China POS
FY11
FY12F
FY13F
FY14F
Second-tier city stores have fared well in the past three years, delivering increasing
profits the company. We believe Hengdeli’s reliance on these cities will continue to
increase over time to eventually become the company’s main growth driver.
Burgeoning middle class
provides a strong sales catalyst
Hengdeli – China revenue mix by city tier
100%
5%
90%
Hengdeli – store space in China by city tier
100%
12%
13%
15%
18%
21%
70%
90%
57%
60%
59%
35%
60%
61%
61%
50%
58%
59%
50%
40%
40%
30%
30%
37%
31%
10%
55%
20%
26%
24%
24%
20%
0%
10%
13%
12%
10%
0%
2006
64
30%
70%
58%
60%
20%
27%
80%
80%
2007
2008
Tier 1
Tier 2
2009
Tier 3
2010
2011
2009
Tier 1
2010
Tier 2
2011
Tier 3
20 April 2012
Compared with Hengdeli, most peers have a slower rollout plan with a focus on
first-tier cities. Meanwhile, Hengdeli has spotted the enormous growth potential in the
mid-market segment. With the aim of extending the coverage of its mid-to-high end
product line, the majority of Hengdeli’s new stores will come under the Prime Time
label. Expansion will focus on tier-three and tier-four cities in the North Eastern region,
such as Shenyang and Tianjin, Eastern China, like Sichuan, and Southern China
regions, including Nanchong and Jiangxi.
Well-positioned to capture future
growth by penetrating China’s
second- and third-tier cities
As urbanization continues, we have a positive view on Hengdeli’s strategy to extend
into second- and third-tier cities. In our view, consumers in those cities make up the
bulk of Hengdeli’s addressable market. We believe that Hengdeli’s mid-end watch
offering will gain traction with the growing number of middle income consumers in
these cities.
Expansion into Taiwan to complete Greater China coverage
Hoping to capture the opportunity for additional sales, Hengdeli entered Taiwan
through its acquisition of 80% of Taiwan Jing Guang Timepiece for HK$48m, at 6x P/E,
in 2009. Taiwan Jing Guang Timepiece owns 31 retail outlets in Taipei, Taichung,
Kaohsiung, Hsinchu, and Chiayi. It specialized in selling internationally renowned
watch brands. As a result of the acquisition, Hengdeli managed to establish a retail
network in the major cities of Taiwan having leading market share. By doing this,
Hengdeli laid a sound foundation for the long-term development of the company’s
overseas business.
Benefits from surging mainlander
visits
In mid-May 2010, Hengdeli opened its Elegant flagship store in Taiwan. The new store
sells the world’s top-ten most exclusive watch brands and serves as a grand
emporium for building brand image.
Hengdeli’s expansion into Taiwan makes good business sense given that in July 2008,
mainland China and Taiwan resumed regular direct flights between the two regions for
the first time in six decades. As retail prices for luxury watches in Taiwan are
approximately 11% cheaper than in mainland China, many mainlanders visit Taiwan in
search of bargains.
Acquired Taiwan Jing Guang
Timepiece to strengthen foothold
in Taiwan
65
Considering the Taiwan market is still at a developing stage, we do not anticipate any
material contribution to the company in the near term. Nevertheless, we anticipate the
broadened platform will be a long-term driver for Hengdeli in capturing additional
market share and sales.
20 April 2012
Hengdeli’s revenue is derived from three major segments, with retail business, the
largest segment, accounting for over 76% of total sales, followed by the wholesale
business (22%). Going forward, we expect the company to continue to rely on the
retail segment, which holds greater potential for rapid growth and higher margins. We
project the segment to account for 80% of total sales by 2013F.
No substantial slowdown in sales
momentum despite the
weakening retail environment
After demonstrating exceptional sales trends in FY11, with growth of 39% YoY,
Hengdeli began to see a slowdown in sales of ultra-luxury items mainly due to the less
positive macro outlook. However, mid-end watch sales at Prime Time and With Time
stores remained robust. Overall, Hengdeli still achieved a double digit sales growth in
January and February 2012. Going further into 2012, Hengdeli’s focus on the
mid-market watch segment, in our view, will provide sales resilience amidst the softer
retail environment.
China retail sales
We expect the core sales drivers of Hengdeli’s China business to be high SSSG and
accelerated store rollout. Currently, mature stores (defined as stores operating for
more than three years) account for 30% of Hengdeli’s China store count and
contribute to approximately 70% of its total China sales. We believe maturing younger
stores will help drive strong overall SSSG as growth can be as high as 50-70% in new
stores. We are also forecasting 40-45 new store openings or an increase of 11-13% in
the store network for China in FY12F-13F. On this measure, our 21-25% YoY retail
sales growth projections for China in FY12F-13F, respectively, do not appear to be
demanding.
Hong Kong retail sales
Organic sales growth will be the main sales driver as we expect new openings in
Hong Kong to be muted. We assume only one store per annum to be added in
2012-2013. Looking ahead, we expect Hengdeli sales in Hong Kong to rise 24% YoY
in FY12F and 19% YoY in FY13F.
Wholesale business
Consistent robust sales from the
wholesale business
Hengdeli’s China operation currently owns the distribution rights for 50 internationally
renowned, of which 18 are on an exclusive basis. Hengdeli is the largest wholesaler of
affordable-luxury watches in China with over 400 customers covering approximately
1,000 stores. With its ownership of exclusive distribution rights for a number of
best-selling international brands, local retailers that intend to carry these brands must
source from Hengdeli.
In recent years, the wholesale business was not the fastest growth segment for
Hengdeli, yet this segment remains financially important as it generates stable cash
inflow and serves as a platform for maintaining close working relationships with its
Swiss watch suppliers.
The wholesale business outlook is anticipated to remain sound given the healthy
industry development in China. We expect sales from this segment to grow steadily by
21% in FY12F and 17% in FY13F and to contribute 21-22% to total sales in
FY12F-13F.
66
20 April 2012
Uptrend in margins
Widening gross margin on rising
contribution from the retail
business and mid-market
products
On a like-for-like basis, Hengdeli’s gross margin has been fairly stable over the past
few years since Swiss watch suppliers dictate ASPs and strictly restrict retailers from
offering excessive discounts. Nonetheless, the rising contribution from the retail
business in China supports a steady expansion in the group’s overall gross margin.
Thanks to the higher gross profit margin carried by mid-end watches (34-35% for
Prime Time versus 31% for Elegant), the increased sales contribution will enhance the
company’s overall gross margin.
Hengdeli – gross profit margin trend
25.8%
25.4%
25.4%
25.5%
FY13F
FY14F
25.3%
25.1%
24.9%
25.0%
24.6%
24.2%
23.9%
23.9%
FY08
FY09
23.8%
23.4%
23.0%
FY10
FY11
FY12F
SG&A expenses and other assumptions
Major cost components remain
stable, and able to levy costs
pressure through robust SSSG
67

Rental expenses. Hengdeli’s rent structure in China is similar to most retailers,
with a fixed base rental on top of a share of approximately 15% of total sales.
90% of Hengdeli’s shops are located in department stores and the rest are
standalone or boutique stores. Since most new stores will be set up in tier-two
and-three cities where rents are relatively lower, we model rental expenses to
be well-contained within 7% of total retail sales in FY12F-13F as SSS
accelerates.

Distribution expenses. Staff costs account for 5% of sales. The company has
no direct exposure to changes in the minimum wage as it always pays its
workers more than the minimum. Distribution costs remained stable at under
12% of sales in FY10 and FY11.

Tax rates. The tax rate imposed to Hengdeli’s mainland operations is 25% and
is expected to remain constant in FY12F-13F. Its Hong Kong business is subject
to a tax rate of 17.5%. We forecast the blended effective tax rate for Hengdeli
will be 24% in FY12F-13F.
20 April 2012
Hengdeli – key assumptions
Year to December (RMB m)
2007
2008
2009
2010
2011
2012F
2013F
2014F
Sales growth by product (YoY, %)
China retail sales
86
36
17
38
38
27
23
18
Hong Kong retail sales
40
(3)
20
41
31
24
19
15
Wholesale revenue
41
13
(19)
25
54
21
17
14
After-sales services revenue
455
58
(6)
34
31
15
12
10
Gross profit margin (%)
22.5
23.9
23.9
24.9
25.1
25.3
25.4
25.5
Retail store numbers
84
204
237
350
405
453
496
539
China
82
197
224
286
332
377
417
457
Hong Kong
2
7
13
16
19
20
21
22
Taiwan
–
–
–
48
54
56
58
60
Retail and after-sales service business as % of total sales
69
68
75
78
76
76
77
77
Wholesale business as % of total sales
31
30
23
20
22
22
21
21
Distribution expense as % of revenue
6.8
9.5
10.0
11.5
11.6
11.7
11.9
12.3
Rental expense as % of retail revenue
–
–
–
7.3
7.3
7.2
7.3
7.4
Staff expense as % of revenue
–
–
–
5.1
5.3
5.4
5.5
5.6
3.4
4.6
4.1
3.4
3.2
3.1
3.1
3.2
19.9
21.1
24.8
24.3
23.4
24.0
24.0
24.0
Other assumptions
Administrative expense as % of revenue
68
20 April 2012
Hengdeli – profit and loss projections
2007
2008
2009
2010
2011
2012F
2013F
2014F
Revenue
4,579
5,516
5,899
8,216
11,375
14,155
17,019
19,729
90
20
7
39
38
24
20
16
(3,549)
(4,197)
(4,490)
(6,167)
(8,518)
(10,580)
(12,689)
(14,705)
1,030
1,319
1,409
2,049
2,857
3,575
4,330
5,024
83
28
7
45
39
25
21
16
Gross margin (%)
22.5
23.9
23.9
24.9
25.1
25.3
25.4
25.5
Government grants
13
15
16
9
10
11
13
15
Investment income (Distributing JV with SWATCH)
11
16
16
19
28
32
37
42
Other income – sub-total
55
50
51
55
141
156
162
195
Distribution costs
(312)
(522)
(590)
(948)
(1,325)
(1,661)
(2,033)
(2,421)
Administrative costs
(156)
(253)
(239)
(281)
(369)
(435)
(527)
(622)
Total SG&A
(483)
(774)
(831)
(1,230)
(1,697)
(2,097)
(2,560)
(3,043)
Distribution costs
6.8
9.5
10.0
11.5
11.6
11.7
11.9
12.3
Administrative costs
3.4
4.6
4.1
3.4
3.2
3.1
3.1
3.2
EBIT
591
623
613
837
1,267
1,606
1,902
2,108
97
6
(2)
37
51
27
18
11
12.9
11.3
10.4
10.2
11.1
11.3
11.2
10.7
YoY (%)
COGS
Gross profit
YoY (%)
Key SG&A expense ratio (%)
YoY (%)
EBIT margin (%)
D&A
EBITDA
YoY (%)
EBITDA margin (%)
30
37
44
53
75
56
41
45
621
660
656
890
1,342
1,661
1,943
2,154
97
6
(1)
36
51
24
17
11
13.6
12.0
11.1
10.8
11.8
11.7
11.4
10.9
123
Interest income
21
10
5
19
90
98
98
Effective interest rate on deposits (%)
3.3
2.6
2.6
2.6
2.0
1.8
1.8
1.8
(60)
(114)
(76)
(83)
(178)
(182)
(173)
(173)
7.3
8.4
5.8
3.7
4.7
4.5
4.5
4.5
Interest expense
Effective interest rate on borrowings (%)
Profit before tax
552
619
514
816
1,198
1,460
1,768
2,013
Income tax
(110)
(131)
(128)
(198)
(280)
(350)
(424)
(483)
Effective tax rate
19.9
21.1
24.8
24.3
23.4
24.0
24.0
24.0
Minority income
(25)
(28)
(21)
(63)
(103)
(124)
(150)
(171)
Net profit
418
460
365
554
815
985
1,192
1,356
YoY (%)
110
10
(21)
52
47
21
21
14
Net margin (%)
9.1
8.3
6.2
6.7
7.2
7.0
7.0
6.9
69
20 April 2012
Improved efficiency in cash
conversion cycle
Healthy cash conversion cycle
Hengdeli’s operating cash flow turned negative in FY10 mainly due to rapid expansion
during the year, which required heavy inventory support. By following a measured
pace of store opening, Hengdeli has brought operating cash to positive territory, with
an inflow of RMB196m in FY11. Management has implemented more stringent
controls over inventory and working capital to ensure positive operating cash flow
going forward. Given the expectation of a reasonable expansion pace, we anticipate
Hengdeli will be able to generate positive cash flow in FY12F-13F.
Inventory management is the key to its retail business expansion with the initial batch
of inventory typically accounting Hengdeli’s for about 90% of its store opening capital
requirements. Despite aggressive network expansion in the past years, Hengdeli
managed to improve inventory turnover in the last three years. For example, Hengdeli
managed to maintain average turnover days at the FY10 level of 165 days in FY11.
With the soon-to-be-implemented ERP system, we anticipate further improvements in
inventory levels for FY12F. We look for inventory turnover days to remain under
control at below 165 days in FY12F-14F. Average payable turnover days was kept
under 75 days for the past three years. We expect payable turnover days to remain
stable at 75 days in FY12F-14F.
Going forward, we anticipate the cash conversion cycle days for FY12F-13F to remain
at the reasonable level of 114-115 days. A stable working capital cycle should support
healthy growth in operating cash flow as well as free cash flow.
Hengdeli – cash conversion cycle and working capital days
220
200
180
160
140
120
100
80
60
40
20
0
(20)
(40)
(60)
(80)
(100)
197
179
155
146
166
165
165
115
18
(51)
164
136
24
23
25
115
25
115
25
114
25
(52)
(66)
FY08
FY09
(75)
(75)
FY10
FY11
FY12F
70
165
(75)
(75)
FY13F
FY14F
20 April 2012
Hengdeli – operating cash flow, free cash flow and net cash flow projections
RMB m
2,500
2,145
1,987
2,000
1,908
1,779
1,713
1,416
1,500
942
1,000
625
663
512
500
155
534
174
115
0
(500)
(1,000)
(205)
(94)
(310)
(280)
(480)
(662)
FY08
(675)
FY09
FY10
FY11
Operating cash flow
FY12F
Free cash flow
FY13F
FY14F
Net cash flow
Hengdeli – balance sheet projections
2007
2008
2009
2010
2011
2012F
2013F
2014F
289
529
600
664
666
750
840
925
Intangible assets
43
43
43
26
23
41
40
40
Investment properties
30
28
26
240
256
256
256
256
Investment in jointly controlled entity
28
31
36
53
56
55
54
53
0
1
1
122
474
474
474
474
Other investments
Deferred tax assets
24
40
39
52
78
78
78
78
Goodwill
213
228
243
278
297
297
297
297
628
900
988
1,437
1,849
1,951
2,038
2,122
Inventories
1,667
2,447
2,404
3,198
4,521
5,044
6,428
6,786
Trade and other receivables
560
450
591
1,005
1,115
1,320
1,516
1,701
Asset classified held for sale
0
0
0
0
136
136
136
136
Cash and equivalents
1,071
685
1,191
3,420
3,968
5,452
5,424
6,838
Current assets – total
3,298
3,581
4,186
7,623
9,740
11,952
13,504
15,462
Bank loans and other loans
245
760
824
1,077
2,042
2,042
2,042
2,042
Trade and other payables
476
584
807
881
1,759
3,259
3,847
4,404
88
70
62
97
144
346
614
933
CB and embedded financial instruments
0
0
0
0
48
48
48
48
Liabilities associated with asset classified as held for sale
0
0
0
0
28
28
28
28
Current liabilities – total
809
1,415
1,692
2,055
4,022
5,723
6,580
7,456
Long-term borrowing
995
716
322
2,317
2,202
2,000
1,800
1,800
Other NC payables
140
18
36
41
35
40
40
40
1,134
734
358
2,359
2,237
2,040
1,840
1,840
Current tax payables
Non-current liabilities – total
Minorities
197
236
257
329
440
545
673
818
Equity
1,785
2,096
2,867
4,316
4,891
5,595
6,449
7,469
Total assets
3,926
4,481
5,174
9,059
11,589
13,903
15,542
17,583
3,926
4,481
5,174
9,059
11,589
13,903
15,542
17,583
Gross debt
1,240
1,476
1,146
3,394
4,244
4,042
3,842
3,842
Net debt (cash)
253
888
(5)
(16)
302
(1,410)
(1,582)
(2,996)
Net gearing (%)
14.2
42.4
Net cash
Net cash
6.2
Net cash
Net cash
Net cash
71
20 April 2012
Hengdeli – cash flow projections
2007
2008
2009
2010
2011
2012F
2013F
2014F
EBIT
621
660
656
890
1,342
1,661
1,943
2,154
D&A
30
37
44
53
75
56
41
45
EBITDA
651
697
700
944
1,417
1,717
1,985
2,199
Other non-cash adjustment
(58)
(101)
(29)
(44)
(102)
(117)
(99)
(90)
Operating cash flow before changes in working capital
593
595
671
900
1,316
1,600
1,885
2,109
Inventory
(353)
(740)
42
(739)
(1,281)
(523)
(1,383)
(358)
Trade and other receivables
(260)
96
(105)
(227)
(256)
(205)
(196)
(186)
35
72
215
14
664
1,505
589
557
(577)
(572)
153
(951)
(873)
777
(991)
13
Total working capital changes
Interest received
Interest paid
Tax paid
Operating cash flow
22
10
5
19
90
98
98
123
(68)
(82)
(77)
(83)
(171)
(182)
(173)
(173)
(96)
(157)
(128)
(165)
(247)
(149)
(156)
(164)
(126)
(205)
625
(280)
115
2,145
663
1,908
(130)
Capex for acquisition of:
(60)
(274)
(110)
(393)
(208)
(140)
(130)
Land use rights
0
0
0
0
0
0
1
1
Intangibles
0
(1)
(2)
(2)
(2)
(18)
(0)
(0)
Total capex
(60)
(275)
(112)
(395)
(209)
(158)
(129)
(129)
(186)
(480)
512
(675)
(94)
1,987
534
1,779
0
0
0
0
0
0
1
1
(7)
(13)
56
30
(16)
26
0
0
Reorganization
0
0
0
0
0
0
0
0
Proceeds from issue of shares
0
(6)
526
923
5
0
0
0
Dividend paid
(76)
(163)
(153)
(123)
(204)
(300)
(361)
(364)
Net cash flow
(269)
(662)
942
155
(310)
1,713
174
1,416
Gross cash flow
(889)
(1,272)
(150)
(907)
(1,602)
1,510
(26)
1,416
Year to December
2007
2008
2009
2010
2011
2012F
2013F
2014F
ROAE (%)
26.9
25.1
15.4
14.9
16.9
18.1
19.2
19.1
ROAA (%)
13.1
10.9
7.6
7.8
7.9
7.7
8.1
8.2
ROIC (%)
26.0
19.5
16.9
17.8
20.7
25.5
29.7
31.0
151
179
197
166
165
165
165
164
32
18
24
23
25
25
25
25
49
51
66
52
75
75
75
75
134
146
155
136
115
115
115
114
Net gearing (%)
14.2
42.4
Net cash
Net cash
6.2
Net cash
Net cash
Net cash
Gross gearing (%)
69.4
70.4
40.0
78.6
86.8
72.2
59.6
51.4
Free cash flow
Other investing cashflow
Changes in pledged deposit
Hengdeli – key financial ratios
72
20 April 2012
Company specific risks
Management shares transaction
Public filings show that the Swatch Group (UHR VX, Not Rated), the second-largest
shareholder in Hengdeli, substantially raised its stake in the company, from 9.05% to
20.42%, on 21 July 2011. Chairman Zhang Yuping, with a 35.42% stake in Hengdeli,
has personally pledged about 500m shares, or an 11% stake for a fixed term of three
years till 2014, in return for US$100m from the Swatch Group. There is no option or
obligation for the Swatch Group to acquire the shares and the chairman affirms he has
no plan to sell the shares under the pledge.
The chairman explained that the funding is purely for personal investments in
business ventures unrelated to Hengdeli’s operations. Management emphasized that
there will be no change in Hengdeli’s board, management or operations after the
change in shareholding structure. We believe the pledge arrangement, while only a
private agreement between major shareholders, will be viewed cautiously by the
market. The on-going corporate governance concerns held by some investors do not
help.
Senior management
Board of directors
Mr. Zhang Yuping (Alia, Cheung Yu Ping) – Chairman and executive
director
Mr. Zhang, who founded the company in 1999, is in charge of overall management
and strategic development. He has more than 20 years of experience in the high-end
consumables distribution industry for the China market.
Mr. Song Jianwen – Executive director
Mr. Song is in charge of finance and investment at Hengdeli. Mr. Song graduated from
Zhongnan Finance Economics University with a Masters Degree in Economics. He
joined the company in 2001 and has over 10 years of experience in finance and
accounting.
Mr. Huang Yonghua – Executive director
Mr. Huang is in charge of the company’s business coordination and operational
supervision. Joined the company in 2001, Mr. Huang has more than 10 years of
experience as a manager China’s watch distribution industry.
Mr. Chen Sheng – Non-executive director
Mr. Chen joined the company in 2007 and is responsible for the group’s investment
activities. He graduated from Fudan University in Shanghai with a Master’s Degree in
Business Administration.
73
20 April 2012
Mr. Shen Zhiyuan – Non-executive director
Mr. Shen graduated from the Beijing Institute of Business (北京商学院). Later, he
became General Manager of Beijing Yishang Group (北京一商集团). He is currently
the Vice Chairman of the Association of PRC Enterprises (中国商业企业协会) and
Chairman of the Association of Beijing Enterprises. (北京商业企业协会). Mr. Shen
joined the group in 2004.
Mr. Shi Zhongyang – Non-executive director
Mr. Shi graduated from Nanjing University in China and the University of Goetting in
Germany with a Master’s Degree in Law. Mr. Shi joined The Swatch Group Limited in
2000 and joined Hengdeli in 2006. He is currently legal counsel in the legal
department of The Swatch Group Limited.
Mr. Cai Jianmin – Independent non-executive director
Mr. Cai joined Hengdeli in 2005. He has held senior financial positions in various
companies including Shanghai Hualian (Group) (上海华联(集团)). He graduated from
University of Edinburgh, Scotland with a Bachelor’s Degree and a Doctorate Degree
in Electrical Engineering. Mr. Wong is currently a professor in the Department of
Systems Engineering and Engineering Management at Chinese University of Hong
Kong. He obtained his qualification as a Chartered Engineer (CEng) in 1991, and is
now a member of the Institute of Electrical Engineers and a professional member of
the Association of Computing Machinery.
Senior management
Mr. Zhuang Liming – Vice chairman of Shanghai Xinyu
After graduating from Beijing Foreign Trade College, Mr. Zhuang worked for China’s
Light Industry Commodities Import and Export Company before joining Hengdeli in
2000.
Ms. Wang Lingfei – Deputy president
Ms. Wang is responsible for brand development. Before joining the company in 2005,
she was General Manager of Beijing Yishang Group.
Mr. Lee Wing On, Samuel – Deputy president
Mr. Lee is responsible for retailing in Hong Kong. He joined the company in 2006 and
has over 20 years of experience in the Hong Kong watch retail industry.
Mr. Stan Lee – Deputy president
Mr. Lee is responsible for retailing on the mainland. He joined Hengdeli in 2007, and
has over 20 years of experience in watch manufacturing and distribution.
74
20 April 2012
Luk Fook Holdings (590 HK)
Company Rating: Neutral
Losing a bit of glitter
(initiation)
Despite its shorter operating history relative to peers, Luk
Fook has grown to become the third-largest gold and jewelry
retailer in Hong Kong, where it enjoys high customer
recognition and differentiates itself from Chow Tai Fook by
having a higher turnover contribution from gem-set products.
The major shortcomings of Luk Fook stem from its
franchising-driven operation in China. While valuations are
compelling, significant near-term challenges arise as SSSG
weakens on the back of consolidating gold price. We initiate
coverage on this stock with a Neutral rating.




Price:
HK$20.90
Target:
HK$21.80
(initiation)
Trading data
52-week range
HK$19.2 – 46.15
HK$12,312/US$1,586
589
Wide exposure to gem-set products. Luk Fook’s sales
from gem-set items contribute to over 40% of its total
jewelry sales. Gem-set products have more stable
pricing and offer higher margins than gold jewelry.
Free float (%)
55
5.5
Shortcomings
from
China
operation.
Well
established and recognized in Hong Kong, Luk Fook’s
major negatives arise from its China operation which is
predominantly franchising-driven. Another negative
comes from its weak presence in China. Luk Fook only
owns 3% of the market in China. The intense
competition in the China market means it can be costly
and risky for its franchised store network to scale up.
Major near-term challenges. On top of declining
SSSG, Luk Fook hedges only 20% of its gold price risk.
With gold price moving sideway, gross margin could be
under pressure.
Initiate with Neutral. Valuations of Luk Fook are
undemanding as it trades on 8x CY13F P/E but the
stock could further de-rate in the near term before its
SSSG troughs out and gold price regains momentum.
For now, we value the counter on 8.5x CY13F P/E, a
35% discount to our target valuation for Chow Tai Fook.
19.5
9.3
Stock price vs. HSI
HK$
46
42
38
34
30
26
22
18
19-Apr-11
1-Jul-11
12-Sep-11
Luk Fook
Source: Bloomberg
Financial forecast
Year to 31 March
FY10
FY11
FY12F
FY13F
FY14F
Revenue (HK$m)
5,386
8,091
11,530
13,403
15,973
Net profit (HK$m)
EPS (HKD)
EPS (YoY, %)
P/E (x)
531
866
1,303
1,283
1,594
Claudia Ching
1.079
1.705
2.303
2.178
2.705
93
58
35
(5)
24
(852) 2532 2528
[email protected]
19.4
12.3
9.1
9.6
7.7
Yield (%)
2.1
3.3
4.5
4.4
5.2
FCF yield (%)
0.0
1.2
3.4
6.2
7.7
21.0
ROAE (%)
36.5
34.1
28.1
20.1
P/B (x)
7.3
3.6
2.1
1.8
1.5
Net gearing (%)
1.6
Net cash
Net cash
Net cash
Net cash
75
Forrest Chan, CFA
(852) 2532 6743
[email protected]
Timothy Sun
(852) 2532 6746
[email protected]
24-Nov-11
HSI (rebased)
5-Feb-12
18-Apr-12
20 April 2012
A well-recognised domestic
brand in Greater China
Luk Fook began with only one outlet in 1991. Since that humble beginning, it has
evolved into one of the most successful jewelry retail brands in Greater China. It
sources, designs, retails, wholesales a variety of gold jewelry and ornaments,
including gem-set jewelry and gemstones. Over the years, Luk Fook has earned high
brand recognition from both domestic and mainland shoppers, who have come to
appreciate its high product quality and the diversity in product offering.
Luk Fook has an extensive retail network of over 800 POS in Hong Kong, Macau and
China, including directly-managed and franchised outlets. The company also runs a
number of stores in overseas markets, including Singapore, Canada and the United
States. In addition, it has an online business that doubles as a business-to-business
trading platform among manufacturers, wholesalers and retailers globally.
Looking to increase the sales
contribution from gem-set jewelry
Luk Fook has expertise in gem-set products and is renowned for its exquisite designs
and craftsmanship. This represents an important competitive advantage as gem-set
products tend to be high-margin and their sales are less vulnerable to gold price
fluctuations. With an anticipated increase in contribution from higher-margin gem-set
products, we see potential upside for Luk Fook’s gross margins in the long run.
Market position of jewelers
Luxury
Van Cleef & Arpels
Cartier
Bulgari
Tiffany
Chow Tai Fook
Tesiro
Chow Sang Sang
3D-Gold
Emperor Watch
& Jewellery
CHJ Jewellery
Jovan
Limited
geographic
coverage
Daimengde
Fuhui
Fuqi
Jewelry
Lukfook
TSL
Kimberlite
Diamond
Ming
Jewelry
Laofengxiang
Laomiao
First Asia Jewellery
Chow Tai Seng
Extensive
geographic
coverage
Batar Jewellery
Affordable
Gold and jewelry icon in Hong Kong
Third-largest gold and jewelry
retailer in Hong Kong
76
With only 21 years of operating history, Luk Fook is a younger brand relative to Chow
Tai Fook or Chow Sang Sang, both of which have been around for 70 years or more.
Despite its relatively short life so far, Luk Fook has developed into a leading Hong
Kong-based gold and jewelry retailer targeting middle- to upper-income customers in
the market for appealing designs and a wide product range. The company has earned
high praise from customers and is considered a trusted household brand in Hong
Kong and China. In 2010, it accounted for the third-largest market share of 7% of
Hong Kong’s jewelry retail market, exceeded only by Chow Tai Fook’s 20% and Chow
Sang Sang’s 9%.
Stores located in prime tourists
shopping areas
20 April 2012
Luk Fook is well-known to mainland Chinese shoppers as many of its stores are
located in prime tourist shopping destinations in Hong Kong, including Tsim Sha Tsui,
Mong Kok and Causeway Bay, in short, the favoured destinations of mainland visitors
to Hong Kong. It is currently ranked second among Hong Kong jewelry retailers in the
UnionPay market pool, just behind market leader Chow Tai Fook. Luk Fook also won
the coveted “PRC consumers most favored Hong Kong brand” for several years
running. Such achievements bespeak of the high regard mainland shoppers have for
Luk Fook.
Jewelry market share by retail value in China (2010)
14%
13%
12%
10%
9%
8%
7%
7%
6%
6%
4%
4%
4%
3%
3%
2%
2%
2%
0%
Chow Tai Lao Feng Chow Tai Lao Miao Beijing First Asia Zhe Jiang
Fook
Xiang
Seng
Caishikou
Ming
Cartier
Luk Fook Kimberlite
Diamond
Chow
Sang
Sang
Jewelry market share by retail value in Hong Kong and Macau (2010)
22%
20%
20%
18%
16%
14%
12%
10%
9%
7%
8%
6%
4%
4%
3%
2%
2%
2%
2%
2%
2%
Qeelin
CSS
0%
Chow Tai Chow Sang Luk Fook
Fook
Sang
77
MaBelle
Cartier
Tiffany &
Co
King Fook Seng Feng
20 April 2012
Luk Fook’s flagship store in Tsim Sha Tsui, Hong Kong
Luk Fook’s shop in Beijing
Source: Company presentation
Source: Company presentation
Strength in gem-set jewelry backed by reputation for authenticity,
product quality and fashionable designs
Renowned for offering authentic,
high quality gold and jewelry
items
In an industry where product differences are generally subtle, Luk Fook has built an
enviable reputation for offering exquisite, creative and stylish designs. Its design
excellence has been rewarded by higher-than-average sales contribution from
gem-set jewelry products, which tend to provide more room for design variety versus
gold jewelry. Luk Fook is a keen participant in various local and international jewelry
design competitions, where it has collected more than 140 awards and special
mentions at various international and local design competitions. In FY11, Luk Fook
generated 41% of its sales from gem-set products, materially higher than that of its
peers. Wider exposure to gem-set products is a positive, in our view, since demand is
usually stickier and has less correlation with commodity price, and they offer higher
margins. Finally, within the gem-set segment, there is more room for product mix
upgrades to drive gross margins.
Luk Fook’s gem-set jewelry products
Luk Fook’s gold products
78
20 April 2012
Gem-set vs. other product sales split between Luk Fook, Chow Sang Sang and
Chow Tai Fook
100%
90%
80%
48%
59%
70%
74%
60%
50%
40%
30%
52%
41%
20%
26%
10%
0%
Luk Fook
Chow Tai Fook
Gem-set jewelry
Other products
Chow Sang Sang
Source: Company data, Chow Sang Sang, Chow Tai Fook latest financial data
Luk Fook – sales split trend
100%
90%
80%
70%
54%
53%
55%
54%
46%
47%
45%
47%
FY09
FY10
59%
60%
50%
40%
30%
20%
41%
10%
0%
Gem-set jewellery
FY11
1H FY11
Gold/platinum jewellery
1H FY12
Increasing self-sufficiency ratio
Adding production plant capacity
to support sales growth and
enhance margins
Luk Fook has its own gem-set jewelry manufacturing plant in Panyu, Guangdong,
which supplies around 50% of its gem-set jewelry. Having its own processing plant
means that Luk Fook is able to ensure high product standards for its gem-set jewelry
products. This also means that cost effectiveness and production efficiency can be
enhanced. The group invested approximately RMB100m in 2003 in a large-scale
jewelry processing plant in Panyu, Guangdong, with a total site area of over
350,000 sqf.
Luk Fook is now expanding its production plant to increase capacity to support sales
growth. The construction of the jewelry processing plant phase II, also situated in
Panyu, has begun and operations are expected to commence in October 2012. Once
phase II becomes fully operational, total production capacity of the group will double.
The group expects to increase its in-house supply ratio for gem-set jewelry from 50%
currently to 100% in the long run.
79
20 April 2012
Longest history as a listed company
Luk Fook was listed in 1997 which means it has the longest history as a public
company among the four companies we cover in this report. Over the years,
management has established a solid track record of achieving satisfactory business
development, as shown in the following charts.
Luk Fook – turnover since FY96
Luk Fook – earnings since FY96
HK$b
9
8.1
HKm
1,000
8
900
7
800
700
5.4
600
5
400
Source: Company data, Bloomberg
48
78
127
97
FY11
65
FY10
70
FY06
81
FY05
40
FY04
78
FY03
63
FY02
47
FY01
FY11
FY10
FY09
FY08
FY07
FY06
FY05
FY04
FY03
FY02
FY01
FY00
FY99
FY98
0
FY97
0
FY96
100
FY00
200
1
FY99
1.7 1.6 1.5
1.5 1.6
FY98
1.4
FY97
1.5
278
199
FY96
1.1
1.7
318
300
2.0 2.1
FY07
2.8
FY09
3.4
3
2
500
4.0
4
537
FY08
6
877
Source: Company data, Bloomberg
Shortcomings
Relatively low presence in China
80
Under-represented in China. Luk Fook has a strong franchise in the Hong Kong
market, but its market share in China is still low. In 2010, it had market share of only
3% in China (versus 12.6% for Chow Tai Fook), and was ranked ninth by retail value.
As at end-September 2011, it had 738 POS in China including 686 franchised stores
and 52 directly managed outlets, compared with Chow Tai Fook’s jewelry store count
of 1,505. Considering Chow Tai Fook’s market share is three times larger than Luk
Fook’s, it is clear that Luk Fook’s China unit has lower store productivity than that of
Chow Tai Fook. As a result of the use of franchising, China contributed only 17% of
Luk Fook’s total turnover and only 6% of EBIT in FY11. Luk Fook’s underexposure to
China disqualifies it as a proxy for that market. Indeed, we look at the stock as solely a
proxy of the Hong Kong’s jewelry market.
Heavy reliance on franchisees
20 April 2012
Franchising risk. Unlike Chow Tai Fook, Luk Fook pursues an asset-light expansion
model in China where over 93% of its POS are franchised outlets.
Luk Fook – sales mix by channel
100%
80%
9%
8%
7%
8%
9%
8%
8%
83%
83%
84%
85%
FY13F
Other
FY14F
FY15F
9%
11%
16%
16%
7%
8%
78%
76%
80%
FY09
FY10
FY11
Direct retail
9%
60%
40%
20%
0%
FY12F
Wholesale
Luk Fook – group’s POS breakdown
100%
12%
13%
12%
12%
12%
12%
12%
88%
87%
88%
88%
88%
88%
88%
FY09
FY10
FY11
FY14F
FY15F
80%
60%
40%
20%
0%
FY12F
FY13F
Franchse
Direct retail
Franchising gives Luk Fook the benefit of lower working capital requirements and
faster retail network expansion. But there are also major risks and disadvantages
inherent in the franchising business model, including limited access to market
intelligence, difficulties in monitoring franchisee performance as well as reputation risk.
Luk Fook tries to mitigate franchising risk by enforcing strict standards on its
franchisees. A key requirement is that all items distributed to licensees are handled
over on cash-on-delivery payment terms. New joiners also have to meet certain
prerequisites laid down by Luk Fook in order to receive store opening approvals.
81
20 April 2012
Luk Fook closely monitors its licensees along the following lines:
Most sensitive to gold price
fluctuations compared with peers

Quality and inventory control over jewelry products conducted by real-time POS
and surveillance systems

In-house audit team to check POS financials

Standardized point-of-sale systems

Mysterious shoppers

Penalty of RMB50,000, RMB100,000 or RMB200,000 for selling inferior quality
jewelry or breaking licensing rules and

A reward of 20% on the collection of penalties to any parties who discover and
report violations
Near-term margin pressure. Compared with Chow Tai Fook, which hedges 90% of
its gold inventory, Luk Fook’s margin is more vulnerable to gold price changes given
that the company only hedges 20% of its total gold inventory and keeps about three
months of gold inventory. In the case of sharp movements in gold prices, particularly
falling gold prices, Luk Fook’s gross margins suffer. Luk Fook’s gross margin also
benefited from rising gold price between 2009 and 2011, suggesting that the recent
consolidation in gold price could lead to gross margin contraction.
We forecast 22% earnings CAGR for Luk Fook in FY11-13F, with FY13F likely to see
an earnings decline as sales momentum weakens and gold price fluctuates.
Hong Kong and Macau
FY13F will be challenging given
weakening SSSG in its core
markets
Luk Fook believes it is already well-represented in the Hong Kong and Macau markets
with good store coverage in key shopping areas. The plan is to add two-to-three new
stores in Hong Kong and one-to-two outlets in Macau per year going forward.
Combined with the SSSG estimates discussed at the beginning of this report, we look
for 49% turnover growth in each of Hong Kong and Macau in FY12F, but slower sales
growth of only 15% in FY13F on the back of lower SSSG.
China
Luk Fook’s China operation is dominated by franchised stores which account for 686
out of its 738 POS there. Its footprint in China will continue to grow as it adds both
franchised stores and directly-run retail points. We forecast 12-16% growth, or
100-102 licensed stores added annually. In addition, 10-15 self-run POS will be
opened annually, mainly in tier-one or two cities. As a result, we forecast 29-41%
China retail turnover growth and 22-27% overall wholesale revenue growth in
FY12F-13F, with the latter representing a rough proxy for the company’s wholesale
business in China given that overseas wholesale contribution is marginal.
82
20 April 2012
Gross margin dilution in the near term
Gross margin pressure in the
short term as gold price trades
sideways
We see potential downside risk to the gross margin of Luk Fook’s gold products in
FY13F. As discussed above, Luk Fook’s margin is more vulnerable to gold price
changes than peers given that the company only hedges 20% of its total gold
inventory and keeps about three months of gold inventory. In the event of sharp
movements in gold prices, in particularly falling gold prices, Luk Fook’s gross margins
could fall. We estimate Luk Fook’s gross profit margin will decline from 23.9% in
FY12F to 22.4% in FY13F.
As for the gemstone jewelry business, Luk Fook is hoping to increase the segment’s
contribution in the coming years given the more attractive profitability. The group’s
gem-set jewelry earns a higher gross margin of about 35% to 39% versus
gold/platinum jewelry with around 14% to 15%. In our view, the steady upward trend
in diamond and gemstone prices should also favor Luk Fook’s operations ahead.
That said, we believe Luk Fook’s product mix changes will not vary materially in the
medium term as most Chinese still prefer to buy gold jewelry as a form of wealth
protection and as a status symbol. Therefore, we expect there will only be incremental
adjustments in product mix over the long run.
Luk Fook gross profit margin trend
25.4%
24.9%
24.5%
24.0%
23.7%
23.9%
23.7%
23.6%
23.3%
22.7%
22.4%
22.1%
21.8%
20.9%
20.0%
FY08
FY09
FY10
FY11
FY12F
FY13F
FY14F
FY15F
Rise in key expense ratio for FY12F-13F
We expect Luk Fook to face greater operating cost pressure in FY12F-14F particularly
on the rental costs front, as most of the group’s stores in Hong Kong are located in
prime shopping areas. Management has indicated that rental increments for FY12F
will be exceptionally high, not only because of the revision of the renewal contracts,
but because the rise has also been caused by high rental rates for its new stores
established in Hong Kong during the period. Nonetheless, helped by high SSSG in
FY12F, we believe Luk Fook’s rental ratio will only increase by 0.1ppt, from 3.1% to
3.2% of total sales in FY12F. Going forward, we expect Luk Fook to see moderating
SSSG in FY13F-14F, and with rental hikes for its stores destined to continue, we
anticipate a jump in the company’s rental ratio, from 3.2% of total sales in FY12F, to
3.4% and 3.5% of total sales in FY13F-14F respectively.
83
20 April 2012
Staff costs, representing 4.7% of total sales in FY11, is not a major issue thanks to the
significant variable portion of Luk Fook’s staff compensation structure. Luk Fook
typically spends less than 1% of sales on advertising and promotional expenses. We
do not expect a material change in A&P spending for FY12F-13F but expect it to be
maintained at less than 1% of total sales.
Luk Fook – key assumptions
2009
2010
2011
2012F
2013F
2014F
2015F
Total POS
456
557
699
817
927
1,045
1,163
China – sub-total
419
519
657
772
882
999
1,116
19
36
39
54
64
79
94
400
483
618
718
818
920
1,022
30
31
33
34
34
35
36
Other markets – sub total
7
7
9
11
11
11
11
46
76
117
118
110
118
118
China – sub-total
43
75
113
115
110
117
117
8
17
3
15
10
15
15
35
58
110
100
100
102
102
2
1
2
1
0
1
1
1
0
2
2
0
0
0
18
22
25
17
13
13
11
China – sub-total
19
24
27
18
14
13
12
73
89
8
38
19
23
19
18
21
28
16
14
12
11
7
3
6
3
0
3
3
17
0
29
22
0
0
0
28
(12)
33
25
13
15
13
9
17
30
38
10
12
13
259
452
739
937
1141
1348
1549
74
64
27
22
18
15
1
1
1
1
1
2
44
28
11
9
7
5
154
253
338
416
487
546
22
64
34
23
17
12
Royalty income per licensee
0
0
0
1
1
1
YoY (%)
1
28
15
8
4
1
SSSG (%)
China
Hong Kong/Macau
Wholesale (supply of gem set to the licensee)
YoY (%)
Wholesales per licensee
1
YoY (%)
Royalty income
126
YoY (%)
Consultancy fee income
11
19
22
26
29
32
35
YoY (%)
160
73
16
21
16
12
9
Gross margin (%)
22.1
24.0
23.7
23.9
22.4
23.3
23.7
Total staff cost as % of total sales
6.0
4.9
4.7
5.1
5.2
5.3
5.3
Total lease costs as % of direct retail sales
5.3
4.8
3.9
4.1
4.4
4.6
4.6
Other expenses as % of total sales
4.6
4.1
3.4
3.5
3.7
3.8
3.9
84
20 April 2012
Luk Fook – revenue projections
2009
2010
2011
2012F
2013F
2014F
2015F
Total revenue
3,959
5,386
8,091
11,530
13,403
15,973
19,038
18
36
50
43
16
19
19
YoY (%)
Revenue by market
Retail, China
177
289
454
641
826
1,080
1,368
2,898
3,802
5,986
8,919
10,289
12,288
14,766
Wholesale, China
259
452
739
937
1,141
1,348
1,549
Scrap of gold and platinum and gold bullion
487
671
637
669
702
737
774
Licensing (royalty fee 2-12%)
138
174
276
364
445
519
582
(90)
63
57
41
29
31
27
12
31
57
49
15
19
20
5,991
74
64
27
22
18
15
38
(5)
5
5
5
5
26
59
32
22
17
12
Retail, China
Wholesale, China
(114)
Retail, China
Wholesale, China
4
5
6
6
6
7
7
73
71
74
77
77
77
78
7
8
9
8
9
8
8
12
12
8
6
5
5
4
3
3
3
3
3
3
3
3,076
4,091
6,440
9,560
11,114
13,369
16,134
259
452
739
937
1,141
1,348
1,549
Revenue by sales channel
Retail
Wholesale
Revenue growth by sales channel (%)
Retail
Wholesale
(29)
33
57
48
16
20
21
5,991
74
64
27
22
18
15
78
76
80
83
83
84
85
7
8
9
8
9
8
8
16
16
11
9
9
8
7
Revenue mix by sales channel (%)
Retail
Wholesale
Others
85
20 April 2012
Luk Fook – profit and loss projections
2009
2010
2011
2012F
2013F
2014F
2015F
1H11
2H11
1H12
2H12F
Total revenue
YoY (%)
3,959
18
5,386
36
8,091
50
11,530
43
13,403
16
15,973
19
19,038
19
3,264
56
4,827
46
5,511
69
6,019
25
(3,085)
122
(4,093)
133
(6,174)
151
(8,780) (10,398) (12,250) (14,520)
142
118
118
119
(2,497)
60
(3,677)
45
(4,159)
67
(4,621)
26
874
4
22.1
1,294
48
24.0
1,917
48
23.7
2,751
43
23.9
3,005
9
22.4
3,723
24
23.3
4,518
21
23.7
767
46
23.5
1,150
50
23.8
1,353
76
24.5
1,398
22
23.2
32
22
19
15
12
10
7
5
14
9
6
(239)
5
6.0
(264)
10
4.9
(382)
45
4.7
(450)
18
5.1
(532)
18
5.2
(648)
22
5.3
(785)
21
5.3
(149)
28
4.6
(233)
58
4.8
(211)
42
3.8
(239)
3
4.0
(36)
13
0.9
(44)
21
0.8
(51)
16
0.6
(52)
1
0.4
(65)
26
0.5
(81)
25
0.5
(96)
18
0.5
(24)
23
0.7
(27)
10
0.6
(33)
(38)
0.6
(18)
32
0.3
Rental costs
YoY (%)
As % of turnover
(164)
30
4.2
(197)
20
3.7
(253)
28
3.1
(369)
46
3.2
(450)
22
3.4
(563)
25
3.5
(681)
21
3.6
(120)
31
3.7
(133)
26
2.8
(133)
11
2.4
(236)
77
3.9
A&P costs
YoY (%)
As % of turnover
(33)
(7)
0.8
(33)
0
0.6
(38)
15
0.5
(58)
52
0.5
(80)
39
0.6
(96)
19
0.6
(114)
19
0.6
(19)
6
0.6
(19)
24
0.4
(23)
20
0.4
(35)
84
0.6
Commission expense to credit cards
YoY (%)
As % of turnover
(32)
25
0.8
(43)
35
0.8
(68)
59
0.8
(92)
36
0.8
(107)
16
0.8
(128)
19
0.8
(152)
19
0.8
(26)
60
0.8
(42)
59
0.9
(46)
77
0.8
(46)
10
0.8
(587)
11
14.8
(680)
16
12.6
(912)
34
11.3
(1,221)
34
10.6
(1,479)
21
11.0
(1,823)
23
11.4
(2,212)
21
11.6
(396)
29
12.1
(516)
38
10.7
(520)
31
9.4
(701)
36
11.6
318
(14)
8.0
635
99
11.8
1,024
61
12.7
1,545
51
13.4
1,538
(0)
11.5
1,910
24
12.0
2,313
21
12.2
377
64
11.5
647
59
13.4
842
124
15.3
703
9
11.7
36
44
51
52
65
81
96
24
27
33
18
355
(12)
9.0
679
91
12.6
1,075
58
13.3
1,597
49
13.8
1,603
0
12.0
1,991
24
12.5
2,409
21
12.7
401
61
12.3
674
57
14.0
875
118
15.9
721
7
12.0
5
(8)
1
0
(4)
2
9
(5)
0
7
0
1
9
0
1
11
0
1
14
0
1
3
(3)
1
6
(2)
(0)
3
0
3
4
0
(2)
Profit before tax
YoY (%)
As % of turnover
316
(15)
8
634
101
12
1,029
62
13
1,553
51
13
1,547
(0)
12
1,922
24
12
2,328
21
12
378
64
12
651
61
13
848
124
15
705
8
12
Tax
(38)
12
(98)
15
(152)
15
(233)
15
(248)
16
(308)
16
(396)
17
(54)
14
(98)
15
(120)
14
(113)
16
(3)
(5)
(11)
(17)
(17)
(21)
(25)
(4)
(7)
(8)
(9)
275
(12)
7.0
531
93
10.0
866
63
10.8
1,303
50
11.4
1,283
(2)
9.7
1,594
24
10.1
1,907
20
10.1
320
71
9.9
546
59
11.5
720
63
13.2
583
125
9.8
COGS
YoY (%)
Gross profit
YoY (%)
Gross margin (%)
Staff costs
YoY (%)
As % of turnover
YoY (%)
As % of turnover
YoY
EBIT
YoY (%)
EBIT margin (%)
Depreciation and amortization included in SG&A
EBITDA
YoY (%)
EBITDA margin (%)
Interest income
Interest expense
Share of results of an associate
Minority interest
Net profit
YoY (%)
Net margin (%)
86
20 April 2012
Net cash positioning with AMPLE
cash on hand of c.HK$2.5b by
FY12F
The majority of Luk Fook’s planned openings will be franchised outlets and meaning
that expansion will create only minimal burden to the company’s working capital. Luk
Fook’s capex is mainly for openings of a small number of self-owned stores and
regular maintenance. Management is setting a capex target of HK$140-160m for
FY12F-13F, mainly to set up 10-15 boutiques across the PRC. These capex targets
are not significant considering the company’s operating cash flow of HK$500m-plus in
FY12F-13F. Moreover, Luk Fook was in a net cash position of HK$318m as at
end-September, 2011. More recently, in Janurary 2012, it raised an additional amount
of HK$1.3b via a top-up placement.
Luk Fook cash conversion cycle and working capital days
180
146
150
132
139
133
129
116
120
100
107
101
97
141
139
109
106
90
60
30
4
3
4
4
4
4
4
0
(30)
(33)
(35)
(36)
(60)
FY09
FY10
(36)
(37)
FY11
FY12F
FY13F
(37)
(37)
FY14F
FY15F
Luk Fook operating cash flow, free cash flow and net cash flow projections
HK$m
1,800
1,563
1,600
1,400
1,200
1,000
1,000
762
800
561
600
400
1,103
943
922
340 311
212
200
421
311
244
1,025
865
719
534
580
143
(4)
0
(200)
(136)
(400)
FY09
FY10
FY11
Operating cash flow
87
FY12F
FY13F
FY14F
Free cash flow
Net cash flow
FY15F
20 April 2012
Luk Fook – balance sheet projections
2009
2010
2011
2012F
2013F
2014F
2015F
1H11
1H12
108
380
370
459
555
634
699
336
385
17
15
15
15
14
14
13
6
40
Investment properties
0
0
81
81
81
81
81
82
90
Interests in associate
2
5
5
6
6
7
8
5
8
Trading license
1
1
1
1
1
1
1
1
1
Rental deposits
26
31
40
59
72
90
109
33
35
Leasehold land and land use rights
Deferred tax assets
Inventory
14
14
19
19
19
19
19
16
31
168
446
531
639
748
846
930
480
592
1,219
1,736
2,631
3,775
4,159
5,145
6,098
2,208
3,927
Trade receivables
37
74
109
150
174
208
247
80
145
Deposits, prepayments and other receivables
44
46
41
58
67
80
95
47
81
Amt due from associate
6
8
5
5
5
5
5
33
0
Bank balance and cash
280
287
966
2,529
3,063
3,782
4,359
274
413
1,586
2,151
3,751
6,517
7,468
9,219
10,805
2,642
4,566
259
530
686
1,054
1,040
1,470
1,452
511
865
Short-term bank loans
169
314
0
0
0
0
0
0
95
28
50
90
140
149
185
237
608
166
Total current assets
Taxation payable
Amount due to an associate
Total current liabilities
Deferred tax liabilities
Employees benefit
Long-term bank loans
Total non-current liabilities
Shareholder equity
0
0
0
0
0
0
0
79
1
456
894
777
1,193
1,188
1,654
1,689
1,198
1,127
3
7
19
19
19
19
19
14
27
23
12
28
31
34
37
41
12
28
0
0
0
0
0
0
0
0
0
26
19
46
49
52
56
59
26
55
1,196
1,523
3,196
5,624
6,671
7,964
9,471
1,870
3,933
Minority interest
18
23
35
52
69
90
115
28
44
Proposed dividend
59
138
228
238
236
300
401
0
0
Total equity
1,273
1,683
3,458
5,914
6,976
8,355
9,986
1,897
3,977
Total assets
1,754
2,597
4,282
7,156
8,216
10,065
11,735
3,122
5,158
1,754
2,597
4,282
7,156
8,216
10,065
11,735
3,122
5,158
Gross debt
Net debt
Net gearing (%)
88
169
314
0
0
0
0
0
0
95
(111)
27
(966)
(2,529)
(3,063)
(3,782)
(4,359)
(274)
(318)
Net cash
1.6
Net cash
Net cash
Net cash
Net cash
Net cash
Net cash
Net cash
20 April 2012
Luk Fook – cash flow projections
2009
2010
2011
2012F
2013F
2014F
2015F
318
635
1,024
1,545
1,538
1,910
2,313
39
44
51
52
65
81
96
355
679
1,075
1,597
1,603
1,991
2,409
25
(26)
24
(9)
(1)
(3)
(1)
Inventory
29
(513)
(870)
(1,144)
(384)
(986)
(953)
Receivables
(3)
(32)
(36)
(58)
(34)
(46)
(55)
Payables
(26)
272
156
367
(14)
430
(18)
Tax paid
(48)
(71)
(108)
(184)
(239)
(272)
(343)
EBIT
EBITDA
Interest paid
Interest received
8
3
5
0
0
0
0
(0)
(0)
(1)
(8)
(9)
(11)
(13)
Operating cash flow
340
311
244
561
922
1,103
1,025
Capex
(30)
(315)
(101)
(140)
(160)
(160)
(160)
Free cash flow
311
(4)
143
421
762
943
865
2
2
2
8
9
11
13
0
0
0
0
0
0
1
Share issue
0
0
1,134
1,363
0
0
0
(101)
(133)
(279)
(228)
(238)
(236)
(300)
Dividend paid
0
0
0
0
0
0
1
212
(136)
1,000
1,563
534
719
580
Year to December
2009
2010
2011
2012F
2013F
2014F
2015F
ROAE (%)
23.5
36.5
34.1
28.1
20.1
21.0
21.0
ROAA (%)
15.9
24.4
25.2
22.8
16.7
17.4
17.5
ROIC (%)
24.2
37.5
41.4
44.4
35.2
37.6
37.4
146
132
129
133
139
139
141
3
4
4
4
4
4
4
33
35
36
36
37
37
37
Net cash flow
Luk Fook – key financial ratios
Net gearing (%)
Gross gearing (%)
89
116
100
97
101
107
106
109
Net cash
0.0
Net cash
Net cash
Net cash
Net cash
Net cash
13.3
18.6
0.0
0.0
0.0
0.0
0.0
20 April 2012
Company-specific investment risks
Share disposal risk
Luk Fook’s major shareholders and directors have a history of reducing ownership in
Luk Fook, exhibited in the below table. Capital raised in the past was mainly used to
raise the company’s liquidity, purchase inventory and expand. While the company’s
key shareholders remain the same, we nevertheless view Luk Fook’s history of share
disposals as a key risk that could trigger short-selling of the stock.
Luk Fook – past capital raising activities
Type
# of shares issued
Net proceeds
HK$ / share
December 2010
Issue date
Top-up placement
42,000,000
1,134
23.15
January 2011
Top-up placement
46,600,000
1,341
29.25
Directors
Mr. Wong Wai Sheung – Chief Executive Officer and founder
Mr. Wong has over 43 years of experience in the Hong Kong jewelry industry and is
responsible for overall strategic planning and management of the group. Mr. Wong is
also the Associate Director of The Kowloon Gold Silver and Jewel Merchant’s Staff
Association, a post he has held since November 1993. He has also been the
Honorary Permanent Chairman of Jadeware Traders Industry & Commerce
Association and Chairman of the Supervisory Committee of Kowloon Jewellers’ and
Goldsmiths’ Association since 2001. In 2005 he was elected Honorary Chairman of
Macau Goldsmith’s Guild and appointed Honorary Chairman of the First General
Committee of Guangdong Golden Jewelry and Jade Industry’s Association in 2006.
He has been a member of the Hong Kong Trade Development Council Jewellery
Advisory Committee and the QTSA Governing Council (Retailer Category) and an
elected member of the General Committee of the Hong Kong Brand Development
Council sine 2008. Mr. Wong is the father of Mr. Wong Ho Lung, Danny and Miss
Wong Lan Sze, Nancy, all directors at the company.
Mr. Tse Moon Chuen – Director, deputy general manager and co-founder
Mr. Tse has over 37 years of experience in the jewellery retailing business and is
responsible for sales operations and administration of the group’s retail shops. He has
been appointed to various positions over the years including as an executive
committee member of the Diamond Federation of Hong Kong, China Ltd. since 2000;
an alternate committee member of the Chinese Gold & Silver Exchange Society since
July 2004 and Vice-Chairman of the Kowloon Pearls, Precious Stones, Jade, Gold
and Silver Ornament Merchants Association since 2005.
Mr. Law Tim Fuk, Paul – Director, Company secretary and Financial
controller
Mr. Lau joined the group in 1996. He is a member of the ACCA, the CIMA, the HK
ICSAN. Mr. Law has over 16 years of accounting and auditing experience and over 19
years of experience in commerce. He is mainly responsible for the accounting and
finance of the group. He also handles communications with institutional investors and
financial reporters.
90
20 April 2012
Senior Management
Mr. Au Kwok Kau – General manager and co-founder
Mr. Au is one of the co-founders of the company and was the General Manager of the
group since 1992. Since 2007 he has served as the group General Manager. Mr Au is
responsible for the overall administration of Luk Fook and has over 38 years of
experience in Hong Kong’s jewelry industry.
Ms. Chung Vai Ping, Icy – Senior Product Development Manager
Ms. Chung has over 20 years experience within the jewelry industry. She joined the
group in 1990 and is mainly responsible for the product development, jewelry
purchasing, wholesaling and retailing business of the group. Ms. Chung frequently
visits jewelry exhibitions worldwide in order to explore new products and source the
finest jewelry and jewelry parts. In 2001, she won the Best of Show Award with her
“Flashing” design at the 2nd Hong Kong Jewellery Design Competition. She was
awarded the title GIA Diamonds Graduate in 2004.
Luk Fook’s shareholding structure
Luk Fook (Control) Ltd.
39.8%
Public
60.2%
Luk Fook Holdings Ltd.
(590 HK)
91
20 April 2012
Appendix : Peer comparison
Chow Tai Fook (1929 HK)
Emperor (887 HK)
Hengdeli (3389 HK)
Year to March
Year to December
Year to December
Luk Fook (590 HK)
Year to March
FY11
FY12F
FY10
FY11
FY10
FY11
FY11
FY12F
1,361
1,620
61
80
350
405
699
817
1,277
1,528
40
57
286
332
657
772
84
92
21
23
64
73
42
45
Direct
970
1,146
61
80
350
405
81
99
Franchised
391
474
–
–
–
–
618
718
Total POS
Total POS by region
China
Hong Kong, Macau & others
POS breakdown by format
POS breakdown by format (%)
Direct
71
71
100
100
100
100
12
12
Franchised
29
29
–
–
–
–
88
88
Total sales (HK$m)
35,046
55,615
4,095
5,862
7,157
9,462
8,091
11,530
Direct retail
30,033
46,438
4,095
5,862
5,553
7,145
6,440
9,560
Wholesale
5,009
9,177
–
–
1,447
2,122
739
937
–
–
–
–
157
196
912
1,033
Other
Sales mix – by channel (%)
Direct retail
86
83
100
100
78
76
80
83
Wholesale
14
17
–
–
20
22
9
8
Other
–
–
–
–
2
2
11
9
Sales mix – by region (HK$m)
China
19,472
31,272
462
622
4,731
6,455
1,468
1,942
Hong Kong
15,571
24,343
3,366
4,863
2,101
2,626
5,986
8,919
–
–
267
377
325
381
637
669
Other
Sales mix – by region (%)
China
56
56
11
11
66
68
18
17
Hong Kong
44
44
82
83
29
28
74
77
Other
–
–
7
6
5
4
8
6
Sales mix – by product (HK$m)
Gem-set jewelry
8,963
–
633
1,030
–
–
2,898
–
Platinum/karat gold products
4,869
–
–
–
–
–
–
–
Gold items
18,725
–
–
–
–
–
3,542
–
Watches
2,486
–
3,461
4,832
7,157
9,462
–
–
Sales mix – by product (%)
Gem-set jewelry
26
–
15
18
–
–
45
–
Gold items
67
–
–
–
–
–
55
–
Watches
7
–
85
82
100
100
–
–
28.3
29.5
25.6
28.8
24.9
25.1
23.7
23.9
Gross profit margin (%)
(continued on next page)
92
20 April 2012
Appendix : Peer comparison (continued from previous page)
Chow Tai Fook (1929 HK)
Emperor (887 HK)
Hengdeli (3389 HK)
Year to March
Year to December
Year to December
FY11
Luk Fook (590 HK)
Year to March
FY12F
FY10
FY11
FY10
FY11
FY11
FY12F
Key SG&A expense ratio (%)
Rental
5.7
5.0
6.7
6.9
5.7
5.5
3.1
3.2
Staff
5.2
4.8
3.8
3.9
5.1
5.3
4.7
5.1
Other operating expense
4.6
4.2
1.1
1.2
0.8
0.9
3.4
3.5
1,545
EBIT (HK$m)
4,656
8,861
413
764
729
1,054
1,024
EBIT margin (%)
13.3
15.9
10.1
13.0
10.2
11.1
12.7
13.4
EBITDA (HK$m)
4,402
8,475
454
831
775
1,117
1,075
1,597
EBITDA margin (%)
12.6
15.2
11.1
14.2
10.8
11.8
13.3
13.8
Net profit (HK$m)
3,538
6,516
134
627
482
678
877
1,320
Normalised net profit (HK$m)
3,538
6,516
325
636
482
678
866
1,303
Normalised net profit margin (%)
10.1
11.7
7.9
10.9
6.7
7.2
10.8
11.4
133
192
210
207
243
166
165
129
14
13
17
12
23
25
4
4
6
6
(40)
(35)
(52)
(75)
(36)
(36)
101
200
218
184
219
136
115
97
Gross debt (HK$m)
6,813
13,100
67
340
2,956
3,530
0
0
Net debt (HK$m)
1,208
(8,300)
(534)
(464)
(14)
252
(966)
(2,529)
Net gearing (%)
10.3
Net cash
Net cash
Net cash
Net cash
6.2
Net cash
Net cash
ROAE (%)
36.4
32.5
6.6
20.5
14.9
16.9
34.1
28.1
ROAA (%)
15.9
16.0
5.1
16.1
7.8
7.9
25.2
22.8
ROIC (%)
24.3
28.1
20.8
24.4
17.8
20.7
41.4
44.4
* As % of direct retail sales
Note: Hengdeli’s data was originally presented in RMB; RMB/HK$ exchange rate of 1.2 was applied to all figures
93
20 April 2012
Rating definitions
Outperform (O) – expected return >10% over the next twelve months
Neutral (N) – expected return between -10% to 10% over the next twelve months
Underperform (U) – expected return < -10% over the next twelve months
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or issuers; and (ii) no part of any of their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this report;
and (iii) they receive no insider information/non-public price-sensitive information in relation to the subject securities or issuers which may influence the recommendations
made by them. The authors of this report further confirm that (i) neither they nor their respective associate(s) (as defined in the Code of Conduct issued by the Hong Kong
Securities and Futures Commission) has dealt in or traded in the securities covered in this research report within 30 calendar days prior to the date of issue of the report; (ii)
neither they nor their respective associate(s) serves as an officer of any of the Hong Kong listed companies covered in this report; and (iii) neither they nor their respective
associate(s) has any financial interests in the securities covered in this report.
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Limited, its affiliates and/or subsidiaries (collectively “CCBIS”) do not warrant its completeness or accuracy or appropriateness for any purpose or any person whatsoever.
Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Investment involves risk and past performance is
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CCBI group has an investment banking relationship with Chow Tai Fook Jewellery Group Ltd. (1929 HK) within the past 12 months.
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Initiation on Jewelry and Watch Sector

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