A Fast Developing Jewellery Retailer in HK and Mainland ...pg.jrj.com.cn/acc/Res/HK_RES/STOCK/2014/3/6/59784193-737b-48c… · GTJA Research 国泰君安研究 Luk Fook Jewellery

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Company Report: Luk Fook Jewellery (00590 HK) Kevin Guo 郭勇

公司报告：六福珠宝 (00590 HK) +86 755 [email protected]

6 March 2014

A Fast Developing Jewellery Retailer in HK and MainlandMarkets 一家在香港和大陆市场快速发展的珠宝零售商

Luk Fook Jewellery is a fast developing jewellery retailer in the Hong Kong, Macau and Mainland China markets. Luk Fook puts forth maximum effort to reach its goal of becoming a globally recognized and desired brand, and is one of the Hong Kong’s most renowned brands in the luxury industry.

Luk Fook has established an extensive jewellery retail network in Hong Kong, Macau and Mainland China. The Company had a total of 1,188 POS in 1H2014 and 1,132 are located in Mainland China. The Company plans to open 150-200 POS each year in Mainland China in the next 3 years.

We expect jewellery consumption demand of Mainland China to continue to rise due to growing disposable income of residents and the expansion of middle-income and high middle-income groups.

Total revenue of the Company is expected to increase by 40.9%, 18.8% and 13.4%, respectively, from FY2014 to FY2016 due to expanding retail network and SSSG. Total EPS is expected to increase by 37.0%, 12.0% and 14.3%, respectively, to HKD 2.946, 3.299 and 3.711 from FY2014 to FY2016.

Initiate coverage with “Buy” rating and TP of HKD33.00. Our target price of HK$ 33.00 represents 10.0x FY15PE.

六福珠宝是一家在香港、澳门和大陆市场快速发展的珠宝零售商。公司致力于使六福成为

全球知名和喜爱的品牌以及香港知名的奢侈品牌之一。

六福在香港、澳门和中国大陆建立了一个广泛的珠宝零售网络。截止 2014 财年上半年公

司共拥有 1,188 家零售点，其中 1,132 家位于大陆。公司计划未来 3 年在大陆每年新开

150-200 家零售点。

我们预计大陆居民的珠宝消费需求将随着可支配收入的增加以及中等收入群体、中高收入

群体的扩大而不断上升。

随着零售网络的扩大以及同店销售增长，预计公司 2014 至 2016 财年的收入增长将分别达

到 40.9%，18.8%和 13.4%。公司每股盈利 2014 至 2016 财年将分别增长 37.0%，12.0%和 14.3%至 2.946, 3.299 和 3.711 港元。

首次覆盖目标价为 33.00 港元，相当于 10.0 倍 FY15 PE, 投资评级为“买入”。

Rating: Buy Initial 评级：买入 (首次研究)

6-18m TP 目标价: HK$33.00Revised from 原目标价: n.a. Share price 股价： HK$25.500

Stock performance 股价表现

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HSI Index Luk Fook Jewellery

Change in Share Price 股价变动

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1 Y 1 年

Abs. % 绝对变动 % (2.9) (11.1) 1.2 Rel. % to HS index 相对恒指变动 % (9.0) (6.4) 1.1 Avg. share price(HK$) 平均股价（港元） 26.8 27.7 23.9

Source: Bloomberg, Guotai Junan International.

Year End 年结

Turnover 收入

Net Profit 股东净利

EPS 每股净利

EPS每股净利变动

PER市盈率

BPS每股净资产

PBR市净率

DPS 每股股息

Yield 股息率

ROE净资产收益率

03/31 (HKD m) (HKD m) (HKD) (△%) (x) (HKD) (x) (HKD) (%) (%)

2012A 11,907 1,334 2.430 42.1% 11.3 10.262 2.7 0.960 3.485 29.6 2013A 13,412 1,266 2.150 -11.5% 12.8 11.298 2.4 0.860 3.122 21.1 2014F 18,902 1,735 2.946 37.0% 9.4 12.777 2.2 1.178 4.277 25.0 2015F 22,453 1,944 3.299 12.0% 8.3 14.602 1.9 1.485 5.389 24.3 2016F 25,452 2,222 3.771 14.3% 7.3 16.310 1.7 2.074 7.529 24.6 Shares in issue (m) 总股数 (m) 589.1 Major shareholder 大股东 Luk Fook Control 39.8%Market cap. (HK$ m) 市值 (HK$ m) 15,493.5 Free float (%) 自由流通比率 (%) 60.2%3 month average vol. 3 个月平均成交股数 (‘000) 2,110.9 FY14 Net gearing (%) FY14 净负债/股东资金 (%) Net cash52 Weeks high/low (HK$) 52 周高/低 34.000 / 16.880 FY14 Est. NAV(HK$) FY14 每股估值（港元） 44.8

Source︰the Company, Guotai Junan International.

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Industry The macro economy of China is expected to maintain fast growth in the next 5 years. Chinese macro economy rebounded faster than developed countries in the wake of global financial crisis. Although the economic growth of China is expected to slow down in the next few years due to economic structural reform, it is still expected to maintain above the level of about 7%, which is also much higher than that of western developed countries and most other countries. The new leaders of China intentionally slightly revise down GDP growth target to pursue more harmonious economic growth. In the mean time, we expect the GDP per capita of China to grow in accordance with that of macro economy and maintain growth at a high single digit. The disposal income of Chinese residents grew fast in the past decade and the middle income group expanded significantly. We expect the disposal income growth rate of urban residents to maintain at high single-digit level, which is supported by the steady economic growth of China and growing property income. We expect the net income of rural residents to grow faster than that of disposal income of urban residents, which is expected to maintain at double-digital level, due to low historical base, more salary income and transfer income from the government.

National retail sales and jewellery consumption are expected to maintain fast growth due to rising disposable income and consumption oriented economic growth. National retail sales maintained double-digit growth in the past decade due to fast economic growth and living standard improvement. We expect national retail sales to maintain fast growth in the coming years due to higher disposal income, higher urbanization rate and the improvement of social security system. On the other hand, the consumption oriented economic structural transformation will also promote consumption. Generally speaking, jewellery retail sales of China grew faster than that of retail sales, especially in recent years. The preference of gold jewellery

Figure 1: The GDP Growth of Chinese Economy Figure 2: GDP Per Capita of China

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Source: National Bureau of Statistics of China, Guotai Junan International. Source: National Bureau of Statistics of China, Guotai Junan International.

Figure 3: Disposal Income Per Capita of Urban Residents

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of Chinese traditional culture and higher disposal income are the main drivers of jewellery consumption. We expect jewellery retail to maintain fast growth rate in the coming years as the middle income group of China expands quickly.

The massive amount of newly married couples in the coming years and more and more regions with higher income are positive for jewellery consumption. Citizens born in 1980s and 1990s are a relatively large group in China and their age is eligible for marriage. It is common in traditional Chinese culture to buy gold jewellery and other jewelleries as a wedding gift. Hence, a large number of newlyweds each year in China is a strong driver of jewllery consumption. We expect the newlyweds to maintain high single-digit growth in the next 3 years. At the same time, thanks to persistent economic growth, more and more municipal regions are becoming high income regions with strong consumption ability. In 2012, among all the 289 municipal regions, about 30% of them had a GDP per capita of more than RMB 50,000 and 14 of them had a GDP per capita of higher than RMB 100,000. As the Chinese economy is expected to maintain fast growth in the next few years, we expect more and more municipal regions to become rich regions with strong consumption ability.

Tourists from Mainland are expected to maintain at high growth level in the next few years. With further development of the economy of Mainland China and social connections between the Mainland and Hong Kong and the relaxation of the Individual Visit Scheme, Mainland visitors to Hong Kong kept on increasing fast in the past. The Individual Visit Scheme has been expanded to cover more than 50 Mainland cities since its introduction in July 2003. Starting from April 2009, individual visit exit endorsements valid for one year and good for multiple visits have been issued to eligible Shenzhen residents visiting Hong Kong. Over the past five years, the number of Mainland visitors travelling on this type of exit endorsement increased drastically. Total Mainland tourists have exceeded 40 million in 2013 and represented nearly 75% of the total tourists of Hong

Figure 5:Social Retail Sales of China Figure 6: Jewellery Retail Sales of China

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Figure 7: Married Couples of China Figure 8: Municipal Distribution of GDP Per Capita in 2012

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Kong. Although Hong Kong tourism infrastructure is becoming saturated and the Individual Visit Scheme might be tighten, we expect tourists from Mainland China to maintain fast growth as Hong Kong is still attractive as a popular tourism destination and shopping paradise.

Gold market: Gold prices are under long-term pressure Gold prices plunged due to various negative factors in 2013. Gold prices plunged nearly 30% in 2013 from its record high of US$ 1,923.7/oz as the global financial market risks mitigated and investors are worrying over that central banks will scale back their loose monetary policy. The policy trend of the Federal Reserve remains to be the major determinant of gold prices. As the U.S. economic recovery gained momentum, Federal Reserve policy makers signaled that they may further scale back on stimulus, curbing demand for gold as a safe haven. Besides, investors started to abandon gold asset since the beginning of 2013 as equity markets in the developed countries performed well. As a result, gold prices plunged significantly in 2013.

The loose monetary policy of major central banks provides strong support for gold prices and we do not expect them to change in near-term. As the global economy remains weak, we don’t see any likelihood of monetary stimulus being ever ramped down any time soon. The slow-down of economies gave central banks justification for maintaining their monetary easing. At the same time, the long-term real interest rate remains low which helps support gold prices. Although economic risks and uncertainties in the financial system have been mitigated recently, they remain at high levels and thus make gold an attractive asset. We believe the loose monetary policy will not come to an end until the global economy gains robust growth

Figure 9: Tourist Arrivals to Hong Kong Figure 10: Tourist Arrivals Growth Rate

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Source: Hong Kong Immigration Department, Hong Kong Economic Journal, Guotai Junan International.

Source: Hong Kong Immigration Department, Hong Kong Economic Journal, Guotai Junan International.

Figure 11: Gold Prices Figure 12: Real Interest Rate and Gold Prices

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momentum. However, several central banks do start to scale back from quantitative easing as macro economy improves but without specific quitting roadmap, which will weigh on gold prices.

Global inflation remains at low levels, which reduces gold’s attraction for value-reserve. Although central banks started to pump large sums of money into economy since 2009, global inflation generally remains at low levels. The bumping economies which lack recovery momentum are unable to transform the massive money into higher inflation level. As the global economy is not expected to grow fast in the coming years, we expect global inflation to remain at current levels and residents are not expected to flock to gold for value-reserve. We expect gold prices to remain under long-term pressure and to decline in the coming years. We expect gold prices to come under pressure in the long-term as some central banks start to scale back from quantitative easing. The massive selling of gold assets by speculators also has negative impact on gold prices. In the short-term, global low interest rate environment and loose monetary policies of major central banks will provide support to gold prices. Besides, central banks continue to expand their gold reserves while consumption demand from India and China remains strong. Thus, we expect gold to be traded around US$1,200 in the near-term. We expect gold prices to decline slowly in 2014-2015 as global economic risks are mitigated further and the macro economy gains robust recovery.

Figure 13: M2 growth rate of major economies Figure 14: Total known ETF holdings of gold

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Company Profile Luk Fook Jewellery is a fast developing jewellery retailer in the Hong Kong, Macau and Mainland China markets. Established in 1991, Luk Fook is one of the leading jewellery retailers in Hong Kong and Mainland China. The Company is principally engaged in the sourcing, designing, wholesaling, trademark licensing and retailing of a variety of gold and platinum jewellery, gold ornaments and gem-set jewellery, with a total of over 1,100 retail shops in Mainland China, Hong Kong, Macau, Singapore, the United States and Canada. The Company was listed on the Main Board of the Stock Exchange of Hong Kong Limited in May 1997. The corporate vision of the Group is to become the “Brand of Hong Kong, Sparkling the World”. Luk Fook puts forth maximum effort to reach its goal of becoming a globally recognized and desired brand, and as one of the Hong Kong’s most renowned brands in the luxury industry. The Group commits to crafting the finest jewellery for customers to further establish its reputation in the international market. Hong Kong is the largest single market of the Company. In recent years, Luk Fook has also expanded its jewellery retail network in Mainland China rapidly, in order to benefit from the rising jewellery and luxury goods consumption demand of mainland citizens. Business Overview Brand The brand “六福”( Luk Fook) is a well-known jewellery brand in Hong Kong, Macau and Mainland China. The Company has put forth continuous effort to build a brand image that is welcoming and warm-hearted through various aspects including marketing campaigns and excellent service programs. Intensive marketing campaigns help the Company to communicate its unique brand image to the public and retain customer loyalty. To further strengthen the connection between Lukfook and the concept of beauty, the brand not only sponsored the diamond crown and precious jewellery pieces for the “Miss Hong Kong Pageant” for the 15th consecutive year, but also served as the exclusive sponsor of the crown for the “Miss Universe China Reignwood Pageant” for the 2nd year and the jewellery sponsor of the “Miss Chinese Pageant” in Vancouver and Toronto, Canada. The “Luk Fook” brand of the Company was granted “Well-known Trademark” title by the State administrative authorities in Mainland China, which reaffirms Luk Fook’s rising recognition and brand awareness in Mainland China. Retail network Luk Fook has established an extensive jewellery retail network in Hong Kong, Macau and Mainland China. Luk Fook opened about 1,200 POS as of date 31 December 2013. Hong Kong and Macau are the most important single market of the Company and the Company had a total of 42 and 10 POS, respectively, in Hong Kong and Macau as of date 31 December 2013. The Company continues to open the new jewellery POS in Hong Kong and Macau, which are the main tourist destinations of Mainland residents. At the mean time, the opening of new POS in Mainland China maintained at a high level of about 200 each year, which significantly expands the total retail network coverage of the Company. As of date 30 September 2013, Luk Fook had a total of 1,132 jewellery POS in Mainland China. The Company has accelerated the opening of new POS in recent years as the consumption need of jewellery of mainland residents rose significantly. Generally speaking, the POS coverage of lower tier cities in the PRC grew faster than that of developed regions. The Company is strongly positioned to benefit from the fast rising jewellery demand from Mainland residents. Generally speaking, the middle-class and high-middle class group of Mainland China have expanded rapidly in recent years as rising disposal income and the fast growth of real estate prices are making Mainland residents richer and richer. As a well-known jewellery brand originated in Hong Kong, Luk Fook has established extensive retail network in Mainland China and the network is still expanding and penetrates into lower tier cites. The Company also opens more jewellery and watch POS in Hong Kong and Macau as well, which are popular tourism destinations of Mainland residents. With the current expanding strategy, we believe the Company is well positioned to benefit from the fast growing jewellery demand of Mainland Citizens.

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Table 1: The Retail Network of Luk Fook FY2009 FY2010 FY2011 FY2012 FY2013 1H2014

Hong Kong 30 31 33 32 37 42 Macau 4 4 5 6 9 10 Other locations 2 3 5 5 4 4 Mainland China 419 519 657 819 1,022 1,132 Total jewellery POS 455 557 700 862 1,072 1,188 Total jewellery POS yoy 22.4% 25.7% 23.1% 24.4% 20.9%

Source: The Company, Guotai Junan International.

Operation model Luk Fook relies heavily on franchisee retailers in Mainland China market. The jewellery POS of the Company consists of self-operated stores and franchised stores, which usually operate as standalone stores or concessionaire counters in department stores. All of the jewellery POS in Hong Kong, Macau and other locations are self-operated stores under the direct control of the Company. However, Luk Fook relies heavily on franchisees to expand in the Mainland China market. As we can see, among all the jewellery POS in Mainland China, only slightly higher than 10% of all the POS are self-operated stores while the rest is franchise stores. The franchise model helps expand the retail footprint of the Company quickly, especially in Tier III cities and Tier IV cities, as the Company could leverage on the local knowledge and premises of franchisees and provide the Company with a flexible and faster rollout strategy that requires minimal capital commitment. Although the Company selects its franchisees carefully, the daily operations of franchise POS are not under direct control of the Company. Table 2: The Operational Model of Luk Fook POS

FY2009 FY2010 FY2011 FY2012 FY2013 1H2014 Self-operated 55 74 81 104 128 135 Licensed 400 483 619 758 944 1,053 Total 455 557 700 862 1,072 1,188

Self-operated 12.1% 13.3% 11.6% 12.1% 11.9% 12.1% Licensed 87.9% 86.7% 88.4% 87.9% 88.1% 87.9%


Table 3: The Operational Model of Luk Fook POS in Mainland

FY2009 FY2010 FY2011 FY2012 FY2013 1H2014 Self-operated 19 36 39 61 78 79 Licensed 400 483 618 758 944 1,053 Total 419 519 657 819 1,022 1,132

Self-operated 4.5% 6.9% 5.9% 7.4% 7.6% 7.0% Licensed 95.5% 93.1% 94.1% 92.6% 92.4% 93.0%


Revenue breakdown by business Jewellery retail is the largest business of the Company, but the jewellery wholesale business also grew steadily. Total revenue of the Company consists of jewellery retail business, jewellery wholesale business and licensing business. Jewellery retail business refers to jewellery sold through self-operated POS. Although the number of self-operated POS is relatively small, they are mainly located in Hong Kong, Macau and large cities in Mainland. The average turnover of Hong Kong and Macau POS is much larger than that of Mainland POS. As a result, jewellery retail business contributed the largest part of revenue to the Company. Jewellery wholesale business refers to jewellery sold through franchised POS, mainly located in Mainland China. Jewellery wholesale business contributed about 15% of total revenue to the Company in FY2013. However, they are expected to grow fast in the coming years as the Company accelerates opening of new jewellery POS in Mainland

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through licensed POS. Table 4: Revenue Breakdown by Business

HKD million FY2009 FY2010 FY2011 FY2012 FY2013 1H2014 Retailing 3,075.6 4,090.8 6,440.1 9,667.8 10,933.4 18,628.4 Wholesaling 746.1 1,122.1 1,375.5 1,813.0 2,027.7 2,437.1 Licensing 137.5 173.5 275.6 426.7 450.5 518.1 Total 3,959.2 5,386.4 8,091.1 11,907.4 13,411.7 21,583.6

Retailing 77.7% 75.9% 79.6% 81.2% 81.5% 86.3% Wholesaling 18.8% 20.8% 17.0% 15.2% 15.1% 11.3% Licensing 3.5% 3.2% 3.4% 3.6% 3.4% 2.4%


Revenue breakdown by geography Hong Kong is the largest single market of the Company, but the proportion contributed by Mainland China grew steadily. Although Luk Fook only has 37 POS in Hong Kong, they contributed 65% of total revenue in FY2013. Mainland tourists visiting Hong Kong increased fast in the past few years and jewellery is usually a favourite commodity on their purchase list. The situation remains the same to that of Macau as Mainland tourists going to Macau also maintained fast growth in the past few years. Mainland market took about 20% share of the total revenue of the Company but holds great growth potential. As a matter of fact, Mainland tourists are the largest single consumer group of the Company as most jewellery sold in Hong Kong and Macau are purchased by Mainland tourists. The fast expansion of retail network in Mainland China not only helps lift jewellery sales, but also raises the brand awareness of the Company. Table 5: Luk Fook Revenue Breakdown by Geography

HKD million FY2009 FY2010 FY2011 FY2012 FY2013 1H2014 Hong Kong 3,113.1 4,003.3 5,886.8 8,278.5 8,715.9 6,456.3 Mainland China 551.5 855.5 1,401.8 2,204.6 2,841.6 2,112.6 Other locations 294.7 527.6 802.6 1,424.3 1,854.2 1,497.2 Total 3,959.2 5,386.4 8,091.1 11,907.4 13,411.6 10,066.1

Hong Kong 78.6% 74.3% 72.8% 69.5% 65.0% 64.1% Mainland China 13.9% 15.9% 17.3% 18.5% 21.2% 21.0% Other locations 7.4% 9.8% 9.9% 12.0% 13.8% 14.9%


Figure 15: Luk Fook Revenue Breakdown by Business Figure 16: Luk Fook Revenue Breakdown by Geography

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Source: The Company, Guotai Junan International. Source: The Company, Guotai Junan International.

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Product structure Gold and platinum products contribute the largest part of revenue while gem-set jewellery products contribute the largest part of gross profit. Generally speaking, gold and platinum products are the most popular products for Mainland tourists and the plunge of gold prices in 2013 also promoted the sales of gold products. Well known for its exquisite product design as well as brilliant craftsmanship, the Company has a diversified product mix to satisfy the needs of a wide range of customers. The Company has introduced the following selections:“Love is Beauty Collection”, “Wedding Collection”, “Love Forever Collection” and etc. to target middle class and high-end consumer markets in Mainland China, Hong Kong, Macau and overseas. However, gem-set jewellery products contributed the largest part of gross profits as they are sophisticated designed and crafted and usually with higher gross margin.

Figure 17: Luk Fook Revenue Breakdown by Product Figure 18: Luk Fook Gross Profit Breakdown by Product

38%

62%

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63%

Inner: FY2012 Outer: FY2013

Gem-set

Gold & platinum

65.2%

34.8%

65.5%

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Gem-set

Gold & platinum


Figure 19: Luk Fook Revenue Breakdown by Product Figure 20: Luk Fook Gross Profit Breakdown by Product

37.30%

62.70%

28.20%

71.80%

Inner: 1H2013 Outer: 1H2014

Gem-set

Gold & platinum64.10%

35.90%

56.30%

43.70%

Inner: 1H2013 Outer: 1H2014

Gem-set

Gold & platinum


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Financial analysis The Company will continue to expand the retail network at a fast pace and add about 150-200 POS each year in China in the next 3 years. In order to capture the opportunity of rising jewellery consumption demand of mainland residents, the Company will keep on expanding its retail network in Hong Kong and Mainland China. We expect jewellery retail POS in Hong Kong and Macau to grow steadily in the next 3 years and add about 3-5 POS each year. Considering the high sales level of each POS located in Hong Kong and Macau, we expect the newly opened jewellery POS in Hong Kong and Macau will contribute considerable sales. Mainland China is the main market where the Company expands and we expect the Company to open about 150-200 new POS each year in the next 3 years. However, the Company depends heavily on franchisees to expand its jewellery retail network and most of the newly opened POS are licensed POS. Although it is helpful to leverage on franchisee’s local knowledge and customer base and reduce the risks and capital expenditure to expand, the Company has less control on licensed POS than self-operated POS. On the other hand, lower tier cities are the major expansion and the Company will depend more on franchisees to penetrate into these markets.

We expect the SSSG of self-operated POS to rise to about 25% in FY2014 and maintain at about 6% from FY2015-FY2017. Jewellery consumption of Mainland citizens is inspired by the fast drop of gold prices in 2013 and the total sales of the Company and other jewellery retailers benefited a lot from the fast drop of gold prices and recorded significant sales growth. We expect the SSSG of self-operated POS of the Company to rise to about 25% in FY2014 and the SSSG of Mainland self-operated POS is expected to grow faster than that of Hong Kong and Macau self-operated POS. Generally speaking, the average jewellery consumption level of mainland residents is still much lower than that of developed countries.

Figure 21: The Retail Network of Luk Fook Figure 22: Luk Fook Retail Network Breakdown

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Figure 23: Mainland POS Distribution of Luk Fook Figure 24: Mainland POS Distribution of Luk Fook

353, 43%

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As disposal income of mainland residents is expected to continue to rise amid the robust macro economic growth, more and more residents can afford to buy luxury jewellery and more willing to purchase jewellery products. As the middle income and high-middle income group continues to expand, we expect the SSSG of the Company to maintain at a high growth level. We expect gold prices to continue to decline in the next 3 years, thus boosting the consumption of gold products in Mainland China which was evident in 2013. We expect the SSSG of self-operated to maintain at about 6% from FY2015-2017. Total revenue of the Company is expected to grow by 40.9%, 18.8% and 13.4%, respectively, from FY2014 to FY2016. We expect total sales of the Company to maintain at a fast growth rate in the next 3 years. The Company benefits greatly from rising jewelley consumption demand of mainland residents due to its extensive jewellery network. Total revenue growth of the Company is attributable mainly to 2 positive factors: retail network expansion and SSSG. As a result, we expect total revenue of the Company to grow by 40.9%, 18.8% and 13.4%, respectively, from FY2014 to FY2016.

Gross profit & margin analysis We expect gross profit of the Company to maintain double-digital growth from FY2014-FY2017 and the gross margin to maintain at the level of about 20.0%. We expect gross margin of the Company to decline slightly from FY2014-FY2017 and maintain above the level of about 20.0%. The fluctuation of gold prices is usually hedged by Jewellery producers through gold loans and gold futures, and the gross margin of the Company is more impacted by the product structure. Luk Fook is a strong jewellery brand and the Company possesses relatively strong bargaining power. However, we do expect the gross margin to decline slightly as the sales proportion of gold product increases. Hence, we expect total gross profit of the Company to grow along with that of total revenue. We expect total gross profit of the Company to increase significantly in FY2014 and maintain at double-digital growth from FY2015-FY2017.

Figure 25: The Operation Model of Luk Fook Figure 26: The Revenue of Luk Fook

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Operating expenses The selling and distribution costs and rental expenses of the Company are expected to grow fast, but generally remain at reasonable level. The selling & distribution costs and administrative expenses of the Company increased fast in the past few years as total revenue increased, but the growth rate was lower than that of total revenue. As a result, total share of selling and distribution costs and administrative expenses to that of total revenue even decreased. We expect selling and distribution costs of the Company to increase rapidly in the next 3 years as the Company expands, but the level is expected to remain at about 10% of total revenue. Rental costs also grew significantly as the Company opened new self-operated POS in Hong Kong, Macau and Mainland China and the new lease costs in Hong Kong rose significantly. We expect the Company to continue to come under the pressure of rising rental costs, but the impact was limited due to its relatively lower proportion, which remains at the level of about below 3.5% as of total revenue. The advertising and promotion costs are relatively small compared to that of total sales, so even the rapid growth in the future has little impact on the operating results of the Company.

Net profit & Net margin Total net profit attributable to shareholders is expected to grow by 37.0%, 12.0% and 14.3%, respectively, from FY2014 to FY2016 and net margin of the Company is expected to maintain at about 9.0%. We expect net margin of the

Figure 27: The Gross Profit of Luk Fook Figure 28: The Gross Margin of Luk Fook

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Figure 29: Selling and Distribution Costs of Luk Fook Figure 30: Rental Costs of Luk Fook

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Company to decline slightly in the next 3 years but generally stay at the level of about 9.0%. The gross margin of the Company is expected to decline slightly as the sales proportion of gold product increases. At the same time, selling and distribution costs, administrative expenses, staff and rental costs are also expected to rise, but the impact was limited. As a result, we expect net margin of the Company to decline slightly but maintain at the level of about 9.0%. Hence, total net profit attributable to shareholders is expected to grow by 37.0%, 12.0% and 14.3%, respectively, from FY2014 to FY2016.

Inventory turnover rate We expect the inventory turnover rate of the Company to remain at the level of about 2.8 from FY2014-FY2017. Given the business nature and products, Luk Fook has to maintain a substantial level of inventory in the form of raw materials and finished products. Historically, the inventory turnover rate of the Company fluctuated around 2.8 (the inventory turnover days fluctuated about 125 days), which outperformed its industry peers. We expect the inventory turnover rate of the Company to maintain at current level as there are not many changes in the operation.

Figure 31: The Net Profit of Luk Fook Figure 32: EPS of Luk Fook

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Figure 33: The Net Margin of Luk Fook Figure 34: Inventory Turnover Rate & Days of Luk Fook

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Valuation We select major Hong Kong and Mainland jewellery retailers to valuate Luk Fook. We also compare financial data of the Company to that of international luxury jewellery retailer Tiffany. We believe Chow Tai Fook and Chow Sang Sang are the closest comparable peers in Hong Kong considering revenue and POS coverage. Lao Feng Xiang, Yuyuan Shangcheng and Ming Jewellery are major jewellery retailers in Mainland China and we believe they are also comparable peers to Luk Fook. Luk Fook has comparable jewellery POS coverage as that of major Hong Kong and Mainland jewellery retailers but relies heavily on franchisees. The number of jewellery POS of Luk Fook is less than that of Chow Tai Fook, but much larger than that of Chow Sang Sang. The jewellery POS of the Company is also comparable to that of Chinese jewellery retailers in Mainland China but with unique coverage in Hong Kong and Macau. Mainland jewellery retailers do not have POS in Hong Kong and Macau, which are an important and high-value jewellery market. However, Luk Fook mainly expands its jewellery retail network in Mainland through licensed POS. The POS self-operated ratio of the Company is about 12%, which is much lower than that of the 75% of Chow Tai Fook and the 38% of Ming Jewellery, but comparable with other jewellery retailers. Table 6: Retail Networks of Hong Kong and Mainland Jewellery Retailers, end of fiscal year.

Chow Tai Fook

Luk Fook

Chow Sang Sang

Lao Feng Xiang

Yuyuan Shangcheng

Ming Jewellery

HK, Macau and other areas 108 50 44 1 0 0 Mainland China Tier I cities 232 435 Tier II cities 811 238 Tier III cities 691 349 Sub-total 1,734 1,022 274 2,300 1,658 375 Watch POS 112 Total POS 1,954 1,072 318 2,301 1,658 1,000* Source: the Company, Guotai Junan International.

*: The Company only released estimated numbers. Table 7: Operation Model of Hong Kong and Mainland Jewellery Retailers, end of fiscal year.

Chow Tai Fook

Luk Fook

Chow Sang Sang

Lao Feng Xiang

Yuyuan Jewellery

Ming Jewellery

Hong Kong, Macau and other areas 103 50 44 1 0 0 Mainland Jewellery POS Self-operated 1,209 78 149 375 Franchised 431 944 763 Other POS 1,388 Sub-total 1,640 1,022 274 Total Jewellery POS 1,743 1,072 318 2301 1,658 1,000* Self-operated ratio 75.3% 11.9% - 6.5% - 37.5% Source: the Company, Guotai Junan International. The profitability of Luk Fook is lower than that of Tiffany and Chow Tai Fook, but much higher than other jewellery retailers. Luk Fook has maintained gross margin at the level of about 21% in recent years, slightly lower than that of Chow Tai Fook but higher than Chow Sang Sang and the single digit level of mainland jewellery retailers. The net margin of Luk Fook was 9.4% in FY2013, which is comparable to that of Chow Tai Fook and also higher than that of other jewellery retailers. Sales growth rate of the Company is comparable to that of its Hong Kong peers, but is slightly lower than that of mainland jewellery retailers. The Company recorded a CAGR of 28.70% in sales from FY2011-FY2013, which is slightly higher than that of its Hong Kong peers, but lower than that of mainland jewellery retailers. However, the sales growth rate of the Company is much higher than that of Tiffany as it benefits a lot from the rising jewellery demand of Chinese residents.

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Table 8: Financial Data of Jewellery Retailers

Company Chow Tai Fook Luk Fook Chow Sang

Sang Tiffany Lao Feng Xiang Yuyuan Ming

Jewellery1929 HK 590 HK 116 HK TIF US 600612 600655 002574 HKD mn HKD mn HKD mn HKD mn HKD mn HKD mn HKD mn

FY2012/13 Revenue 57,433.9 13,411.7 18,260.2 29,428.9 31,221.7 24,752.1 8,152.6 FY2012/13 EBITDA 7,513.4 1,621.3 1,355.4 6,677.0 1,511.3 811.1 228.1 FY2012/13 Net Profit 5,505.3 1,265.8 984.8 3,227.8 751.5 1,189.9 90.7

Gross margin 28.4% 21.1% 18.8% 57.0% 7.6% 7.5% 5.8% EBITDA margin 13.1% 12.1% 7.4% 22.7% 4.8% 3.3% 2.8% Net margin 9.6% 9.4% 5.4% 11.0% 2.4% 4.8% 1.1%

3-year revenue growth CAGR 28.0% 28.7% 24.9% 10.8% 38.3% 34.5% 33.0% 3-year net profit growth CAGR 24.7% 20.9% 14.0% 6.2% 51.4% 24.1% -39.6% Source: Bloomberg, Guotai Junan International. Initiate coverage of the Company with “Buy” rating and TP of HK$33.00. Luk Fook is a fast growing jewellery retailer in the Greater China market with strong brand. The Company benefits greatly from the rising jewellery consumption demand of Chinese residents as their disposal income continues to rise and they pursue upgrade to a higher living standard. The Company continues to expand its retail network in Mainland China, especially Tier III and lower tier cities where hold great growth potential. We expect the Company to maintain its gross margin and maintain rapid growth at the same time. However, the POS self-operated ratio is lower than that of its Hong Kong and mainland peers, which is negative to the control of business. As a result, we expect that the Company should trade at a slight discount over its peers. Hence, we set our target price at HK$33.00, which represents 10.0x FY15 PE. Our investment rating for the Company is “Buy”.

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Table 9: Peers

Company Stock Code Currency Last price

PE PB ROE(%) 12A 13F 14F 15F 12A 13F 14F 15F 13F

Chow Tai Fook Jewellery Grou 1929 HK HKD 14.32 26.0 19.4 17.3 15.1 4.9 4.2 3.8 3.3 18.2 Luk Fook Holdings Intl Ltd 590 HK HKD 25.50 11.9 9.2 8.5 7.2 2.7 2.4 2.0 1.8 19.8 Chow Sang Sang Hldg 116 HK HKD 22.35 15.4 12.4 10.7 9.4 2.2 1.9 1.7 1.6 16.4 Hengdeli Holdings Ltd 3389 HK HKD 1.60 7.3 9.2 7.8 7.0 1.1 1.0 0.9 0.8 11.1 Emperor Watch & Jewellery 887 HK HKD 0.62 10.3 13.8 10.7 8.9 1.0 1.0 0.9 0.9 7.5 Simple Average 14.2 12.8 11.0 9.5 2.4 2.1 1.9 1.7 14.6 Weighted Average 22.3 17.1 15.2 13.2 4.2 3.6 3.2 2.8 17.6

Lao Feng Xiang Co Ltd-A 600612 CH CNY 25.81 22.1 18.5 14.8 12.1 4.9 4.0 3.3 2.7 23.3 Shanghai Yuyuan Tourist-A 600655 CH CNY 7.79 11.6 10.6 9.6 9.2 1.9 1.6 1.4 1.2 15.6 Zhejiang Ming Jewelry Co-A 002574 CH CNY 23.29 75.1 62.1 49.8 39.8 2.0 1.9 1.9 1.8 3.4 Simple Average 36.3 30.4 24.7 20.4 2.9 2.5 2.2 1.9 14.1 Weighted Average 28.9 24.4 20.0 16.7 3.1 2.7 2.3 1.9 16.2

Tiffany & Co TIF US USD 93.34 28.5 24.8 21.9 19.3 5.0 4.6 4.2 3.8 16.6 Cie Financiere Richemon-Reg CFR VX CHF 87.10 19.7 18.9 17.1 15.2 4.7 3.7 3.3 2.9 20.4 Swatch Group Ag/The-Br UHR VX CHF 580.00 19.6 18.5 16.7 15.0 3.4 3.1 2.8 2.4 17.6 Titan Co Ltd TTAN IN INR 245.65 30.1 29.5 25.7 21.1 14.9 11.3 8.9 7.2 43.0 Simple Average 24.4 22.9 20.4 17.6 7.0 5.7 4.8 4.1 24.4 Weighted Average 20.9 19.7 17.7 15.8 4.6 3.9 3.4 3.0 19.8

Source: Bloomberg, Guotai Junan International.

Note: Companies with fiscal year ended at 31 March have been adjusted to be comparable to Companies with calendar year.

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Major risks Retail network expansion likely to slow down given high penetration rate. The retail network of Luk Fook is expanding fast. However, the opening of new POS might slow down in the future given high penetration rate, especially in developed regions, such as Hong Kong, Macau, Tier I and Tier II cities. Risks related to fluctuations of raw material prices. The Company has to maintain a substantial inventory level of raw materials for the production, and fluctuations of raw materials prices could lead to meaningful loss. Challenging economic conditions and economic uncertainty could adversely affect sales growth of the Company. Turnover of the Company is particularly sensitive to changes in economic conditions and consumer confidence, especially those in the PRC, Hong Kong and Macau. Consumer confidence is affected by, among other factors, general business conditions, stock market and real estate market conditions, as well as current and expected future global or regional macro economic conditions such as employment rate, inflation and interest rate. Market competition. The jewellery business is highly competitive. The Company faces competition from many competitors on the national or local level, including those high-end international luxury brands, Hong Kong jewellery retailers and mainland retailers. If the Company is unable to remain competitive, it will lose market share to their competitors as well as new entrants. The Individual Visit Scheme might be tightened in the Future. The tourism infrastructure of Hong Kong is nearly saturated due to the fast growth of Mainland tourists and the government administration might consider to tighten the Individual Visit Scheme. Mainland tourists is the largest single customer group of the Company and the tighten of Individual Visit Scheme will slow down the growth rate of Mainland tourists.

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Income Statement Yr end 31 Mar (HKD m) 2012A 2013A 2014F 2015F 2016F Sales 11,907 13,412 18,902 22,453 25,452 COGS (9,149) (10,582) (14,933) (17,873) (20,260) Gross profit 2,759 2,830 3,969 4,580 5,192 Selling and distribution costs (1,076) (1,311) (1,815) (2,156) (2,418) Administrative expenses (136) (115) (189) (225) (255) Other Income and Gains 71 105 112 120 127 Other Expenses and Losses (22) 13 (13) (7) (2) Finance Costs 0 6 7 7 8 Profit before tax 1,595 1,530 2,072 2,321 2,653 Taxation (248) (260) (332) (371) (424) Profit after tax 1,347 1,269 1,741 1,950 2,228 Minority Interest (13) (3) (5) (6) (7) Profit attributable to shareholders' 1,334 1,266 1,735 1,944 2,222 EPS 2.430 2.150 2.946 3.299 3.771 DPS 0.960 0.860 1.178 1.485 2.074 Source: the Company, Guotai Junan International.

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Balance Sheet Yr end 31 Mar (HKD m) 2012A 2013A 2014F 2015F 2016F Property, plant and equipment 395 516 623 698 739 Land use rights 49 189 232 254 265 Investment properties 62 32 36 39 43 Interests in an associate 8 7 15 10 11 Trading licence 1 1 1 1 1 Rental deposits and prepayments 64 100 108 117 126 Deferred income tax assets 30 30 33 36 40 Non-Current Assets 609 876 1,048 1,156 1,225 Inventories 4,330 4,955 5,671 6,736 7,636 Trade receivables 163 317 378 404 458 Deposits, prepayments and other receivables 98 198 218 239 263 Amount due from an associate 0 4 12 13 14 Income tax recoverable 0 25 30 32 34 Cash and cash equivalents 1,538 1,187 1,757 1,900 2,096 Current Assets 6,129 6,686 8,066 9,324 10,501 Total Assets 6,738 7,562 9,114 10,480 11,726 Deferred income tax liabilities 24 42 49 54 59 Employee benefit obligations 54 38 42 46 50 Long-term bank borrowings, secured 0 0 0 0 0 Non-current liabilities 78 80 90 100 110 Trade payables, other payables and accruals 877 938 1,418 1,684 1,909 Amount due to an associate 21 0 0 0 0 Current income tax liabilities 118 66 79 94 99 Short-term bank borrowings, unsecured 0 0 0 0 0 Current liabilities 1,016 1,004 1,496 1,778 2,008 Total Liabilities 1,094 1,084 1,587 1,878 2,118 Minority Interest 49 53 61 67 74 Total Shareholders Equity 5,596 6,425 7,466 8,535 9,535 Source: the Company, Guotai Junan International.

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Cash Flow Statement Yr end 31 Mar (HKD m) 2012A 2013A 2014F 2015F 2016F EBIT 1,595 1,523 2,065 2,314 2,645 Income tax (223) (320) (332) (371) (424) Adjust for depre.&amort. 73 100 110 134 151 Change in WC (1,573) (864) (310) (831) (735) Others 28 (13) (17) (6) (28) Cash from Operations (100) 426 1,518 1,239 1,608 Capital expenditure (153) (307) (260) (230) (200) Others 4 7 7 8 10 Cash from Investing (149) (300) (253) (222) (190) Share issue 1,340 0 0 0 0 Net bank borrowings 0 0 0 0 0 Dividend paid (515) (477) (694) (875) (1,222) Others (3) (0) 0 0 0 Cash flows from financing 821 (477) (694) (875) (1,222) Net Change in Cash 572 (351) 570 143 197 Cash and cash equivalents at 1st April 966 1,538 1,187 1,757 1,900 Cash and cash equivalents at 31st Mar 1,538 1,187 1,757 1,900 2,096 Source: the Company, Guotai Junan International. Financial Ratios Yr end 31 Mar (HKD m) 2012A 2013A 2014F 2015F 2016F Gross margin 23.2% 21.1% 21.0% 20.4% 20.4% Net margin 11.2% 9.4% 9.2% 8.7% 8.7% ROE 29.6% 21.1% 25.0% 24.3% 24.6% ROA 24.2% 17.7% 20.8% 19.8% 20.0% ROCE 27.9% 23.2% 27.1% 26.6% 27.2% Free CF (253) 119 1,258 1,009 1,408 Net gearing -34.1% -19.7% -25.3% -23.7% -23.2% Inventory turnover rate 2.6 2.3 2.8 2.9 2.8 Source: The Company, Guotai Junan International.

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Company Rating Definition The Benchmark: Hong Kong Hang Seng Index Time Horizon: 6 to 18 months

Rating Definition Buy Relative Performance >15%;

or the fundamental outlook of the company or sector is favorable. Accumulate Relative Performance is 5% to 15%;

or the fundamental outlook of the company or sector is favorable.

Neutral Relative Performance is -5% to 5%; or the fundamental outlook of the company or sector is neutral.

Reduce Relative Performance is -5% to -15%; or the fundamental outlook of the company or sector is unfavorable.

Sell Relative Performance <-15%; or the fundamental outlook of the company or sector is unfavorable.

Sector Rating Definition The Benchmark: Hong Kong Hang Seng Index Time Horizon: 6 to 18 months

Rating Definition Outperform Relative Performance >5%;

or the fundamental outlook of the sector is favorable. Neutral Relative Performance is -5% to 5%;

or the fundamental outlook of the sector is neutral. Underperform Relative Performance <-5%;

or the fundamental outlook of the sector is unfavorable. DISCLOSURE OF INTERESTS

(1) The Analysts and their associates do not serve as an officer of the issuer mentioned in this Research Report. (2) The Analysts and their associates do not have any financial interests in relation to the issuer mentioned in this Research Report. (3) Except for Shandong Chenming Paper Holdings Limited-H shares (01812), China All Access (Holdings) Limited (00633) and China

U-Ton Holdings Limited (08232), Guotai Junan and its group companies do not hold equal to or more than 1% of the market capitalization of the issuer mentioned in this Research Report.

(4) Guotai Junan and its group companies have not had investment banking relationships with the issuer mentioned in this Research Report within the preceding 12 months.

DISCLAIMER This Research Report does not constitute an invitation or offer to acquire, purchase or subscribe for securities by Guotai Junan Securities (Hong Kong) Limited ("Guotai Junan"). Guotai Junan and its group companies may do business that relates to companies covered in research reports, including investment banking, investment services and etc. (for example, the placing agent, lead manager, sponsor, underwriter or invest proprietarily). Any opinions expressed in this report may differ or be contrary to opinions or investment strategies expressed orally or in written form by sales persons, dealers and other professional executives of Guotai Junan group of companies. Any opinions expressed in this report may differ or be contrary to opinions or investment decisions made by the asset management and investment banking groups of Guotai Junan. Though best effort has been made to ensure the accuracy of the information and data contained in this Research Report, Guotai Junan does not guarantee the accuracy and completeness of the information and data herein. This Research Report may contain some forward-looking estimates and forecasts derived from the assumptions of the future political and economic conditions with inherently unpredictable and mutable situation, so uncertainty may contain. Investors should understand and comprehend the investment objectives and its related risks, and where necessary consult their own financial advisers prior to any investment decision. This Research Report is not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject Guotai Junan and its group companies to any registration or licensing requirement within such jurisdiction. © 2014 Guotai Junan Securities (Hong Kong) Limited. All Rights Reserved. 27/F., Low Block, Grand Millennium Plaza, 181 Queen’s Road Central, Hong Kong. Tel.: (852) 2509-9118 Fax: (852) 2509-7793 Website: www.gtja.com.hk

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A Fast Developing Jewellery Retailer in HK and Mainland ...pg.jrj.com.cn/acc/Res/HK_RES/STOCK/2014/3/6/59784193-737b-48c… · GTJA Research 国泰君安研究 Luk Fook Jewellery