Luk Fook (590 HK) Strong 1Q gem-set SSS in China. Core profit (HK$ m) Net profit (HK$ m) Turnover (HK$ m)

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1 Equity Research Consumer Discretionary Luk Fook (590 HK) Hold (maintained) Target price: HK$23.10 Strong 1Q gem-set SSS in China China gem-set SSS outperformed CTF SSS in China improved from -5% in 1QFY15 to in 1QFY16. Most impressive was the QoQ acceleration in gem-set SSSG from 11% to 23% (vs CTF s 3% to -4%), driven by the company s incentive scheme and department stores promotional activities. Gem-set ASP saw a single-digit decline in 1QFY15. The gold SSS decline narrowed slightly QoQ from to. SSSG at licensed stores was similar to self-operated stores. Albert Yip, CFA SFC CE No. ADT599 albertyip@gfgroup.com.hk GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Stock performance HK & Macau SSS improved mildly SSS improved slightly from -22% in 4QFY15 to -19% in 1QFY16. Gold and gem-set SSS came in at - (vs -22% in 4QFY15) and -19% (vs -22% in 4QFY15). Gem-set ASP saw a double-digit decline in 1QFY16. Overall, the trend was similar to CTF. Store expansion in 1QFY16 During the period, LF added one self-operated store and 12 licensed stores in China. The company needs to accelerate its pace of expansion to meet its target of 20/80 net-openings of self-operated stores/licensed stores, respectively, in FY16. FY16 outlook 1) For the nine stores subject to rent renewal in HK so far this year, there has been a mid single-digit increase in average rental reversion, and management expects a mild increase in average rental reversion in FY16. 2) They also expect the downward trend in gem-set ASP to continue. 3) Management believes it is too early to talk about the impact of the recent stock market volatility on SSS trend so far in Jul. 4) Management also believes an improvement in gem-set sales mix could support its OP margin in FY16. Maintain Hold and TP of HK$23.10 The sector outlook remains challenging. In HK, the main risk is the slowing mainland visitor trend. In China, the challenges are competition from domestic peers such as Lao Feng Xiang and the increasing difficulty of opening licensed stores amid a sluggish economy. Compared to its peers, LF saw the biggest improvement in gem-set sales mix during the quarter. Its continuing push for higher gemset sales mix should ease deleveraging pressure. LF is currently trading at 8.3x FY16E P/E, which is undemanding compared to CTF s (1929 HK, Underperform) 16x FY16E P/E and Lao Feng Xiang s ( CH) 22x FY15E P/E. Our TP of HK$23.10 is based on 8.5x FY16E P/E, continuing at its historical average forward P/E. - - Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Source: Bloomberg HSI Luk Fook Key data Jul 15 close Shares in issue (m) Major shareholder Wong Wai Sheung (42.2%) Market cap (HK$ bn) M avg. vol. (m) W high/low 30.80/20.10 Source: Bloomberg Stock valuation Year-end March Turnover Net profit Core profit Core EPS EPS YoY Core P/E Yield BPS P/B ROE ,412 1,266 1, ,215 1,865 1, ,923 1,615 1, E 16,098 1,604 1, E 16,829 1,700 1, Note: Core profit excludes fair value change in convertible bonds

2 Figure 1: SSS trend for jewelry companies Calendar Year 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 SSS trend Chow Tai Fook -2% 4 18% 4% % -16% -15% China -5% 31% 11% 13% 15% -28% -12% -15% -9% - HK and Macau 4% 6 26% -9% -5-29% -21% -26% -24% Luk Fook na na na 9% - -54% -21% % China 14% % 1% -52% - -11% -5% HK and Macau 29% 83% 6% -12% -54% - -6% -22% -19% Chow Sang Sang China % --- FY13: ve mid sd flat mild +ve slight better QoQ HK and Macau FY13: 33% % --- -ve dd -ve sd -ve low-teen -ve low teen SSS trend by category Chow Tai Fook Gold products 8% 7 32% 14% -2% -56% -33% -21% -19% -12% China na na na na na -61% -29% -28% - -2% HK and Macau na na na na na -51% -3-14% -32% -25% Gem-set jewellery -16% 3% 8% 14% 2% -12% -6% - China na na na na na mid sd ve low sd 3% -4% HK and Macau na na na na na -ve low sd -ve mid sd -22% -1-16% Luk Fook Gold and platinum products na 1 56% 19% -15% -65% -28% -6% -21% -18% China na na na -3% -59% -38% -16% - - HK and Macau na na na 15% -18% -65% -2-5% -22% - Gem-set jewellery na 21% -4% -2% -19% -6% -8% - -18% China na na na -6% 23% 5% 14% 13% 11% 23% HK and Macau na na na 28% -3% % -22% -19% Source: Company data, GF Securities (HK) estimates Figure 2: Quarterly SSS trend Figure 3: SSS growth % 46% % 83% 7 36% 25% 22% 4% 4% % 1% -6% -5% 14% 6% - -2% -12% -52% - -11% -22% -19% -54% 3QFY13 4QFY13 1QFY14 2QFY14 3QFY13 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY % -8% -28% - FY12 FY13 FY14 FY15 FY16E FY17E China HK & Macau China HK & Macau Sources: Company data, GF Securities (HK) Sources: Company data, GF Securities (HK) Figure 4: Total store number 1,800 1,600 1,400 1,200 1, % 22% 23% 24% 1, ,478 1,543 1,382 1,268 18% 9% 4% FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E Total stores Growth 25% 15% 5% Page 2

3 Figure 5: P/E band Nov-09 May-10 Nov-10 May-11 Nov-11 May-12 Nov-12 May-13 Nov-13 May-14 Nov-14 May-15 19x 15x 11x 7x 3x Sources: Bloomberg, GF Securities (HK) estimates Figure 6: Key assumptions (HK$m) FY13 FY14 FY15 FY16E FY17E Total revenue 13,412 19,215 15,923 16,098 16,829 growth % 12.6% 43.3% -17.1% 1.1% 4.5% - Retail revenue - HK, Macau and overseas markets 9,920 14,514 11,330 11,072 11,294 growth % 11.2% 46.3% -21.9% -2.3% 2. store growth 21.1% 19.6% 5.5% 5.2% 0. SSS 7.2% % Retail revenue - China market 1,014 1,650 1,222 1,342 1,570 growth % 36.3% % 9.8% 17. store growth 27.9% 6.4% -4.8% 22.8% 10.3% SSS 7.3% 45.9% -29.8% Wholesale revenue 2,028 2,433 2,794 3,023 3,238 growth % 11.8% % 8.2% 7.1% - Licensing revenue growth % 5.6% 37.3% -6.6% 14.5% 10. Gross profit 2,830 4,214 3,832 3,957 4,166 Gross margin 21.1% 21.9% 24.1% 24.6% 24.8% Product mix gold & platinum % 60.2% gem-set 37.3% 32.8% 39.8% Selling expenses ratio 9.8% % 12.6% 12. Administrative expenses ratio 0.9% 0.8% 0.9% Operating profit 1,524 2,309 1,967 1,984 2,084 growth % -4.3% 51.5% -14.8% 0.9% 5. OP margin 11.4% % 12.3% 12.4% Core profit 1,266 1,865 1,605 1,604 1,700 growth % -5.1% 47.3% -13.9% -0.1% 6. Core profit margin 9.4% % % Payout ratio Page 3

4 Figure 7: Financial statements Income Statement Balance Sheet Year end Mar 31 FY13 FY14 FY15 FY16E FY17E Year end Mar 31 FY13 FY14 FY15 FY16E FY17E Revenue 13,412 19,215 15,923 16,098 16,829 Fixed assets Cost of sales (10,582) (15,001) (12,091) (12,141) (12,664) PPE Gross profit 2,830 4,214 3,832 3,957 4,166 Land use rights Investment properties Other income Investment in associate and JV Selling & distribution expenses (1,311) (1,923) (1,937) (2,029) (2,137) Shareholders loans to an associate Administration expenses (115) (151) (147) (153) (162) CB Other gains/(losses), net Others Operating profit 1,524 2,309 1,967 1,984 2,084 Deferred tax assets ,041 1,451 1,356 1,285 Net finance cost Non-recurring gains Current assets Share of profit/(loss) of associate and JV (1) (0) (22) (30) (18) Inventories 4,955 6,225 7,395 7,190 7,644 Profit before tax 1,530 2,321 1,983 1,990 2,122 A/C receivables Income tax expense (260) (454) (362) (378) (412) Deposits and prepayments Non-controlling interests (3) (2) (6) (8) (11) Shareholders loans to an associate Net profit 1,266 1,865 1,615 1,604 1,700 Others Core profit 1,266 1,865 1,605 1,604 1,700 Term deposit ,500 2,000 Core EPS Cash and cash equivalents 1,187 1,646 1,140 2,508 3,262 6,686 8,546 10,060 11,717 13,446 Growth rates Revenue (17) 1 5 Total assets 7,562 9,586 11,511 13,073 14,731 Core profit (5) 47 (14) (0) 6 Core EPS (11) 47 (14) (0) 6 Current liabilities A/C payables Margin & ratios Other payables Gross profit margin Bank borrowings ,471 1,971 2,471 OP margin Gold loans Net profit margin Others Effective tax rate Tax liabilities Payout ratio ,004 1,798 2,791 3,410 3,998 Cash Flow Statement Non-current liabilities Year end Mar 31 FY13 FY14 FY15 FY16E FY17E Employee benefit obligations Profit before tax 1,530 2,321 1,990 2,122 Deferred tax liabilities Share of (profit)/loss of associate and JV Net finance cost (6) (12) (36) (56) Depreciation and amortization Equity Others (15) (9) 0 0 Shareholders' equity 6,425 7,641 8,536 9,430 10,463 Change in amount due to an associate (25) Non-controlling interests Change of working capital (839) (1,231) 223 (424) 6,478 7,699 8,601 9,544 10,612 Tax paid (320) (237) (370) (395) Operating cash flow ,015 1,438 Total liabilities & equity 7,562 9,586 11,511 13,073 14,731 Capex (307) (258) (120) (120) Financial Ratios Disposals Year end Mar 31 FY13 FY14 FY15 FY16E FY17E Interest received Current ratio Purchase of financial assets 0 (8) 0 0 Quick ratio Purchase of associate or JV Shareholder loan to associate A/C receivable turnover days Change in term deposits 761 (158) (550) (500) A/C payable turnover days Others Inventory turnover days Investing cash flow 461 (406) (603) (523) Asset turnover Change of borrowings Total assets/total equity Change of gold loans Net cash 1,187 1, ,700 2,433 Contributions from non-controlling interests Dividend paid (477) (654) (645) (661) ROE Interest paid (0) (3) (36) (46) ROA Financing cash flow (477) (89) (45) (161) Net change of cash flow , Forex changes 1 (8) 0 0 Page 4

5 Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than Neutral Expected sector relative performance ranges between - and Cautious Sector expected to underperform benchmark by more than Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. 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