Luk Fook (590 HK) Hold (maintained) Target price: HK$ In line results, 1QFY17 remains weak. Equity Research Consumer Discretionary.

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1 Equity Research Consumer Discretionary Luk Fook (590 HK) Hold (maintained) Target price: HK$16.50 In line results, 1QFY17 remains weak In line results Net profit slumped 41% YoY to HK$959m in 1QFY17, in the middle of the 35-45% decline stated in its profit warning, and 2% below consensus. LF raised its payout ratio from 40% to 68% by giving a special dividend of HK$0.21/share, to keep full-year dividend unchanged at HK$1.1/share. 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 10% 0% -10% - -30% -40% -50% Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Outlook 1) FY17 YTD SSS has continued to decline due to uncertainties in the economic outlook, but we expect the decline to narrow compared to 4QFY16 (HK & Macau -28%, China -19%). Management expects 2HFY17 SSS to be better than 1HFY17 due to the low base; 2) Store plan: While LF targets 50 new store additions in China (50/50 between self-operated/licensed stores), it will continue to optimize its retail network in HK; 3) Around 1/3 of stores in HK & Macau will have their leases renewed in FY17. For the leases renewed so far, management has said there was a teen-level decline in rent. As LF will open new street stores in China in FY17, management does not expect rental expenses to drop very much; 4) Payout ratio will be maintained at 40% as special dividend is not committed; 5) Management targets its associate company, CDS, to break even in two years. Results highlights Excluding the fair value change in its CB, core net profit would have dropped by 41% YoY. Revenue fell 12% YoY driven by /8% SSS declines HK & Macau/China. GM narrowed 0.9pp to 23.2%, 0.5pp below our estimate. The decline was led by a 0.7pp increase for gold products in the sales mix to 60.9%, and a 2.2pp contraction of gem-set GM due to the adjustment of retail prices in 2HFY16 in response to lower diamond prices. Gold product GM roared from 11.8% in 1HFY16 to 15.5% in 2HFY16, driven by the surge in the gold price. Opex ratio rose 2.1pp to 15.2%, mainly attributable to a 1pp/0.4pp/0.3pp increase in rental/staff/a&p expense ratios. Losses at its associate company, CDS, also widened from HK$23m to HK$81m. The proportion of revenue and profit contribution from China increased by 3pp/10pp to 28%/44%. Net cash balance increased from HK$377m in FY15 to HK$1.7bn in FY16. Maintain Hold We revise down our FY17 core net profit forecast by 3%, mainly to reflect lower-than-expected GM for gem-set products, and forecast a 6% YoY decline for core net profit in FY17, driven by a 10%/5% SSS decline in HK & Macau/China. Trading at 11.1x FY17E P/E, we believe share price upside is very limited as the current valuation is above its historical average, and as we expect weak jewelry sales to continue due to softening China/HK economic growth. We revise our TP from HK$16.40 to HK$16.50, based on 10.5x FY17E P/E (historical average) as we roll forward our valuation basis. HSI Luk Fook Source: Bloomberg Key data Jun 24 close (HK$) Shares in issue (m) Major shareholder Wong Wai Sheung (42.2%) Market cap (HK$ bn) M avg. vol. (m) W high/low (HK$) 22.98/12.78 Source: Bloomberg Stock valuation Year-end March Turnover (HK$ m) Net profit (HK$ m) Core profit (HK$ m) Core EPS (HK$) EPS YoY (%) Core P/E Yield (%) BPS (HK$) P/B ROE (%) ,215 1,865 1, ,923 1,615 1, , E 13, E 12, Sources: Company data, GF Securities (HK) Note: Core profit excludes fair value changes for financial assets and derivatives, and impairment losses for intangible assets

2 Figure 1: Results review Y/E Mar (HK$ m) FY16 FY15 % change 2H16 2H15 % change 1H16 1H15 % change Revenue 14,031 15,923-12% 7,066 8,380-16% 6,965 7,542-8% Cost of sales (10,777) (12,091) -11% (5,391) (6,348) -15% (5,386) (5,743) -6% Gross profit 3,254 3,832-15% 1,675 2,033-18% 1,579 1,799-12% Other income % % Selling and distribution expenses (1,982) (1,937) 2% (1,024) (1,026) 0% (958) (911) 5% Administrative expenses (149) (147) 1% (87) (82) 6% (62) (66) -5% Other expenses (30) % (26) 4-825% (4) % Operating profit 1,233 1,967-37% 619 1,004-38% % Adjusted operating profit Finance income % % % Finance costs (14) (20) -33% (4) (14) -69% (9) (7) 43% Non-recurring gains (21) 9-323% (1) (6) -92% (20) % Share of profit/(loss) of associate (79) (22) 260% (33) (17) 94% (47) (5) 795% Profit before tax 1,161 1,983-41% % % Tax expense (200) (362) -45% (98) (182) -46% (102) (180) -43% Profit after tax 961 1,620-41% % % Non-controlling interests (3) (6) -53% (3) (3) -2% (0) (3) -99% Net profit 959 1,615-41% % % Core profit 979 1,605-39% % % EPS (HK$) % % % Core EPS (HK$) % % % DPS (HK$) % % Margin & Ratio (%) Gross margin (0.9) (0.6) (1.2) Operating margin (3.6) (3.2) (4.0) SG&A expense/revenue Core profit margin (3.1) (2.7) (3.5) Effective tax rate (1.1) (1.9) (0.2) Payout ratio FY16 FY15 change 1H16 1H15 change Inventory days Net cash (HK$ m) 1, % 1, % Source: Company data, GF Securities (HK) estimates Figure 2: Quarterly SSS trend Figure 3: SSS growth 140% 1 100% 80% 60% 40% 0% - -40% -60% 29% 117% 83% 70% 36% 1% 30% 1% -5% 0% 2% -10% -19% -2% 14% 6% - -6% -12%-52% -11% -30% -22%-19% -7% -26%-28% -54% 3QFY13 1QFY14 3QFY13 1QFY15 3QFY15 1QFY16 3QFY16 China HK & Macau 50% 40% 30% 10% 0% -10% - -30% 46% 41% 25% 22% 7% -5% -3% 7% -8% -4% -28% -10% - -30% FY12 FY13 FY14 FY15 FY16 FY17E FY18E China HK & Macau Sources: Company data, GF Securities (HK) Figure 4: FY16 revenue breakdown by segment Figure 5: FY16 profit breakdown by segment China - retail 9% 3% China - 15% China - licensing 4% retail 69% China - licensing 23% China - 15% China - retail 6% 7% retail 49% Sources: Company data, GF Securities (HK) 2

3 Figure 6: Jewelry companies SSS trend Calendar Year 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 SSS trend Chow Tai Fook -2% 47% 18% 10% 4% -40% - -18% -16% -15% -3% -15% -26% China -5% 31% 11% 13% 15% -28% -12% -15% -9% -7% 6% -6% -25% HK and Macau 4% 67% 26% 7% -9% -50% -29% -21% -26% -24% -13% -23% -27% Luk Fook na na na 9% -10% -54% -21% -7% - -18% -6% -25% -27% China 14% 117% 70% 36% 1% -52% -30% -11% -5% 0% 2% -10% -19% HK and Macau 29% 83% 30% 6% -12% -54% - -6% -22% -19% -7% -26% -28% Chow Sang Sang China % --- na FY13: --- -ve --- -ve mid sd flat % ve low-teen +ve low sd -ve low sd HK and Macau % ---- na FY13: 33% --- -ve 32% --- -ve dd -ve sd ve 12% ve low sd -ve high-teen -ve high-teen SSS volume growth Chow Tai Fook China 36% -24% -13% -16% -12% -10% 13% -7% -25% HK and Macau 15% -44% -22% -13% -28% -30% -18% -21% -29% Luk Fook gold SSS volume growth China 26% -54% -34% -10% -5% 2% 10% -10% -29% HK and Macau -1% -63% -24% 1% -18% -13% 21% -19% -24% SSS trend by category Chow Tai Fook Gold products 8% 77% 32% 14% -2% -56% -33% -21% -19% -12% 13% -14% -27% China na na na na na -61% -29% -28% -10% -2% 22% -3% -29% HK and Macau na na na na na -51% -37% -14% -32% -25% 4% -24% -25% Gem-set jewellery -16% 7% 3% 8% 14% 2% 0% -12% -6% -10% -13% -12% -23% China na na na na na mid sd ve low sd 3% -4% -4% -7% -24% HK and Macau na na na na na -ve low sd -ve mid sd -22% -17% -16% -24% -16% -22% Luk Fook Gold and platinum products na 130% 56% 19% -15% -65% -28% -6% -21% -18% 5% -25% -28% China na na na 40% -3% -59% -38% -16% -10% -7% -1% -14% -27% HK and Macau na na na 15% -18% -65% -27% -5% -22% - 6% -26% -28% Gem-set jewellery na 21% 10% -4% -2% -19% -6% -8% - -18% -26% -26% -25% China na na na -6% 23% 5% 14% 13% 11% 23% 13% 2% 4% HK and Macau na na na 28% -3% - -7% -9% -22% -19% -28% -27% -27% Source: Company data, GF Securities (HK) estimates Figure 7: Total store number 1,800 1,600 1,400 1,200 1, % 22% 26% 1,538 24% 1,437 1,494 1,383 1,268 25% 23% 1, % 15% % 9% 5% 4% 4% 3% 0% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E Total stores Growth (%) Sources: Company data, GF Securities (HK) estimates 3

4 Figure 8: Key assumptions (HK$m) FY13 FY14 FY15 FY16 FY17E FY18E Total revenue 13,412 19,215 15,923 14,031 13,280 12,990 growth % 12.6% 43.3% -17.1% -11.9% -5.4% -2.2% - Retail revenue - HK, Macau and overseas markets 9,920 14,514 11,330 9,629 8,730 8,297 growth % 11.2% 46.3% -21.9% -15.0% -9.3% -5.0% store growth (%) 21.1% 19.6% 5.5% -1.7% 1.8% 0.0% SSS (%) 7.2% 22.0% -28.2% -20.0% -10.0% -4.0% - Retail revenue - China market 1,014 1,650 1,222 1,312 1,454 1,572 growth % 36.3% 62.7% -25.9% 7.4% 10.8% 8.1% store growth (%) 27.9% 6.4% -4.8% 44.3% 25.4% 16.1% SSS (%) 7.3% 45.9% -29.8% -8.0% -5.0% -3.0% - Wholesale revenue 2,028 2,433 2,794 2,563 2,562 2,583 growth % 11.8% 20.0% 14.8% -8.3% 0.0% 0.8% - Licensing revenue growth % 5.6% 37.3% -6.6% -8.6% 1.3% 0.8% Gross profit 2,830 4,214 3,832 3,254 3,052 2,992 Gross margin (%) 21.1% 21.9% 24.1% 23.2% 23.0% 23.0% Product mix (%) gold & platinum 62.7% 67.2% 60.2% 60.9% 59.0% 58.0% gem-set 37.3% 32.8% 39.8% 39.1% 41.0% 42.0% Selling expenses ratio (%) 9.8% 10.0% 12.2% 14.1% 14.3% 14.3% Administrative expenses ratio (%) 0.9% 0.8% 0.9% 1.1% 1.2% 1.2% Operating profit 1,524 2,309 1,967 1,233 1,133 1,103 growth % -4.3% 51.5% -14.8% -37.3% -8.1% -2.6% OP margin (%) 11.4% 12.0% 12.4% 8.8% 8.5% 8.5% Core profit 1,266 1,865 1, growth % -5.1% 47.3% -13.9% -39.0% -5.9% -0.5% Core profit margin (%) 9.4% 9.7% 10.1% 7.0% 6.9% 7.1% Payout ratio (%) 40% 40% 40% 68% 40% 40% Sources: Company data, GF Securities (HK) estimates 4

5 Figure 9: Financial statements Income Statement Balance Sheet Year-end Mar 31 (HK$ m) FY14 FY15 FY16 FY17E FY18E Year-end Mar 31 (HK$ m) FY14 FY15 FY16 FY17E FY18E Revenue 19,215 15,923 14,031 13,280 12,990 Fixed assets Cost of sales (15,001) (12,091) (10,777) (10,229) (9,999) PPE Gross profit 4,214 3,832 3,254 3,052 2,992 Land use rights Investment properties Other income Investment in associates Selling & distribution expenses (1,923) (1,937) (1,982) (1,895) (1,859) Shareholders loans to an associate Administration expenses (151) (147) (149) (153) (156) CB Other gains/(losses), net (30) 0 0 Others Operating profit 2,309 1,967 1,233 1,133 1,103 Deferred tax assets ,041 1,451 1,300 1,222 1,128 Net finance cost Non-recurring gains 0 9 (21) 0 0 Current assets Share of profit/(loss) of associates (0) (22) (79) (45) (20) Inventories 6,225 7,395 6,345 6,013 5,873 Profit before tax 2,321 1,983 1,161 1,121 1,124 A/C receivables Income tax expense (454) (362) (200) (198) (206) Deposits and prepayments Non-controlling interests (2) (6) (3) (1) (2) Shareholders loans to an associate Net profit 1,865 1, Others Core profit 1,865 1, CB Core EPS (HK$) Cash and cash equivalents 1,805 2,090 2,432 3,206 3,943 8,546 10,060 9,330 9,727 10,360 Growth rates (%) Revenue 43 (17) (12) (5) (2) Total assets 9,586 11,511 10,629 10,949 11,488 Core profit 47 (14) (39) (6) (0) Core EPS 47 (14) (39) (6) (0) Current liabilities A/C payables Margin & ratios (%) Other payables Gross profit margin Bank borrowings 568 1, OP margin Gold loans Net profit margin Others Effective tax rate Tax liabilities Payout ratio ,798 2,791 1,757 1,640 1,628 Cash Flow Statement Non-current liabilities Year-end Mar 31 (HK$ m) FY14 FY15 FY16 FY17E FY18E Employee benefit obligations Profit before tax 2,321 1,983 1,121 1,124 Deferred tax liabilities Share of (profit)/loss of associate and JV Net finance cost (12) (28) 10 9 Depreciation and amortization Equity Others (9) (15) 0 0 Shareholders' equity 7,641 8,536 8,674 9,110 9,660 Change in amount due to an associate 6 (30) 0 0 Non-controlling interests Change of working capital (1,231) (1,203) ,699 8,601 8,769 9,207 9,758 Tax paid (237) (462) (199) (202) Operating cash flow ,428 1,220 Total liabilities & equity 9,586 11,511 10,629 10,949 11,488 Capex (258) (181) (100) (100) Financial Ratios Disposals Year-end Mar 31 FY14 FY15 FY16 FY17E FY18E Interest received Current ratio Purchase of financial assets (8) (57) 0 0 Quick ratio Purchase of associate 0 (245) 0 0 Shareholder loan to associate 0 (120) 0 0 A/C receivable turnover days Change in term deposits (158) (557) (300) (200) A/C payable turnover days Others Inventory turnover days Investing cash flow (406) (1,133) (400) (300) Asset turnover Change of borrowings Total assets/total equity Change of gold loans (37) (6) Net cash 1, ,228 2,532 3,275 Contributions from non-controlling interests Dividend paid (654) (700) (508) (368) ROE (%) Interest paid (3) (20) (10) (9) ROA (%) Financing cash flow (89) 451 (554) (383) Net change of cash flow 467 (258) Forex changes (8) (13) 0 0 Sources: Company data, GF Securities (HK) estimates 5

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