Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Oct 15, 2015

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1 Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 15E 16E 15E 16E HSI HSCEI MXCN SHSZ SHCOMP SZCOMP INDU SPX CCMP UKX NKY Hong Kong ADRs HK ticker Company Local (HK$) Daily (%) ADR (US$) Daily (%) 1398 ICBC CHINA MOBILE PETROCHINA CCB TENCENT BANK OF CHINA HSBC CHINA LIFE SINOPEC PING AN Econ data release China Data Date Period Prior Cons Ind Prod Growth Cum 19-Oct SEP Ind Prod Growth Mthly 19-Oct SEP FAI Cum YoY 19-Oct SEP Retail Sales Cum 19-Oct SEP Retail Sales Mthly 19-Oct SEP GDP Cum YoY 19-Oct 3Q GDP QoQ 19-Oct 3Q GDP Quarterly YoY 19-Oct 3Q US Data Date Period Prior Cons CPI Urban YoY 15-Oct SEP Initial Jobless Claims 15-Oct 10-Oct Cont Jobless Claims 15-Oct 3-Oct Source: Bloomberg GF events Date Event Location 19 Oct Peak Sport investor luncheon Hong Kong Source: GF Securities (HK) A-Share Market Investment Strategy: President Xi s UK visit a potential catalyst for football-related A-share names The Ministry of Foreign Affairs has indicated that President Xi will visit the UK during Oct Apart from attending events hosted by the Queen and meeting the Prime Minister, President Xi will also visit technological research and business projects in Manchester. We believe a wide variety of subjects will be covered during the visit with a series of cooperative agreements to be reached. In addition to the two important topics of nuclear power and high-speed rail development, cooperation in football is also worth noting. Retail: Cross-border e-commerce to offer opportunities for overseas health products The GFRI (which includes e-commerce and emerging channels) outperformed top 100 retailers sales growth in Aug. The expansion of the cross-border e-commerce channel has allowed overseas health products meeting their respective local food and drugs regulation to be imported into China. We believe this will substantially lower the entry barrier to the Chinese market, offering opportunities for leading overseas brands whose development in China s offline market was previously limited. We have a neutral view on the sector, and see a fair amount of downward pressure on its 3Q15 earnings outlook. Hong Kong Market Luk Fook (590 HK, Hold): 2Q gem-set SSS weak in HK but China still positive; maintain Hold Overall SSS rebounded in 2QFY16 led by the gold fever in Jul and Aug. While gold product SSS rebounded, gem-set product SSS dropped further. Management is cautious on the near-term outlook and expects a bottoming out in 4QFY16 at the earliest. The net store openings target for FY16 has been cut from 100 to 80 stores. We lower our FY16/17 net profit estimates by 6% to reflect lower HK & Macau SSS assumptions, fewer new stores in China and lower GM. We lower our TP from HK$23.10 to HK$ Maintain Hold. Daphne (210 HK, Underperform): Weak 3Q, 4Q still challenging Weak SSS in 3Q15 was mainly a result of a lower ASP due to heavy discounts in Aug and Sep. The company s plan to close stores more aggressively is aimed at saving its bottom line and boosting store efficiency, however the low brand loyalty and high price sensitivity in the mass market may dilute efforts to raise sales per store. We maintain our estimate for a loss in FY15 given negative SSS and the decline in GM YoY in 3Q15. 4Q15 still looks challenging for both SSS and GM. We maintain our TP of HK$1.20 and our Underperform rating. IGG (799 HK, Buy): Takeaways from conference call with management; further weakness in 3Q15 The two key games launched this year have not performed well. In addition, its core games are entering a period of decline, with both Castle Clash and Clash of Lord seeing an accelerated decline in gross revenue in 3Q15. We expect revenue to decline by 14% YoY (11% QoQ) during the quarter, and see a 61% YoY (35% QoQ) drop in net profit on increased marketing expenses for its mobile IM app, Link. There is only one key game still in the pipeline for this year. Our earnings forecasts and rating are under review. Alex Fan, CFA, Head of Research, SFC CE No. ADJ672 alexfan@gfgroup.com.hk Gao Yedong, Editor, SFC CE No. BAI002 yedonggao@gfgroup.com.hk

2 Investment Strategy: President Xi s UK visit a potential catalyst for footballrelated A-share names Nuclear power, HSR, football cooperation key to watch during Xi s UK visit The Ministry of Foreign Affairs has indicated that President Xi will visit the UK during Oct 19-23, which would be the first state visit to the country paid by a Chinese President in a decade. Apart from attending events hosted by the Queen and meeting the Prime Minister, President Xi will also visit technological research and business projects in Manchester. We believe a wide variety of subjects will be covered during the visit with a series of cooperative agreements to be reached. In addition to the two important topics of nuclear power and high-speed rail development, cooperation in football is also worth noting. Football cooperation As a football lover himself, President Xi has long called for reforms in the Chinese football industry. In fact, football was a major topic when he met Prince William in early Mar. We believe Xi s upcoming visit to Manchester is likely to foster the two country s cooperation in this field. Related A-share stocks include Ledman Optoelectronic ( CH), Lander Sports Development ( CH), Jiangsu Sainty ( CH), Hualu Baina Film & TV ( CH) and United Travel ( CH). Nuclear power and HSR development In addition, companies also worth watching in relation to nuclear power development include SUFA Technology Industry ( CH), China First Heavy Industries ( CH), Shanghai Electric ( CH), Yingliu Electromechanical ( CH), JIULI Hi-tech Metals ( CH) and Jiangsu Shentong Valve ( CH); those related to highspeed rail development include CRRC ( CH), China High-Speed Railway Technology ( CH), Yonggui Electric Equipment ( CH), Jinxi Axle ( CH) and China Railway Construction ( CH). Retail: Cross-border e-commerce to offer opportunities for overseas health products Offline retail sales yet to pick up The GF Retail Index rose 13.42% YoY in Aug, strengthening by 1.25pp YoY and 0.10pp MoM. In contrast, the top 100 retailers across the country saw sales grow by just 0.90% YoY during the month, slowing by 2.4pp YoY and 0.6pp MoM, with any improvement yet to be seen. The GFRI outperformed top 100 retailer sales growth as the former also covers the e-commerce and other emerging business channels. YoY sales growth at the top 100 retailer in Aug was mainly driven by strength in jewelry and home appliances, while YoY sales declines were seen in apparel, food products, goods for daily use and cosmetics. Cross-border e-commerce to offer opportunities for overseas health products The competitive landscape of the health product industry in China has previously been stable with Amway and BY-Health ( CH) dominating the market. However, the expansion of the crossborder e-commerce channel has allowed overseas health products meeting their respective local food and drugs regulation to be imported into China. We believe this will substantially lower the entry barrier to the Chinese market, offering opportunities for leading overseas brands whose development in China s offline market was previously limited. In addition, we also highlight crossborder logistics firms with high barriers to competition and clear earnings visibility. 3Q15 earnings under pressure We have a neutral view on the sector as a whole, and see a fair amount of downward pressure on its 3Q15 earnings outlook. We like Lao Feng Xiang ( CH), Yonghui Superstores ( CH) and Wangfujing Department Store ( CH) as defensive plays, and Dashang ( CH) given the considerable share price corrections it has recently been through. We also suggest watching Hualian Department Store ( CH) which might resume trading within this month, as well as Lansheng Corporation ( CH) given the SOE reform and Shanghai Disneyland investment themes. Luk Fook (590 HK, Hold): 2Q gem-set SSS weak in HK but China still positive; maintain Hold 2QFY16 gem-set SSS fell 26% Overall SSS rebounded to -6% in 2QFY16 (vs -18% in 1QFY16), led by the gold fever in Jul and Aug. While gold product SSS rebounded to +5% in 2QFY16 (vs - Page 2

3 18% in 1QFY16), gem-set product SSS dropped further to -26% (vs -18% in 1QFY16). In HK & Macau, the SSS rebound to -7% in 2QFY16 (vs -19% in 1QFY16) was led by the 6% gold product SSSG (vs -20% in 1QFY16). Gem-set SSS weakened to -28% from -19%. In China, gem-set SSSG was kept at +13% (vs +23% in 1QFY16) despite a high base. The gold product SSS decline narrowed from -7% in 1QFY16 to -1% in 2QFY16. Product mix For the company s 2QFY16 retail operations, management stated that gem-set sales mix dropped YoY from 35% to 28% due to a higher sales mix of gold products. During the period, the sales mix of platinum was pretty stable at 5%. Outlook 1) LF did not release SSSG data during Golden Week this year as sales performance during the week was not golden. 2) Management is cautious on the near-term outlook and expects a bottoming out in 4QFY16 at the earliest. 3) The net store openings target for China in FY16 has been cut from 100 to 80 due to delays in the opening of certain department stores given the renovation work needed to upgrade them into shopping malls. 4) Gem-set GM for both retail and wholesale saw a slight decline due to increased promotions and the decline in the raw diamond price. 5) Management expects no major changes in store number in HK & Macau in FY16 but expects there to be less stores in traditional prime shopping districts and more stores in residential areas and the New Territories. 6) Management still expects to see a mild increase in average rental reversion in FY16, led by a rental increase for shops in residential areas. Maintain Hold We lower our FY16/17 net profit estimates by 6% to reflect lower HK & Macau SSS assumptions, fewer new stores in China and lower GM. Following this earnings revision, we forecast a 6% net profit decline in FY16 and 6% net profit growth in FY17. Compared to peers, LF still has the room to improve its gem-set sales mix in China (21% vs 36% in HK & Macau market in FY15). This would mean a better earnings outlook than CTF (1929 HK, Underperform), in our view. We lower our TP from HK$23.10 to HK$21.80, still based on 8.5x FY16E P/E (its historical average forward P/E). (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) Daphne (210 HK, Underperform): Weak 3Q, 4Q still challenging 3Q15 SSS dropped further 3Q15 SSS declined QoQ to -20% from -18% in 2Q15 on a high comparable base (+6% in 3Q14 vs -2% in 2Q14). The SSS decline was mainly led by a lower ASP as the company had offered heavier discounts in Aug and Sep due to 1) the clearance of 2015 Spring and Summer as well as 2014 Summer product inventories and 2) the very aggressive discounts offered by some competitors. We expect a slight decline in GM in 3Q15. More store closures During 3Q15, the company had a net closure of 219 stores. The company expects this to reduce by another 200 stores in 4Q15. The net closure number in 2H15 will be greater than management s guidance of 200+ stores provided in Aug Although we think the more aggressive store closure plan is a good move to save bottom line and boost store efficiency, the low brand loyalty and high price sensitivity in the mass market may dilute efforts to raise sales per store. 4Q15 still challenging The company will continue to clear its 2014 Summer and 2015 Spring and Summer product inventories through domestic online platforms and franchisees and export sales in 4Q15. We are concerned that the company may need to increase discounts for 2015 Fall and Winter products because the level of these inventories may be excessive, given the company may not have had an aggressive store closure plan when these production orders were placed. The company targets to lower inventory turnover days to 200 days by the end of FY15 (vs 238 days in 1H15). We therefore expect GM pressure to continue in 4Q15. Furthermore, Singles Day online sales could also hurt Daphne s SSS in 4Q15. Maintain Underperform Given negative SSS and the decline in GM YoY in 3Q15, we maintain our estimate for a loss in FY15. 4Q15 still looks challenging for both SSS and GM. We maintain our TP of HK$1.20, based on 0.4x FY15E P/B. (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) Page 3

4 IGG (799 HK, Buy): Takeaways from conference call with management; further weakness in 3Q15 Poor performance in new games At the beginning of this year, the company guided that three key new games would be commercialized this year. Two of them have now been launched, but have not performed well. Final Fable, launched in Jun, delivered average performance in 3Q15; Game of King performed poorly and was subsequently re-released. Meanwhile, the launch of Age of Kingdoms was delayed from Sep to Nov. Core games entering a period of decline Core games including Castle Clash and Clash of Lord saw an accelerated decline in gross revenue in 3Q15, mainly due to their maturity. Monthly gross revenue from Castle Clash decreased from US$10m in 2Q15 to around US$9m in 3Q15. Monthly gross revenue from the Clash of Lord series dropped from around US$3m in 2Q15 to around US$1.5m in 3Q15. Margin contraction on increased promotional efforts for Link The company increased marketing efforts to promote its mobile IM app Link in 3Q15. As such, we expect net margin to narrow further compared with 2Q15. Stable dividend policy Management indicated that the company will maintain a stable dividend payout ratio of around 30%. Further weakness in 3Q earnings Given the continued decline in core games and poor performance in new games, we expect revenue to decline by 14% YoY and 11% QoQ in 3Q15. We expect net profit to decline by 61% YoY and 35% QoQ to US$7m in 3Q15 due to increased marketing expenses for Link. Rating under review There is only one key game still in the pipeline for this year. We see more downside risk due to the continued decline in existing core games and more uncertain earnings contribution from new games in coming few quarters. The company s share have rebounded by 15% this month and are now trading at 13.5x 2015E P/E and 10x 2015 ex-cash P/E. Our earnings forecasts and rating are under review. (Ryan Zhu, Research Analyst, SFC CE No. BDK820, zhuran@gfgroup.com.hk ) 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 10% Neutral Expected sector relative performance ranges between -10% and 10% Cautious Sector expected to underperform benchmark by more than 10% 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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