Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK)

Transcription

1 Asia Pacific/Hong Kong Equity Research Luxury Goods Rating NEUTRAL Price (1 Feb 12, HK$) 1. Target price (HK$) 1.72¹ Chg to TP (%) 9.2 Market cap. (HK$ mn) 1, Enterprise value (HK$ mn) 13,1 Number of shares (mn) 1,. Free float (%) 1.7 2week price range *Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix). Share price performance Jan12 Price (LHS) Research Analysts Gabriel Chan, CFA gabriel.chan@creditsuisse.com Isis Wong isis.wong@creditsuisse.com Rebased Rel (RHS) The price relative chart measures performance against the MSCI CHINA F IDX which closed at 91.3 on 1/2/12 On 1/2/12 the spot exchange rate was HK$7.76/US$ Performance Over 1M 3M 12M Absolute (%) Relative (%) Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) INITIATION The crown jewel of the fastgrowing Chinese luxury consumer market We initiate coverage with a NEUTRAL call at HK$1.72, implying 9.2% potential upside. We set our target price at HK$1.72, based on FY3/13E P/E of 17x, implying upside potential of 9.2%. We believe CTF is already trading at a fair value and thus initiate coverage with a NEUTRAL rating. Chow Tai Fook (CTF) means jewellery. CTF is the leading jeweller in China as well as Hong Kong/Macau. With a history of over 8 years of operations and an extensive retail network, CTF has established strong brand recognition. Moreover, a vertically integrated operation, being one of the very few jewellers that have the capability to process rough diamonds, offers a significant sourcing and pricing advantage against competitors. Well positioned in one of the fastestgrowing retail segments in China and Hong Kong. Jewellery sales are projected to sustain a high growth rate in both China and Hong Kong/Macau; the retail value of the jewellery market in China is expected to grow at a 38.6%, CAGR to HK$1,8 bn, in 21 while Hong Kong and Macau are projected to see a 39.2% CAGR. In our view, CTF s strong brand recognition should help extend its lead in the fastgrowing Chinese luxury consumer market. Some 1.8% earnings CAGR between FY3/11 and FY3/1E. We project CTF s net profit growing from HK$3,38 mn to HK$12,371 mn, implying a 1.8% CAGR, largely driven by a 6% increase in POS to 1,986 as at FY3/1E, 189% samestore sales growth (SSSG) in China and Hong Kong/Macau. CTF s conservative gold price hedging strategy implies higher earnings quality as performance is less affected by gold price volatility. Note: CTF relies strongly on mainland Chinese visitors to Hong Kong/Macau; any decline in travel flow here could have a material adverse effect on CTF. Financial and valuation metrics Year 3/11A 3/12E 3/13E 3/1E Revenue (HK$ mn) 3,2. 9, , ,31.3 EBITDA (HK$ mn), ,7.2 12,96. 17,6.8 EBIT (HK$ mn), , ,.1 16,919.3 Net profit (HK$ mn) 3,37.6 6,.8 9, ,371.1 EPS (CS adj.) (HK$) Change from previous EPS (%) n.a. Consensus EPS (HK$) n.a EPS growth (%) P/E (x) Dividend yield (%) EV/EBITDA (x) P/B (x) ROE (%) Net debt/equity (%) 1.3 net cash net cash net cash Source: Company data, Thomson Reuters, Credit Suisse estimates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NONUS ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Focus charts Figure 1: China s jewellery market is booming E CAGR: 13 Gold products:.2% 11 Platinum/ Kgold products: 39.% Gemset jewelley: 3.% 9 Total: 38.6% E212E213E 21E21E Gold products Plantinum/Kgold products Gemset jewellery Source: Frost & Sullivan Figure 3: CTF has the highest market share in HK/Macau jewellery market (21) Figure 2: Revenue projection by geography (HK$ mn) 1, 12, 1, 8, 6,, 2, FY3/9 FY3/1 FY3/11 FY3/12E FY3/13E FY3/1E China retail HK/Macau retail Wholesales Figure : Largest market share in China jewellery market (21) Chow Tai Fook 2.1% Chow Tai Fook 12.6% Chow Sang Sang 8.7% Lao Feng Xiang 9.% Luk Fook 7.3% Chow Tai Seng 7.1% MaBelle 3.9% Lao Miao 6.9% Cartier 2.8% Beijing Caishikou 6.% Tiffany & Co. 2.2% First Asia 3.8%.%.% 1.% 1.% 2.% 2.% Source: Frost & Sullivan Figure : CTF s net profit is projected to see a 1.8% CAGR during FY111E (HK$ mn) 1, 12, 1, 8, CAGR = 1.8% 6,, CAGR = 36.6% 2, FY3/9 FY3/1 FY3/11 FY3/12E FY3/13E FY3/1E CTF's Net profit.% 2.%.% 6.% 8.% 1.% 12.% 1.% 16.% Source: Frost & Sullivan Figure 6: CTF is expected to have stronger earnings growth than peers Growth rate (%) FY1 FY11 FY12E FY13E FY1E Chow Tai Fook Luk Fook Chow Sang Sang Source: Company data, IBES, Credit Suisse estimates Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 2

3 The crown jewel of the fastgrowing Chinese luxury consumer market Chow Tai Fook means jewellery We initiate coverage on Chow Tai Fook with a target price at HK$1.72 based on FY3/13E P/E of 17x, implying upside potential of 9.2%. Chow Tai Fook (CTF) is a leading jeweller in China as well as Hong Kong and Macau, with market shares of 12.6% and 2.1% in 21, respectively. Its leading market shares in both the markets have been growing, and we expect them to grow further in the future. It has an over 8year history of operations, together with what we believe is the largest and most extensive retail network in the Greater China region of 1,6 POS as at 3 September 211, creating strong brand recognition. CTF has a range of jewellery products made from varied raw material at different price points, suitable for different generations. Besides, CTF sells luxury watches, and has established good relationships with reputable suppliers including LVMH (LVMH.PA, Eu 123.6, RESTRICTED), Compagnie Financiere Richemont SA (CFR.VX, SFr2.1, NEUTRAL, TP SFr.), Rolex (Not listed) and the Swatch Group (UHR.VX, SFr387.8, OUTPERFORM, TP SFr8.). Moreover, CTF s vertically integrated operations and it being one of the very few jewellers possessing the capability to process rough diamonds provide it with a significant sourcing and pricing advantage against competitors. Given this, we expect the lead in China to widen further while its dominant position is likely to sustain in Hong Kong and Macau. Jewellery: One of the fastest growing retail segments With continuous economic growth in China, an expanding middleincome class and a strong culture of gifting, jewellery sales are projected to sustain a high growth rate in both China and Hong Kong/Macau. According to an independent market research report published by Frost & Sullivan (F&S) in August 211, the retail value of the jewellery market in China is expected to grow at a fast rate of a 38.6% CAGR from HK$32.2 bn 21 to HK$1,8 bn in 21. F&S also projects a similar retail value CAGR of 39.2% in Hong Kong and Macau over the same period. In our view, CTF s strong brand recognition, extensive sales network and vertically integrated operations should help extend its lead in this fastgrowing Chinese luxury consumer market. Initiate coverage with NEUTRAL We project CTF s net profit will grow from HK$3,38 mn in FY3/11 to HK$12,371 mn in FY3/1, implying a 1.8% CAGR. We expect the strong earnings CAGR to be largely driven by a 6% increase in POS during the period from 1,38 as at FY3/11 to 1,986 as at FY3/1 and 189% samestore sales growth (SSSG) in China and Hong Kong/Macau, supported by strong demand from the expanding Chinese middleincome class. On the other hand, given CTF s conservative hedging strategy, we expect its gross margin to remain stable over the next three years, providing a solid foundation for further operating leverage. Its conservative gold hedging strategy also represents higher earnings quality, in our view. Despite the lack of benefit from gold price appreciation, CTF recorded stronger earnings growth in FY3/11, compared with those of its major listed peers. To determine CTF s fair value, we have compared it against a group of Hong Kong/Chinalisted jewellery and luxury watch retailers. Our target price of HK$1.72, based on FY3/13E P/E of 17x, has already priced in a premium to its peers on the back of its leading position in the industry and strong brand recognition. We believe CTF is already trading at a fair value and thus initiate coverage with a NEUTRAL. Note that CTF relies strongly on mainland Chinese visitors to Hong Kong/Macau; thus, any decline in travel flow into these regions could have a material adverse effect on the company. CTF is a leading jeweller in the Greater China region with over 1, POS Vertically integrated operation, which only very few jewellers have adopted HK/Macau jewellery market is expected to grow at a CAGR of 39.2% during 21 1, slightly faster than that in China Extensive store expansion and strong demand from the Chinese middle class should drive net profit to grow to HK$12. bn by FY3/1E Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 3

4 Financial summary Figure 7: Financial summary Yearend 31 March (HK$ mn) FY9A FY1A FY11A FY12E FY13E FY1E Profit and loss Turnover 18,1.9 22, ,2. 9, , ,31.3 Gross profit,326. 6,. 9, ,279. 2,197. 3,373.1 Other income (excl. interest) SG&A (excl. depreciation) (2,97.1) (3,733.2) (,1.8) (8,396.8) (12,87.9) (17,13.) EBITDA 2,1.2 2,92.9, ,7.2 12,96. 17,6.8 Depreciation & amortisation (16.) (22.8) (2.7) (39.6) (.) (627.) EBIT 2,29.7 2,69.1, , ,.1 16,919.3 Net interest income/(cost) (68.) 1. (31.9) (16.) (131.) (183.) Associates, others, exceptionals Profit before tax 2,223. 2,718.6, , , ,73.8 Taxation (39.1) (11.8) (97.3) (1,81.) (2,711.2) (3,89.2) Minority interest (17.7) (68.2) (13.9) (23.) (36.3) (1.) Net profit 1, , ,37.6 6,.8 9, ,371.1 Balance sheet Assets Cash 1, ,16.7,6.8 12,1.8 1, ,87. Inventories 8,9.2 9, ,1.8 26,72. 37,1.9 6,92.7 Other current assets,18.3,69.3,813.6,718. 7,39. 9,836.9 Leasehold land and rights Interest in associates Other noncurrent assets Fixed assets ,16.3 1,18.2 2,13.6 2,.6 Total assets 1,9. 17,1.3 29,8.7 6, ,16. 8,7. Liabilities Current debt 2,17. 2,39. 6, ,16.1 1, ,33. Other current liabilities,69. 6,161. 1,.6,63. 8, ,262.2 Longterm debt Other noncurrent liabilities Total liabilities 7, , , , , ,783.2 Shareholders' equities Share capital ,. 1,. 1,. Reserves,6. 7,8.7 1, , , ,33. Share premium acct....,97.7,97.7,97.7 Minority interests ,.2 Total equities 6,1.9 8,33. 11, ,19. 39,13.3,792.2 Cash flow Pretax profit 2,223. 2,718.6, , , ,73.8 Taxes paid (36.) (399.) (729.6) (33.) (1,81.) (2,711.2) Depreciation & amortisation Others 83.7 (21.2) Gross cash flow 2,12.2 2,2.2, , ,19. 1,83.6 Net capex (8.8) (319.9) (823.9) (712.) (1,121.8) (938.) Net change in working capital 1,268.8 (1,72.8) (,266.2) (16,28.1) (9,39.7) (9,916.9) Free cash flow 2, (92.2) (8,198.) 93. 3,98.2 Dividends paid (3.) (36.7) (39.3) (,29.3) (761.) (1,89.) Change in share capital , Others (9.7) (16.) (131.) (183.) Net cash flow 2, (96.) 1,693. (299.) 1,97.3 Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK)

5 Chow Tai Fook means jewellery It all began in 1929 We initiate coverage on Chow Tai Fook with a target price of HK$1.72 based on FY3/13E P/E of 17x, implying upside potential of 9.2%. Chow Tai Fook (CTF) is a leading jeweller by market share with a presence in China as well as Hong Kong and Macau. The company s origin dates back to 1929, when it first entered the jewellery business in China. Over the past 8odd years, CTF has transformed itself into one of the most recognised jewellery brands in the Greater China region. CTF ranked along with Tiffany & Co. (TIF, $63.8, Not rated) and Cartier (Not listed) among the Top Three Brands Most Likely to be Purchased in 21 in China, according to an independent market survey on jewellery brands conducted by Bain & Company in November 21. We will discuss CTF s strong brand recognition in detail in later sections. Besides its long history and extensive network of 1,6 stores in China and Hong Kong as at 3 September 211, CTF has been innovative in promotions and set high quality standards to enhance the consumer confidence. CTF is the first firm to launch gold jewellery products in Hong Kong and Macau to promote purity with ensured quality in 196. Subsequently, in 199, CTF implemented a fixed price policy, which increased transparency and greatly improved customer shopping experience as it removed the need for the thencustomary extensive price negotiations. A diversified product range CTF has a range of jewellery products encompassing jewellery made from diverse raw material and available at varying price points, suitable for different generations and life cycle of customers. Jewellery products are categorised into (1) gemset jewellery, (2) platinum/kgold products, and (3) gold products. Note that the jewellery products that include diamonds and gemstones are categorised as gemset jewellery. Figure 8: Wide variety of products CTF is ranked along with Tiffany and Cartier CTF offers a wide range of products at various price bands Source: Company Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK)

6 Besides jewellery, CTF entered luxury watch retailing in Hong Kong/Macau during the 196s, expanding that business into China in 28. CTF has built good relationships with reputable suppliers including LVMH Group, Richemont Group, Rolex Group and the Swatch Group. The figure below shows CTF s revenue trend by product category. CTF entered the luxury watch business in the 196s, and this now accounts for around 7% of turnover Figure 9: Revenue by product category (HK$ mn) 1, 12, 1, 8, 6,, 2, FY3/9 FY3/1 FY3/11 FY3/12E FY3/13E FY3/1E Gemset jew ellery Gold jew ellery Platinum/ Kgold jew ellery Lux ury w atches A vertically integrated model It is important to note that CTF has vertically integrated operations that give it centralised and tight control over its processes from raw material procurement, design, production, marketing to retailing through its extensive POS network. CTF is one of the very few jewellers in Greater China with the capability to process rough diamonds. Long business relationships with DTC and Rio Tinto CTF has been a DTC Sightholder since 1973 and became a Rio Tinto (RIO.AX, A$68.7, OUTPERFORM, TP A$9.) Select Diamantaire in 29, which means it secures its source of rough diamonds from the two of the largest suppliers in the world. Under the respective supply agreements with DTC and Rio Tinto, the two companies agree to supply CTF with rough diamonds that meet preagreed specifications, up to a stipulated value and for a specified period. Note that the capability to source and process rough diamonds provides CTF with significant sourcing and cost advantages in gemset jewellery, as it can secure enough raw material to meet rising demand, while the margins saved from the additional diamond processing cost give the company the flexibility to set more competitive pricing while enjoying higher margin. Largest production capacity among HKlisted jewellers Currently, CTF has nine jewellery factories employing over 3, workers. As at the end of FY3/11, we estimate that the factories combined product capacity was about mn pieces p.a., which we believe is the largest among all Hong Konglisted jewellers. The nine factories consist of one factory in Hong Kong that produces gemset jewellery, four factories in Shenzhen (gemset jewellery, Kgold and gold products) and four factories in Shunde (gemset jewellery, platinum/kgold and gold products). In addition, CTF has three diamond polishing factories, two in South Africa and one in Shunde. Long and solid relationships with DTC and Rio Tinto provide CTF with stable supply of gemstones and diamonds Operating three diamond polishing and nine jewellery factories with estimated combined production capacity of about mn pieces p.a. Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 6

7 We estimate CTF s existing production capacity is only enough to satisfy about % of its retail sales requirements. Thus, it outsources production of some jewellery products (particularly those that are easytomake and yield lower profit margins) to external manufacturers but under CTF s strict quality control, including sample checking of physical characteristics and chemical composition. Defective products are returned and payment is made only upon receipt of finished products with satisfactory artisanship. CTF also conducts random site checking and audits these production facilities. About % of production is outsourced to local jewellery manufacturers in the PRC CTF continues to develop, upgrade and expand its production facilities. We believe the potential new production facilities will increase its capacity by at least 2% by FY3/13 once it is fully operational. In our view, the additional capacity should support an enlarged POS network of 2,. CTF is also planning to build a research and development facility in Shenzhen which will focus on the R&D of new material, production technology and the automation of production. This is, in our view, a prudent strategy to support longterm POS expansion. Short production leadtime of 2 working days only On the back of fully vertically integrated operations, CTF enjoys a relatively short order leadtime. CTF plans its production schedule by considering (1) the anticipated sales trend based on realtime data collected from all its POS, including both selfoperated and franchised ones, (2) its POS expansion plan, (3) production leadtime, and () its raw material procurement plans. From order to POS delivery, total lead time typically ranges from 2 to working days. Short production leadtime allows CTF to react to changes in market and support revenue growth In our view, such a short production lead time should help CTF react faster to market demand changes, supporting stronger revenue growth during good times, as stores are equipped with sufficient inventory. During bad times, this should reduce cash flow risk, as the inventory level can be adjusted quickly, while it can also change its product mix quite rapidly to adapt to market demands. Wellrecognised design capability CTF s design team consists of over designers. The design team has won numerous prestigious awards. Some of the most recent awards include: 211 International Jewellery Design Competition Aesthetic Award. Design team is experienced and well recognised by the industry 211 International Jewellery Design Competition Craftsmanship and Technology Award Figure 1: 211 International Jewellery Design Competition CTF s winners Source: HKTDC website Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 7

8 Extensive POS network of over 1, CTF has established and operates an extensive distribution network in the Greater China region, with 1,6 POS as at 3 September 211. The company is planning to achieve a net increase of 2 jewellery POS per year from 212 to 21, and targets having approximately 2, POS by FY3/16, wherein we project 1,986 POS will be in place by the end of FY3/1. The majority of the new POS openings are expected to be in China, and CTF expects to open an average of three to five POS per year in Hong Kong and Macau. Targets 2, POS by FY3/16 Figure 11: POS trend and breakdown Number of POS FY8 FY9 FY1 FY11 1H FY12 PRC ,9 1,27 1,17 Selfoperated Franchised HK, Macau and other Asian markets Selfoperated Franchised Total POS ,179 1,38 1,6 Source: Company data CTF s POS consist of both selfoperated and franchised which account for approximately 7% and 3%, respectively. We note this ratio is quite different from the industry average. According to a Frost & Sullivan report, only 32% of POS in China were selfoperated by jewellery brands as at enddecember 21. In our view, the difference is largely due to CTF s stronger financial background, which can support the capital requirements for new POS openings, as well as its long operating history, which means it has more experience relative to many local jewellery retailers. In the longer run, the selfoperating model will also allow CTF to capture 1% of the economics of these POS without sharing them with their franchisees. Strong financial background allows the company more selfoperating shops than peers On the other hand, about 2% of CTF s selfoperated jewellery POS in China are joint ventures. CTF controls all aspects of management of these JV POS including store concept design, turnover strategy, product mix and inventory level, daily operations, and branding and marketing activities, with JV partners not actively involved in the daytoday management. As at endfy3/11, CTF had 23 JV partners. In fact, some franchisees are also CTF s JV partners. There are occasions when some franchisees seek to expand their businesses by opening more stores, but, lacking enough capital, they eventually form a JV with CTF for the new stores while maintaining the franchisee relationship for the original ones. Franchisees to help penetrate into Tier 3 cities CTF started entering franchise arrangements in 1998 and, as at 3 September 211, had over 1 franchise partners. CTF intends to utilise the franchise model to expand its POS network in Tier 3 and cities in China, by leveraging their local knowledge, particularly their customer base and market intelligence about store locations. In our view, this is also a faster, more flexible and less capitalintensive way to drive POS expansion. Franchising model is more cost effective for entering Tier 3 cities, while CTF monitors the franchisees closely All of CTF s franchise stores are under the same setup as the selfoperated stores. Staff members of franchised POS are required to undergo the same training programmes as those of selfoperated stores, and all of them enjoy the same salary and incentives. To ensure a unified shopping experience, franchisees are required to operate these POS under CTF s requirements, and franchisees are strictly forbidden to sell unauthorised products. CTF also conducts routine checks and inspections at the franchised POS locations to ensure operations are in accordance with its requirements. Moreover, CTF is Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 8

9 able to monitor franchisees sales and inventory levels through its information and database system on a realtime basis. The products sold at franchised POS are supplied exclusively by CTF, and normally on a cashondelivery basis. CTF also receives payments for startup service fees, which is booked as other income on the company s P&L statement. Further, CTF has the right to set the purchase price at which the franchisees are to buy from it and the retail price at which franchisees are to sell the products. Compared to peers, CTF has a higher proportion of selfoperated POS, which we believe allows CTF to capture higher margins without having to share profits with franchisees. Figure 12: CTF has a higher proportion of selfoperated POS % of self operated POS Chow Tai Fook (1HFY12) Source: Company data Luk Fook (FY3/11) Chow Sang Sang (FY12/1) China jewellery market (21) Most recognised jewellery brand in China and Hong Kong/Macau F & S survey indicates that CTF has the highest brand awareness F & S conducted a consumer survey in China, Hong Kong and Macau in August 211 on jewellery brand awareness and purchase patterns. For brand awareness, on an unaided format, implying that the respondents were being asked to name the brands they recognised without any prompting, 73.9% of the 3, respondents in China and 7.% of the respondents in Hong Kong and Macau went with CTF, the highest response in both the regions. These represent a significant advantage compared to the secondplaced brand, which had only 3.% and 7.7% respondents in China and Hong Kong/Macau naming the brands without a prompt. CTF is the bestknown jewellery brand in China, Hong Kong and Macau Figure 13: China unaided brand awareness on total market, 211 Chow Tai Fook 73.9% Lao Feng Xiang 3.% Chow Sang Sang 3.1% Source: Frost & Sullivan Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 9

10 Figure 1: HK and Macau unaided brand awareness on total market, 211 Chow Tai Fook 7.% Tse Sui Luen 7.7% Chow Sang Sang 9.3%.% 1.% 2.% 3.%.%.% 6.% 7.% 8.% Source: Frost & Sullivan CS China Consumer Survey 212 also shows similar results Credit Suisse s China research team has been conducting a comprehensive consumer survey for China over the past eight years. In 212, we interviewed 2,9 respondents in ten cities in China during December 211. We present the summary of our survey results below. CS survey also noted that CTF is the most popular jewellery brand (1) CTF is the most popular jewellery brand as 23% of the respondents who purchased any jewellery had previously purchased jewellery from CTF. Figure 1: Brands of jewellery purchased Chow Taifook 23 Laofengxiang 1 The brand is also wellreceived by the younger generation Chowtaiseng 12 Chow sengseng Luk Fook Diamend Kingtaifoo Swarovski TSL Cartier Boucheron Others/D.K. 39 Source: Credit Suisse China Consumer Survey 212 (2) When asked which brand of jewellery they intended to buy, 2% of respondents mentioned CTF, again the highest among all brands, particularly among the younger generation aged between 18 and years. Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 1

11 Figure 16: Brands of jewellery intended to buy by city % BJ SH GZ CD SY JH XF BOJ HD PT Chow Taifook Laofengxiang Chowtaiseng Chow sengseng Luk Fook Cartier 13 8 Swarovski Bulgari Diamend 1 21 Boucheron TSL 3 9 Kingtaifoo dgold 3 2 Others/D.K Total * Note the sum of response % is greater than 1% as the respondents are allowed to choose more than one brand. Source: Credit Suisse China Consumer Survey 212 Figure 17: Brands of jewellery intended to buy by age % Chow Taifook Laofengxiang Chowtaiseng Chow sengseng Luk Fook Cartier 2 Sw arovski 1 Bulgari Diamend Boucheron TSL 3 3 Kingtaifoo 7 3 3dgold O thers/d.k Total * Note the sum of response % is greater than 1% as the respondents are allowed to choose more than one brand. Source: Credit Suisse China Consumer Survey 212 All of these have resulted in the leading, and continuously expanding, market share The jewellery retailer market is still very fragmented in China but we expect industry consolidation to continue. According to an F&S report considering only jewellery retailers whose revenues exceed Rmb mn p.a., the top ten players have a combined market share of 7.%. Within this segment, CTF had about 12.6% market share in 21 compared with 9.% and 7.1% for the second and third players, respectively. Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 11

12 On the other hand, CTF has an even more dominant market share leadership position in Hong Kong and Macau. Based on the same report, the topten companies accounted for about 1.7% market share in Hong Kong and Macau in 21, with CTF capturing about 2.1% of the total market share compared with the significantly lower 8.7% and 7.3% market shares achieved by the second and third players, respectively. CTF has the largest market share of the China, HK & Macau jewellery markets Figure 18: CTF's market share in China (21) Chow Tai Fook 12.6% Lao Feng Xiang 9.% Chow Tai Seng Lao Miao Beijing Caishikou 6.% 7.1% 6.9% First Asia 3.8% Source: Frost & Sullivan Figure 19: CTF's market share in Hong Kong/Macau (21) Chow Tai Fook 2.1% Chow Sang Sang 8.7% Luk Fook 7.3% MaBelle 3.9% Cart ier 2.8% Tiffany & Co. 2.2% Source: Frost & Sullivan Based on our projected revenue growth of about 9.2% CAGR between FY3/11 and FY3/1, and comparing this against the growth projections of the retail value of the jewellery market in China by F&S, we expect CTF s market share to increase to about 19.2% in FY3/1. Similarly, for the Hong Kong/Macau market, based on our revenue growth projection of about a 36% CAGR between FY3/11 and FY3/1, we expect CTF s market share to remain stable at around 2% through the next three financial years. The decline in market share in Hong Kong in FY3/1E is largely due to our much more conservative revenue growth assumptions compared to F&S s. CTF s market share is expected to expand to 19.2% in China by FY3/1 Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 12

13 Figure 2: CTF s market share projection, FY111 2.% 22.% 21.% 2.% 1.% 16.% 18.% 19.2% 18.7% 1.% FY12E FY13E FY1E China Hong Kong/Macau Source: Credit Suisse estimates Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 13

14 Jewellery: One of the fastestgrowing retail segments Growth in China jewellery market outpaces the consumer goods market Driven primarily by increasing disposable income and the performance of the overall economy and the custom of purchasing gold/jewellery as gifts, China s jewellery market is forecast to grow at a significantly faster rate (38.6% CAGR from 211) than the consumer goods market (2.% CAGR) to reach HK$1,8 bn by 21, making China the largest jewellery market globally, according to F&S. Figure 21: China jewellery market is growing at 38.6% E CAGR: 13 Gold products:.2% 11 Platinum/ Kgold products: 39.% Gemset jewelley: 3.% 9 Total: 38.6% Tier 3 and cities have greater growth momentum than Tier 1 cities E 212E 213E 21E 21E Gold products Plantinum/Kgold products Gemset jewellery Source: Frost & Sullivan Because of rising affluence and lower operational costs in Tier 3 and other lowertier cities, many largescale jewellers are shifting focus to these cities to explore growth opportunities. As such, jewellery retail sales from Tier 1 and 2 cities, which have already grown significantly historically, are expected to grow at a slower rate than Tier 3 and other lower tier cities, and contribute to 7.3% (21: 66.3%) of the total China jewellery market by 21 according to F&S. Comparatively, the contribution from Tier 3 and other lowertier cities is expected to increase significantly during 211 and account for approximately 2.7% (21: 33.7%) of the total China jewellery market by 21 with 211E CAGR of.3%, according to F&S. and expected to account for 2.7% of the total China jewellery market by 21 Please note that according to our analysis, CTF s exposure to lowertier cities is higher than peers, as local jewellers are mostly regionalbased, while Hong Kongbased jewellers still focus more on expansion into Tier 1 cities. On a per capita basis, jewellery consumption in the Greater China region is still at a nascent stage relative to mature markets such as the US and the European Union which implies strong growth potential. Specifically, per capita jewellery consumption in both China and Macau is less than the world average. Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 1

15 Figure 22: Per capita jewellery consumption in China is just onetenth of the US United States 26 European Union 21 Hong Kong 97 Japan 81 World Macau 36 3 The PRC in US$ Source: Frost & Sullivan report Demandsupply mismatch push up prices of precious stones and metals Transactions of jewellery raw material generally happen on the governmentorganised platforms such as the Shanghai Gold Exchange and the Shanghai Diamond Exchange. Rough diamonds can be procured directly from suppliers such as DTC, the world s largest rough diamond supplier, or from the secondary market. Demand for precious stones and metals far exceeds the supply From 26 to 21, global gold mine tonnage production saw only a 2.% CAGR, which is far below the growth of demand for gold jewellery manufacturing in China at a CAGR of 1.3%. Similar instances of demandsupply mismatch are observed in other raw material markets, which, in turn, drove the scarcity value of precious stones and metals. Figure 23: Annual/average gold/platinum price saw a CAGR of 2.7% (27 Oct 11) US$ per ounce Oct11 Gold Platinum Source: World Gold Council, GFMS Limited, Frost & Sullivan report Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 1

16 Figure 2: Change in annual/period average price of polished diamonds with specification of DH, IFVS2 and VG+ US$ per ounce 2.% 2.% 1.% 1.% 1.3% 1.7%.%.% 6.%.1%.% 1.% Oct11 Source: Rapaport, Frost & Sullivan report 7.6% Chinese consumers like gold products while platinum jewellery remains underpenetrated Due to gold s particular appeal as a symbol of prosperity in Chinese culture, gold products are estimated to maintain their leading position, with 211 CAGR of.2% and to account for nearly.% of the total China jewellery market by 21, according to F&S. Platinum jewellery remains relatively underpenetrated primarily due to its higher average selling price while Kgold jewellery has a strong consumer appeal in China due to its relatively low average selling price. Platinum/Kgold products are forecast to record a strongerthanaverage growth profile of 39.% from 21 to 21, reaching HK$318.9 bn by 21, according to F&S. Gemset jewellery, which represents the second largest product category by retail value in China, is forecast to see 211 CAGR of 3.%, reaching HK$386 bn by 21, according to F&S. Mass luxury jewellery is expected to experience the strongest growth in China Mass luxury was estimated to represent approximately 6.7% of the total jewellery market in China in 21. As jewellery retailers continue to emphasise growth opportunities in Tier 2, 3 and other lowertier cities, the mass luxury segment is forecast to experience the strongest growth relative to the industry, at a CAGR of 39.1% during 211, reaching HK$891.6 bn, or approximately 7.6% of the total market, by 21 according to F&S. Chinese culturally prefer gold products The strong growth in Tier 2 and 3 cities solidifies the leading position of mass luxury jewellery Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 16

17 Figure 2: Mass luxury jewellery accounted for 6.7% of total China market in 21 Highend (price greater than HK$1,) 32.9% Mass luxury (price greater than HK$2, and less than HK$1,) 6.7% Low end (price less than hk$2,) 1.% Source: Frost & Sullivan report Consumers prefer to purchase jewellery from department stores and POS are mainly operated under a franchise model In China, jewellery products are primarily retailed through five types of distribution channels, comprising standalone branded stores, stores in shopping malls, department stores, specialised markets, and others (including the Internet). Within these, department store sales accounted for the largest portion in 21, at.7% of the total share, according to F&S. Due to consumers confidence on brand selection by operators, sales in the PRC happen mainly through department stores Figure 26: China consumers prefer department stores Others (including the Internet) Specialised markets 1.7% 9.8% Stores in shopping mall 13.7% Department stores.7% Source: Frost & Sullivan report Standalone branded stores 3.1% Consumers generally place greater confidence in, and find comfort while purchasing products from, department stores due to their perception that brands offered by these stores have undergone a selection process that is generally based on merits of quality, authenticity and consumer appeal. It is expected that department store sales will gain an increasingly larger share of the market as a retail channel, given it is a method commonly adopted by retailers while penetrating Tier 3 and other lowertier cities due to its lower cost of expansion and greater customer traffic, according to F&S. Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 17

18 In 21, selfoperated stores accounted for approximately 32% of total 8, jewellery POS in China while the franchising model accounted for the remaining 68%, according to an F&S report. For jewellery retailers, selfoperated stores remain an important ownership format that allows greater operational control and an opportunity to earn full retail margins. However, due to the vast geographic coverage of China and costs associated with extensive store rollouts, the franchising model has gained popularity with jewellery retailers as a costeffective and efficient form of expansion, especially in lowertier cities. In the PRC. selfoperated stores only accounted for 32% of the total POS Growth in retail sales in Hong Kong mainly driven by mainland visitors The Hong Kong and Macau jewellery industry had retail sales of HK$62 bn in 21, with Hong Kong contributing approximately 8.3%. Over 21 to 21, the market is forecast to see a CAGR of 39.2%, reaching HK$32.3 bn by 21, according to F&S. Macau s jewellery market growth is forecast to outpace that of Hong Kong with the latter s contribution estimated to drop to 69.2% of the total market by 21. Macau jewellery market growth is expected to outpace that of Hong Kong Figure 27: Retail value of jewellery market in HK and Macau (HK$ bn) Overall 21 21E CAGR: 39.2% E 212E 213E 21E 21E Hong Kong Macau Source: Frost & Sullivan report Based on our study of Hong Kong retail sales, which have been witnessing a.3% CAGR over the past ten years, we note that the growth is mainly driven by mainland visitors, who contributed to 23% of retail sales in 21 compared with only about % in 2. Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 18

19 Figure 28: Hong Kong retail sales trend (HK$ mn) 3, 2, 2, 1, 1,, 221 CAGR =.3% Figure 29: Tourists contribution to HK retail sales (%) Local Mainland China visitors Other tourists Mainland tourists Other tourists Source: Hong Kong Statistic and Census Department, Hong Kong Tourism Board Figure 3: Extourist retail sales trend (HK$ mn) 2, Source: Hong Kong Statistic and Census Department, Hong Kong Tourism Board Figure 31: Mainland visitors retail sales trend (HK$ mn) 7, 2, 1, 221 CAGR = 1.9% 6,,, 221 CAGR = 22.3% 1, 3, 2,, 1, Source: Hong Kong Statistic and Census Department, Hong Kong Tourism Board, Credit Suisse estimates Source: Hong Kong Statistic and Census Department, Hong Kong Tourism Board Stripping out mainland Chinese tourists, Hong Kong retail sales would have shown only a 2.2% CAGR between 2 and 21. If one were to further strip out contributions from other tourists, the growth rate would have been even lower at 1.9%. Note also that Hong Kong retail sales recorded YoY declines for two consecutive years in 29 and 21, if we strip out the contribution from mainland Chinese visitors. The importance of mainland Chinese tourists comes from both the increase in their numbers and their per capita spending. Between 2 and 21, Hong Kong inbound visitors experienced a 1.7% CAGR, while for mainland Chinese alone, visits saw a 19.6% CAGR during the same period. Another interesting point to note is that in 2, only 29% of inbound visitors came from mainland China, while in 21, they accounted for 63% of total visitors to Hong Kong. Local retail spending has been declining over the past two years Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 19

20 Figure 32: HK inbound visitors trend (mn) Figure 33: Mainland Chinese visitors trend (mn) CAGR = 1.7% CAGR = 19.6% Mainland Chinese tourists All other tourists Mainland Chinese tourists Source: Hong Kong Tourism Board Source: Hong Kong Tourism Board In terms of shopping spend per visitor, the growth exhibited by mainland Chinese visitors also outpaced that of tourists from other countries, from the trough in 2. Note that mainland tourists also tend to utilise a higher proportion of their total spending on shopping in comparison with tourists from other countries. Figure 3: Shopping spend per capita trend (HK$) 6, Figure 3: Shopping as % of total spending (%) 8,, 3, 2, 1, All tourists Mainland Chinese toursits All tourists Mainland Chinese toursits Source: Hong Kong Tourism Board Source: Hong Kong Tourism Board Extensive POS network drives stronger sales in HK Even though some companies belong to the same segment, selling products with little price differential and product differentiation, their sales performance in Hong Kong can vary significantly. In our opinion, the jewellery segment is a very good example of this. There are four major listed jewellery retailers in Hong Kong, namely, Luk Fook (9.HK, HK$27.8, OUTPERFORM [V], TP HK$37.8), Chow Sang Sang (116.HK, HK$18.8, Not rated), King Fook (28.HK, HK$1.13, Not rated) and Tse Sui Luen (17.HK, HK$.8, Not rated). The majority of these companies sales is generated from gold jewellery, which has very little price differential as it is sold on the marktomarket spot price of gold, and there is also minimal product differentiation, in our view. However, based on their respective latest financial statements, the four companies had substantially different sales performances. These ranged from 7.% YoY sales growth by We have studied the Hong Kong retail revenue growth of four listed jewellery retailers Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 2

21 Luk Fook (March yearend) to 36% YoY by Chow Sang Sang (December yearend possibly an understatement, as jewellery and watch sales growth accelerated since the start of 211), to 2.9% YoY by Tse Sui Luen (February yearend) to only.% by King Fook (March yearend). Having factored in the over 2% rise in gold price over the past year, both Tse Sui Luen and King Fook registered barely any volume growth. We believe the key reason behind the stark differences in Hong Kong retail sales performance was brand recognition. As mentioned above, there is little price and product differentiation for gold jewellery. Therefore, differences in brand recognition will likely largely depend on a company s sales network penetration in China. Among the four listed companies, Luk Fook has the highest number of stores in China 67 as at the end of March 211 while King Fook has the lowest at only three. In our view, it is King Fook s limited exposure in China that resulted in its market share loss in Hong Kong. After all, we believe that retail sales growth in Hong Kong is largely driven by visiting mainland Chinese tourists. and noticed a high correlation to the size of their sales networks in China Figure 36: Comparison across major listed jewellery retailers in Hong Kong Latest FY HK sales YoY change No. of stores YoY change No. of stores YoY change Company Ticket (HK$ mn) (%) in HK (no.) in China (no.) Luk Fook 9.HK, Chow Sang Sang 116.HK, Tse Sui Luen 17.HK 2, King Fook 28.HK 1, Source: Company data Given the CTF has the largest number of POS in China and Hong Kong among all listed Hong Kong jewellery retailers as listed above, we believe it can maintain its market share leadership position, and likely extend it further. Similar purchase habits in Hong Kong and Macau with that in China Similar to China, sales of gold products account for the major retail sales of jewellery in HK and Macau, though to a less dominant extent. In contrast to gold products contributing 1.% of jewellery sales in China in 21, gold product sales accounted for only.6% of total jewellery sales in Hong Kong and Macau. Gold products are estimated to maintain their leadership position with a CAGR of.%, reaching HK$137. bn, or 2.% of the market by 21. Figure 37: Gold products maintain the leadership position with CAGR of.% 211E E CAGR: Gold products:.% Platinum/ Kgold products:.% Gemset jew elley : 37.6% Total: 39.2% Proportionately, Hong Kong shoppers buy less gold than people in China do, but still demonstrate a similar shopping habit E 212E 213E 21E 21E Gold products Plantinum/Kgold products Gemset jew ellery Source: Frost & Sullivan report Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 21

22 In Hong Kong and Macau, the significance of the mass to highend luxury segment in the jewellery industry is even more pronounced as compared to that within China primarily due to higher domestic income levels, greater willingness to pay for jewellery products and the rising disposable income of Chinese tourists. In 21, the mass to highend luxury segment in Hong Kong and Macau represented 92.% of the total jewellery market compared with 89.6% in China. Similar to China, the growth of this segment is expected to outpace the rest of the industry, with an aggregate 211 CAGR of 39.6%, according to F&S. Figure 38: Mass to highend market luxury segment more significant in HK and Macau Mass lux ury (price greater than HK$2, and less than HK$1,) 3.8% Total 21 retail value: HK$62bn Highend (price greater than HK$1,) 38.6% Low end (price less than HK$2,) 7.6% Source: Frost & Sullivan report In Hong Kong, standalone branded stores and stores in shopping malls represented the major sales channels by number of POS, at 6.8% and.2% of the 9 POS in 21, respectively, according to a F&S report. Within these, approximately 99% were selfowned on the back of the relatively small size of Hong Kong and Macau compared to China. Mass to highend luxury watch* segment is expected to see a 32..% CAGR in 211 Unlike China, standalone branded stores and stores in shopping malls represent the major sales channels Figure 39: China s mass to highend luxury watch market is estimated to see a 3.8% CAGR from E CAGR : 3.8% E 212E 213E 21E 21E Source: Frost & Sullivan Report * In China, the mass to highend luxury watch segment is defined as watches with a retail price of no less than Rmb3,. Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 22

23 According to an F&S report, the mass to highend luxury watch market in China is estimated to have reached HK$38 bn in 21, up from HK$16 bn in 26, representing a CAGR of 2.8%. The China watch market is mainly dominated by imported Swiss brands, local domestic manufacturers and other Asian and Japanese players in the mass to highend luxury range. The market is gradually witnessing a change in consumer attitudes and lifestyle with rising demand for quality and status given an urbanising middle class. As such, the mass to highend luxury watch players are expected to benefit from this trend. In particular, for consumers in the highend segment of the market, brand image, brand reputation and style have become increasingly important purchase criteria. Mass to highend market saw a 2.8% CAGR between 26 and 21 Figure : HK and Macau market is forecast to grow at a faster rate than historical levels with a CAGR of 3.1% over E CAGR: 16 Hong Kong: 32.% 1 Macau:.% 12 Total: 3.1% E 212E 213E 21E 21E Hong Kong Macau Source: Frost & Sullivan report * In Hong Kong & Macau, the mass to highend luxury watch segment is defined as watches with a retail price of no less than HK$1,. Imports of Swiss watches into Hong Kong accounted for approximately onefifth of the world s total Swiss watch imports in 21, according to the Federation of the Swiss Watch Industry. The strong growth in branded mass to highend luxury watches in Hong Kong and Macau can be attributed to the rapidly growing number of tourists, rising standard of living of Chinese tourists, increasing domestic expenditure on luxury goods and a growing desire for authentic, aspirational brands. Hong Kong is the largest export market for Swiss watches, accounting for 2% of total exports According to F&S, from 26 to 21, the market for mass to highend luxury watches in Hong Kong and Macau grew from HK$17. bn to HK$3.6 bn, representing a CAGR of 19.%. From 21 to 21, the market is forecasted to grow at a faster rate than historical levels with a CAGR of 3.1%, reaching HK$1.2 bn by 21. The export share of Swiss watches to Hong Kong increased from 16% in 29 to 21% in 211, in line with the strong growth in demand during the period, according to the Federation of the Swiss Watch Industry. Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 23

24 Figure 1: Exports of Swiss watches Value (CHF mn) 2, 18, 16, 1, 12, 1, 8, 6,, 2, 17,.3 1, ,2.1 3,66.2 2,8.8 1,91.2 Jan Nov 29 Jan Nov 21 Jan Nov 211 Hong Kong Total ex ports Source: Federation of the Swiss Watch Industry FH Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 2

25 Initiate coverage with NEUTRAL % revenue CAGR between FY3/11 and FY3/1E On the back of the strong jewellery demand outlook in both China and Hong Kong/Macau as discussed in the previous section, we project CTF to show a strong revenue CAGR of % from HK$3,3 mn in FY3/11 to HK$117,31 mn in FY3/1E. A 6% increase in POS We expect the strong revenue CAGR to be driven by a 6% increase in POS during the period from 1,38 in endfy3/11 to 1,986 in endfy3/1. This annual net POS additions are in line with the CTF target of adding 2 new POS in China and three to five new POS in Hong Kong/ Macau per year. Figure 2: CTF's POS expansion projection FY3/9 FY3/1 FY3/11 FY3/12E FY3/13E FY3/1E China Selfoperated ,63 1,163 1,23 Franchised ,9 1,27 1, 1,72 1,869 YoY increase (%) Hong Kong/ Macau and other Asian markets Selfoperated Franchised YoY increase (%) Grand total 96 1,179 1,38 1,62 1,832 1,986 YoY increase (%) % SSSG in China Further, we project CTF s SSS growth will stay strong at 9% in China during FY3/12 and gradually normalise to 18% in FY3/1E. The table below shows details of our SSS growth assumptions. Note, in our financial forecasts, we have assumed that the gold price will remain at the average level of October 211 of US$1,6 per ounce. Thus, a part of the slowing SSS growth would be due to this stable gold price, which had elevated CTF s SSSG in 1H FY3/12. For Hong Kong, we expect a similar SSSG, with a slight variation on the back of product mix. Figure 3: CTF's SSSG projection and assumptions China FY3/12E FY3/13E FY3/1E Gemset jewellery ASP (% change) 1 Volume (% change) Gold jewellery ASP (% change) 2 Volume (% change) Platinum/ Kgold jewellery ASP (% change) 1 Volume (% change) Luxury watches ASP (% change) Volume (% change) Overall SSSG HK/Macau SSSG Source: Credit Suisse estimates Chow Tai Fook Jewellery Group Limited (1929.HK / 1929 HK) 2