Luk Fook (590 HK) Hold Target price: HK$ Downgrade to Hold on more challenging HK & Macau market outlook. Equity Research Consumer Discretionary

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1 Equity Research Consumer Discretionary Luk Fook (590 HK) Hold Target price: HK$24.60 Albert Yip, CFA SFC CE No. ADT GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Downgrade to Hold on more challenging HK & Macau market outlook Downgrade from Buy to Hold LF reported weak sales in HK & Macau for the CNY period. We downgrade the company given the increasingly challenging outlook for the HK retail market due to softening mainland visitor arrivals and their decreasing purchasing power. Visibility is also clouded by recent protests against parallel traders, which could negatively affect growth in mainland visitors going forward. Of the three key jewelry names, we estimate LF has the highest retail exposure to HK & Macau in terms of profit contribution (LF: 58% vs CTF: 51% and CSS: 54% in their latest interim results). During the CNY period, LF s SSS in HK & Macau were still better than CTF but the degree of outperformance over CTF narrowed sharply compared to 3QFY15. We lower our FY15-17 core profit estimates by 3-14% and cut our TP from HK$33.60 to HK$24.60, based on 8.5x FY16E P/E (previously 10.5x), due to the sector de-rating. CNY sales slightly better than CTF SSS in HK & Macau declined by 25% YoY. China SSS rose 15% YoY. LF s SSS were slightly above CTF in both HK & Macau and China. However, LF s 21% YoY decline in overall SSS was lower than CTF s 4% decline as most of LF s stores in China are licensed stores (figure 3). HK & Macau sales weaker than 3QFY15 SSS in the CNY period declined 25% YoY, down from the 6% decline in 3QFY15. LF s SSS outperformance over CTF (SSS -29% in the CNY period) narrowed sharply compared to 3QFY15 (-6% vs -21%) as CTF s 3QFY15 sales were affected by the protests. We expect the three major jewelry retailers to see similar SSS trends going forward. Gem-set SSS were down 14% YoY, better than gold s -34%. China market recovering Gem-set SSS improved from 13% in 3QFY15 to 65% YoY during the CNY period as Valentine s Day also fell within the holiday period. Gold SSS also improved to 3% YoY (vs -16% in 3QFY15). Licensed stores saw a similar SSS trend compared to self-operated stores during the CNY period. Product mix improvement Given gem-set SSS strongly outperformed gold SSS in both China and HK & Macau during the CNY period, we expect the gem-set sales mix to improve YoY in 4QFY15. Stock performance Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Source: Bloomberg Key data Source: Bloomberg HSI Luk Fook Mar 4 close Shares in issue (m) Major shareholder Wong Wai Sheung (42.2%) Market cap (HK$ bn) M avg. vol. (m) W high/low 30.80/19.26 Licensed stores to see low-teen growth Due to delays in the handover of store premises from landlords, management has lowered its growth guidance for licensed stores in China from 15% to low-teen growth in FY15/16. Rental trend Following the lower-than-expected increase in rent at one of its Macau stores, management expects a 20-3 rental increase for lease renewals in FY15 (previous estimate: +30-4). The company has 25 lease agreements due to be renewed in FY16; management initially expects a low-teen rental increase. Earnings forecasts cut We lower our FY15/16/17 core profit estimates by 3%//14% mainly to reflect weaker-than-expected HK & Macau sales and a slowdown in licensed store growth. Looking into FY16, while we anticipate a gradual recovery given the low comparable base for 2HFY16, visibility in HK & Macau is low. That said, we expect the profit contribution from China to trend up going forward on better growth potential. 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, E 16,518 1,602 1, E 17,629 1,702 1, E 18,794 1,870 1, Sources: Company data, GF Securities (HK) estimates Note: Core profit excludes fair value change in convertible bonds

2 P/B Company report Figure 1: Quarterly SSS trend Figure 2: SSS growth % 117% 83% 7 36% % 25% 7% 46% 22% 8% 7% % 3 1% -11% 14% 6% -2-2% -12% -6% -52% -3-54% 3QFY13 4QFY13 1QFY14 2QFY14 3QFY13 4QFY14 1QFY15 2QFY15 3QFY % 2% 3% -22% -21% FY12 FY13 FY14 FY15E FY16E FY17E China HK & Macau China HK & Macau Sources: Company data, GF Securities (HK) Sources: Company data, GF Securities (HK) Figure 3: Peer SSS comparison - CNY period (Feb 5-22, 2015) LF China HK & Macau Group CTF China HK & Macau Group Overall 15% -25% -21% Overall 11% -29% -4% Gem-set 65% -14% - Gem-set 62% -17% 26% Gold 3% -34% -29% Gold -2% -38% -14% Sources: Companies Figure 4: Consumer sector ROE and P/B analysis (FY15E) R² = y = x CTF CSS LF ROE Sources: Bloomberg, GF Securities (HK) estimates Page 2

3 Figure 5: Total store number 1,800 1,600 1,400 1,200 1, ,680 26% 1,556 1,412 22% 1,268 23% 24% 1,072 18% % 8% FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E Total stores Growth 3 25% 2 15% 5% Sources: Company, GF Securities (HK) estimates Figure 6: 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 19x 15x 11x 7x 3x Sources: Bloomberg, GF Securities (HK) estimates Page 3

4 Figure 7: Financial statements Profit & Loss Balance Sheet Year end Mar 31 FY13 FY14 FY15E FY16E FY17E Year end Mar 31 FY13 FY14 FY15E FY16E FY17E Revenue 13,412 19,215 16,518 17,629 18,794 Fixed assets Cost of sales (10,582) (15,001) (12,624) (13,445) (14,299) PPE Gross profit 2,830 4,214 3,894 4,185 4,494 Land use rights Investment properties Other income Investment in associate and JV Selling & distribution expenses (1,311) (1,923) (2,008) (2,161) (2,286) Shareholders loans to an associate Administration expenses (115) (151) (134) (138) (144) CB Other gains/(losses), net Others Operating profit 1,524 2,309 1,982 2,115 2,307 Deferred tax assets ,041 1,543 1,523 1,524 Net finance cost Non-recurring gains Current assets Share of profit/(loss) of associate and JV (1) (0) (18) (22) (4) Inventories 4,955 6,225 5,588 6,123 6,570 Profit before tax 1,530 2,321 2,007 2,141 2,367 A/C receivables Income tax expense (260) (454) (401) (435) (492) Deposits and prepayments Non-controlling interests (3) (2) (4) (4) (5) Others Net profit 1,266 1,865 1,602 1,702 1,870 Term deposit ,000 1,500 2,000 Core profit 1,266 1,865 1,587 1,702 1,870 Cash and cash equivalents 1,187 1,646 2,063 2,179 2,485 Core EPS ,686 8,546 9,097 10,275 11,560 Growth rates Total assets 7,562 9,586 10,640 11,798 13,083 Revenue (14) 7 7 Core profit (5) 47 (15) 7 10 Current liabilities Core EPS (11) 47 (15) 7 10 A/C payables Other payables Margin & ratios Bank borrowings Gross profit margin Gold loans OP margin Others Net profit margin Tax liabilities Effective tax rate ,004 1,798 1,931 2,046 2,174 Payout ratio Cash Flow Statement Non-current liabilities Employee benefit obligations Year end Mar 31 FY13 FY14 FY15E FY16E FY17E Deferred tax liabilities Profit before tax 1,530 2,321 2,007 2,141 2, Share of (profit)/loss of associate and JV Net finance cost (6) (12) (28) (47) (64) Equity Depreciation and amortization Shareholders' equity 6,425 7,641 8,563 9,600 10,750 Others (15) (9) (28) 0 0 Non-controlling interests Change in amount due to an associate (25) ,478 7,699 8,625 9,666 10,821 Change of working capital (839) (1,231) 567 (504) (413) Tax paid (320) (237) (428) (418) (463) Total liabilities & equity 7,562 9,586 10,640 11,798 13,083 Operating cash flow ,247 1,353 1,586 Financial Ratios Capex (307) (258) (220) (150) (150) Year end Mar 31 FY13 FY14 FY15E FY16E FY17E Disposals Current ratio Interest received Quick ratio Purchase of financial assets 0 (8) (57) 0 0 Purchase of associate or JV 0 0 (245) 0 0 A/C receivable turnover days Shareholder loan to associate 0 0 (100) 0 0 A/C payable turnover days Change in term deposits 761 (158) (842) (500) (500) Inventory turnover days Others Investing cash flow 461 (406) (1,422) (589) (572) Asset turnover Total assets/total equity Change of borrowings Net cash 1,187 1,237 2,194 2,780 3,562 Change of gold loans Dividend paid (477) (654) (694) (661) (714) ROE Interest paid (0) (3) (16) (16) (17) ROA Financing cash flow (477) (89) (408) (648) (707) Net change of cash flow Forex changes 1 (8) Sources: Company data, GF Securities (HK) estimates 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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