Equity Research Consumer Discretionary Luk Fook (590 HK) Hold (downgraded) Target price: HK$34.80 Albert Yip, CFA SFC CE No. ADT599 albertyip@gfgroup.com.hk +852 3719 1010 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong 1HFY18 results beat, but downgrade from Accumulate to Hold on rich valuation Downgrade from Accumulate to Hold Core net profit +21% YoY to HK$520m, /9% above our estimates/bloomberg consensus estimates, mainly due to higher-thanexpected gold product GPM on less promotional activities. Looking ahead, we think the best times for jewelry retailers have passed for three reasons: SSSG is set to moderate, the decline in street shop rental reversion in HK will narrow next year, and mainland China tourist arrivals might be affected as tension between China and Korea is easing. We lift our FY18 and FY19 net profit estimates by on higher GPM and expect net profit growth to slow from 21% in FY18 to 11% in FY19. The stock is now trading at 15.9x 1-year forward P/E, above its historical average +2sd (15x). Our TP is adjusted from HK$33.00 to HK$34.80, still based on 15x FY19 P/E. Best times have passed 1) SSSG to moderate Given the recovery in SSS since 3QFY17, there should be a steadily higher comparable base for LF during 3QFY18-1QFY19. Though LF delivered sector-leading SSSG in 2Q and 3QFY18 thanks to its wellreceived good value-for-money products, we think these products niches may not be sustainable because competitors could launch similar products. 2) HK shop rental stabilizing Due to a gradual recovery in HK retail sales, the QoQ decline in HK street shop rental narrowed from -1.8% QoQ in 2Q17 to -0.3% QoQ in 3Q17 according to the CBRE. According to industry experts, it is expected that shop rental will be stable in 2018 given that HK retail sales growth has bottomed out. LF s rental reversion decline for prime street shops narrowed to 30-4 in 1HFY18 from 40-5 in 1QFY18. We expect the decline in rental reversion to narrow in 2018. 3) Tension between China and Korea easing Spring Airlines (601021 CH) resumed its three flights per week from Ningbo to Jeju on 31 Oct 2017, suggesting that the tension between China and Korea is easing. If the Korea travel ban (enforced March 2017) is lifted, it would impact HK s mainland visitor arrivals. Stock performance 8 7 6 5 4 3 - - Nov-16 Feb-17 May-17 Aug-17 HSI Luk Fook Outlook 1) Oct and Nov 2017 trading update: We estimate that HK & Macau SSSG was slightly negative in Oct 2017 and rebounded to double-digit growth in Nov 2017 due to a low base (HK jewelry retail sales was flat in Oct 2016 and fell 1 in Nov 2016). The base for Dec 2017 would be even higher as HK jewelry retail sales saw 2% growth in Dec 2016 (Figure 2). In China, we estimate SSSG was slightly positive in Oct and single-digit growth in Nov. Gem-set SSS performed better than gold products in HK & Macau, but gold was better in China. 2) Management still expects double-digit SSSG in China and single-digit SSSG in HK & Macau in FY18; 3) LF has raised its net store addition target from 50 to not less than 100 in China in FY18. Source: Bloomberg Key data Nov 29 close (HK$) 34.85 Shares in issue (m) 587.1 Major shareholder Wong Wai Sheung (42.2%) Market cap (HK$ bn) 20.5 3M avg. vol. (m) 0.9 52W high/low (HK$) 36.15/19.63 Source: Bloomberg Stock valuation Year-end March Turnover (HK$ m) Net profit (HK$ m) Core profit (HK$ m) Core EPS (HK$) EPS YoY Core P/E Yield BPS (HK$) P/B ROE 2015 15,923 1,615 1,605 2.725-14 12.8 3.1 14.5 2.4 19.8 2016 14,031 959 979 1.664-39 21.0 3.1 14.8 2.4 11.4 2017 12,807 1,017 1,014 1.727 4 20.2 3.1 15.1 2.3 11.6 2018E 14,133 1,228 1,228 2.091 21 16.7 3.1 16.2 2.2 13.4 2019E 14,904 1,361 1,361 2.318 11 15.1 3.1 17.5 2.0 13.8
Company report Results highlights Excluding the holding gain from gold price movements and unrealized hedging gains, adjusted net profit would have jumped by 4+ according to management. Revenue rose 1, led by 17%/11% SSSG in China and HK & Macau. GPM fell 1.8ppt to 26.2% because LF did not see a significant holding gain from gold price movements in 1HFY18 (vs. HK$140m holding gain in 1HFY17). However, GPM was 1.3ppt above our estimate due to less promotional activities for gold products. Gold product GPM fell 3.2ppt to 16.1%. Going forward, management expects a normalized gold product GPM will be above the previous normal range of 12-13% but could be less than 16%. Gem-set GPM also dropped 1.2ppt to 34.8% as GPM normalized. OP +1 and OPM flat at 10.3%. The impact from positive operating leverage offset the impact of the GPM decline. Losses at its associate company, 3D-gold, decreased from HK$31m to HK$25m. Net cash balance remained stable at HK$1.4bn. Figure 1: Results highlights Y/E Mar (HK$ m) 1HFY18 1HFY17 % change Remarks Revenue 6,283 5,469 1 HK & Macau/China SSSG +11%/+17% Cost of sales (4,636) (3,937) 18% Gross profit 1,647 1,532 8% Other income 77 83-8% Selling and distribution expenses (997) (941) Minimum rent dropped 1% YoY, the rental reversion decline of 6% 30-4 of shops at prime location was largely offset by openings of Parisans shop and overseas shops Administrative expenses (75) (72) Other expenses (7) (41) -8 Operating profit 645 561 1 Adjusted operating profit Finance income 13 13 Finance costs (3) (4) -41% Non-recurring gains 0 (2) -11 Share of profit/(loss) of associate (25) (31) -22% Profit before tax 631 535 18% Tax expense (110) (102) 8% Profit after tax 521 434 Non-controlling interests (1) (4) -76% Net profit 520 429 21% Core profit 520 432 EPS (HK$) 0.89 0.73 21% Core EPS (HK$) 0.89 0.74 DPS (HK$) 0.55 0.55 Margin & Ratio Gross margin 26.2 28.0 (1.8) Operating margin 10.3 10.3 0.0 SG&A expense/revenue 17.1 18.5 (1.5) Core profit margin 8.3 7.9 0.4 Effective tax rate 17.4 19.0 (1.7) Payout ratio 62.1 75.2 (13.2) 1HFY18 1HFY17 change Inventory days 287 311 (24) Net cash (HK$ m) 1,404 1,502-7% Sources: Company data, GF Securities (Hong Kong) Excluding holding gain of gold price movement and unrealized hedging gains, adjusted net profit would increase by >4 Dropped due to high base, gold product GM at 16.1%, above normal range of 12-13%, because of less promotion activities 2
Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Jan & Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan & Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan & Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Company report Figure 2: HK jewelry retail sales growth (YoY) Figure 3: China jewelry retail sales growth moderating 20 10 0-10 -20-30 -40-50 1 19.3% - -2. - 10.7% 10.3% 1. 14.2% 17. 6. 4. 4.9% 11.1% -1. Gold, silver and jewelry 5. -9.3% 1.2% -1.1% -2. -6.3% 8.2% 9.6% 6. 7.2% 7. 5. 4.8% 2. 2.7% 6.3% 2.6% 5.3% 2. Sources: Hong Kong Census & Statistics Department, National Bureau of Statistics of China GF Securities (Hong Kong) Figure 4: Jewelry companies SSS trend Calendar Year 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 Oct-17 Nov-17 Avg gold price (US$) 1,126 1,105 1,181 1,259 1,335 1,217 1,218 1,259 1,279 Avg gold price YoY -12% -8% -3% 19% 3% - SSS trend Chow Tai Fook (1929 HK) -3% -1-26% na na na na na China 6% -6% -2-17% -22% 12% 11% 9% HK and Macau -13% -23% -27% - -3-2% 13% Luk Fook (590 HK) -6% -2-27% -2-37% - 2% 17% slightly -ve China 2% - -19% -2-23% 11% 23% 11% +ve +ve sd HK and Macau -7% -26% -28% -2-39% -11% 1% 3% 18% -ve +ve dd Chow Sang Sang (116 HK) China +ve sd -11% ------- -ve ----- -ve low to mid-teen mid to high sd high sd high sd mid sd flat HK and Macau +ve low sd -ve high-teen ----- -ve 26% ----- ----- -ve 3 ----- -ve 7% -ve 2-3% -ve 2-3% mid sd flat RSV trend Chow Tai Fook (1929 HK) China 9% -6% -2-13% -17% 7% 16% 17% 1 HK and Macau - - -26% -22% -33% -6% 1% 7% 12% SSS trend by category Chow Tai Fook (1929 HK) Gold products 13% -1-27% na na na na na na China 22% -3% -29% -22% -27% 7% 17% 16% 1 HK and Macau -2-2 -12% -36% 8% 19% 9% 21% Gem-set jewellery -13% -12% -23% na na na na na na -7% -2-12% -17% - 3% -1% HK and Macau -2-16% -22% -27% -23% -17% -17% - 7% Luk Fook (590 HK) Gold and platinum products -2-28% -26% -47% -11% -1% 21% 1% -1-27% -29% -3 2% 16% 32% 19% HK and Macau 6% -26% -28% -2-49% -12% - 21% Gem-set jewellery -26% -26% -2-19% -1-11% 9% 16% China 13% 2% -8% -3% 6% -2% HK and Macau -28% -27% -27% - -1-12% 9% 18% Chow Sang Sang (116 HK) Gold and platinum products ------ -ve 13% ------- ----- -ve 32% ----- lsd 6-7% low- teen +ve HK and Macau -49% -ve msd +ve -ve Gem-set jewellery ------------ 8% -------------- low-teen mid-teens +ve lsd -ve mid sd -ve HK and Macau better than LF -ve low-teen -ve hsd -ve dd -ve high sd +ve Source: Company data, GF Securities (Hong Kong) estimates Note: Chow Sang Sang figures are GF Securities (Hong Kong) estimates. 3
3QFY13 4QFY13 1QFY14 2QFY14 3QFY13 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 Company report Figure 5: Quarterly SSS trend Figure 6: SSS growth 14 1 10 8 6 4 - -4-6 117% 7 83% 36% 29% 23% 1% 1% - 2% 11% 3-6% - -19%-2-23% -2% 1-6% 1% 3% -12% -7% -52% -11% -22% -3-19% -11% -26%-28% -2-39% -5 5 4 3 - - -3 46% 41% 2 13% 22% 7% - 7% -8% 1% -28% - - -3 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E China HK & Macau China HK & Macau Figure 7: 1HFY18 revenue breakdown by segment retail 1 1 licensing retail 61% Figure 8: 1HFY18 profit breakdown by segment licensing 2 17% retail retail 37% 11% Sources: Company data, GF Securities (Hong Kong) Figure 9: Total store number 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1,661 1,608 26% 2 1,437 1,383 22% 1,268 23% 1,072 862 18% 700 557 9% 7% 3% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E Total stores Growth 3 2 1 4
Nov-09 May-10 Nov-10 May-11 Nov-11 May-12 Nov-12 May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17 Company report Figure 10: P/E band (HK$) 60 55 50 45 40 35 30 25 20 15 10 5 0 19x 15x 11x 7x 3x Sources: Bloomberg, GF Securities (Hong Kong) estimates Figure 11: Key assumptions (HK$ m) FY15 FY16 FY17 FY18E FY19E Total revenue 15,923 14,031 12,807 14,133 14,904 growth % -17.1% -11.9% -8.7% 10.3% 5. - Retail revenue - HK, Macau and overseas markets 11,330 9,629 7,959 8,547 8,824 growth % -21.9% -15. -17.3% 7. 3.2% store growth 5. 0. 4.8% 4. 4.3% SSS -28.2% -20. -19. 7. 2. - Retail revenue - China market 1,222 1,312 1,659 2,204 2,495 growth % -25.9% 7. 26. 32.8% 13.2% store growth -4.8% 44.3% 24.6% 24.6% 14.1% SSS -29.8% -8. -4.8% 11. 4. - Wholesale revenue 2,794 2,563 2,672 2,782 2,935 growth % 14.8% -8.3% 4.3% 4.1% 5. - Licensing revenue 578 528 516 599 650 growth % -6.6% -8.6% -2.2% 16.1% 8. Gross profit 3,832 3,254 3,277 3,618 3,808 Gross margin 24.1% 23.2% 25.6% 25.6% 25.6% Product mix gold & platinum 60.2% 60.9% 57.1% 56.9% 56. gem-set 39.8% 39.1% 42.9% 43.1% 43.3% Selling expenses ratio 12.2% 14.1% 15.6% 14.8% 14. Administrative expenses ratio 0.9% 1.1% 1.2% 1.2% 1.2% Operating profit 1,967 1,233 1,286 1,525 1,669 growth % -14.8% -37.3% 4. 18.6% 9. OP margin 12. 8.8% 10. 10.8% 11.2% Core profit 1,605 979 1,014 1,228 1,361 growth % -13.9% -39. 3. 21.1% 10.9% Core profit margin 10.1% 7. 7.9% 8.7% 9.1% Payout ratio 4 68% 6 53% 47% 5
Company report Figure 12: Financial statements Income Statement Balance Sheet Year-end March 31 (HK$ m) FY15 FY16 FY17 FY18E FY19E Year-end March 31 (HK$ m) FY15 FY16 FY17 FY18E FY19E Revenue 15,923 14,031 12,807 14,133 14,904 Fixed assets Cost of sales (12,091) (10,777) (9,530) (10,514) (11,096) PPE 618 604 564 568 551 Gross profit 3,832 3,254 3,277 3,618 3,808 Land use rights 225 215 248 239 230 Investment properties 46 25 35 34 33 Other income 174 139 176 171 180 Investment in associates 246 155 85 41 21 Selling & distribution expenses (1,937) (1,982) (1,994) (2,092) (2,146) Shareholders loans to an associate 83 87 91 91 91 Administration expenses (147) (149) (155) (165) (173) CB 67 46 49 49 0 Other gains/(losses), net 45 (30) (17) (7) 0 Others 138 132 130 130 130 Operating profit 1,967 1,233 1,286 1,525 1,669 Deferred tax assets 28 37 46 46 46 1,451 1,300 1,248 1,197 1,102 Net finance costs 28 28 15 15 17 Non-recurring gains 9 (21) 3 0 0 Current assets Share of profit/(loss) of associates (22) (79) (54) (44) (20) Inventories 7,395 6,345 6,973 7,474 7,814 Profit before tax 1,983 1,161 1,250 1,497 1,667 A/C receivables 201 215 217 240 253 Income tax expense (362) (200) (223) (260) (295) Deposits and prepayments 258 242 323 357 376 Non-controlling interests (6) (3) (10) (9) (10) Shareholders loans to an associate 20 20 20 20 20 Net profit 1,615 959 1,017 1,228 1,361 Others 97 77 36 36 36 Core profit 1,605 979 1,014 1,228 1,361 CB 0 0 0 0 49 Core EPS (HK$) 2.73 1.66 1.73 2.09 2.32 ST deposits 715 71 333 333 333 Cash and cash equivalents 1,375 2,362 1,529 1,845 2,423 Growth rates 10,060 9,330 9,431 10,304 11,304 Revenue (17) (12) (9) 10 5 Core profit (14) (39) 4 21 11 Total assets 11,511 10,629 10,679 11,502 12,406 Core EPS (14) (39) 4 21 11 Current liabilities Margin & ratios A/C payables 218 246 382 438 481 Gross profit margin 24.1 23.2 25.6 25.6 25.6 Other payables 684 646 623 688 725 OP margin 12.4 8.8 10.0 10.8 11.2 Bank borrowings 1,471 400 0 0 0 Net profit margin 10.1 6.8 7.9 8.7 9.1 Gold loans 243 311 437 523 547 Effective tax rate 18.3 17.2 17.8 17.4 17.7 Others 2 2 2 2 2 Payout ratio 40.1 67.5 68.5 52.6 47.4 Tax liabilities 174 151 150 143 162 2,791 1,757 1,594 1,794 1,917 Cash Flow Statement Year-end March 31 (HK$ m) FY15 FY16 FY17E FY18E FY19E Non-current liabilities Profit before tax 1,983 1,161 1,250 1,497 1,667 Employee benefit obligations 34 24 24 26 28 Share of (profit)/loss of associates and JVs 22 79 54 44 20 Deferred tax liabilities 85 80 82 82 82 Net finance costs (28) (28) (15) (15) (17) 119 104 105 108 109 Depreciation and amortization 158 136 131 128 126 Others (15) 37 25 7 0 Equity Change in amount due to an associate (30) (25) 23 0 0 Shareholders' equity 8,536 8,674 8,873 9,485 10,254 Change of working capital (1,203) 898 (534) (436) (292) Non-controlling interests 64 95 107 115 126 Tax paid (462) (195) (215) (242) (278) 8,601 8,769 8,980 9,600 10,380 Operating cash flow 424 2,063 720 982 1,226 Total liabilities & equity 11,511 10,629 10,679 11,502 12,406 Capex (181) (113) (168) (122) (100) Disposals 1 1 0 0 0 Financial Ratios Interest received 25 56 19 27 31 Year-end March 31 (HK$ m) FY15 FY16 FY17 FY18E FY19E Purchase of financial assets (57) (4) 0 0 57 Current ratio 3.6 5.3 5.9 5.7 5.9 Purchase of associate (245) 0 0 0 0 Quick ratio 1.0 1.7 1.5 1.6 1.8 Shareholder loan to associate (120) 0 0 0 0 Change in term deposits (557) 644 (262) 0 0 A/C receivable turnover days 5 5 6 6 6 Others 0 29 3 0 0 A/C payable turnover days 8 8 12 14 15 Investing cash flow (1,133) 614 (408) (95) (12) Inventory turnover days 209 238 261 256 256 Change of borrowings 905 (1,071) (400) 0 0 Asset turnover 1.4 1.3 1.2 1.2 1.2 Change of gold loans 266 94 (77) 86 24 Total assets/total equity 1.3 1.2 1.2 1.2 1.2 Share repurchase 0 (29) 0 0 0 Net cash 377 1,721 1,425 1,654 2,209 Contributions from non-controlling interests 0 0 0 0 0 Dividend paid (700) (648) (646) (646) (646) ROE 19.8 11.4 11.6 13.4 13.8 Interest paid (20) (14) (9) (12) (13) ROA 15.2 8.8 9.5 11.1 11.4 Financing cash flow 451 (1,668) (1,131) (572) (635) Net change of cash flow (258) 1,009 (819) 316 578 Forex changes (13) (22) (13) 0 0 6
Company report Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 1 Accumulate Stock expected to outperform benchmark by more than but not more than 1 Hold Expected stock relative performance ranges between - and Underperform Stock expected to underperform benchmark by more than 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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