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 +852 3719 1010 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$16.50, based on 10.5x FY17E P/E (historical average) as we roll forward our valuation basis. HSI Luk Fook Source: Bloomberg Key data Jun 24 close (HK$) 17.42 Shares in issue (m) 587.1 Major shareholder Wong Wai Sheung (42.2%) Market cap (HK$ bn) 10.2 3M avg. vol. (m) 0.8 52W 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 (%) 2014 19,215 1,865 1,865 3.166 47 5.5 7.3 13.0 1.3 26.5 2015 15,923 1,615 1,605 2.725-14 6.4 6.3 14.5 1.2 19.8 2016 14,031 959 979 1.664-39 10.5 6.3 14.8 1.2 11.4 2017E 13,280 921 921 1.569-6 11.1 3.6 15.5 1.1 10.4 2018E 12,990 917 917 1.562 0 11.2 3.6 16.5 1.1 9.8 Sources: Company data, GF Securities (HK) Note: Core profit excludes fair value changes for financial assets and derivatives, and impairment losses for intangible assets
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 139 174-80 76 6% 59 99-40% 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) 45-166% (26) 4-825% (4) 42-110% Operating profit 1,233 1,967-37% 619 1,004-38% 614 963-36% Adjusted operating profit Finance income 42 49-15% 14 27-48% 27 21 28% Finance costs (14) (20) -33% (4) (14) -69% (9) (7) 43% Non-recurring gains (21) 9-323% (1) (6) -92% (20) 16-229% Share of profit/(loss) of associate (79) (22) 260% (33) (17) 94% (47) (5) 795% Profit before tax 1,161 1,983-41% 596 995-40% 565 988-43% Tax expense (200) (362) -45% (98) (182) -46% (102) (180) -43% Profit after tax 961 1,620-41% 498 813-39% 463 808-43% Non-controlling interests (3) (6) -53% (3) (3) -2% (0) (3) -99% Net profit 959 1,615-41% 495 810-39% 463 805-42% Core profit 979 1,605-39% 496 816-39% 483 789-39% EPS (HK$) 1.63 2.74-41% 0.84 1.04-19% 0.79 1.71-54% Core EPS (HK$) 1.66 2.73-39% 0.84 1.02-17% 0.82 1.71-52% DPS (HK$) 1.10 1.10 0% 0.32 0.55-43% Margin & Ratio (%) Gross margin 23.2 24.1 (0.9) 23.7 24.3 (0.6) 22.7 23.9 (1.2) Operating margin 8.8 12.4 (3.6) 8.8 12.0 (3.2) 8.8 12.8 (4.0) SG&A expense/revenue 15.2 13.1 2.1 15.7 13.2 2.5 14.6 13.0 1.7 Core profit margin 7.0 10.1 (3.1) 7.0 9.7 (2.7) 6.9 10.5 (3.5) Effective tax rate 17.2 18.3 (1.1) 16.4 18.3 (1.9) 18.0 18.2 (0.2) Payout ratio 67.5 40.1 27.4 40.1 32.3 7.8 FY16 FY15 change 1H16 1H15 change Inventory days 238 209 29 243 213 30 Net cash (HK$ m) 1,721 377 357% 1,224 933 31% 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
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 --- 31% --- na FY13: --- -ve --- -ve mid sd flat ------ 5% ------ +ve low-teen +ve low sd -ve low sd HK and Macau --- 50% ---- 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 1,000 800 600 400 200 0 30% 22% 26% 1,538 24% 1,437 1,494 1,383 1,268 25% 23% 1,072 862 18% 15% 700 557 10% 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
Figure 8: Key assumptions (HK$m) FY13 FY14 FY15 FY16 FY17E FY18E Total revenue 13,412 19,215 15,923 14,031 13,280 12,990 growth % 12.6% 43.3% -17.1% -11.9% -5.4% -2.2% - Retail revenue - HK, Macau and overseas markets 9,920 14,514 11,330 9,629 8,730 8,297 growth % 11.2% 46.3% -21.9% -15.0% -9.3% -5.0% store growth (%) 21.1% 19.6% 5.5% -1.7% 1.8% 0.0% SSS (%) 7.2% 22.0% -28.2% -20.0% -10.0% -4.0% - Retail revenue - China market 1,014 1,650 1,222 1,312 1,454 1,572 growth % 36.3% 62.7% -25.9% 7.4% 10.8% 8.1% store growth (%) 27.9% 6.4% -4.8% 44.3% 25.4% 16.1% SSS (%) 7.3% 45.9% -29.8% -8.0% -5.0% -3.0% - Wholesale revenue 2,028 2,433 2,794 2,563 2,562 2,583 growth % 11.8% 20.0% 14.8% -8.3% 0.0% 0.8% - Licensing revenue 451 618 578 528 535 539 growth % 5.6% 37.3% -6.6% -8.6% 1.3% 0.8% Gross profit 2,830 4,214 3,832 3,254 3,052 2,992 Gross margin (%) 21.1% 21.9% 24.1% 23.2% 23.0% 23.0% Product mix (%) gold & platinum 62.7% 67.2% 60.2% 60.9% 59.0% 58.0% gem-set 37.3% 32.8% 39.8% 39.1% 41.0% 42.0% Selling expenses ratio (%) 9.8% 10.0% 12.2% 14.1% 14.3% 14.3% Administrative expenses ratio (%) 0.9% 0.8% 0.9% 1.1% 1.2% 1.2% Operating profit 1,524 2,309 1,967 1,233 1,133 1,103 growth % -4.3% 51.5% -14.8% -37.3% -8.1% -2.6% OP margin (%) 11.4% 12.0% 12.4% 8.8% 8.5% 8.5% Core profit 1,266 1,865 1,605 979 921 917 growth % -5.1% 47.3% -13.9% -39.0% -5.9% -0.5% Core profit margin (%) 9.4% 9.7% 10.1% 7.0% 6.9% 7.1% Payout ratio (%) 40% 40% 40% 68% 40% 40% Sources: Company data, GF Securities (HK) estimates 4
Figure 9: Financial statements Income Statement Balance Sheet Year-end Mar 31 (HK$ 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 566 618 604 579 560 Gross profit 4,214 3,832 3,254 3,052 2,992 Land use rights 183 225 215 208 200 Investment properties 46 46 25 24 23 Other income 108 174 139 130 127 Investment in associates 7 246 155 110 90 Selling & distribution expenses (1,923) (1,937) (1,982) (1,895) (1,859) Shareholders loans to an associate 0 83 87 87 87 Administration expenses (151) (147) (149) (153) (156) CB 0 67 46 46 0 Other gains/(losses), net 61 45 (30) 0 0 Others 205 138 132 132 132 Operating profit 2,309 1,967 1,233 1,133 1,103 Deferred tax assets 34 28 37 37 37 1,041 1,451 1,300 1,222 1,128 Net finance cost 12 28 28 33 41 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 226 201 215 203 199 Income tax expense (454) (362) (200) (198) (206) Deposits and prepayments 275 258 242 229 224 Non-controlling interests (2) (6) (3) (1) (2) Shareholders loans to an associate 0 20 20 20 20 Net profit 1,865 1,615 959 921 917 Others 15 97 77 56 56 Core profit 1,865 1,605 979 921 917 CB 0 0 0 0 46 Core EPS (HK$) 3.17 2.73 1.64 1.57 1.56 Cash and cash equivalents 1,805 2,090 2,432 3,206 3,943 8,546 10,060 9,330 9,727 10,360 Growth rates (%) Revenue 43 (17) (12) (5) (2) Total assets 9,586 11,511 10,629 10,949 11,488 Core profit 47 (14) (39) (6) (0) Core EPS 47 (14) (39) (6) (0) Current liabilities A/C payables 338 218 246 243 247 Margin & ratios (%) Other payables 641 684 646 612 598 Gross profit margin 21.9 24.1 23.2 23.0 23.0 Bank borrowings 568 1,471 400 400 400 OP margin 12.0 12.4 8.8 8.5 8.5 Gold loans 0 243 311 274 267 Net profit margin 9.7 10.1 6.8 6.9 7.1 Others 2 2 2 2 2 Effective tax rate 19.5 18.3 17.2 17.7 18.3 Tax liabilities 249 174 151 109 113 Payout ratio 40.1 40.1 67.5 40.0 40.0 1,798 2,791 1,757 1,640 1,628 Cash Flow Statement Non-current liabilities Year-end Mar 31 (HK$ m) FY14 FY15 FY16 FY17E FY18E Employee benefit obligations 35 34 24 23 22 Profit before tax 2,321 1,983 1,121 1,124 Deferred tax liabilities 55 85 80 80 80 Share of (profit)/loss of associate and JV 0 22 45 20 89 119 104 103 102 Net finance cost (12) (28) 10 9 Depreciation and amortization 124 158 133 128 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 58 64 95 97 98 Change of working capital (1,231) (1,203) 318 141 7,699 8,601 8,769 9,207 9,758 Tax paid (237) (462) (199) (202) Operating cash flow 962 424 1,428 1,220 Total liabilities & equity 9,586 11,511 10,629 10,949 11,488 Capex (258) (181) (100) (100) Financial Ratios Disposals 1 1 0 0 Year-end Mar 31 FY14 FY15 FY16 FY17E FY18E Interest received 15 25 0 0 Current ratio 4.8 3.6 5.7 5.9 6.4 Purchase of financial assets (8) (57) 0 0 Quick ratio 1.3 1.0 2.1 2.3 2.8 Purchase of associate 0 (245) 0 0 Shareholder loan to associate 0 (120) 0 0 A/C receivable turnover days 5 5 5 6 6 Change in term deposits (158) (557) (300) (200) A/C payable turnover days 10 8 7 9 9 Others 3 0 0 0 Inventory turnover days 138 209 241 225 222 Investing cash flow (406) (1,133) (400) (300) Asset turnover 2.0 1.4 1.3 1.2 1.1 Change of borrowings 568 905 0 0 Total assets/total equity 1.2 1.3 1.2 1.2 1.2 Change of gold loans 0 266 (37) (6) Net cash 1,237 377 2,228 2,532 3,275 Contributions from non-controlling interests 0 0 0 0 Dividend paid (654) (700) (508) (368) ROE (%) 26.5 19.8 11.2 10.4 9.8 Interest paid (3) (20) (10) (9) ROA (%) 21.8 15.2 8.7 8.5 8.2 Financing cash flow (89) 451 (554) (383) Net change of cash flow 467 (258) 473 537 Forex changes (8) (13) 0 0 Sources: Company data, GF Securities (HK) estimates 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. Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited ( GF Securities (Hong Kong) ) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies do not have any investment banking relationship with the companies mentioned in this research report in the past 12 months. (3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial interests or hold any shares of the securities mentioned in this report. Disclaimer This report is prepared by GF Securities (Hong Kong). It is published solely for information purpose and does not constitute an offer to buy or sell any securities or a solicitation of an offer to buy, or recommendation for investment in, any securities. The research report is intended solely for use of the clients of GF Securities (Hong Kong). The securities mentioned in the research report may not be allowed to be sold in certain jurisdictions. No action has been taken to permit the distribution of the research reports to any person in any jurisdiction that the circulation or distribution of such research report is unlawful. No representation or warranty, either express or implied, is made by GF Securities (Hong Kong) as to their accuracy and completeness of the information contained in the research report. GF Securities (Hong Kong) accepts no liability for all loss arising from the use of the materials presented in the research report, unless is excluded by applicable laws or regulations. Please be aware of the fact that investments involve risks and the price of securities may be fluctuated and therefore return may be varied, past results do not guarantee future performance. Any recommendation contained in the research report does not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. The report is not to be taken in substitution for the exercise of judgment by respective recipients of the report, where necessary, recipients should obtain professional advice before making investment decisions. GF Securities (Hong Kong) may have issued, and may in the future issue, other communications that are inconsistent with, and reach different conclusions from, the information presented in the research report. The points of view, opinions and analytical methods adopted in the research report are solely expressed by the analysts but not that of GF Securities (Hong Kong) or its affiliates. The information, opinions and forecasts presented in the research report are the current opinions of the analysts as of the date appearing on this material only which may subject to change at any time without notice. The salesperson, dealer or other professionals of GF Securities (Hong Kong) may deliver opposite points of view to their clients and the proprietary trading division with respect to market commentary or dealing strategy either in writing or verbally. The proprietary trading division of GF Securities (Hong Kong) may have different investment decision which may be contrary to the opinions expressed in the research report. GF Securities (Hong Kong) or its affiliates or respective directors, officers, analysts and employees may have rights and interests in securities mentioned in the research report. Recipients should be aware of relevant disclosure of interest (if any) when reading the report. Copyright GF Securities (Hong Kong) Brokerage Limited. Without the prior written consent obtained from GF Securities (Hong Kong) Brokerage Limited, any part of the materials contained herein should not (i) in any forms be copied or reproduced or (ii) be re-disseminated. GF Securities (Hong Kong) Brokerage Limited. All rights reserved. 29-30/F, Li Po Chun Chambers, 189 Des Voeux Road Central, Hong Kong Tel: +852 3719 1111 Fax: +852 2907 6176 Website: http://www.gfgroup.com.hk 6