Equity Market Equity Morning Notes

Ryan Zheng (SFC CE:BOB758) (852) 3519 1294 June 26, 2020 Friday Market Wrap HSI▼0.50% HSCEI▼0.57% Turnover HK$115.4 bn ▼9% (30-day average) SSE Composite▲0.30% SZSE Component ▲0.17% Sector tracking Stock tracking 1D ▲% 1Y ▲% 1D ▲% 1Q ▲%

Equip 5.8 Equip 288.7 ZHONG AO HOME GR(1538) 34.8 SUNSHINE OILSAND(2012) 275.8

Semicon 3.4 Semicon 157.5 NOBLE ENGINEERIN(8445) 33.3 YADEA GROUP HOLD(1585) 219.2

Electrical 2.1 Household Prod 70.5 LIFE CONCEPTS HO(8056) 29.8 BOSSINI INTL(592) 193.4

Paper 1.7 Softw & Serv 48.0 GOAL FORWARD HOL(1854) 26.6 ZHONG AO HOME GR(1538) 178.6

Diversified 1.6 Personal Prod 37.0 DA YU FINANCIAL(1073) 25.0 TRANSMIT ENTERTA(1326) 144.6

Market Highlight CR Asia (831 HK): A Defensive Alternative Amid Sluggish Market Convenience Asia owns , Saint Honore Cake Shop and fast-fashion eyewear chain Zoff, operating around 600 stores in Hong Kong, and throughout the Pearl River Delta region. The Fung Group, holding a 40.89% stake in CR Asia, also has a controlling stake in many companies including Li & Fung and Global Brands (787 HK), yet most of which are small- and mid-caps. Li & Fung, once a blue-chip company, has stumbled badly in recent years, with the share price sliding over 90%. It announced on Mar. 21 that the Company’s shareholders have approved the privatization proposal offered via a Scheme of Arrangement for a cancellation consideration of 1.25 HKD per share in cash, representing a premium of about 150% to the stock last closing price. The Fung Group Structure

The Fung Group’s major moves in recent years: In 2016, Li & Fung sold its consumer and healthcare business in Asia to Dah Chong Hong. 冯氏集团公司 In 2017, the Fung Group sold its stake in Trinity (891 HK) to Shandong Ruyi. In 2018, Global Brands (787 HK) sold its children’s wear and accessories business to Differential Brands Group Inc. In May 2020, the majority of shareholders agreed for Li&Fung’s controlling shareholders to take the company private , at HKD1.25 per share

CR Asia (831 HK) Li & Fung LH Pegasus Global Brands Group (787 HK) , cake shop and global supply chain solution focused on aesthetics, sweater and eyewear store brand fashion wear wholesale provider home appliances business A Defensive Alternative Amid Crisis

The social incidents since 2019 have delivered a massive blow to CR Asia share price/HSI Hong Kong’s tourism. Adding to the gloomy picture, the COVID-19 pandemic is making a recovery all the harder. However, with local 831 HK Equity HSI Index residents being the major customer base for its convenience store 130 and cake shop businesses, CR Asia was little impacted by the weak tourism figures. 120 110 Based on the historical operating data, CR Asia managed to maintain a robust sales growth during the 2003 SARS pandemic and the 2008 100 financial crisis, which proves it an optimal defensive alternative amid the bearish market. 90 80 The recent globally-spreading pandemic led the HSI to record a sharp slump, and yet CR Asia shares sustained a steady performance 70 thanks to its sound defensive and robust sales. 06/2019 09/2019 12/2019 03/2020 06/2020

Orient Securities (Hong Kong) Limited 1 June 26, 2020

Group’s 10-year Operation and Share Price Performance (HKD)

8 The rising capex for online shopping platform and the increasing rents and labor costs 6 caused the profitability to shrink. 10-year Share Price 4 Performance (HKD) The economic revival and the surging 2 mainland travellers to Hong Kong bode well for the retail demand growth. 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Year 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Basic profits attributable to shareholders (HKD mn) and changes (100%) The surge in the number of mainland travellers to Hong Kong brought by The rising rents and the The Group further the economic recovery from the 2008 financial crisis significantly stoked increasing labor costs expanded its the retail demand for the Group, which led to the steady profit growth further decreased the convenience store 250 60% SegmentRevenue (HKD mn) 187 of its convenience store business in Hong Kong. However, in 2012, the Group’s profitability. business in Hong Kong 172 200 153 159 157 155 Convenience rents and the minimal labor costs climbed up, which cast a shadow over Meanwhile, Hong Kong through online/offline 131 131 40% 150 116 the Group’s profit growth. By 2013, the Group expanded its business in government issued a new interactions and sales 89 store the mainland of with the opening of 69 Circle Ks in and policy to restrict promotions. It also 100 20% . But the demand was soft across the mainland of China, which multiple-entry permit cooperated with other 50 furthered weighed on the Group’s profitability. The Group shut down all holders, which led to a mobile payment 0% of its mainland convenience stores in 2014. collapse in demand from channels to improve 0 mainland travellers. profitability. (50) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 -20% The rising labor and raw material As for its Hong Kong business, The Group slowed down its expansion in Hong Kong, 250 60% costs cast a dark cloud over the the profit further shrank due to Macau and the mainland of China and shut down the 200 Group’s profit growth, which, the rising rents and increasing stores that missed the profit target to improve 40% however, only fell slightly thanks to labor and raw material costs. profitability. Meanwhile, it encouraged product 150 100 20% the improving product innovation Meanwhile, the accelerating innovation by launching multiple hyped products and 48 45 43 41 43 50 36 38 25 33 Cake shop and the price structure adjustment. costs brought by continuous new conducted sales promotions through online/offline 50 0% Meanwhile, the cake shop business openings and RMB appreciation interactions. It also created a membership system to 0 embarked on exploration of led to a fall in the operating raise customer loyalty. All of these significantly 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 mainland market by opening 38 profit of its mainland business. improved the profit for its cake shop business. (50) -20% stores in Guangzhou and Shenzhen. The Group launched The traffic of the online platform gradually climbed 250 60% 200 “FingerShopping” online up and the profit improved. Meanwhile, the Group 40%

150 Others The Group had no participation in shopping platform in 2013. The secured the franchise for Zoff and expanded its 100 20% 50 (21) 2 other businesses. intense promotions in the early business in Hong Kong. Altogether the Group opened 0 0 0 (6) (15) (22) (13) (1) 0% businesses stage and the rising rents and 9 Zoff stores in Hong Kong, many of which have 0 labor costs deepened the losses. continuously recorded profits. (50) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 -20%

Convenien 2010 -3% 2013 2015 2017 1% 2019 -6% ce store -9% 21% Core 24% 12% 20% Operating Cake shop 35% 65% 73% Profit 77% Other Breakdown 74% 78% businesses

The retail demand gradually revived The Group embarked on the The Group slowed down its mainland expansion 238 Overall Profits 250 214 60% due to the surging visitors to Hong operation of e-commerce platform. and shifted its focus to HK e-commerce service by 177 183 Kong after the financial crisis, which Its earlier operating and marketing conducting promotions through online/offline 200 166 161 168 162 170 136 40% (HKD mn) led to a significant growth in the expenses accumulated, which interactions, which achieved remarkable results. 150 Group’s Hong Kong business. As for weighed on the GPM. Also, the Also, it kept improving the profitability per store its mainland business, the labor/raw material costs climbed up and shut down stores that missed the profit 100 20% 50 accelerating business expansion due to the economic revival in HK. target to increase the GPM. Meanwhile, It 0% increased the Group’s capex, which Meanwhile, the RMB appreciation secured the franchise for Zoff and opened 9 0 delivered a shock to the profit. led to severe losses of its mainland stores, most of which have recorded profits. (50) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 -20% business, which caused the Group to sell off all of them in 2014. Source: Company data, Orient Securities (Hong Kong) Orient Securities (Hong Kong) Limited 2 June 26, 2020

Business Composition Circle K Stores: CR Asia operates 336 Circle K stores in Hong Kong, all of which are wholly-owned and managed by the Company. It operates 47 franchised Circle K stores in Macau and Zhuhai. Circle K stores offer a selective range of daily consumables including packaged drinks, candies and snacks, newspapers and magazines, etc. The store also provides a range of convenience services such as bill payment, reloading, ticketing and cash withdrawal services. It cooperated with “FingerShopping”, Hong Kong one-stop online platform “OK Stamp It” and Taiwan online bookstore Kingstone, providing online shopping and pickup services to embrace the latest lifestyle trend.

Saint Honore Cake Shops: Saint Honore has expanded its retail store network across Hong Kong, Macau and Guangzhou, distributing and selling bakery and festive products through its own retailing operations. The number of Saint Honore stores reached 126 as at 31 Dec. 2019. Saint Honore Holdings Limited opened its first store in Happy Valley, Hong Kong in 1972 and it was fully acquired and consolidated by CR Asia in 2007. Zoff Eyewear Stores: Zoff is one of the three leading fast-fashion eyewear chains in Japan. CR Asia secured the Hong Kong, Macau and Southern China franchise for Zoff in 2007. The first Zoff eyewear shop was officially launched in Hong Kong in Nov. 2017. CR Asia has opened 9 Zoff stores in Hong Kong as at 31 Dec. 2019. Business Concentrated in Hong Kong Market with Convenience Stores Being Major Revenue Source In 2019, most of CR Asia’s revenue came from convenience stores, which contributed 80% of the revenue. Sales from the mainland of China only contributed 2% of the total revenue, all of which were from Saint Honore stores in Guangzhou. As the major revenue source for developing business, Zoff eyewear stores accounted for a modest portion of the overall revenue as the business is currently at its early stage. Convenience stores, being the major revenue source, contributed 78% of the core profit. Only mainland cake stores recorded slight losses. CR Asia once tried to take a bite into mainland market. It established its first mainland Circle K outlet in 2002, which, however, continuously suffered severe losses. Circle K’s parent company in Guangzhou recorded net losses of around 21.4 million HKD in 2014. CR Asia sold all of its Guangzhou Circle Ks to Fung Holdings Limited for a consideration of 48 million HKD in Aug. 2015. Suning Xiaodian, the convenience store arm of online retailer Suning.com, acquired over 60 Circle K outlets in Guangzhou under the Fung Retailing Group. It is estimated that CR Asia will not expand its mainland business in the near future considering its earlier failed attempts.

CR Asia Revenue Breakdown (by segment) CR Asia Core Operating Profit Breakdown (by segment)

1% 2% Convenience store 2% 0% Convenience store 21% 16% Cake shop (Hong Kong Cake shop (Hong Kong and other areas) and other areas) Cake shop (the Cake shop (the mainland of China) mainland of China)

Developing business 78% Developing business 80%

Source: Company data, Orient Securities (Hong Kong) Target Local Residents and Turnover Maintained Growth Amid Crisis

CR Asia Retail Turnover (HKD mn) and Growth (%) Hong Kong has been through three major crises, namely 2003 SARS 6000 35% pandemic, 2008 financial crisis and 2019 2008 2019 social upheaval social upheaval, since the 21st century. 5000 financial 30% These three crises delivered a massive 2003 SARS crisis 25% 4000 crisis shock to Hong Kong’s tourism and retail industry. However, CR Asia’s retail sales 20% 3000 have maintained growth since its 15% flotation in 2001 as it targets local 2000 business. 10% The coronavirus pandemic since 2020

1000 5% also delivered a massive blow to Hong Kong’s tourism, which would cast a 0 0% shadow over CR Asia’s business growth.

However, the overall situation is still

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2001 under control. Source: Company data, Orient Securities (Hong Kong) Orient Securities (Hong Kong) Limited 3 June 26, 2020

Operating Costs Mainly Consist of Labor Costs and Rent Costs Given the fierce competition in Hong Kong’s convenience store industry, its overall net profit margin is extremely low. In 2009, it recorded 208 million HKD in net profits with the net profit margin reaching only 3.7%. Except for the large proportion of deposit costs in the retail industry, the operating costs control is pivotal to the profitability of convenience stores. CR Asia’s operating costs mainly consist of labor costs and rent costs. Hong Kong’s rents and labor costs have been climbing up over the past decade with the labor costs rising from 595 million HKD in 2010 to 956 million HKD in 2019. However, the proportion of labor costs in total sales maintained at around 17% as the turnover also recorded a significant growth. Hong Kong’s retail rental market has been thriving over the past decade due to the burgeoning tourism. The Group’s rent costs increased from 326 million HKD in 2010 to 576 million HKD in 2019 with a rising proportion in total sales, up from 9.1% in 2010 to 10.2% in 2019. Labor Costs (HKD mn) and as % of Total Sales Rent Costs (HKD mn) and as % of Total Sales

1200 17.2% 700 10.5% 600 1000 17.0% 500 10.0% 800 16.8% 400 600 16.6% 9.5% 300 400 16.4% 200 9.0% 200 16.2% 100 0 16.0% 0 8.5% 2010201120122013201420152016201720182019 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: Company data, Orient Securities (Hong Kong)

Lowering Rents in Hong Kong Bode Well for NPM Growth: Golden Opportunity for Store Network Expansion Hong Kong’s rental market has been through the golden ten years after the financial crisis. However, the social upheaval since the second half of 2019 delivered a blow to Hong Kong’s tourism with the number of travellers to Hong Kong down 39.1%, which caused the rent index to fall over 6%, weighing on Hong Kong’s rental market. As the major operating costs, the rent costs see a decrease due to the falling retail rents in Hong Kong, which would drive the Group’s overall net profit margin higher. CR Asia adopted a prudent strategy in store network expansion amid the rent spike. The rent lowering this time offers a good opportunity for the Group to expand its store network in Hong Kong, firing up the Group’s organic growth engine.

195 Retail Rents and Sales Price Index 340 Number of Circle K Stores in Hong Kong 190 335 330 185 325 180 320 Hong Kong's retail rental market has kept rising all 175 Hong Kong’s retail rental 315 the way up after the financial crisis and the Group market recorded a sharp adopted a prudent store-opening strategy to contorl 310 170 slump since 2H19. costs. It only opened 5 new convenience stores in 305 Hong Kong during 2012-2019. 165 300 1/2015 11/2015 9/2017 7/2017 5/2018 3/2019 1/2020 2012 2013 2014 2015 2016 2017 2018 2019 Source: Rating and Valuation Department, company data, Orient Securities (Hong Kong) Sufficient Cash in Bank with Generous Dividend Payout It is a policy of the Company that, on an annual basis, the Company will distribute, as normal dividend, not less than 50% of the Group’s net profit to the shareholders. The actual distribution percentage will be considered and determined by the Board based on the operating results, cash flow, financial position, business prospects, statutory and regulatory restrictions relating to dividend distributions and other factors the DPS (HKD) and Dividend Payout Ratio (%) Board considers appropriate. As at 31 Dec. 2019, the Group had a net cash balance of 0.3 120% 643 million HKD, generated mainly from daily business operations. The Group had no bank borrowings. 0.25 100% Currently it has no plan for large-scale expansion. It has a 0.2 80% low level of capex and surplus cash in bank, which 0.15 60% supports a high dividend payout. The Group’s recent dividend payout ratios have way 0.1 40% outperformed its stipulated distribution percentage, 0.05 20% breaking above 90% for three consecutive years. With sufficient cash in bank, the Group is expected to maintain 0 0% a high dividend payout, which makes it an ideal candidate 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 for long-term investment. Source: Company data, Orient Securities (Hong Kong)

Orient Securities (Hong Kong) Limited 4 June 26, 2020

Peers Comparison for Convenience Store Industry Circle K – CR Asia (831 HK) 7-Eleven – Dairy Farm (DFI.SP) CR Asia opened its In 1989, Dairy Farm first Circle K acquired the 7-Eleven Convenience Store in convenience store chain Hong Kong in 1985. from Jardine Matheson. Business History The number of Circle K It acquired Daily Stop, a stores expanded to convenience-store 100 by 1995 and its chain, and converted th 300 Hong Kong store them to 7-Eleven stores was opened in 2010. in 2004.

packaged food and drinks, daily necessities, some packaged food and drinks, daily necessities, some stores Product stores are equipped with a baking room to provide provide breakfast and cooked food baked/cooked food mainly located in communities and second most prime mainly located in railway stations and major commercial Place commercial streets; a total of 383 stores across Hong street; a total of 1,013 stores across Hong Kong and Kong and Macau; sold its mainland business in 2015 Macau and 1,281 stores in the mainland of China Price above the average supermarket prices above the average supermarket prices partnered with e-payment service providers to offer discounts (full reduction); membership point membership point accumulation system and marketing Promotion accumulation system and marketing activities such as activities collecting stamps to exchange for gifts Store size small-sized stores (no more than 50 square meters) small-sized stores (no more than 50 square meters) Circle K stores mainly located in communities and second most prime commercial streets to further cut rent costs while 7-Eleven are more inclined to high-foot-traffic areas such railway station and major commercial Our view streets. The store coverage gap between Circle K and 7-Eleven has increasingly widened as Circle K ceased its mainland business expansion. Results Comparison (HKD mn) (HKD mn) Revenue 20000 20000 comparison 16,412 16,937 15,117 15,655 (convenience store) 15000 15000

10000 10000

4,063 3,850 4,207 4,524 5000 5000

0 0 2016 2017 2018 2019 2016 2017 2018 2019

(Convenience store) 4.39% 3.56% Operating profit margin: The revenue gap between Circle K and 7-Eleven is mainly brought by the difference in the number of stores. Our view The relatively conservative store location choices and store opening speed give Circle K an edge over 7-Eleven, which bodes well for its operating GPM growth. Valuations Comparison Total market value 2.75 billion HKD around 48.3 billion HKD P/E 13.3x 19.1x P/B 3.79x 5.1x

Dividend yield 12.74% 4.58%

Though CR Asia has a higher dividend yield, it has a relatively lower valuation (current PE: 13.49x) compared with Dairy Farm as it lacks organic growth momentum due to the single industrial structure and its exit from mainland Our view market. Dairy Farm, on the contrary, owns leading cross-industrial retailers such as Mannings, 7-Eleven Convenience Stores, Market Place Supermarkets and Wellcome Supermarkets, and meanwhile its mainland 7-Elevene business recorded positive results, all of which led to a relatively higher PE valuation. Source: Company data, Orient Securities (Hong Kong)

Orient Securities (Hong Kong) Limited 5 June 26, 2020

Revenue Revenue Breakdown Financial Summary Convenience store (HKD mn) (HKD mn) 2017 2018 2019 Cake shop (Hong Kong and other areas) Revenue 5,094 5,320 5,632 6000 Cake shop (the mainland of China) 5000 Developing business EBIT 183 218 257 Net profit 150 183 208 4000 2% 2% Dividend yield 20.6 27.3 29.3 3000 16% EPS (USD) 0.198 0.240 0.272 2000 DPS (HKD) 0.180 0.220 0.250 1000 Net gearing (69.4) (73.5) 9.7 80% 0 Free cash flow 219 197 N/A 2015 2016 2017 2018 2019 Dividend payout 91.3 91.6 91.8 The Group has recorded a steady The Group’s current major revenue The Group has a sound financial position with a annual growth in revenue since 2015. source is from convenience stores while sufficient cash flow, which supports high its major revenue source for developing dividend payout. Its dividend payout ratio has business is from Zoff eyewear stores. maintained above 90% in recent years.

Strength Weakness

 The sluggish tourism has a slight impact on  Hong Kong’s convenience store the Group as it targets local residents. market has been approaching its  The supermarkets selling daily necessities saturation point and the available are impacted slightly by the pandemic as expansion area for the Group is only the demand for non-necessity quite limited. products decreased.  Faced with the fierce competition  The sound financial position supports its in Hong Kong market, the Group robust dividend policy with a generous has a relatively low net profit dividend payout for consecutive years. margin.  The exchange rate volatility has little impact on the Group as its business is concentrated in Hong Kong market. Opportunity Threat

 The rent for lease renewal has a downside  The competition among other potential as Hong Kong’s retail rental convenience stores such as 7-11 market has been cooling down. and is quite fierce.  The Group has been expanding its Zoff  The rising costs weighed on the business in Hong Kong. Group’s thin net profit margin. 10% 10% 21% 32% 21% 32%

37%

Key Risk Valuation Our Opinion 37%

 The rising rents and labor costs weighed  The sluggish tourism has a slight impact on the on the Group’s profitability. P/E 13.3x Group as it mainly sells daily necessities. -4%17%  The falling retail rents in Hong Kong is likely to 50% -4%17% drive the net profit margin higher. 29% 50%  The Group has a generous dividend policy with 29% a sufficient cash flow. Its dividend payout ratio P/B 3.8x has maintained high for consecutive years.  The Group has limited room for development as its business is concentrated in Hong Kong and the competition among Hong Kong Dividend yield 12.7% convenience stores is getting increasingly fierce.

Relative Performance P/E Band P/B Band

The share price outperformed the HSI over The Group’s P/E ratio is 13.3x, lower than its The Group’s P/B ratio is 3.8x, lower than its the past year. 5-year-average. 5-year-average of 4.0x.

Orient Securities (Hong Kong) Limited 6 June 26, 2020

Analyst Certification I, Ryan Zheng (Zheng Kaien), being the person primarily responsible for the content of this research report, in whole or in part, hereby certify that: (1) all of the views expressed in this report accurately reflect my personal view about the subject company(ies) and its (or their) securities; (2) no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report, or our Investment Banking Department; (3) I am not, directly or indirectly, supervised by or reporting to our Investment Banking Department; (4) the subject company(ies) do(es) not fall into the restriction of the quiet period as defined in paragraph 16.5(g) of SFC Code of Conduct; (5) I and my associates do not deal in or trade in the stock(s) covered in this report within 30 calendar days prior to the date of issue of the report; (6) I and my associates do not serve as an officer(s) of the listed company(ies) covered in this report; and (7) I and my associates have no financial interests in relation to the listed company (ies) covered in this report.

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Orient Securities (Hong Kong) Limited 7 June 26, 2020