Equity Research January 18, 2018

Luk Fook Holdings Growth weakens due to high base and drop in volume

Company Update Maintain HOLD

What's new Ticker 00590.HK Luk Fook announced its 3QFY18 (October–December 2017) CICC investment rating HOLD operating data: overall SSSG of its retail business was +1%, slowing Last close HK$32.20 markedly from 2QFY18’s +17% due to the higher base in 3QFY17 and CICC target HK$35.51 drop in volume caused by the higher gold price. 52wk price range HK$35.57~20.29 Market cap (bn) HK$19 Comments Daily value (mn) HK$21.45 SSSG of Mainland was -4% due to its higher base vs. HK/Macau; Shares outstanding (mn) 587 specifically, licensed shops outperformed self-operated ones. Besides, Free float (%) 100 the Company recorded >100% sales growth for the Singles’ Day Daily volume (mn sh) 0.65 online shopping festival, and e-business typically has stronger Business sector Luxury & Jewelry profitability compared to self-operated stores, with the former’s single-digit OPM outpacing the latter’s. HK/Macau SSSG +1%, led by 00590.HK HSCEI 168 the launch of good-value-for-money gem-set jewelry products. Total POS +73 in 3QFY18 to reach 1,615 (Mainland +71; HK & Macau +2). 151 134 Peer comparison: Luk Fook vs. Chow Tai Fook: in October-December 2017, Chow Tai Fook’s SSSG was 5% in Mainland China & HK/Macau, 117 outperforming Luk Fook; however, partially due to the fact that CTF (%) Value Relative 100 offered deeper discounts to promote its gold products at year end. 83 Jan-2017 Apr-2017 Jul-2017 Oct-2017 Jan-2018 Prospects: 1) Luk Fook plans to open at least 100 POS for FY18. 2) The Company maintained their single-digit SSSG projection for HK/Macau, (HK$ mn) 2016A 2017A 2018E 2019E but lowered that of Mainland China from double-digit to single-digit level for FY18; while the faster-than-expected channel expansion Revenue 14,031 12,807 14,469 16,530 could offset the negative effect. 3) As of profitability, Luk Fook (+/-) -11.9% -8.7% 13.0% 14.2% expects its 2HFY18 OPM to remain stable HoH at around 10%, but to Net profit 959 1,017 1,148 1,303 (+/-) -40.6% 6.1% 12.9% 13.5% improve YoY. And, 4) for 4QFY18, the SSSG of gem-set jewelry is likely to turn positive in the Mainland due to the lower base in 4Q. EPS 1.63 1.73 1.96 2.22 BPS 14.77 15.11 15.92 16.98 DPS 1.10 1.10 1.10 1.10 Valuation and recommendation CPS 3.51 1.23 1.49 1.78 We maintain our FY18/19e EPS forecasts at HK$1.96/2.22 P/E 19.7 18.6 16.5 14.5 (+12.9%/+13.5% YoY). Luk Fook is trading at 16.5x/14.5x FY18/19e P/B 2.2 2.1 2.0 1.9 P/E. We maintain our HOLD rating and cut our target price by 9.2% EV/EBITDA 12.6 12.1 10.5 9.2 to HK$35.51 due to valuation shift (based on 16x FY19e P/E), 10.3% Dividend yield 3.4% 3.4% 3.4% 3.4% upside. Its licensing business model makes it easier to penetrate ROAA 8.7% 9.5% 10.5% 11.2% lower-tier cities; while with its limited market share (ranking fifth in ROAE 11.1% 11.6% 12.6% 13.5% Mainland China), the competitive environment remains challenging.

Risks Gold price fluctuations. Source: Wind, Bloomberg, company data, CICC Research

Haiyan GUO Jinfeng QIN Analyst Associate [email protected] [email protected] SAC Reg. No.: S0080511080006 SAC Reg. No.: S0080116100004 SFC CE Ref: AIQ935

Please read carefully the important disclosures at the end of this report CICC Research: January 18, 2018

Financial summary

Financial statement (HKD mn) 2016A 2017A 2018E 2019E Financial ratios 2016A 2017A 2018E 2019E Income statement Growth ability Revenue 14,031 12,807 14,469 16,530 Revenue -11.9% -8.7% 13.0% 14.2% COGS -10,777 -9,530 -10,939 -12,480 Operating profit -38.7% 6.4% 11.0% 13.1% Selling expenses -1,982 -1,994 -2,055 -2,380 EBITDA -36.8% 5.4% 14.2% 12.4% Administrative expenses -149 -155 -175 -200 Net profit -40.6% 6.1% 12.9% 13.5% Other ops income (expense) -51 -14 -14 -17 Profitability Operating profit 1,212 1,289 1,431 1,618 Gross margin 23.2% 25.6% 24.4% 24.5% Finance costs -14 -9 0 0 Operating margin 8.6% 10.1% 9.9% 9.8% Other income (expense) -79 -54 -54 -54 EBITDA margin 9.6% 11.1% 11.2% 11.0% Profit before income tax 1,161 1,250 1,397 1,585 Net margin 6.8% 7.9% 7.9% 7.9% Income tax -200 -223 -238 -270 Liquidity Minority interest -3 -10 -11 -13 Current ratio 5.31 5.92 5.98 6.29 Net profit 959 1,017 1,148 1,303 Quick ratio 1.70 1.54 1.56 1.69 EBITDA 1,347 1,420 1,621 1,822 Cash ratio 1.38 1.17 1.15 1.27 Recurrent net income 959 1,017 1,148 1,303 Liabilities / assets 17.5% 15.9% 16.0% 15.5% Balance sheet Net debt / equity net cash net cash net cash net cash Cash and bank balances 2,432 1,862 1,945 2,217 Return Trade and bill receivables 215 217 244 279 RoA 8.7% 9.5% 10.5% 11.2% Inventories 6,345 6,973 7,492 8,035 RoE 11.1% 11.6% 12.6% 13.5% Other current assets 338 380 460 460 Per-share data Total current assets 9,330 9,431 10,142 10,991 EPS (HKD) 1.63 1.73 1.96 2.22 Fixed assets and CIP 604 564 504 409 BPS (HKD) 14.77 15.11 15.92 16.98 Intangible assets and others 696 684 620 556 DPS (HKD) 1.10 1.10 1.10 1.10 Total non-current assets 1,300 1,248 1,124 965 Cash flow per share (HKD) 3.51 1.23 1.49 1.78 Total assets 10,629 10,679 11,266 11,956 Valuation Short-term borrowings 400 0 0 0 P/E 19.7 18.6 16.5 14.5 Trade and bill payables 246 382 360 411 P/B 2.2 2.1 2.0 1.9 Other current liabilities 1,111 1,212 1,337 1,337 EV/EBITDA 12.6 12.1 10.5 9.2 Total current liabilities 1,757 1,594 1,697 1,748 Dividend yield 3.4% 3.4% 3.4% 3.4% Long-term borrowings 0 0 0 0 Total non-current liabilities 104 105 105 105 Total liabilities 1,861 1,699 1,803 1,853 Share capital 59 59 59 59 Retained profit 8,615 8,815 9,287 9,913 Equity 8,674 8,873 9,345 9,972 Total liabilities & equity 10,629 10,679 11,266 11,956 Cash flow statement Pretax profit 1,161 1,250 1,397 1,585 Depreciation & amortization 135 131 190 204 Change in working capital 872 -511 -524 -527 Others -106 -149 -187 -220 Cash flow from operations 2,063 720 877 1,042 Capital expenditure -104 -95 -122 -100 Others 718 -314 21 22 Cash flow from investing 614 -408 -101 -78 Equity financing -29 0 0 0 Bank borrowings -1,071 -400 0 0 Others -567 -731 -646 -646 Cash flow from financing -1,668 -1,131 -646 -646 Foreign exchange gain (loss) -22 -13 -47 -47 Net changes in cash 987 -832 83 272 Source: Company data, CICC Research

Company description

Luk Fook is one of the leading jewellery retailers in Hong Kong and Mainland China. The Group principally engages in the sourcing, designing, wholesaling, trademark licensing and retailing of a variety of gold and platinum jewelry, gold ornaments and gem-set jewelry with shops in Mainland China, Hong Kong, Macau, Singapore, the United States and Canada. Throughout the years, its achievements have been reflected by the outstanding performance in merchandising, sales, administration, financial and marketing aspects. The group will continue to identify new business opportunities in the international market.

Please read carefully the important disclosures at the end of this report 2 CICC Research: January 18, 2018

Figure 1: SSSG breakdown by region 80% 66% HK/Macau Mainland China 60%

40% 33% 36% 23% 18% 20% 11% 11% 6% 5% 1% 0% 2% 1% 3% 1% 0%

-6% -5% -7% -4% -20% -12% -11% -10% -11% -19% -20% -19% -23% -22% -26% -24% -24% -30% -28% -40% -39%

-60% -54% -52%

Source: Company data, CICC Research

Figure 2: SSSG breakdown by category 80% 58% Gold Gem-set Jewelry 60%

40% 21% 19% 16% 20% 11% 11% 9% 10% 4% 5% 5% 0% -2% -1% -6%-6% -4% -3% -20% -8% -11% -15% -18%-18% -14% -19% -21%-20% -25% -25% -19% -26% -26%-28% -26% -40% -28%

-47% -60% -65% -80%

Source: Company data, CICC Research

Figure 3: SSSG comparison: Luk Fook vs. Chow Tai Fook SSSG 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 Luk Fook Overall -54% -21% -7% -20% -18% -6% -25% -27% -24% -37% -10% 2% 5% 17% 1% HK/Macau -54% -20% -6% -22% -19% -7% -26% -28% -24% -39% -11% 1% 3% 18% 1% Mainland China -52% -30% -11% -5% 0% 2% -10% -19% -24% -23% 5% 11% 23% 11% -4% Chow Tai Fook Overall -40% -20% -18% -16% -15% -3% -15% -26% ------HK/Macau -50% -29% -21% -26% -24% -13% -23% -27% -20% -30% -2% 4% 5% 13% 5% Mainland China -28% -12% -15% -9% -7% 6% -6% -25% -17% -22% 4% 12% 11% 9% 5% Source: Company data, CICC Research. Note: The overall SSSG of Chow Tai Fook was not disclosed since 1QFY17.

Please read carefully the important disclosures at the end of this report 3 CICC Research: January 18, 2018

Figure 4: P/E and P/B bands

70 1Y Forward P/E Band 70 1Y Forward P/B Band

60 60

50 50

40 40

30 30

20 20

10 10

0 0 12/01 13/01 14/01 15/01 16/01 17/01 18/01 12/01 13/01 14/01 15/01 16/01 17/01 18/01

Stock price 20.0 x 15.0 x 10.0 x 5.0 x Stock price 4.0 x 3.0 x 2.0 x 1.0 x

Source: Bloomberg, company data, CICC Research

Figure 5: Comparable valuations Price Mkt cap Net Profit (mn, report currency) EPS (local currency) P/E 2016~2018 Ticker Company PEG (Local) (mn) 2016A YoY 2017E YoY 2018E YoY 2016A 2017E 2018E 2016A 2017E 2018E Net Profit CAGR Apparel & Textiles (A shares) Casual w ear 002269.SZ Metersbonw e 3.18 7,990 36 N/M 47 29% 68 46% 0.01 0.02 0.03 221.0 170.9 117.4 37.2% 5.9

Casual w ear 002563.SZ Semir 8.89 23,948 1,427 6% 1,593 12% 1,810 14% 0.53 0.59 0.67 16.8 15.0 13.2 12.6% 1.3

002503.SZ SYT 5.50 17,183 362 86% 784 117% 1,025 31% 0.12 0.25 0.33 47.5 21.9 16.8 68.4% 0.7

Mensw ear 002029.SZ Septw olves 8.39 6,340 267 -2% 299 12% 343 15% 0.35 0.40 0.45 23.7 21.2 18.5 13.3% 1.8 600398.SH Heilan Home 10.39 46,680 3,123 6% 3,444 10% 3,882 13% 0.70 0.77 0.86 14.9 13.6 12.0 11.5% 1.3

600177.SH Youngor 9.73 34,847 3,685 -16% 3,992 8% 4,208 5% 1.03 1.11 1.18 9.5 8.7 8.3 6.9% 1.4

002154.SZ Baoxiniao 3.31 4,181 (387) -487% (30) N/M 28 N/M -0.31 -0.02 0.02 N/M N/M 147.3 N/M N/M

Home textiles 002293.SZ Luolai 14.13 9,960 317 -23% 385 21% 440 14% 0.45 0.55 0.62 31.4 25.9 22.6 17.8% 1.8

002327.SZ Fuanna 9.85 8,539 439 9% 481 10% 523 9% 0.51 0.55 0.60 19.4 17.8 16.3 9.2% 2.1 002397.SZ Mendale 6.58 5,022 97 -37% 124 28% 154 24% 0.13 0.16 0.20 51.6 40.4 32.6 25.8% 2.0

Outdoor 300005.SZ Toread 5.63 5,018 166 -37% 141 -15% 163 15% 0.19 0.16 0.18 30.3 35.6 30.9 -0.9% N/M

Footw ear 603001.SH Aokang 14.20 5,694 305 -22% 299 -2% 322 7% 0.76 0.75 0.80 18.7 19.0 17.7 2.7% 6.9

Textiles 000726.SZ Luthai A 11.12 805 13% 905 12% 1,004 11% 0.87 0.98 1.09 12.7 11.3 10.2 11.7% 1.1 9,053 200726.SZ Luthai B 8.50 805 13% 905 12% 1,004 11% 0.97 1.18 1.35 8.7 7.2 6.3 11.7% 0.7 Apparel & Textiles (H shares) Intimate w ear 2298.HK Cosmo Lady 2.63 5,645 242 -55% 274 13% 320 17% 0.13 0.15 0.19 20.9 17.2 14.2 15.0% 1.4

2199.HK Regina Miracle 7.49 9,170 98 -78% 239 144% 300 26% 0.08 0.19 0.24 93.9 38.4 30.6 75.2% 1.2

Mensw ear 1234.HK China Lilang 7.14 8,546 540 -14% 558 3% 587 5% 0.50 0.56 0.61 14.2 12.8 11.7 4.2% 3.4

Womensw ear 6116.HK La Chapelle 9.00 4,929 532 -14% 538 1% 559 4% 1.08 1.18 1.27 8.3 7.6 7.1 2.5% 3.3 Sportsw ear 2331.HK Li Ning 6.67 14,530 643 4395% 496 -23% 636 28% 0.33 0.27 0.36 20.2 22.7 18.4 -0.5% N/M 3818.HK China Dongxiang 1.49 8,455 870 8% 918 6% 969 6% 0.17 0.19 0.21 8.7 7.7 7.0 5.5% 1.6 2020.HK Anta sports 37.55 100,806 2,386 17% 2,945 23% 3,502 19% 0.99 1.32 1.62 37.9 28.5 23.2 21.2% 1.8

1368.HK Xtep International 3.50 7,781 528 -15% 368 -30% 455 24% 0.26 0.20 0.25 13.2 17.6 13.8 -7.1% N/M

Textiles 2313.HK Shenzhou International 77.60 116,650 2,948 25% 3,598 22% 4,281 19% 2.19 2.87 3.54 35.5 23.6 19.8 20.5% 1.7 1382.HK Pacific Textile 8.16 11,803 976 -13% 1,002 3% 1,070 7% 0.67 0.69 0.74 12.1 11.8 11.0 4.7% 2.6

2678.HK Texhong Textile 11.00 10,065 1,188 101% 1,445 22% 1,669 15% 1.45 1.90 2.27 7.6 5.8 4.9 18.5% 0.4 Luxury & Jew elry (A shares) 600612.SH Lao Feng Xiang 42.16 1,057 -5% 1,221 15% 1,331 9% 2.02 2.33 2.54 20.9 18.1 16.6 12.2% 1.7 18,326 900905.SH Lao Feng Xiang B 3.71 1,057 -5% 1,221 15% 1,331 9% 0.29 0.34 0.36 12.7 10.8 10.2 12.2% 1.0

002345.SZ CHJ 10.75 9,733 234 -8% 264 13% 291 10% 0.26 0.29 0.32 41.7 36.9 33.5 11.5% 3.6

000026.SZ Fiyta 10.63 111 -9% 155 40% 198 28% 0.25 0.35 0.45 42.1 30.2 23.6 33.6% 1.3 4,221 200026.SZ Fiyta B 6.22 111 -9% 155 40% 198 28% 0.28 0.42 0.56 22.1 14.7 11.1 33.6% 0.6 Luxury & Jew elry (H shares) 1929.HK Chow Tai Fook 8.56 85,600 3,055 4% 3,956 29% 4,358 10% 0.31 0.40 0.44 28.0 21.6 19.6 19.4% 1.4

0590.HK Luk Fook 32.20 18,905 1,017 6% 1,148 13% 1,303 13% 1.73 1.96 2.22 18.6 16.5 14.5 13.2% 1.4 0116.HK Chow Sang Sang 18.60 12,591 742 -34% 834 12% 900 8% 1.10 1.23 1.33 17.0 15.1 14.0 10.1% 1.7 Source: Bloomberg, company data, CICC Research. Note: highlighted companies are covered by CICC and use our forecasts; all others are based on consensus estimates.

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