Chow Sang Sang Version 5 | Bloomberg: 116 HK EQUITY | Reuters: 0116.HK Refer to Important Disclosures at the End of This Report

China / Hong Kong Company Guide

Chow Sang Sang Version 5 | Bloomberg: 116 HK EQUITY | Reuters: 0116.HK Refer to important disclosures at the end of this report

DBS Group Research . Equity 1 Feb 2017

BUY Potential earnings rebound Last Traded Price ( 1 Feb 2017):HK$14.80 (HSI : 23,318) Price Target 12-mth: HK$16.65 (13% upside) Sequential improvement intact. According to channel checks, Chow Sang Sang’s (CSS) sales momentum for Dec 2016 has strengthened to Potential Catalyst: Recovery in SSSG and profitability positive y-o-y same-store sales growth (SSSG) in both HK/Macau and Where we differ: Our core profit estimates for FY16/FY17/FY18 are China, along with decent gold product sales for the former and strong 5%/3%/6% below consensus.

gem-set sales for the latter. As 1H17 could continue to benefit from a Analyst low base (1H16 SSSG: -26% for HK/Macau; -5% for China), we believe Mavis HUI +852 2863 8879 [email protected] the company could sustain a recovering sales trend. Further enhancement in product-mix, costs control and operating leverage What’s New could also prompt an earnings rebound in the coming 6-12 months.  Gradual sales recovery remains on track Medium-term prospects also stay positive as consumer affordability in China ascends over time.  A low base for the next 6-9 months could more easily fuel a better trend 2016 results preview. CSS will report in Mar 2017. Its recent profit warning announcement stated expectations of a 30-40% y-o-y  Trading at 10.7x FY17 PE and 3.8% yield, we earnings fall in 2016. This was mainly attributable to (i) a high base

maintain BUY given HK$246m disposal gain of HK Exchanges Shares in 2015, and (ii) the decline in sales turnover for most of 2016 as demand weakened. We estimate CSS to post a 14% sales decline to HK$16.4bn and 38% Price Relative net profit fall to HK$705m, while core profit could decline slightly by HK$ Relative Index

27.9 217 3% to HK$799m (excluding one-offs). 25.9 197 23.9 177 21.9 Better margins will be the key. Looking ahead, 2017 should be a year 157 19.9 137 with mild top-line growth, along with a low base and possible upside 17.9 15.9 117 surprise from gold product sales should gold price edge down further 13.9 97 to attract more purchases. Potential margin improvements could also 11.9 77 9.9 57 come from (i) recovering gross margin for gem-sets as diamond prices Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 bottom-out on tighter supply controls, and (ii) better operating leverage Chow Sang Sang (LHS) Relative HSI (RHS) along with sales and cost improvements, especially on rentals of Forecasts and Valuation standalone stores in HK as CSS continues to renew the expensive leases FY Dec (HK$ m) 2015A 2016E 2017F 2018F Turnover 19,069 16,410 17,575 19,470 from 3 years ago. Further rationalization of its stores in HK will also EBITDA 1,242 1,221 1,371 1,528 help overall efficiency. Pre-tax Profit 1,368 979 1,221 1,375 Valuation: Net Profit 1,130 705 940 1,127 Our TP of HK$16.65 benchmarks 4% FY18 yield, equivalent to 12x Core profit 826 799 940 1,127 FY17 PE (i.e. its average PE). EPS (HK$) 1.67 1.04 1.39 1.67 Core EPS (HK$) 1.22 1.18 1.39 1.67 Core EPS Gth (%) (23.1) (3.3) 17.7 19.9 Key Risks to Our View: DPS (HK$) 0.62 0.42 0.56 0.67 Economic downturn; a further substantial RMB depreciation; policy BV Per Share (HK$) 13.41 14.04 14.87 15.87 changes; strong volatility of gold prices; intensifying competition; and PE (X) 8.9 14.2 10.7 8.9 catastrophic events. Core PE (X) 12.1 12.5 10.7 8.9 P/Cash Flow (X) 7.1 4.8 13.2 14.3 P/Free CF (X) 8.1 5.2 16.7 18.6 At A Glance Issued Capital (m shrs) 677 EV/EBITDA (X) 8.1 7.0 6.1 5.4 Net Div Yield (%) 4.2 2.8 3.8 4.5 Mkt. Cap (HK$m/US$m) 10,018 / 1,291 P/Book Value (X) 1.1 1.1 1.0 0.9 Major Shareholders Net Debt/Equity (X) 0.0 CASH CASH CASH Chow family (%) 58.1 ROAE (%) 12.8 7.6 9.6 10.8 The Capital Group Companies, Inc. (%) 11.0 Core profit Rev (%): Nil Nil Nil Schroders Plc (%) 7.0 Consensus EPS (HK$) 1.20 1.38 1.64 Free Float (%) 23.9 Other Broker Recs: B: 5 S: 0 H: 3 3m Avg. Daily Val. (US$m) 0.8 ICB Industry : Consumer Services / General Retailers Source of all data on this page: Company, DBSV, Thomson Reuters,

HKEX

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Company Guide

Chow Sang Sang

CRITICAL DATA POINTS TO WATCH Hong Kong and Macau

80 Earnings Drivers: 73 74 75 70 Long track record. CSS possesses >80 years of heritage and is 61 58 among the older names in the jewellery industry of Greater 60 China. Amongst major peers, the company also maintains the 50 40 longest listing history of >40 years in Hong Kong. All these 30 have helped to reinforce sound brand awareness and 20

customer confidence, which are crucial elements to succeed 10

especially for industries offering bigger ticket-size items, like 0 jewellery retailing. 2014A 2015A 2016F 2017F 2018F (Note: sales network is broken down into jewellery and watch stores in its disclosure since 2016) Prudent store management. Unlike its major competitors, CSS China maintains a strategy to only open self-operated stores, even 450 in the Mainland China. By doing so, its operations and 405 400 385 customer service level could likely be better controlled to 365 350 322 335 enhance sales efficiency per store. 300 250 Dual-brand expansion. Aside from its core “Chow Sang Sang” 200 brand, the company also operates stores under its “Emphasis” 150 100 brand that targets at younger customers who look for more 50 trendy jewelleries. By growing its retail chain under both 0 brands, CSS has successfully captured a wider range of 2014A 2015A 2016F 2017F 2018F

consumers across different price range and demand. Taiwan

Supportive demand from weddings and new borns. The 30 25 24 market currently believes that jewellery demand from Chinese 25 23 23 22 newlywed couples alone could reach at least RMB80bn each 20 year, stemming from 12-13m couples getting married per annum and an average jewellery spending of >RMB6,000 per 15 couple, given that Chinese weddings cost >RMB80,000 on 10

average nowadays (source: China Wedding Industry 5

Development Report). This, comparing to an average of 0 >USD26,000 (or >RMB180,000) in the US that includes 2014A 2015A 2016F 2017F 2018F >USD4,500 (or >RMB30,000) in jewellery consumption, suggests ample upside in PRC jewellery demand as Chinese Total

become more affluent ahead. Besides, earlier proposal of a 2- 600 505 child policy in China could potentially boost overall PRC 483 500 461 demand for new born jewellery gifts in the coming years. 405 416 400

Rising affluence in China. Thanks to the rising per capita 300 income in China along with government’s long-term goal to 200

boost domestic consumption, major jewellery retailers 100 including CSS stand as key beneficiaries of improving 0 spending power over time. This has also caused the gradual 2014A 2015A 2016F 2017F 2018F shift in preferences for gem-set jewelleries that usually Source: Company, DBS Vickers demand higher average prices than gold products. As gem- sets also generally offer better gross margins (38-42% in 1H16) versus gold products (18-27% in 1H16, including fixed price gold), the continual shift in product-mix towards these higher margin jewelleries should help to beef up overall gross margin in the medium-term.

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Company Guide Chow Sang Sang

Leverage & Asset Turnover (x) Balance Sheet: 0.35 1.7 As CSS continues to open self-operated stores rather than 0.30 1.7 1.6 franchisees or licensees, the company maintained a small gross 0.25 gearing of 18% as of Jun 2016, which should be very reasonable 1.6 0.20 as all inventories are kept in its own book. In terms of cash flows, 1.5 0.15 CSS is expected to generate well over HK$500m operating cash 1.5 0.10 inflows a year in the coming 2 years, comfortably financing its 1.4 normal capex requirement of HK$150-200m per annum. 0.05 1.4 0.00 1.3 2014A 2015A 2016F 2017F 2018F Gross Debt to Equity (LHS) Asset Turnover (RHS) Capital Expenditure Share Price Drivers: HK$m CSS has already built well-recognized brand names and strong 200.0 foothold in China, HK and Macau. The company should be in a 180.0 160.0 good position to secure sound medium-term growth prospects 140.0 in the region. While 2017 could still be filled with challenges, 120.0 100.0 market expectations of potential sales improvement, or more 80.0 likely, margin rebound could possibly prompt further re-rating. 60.0 40.0 20.0 0.0 2014A 2015A 2016F 2017F 2018F

Key Risks: Capital Expenditure (-) Apart from any possible economic downturns that could affect ROE consumer sentiment, CSS’ businesses could also be affected by price volatility of its inventories (e.g. gold). Yet, relatively 12.0% speaking, the more profitable gem-set jewellery division should 10.0% be less affected by price changes amid a steadier uptrend in 8.0% overall diamond & gemstone prices over the longer run. 6.0%

4.0%

Company Background: 2.0% CSS mainly manufactures and retails gold and gem-set jewelry 0.0% products across the Greater China. The company also retails 2014A 2015A 2016F 2017F 2018F watches, and provides securities and commodity brokerage Forward PE Band services and trades in gold bullion. (x) 17.8 +2sd: 16.8x 15.8 +1sd: 14.8x 13.8 Avg: 12.7x 11.8 ‐1sd: 10.7x 9.8 ‐2sd: 8.7x 7.8 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 PB Band

2.5 (x) 2.3 +2sd: 2.18x 2.1 1.9 +1sd: 1.8x 1.7 1.5 Avg: 1.42x 1.3 1.1 ‐1sd: 1.04x 0.9

0.7 ‐2sd: 0.65x 0.5 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Source: Company, DBS Vickers

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Company Guide

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Key Assumptions FY Dec 2014A 2015A 2016E 2017F 2018F Hong Kong and Macau 61.0 58.0 73.0 74.0 75.0 China 322.0 335.0 365.0 385.0 405.0 Taiwan 22.0 23.0 23.0 24.0 25.0 Total 405.0 416.0 461.0 483.0 505.0 Source: Company, DBS Vickers

Segmental Breakdown (HK$ m)

FY Dec 2014A 2015A 2016F 2017F 2018F Revenues (HK$ m) Manufacture & retail of 16,933 16,723 14,482 15,550 17,344 jewellery Wholesale of precious 2,108 2,244 1,851 1,944 2,041 metals Securities & futures 40 51 20 21 22 broking Other businesses 166 52 57 60 63 Total 19,246 19,069 16,410 17,575 19,470 Segmental profit (HK$ m) Manufacture & retail of 1,255 1,007 1,160 1,293 1,494 jewellery Wholesale of precious 22 23 25 26 28 metals Securities & futures 20 27 10 11 11 broking Other businesses 44 43 15 16 17 Total 1,342 1,100 1,211 1,346 1,550 Segmental profit Margins

(%) Manufacture & retail of 7.4 6.0 8.0 8.3 8.6 jewellery Wholesale of precious 1.1 1.0 1.4 1.4 1.4 metals Securities & futures 50.1 52.8 50.4 50.4 50.4 broking Other businesses 26.7 83.7 27.0 27.0 27.0 Total 7.0 5.8 7.4 7.7 8.0 Source: Company, DBS Vickers

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Company Guide Chow Sang Sang

Income Statement (HK$ m) FY Dec 2014A 2015A 2016E 2017F 2018F Revenue 19,246 19,069 16,410 17,575 19,470 Cost of Goods Sold (14,951) (14,841) (12,263) (13,133) (14,549) Gross Profit 4,295 4,228 4,147 4,442 4,921 Other Opng (Exp)/Inc (2,978) (3,196) (3,137) (3,284) (3,609) Operating Profit 1,317 1,032 1,011 1,157 1,312 Other Non Opg (Exp)/Inc 0 0 0 0 0 Associates & JV Inc 2 0 1 1 1 Net Interest (Exp)/Inc 15 9 39 40 40 Dividend Income 20 23 23 23 23 Exceptional Gain/(Loss) 8 304 (94) 0 0 Pre-tax Profit 1,362 1,368 979 1,221 1,375 Tax (277) (238) (274) (281) (247) Minority Interest (3) 0 0 0 0 Preference Dividend 0 0 0 0 0 Net Profit 1,082 1,130 705 940 1,127 Net Profit before Except. 1,075 826 799 940 1,127 EBITDA 1,524 1,242 1,221 1,371 1,528 Growth Revenue Gth (%) (23.5) (0.9) (13.9) 7.1 10.8 EBITDA Gth (%) (5.0) (18.5) (1.8) 12.3 11.5 Opg Profit Gth (%) (7.0) (21.6) (2.1) 14.5 13.3 Net Profit Gth (%) (11.2) 4.4 (37.6) 33.4 19.9 Margins & Ratio Gross Margins (%) 22.3 22.2 25.3 25.3 25.3 Opg Profit Margin (%) 6.8 5.4 6.2 6.6 6.7 Net Profit Margin (%) 5.6 5.9 4.3 5.4 5.8 ROAE (%) 13.1 12.8 7.6 9.6 10.8 ROA (%) 9.2 9.3 5.8 7.6 8.7 ROCE (%) 10.0 7.7 6.5 7.7 8.9 Div Payout Ratio (%) 38.2 37.1 40.0 40.0 40.0 Net Interest Cover (x) NM NM NM NM NM Source: Company, DBS Vickers

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Balance Sheet (HK$ m) FY Dec 2014A 2015A 2016E 2017F 2018F

Net Fixed Assets 1,042 1,017 1,062 1,060 1,059 Invts in Associates & JVs 25 25 25 25 25 Other LT Assets 1,147 1,088 1,112 1,139 1,168 Cash & ST Invts 1,022 1,663 3,076 3,144 3,101 Inventory 7,385 6,676 5,483 5,836 6,426 Debtors 1,195 1,150 990 1,060 1,175 Other Current Assets 426 391 391 391 391 Total Assets 12,242 12,011 12,139 12,655 13,344

ST Debt 1,728 1,372 1,213 1,086 984 Creditors 1,144 913 754 808 895 Other Current Liab 36 95 101 107 113 LT Debt 526 383 383 383 383 Other LT Liabilities 161 170 187 206 227 Shareholder’s Equity 8,647 9,078 9,501 10,065 10,741 Minority Interests 0 0 0 0 0 Total Cap. & Liab. 12,242 12,011 12,139 12,655 13,344

Non-Cash Wkg. Capital 7,827 7,210 6,009 6,373 6,983 Net Cash/(Debt) (1,233) (92) 1,480 1,675 1,734 Debtors Turn (avg days) 22.0 22.5 23.8 21.3 20.9 Creditors Turn (avg days) 29.0 25.6 25.2 22.0 21.6 Inventory Turn (avg days) 176.1 175.1 183.8 159.6 155.9 Asset Turnover (x) 1.6 1.6 1.4 1.4 1.5 Current Ratio (x) 3.4 4.2 4.8 5.2 5.6 Quick Ratio (x) 0.8 1.2 2.0 2.1 2.1 Net Debt/Equity (X) 0.1 0.0 CASH CASH CASH Net Debt/Equity ex MI (X) 0.1 0.0 CASH CASH CASH Capex to Debt (%) 8.3 9.8 9.7 10.8 11.8 Z-Score (X) 5.0 5.4 5.4 5.6 5.7 Source: Company, DBS Vickers

Cash Flow Statement (HK$ m) FY Dec 2014A 2015A 2016E 2017F 2018F

Pre-Tax Profit 1,362 1,368 979 1,221 1,375 Dep. & Amort. 185 187 187 190 193 Tax Paid (365) (147) (274) (281) (247) Assoc. & JV Inc/(loss) (5) 0 (1) (1) (1) (Pft)/ Loss on disposal of FAs (46) (387) 0 0 0 Chg in Wkg.Cap. (751) 359 1,195 (370) (617) Other Operating CF 8 22 (2) (2) (2) Net Operating CF 388 1,403 2,084 757 700 Capital Exp.(net) (188) (172) (155) (158) (161) Other Invts.(net) 0 246 0 0 0 Invts in Assoc. & JV (38) 0 0 0 0 Div from Assoc & JV 20 2 23 23 23 Other Investing CF (34) (4) (24) (26) (29) Net Investing CF (240) 71 (156) (162) (168) Div Paid (447) (413) (282) (376) (451) Chg in Gross Debt 58 (264) 0 0 0 Capital Issues 0 0 0 0 0 Other Financing CF 255 (145) (233) (152) (125) Net Financing CF (134) (821) (515) (528) (575) Currency Adjustments (15) (40) 0 0 0 Chg in Cash 0 612 1,413 67 (43) Opg CFPS (HK$) 1.68 1.54 1.31 1.66 1.95 Free CFPS (HK$) 0.30 1.82 2.85 0.88 0.80 Source: Company, DBS Vickers

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Company Guide Chow Sang Sang

Target Price & Ratings History

S.No. Date Closing 12-mth Rating HK$ Price Target 17.0 2 3 1 Price 16.0 4 1: 23-Mar-16 HK$12.16 HK$14.01 Buy 15.0 2: 31-Aug-16 HK$14.86 HK$13.78 Hold 3: 21-Nov-16 HK$13.64 HK$16.65 Buy 14.0 4: 22-Nov-16 HK$13.64 HK$16.65 Buy 13.0

12.0

11.0

10.0 Jul-16 Jan-17 Jun-16 Feb-17 Oct-16 Feb-16 Sep-16 Apr-16 Dec-16 Nov-16 Mar-16 Aug-16 May-16

Source: DBS Vickers Analyst: Mavis HUI

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Company Guide

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DBSVHK recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends

Completed Date: 1 Feb 2017 17:42:47 (HKT) Dissemination Date: 1 Feb 2017 18:40:21 (HKT)

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Company Guide Chow Sang Sang

ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The DBS Group has procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports. As of 1 February 2017, the analyst(s) and his/her spouse and/or relatives who are financially dependent on the analyst(s), do not hold interests in the securities recommended in this report (“interest” includes direct or indirect ownership of securities). The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment banking function of the DBS Group and procedures are in place to ensure that confidential information held by either the research or investment banking function is handled appropriately.

COMPANY-SPECIFIC / REGULATORY DISCLOSURES 1. DBSVHK and its subsidiaries do not have a proprietary position in the securities recommended/mentioned in this report as of 27 Jan 2017.

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Company Guide

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