hong kong jewellery retailers - oriental patron kong jewellery... · thu, 01 nov 2012 hong kong...

Thu, 01 Nov 2012

Equi ty Research Hong Kong Jewellery Retailers Consumer/ China

Weak consumption demand in mid-term

We initiate coverage of Luk Fook (590 HK, Sell), (Chow Tai Fook, Sell) and

Chow Sang Sang (116 HK, Hold).

Despite the release of QE3, Gold demand remains weak in short term. The

surprise arrival of QE3 doesn't have a big impact on retail sales. With the recent

Golden week figure, Luk Fook has hit the most with the most negative SSSG

(-35%) where Chow Sang Sang and Chow Tai Fook has recorded a double digit

SSSG decrease in Hong Kong. October and November would unlikely see

recovery yet.

Luk Fook’s net profit would unlikely be exciting - With our forecast of 20% yoy

rental increase, we forecast Luk Fook (590 HK) would likely record a decrease

(-10.2%) in net profit in FY2013. With over 70% Hong Kong revenue contribution,

Luk Fook would likely hit most with the recent weak demand. We forecast all

three companies net margin would decrease despite if a small GP margin

improvement has been shown.

Chow Tai Fook would have slower stores expansion plan- With recent weak

demand evidenced, Chow Tai Fook (1929 HK) likely would likely slowdown with

its store expansion due to sales We forecast Chow Tai Fook to have slower store

opening in FY2014 with total 1,994 stores.

Chow Sang Sang’s gem-set jewellery sales remains positive- We believe

Chow Sang Sang’s Gem-set jewellery sales remains positive which carries higher

Gross margin. The reasonable stores expansion plan prevents net margin

erosion. 40% hedging system gives a more stable to gold price sensitivity.

What do we recommend? We recommend Hold on Chow Sang Sang (116 HK)

with a TP HK$17.6, which is 6% upside to current price. We recommend Sell on

Luk Fook (590 HK) with a TP HK$16.3.We initiate with a sell on Chow Tai Fook

(1929 HK) with TP HK$8.2.

Terence Lok

Analyst

+852 2135 0212

[email protected]

Sector Report

Exhibit1: Recommendat ions summary Company Stock code Rating Closed Price Target Price Upside (%)

Luk Fook 590 HK Sell 19.48 16.3 -16%

Chow Tai Fook 1929 HK Sell 9.56 8.2 -14%

Chow Sang Sang 116 HK Hold 16.54 17.6 +6%

Source: Bloomberg, OP Research

Thu, 01 Nov 2012

Hong Kong Jewellery Retailers

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Table of Contents

Our preferred order ...................................................................................................................................... 3

Valuation comparison ................................................................................................................................... 4

Why invest in Jewellery sector in mid term? ................................................................................................. 5

Luk Fook Holdings (590 HK) – Unclear in mid-term ....................................................................................15

Investment thesis .................................................................................................................................18

Risks ....................................................................................................................................................26

Financial Summary – Luk Fook Holdings (590 HK) ..............................................................................28

Chow Sang Sang (116 HK) – Attractive valuation, but gold consumption remains weak .............................29


Risk......................................................................................................................................................40

Financial Summary – Chow Sang Sang (116 HK) ................................................................................42

Chow Tai Fook (1929 HK) – market share justify its valuation? ...................................................................43


Risk......................................................................................................................................................54

Financial Summary – Chow Tai Fook (1929 HK) ..................................................................................56

Thu, 01 Nov 2012


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Our preferred order

Luk Fook (590 HK) - Sell TP HK$16.3

Despite ASP likely increase, but demand for gold remains weak in

short term- Management likely increase gold product ASP due to increase

of gold. However, large volume decrease doesn't offset the increase of ASP

which likely lead to no improvement in margin.

Resign of Paul Law, CFO of Luk Fook- In our view with Paul serving over

10 years in Luk Fook since IPO, the forward looking of Luk Fook remains

uncertain in mid-term depending on the new CFO, ex bossini CEO

guidelines. We remain cautious on Luk Fook in the mid-term on its

operation.

We forecast net profit at HK$1.2billion - Based on SSSG China of 8%

and SSSG HK of 1% assumption; we result our net profit in line with

consensus forecast. We believe with recent 35% yoy decrease in golden

week, Luk Fook has underperformed against its peers especially in HK.

Chow Tai Fook (1929 HK) - Sell TP HK$8.2

Slower stores opening- With weak demand of jewellery purchase, Chow

tai Fook has the most Stores in Hong Kong (we forecast 103 stores in HK

and Macau for 2013) which carries the highest rental cost against its peers.

Not much product differentiation- We believe jewellery sales depends on

the jewellery sentiment despite of the higher end jewellery sold by Chow Tai

Fook.

Weak Gem-set as product mix- Recent 1QFY13 hasn't proved increase of

gem-set jewellery product mix, we forecast 29.2% for 2013 GP margin, only

0.1ppt improvement.

Chow Sang Sang (116 HK) - Hold TP HK$17.6

Despite QE3 policy release, this has a small impact on the demand

side of gold purchase- As the QE3 surprisingly come in September, many

investors are still suspect on such policy. This arguable might shows more

gold consumption from investors, but with the weak sentiment, the actual

demand consumption remains cautious.

Product mix- We expect a further increase in gold as product mix since we

believe recent gem-set jewellery sales remain weak. With 1H12 product mix,

there has shown a drop in Gem-set jewellery as product mix. In our analysis,

we assume 62%/31%/7% for gold, gem-set jewellery and watch product mix

proportion for Hong Kong segment. For China segment, we assume

66%/34% for gold and gem-set jewellery.

Reasonable store expansion plan- Chow Sang Sang has a reasonable

store expansion plan which opens less than 50 stores in PRC each year.

We forecast CSS to open 50 stores and 5 new stores in Hong Kong. 1H12

CSS has already opened 23 stores in the PRC.

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Valuation comparison

Exhibit2: Peer Group Comparison

Company Ticker Price

Mkt

cap

(US$m)

Weighted

by MKT

Cap

3-mth

avg t/o

(US$m)

PER

Hist

(x)

PER

FY1

(x)

PER

FY2

(x)

EPS

FY1

YoY%

EPS

FY2

YoY%

3-Yr

EPS

Cagr

(%)

PEG

(x)

Div yld

Hist

(%)

Div

yld

FY1

(%)

P/B

Hist

(x)

P/B FY1

(x)

EV/

Ebitda

Hist

EV/

Ebitda

Cur Yr

Net

gearing

Hist

(%)

Gross

margin

Hist

(%)

Net

margin

Hist

(%)

ROE

Hist

(%)

ROE

FY1

(%)

Sh px

1-mth

%

Sh px

3-mth

%

Sh px

1

DAY

3-mth

%

Lvmh Moet Hennes MC FP 125.40 82,588 46% 83.8 20.0 17.3 15.7 15.4 10.6 12.3 1.40 2.1 2.4 2.65 2.53 11.5 10.0 21.1 65.8 13.0 15.6 15.6 4.0 1.6 (1.1)

Burberry Group BRBY LN 1,166.00 8,311 5% 1,762.4 1,930.5 17.6 15.5 9.8 13.1 12.5 1.40 2.4 0.0 5.90 5.03 10.3 9.6 0.0 69.9 14.2 33.3 29.9 15.0 (7.3) (1.2)

Ferragamo Spa SFER IM 15.67 3,422 2% 8.3 32.5 25.7 18.8 26.2 36.9 26.9 0.96 1.8 2.0 12.48 9.40 14.9 12.1 8.0 64.2 8.2 40.2 39.5 (5.1) (1.0) (1.3)

Ppr PP FP 135.65 22,176 12% 29.8 17.3 15.2 13.1 14.2 15.5 14.9 1.02 2.6 3.0 1.55 1.47 11.7 10.8 29.0 50.9 8.1 9.5 9.4 13.0 10.5 0.1

Tod'S Spa TOD IM 90.25 3,582 2% 9.7 20.5 18.6 16.7 10.2 11.0 11.1 1.68 2.8 3.1 4.03 3.67 11.5 10.7 0.0 N/A 15.1 22.2 20.5 3.6 20.2 (1.0)

Prada S.P.A. 1913 HK 63.35 20,916 12% 19.6 62.3 26.7 21.5 38.8 24.2 26.7 1.00 0.8 0.7 8.85 7.06 21.3 15.8 0.0 71.5 16.9 28.5 28.5 9.4 23.0 0.2

Ralph Lauren Cor RL US 153.69 14,009 8% 144.2 20.9 19.7 16.8 6.1 17.3 12.8 1.54 0.8 0.8 4.03 3.63 10.3 9.7 0.0 58.3 9.9 20.7 19.4 1.3 8.0 0.8

Tiffany & Co TIF US 63.22 8,006 4% 118.7 18.3 17.6 15.4 4.2 14.2 11.1 1.58 1.9 2.0 3.34 3.10 10.1 9.4 11.5 59.0 12.1 18.6 18.2 2.8 15.4 1.0

Coach Inc COH US 56.05 15,912 9% 327.8 15.6 14.5 12.6 7.4 14.9 12.4 1.17 1.9 2.0 8.02 6.87 NA NA 0.0 72.8 21.8 54.9 52.7 2.5 12.5 0.3

Average 259.4 18.3 15.6 11.7 16.7 14.3 1.3 2.0 1.9 5.3 4.5 11.5 10.3 8.7 63.0 12.8 26.9 25.7 4.6 7.5 (0.3)

Market weighted average 113.2 18.3 15.9 15.9 14.5 14.6 1.3 1.9 2.0 4.2 3.7 11.5 9.9 14.0 63.2 13.3 21.8 21.3 5.7 7.2 (0.4)

Belle Internatio 1880 HK 14.46 15,737 83% 24.1 23.1 20.6 17.6 12.0 17.0 15.2 1.35 1.4 1.5 4.68 4.35 NA NA 0.0 57.2 14.7 23.2 22.4 3.0 0.0 0.1

Daphne Internati 210 HK 9.25 1,966 10% 4.6 16.2 16.1 13.0 0.9 23.8 14.4 1.12 1.9 2.0 3.47 3.28 NA NA 0.0 61.1 10.9 24.6 22.7 18.9 21.6 (1.1)

Trinity Ltd 891 HK 5.39 1,194 6% 2.1 17.8 16.2 13.9 9.6 16.6 14.3 1.14 4.3 4.2 2.83 2.70 NA NA 0.0 80.7 19.7 16.9 16.3 3.7 7.8 (0.7)

Average 17.8 16.2 13.9 7.5 19.1 14.3 1.1 4.3 NA 2.8 NA NA NA 0.0 80.7 19.7 16.9 NA 3.7 7.8 (0.7)


Parkson Retail 3368 HK 6.61 2,397 17% 3.3 13.3 14.0 12.6 (4.8) 10.8 6.7 2.08 3.3 3.2 2.74 2.56 7.5 8.1 0.0 N/A 25.7 20.6 19.4 1.7 (5.2) 0.8

Golden Eagle Ret 3308 HK 17.34 4,324 30% 9.0 22.4 21.7 18.4 3.4 17.9 13.2 1.64 1.3 1.3 5.77 4.95 15.3 14.0 0.0 76.3 37.7 28.0 25.0 13.9 21.8 2.0

Intime Departmen 1833 HK 9.23 2,383 17% 5.3 17.3 16.7 13.9 3.7 19.7 11.8 1.41 2.3 2.4 2.13 2.07 18.2 13.9 31.5 69.6 26.4 13.9 13.0 9.9 26.1 0.5

Maoye Intl Hldgs 848 HK 1.61 1,116 8% 1.4 10.8 9.7 8.9 11.7 9.0 11.9 0.81 5.7 3.6 1.27 1.10 8.1 9.2 37.6 60.2 19.1 14.8 11.9 17.5 32.0 3.2

Pcd Stores Group 331 HK 0.74 402 3% 1.6 8.1 7.4 5.4 8.1 37.5 20.7 0.36 4.8 6.7 1.05 0.98 5.5 5.1 0.0 80.0 24.5 9.1 13.4 19.4 29.8 1.4

Lifestyle Intl 1212 HK 16.72 3,590 25% 2.6 14.9 14.8 13.2 0.8 11.5 6.3 2.33 2.8 2.7 3.16 2.94 11.2 10.8 0.0 58.5 36.8 23.9 21.2 4.4 (0.6) 1.0

Shirble Departme 312 HK 0.72 232 2% N/A 5.8 N/A N/A N/A N/A N/A N/A N/A N/A 0.95 N/A NA NA 0.0 N/A 15.6 22.3 N/A 0.0 0.0 0.0

Average 13.2 14.0 12.1 3.8 17.7 11.8 1.4 3.4 3.3 2.4 2.4 11.0 10.2 9.9 68.9 26.5 19.0 17.3 9.5 14.8 1.3

Market weighted average 16.6 16.2 14.0 2.2 15.0 10.1 1.7 2.6 2.5 3.5 3.1 12.4 11.4 8.1 55.7 31.4 21.8 19.4 9.1 13.1 1.3

Luk Fook Hldgs I 590 HK 19.48 1,511 10% 10.2 8.2 9.4 8.0 (13.1) 18.1 6.8 1.39 4.8 4.1 2.09 1.82 6.1 6.5 0.0 23.2 11.2 29.6 21.3 (22.9) 4.6 2.1

Chow Sang Sang 116 HK 16.54 1,464 9% 2.5 10.4 10.8 8.7 (4.2) 25.1 11.9 0.91 3.5 3.3 1.79 1.60 8.1 8.9 27.4 19.0 6.4 16.9 15.6 (13.2) 7.2 1.3

Chow Tai Fook Je 1929 HK 9.56 12,361 80% 8.7 14.0 14.4 11.6 (3.1) 24.4 13.0 1.11 1.0 1.4 3.31 2.70 10.8 10.7 16.3 29.1 11.2 31.5 20.8 (13.2) 8.2 0.2

Tse Sui Luen Jew 417 HK 4.15 113 1% 0.0 5.4 N/A N/A N/A N/A N/A N/A 3.7 N/A 0.93 N/A 4.1 N/A 36.0 47.9 4.8 18.6 N/A (13.7) (15.3) 0.0

Average 9.5 11.6 9.4 (6.8) 22.5 10.6 1.1 3.3 3.0 2.0 2.0 7.3 8.7 19.9 29.8 8.4 24.1 19.2 (15.8) 1.2 0.9

Market weighted average 13.0 13.5 10.9 (4.1) 23.7 12.2 1.1 1.7 1.9 3.0 2.5 10.1 10.0 15.9 27.7 10.7 29.8 20.2 (14.2) 7.6 0.5

Emperor Watch & 887 HK 0.76 659 29% 2.4 7.8 9.6 7.9 (18.6) 21.5 5.8 1.65 3.4 3.2 1.29 1.21 6.1 7.1 0.0 28.8 10.7 15.7 13.7 (9.5) 10.1 2.7

Oriental Watch 398 HK 2.32 171 8% 0.5 8.0 6.3 6.3 27.2 (0.3) 14.8 0.43 4.7 4.7 0.63 0.60 6.3 5.6 14.3 21.0 4.2 8.3 10.1 (10.1) (0.9) 0.0

Hengdeli Holding 3389 HK 2.51 1,423 63% 3.3 10.9 11.3 10.2 (3.8) 11.8 7.4 1.54 3.1 3.2 1.71 1.58 8.8 8.0 6.6 25.1 7.2 19.1 15.4 11.6 17.8 2.9

Average 8.9 9.1 8.1 1.6 11.0 9.3 1.2 3.8 3.7 1.2 NA 7.1 NA 7.0 25.0 7.3 14.4 NA (2.7) 9.0 1.9

Market weighted average 9.8 10.5 9.2 (5.8) 13.7 7.5 1.5 3.3 3.3 1.5 1.4 7.8 7.6 5.2 25.9 8.0 17.3 14.5 3.7 14.2 2.6

* Outliners and "N/A" entries are in red and excl. from the calculation of averages


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Why invest in Jewellery sector in mid term?

China jewellery sector

According to Frost & Sullivan report, China’s retail sales of consumer goods are

expected to grow at 20.5% for 2010-2015E CAGR.

Exhibit 3: Retail value of jewellery market in PRC with breakdown by

product

Source: World Gold Council

On the demand side

Recent global demand trend for Gold- Global gold demand in Q212 has met

approximately 990 tons as compared to the full year of 4,067 tons in 2011,

according to World Gold Council. Despite a slight drop of 7% as compared to

2Q11, we see there are more rooms for gold consumption in 2H 2012 especially

with the QE3 release. There is a reminder that the demand of gold was

exceptional high in 2011. The average gold price hit US1,609.49/oz which grows

7% yoy.

Exhibit 4: Gold demand by category in tones and gold price (US/oz)


54 71 92 112 156 221 309 433

605 843

21 28 38 44 61

85 119

165

230

319

33 43 54 64 86

117

159

214

288

386

0

400

800

1,200

1,600

2,000

2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E

Gold products Platinum/karat gold products Gem-set jewellery

(HK$ bn)

Total: 2010-2015E CAGR: 38.6%Gold products: 2010-2015E CAGR: 40.2%

Platinum/karat gold products: 2010-2015E CAGR: 39.5%Gem-set jewellery: 2010-2015E CAGR: 35.0%

0

400

800

1,200

1,600

2,000

Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10 Q1'11 Q2'11 Q3'11 Q4'11 Q1'12 Q2'12

Jewellery Technology Investment

Official sector purchases London PM fix (US$/oz)

(Tonnes, US$/oz)

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Exhibit 5: China retail sales for gold

Source: Bloomberg

China and India accounted for 55% of global jewellery demand-Gold has

always been one of the popular items for China consumer given the social statue

but more importantly, the store of value as a substitute of money. As quoted from

Frost & Sullivan report, among all three of jewellery segment, the consumption of

gold products is anticipating an increase of 40.2% CAGR 2010-2015. Despite of a

slowing GDP during second quarter of 2012, the consumption of jewellery in

China dropped 9% to 93.8 tones. However, there is a reminder that Q2 is typically

weaker. According to World Gold Council, they are expecting the pickup in fourth

quarter as well. We also argue that the release of QE3 would possible affect the

global jewellery consumption, however, more importantly; the result of China

domestic policy.

Exhibit 6: Global gold consumption intensity in 2011


0

20

40

60

80

0

5

10

15

20

Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Apr-12

(RMB bn)

China retail sales gold, silver& Jewellery

China retail sales gold,silver & Jewellery yoy

0

1

2

3

4

5

0 10 20 30 40 50 60

(Per capita gold consumption (gm))

GDP per capita (US$'000)

Hong Kong

Taiwan

Thailand

India

China

Indonesia

Russia

Saudi Arabia

South Korea

Italy United Kingdom

Japan USA

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Global supply side at 1,059.1 tonnes in Q2 2012

Modest uptrend- The global gold supply in Q2 was unchanged. First in mine

production aspect, 706.4 tonnes was produced, 3 tonnes above yoy. A number of

counties have seen of an increase in mine production includes China where Q2

production was up by approximately 4-5%.Second, supply generated by recycling

of old gold (account of 42% of global total) slightly declined due to lack of market

suppliers of old gold which shows the proportion of people of holding gold

increases.

Exhibit 7: Breakdown of gold mine supply by countries


China13%

Australia9%

United States8%

Russia8%

South Africa

7%Peru7%

Indonesia4%

Canada4%

Ghana3%

Other37%

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Hong Kong jewellery sector

According to World Gold Council, Hong Kong jewellery demand has reached 7.3

tonnes, 8% yoy higher and 43% above the five-year average of 5.1 tonnes With

approximately 20% including 17% VAT and 5% consumption tax, the price

difference between China and Hong Kong, the increase of number of tourists

from China provides the key contributor to jewellery sector. According to Hong

Kong census, there are approximately 42 million tourists visited in Hong Kong in

2011 and expecting to grow at 8.5% 2010-2015 CAGR according from Frost &

Sullivan. With the support of ‘individual Visit Scheme’ in 2003, more importantly,

PRC tourist contributes more than 40% of total Hong Kong jewellery retail sales in

2010.

Exhibit 8: HK retail sales jewellery volume vs number of PRC tourist

Source: HK tourist board

Exhibit 9: Retail sales of consumer goods in HK and Macau


0%

10%

20%

30%

40%

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12

Total number of tourist to HK Mainaland tourist to HK

HK retail sales of jewellery, watches yoy

219.0 247.0 273.1 274.7 325.0

370.7 415.7

466.3 522.9

587.3

10.7 14.2

19.4 22.4

29.8

38.5

48.9

61.9

78.5

99.6

0

200

400

600

800

2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E

Hong Kong Macau

(HK$ bn)

Total: 2010-2015E CAGR: 14.1%Hong Kong: 2010-2015E CAGR: 12.6%

Macau: 2010-2015E CAGR: 27.3%

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Exhibit 10: Type of jewellery sales in Hong Kong and Macau


10.1 13.3 16.0 17.5 25.2 35.6 50.3 70.4

98.5 137.5

5.0 6.6 8.0 8.8 12.6

17.7 24.9

34.8

48.5

67.5

10.2 13.2 15.7 17.2 24.2

33.6

46.4

63.6

87.2

119.3

0

50

100

150

200

250

300

350

2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E

Gold products Platinum/karat gold products Gem-set jewellery

(HK$ bn)

Total: 2010-2015E CAGR: 39.2%Gold products: 2010-2015E CAGR: 40.4%

Platinum/karat gold products: 2010-2015E CAGR: 40.0%Gem-set jewellery: 2010-2015E CAGR: 37.6%

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Positive gold trend with QE3, but less impact on consumption

demand

As seen in figure 3, the releases of QE1 and QE2 have boosted up the China

gold, silver& Jewellery consumption given a strong economy.

Exhibit 11: Global comparison


Gold price trend:

However, we argue the short-term reaction from China to QE3 is the critical for

domestic demand for gold especially for gold investors.

Yes, we see that the release of QE3 unarguably would, of course, able to boost

up gold price to possible to highest price, hence Luk Fook has the least hedging

exposure would likely benefit its margin. Looking at the QE1 and QE2 policies

respectively, as financial crisis broke out in September/October 2008 and QE1

was released in Nov 2008. The effect stayed for about a year and half. (Till

around March 2010). The gold price has hit to around US$ 1,300 Troy/ ounce

from under US$ 1000 Troy/ ounce. However the QE2 duration has a shorter

duration but hitting historically highest gold price at the end of QE2 in June 2011.

Both releases of policies has raised gold price for at least 26% and 25%

respectively. We think US dollars would depreciate and investor would switch

their investment into US dollars and driving down the commodity price.

Demand remains weak:

Despite the arrival of surprising QE3 policy released, we haven’t seen a trend for

boosting up a significant level of consumption demand for gold. Depending on the

number of commodity investors, our discover might see a small amount of gold

bars purchase increases, however with large ticket size purchase decreases and

economy downturn, average selling price increases, due to gold price increase,

this would hard to stimulate demand in the short run.

0

500

1,000

1,500

2,000

0

20

40

60

80

Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Apr-12

(Share price)

Chow Sang Sang Luk Fook Gold price

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Hedging system


Chow Sang Sang Chow Tai Fook Luk Fook

2011 Product mix-%

Gold

58.9% 53.4% 55.0%

Non gold jewellery 34.9% 39.5% 45.0%

Watches

5.9% 7.1%

Hedging proportion Hedge around 40% hedge 100% through gold

loan

Hedge around 15%-20%

through short selling

2011 Gross margin-% 19.5% 28.3% 23.7%

Source: OP research

Luk Fook and Chow Sang Sang

The release of QE3 would drive up both commodity price and sales of gold in

short term, and FY2H12 might likely perform better than 1H12. But overall profit

might not offset by the high base and weak sentiment of gold purchase. We

believe with recent share price trend, Luk Fook has underperformed due to recent

golden week. Despite Chow Sang Sang has the lowest GP margin out of all three

jewelleries, we think Chow Sang Sang with its prudential expansion and hedging

system allows a reasonable growth in mid to long term.

Chow Tai Fook

The question of the increase gem-set jewellery as product mix remains a

question for Chow Tai Fook (1929 HK) in 2H2012. With our latest Roadshow,

management has indicated the increase of gem-set jewellery for capturing better

gross margin, however, with the latest 1Q13 hasn't revealed such trend. But if

Chow Tai Fook able to shift its product mix from gold to Gem-set jewellery, then

this would be a catalyst turning over in 2H2012. Out of all three jewelleries

companies, Chow Tai Fook has achieved the highest GP margin which leads to a

higher net margin compares to its peers.

Exhibit 13: GP margin comparison


18.3%19.9% 19.0%

28.9% 28.6% 28.3%

22.1%24.0% 23.7%

0

400

800

1,200

1,600

2,000

0%

5%

10%

15%

20%

25%

30%

35%

2009 2010 2011

CSS ( calendarised) Chow tai Fook

Luk Fook Average gold price-End march

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SSSG

HK

After golden week, there are more SSSG guidance has been downgraded

especially Luk Fook (590 HK). With Management guided of 1% SSSG for Hong

Kong along with high base, we see the net profit would drop with weak demand

and increasing rental expenses (we forecast 20% increase yoy). For Chow Sang

Sang (116 HK) which recorded a double digit decrease of SSSG during Golden

Week, we forecast at 5% SSSG for the whole year. Despite Gem-set jewellery

remains stable, gold purchase has dropped significantly. For Chow Tai Fook

(1929 HK), we also forecast 1% SSSG.

Exhibit 14: SSSG HK comparison

SSSG HK FY10A FY11A FY12A FY13E FY14E FY15E

Chow Sang Sang 29% 28% 5% 10% 15% 9%

Chow Sang Sang (calendized) 7% 29% 22% 6% 11% 14%

Chow Tai Fook 16% 32% 48% 1% 5% 10%

Luk Fook 17% 30% 40% 1% 5% 8%

Source: OP research

China

For Luk Fook, with the recent monthly SSSG, we see April to June remains a

strong SSSG with double digit where SSSG starts to decline from August to

negative double digit SSSG in September ( -11%). We forecast at 8% SSSG

given the relative strong SSSG in 1HFY2013.

For Chow Sang Sang, we forecast at 5% SSSG and we think such estimation has

been moderate comparing with the level of 2009. Despite a double digit decrease

has been recorded from Golden week, there is a reminder of the exception high

base of 2011 which leads to a lower SSSG this year.

For Chow Tai Fook, we forecast 8% SSSG from the actual SSSG of 32% in

FY2011.

Exhibit 15: SSSG China comparison

SSSG China FY10A FY11A FY12A FY13E FY14E FY15E

Chow Sang Sang 23% 37% 5% 10% 15% 10%

Chow Sang Sang (calendized) 16% 27% 29% 6% 11% 11%

Chow Tai Fook 15% 35% 32% 8% 8% 10%

Luk Fook -12% 30% 25% 8% 8% 8%

Source: OP Research

Exhibit 16: EBIT margin vs SG& A

2012 Luk Fook Chow Tai Fook Chow Sang Sang (calendarised)

EBIT margin 13.4% 15.1% 8.4%

SG&A ( to topline) 8.6% 11.0% 9.4%

Source: OP Research

From operating cost, we see Chow Tai Fook has the highest SG&A compares to

its peers and carrying forward, there are more likely increases in SG&A with

labour cost increases ( minimum wage policy) along with rental increases. More

aggressive promotion and advertising might be seen for competition.

Thu, 01 Nov 2012


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Inventory days

Exhibit 17: Inventory days comparison

Inventory turnover days 2010 2011 yoy %

Chow Sang Sang 142 146 2.82%

Chow Tai Fook ( calendared) 192.5 207.75 7.9%

Luk Fook (calendared) 129 136.5 5.8%

Source: OP research

In term of inventory days, Luk Fook has the lowest inventory turnover days which

gold takes around 3 months and jewellery is stored for around 7 months. However,

Chow Tai Fook required higher inventory days for its store expansion plan. Chow

Sang Sang has the reasonable inventory level for provision of new stores

opening. With recent weak gold purchase demand, we might see all three

companies’ gold inventory is expected to rise slightly in FY13.

Exhibit 18: Business models comparison

Chow Sang Sang Chow Tai Fook Luk Fook

Bberg 116 HK 1929 HK 590 HK

Listing year 1973 2011 1997

Established year 1934 1929 1991

Year End December March March

Distribution network

Sales by Geography %-2011

HK/Macau 63.0% 44.40% 72.80%

PRC 35.90% 55.60% 17.30%

No of stores-2011

HK/Macau 57 84 38

PRC-self-operated 232 883 39

PRC-Franchised/License 0 391 618

Total stores 310 1358 700

SSSG-2011

HK/Macau 28% 32.40% 30%

PRC 37% 35.20% 30%

Business model

Vertically-integrated model which

involves sourcing, manufacturing and

retailing before coming to customers,

Retailing and licensing model to

expand through China

Vertically-integrated model which

self-produced for 50%. Using both

franchisees and self-operated models

Vertically-integrated model which all

stores are self-operated in China, HK,

and Macau. Outsource around 2/3 of

jewellery production

Source: OP research

Thu, 01 Nov 2012


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Where the stores are concentrates in China?


Luk Fook Chow Tai Fook

Chow Sang Sang

Source: OP resaerch

Chow Sang Sang only directly runs and controls its retail stores with no franchise

operations. We can see CSS’s stores are mainly concentrated in southern area

with around 87 stores followed by northern area.

Chow Tai Fook runs both retail and franchise models where we see CTF

jewellery stores are mainly located in tier II cities. (726 stores (CTF) vs 204 stores

(Luk Fook)).

Luk Fook runs retails and licensing models. Retails stores are mainly in tier 1

cities where it has located 353 stores (vs. 207 stores of CTF).

Thu, 01 Nov 2012


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Luk Fook Holdings (590 HK) – Unclear in mid-term We initiate Luk Fook (590 HK) with Sell at target price of HK$16.3, implying P/E

8.3x multiple, resulting a 16% downside to current price.

We remain cautious with the recent weak demand after QE3. We forecast SSSG to be 1% for Hong Kong and 8% for China.

Management issue has revealed an unclear guidance for mid-term.

We initiate coverage of Luk Fook (590 HK) with a Sell and a target price of HK$16.3.

With weak demand along and cautious company mid-term, we believe gold consumption

continue to weaken in the second half.

Despite ASP likely increase, demand for gold remains weak in short term-

Management likely increase gold product ASP due to increase of gold. However, large

volume decrease doesn't offset the increase of ASP which likely lead to no improvement in

margin. Along with wage rises and rental increase, net profit would be less exciting.

QE3 unlikely drives up margin with weak gold purchase demand- With the surprise

release of QE3, investors are cautious of the arrival such policy. However, we argue that

the proportion of ‘gold consumption investors’ has only a small impact to boost up sales of

large ticket size consumption.

Resign of Paul Law, CFO of Luk Fook- In our view with Paul serving over 10 years in Luk

Fook since IPO, the forward looking of Luk Fook remains uncertain in mid-term depending

on the new CFO, ex Bossini CEO guidelines. We remain cautious on Luk Fook in the

mid-term on its operation.

We forecast net profit at HK$1.2bn - Based on SSSG China of 8% and SSSG HK of 1%

assumption; we result our net profit in line with consensus forecast. We believe with recent

35% yoy decrease in golden week, Luk Fook has underperformed against its peers

especially in Hong Kong.

Risk: Rising gold price from easing policy 2) Possible recovery of SSSG in FY2H2012 3)

Hong Kong rental decreases.

Valuation: We initiate Luk Fook with a rating of Sell: TP: HK$16.3. Currently Luk Fook is

trading at an undemanding valuation of P/E 8 x and 6.1 x for FY13/ FY14, below its Hong

Kong/ China peers group. We believe1) SSSG unlikely be exciting with high base in 2011.

2) Demand for gold consumption has not yet recover after golden week.

Initial Coverage

Sell

Close price: HK$19.48

Target Price: HK$16.3 (-16%)

Key Data

HKEx code 590

12 Months High (HK$) 37.10

12 Month Low (HK$) 14.70

3M Avg Dail Vol. (mn) 3.60

Issue Share (mn) 589.11

Market Cap (HK$mn) 11,475.82

Fiscal Year 03/2012

Major shareholder (s) Luk Fook (Control) (39.75%)

Source: Company data, Bloomberg, OP Research Closing price are as of 31/10/2012

Price Chart

1mth 3mth 6mth

Absolute % -24.5 8.1 -7.5

Rel. MSCI CHINA % -28.9 0.3 -4.6

PE

Company Profi le Luk Fook is one of the leading jewellery

retailers in Hong Kong and the PRC. The

company involves in wholesaling and

retailing of a variety of platinum and gold

jewellery, gem-set jewellery and gold.

Currently, Luk Fook has over 930 retail

outlets.

Exhibit20: Forecast and Valuation Year to Mar (HK$ mn) FY11A FY12A FY13E FY14E FY15E

Revenue 8,091.1 11,907.4 13,413.4 15,340.4 17,523.6

Growth (%) 50.2 47.2 12.6 14.4 14.2

Net Profit 866.2 1,333.9 1,198.5 1,247.6 1,593.6

Growth (%) 62.9 54.0 (10.2) 4.1 27.7

Diluted EPS (HK$) 1.705 2.425 1.968 2.268 2.897

EPS growth (%) 58.0 42.2 (18.8) 15.2 27.7

Change to previous EPS (%)

0 0 0

Consensus EPS (HK$)

0.000 0.000 0.000

ROE (%) 33.7 29.3 19.8 18.1 20.1

P/E (x) 11.4 8.0 9.9 8.6 6.7

P/B (x) 2.9 1.9 0.2 0.2 0.1

Yield (%) 3.7 5.0 4.1 4.7 6.0

DPS (HK$) 0.726 0.983 0.798 0.920 1.175


0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0

Oct/11 Jan/12 Apr/12 Jul/12

HK$590 HK MSCI CHINA

0

5

10

15

20

25

Dec/06Dec/07Dec/08Dec/09Dec/10Dec/11

Forward P/E Ratio

+1std.

avg.

-1std.

Thu, 01 Nov 2012


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How we different from Consensus?

Exhibit 21: Our forecast vs consensus

FY13 FY14 FY15

OP forecast Consensus % diff OP forecast Consensus % diff OP forecast Consensus % diff

Turnover 13,413 13,659 -1.80% 15,340 15,930.875 -3.7% 17,524 18,512.166 -5.3%

Gross profit 3,032 2,979 1.78% 3,382 3,525.5 -4.1% 3,901 4,170.6 -6.5%

Net profit 1,199 1,241 -3.38% 1,248 1,469.687 -15.0% 1,593.6 1,738.9 -8.3%

EPS 1.968 2.114 -6.9% 2.268 2.499 -9.2% 2.897 2.957 -2.0%

Source: OP Research, Bloomberg

We are in line with consensus with sales forecast come below by 1.8% and net

profit below 3.4%. We assume FY2H12 SSSG would be flat which leads topline

by 12.6% yoy. We believe margin should be at the same level despite of QE3

since gold usually carry lower margin than gem-set jewellery. Our EPS is below

consensus by 6.9%.

We assume 4.5% overall SSSG for FY13, followed by 6.5% and 8% for

FY14 and FY15.

We assume Luk Fook to expand its store network to 1,030 stores in FY13

with 41 in Hong Kong and 984 stores (self-operated and franchised) in

China.

We assume SG&A at 10% to topline where rental grows at a rate of 20%.

Exhibit 22: Luk Fook share price movement


0

5

10

15

20

25

30

35

40

45

Feb-05 Dec-05 Oct-06 Aug-07 Jun-08 Apr-09 Feb-10 Dec-10 Oct-11 Aug-12

Share price

SSSG achieved at 30% for Hk and

China due to japan earthquake

Finan cial Crisis

Market crash

Share repurchase

Thu, 01 Nov 2012


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Valuation

We employ 8.3x PE FY13E to our forecasted EPS for gives out our target price of

HK16.3.We argue that Luk Fook has traded around 8.3x P/E historically. Although

Luk Fook also traded at a discount rate against peers comparison, we believe the

overall gold consumption remains weak for topline. We selected Chow Sang

Sang (116 HK) and Chow Tai Fook (1929 HK) as its peers with 1) similar product

sales 2) Concentration in Hong Kong and PRC area.

Exhibit 23: Luk Fook forward P/E brand


We think our target multiple of 8.3x is a reasonable since the stock has traded

previously below this multiple and especially during the economic crisis in June

2010 and September 2011. Appling our 2013 EPS forecast to result our target

price of HK$16.3. Therefore we initiate with Sell on Luk Fook (590 HK). We are

concern 1) recent change in management team. 2) Higher execution risk on

licensee stores 3) GP Margin likely to be flat or below with lower Gem-set

jewellery as product mix.

FY13E earning looks less exciting- We forecast Luk Fook’s net profit is likely

recorded a negative net profit growth with a slower SSSG in Hong Kong segment.

We forecast HK$1,199 million as net profit due to higher opex ratio. Despite the

release the QE3 might boost up Gold consumption, we predict improvement with

margin is unlikely improved. (Gold carries around 10-12% GP margin)

0

5

10

15

20

25

Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12

Forward P/E Ratio

+1std.

avg.

-1std.

Thu, 01 Nov 2012


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Investment thesis

We forecast Luk Fook’s net profit at RMB 1,199million/ RMB 1,248million for

FY13/FY14.

SSSG might rebound in FY2H12; however remain cautious in midterm with

the recent management structural changes.

Mass market player:

We forecast Luk Fook’s retail sales to increase 8.5% yoy during FY13E and

it is driven by:

1. SSSG- We forecast Luk Fook to achieve 1% for HK and Macau where PRC

to achieve 8% for full year 2013E.

For the recent trend for Hong Kong segment which indicated a 3%

SSSG in June from 7% in May. July SSSG hasn't improved however the

trend continues to drop. We believe Luk Fook should able to achieve

negative SSSG for FY2H2013 given October golden week SSSG.

Exhibit 24: SSSG and net profit

Source: OP Research

For China segment, May FY2012 SSSG has recorded at 30% from 20% in

April; However, July has underperformed due to flood which achieved at 6%.

We forecast SSSG should achieve around 8% for FY13.

Resignation of CFO:

The announcement of resignation of Mr. Law Tim Fuk, Paul as CFO and

executive director, in our view, would have a slight impact in overall Luk Fook

business. With over 16 years servicing for Luk Fook, we believe Paul has played

a crucial role for Luk Fook expansion till now. FY2H2013 business wouldn't have

a hugh impact, we believe, however, long term remained cautious with the new

CFO, Ms Chan So Kuen, ex Bossini CEO guidance.

30.0%

25.0%

8.0% 8.0%

30.0%

40.0%

1.0%

5.0%

9%

9%

10%

10%

11%

11%

12%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

FY11A FY12A FY13E FY14E

SSSG- China SSSG- Hong Kong Net margin

Thu, 01 Nov 2012


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2. New stores opening:

We forecast Luk Fook to open 3 stores in Hong Kong and Macau where

Macau would open 2 stores. We forecast 10 net add stores for PRC

self-operated and another 150 net add stores for PRC Licensed shops. We

forecast at the end of March 2013, the total number of stores would stand at

around 1,030 stores.

Exhibit 25: Luk Fook: POS and revenue forecast

Source: OP Research

Higher volatility on GP margin

We forecast a slight drop of GP margin in FY13 at 22.6% from 24.3% in FY12 due

to weaker sales in gold and gem-set jewellery. The major concern is its drop in

demand (volume). Currently the proportion of sales mix for Luk Fook stood at

40.5% and 59.5% for Gem-set jewellery and Gold Platinum respectively. We

anticipate the product mix should be stable for FY13.

There is a reminder that Gem-set usually carries a higher margin at around 40%

where gold stood at 10-12%. However, Gem-set usually required a higher

inventory days (7 months) where gold at around 3 months.

Opex

Rental has been crucial as a consideration for stores expansion where we expect

Luk Fook’s rental around 31% of SG&A in FY13 as a percentage of sales from

2.8% in FY2012. For Hong Kong segment, rental expenses are fixed for 3 years

where PRC self-operated stores are paid on turnover percentage.

We also maintained promotion and advertising at 0.5% to topline as we might

expect more aggressive advertisement taking place in FY2013/2014.

400483

618758

9081,008

1,108

0

5,000

10,000

15,000

20,000

0

400

800

1,200

1,600

FY09A FY10A FY11A FY12A FY13E FY14E FY15E

(Total POS)

HK & Macau stotes Overseas

PRC self-oeprated PRC-Franchisee

Total Revenue ( HK million)

Thu, 01 Nov 2012


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Exhibit 26: Luk Fook Dragon year product

Leaping Dragon Gold Charisma

Source: Luk Fook

Exhibit 27: Our assumption


HK

Revenue 2,898 3,802 5,986 8,924 9,369 10,442 11,756

Growth 31.2% 57.5% 49.1% 5.0% 11.5% 12.6%

SSSG 17% 30% 40% 1% 5% 8%

China

Revenue 177 289 454 744 1,122 1,446 1,764

Growth 63.0% 57.1% 63.8% 50.7% 28.9% 22.0%

Average store count 19 31 38 50 69 81 91

SSSG (PRC self-operated) -12% 30% 25% 8% 8% 8%

Avg. revenue per franchisee (HK$ mn) 0.701 1.023 1.342 1.761 1.972 2.13 2.3

Growth 45.8% 31.2% 31.2% 12.0% 8.0% 8.0%

Product mix (Overall)

Gold / Platinum sales portion 53% 55% 59% 59% 58% 58%

Gem-set Jewellery sales portion 47% 45% 41% 41% 42% 42%

Gross margin - gold / platinum 15% 14% 14% 14% 14% 14%

Gross margin - gem-set Jewellery 37% 36% 36% 35% 35% 35%

HK, Macau and Overseas retailing





PRC retailing





Blended gross margin

Retailing - HK, Macau and Overseas 21.5% 24.0% 22.3% 22.8% 20.5% 19.5% 19.5%

Retailing - PRC 30.0% 33.0% 32.0% 32.3% 30.6% 30.1% 30.1%

Wholesaling - franchisees 15.0% 18.0% 18.0% 15.0% 12.0% 12.0% 12.0%

Wholesaling - scrap gold 4.8% 4.8% 4.8% 4.8% 4.8% 4.8% 4.8%

Licensing 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Rent

Hong Kong fixed rents 149 203 238 307 382 514 661

Avg no. of HK and Macau stores 34 35 37 38 40 43 46

Average rent per store 4.4 5.8 6.5 8.1 9.7 12.1 14.5

Growth 30.6% 12.5% 23.9% 20.0% 25.0% 20.0%

PRC turnover rents 18 29 45 74 112 145 176

PRC blended concession rate 10% 10% 10% 10% 10% 10% 10%

Source: OP Research

Thu, 01 Nov 2012


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Licensing model allows better penetration through mass market- but

manageable?

Exhibit 28: How does vertical business model work?

Source: Luk Fook

Retail model: Luk Fook employs a retail models in Hong Kong and Macau and

franchise in China. Retail model allows better operational control than Franchise

models which capture better operating margin. Retailing from Hong Kong and

Macau contributed to moist to total revenue, accounting for around 76% for which

we believe this geographic revenue contribution would remain the same for FY13.

In term of allocation of stores, we can see stores are mainly operates in street

stores and shopping malls in Hong Kong where most stores are in department

stores/shopping mail in China.

Franchise model: The Franchise model only occurred in China which provided

Franchisee income and Scrap gold/platinum (customers’ trade in gold products)

segment to Luk Fook topline.

Licensing model: Cash on delivery: The licensing model allows a further and

faster penetration for Luk Fook throughout tier 1- 4 cities. This allows a better

local knowledge and enhancing brand recognition. Such model provides three

major revenue sources to Luk Fook 1) Wholesales of gem-set jewellery to

licensees 2) Royalty income which applies on the jewellery by licensees which

sourced by Luk Fook or third party suppliers. The royal income would be at

around 2.55% for pure gold, 6% for jewellery which above RMB10, 000 wholesale

price and 12% which charges under RMB 10,000 of wholesale price. 3) Luk Fook

also received consultancy fees of RMB 100,000 on a one-off joining fee basis.

The initial investment would require at RMB 5million with a contract renewal

period of 1 year.

Non gemset

Authorized Suppliers

Gemset

Manufacturing Plant

(Panyu)

Wholesale margin

Headquarter

Royalty income

License Shops

Self-operated Shops

Retail margin

Customers

Thu, 01 Nov 2012


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Exhibit 29: Revenue breakdown

Source: OP research

However, we argue of a higher execution risk with the expansion stores in China

through licensing. Despite Luk Fook employ an inventory quality control and DVR

system to keep track on licensing model, in our view, adding 150 licensing store

in each year would further penetrates in China, it also is harder to maintain its

brand image.

On the ground:

We visited one of the stores in Tsui Sha Tsim, one of the Hong Kong main tourist

areas. We see there are around 3-4 managers in the stores in who are serving for

6 customers each time. But there is a reveal a drop of the large ticket size of

jewellery recent, but overall 1st October sales gives a weak sales figure. With a

reminder of the ‘Dragon Year 2012’ which boosts up numbers of new born baby.

Luk Fook also releases a series of new ‘Dragon’ products but it is also end of

dragon year soon and there are no further new Dragon product coming out in end

of year.

Exhibit 30: Luk Fook product

Source: Luk Fook

3,802 5,986

8,924 9,904 11,435

12,874

0

5,000

10,000

15,000

20,000

FY10A FY11A FY12E FY13E FY14E FY15E

Retailing - HK, Macau and Overseas Retailing - PRC

Wholesaling - franchisees Wholesaling - scrap gold

Licensing

Thu, 01 Nov 2012


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Exhibit 31: Luk Fook store in Tsim Sha Tsui, one of the main tourist area

Source: Luk Fook

Bull case:

Macro factors: With a higher GDP in China with lead to higher disposable

income for individual which drives up discretionary consumption. There would be

a wealth effect derived from the reboust China economy. If there is another cut in

RRR in October, then we see the possible of increasing jewellery purchase.

Exhibit 32: Disposable income per capita

Source: Company

1. Higher SSSG than expected- Higher SSSG would come above our

forecast to Luk Fook retail sales. Currently we forecast a SSSG of 1 and 8

for HK and PRC respectively in 2013. There might a higher than SSSG in

2H13 which would impact to our topline forecast.

2. Higher number of Hong Kong tourist- Currently the price difference

between Hong Kong and China is around 20% (because of the consumption

tax). If there is an appreciation of RMB in China which might lead to higher

price difference and encouraging more Chinese tourists for their

consumption in Hong Kong.

17,175

19,109

21,810

81

126

184

0

50

100

150

200

0

5,000

10,000

15,000

20,000

25,000

2009 2010 2011

Disposable income per capita ( LHS)

Total retail sales of gold, silver and jewellery ( RHS)

Thu, 01 Nov 2012


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Bear case:

1. China might see a hard landing of economy: The slowdown of China

economy would be faster than our expectation, affecting our revenue

forecast.

2. Slower SSSG- Our forecast of 1% and 8% for Hong Kong and PRC

respectively might more optimistic on achieving at least double digit of

SSSG in 2H. However, we do see with higher number of public holidays in

2H along with the release would likely to support 2H13 forecast .

3. Number of tourist might decrease, purchasing power decreases as

well- Policy from Hong Kong might restrict the number of tourists entering

Hong Kong which we see Hong Kong and Macau segment contributed more

than 70% to total revenue.

Working capital

Exhibit 33: Inventory days, receivable days and payable days

Source: OP research

Expansion of production facilities:

Luk Fook will open the phase II of jewellery processing plant in Panyu,

Guangdong with over 350,000 sq. ft in Q12013. Therefore we forecast Luk Fook

capex to sales should be at 1.2% we forecast capex of HK$ 185m which spends

on stores expansion (approximately 30%) and the remaining on maintenance and

inventory.

Currently, Luk Fook relies its 50% production of gem-set jewellery from phase I

jewellery plant in Panyu. Pure gold production would be outsourced to third party

OEM. In term of design, Luk Fook also have over 20,000 professional jewellery

design team in Hong Kong, Shenzhen and Panyu but a small proportions of

design also outsourced for customers.

5 5 5 5 5

155 156 173

160 160

47 41

41 41 41

-3

145

-242

1,079

737

(400)

0

400

800

1,200

0

50

100

150

200

250

FY10A FY11A FY12A FY13E FY14E

Receivable days Inventory days

Payable days FCF ( right hand side)

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Exhibit 34: Working capital

Source: OP research

Inventory and hedging system:

Current negative free cash flow- Currently the proportion of inventory in Luk

Fook is at 54% for gold and the rest for Gem-set jewellery which we see going

forward would be similar level for FY13. Despite currently Luk Fook is running

negative free cash flow, we forecast it would turn positive in FY13.

Hedging system: Luk Fook uses futures and forward contracts as financial

instrument to hedge around 15-20% gold which its earning volatiles with gold

price.

315

101 131196 229212

369

541 528633

310.521244.293

-112

1,275

966

(400)

0

400

800

1,200

1,600

FY10A FY11A FY12E FY13E FY14E

Capex Dividend Net operating cash flow

(HK$ mn)

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Risks

1. Raw material supplement- If there are any disruptions from production

plants, it would impact margin of Luk Fook and this includes wage problem,

strikes.

2. Fluctuations in commodity price- This includes diamond, gemstones,

platinum and gold. The fluctuation in price might affect the margin of Luk

Fook which leading a decline in net profit. However, Luk Fool has the least

hedging system comparing Chow Sang Sang and Chow Tai Fook. Luk Fook

mainly uses bullion forward contracts. We see the fluctuation of gold prices is

likely affected by 1) lending and sales by government ( central bank) 2) sales

of recycled gold 3) demand of jewellery

3. Rental pressure- The expansion POS might be not place at prime location

which affecting the store expansion plan. There might a rapid rise in rental

pressure which affects the net profit of Luk Fook. The selection of stores

might have less traffic. Further, the existing leases might not able to renew

due to concessionaire agreement.

4. Disease breakout- If there is suddenly disease similar to SARS would lead

to a decrease in tourists to Hong Kong, impacting the retail sales.

5. Seasonality- Shorter period of public holiday including Chinese New Year

and Christmas would impact the sales. We see the seasonality of Peak

season are in second half including 1 October (Golden Week).

Quality assurance

Quality assurance plays an important role for winning consumers’ confidence. We

realize Luk Fook have contained the only subsidiary laboratory of Hong Kong

jewellery retailer with ISO 17025 in diamond testing and grading qualification.

Thu, 01 Nov 2012


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Company profile

Luk Fook was established its first retail outlet in 1991 and listed in 1997, for which

until now, has an extensive retail and wholesale network of over 900 stores in

Hong Kong, Macau, Singapore, United States and Canada. Luk Fook engages in

sourcing, designing, retailing, wholesaling and licensing of a variety of gold and

platinum, jewellery and gem-set jewellery.

Exhibit 35: Luk Fook shareholding structure

Source: Company

Exhibit 36: Key milestones

Date Milestone

1991 Opened its first jewellery outlet in Hong Kong

1996 Established China Gems Laboratory Limited

1997 Listed in Hong Kong Stock Exchange

1998 Franchise business starts

2000 Start off Shenzhen office

2003 Opened first Canada Store

2004 Operates the factory in Guangdong

2007 Selected as a "Top 10 Hong Kong Retailers" by Retail Asia

2010 Opened first Singapore Store

2011 Commenced phase II of its Guangdong factory

Source: Company

Luk Fook( Control) ,

39.75%

Dragon King investment Ltd,

1.47%

Mr. Wong Wai Sheung, 1.10%

Mr. Chan Wai, 0.65%

Mr. Wong Koon Cheung, 0.45%

Public, 56.58%

Thu, 01 Nov 2012


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Financial Summary – Luk Fook Holdings (590 HK) Year to Mar FY11A FY12A FY13E FY14E FY15E

Year to Mar FY11A FY12A FY13E FY14E FY15E

Income Statement (HK$ mn)

Ratios

Retailing Hong Kong, Macau

and Overseas 5,986 8,924 9,369 10,442 11,756

Gross margin (%) 23.7 23.2 22.6 22.0 22.3

Retailing - PRC 454 744 1,122 1,446 1,764

Operating margin (%) 12.8 13.4 10.9 10.0 11.1

Wholesaling 1,375 1,813 2,389 2,824 3,257

Net margin (%) 10.7 11.2 8.9 8.1 9.1

Licensing 276 427 534 628 746

Selling & dist'n exp/Sales (%) 10.0 9.0 10.2 10.7 9.7

Turnover 8,091 11,907 13,413 15,340 17,524

Admin exp/Sales (%) 1.2 1.1 1.6 1.5 1.5

YoY% 50 47 13 14 14

Payout ratio (%) 42.6 40.5 40.5 40.5 40.5

COGS (6,174) (9,149) (10,382) (11,958) (13,622)

Effective tax (%) 14.8 14.8 17.5 17.5 17.5

Gross profit 1,917 2,759 3,032 3,382 3,901

Total debt/equity (%) 0.0 0.4 0.3 0.3 0.2

Gross margin 23.7% 23.2% 22.6% 22.0% 22.3%

Net debt/equity (%) Net cash Net cash Net cash Net cash Net cash

Other income 56 69 69 69 69

Current ratio (x) 4.8 6.0 5.0 4.9 4.9

Selling & distribution (813) (1,076) (1,374) (1,636) (1,700)

Quick ratio (x) 1.4 1.8 1.8 1.7 1.7

Admin (99) (136) (210) (231) (254)

Inventory T/O (days) 156 173 160 160 160

R&D 0 0 0 0 0

AR T/O (days) 5 5 5 5 5

Other opex (29) (22) (48) (55) (63)

AP T/O (days) 41 41 41 41 41

Total opex (941) (1,235) (1,632) (1,922) (2,017)

Cash conversion cycle (days) 120 137 124 124 124

Operating profit (EBIT) 1,033 1,592 1,468 1,529 1,953

Asset turnover (x) 2.4 2.2 1.8 1.8 1.8

Operating margin 12.8% 13.4% 10.9% 10.0% 11.1%

Financial leverage (x) 1.3 1.2 1.2 1.2 1.2

Provisions 0 0 0 0 0

EBIT margin (%) 12.8 13.4 10.9 10.0 11.1

Finance costs (4) 0 (1) (1) (1)

Interest burden (x) 1.0 1.0 1.0 1.0 1.0

Profit after financing costs 1,029 1,592 1,468 1,528 1,953

Tax burden (x) 0.8 0.8 0.8 0.8 0.8

Associated companies & JVs 0 3 3 3 3

Return on equity (%) 33.7 29.3 19.8 18.1 20.1

Pre-tax profit 1,029 1,595 1,471 1,531 1,956

ROIC (%) 41.9 40.6 28.9 27.1 29.4

Tax (152) (248) (257) (267) (342) Minority interests (11) (13) (15) (16) (20)


Net profit 866 1,334 1,199 1,248 1,594

Balance Sheet (HK$ mn)

YoY% 63 54 (10) 4 28

Fixed assets 466 506 671 844 1,023

Net margin 10.7% 11.2% 8.9% 8.1% 9.1%

Intangible assets & goodwill 0 0 0 0 0

EBITDA 983 1,529 1,513 1,614 2,084


EBITDA margin 12.1% 12.8% 11.3% 10.5% 11.9%

Long-term investments 0 0 0 0 0

EPS (HKD) 1.705 2.425 1.968 2.268 2.897

Other non-current assets 60 95 120 210 310

YoY% 58 42 (19) 15 28

Non-current assets 531 609 802 1,067 1,350

DPS (HKD) 0.726 0.983 0.798 0.920 1.175

Inventories 2,631 4,330 4,551 5,242 5,971


AR 109 163 180 206 235

Cash Flow (HK$ mn)

Prepayments & deposits 41 98 201 230 263

EBITDA 983 1,529 1,513 1,614 2,084

Other current assets 5 0 0 0 0

Chg in working cap (749) (1,620) (64) (571) (606)

Cash 966 1,538 2,242 2,319 2,724

Others 118 0 0 0 0

Current assets 3,751 6,129 7,174 7,997 9,194

Operating cash 352 (91) 1,449 1,043 1,478 Interests paid 0 (0) (1) (1) (1)

AP 686 877 1,154 1,329 1,514

Tax (108) (223) (118) (257) (267)

Tax 90 118 257 267 342

Net cash from operations 244 (314) 1,331 786 1,210

Accruals & other payables 0 0 0 0 0

Bank loans & leases 0 0 0 0 0

Capex (101) (130) (188) (215) (245)

CB & othe debts 0 21 21 21 21

Investments 0 0 0 0 0

Other current liabilities 0 0 0 0 0

Dividends received 0 0 0 0 0

Current liabilities 777 1,016 1,432 1,618 1,877

Sales of assets 0 0 0 0 0 Interests received 1 3 0 0 0


Others 1 (23) 0 0 0

CB & othe debts 0 0 0 0 0

Investing cash (99) (149) (188) (215) (245)

Deferred tax & others 46 78 78 78 78

FCF 145 (463) 1,143 571 965

MI 0 0 15 31 51

Issue of shares 1,134 1,340 0 0 0

Non-current liabilities 46 78 93 109 129

Buy-back 0 0 0 0 0 Minority interests 0 0 0 0 0

Total net assets 3,458 5,644 6,451 7,337 8,537

Dividends paid (279) (515) (439) (494) (559) Net change in bank loans (314) 0 0 0 0

Shareholder's equity 3,458 5,644 6,451 7,337 8,537

Others (5) (3) 0 0 0

Share capital 54 59 59 59 59

Financing cash 537 821 (439) (494) (559)

Reserves 3,404 5,585 6,392 7,279 8,478

Net change in cash 682 358 704 77 405

BVPS (HKD) 6.81 10.26 109.50 124.55 144.91

Exchange rate or other Adj 0 0 0 0 0 Opening cash 112 794 1,152 1,855 1,933

Total debts 0 21 21 21 21

Closing cash 794 1,152 1,855 1,933 2,338

Net cash/(debts) 966 1,517 2,221 2,298 2,703

CFPS (HKD) 0.481 (0.190) 2.185 1.428 2.200

Source: Company, OP Research

Thu, 01 Nov 2012


of 59

Chow Sang Sang (116 HK) – Attractive valuation, but gold consumption remains weak We initiate Chow Sang Sang with hold at target price of HK$ 17.6, implying

12 x P/E multiple, 6% upside to current price.

Gold demand remains weak where gem-set jewellery remains positive. We forecast SSSG to achieve 5% for HK and China respectively.

Our target price implies 12x P/E for 2013 which we think the reasonable expansion allows better cost control, but lack of catalyst for earning growth.

We initiate Chow Sang Sang with Hold rating at target price $17.6, implying 6%

upside to current price.

Stable earnings- We forecast 9.5% growth in topline for 2012E with our assumption

of SSSG achieving 5% and 5% in Hong Kong and China respectively in FY2012.

Despite QE3 policy release, this has a small impact on the demand side of gold

purchase- As the QE3 surprisingly come in September, many investors are still

suspect on such policy. This arguable might shows more gold consumption from

investors, but with the weak sentiment, the actual demand consumption remains

cautious.

Change in product mix- We expect increase in gold as product mix for full year

2012.With 1H12 product mix, there has shown a drop in Gem-set jewellery as product

mix. In our analysis, we assume 62%/31%/7% for gold, gem-set jewellery and watch

product mix proportion for Hong Kong segment. For China segment, we assume

66%/34% for gold and gem-set jewellery.

Reasonable store expansion plan- Chow Sang Sang has a reasonable store

expansion plan which opens less than 50 stores in PRC each year. We forecast CSS

to open 50 stores and 5 new stores in Hong Kong. 1H12 CSS has already opened 23

stores in the PRC.

Undemanding Valuation: Currently CSS trades at 8.9 P/E 2013 which is below

sector average of 9.9x. We believe 1) SSSG remains a mid-to high single digit for

FY12 as evidenced with recent weak Hong Kong jewellery retails sales in jewellery 2)

Gross margin might not see any improvement with less Gem-Set jewellery as product

mix but self-owned stores model should allow to capture better margin than its peers.

3) With 40% of gold hedging system, the increase of gold price might benefit margin.

Initial Coverage

HOLD


Target Price: HK$17.6(+6%)

Key Data

HKEx code 116




Issue Share (mn) 676.92


Fiscal Year 12/2011

Major shareholder (s) Everwin (18%)


Price Chart

1mth 3mth 6mth

Absolute % -14.3 7.8 -17.5

Rel. MSCI CHINA % -18.7 0.1 -14.6

PE

Company Profi le Chow Sang Sang is recognized as premier

diamond, gold and jewellery diamond in

Great China. It operates over 270 retail

outlets in Hong Kong, the PRC and Taiwan.

Exhibit37: Forecast and Valuation Year to Dec (HK$ mn) FY10A FY11A FY12E FY13E FY14E

Revenue 11,705 17,158 18,793 21,671 25,465

Growth (%) 24 47 10 15 18

Net Profit 757 1,094 1,090 1,253 1,450

Growth (%) 32 44 (0) 15 16

Diluted EPS (HK$) 1.162 1.615 1.463 1.683 1.947

EPS growth (%) 22 39 (9) 15 16


0 0 0

Consensus EPS (HK$)

0 0 0

ROE (%) 15.6 18.0 15.9 16.1 16.5

P/E (x) 15.8 11.4 12.6 10.9 9.5

P/B (x) 2.1 1.9 1.9 1.7 1.5

Yield (%) 1.9 2.5 2.3 2.7 3.2

DPS (HK$) 0.353 0.460 0.417 0.505 0.584


0.0

5.0

10.0

15.0

20.0

25.0

30.0

Oct/11 Jan/12 Apr/12 Jul/12


0

5

10

15

20

25

Dec/07 Dec/08 Dec/09 Dec/10 Dec/11

Forward P/E Ratio

+1std.

avg.

-1std.

Thu, 01 Nov 2012


of 59

How we differ from consensus?


FY12 FY13 FY14


Turnover 18,731 19121 -2.03% 21,492 22519 -4.56% 25,255 25671 -1.62%

Gross profit 3,812 3,504 8.79% 4,506 4,263 5.70% 5,295 4,944 7.09%

Net profit 1,090 1,047 -4.11% 1,253 1,310 -4.35% 1,450 1532 -5.35%

EPS 1.463 1.547 -5.43% 1.683 1.938 -13.16% 1.947 2.264 -14.00%

Source: OP Research, Bloomberg

We forecast net profit at HK 1 billion which is 4% below consensus for 2012 and

4% below 2013 consensus forecast. We assume Chow Sang Sang achieving

SSSG of 5% and 5% for Hong Kong retail and PRC retail respectively. We believe

our forecast is quite conservative since CSS has achieved 8% SSSG already in

the PRC market in the 1H12.

In our analysis, we assume gem-set jewellery portion as revenue mix has

decreased where gold products occupies 61% of the total group revenue in FY20

12 compared to 59% in FY2011.

We forecast SG&A as revenue to at 10% in FY12 as compared to 9% in FY2011

with more marketing involved to brand competition. We forecast advertising and

promotion to be at 1.7% to topline in FY2012 (FY2011:1.6%). We forecast Hong

Kong rental carries at a growth rate of 30% where 1/3 of CSS stores required

renewal in FY12. As 1H12, CSS has 45 stores and 12 Emphasis jewellery stores.

Valuation

CSS also sells high end class jewellery, but with a cheaper valuation.

Exhibit 39: Chow Sang Sang PE ratio

Source: OP research

Currently CSS trades at 12.1x/8/9x P/E based on FY2012/FY2013 street

consensus. We forecast the CSS at a target price of HK$ 17.6, 6% upside to the

current price (HK$ 16.5). We forecast CSS 2012 EPS to slightly drop 9% yoy.

Applying our EPS forecast along with our target multiple of 12x to come up with

0

5

10

15

20

25

Mar-07 Dec-07 Sep-08 Jun-09 Mar-10 Dec-10 Sep-11 Jun-12

Forward P/E Ratio

+1std.

avg.

-1std.

Thu, 01 Nov 2012


of 59

our target price. We think the target multiple is conservative since CSS has

traded above this previously in 2011 where financial crisis also takes place.

Exhibit 40: Chow Sang Sang P/B ratio

Source: OP research

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Mar-07 Dec-07 Sep-08 Jun-09 Mar-10 Dec-10 Sep-11 Jun-12

Forward P/B Ratio

+1std.

avg.

-1std.

Thu, 01 Nov 2012


of 59

Investment thesis

All Self-owned Store model for prudential expansion:

Comparing with the other 2 companies, we think Chow Sang Sang has the most

consistent and superior stores expansion. Similarly, stores are operated in

shopping malls and department stores.Focuing on brand development would be

vital than large store expansion plan.

Avoiding overconcentration of stores would benefit with over paid with rental in

Hong Kong segment. We see self-owned stores able capture higher margin and

reducing executive risk.

Exhibit 41: Chow Sang Sang store expansion plan

Source: OP research

Corporation with International Brands- CSS has an exclusive distribution with

16 distinctive international jewellery band including Gucci Jewellery. This reveals

not only Chow Tai Fook sell luxury jewellery where CSS also have its own quality

products.eg Hello Kitty and Disneyland characters.

Exhibit 42: Corporation with Gucci

Source: OP Research

40 45 50 55 60 65

181232

282332

382432

1

1

1

1

0%

5%

10%

15%

20%

25%

30%

0

100

200

300

400

500

600


HK& Macau China Taiwan yoy growth

Thu, 01 Nov 2012


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Revenue

We forecast CSS to achieve topline at HK$ 18,793 million with Hong Kong and

Macau occupies over 72% contribution to revenue. China segment contributes

over 25% topline. We believe mid-term would remain such geographic proportion.

For HK/ Macau retail segment, we forecast at 11% growth for FY2012 with 5 new

add stores. We remain cautious in the 2H jewellery sales performance with the

recent release of August Hong Kong retail sales. We forecast China retail to grow

around 14% yoy. We forecast at a lower SSSG of 5% and 5% for Hong Kong and

China respectively, 10% SSSG for FY2014 for both since we are hoping the

recovery of jewellery sector in FY14. With recent SSSG trend in August, CSS

guided a high single digit in China which mainly driven by volume.

For the commission on securities, futures and commodities trading division, we

believe the proportion remains small (1H12 only occupies 0.2%) to topline

contribution since it is maintained from the family business before. There are

currently 8 HK offices and internet platform and this runs in a commission base.

Exhibit 43: Chow Sang Sang Geographic revenue contribution

Source: OP Research

8,832

12,49013,408

15,314

17,902

19,669

2,764

4,536 5,1846,025

7,1848,103

109 133 139 153 169 185

0%

10%

20%

30%

40%

50%

0

5,000

10,000

15,000

20,000

25,000


(HK$ mn)

Hong Kong and Macau China Taiwan and others Revenue yoy

Thu, 01 Nov 2012


of 59

Product mix

With the recent profit warning from Tsui Sui Luen and king fuk and channel check,

we see gold sales continue to be weak but gem-set remains positive. We

therefore revise down gold to occupy around 61% as revenue mix where we

stabilize gem-set jewellery as product mix to 33%. We maintain watches at

around 6% to total revenue.

Exhibit 44: Chow Sang Sang product revenue contribution

Source: OP research

5,078

6,295

10,105

11,426

13,110

15,405

17,054

3,6594,539

5,986 6,1817,092

8,3349,226

630 794 1,011 1,124 1,397 1,642 1,817

0

5,000

10,000

15,000

20,000

FY09A FY10A FY11A FY12E FY13E FY14E FY15E

Gold Non gold jewellery Watches

Thu, 01 Nov 2012


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Gross margin

As we forecast a stabilized of product mix in Gem-set jewellery for FY12,

therefore we are cautious of the GP margin improvement in FY12. Gem-set

jewellery which usually carries a higher margin (around 39%-42%) where gold

carries at 11%-13% GP margin. We forecast the whole FY12 GP margin at 20.8%

Exhibit 45: Assumption


Retail - HK and macau

Revenue 8,298 7,502 8,832 12,490 13,408 15,314 17,902

Growth

-9.6% 17.7% 41.4% 7.4% 14.2% 16.9%

SSSG

-1% 29% 28% 5% 10% 15%

Retail - PRC self operated

Revenue 1,504 1,876 2,764 4,536 5,184 6,025 7,184

Growth

24.70% 47.40% 64.10% 14.30% 16.20% 19.23%

SSSG (PRC self-operated)

14% 23% 37% 5% 10% 15%

Average selling price (mn)

Gold

3,950 4,750 5,700 6,900 8,300

yoy

20% 20% 20% 20%

Non gold jewellery

11,380 14,210 17,700 22,200 27,700

yoy

25% 25% 25% 25%

Watches

4.70% 4.70% 4.70% 4.70%

Revenue Mix

Gold 48.7% 53.7% 53.8% 58.9% 61.0% 61.0% 61.0%

Non gold jewellery 43.7% 38.7% 38.8% 34.9% 33.0% 33.0% 33.0%

Watches 6.7% 6.7% 6.8% 5.9% 6.0% 6.5% 6.5%

HK and Macau retailing

Gold / Platinum sales portion

61.00% 61.00% 62.00% 63.00% 64.00%

Gem-set Jewellery sales portion

32.00% 32.00% 31.00% 30.00% 29.00%

Watches portion

7.00% 7.00% 7.00% 7.00% 7.00%

Gross margin - gold / platinum

11.00% 12.00% 12.00% 12.00% 12.00%

Gross margin - gem-set Jewellery

39.00% 41.00% 41.00% 41.00% 41.00%

Gross margin - watches

24.00% 25.00% 25.00% 25.00% 25.00%

PRC retailing

.

Gold / Platinum sales portion

65.00% 65.00% 65.00% 66.00% 67.00%

Gem-set Jewellery sales portion

35.00% 35.00% 34.00% 33.00% 32.00%

Gross margin - gold / platinum

11.00% 12.00% 12.00% 12.00% 12.00%

Gross margin - gem-set Jewellery

39.00% 41.00% 41.00% 41.00% 41.00%

Rent

Hong Kong fixed rents

134 122 130 189 250 301

Avg no. of HK and Macau stores

37 38 43 48 53 58

Growth

-13.0% -4.5% 30.0% 20.0% 10.0%

PRC turnover rents

188 276 454 518 602 718

PRC blended concession rate

10.0% 10.0% 10.0% 10.0% 10.0% 10.0%

% of inventory

Gold 30% 30% 30% 30% 30% 30% 30%

Watches 4% 4% 4% 4% 4% 4% 4%

Non gem-set 66% 66% 66% 66% 66% 66% 66%

Total 100% 100% 100% 100% 100% 100% 100%

Source: OP research

Thu, 01 Nov 2012


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EBIT likely to be flat

We forecast SG&A at 10% to topline which rental in Hong Kong to increase at a

growth rate of 30%/20% for FY12/13. With such assumption, we forecast a drop

in operating margin at 8% in FY12 from 8.5% in FY11. We predict EBIT profit to

be flat as FY2011 which leads to a slight yoy drop in net profit with net margin of

5.8% in FY2012.

Exhibit 46: Chow Sang Sang EBIT vs number of stores

Source: OP research

36 40 45 50 55 60 65

143

181

232

282

332

382

432

0%

2%

4%

6%

8%

10%

0

100

200

300

400

500

FY09A FY10A FY11A FY12E FY13E FY14E FY15E

(no. of stores)

HK & Macau China EBIT yoy%

Thu, 01 Nov 2012


of 59

Capex and working capital:

With the company guidance of HK$ 180-200 million capex for FY12 which we

forecast at around HK$ 210 million for which 35% which needed for the new

factory construction acquired in FY2011. With RMB 150 million capex in PRC, we

believe 85% would need for inventory and 15% for renovation fee. For Hong

Kong segment which adding 5 new stores in FY2012, we believe total Hong Kong

capex would be around HK$ 40-45 million for inventory and HKD 4-6million for

renovation.

Exhibit 47: Chow Sang Sang’s working capital

Source: OP research

Currently CSS runs a negative free cash flow which we expect it turns positive in

2012 with an improvement in change in working capital. We expect inventories

level should decrease for the improvement of cash flow.

(1,000)

(500)

0

500

1,000

1,500

FY10A FY11A FY12E FY13E FY14E

Capex Dividend Net operating cash flow

Thu, 01 Nov 2012


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Channel check

With our recent channel check, as we can see from the pictures below, we see

CSS has the creativity of using licensing brands which stands out than its peers

such as using Disneyland characters which widens the market demand.

Exhibit 48: Chow Sang Sang store during golden week

Source: OP research

Exhibit 49: Chow Sang Sang product

Source: OP research

We visit one of the CSS store in Canton Road during golden week which one of

the main tourist attraction, we see despite golden week, the stores aren’t

operating at a full capacity. With over 70% revenue contributions from Hong Kong,

the sentiment of demand remains weak with a evidence of decrease in large

ticket size of jewellery sales.

Thu, 01 Nov 2012


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Hedging system

CSS hedge around 40% of gold products and currently CSS has around 30% of

gold inventory. We believe CSS has the most reasonable hedging system. CSS

uses gold loan and forward contract for hedging as well.

Exhibit 50: Chow Sang Sang inventory breakdown

Source: OP research

Dividend

We forecast dividend payout ratio to maintain at 28.5% for FY12 which makes

CSS has one of the stable dividend payout companies.

759 865

1,469

1,8642,076

2,3822,680

1,6691,904

3,233

4,101

4,567

5,239

5,896

101 115 196 249 277 318 357

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2008 2009 2010 2011 2012E 2013E 2014E

Gold / platinum inventory Gem sets / jewellery inventory Watches inventory

Thu, 01 Nov 2012


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Risk

Weak Mainland Chinese visitors to HK/Macau

If the 2H2012 has a significant decrease in number of tourist might affect our

revenue forecast in Hong Kong geographic segment.

Reputation risk

If the brand image of CSS is affected, this might lose out consumer confidence

over CSS. We see if there are any possible negative news of CSS, then our net

profit forecast might be endangered.

International Brand Corporation

CSS has strong partnerships with 16 distinctive international jewellery and an

exclusive distribution right of Gucci Jewellery in Hong Kong. If CSS unable to

maintain a good relationship with these brand owners, then CSS strategy might

not able to meet its target.

Renewal of current rental agreement

If CSS unable to renew its current Hong Kong rental, then without the prime

location, this might affect sales performance as we predicted. Currently CSS has

1/3 of total Hong Kong stores required for contract renewal.

Endanger in inventory management system

If the inventory Control system might not able functioning to operations, then cash

flow might be affected. Inventory level might be come under or above our

expectation.

Thu, 01 Nov 2012


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Company profile

Chow Sang Sang was established in 1934 and it went listed in 1973. Chow Sang

Sang is recognized as a diamond, gold and jewellery retailer on distribution of

international branded jewellery in Hong Kong, the PRC and Taiwan. Currently

Chow Sang Sang jewellery has reached 255 stores by August 2012. Currently

CSS has 4 factories for it production.

Currently CSS is also expanding its internet business including Tao Bo,

360buy.com

Exhibit 51: Chow Sang Sang Shareholder structure:

Source: OP resaerch

Exhibit 52: Chow Sang Sang History

Source: Company

Everwin18%

Happy Inc10%

Capital Management

8%Others

64%

1930-1970 1970-1980 1980-1990 1990-2000 2000-2012

1934

CSS

Goldsmith

established in

Guangdong

1973

First

company in

the industry listed in

Hong Kong

Stock

Exchange

1998

Re-entered

the

Mainland China

market

2005

Became

sight holder

of Diamond Trading

Company

2006

Launch

brand

revamp campaign

2009

Opened the

first Flagship

Store in Beijing

2011

Opened the

first Flagship

Store in Taiwan

2012 1H

Stable

growth in

China

9

130 9,096

327No. of

Stores

Turnover

(HK$ mn)

Thu, 01 Nov 2012


of 59

Financial Summary – Chow Sang Sang (116 HK) Year to Dec FY10A FY11A FY12E FY13E FY14E

Year to Dec FY10A FY11A FY12E FY13E FY14E


Ratios

Gold 6,295 10,105 11,426 13,110 15,405

Gross margin (%) 19.7 19.0 20.3 20.8 20.8

Non gold jewellery 4,539 5,986 6,181 7,092 8,334


Watches 794 1,011 1,124 1,397 1,642

Net margin (%) 6.5 6.4 5.8 5.8 5.7

Commission on securities,

futures and commodities

trading 77 57 62 71 84


Turnover 11,705 17,158 18,793 21,671 25,465

Admin exp/Sales (%) 2.4 2.0 2.7 2.6 2.5

YoY% 24 47 10 15 18

Payout ratio (%) 30.4 28.5 28.5 30.0 30.0

COGS (9,403) (13,904) (14,981) (17,164) (20,170)

Effective tax (%) 21.3 21.7 23.0 23.0 21.0

Gross profit 2,302 3,254 3,812 4,506 5,295


Gross margin 19.7% 19.0% 20.3% 20.8% 20.8%

Net debt/equity (%) 2.5 17.0 5.8 5.1 7.8

Other income 107 115 115 115 115

Current ratio (x) 3.0 3.0 3.1 3.3 3.4

Selling & distribution (1,140) (1,568) (1,906) (2,326) (2,837)

Quick ratio (x) 0.7 0.7 0.9 0.9 0.8

Admin (276) (337) (516) (572) (638)


R&D 0 0 0 0 0

AR T/O (days) 21 16 15 15 15

Other opex 0 0 0 0 0

AP T/O (days) 21 10 10 10 10

Total opex (1,416) (1,904) (2,421) (2,898) (3,475)


Operating profit (EBIT) 993 1,465 1,505 1,723 1,935

Asset turnover (x) 1.7 1.9 1.8 1.9 2.0




EBIT margin (%) 8.5 8.5 8.0 7.9 7.6

Finance costs (22) (47) (68) (70) (70)


Profit after financing costs 971 1,418 1,437 1,652 1,864

Tax burden (x) 0.8 0.8 0.8 0.8 0.8


Return on equity (%) 15.6 18.0 15.9 16.1 16.5

Pre-tax profit 973 1,419 1,439 1,654 1,866

ROIC (%) 16.1 17.1 15.2 16.1 16.2

Tax (206) (308) (330) (380) (392) Minority interests (10) (18) (18) (21) (24)

Y Year to Dec FY10A FY11A FY12E FY13E FY14E

Net profit 757 1,094 1,090 1,253 1,450


YoY% 32 44 (0) 15 16

Fixed assets 618 718 827 897 924

Net margin 6.5% 6.4% 5.8% 5.8% 5.7%


EBITDA 1,558 1,532 1,581 1,805 2,025


EBITDA margin 13.3% 8.9% 8.4% 8.3% 8.0%


EPS (HKD) 1.162 1.615 1.463 1.683 1.947


YoY% 22 39 (9) 15 16

Non-current assets 1,645 1,536 1,646 1,717 1,746

DPS (HKD) 0.353 0.460 0.417 0.505 0.584

Inventories 4,898 6,214 6,649 7,618 8,952

Year to Dec FY10A FY11A FY12E FY13E FY14E

AR 660 739 772 891 1,047

Cash Flow (HK$ mn)


EBITDA 1,558 1,532 1,581 1,805 2,025

Other current assets 13 322 322 322 322

Chg in working cap (1,918) (1,405) (309) (970) (1,332)

Cash 580 631 1,409 1,407 1,108

Others (356) 129 129 129 129

Current assets 6,371 8,141 9,341 10,455 11,684

Operating cash (715) 255 1,401 965 822 Interests paid 16 15 (68) (70) (70)

AP 548 369 410 470 553

Tax (173) (236) (143) (330) (380)

Tax 89 143 330 380 392

Net cash from operations (873) 33 1,189 564 372


Bank loans & leases 726 1,329 1,329 1,329 1,329

Capex (109) (190) (208) (239) (281)


Investments 0 13 0 0 0


Dividends received 0 0 0 0 0

Current liabilities 2,150 2,720 3,020 3,216 3,423

Sales of assets (18) (42) 0 0 0 Interests received 0 0 0 0 0


Others 7 23 0 0 0


Investing cash (119) (195) (207) (239) (281)


FCF (992) (162) 982 325 91

MI 0 0 18 39 64

Issue of shares 971 0 0 0 0

Non-current liabilities 125 537 662 683 707

Buy-back 0 0 0 0 0 Minority interests (18) (39) 0 0 0

Total net assets 5,740 6,420 7,305 8,274 9,300

Dividends paid (230) (311) (311) (326) (390) Net change in bank loans 109 1,141 107 0 0


Others 29 (132) 0 0 0

Share capital 169 169 169 169 169

Financing cash 861 659 (204) (326) (390)

Reserves 5,571 6,251 7,136 8,105 9,130

Net change in cash (131) 496 778 (1) (299)

BVPS (HKD) 8.81 9.48 9.81 11.11 12.49

Exchange rate or other Adj 7 5 0 0 0 Opening cash 253 129 631 1,409 1,407

Total debts 726 1,723 1,829 1,829 1,829

Closing cash 129 631 1,409 1,407 1,108

Net cash/(debts) (146) (1,092) (421) (422) (721)

CFPS (HKD) (1.339) 0.049 1.597 0.757 0.499


Thu, 01 Nov 2012


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Chow Tai Fook (1929 HK) – market share justify its valuation? We initiate Chow Tai Fook with Sell at target of HK$8.2 implying 12.8x

P/E, showing 14% downside to the current price.

Higher SG&A which captures from higher rentals and staff cost in Hong Kong and China.

We expect a slower expansionary plan with weak consumption sentiment.

We initiate with a Sell on Chow Tai Fook at a target price of HK$8.2, which is

14% downside to current price.

Over expanding stores impacts 2013 net profit. The 3 years expansion plan

might seem slower development with higher rental for FY12 in prime location with

weak sales. Weak demand of gold purchase hardly improves overall GP margin

and we forecast net profit to be flat yoy.

Slower stores opening- With weak demand of jewellery purchase, Chow tai

Fook has the most Stores in Hong Kong (we forecast 103 stores in HK and

Macau for 2013) which carries the highest rental cost against its peers.

Not much product differentiation- We believe jewellery sales depends on the

jewellery sentiment despite of the higher end jewellery sold by Chow Tai Fook.

Gem-set as product mix- Recent 1QFY2013 hasn't proved increase of gem-set

jewellery product mix, we forecast 29.2% for 2013 GP margin, only 0.1ppt

improvement.

Risk: 1) Better expansion plan of number of stores 2) A soft landing of China

economy 3) Raw material supplement cost decrease

Valuation: Chow Tai Fook is trading above our selected peers including Luk Fook

and Chow Sang Sang with a 15x/12.5x P/E 2013/2014 which is above sector

average of 10.6x. Our target price of HK$8.2 implies a 12.8x P/E multiple for

FY13.In our view, with weak consumer sentiment and weak gold sales, SSSG is

likely impacted with slower store opening, hence such high valuation would not

justified comparing with cheaper valuation against its peers.

Initial Coverage

SELL


Target Price: HK$8.2 (-14%)

Key Data

HKEx code 1929




Issue Share (mn) 10,000.00


Fiscal Year 03/2012

Major shareholder (s) CTF holding (89%)


Price Chart

1mth 3mth 6mth

Absolute % -13.4 7.4 -22.8

Rel. MSCI CHINA % -17.8 -0.3 -19.9

PE

Company Profi le Chow Tai Fook is a leading jeweler in PRC

as well as in Hong Kong and Macau jewellery

markets.

Exhibi t53: Forecast and Valuation Year to Mar (HK$ mn) FY11A FY12A FY13E FY14E FY15E

Revenue 35,042.5 56,571.1 63,814.5 71,324.3 79,614.4

Growth (%) 52.8 61.4 12.8 11.8 11.6

Net Profit 3,537.6 6,340.6 5,923.3 7,206.0 7,619.4

Growth (%) 65.4 79.2 (6.6) 21.7 5.7

Diluted EPS (HK$) 0.395 0.685 0.640 0.778 0.823

EPS growth (%) 65.4 73.2 (6.6) 21.7 5.7


0 0 0

Consensus EPS (HK$)

0 0 0

ROE (%) 35.4 30.7 18.2 18.4 16.1

P/E (x) 25.7 14.8 15.9 13.1 12.3

P/B (x) 7.8 3.2 2.6 2.2 1.8

Yield (%) 0.0 1.0 1.7 2.1 1.6

DPS (HK$) 0.000 0.100 0.175 0.213 0.165


0.0

5.0

10.0

15.0

20.0

Dec/11 Mar/12 Jun/12 Sep/12


0

5

10

15

20

25

30

Dec/11 Mar/12 Jun/12 Sep/12

Forward P/E Ratio

+1std.

avg.

-1std.

Thu, 01 Nov 2012


of 59

How we differ from consensus?


FY13 FY14 FY15


Turnover 63,814 67,313 -5.2% 71.324 81,888 -12.9% 79,614 97,643.75 -18.46%

Gross margin 28.50% 27.94% 0.56ppt 29.20% 28.27% 0.93ppt 29.20% 28.34% 0.86ppt

Net profit 5,923 6,790.95 -12.8% 7,206 8,375 -13.9% 7,619 10,089 -24.48%

EPS 0.64 0.68 -5.9% 0.78 0.84 -7% 0.82 1.006 -18.48%

Source: OP research, Bloomberg

We are less optimistic than consensus with sales forecast came below by 5.2%

and net profit below 12.8%. We assume FY13 SSSG at 1% and 6% for Hong

Kong and China segment. We think our assumption has been conservative. Hong

Kong SSSG has recorded a SSSG -1% in 1QFY13 where recent golden week

sales has not further proved improvement yoy. Therefore we forecast our EPS

below consensus by 6%.

We assume 3.5% SSSG overall for FY13, followed by 5% and 10% for

FY14 and FY15.

We assume Chow Tai Fook to expand its store network to 1806 stores in

FY13 with 106 stores in Hong Kong and 1700 stores in China.

We assume SG&A at 11.6% to topline where rental increases at 20%.

Thu, 01 Nov 2012


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Valuation

We value the stock at 12.8x FY13E P/E 2013.We believe Chow Tai Fook has over

valued against its peers, Luk Fook and Chow Sang Sang which also sells

mid-high end jewellery.

Exhibit 55: Chow Tai Fook P/E ratio

Source: OP Research

We apply our target multiple of 12.8x into our EPS forecast together to get out TP

$8.2. We believe recent recorded negative SSSG in 1Q along with double digit

decrease SSSG for golden week, this has approved Chow Tai Fook’s 1HFY2013

which be less exciting. We have been conservative with 1% SSSG for Hong Kong

segment and mid-teen SSSG for China.

Exhibit 56: Chow Tai Fook P/B ratio

Source: OP Research

0

5

10

15

20

25

Dec-11 Mar-12 Jun-12 Sep-12

Forward P/E Ratio

+1std.

avg.

-1std.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Dec-11 Mar-12 Jun-12 Sep-12

Forward P/B Ratio

+1std.

avg.

-1std.

Thu, 01 Nov 2012


of 59

Investment thesis

Revenue

We forecast revenue to increase by 12.8% yoy to HK$ 63,814 million which we

believe gold products continue to be greatest revenue proportion with around

52.6%. We forecast retail sales from Hong Kong and Macau would growth 6.1%

yoy where PRC retail segment to increase 13.4% yoy.

Exhibit 57: Revenue by geographic breakdown

Source: OP research

Total of 2181 stores at end of March 2015

We forecast CTF would have 1,806 stores by the March 2013 with 1,716

jewellery POS and 90 watches stores. We see further expansion in Jewellery

POS network in Mainland China to Tier II to IV cities. Currently CTF have

penetrated into less than half of 712 cities and we see there is further room of

penetration in China in long run.

Exhibit 58: Number of stores

Source: OP research

10,30515,571

24,555 26,064 28,1089,355

14,595

23,26626,375

29,567

3,274

4,877

8,750

11,375

13,650

0

20,000

40,000

60,000

80,000


(HK$ mn)

HK and Macau PRC- retail PRC- Franchise

792

883953

1,018 1,054 1,089

664717 753

804 823 835

128166 200 214 231 254

302391

568

682

784862

85 84 96 106 113 116

0%

5%

10%

15%

20%

25%

0

400

800

1,200

FY10A FY11A FY12A FY13E FY14E FY15E

PRC- Self-operated Wholly-owned

Joint-venture Franchised

Hong Kong, Macau ( all self-operated) yoy

Thu, 01 Nov 2012


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Possible shift of product mix in 2H, but 1Q hasn't shown

The recent trend in 1QFY13 hasn't revealed the increase of proportion of

Gem-set jewellery;we believe shifting of product mix is unlikely result from

2QFY13.Gem-set jewellery might increase as its product mix, but overall sales

remain weak to reveal any improvement in GP margin. We take a conservative

view of forecasting GP margin to dropped 0.6ppt to 28.5%.

Exhibit 59: Product mix

Source: OP research

SG &A

For FY12 rental occupies around 1.2% to topline which we assume 1.5% as

revenue for FY13, assuming 20% yoy rental increase for Hong Kong. Currently

CTF has around one-third of Hong Kong stores required for renewal and we

forecast advertising and promotion to be less than 1% for FY13. CTF has around

20,000 staff which we maintained around 5.5% as revenue for staff cost. Overall

SG&A as revenue we forecast 12%.

6,626

8,962.90

15,378

17,985

20,815

3,5754,869

7,813 7,857 7,711

11,125

18,725

29,742

33,550

37,499

1,609 2,4863,638 4,422 5,299

27.6%

28.0%

28.4%

28.8%

29.2%

29.6%

0

10,000

20,000

30,000

40,000


Gem-set jewellery Platinum/k-gold products

Gold products Watches

Gross margin

Thu, 01 Nov 2012


of 59

Exhibit 60: Chow Tai Fook assumption


% store mix

PRC- Self-operated

Wholly-owned 56% 56% 53% 46% 45% 42% 40%

Joint-venture 10% 11% 12% 12% 12% 12% 12%

Franchised 27% 26% 29% 35% 38% 40% 42%

HK and other asian countries 7% 7% 6% 6% 6% 6% 6%

Revenue portion

Gem-set jewellery 29.8% 28.9% 25.6% 27.2% 28.2% 29.2% 30.2%

Platinum/k-gold products 14.6% 15.6% 13.9% 13.8% 12.3% 10.8% 9.3%

Gold products 49.3% 48.5% 53.4% 52.6% 52.6% 52.6% 52.6%

Watches 6.3% 7.0% 7.1% 6.4% 6.9% 7.4% 7.9%

yoy growth

Gem-set jewellery 20.7% 35.3% 71.6% 17 % 14.5% 15.4%

Platinum/k-gold products

33.0% 36.2% 60.5% 0.6% -2.9% -3.9%

Gold products

22.5% 68.3% 58.8% 12.8% 10.5% 11.6%

Watches

39.1% 54.5% 46.3% 31.1% 25.6% 22.3%

Total revenue

24.6% 52.8% 61.4% 12.8% 10.5% 11.6%

Retail - HK, Macau and overseas

Revenue 8,406 10,305 15,571 24,555 26,064 28,108 31,267

Growth

22.60% 51.10% 57.70% 6.1% 7.8% 11.2%

Average store count 70 78 85 90 101 110 115

SSSG

16.00% 32.40% 48.40% 1.00% 5.00% 10.00%

Retail - PRC self operated

Revenue 6,758 9,355 14,595 23,266 26,375 29,567 33,332

Growth

38.40% 56.00% 59.40% 13.4% 12.1% 12.7%

Average store count 634 713 838 918 986 1,036 1,072

SSSG (PRC self-operated)

15.20% 35.20% 32.00% 6.00% 8.00% 10.00%

Gross margin

Gem-set jewellery

44.5% 47.5% 47.5% 47.5% 49.5% 49.5%


44.0% 45.0% 45.0% 44.0% 45.0% 45.0%

Gold products

15.0% 15.0% 17.0% 15.0% 15.0% 15.0%

Watches

22.7% 27.0% 27.0% 26.0% 27.0% 27.0%

% to COGS

Gem-set jewellery

22% 19% 20% 20% 21% 22%


12% 11% 11% 10% 8% 7%

Gold products

58% 63% 62% 63% 63% 63%

Watches

8% 7% 7% 7% 8% 8%

Rent

HK Macau and other markets

fixed rents 239 298 385 523 777 952 1,071

Avg no. of HK and Macau stores 70 78 85 90 101 110 115

Average rent per store 3.4 3.8 4.6 5.8 7.7 8.7 9.3

Growth

12.30% 18.60% 27.60% 19.6% 4.4% -0.3%

PRC turnover rents 35 58 95 156 255 418 684

Growth %

64.70% 63.60% 63.60% 63.60% 63.60% 63.60%

Total 275 356 480 679 1,032 1,370 1,755

% Rental to revenue 1.50% 1.60% 1.40% 1.20% 1.50% 1.70% 1.90%

% of inventory

Gem-set jewellery 59.7% 51.7% 54.4% 53.6% 55.3% 55.3% 55.3%

Platinum/karat gold products 6.6% 12.2% 7.9% 9.7% 9.7% 9.7% 9.7%

Gold products 25.5% 27.3% 30.5% 29.7% 28.0% 28.0% 28.0%

Watches 8.2% 8.7% 7.2% 6.9% 6.9% 6.9% 6.9%

Packing materials 0.0% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Source: OP Research

Thu, 01 Nov 2012


of 59

Business model

Vertically integrated business model drives better operational efficiency, but not

only Chow Tai Fook has vertically integrated business model. Luk Fook and

Chow Sang Sang both have similar business model but at a cheaper valuation.

Exhibit 61: Chow Tai Fook vertical business model

Source: OP Research

Mix Business model with retail and Franchisee models: CTF employed retail

and Franchise models which allow a closer channel check on its retail models but

also a reasonable expansion to further tier cities with Franchisee models.

Raw material procurement: The vertically integrated business model drives

operational efficiency. CTF secured its diamond supply with DTC and Rio Tinto.

With the fine diamond, CTF would allow it product design for jewellery.

Upstream Midstream Downstream

Raw material procurement

Diamond cutting & polishing

Product design &

developmentProduction Retail

Renewed contracts with DTC and

Rio Tinto with significant increase

in secured diamond supply

R&D Department with over 100

professionals including designers

and goldsmiths to support in-

house designed collections

Use of automated “weighting and

packing” robot shorten “stock in”

process of a jewellery piece to

just 10 seconds and save

manpower

Management has real-time

access to POS data throughout

China from a self-developed IT

system, which monitors sales and

inventory movements and facilitates efficient use of

resources

Thu, 01 Nov 2012


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Working Capital

Inventory

Gem-set jewellery usually required higher inventory (around 4 months for CTF)

and currently Gem-set jewellery occupied around 54% of total inventory where

this is followed by gold products, we forecast the proportion of inventory would

maintain similar level.

Exhibit 62: Inventory days breakdown

Source: OP Research

Hedging system

CTF uses gold loans and bullion forward contracts to hedge against gold

movement. The hedging system usually takes a period of 3-6 months. Gold loan

do not separate from bank borrowing and the cost of gold loan is generally

cheaper than bank borrowing. The process is divided into two position of long and

short position.

Long position- This is position of gold inventory balance. The amount of gold in

inventory is determined daily. If CTF buy more gold as inventory, then this

inventory would be needed to filful into new stores openings and reducing

inventory level after peak season.

Short position- Gold loan balance and outstanding bullion forward contracts. This

is adjusted to match long position again.

Gold loan

If gold price increase, the fair value of gold loan increases with gold price, and a

loss from the increase of gold loan would charge to COGS. This loss will mainly

net against the increase in turnover of gold products from gold price increase.

0 50 100 150 200 250 300

FY10A

FY11A

FY12A

FY13E

FY14E

Overall inventory days Gold / platinum inventory turnover days

Gem sets / jewellery inventory turnover days

Thu, 01 Nov 2012


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Negative cash flow:

CTF aims to open 200 stores for FY13 and CTF aims to open another new

manufacturing factory in Wuhan with 40,000 sq meters and a logistics centre in

Shenzhen with 500,000 sq feet. The factory would require HK$1billion over next

three years. We forecast the capex would be at around 1.3% to revenue (around

HK$1,000 million).The capex would mainly spend on 80% in inventory and 20%

in decoration of stores.

Exhibit 63: Breakdown of capex

Source: OP Research

Exhibit 64: Free cash flow and capex

Source: OP Research

0 200 400 600

2010

2011

2012

Plant and machinery & Motor vehicles (HK$ mn) Land and building& Contruction (HK$ mn)

Furniture, fixtures and equipment (HK$ mn)

0

200

400

600

800

1,000

-8,000

-6,000

-4,000

-2,000

0

2,000

4,000

2010 2011 2012 2013 2014

FCF Capex

Thu, 01 Nov 2012


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On the ground

Exhibit 65: CTF store in Central, Hong Kong

Source: OP Research

Exhibit 66: CTF store in Macau

Source: OP Research

We visited stores in Macau and Hong Kong during weekend. We see in term

of location, Chow Tai Fook has better location which would able to capture

more tourists. One of the stores of Chow Tai Fook, in Macau operated inside

Grand Lisboa. However, this year the prime location would likely lead to pay

higher rentals with weaker sales performance.

Every Chow Tai Fook stores in Hong Kong and Macau, there would also be

other stores like Luk Fook next to it, suggesting the retail network is needed

to compete by stores

Stores are more high-end with more traffic, but consumption remains weak

during channel check.

Thu, 01 Nov 2012


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Exhibit 67: CTF product

Source: OP Research

With similar product design, we do not see any product differentiation between

CTF comparing with Luk Fook. Despite CTF has a strong design team, with

similar products and brands, why go for a higher valuation?

Bear case:

Negative SSSG situation might deteriorate revenue:

We forecast any changes to the revenue would have affected on our target price.

If our assumption of SSSG is too optimistic, then our revenue to net profit would

be affected. However, with the recent trend, we do not see this is happening.

Economy result a hard landing. Rapid increase in retail sales in

2HFY2013.

The release of PRC policy might an impact on Chow Tai Fook profit, For example

the use of China UnionPay would affect discretionary spending. If any policies

such as cutting interest rate, that would impact the consumption growth in China.

Increase in tourist visits

PRC tourist contributes more than 80% to Hong Kong revenue which is the key

market contributor to revenue. If there is a fall of disposable income in China, this

might affect the number of purchase.

Thu, 01 Nov 2012


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Risk

Inventory risk- If Chow Tai Fook couldn't manage its inventory level to

maintain around current inventory days (213 days), and then we see there is

highly risk on its cash flow. There is a reminder that CTF is currently at

net-debt position.

Breakout of disease: If there is another breakout of natural diease like

SARS, then number of tourists might decrease, affecting Hong Kong

business segment. Currently, Hong Kong contributes around 43% to total

revenue.

Reputation- If consumer loses confidence over Chow Tai Fook, then this is

more likely impact on the returning consumers.

Shortage of production- The majority production is located in Hong Kong,

Shenzhen and Shunde, around Pearl River Delta. If any issues such as

strikes would affect the production schedule.

Executive risk- Renewal contracts might not able to get through with

current location. Landlords have not registered with the lease agreement.

Revenue couldn't meet its rental expense, it might result execution of

stores.

Thu, 01 Nov 2012


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Company profile

Chow Tai Fook sells mass luxury and high-end luxury jewellery products including

gem-set jewellery, platinum/Karat gold products and watches in Hong Kong,

Macau and the PRC. Chow Tai Fook had over 8 years operation which now had

over 1,421 jewellery POS and 85 watches POS. The vertical integrated business

models provide a process of raw material, procurement, design and marketing.

Currently CTF has 2 specialized procurement departments and a total of twelve

factories and none jewellery factories and three diamond cutting and polishing

factories.

Exhibit 68: Chow Tai Fook shareholding structure

Source: OP Research

Exhibit 69: Chow Tai Fook milestone

Date Milestone

1938 Opened our first jewellery POS in Macau on Avenida De Almeida Ribeiro

1939 Opened our first jewellery POS in Hong Kong on Queen's Road Central, Hong Kong.

1956 Launched 999.9 gold jewellery products in Hong Kong and Macau and we believe we were

one of the first in promoting such gold jewellery fineness in Hong Kong and Macau.

1973

Zlotowski's, a DTC Sightholder in Johannesburg, South Africa, which procured rough

diamonds from DTC, became our related party. As part of the Reorganisation, Zlotowski's

became a subsidiary of our Group in 2011.

1988

Foshan Yushunfu Jewellery and Diamond Company Limited (“Foshan Yushunfu”), a then

related party, opened its first diamond processing and jewellery manufacturing factory in

Shunde, PRC, thereby strengthening the vertical integration of the Group’s business model.

As part of the Reorganisation, Foshan Yushunfu became a subsidiary of our Group in 2011.

1990

We implemented a “ 一口價” (Fixed Price) Policy, which increased pricing transparency and

greatly improved customer shopping experience as it removed the need for extensive price

negotiations, which was customary then.

1993 CTF HK qualified as a DTC Sightholder, which gave it the right to source rough diamonds

from DTC.

1998 Opened our first “周大福 ” (CHOW TAI FOOK) branded jewellery POS in the PRC, which was

located in Beijing, PRC.

2003 Centralised our PRC operations with the establishment of our PRC headquarter in Shenzhen,

PRC.

2008 Expanded our watch business to the PRC.

2009 Celebrated our 80th anniversary and became a Select Diamantaire of Rio Tinto Diamonds.

2010 Opened our 1,000th jewellery POS in the PRC, which was located in Beijing, PRC.

Zlotowski’s purchased the 507 carat Cullinan Heritage rough diamond for US$35.3million.

Source: Company

CTF Holding

The Company CTFE

NWDS

NWS

NWT

NWCL

Real Reward

Lifestyle international

100% 100%

NWD Go Create

40.5% 100%

50.0%

64.3%

72.3%

59.8% 69.9%

100%

Thu, 01 Nov 2012


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Financial Summary – Chow Tai Fook (1929 HK) Year to Mar FY11A FY12A FY13E FY14E FY15E



Ratios

Gem-set jewellery 8,963 15,378 17,985 20,815 24,031

Gross margin (%) 28.3 29.1 28.5 29.2 29.2

Platinum/k-gold products 4,869 7,813 7,857 7,711 7,413


Gold products 18,725 29,742 33,550 37,499 41,857

Net margin (%) 10.1 11.2 9.3 10.1 9.6

Watches 2,486 3,638 4,422 5,299 6,313


Turnover 35,043 56,571 63,814 71,324 79,614

Admin exp/Sales (%) 2.6 3.0 4.1 4.4 4.6

YoY% 53 61 13 12 12

Payout ratio (%) 0.0 27.4 27.4 27.4 20.0

COGS (25,115) (40,123) (45,632) (50,495) (56,400)

Effective tax (%) 20.5 19.5 23.3 18.0 19.5

Gross profit 9,928 16,448 18,182 20,829 23,214


Gross margin 28.3% 29.1% 28.5% 29.2% 29.2%

Net debt/equity (%) 43.8 Net cash Net cash Net cash Net cash

Other income 235 245 214 214 214

Current ratio (x) 1.6 3.2 3.2 3.4 3.7

Selling & distribution (4,402) (6,320) (7,419) (8,417) (9,536)

Quick ratio (x) 0.6 1.1 1.1 1.2 1.4

Admin (911) (1,715) (2,624) (3,138) (3,676)


R&D 0 0 0 0 0

AR T/O (days) 35 35 35 35 35

Other opex (122) (129) (222) (249) (277)

AP T/O (days) 30 17 17 17 17

Total opex (5,435) (8,164) (10,264) (11,804) (13,489)


Operating profit (EBIT) 4,727 8,529 8,132 9,239 9,939

Asset turnover (x) 1.5 1.5 1.2 1.2 1.2




EBIT margin (%) 13.5 15.1 12.7 13.0 12.5

Finance costs (102) (363) (119) (119) (119)


Profit after financing costs 4,624 8,166 8,013 9,121 9,820

Tax burden (x) 0.8 0.8 0.7 0.8 0.8

Associated companies & JVs (5) 0 0 0 0

Return on equity (%) 35.4 30.7 18.4 18.9 16.8

Pre-tax profit 4,620 8,166 8,013 9,121 9,820

ROIC (%) 27.0 30.3 20.6 22.1 20.5

Tax (947) (1,595) (1,864) (1,640) (1,911) Minority interests (135) (230) (226) (274) (290)


Net profit 3,538 6,341 5,923 7,206 7,619


YoY% 65 79 (7) 22 6

Fixed assets 1,253 1,783 2,784 3,578 4,262

Net margin 10.1% 11.2% 9.3% 10.1% 9.6%


EBITDA 3,845 7,247 7,901 9,241 10,150


EBITDA margin 11.0% 12.8% 12.4% 13.0% 12.7%


EPS (HKD) 0.395 0.685 0.640 0.778 0.823


YoY% 65 73 (7) 22 6

Non-current assets 1,546 2,156 2,896 3,661 4,316

DPS (HKD) 0.000 0.100 0.175 0.213 0.165

Inventories 17,101 29,694 33,496 37,438 41,789


AR 3,363 5,487 6,190 6,918 7,722

Cash Flow (HK$ mn)


EBITDA 3,845 7,247 7,901 9,241 10,150

Other current assets 1,278 72 72 72 72

Chg in working cap (7,513) (14,276) (4,520) (4,481) (4,922)

Cash 5,605 9,988 11,916 13,744 16,794

Others 1,785 0 0 0 0

Current assets 27,503 45,258 51,959 58,491 66,733

Operating cash (1,883) (7,029) 3,381 4,760 5,228 Interests paid 0 20 (119) (119) (119)

AP 2,050 1,838 2,091 2,314 2,584

Tax (730) (1,353) (599) (1,864) (1,640)

Tax 353 599 1,864 1,640 1,911

Net cash from operations (2,612) (8,361) 2,664 2,778 3,469


Bank loans & leases 2,881 5,574 5,574 5,574 5,574

Capex (769) (867) (830) (856) (955)

Gold loans 3,932 5,807 6,387 7,026 7,729

Investments (50) (132) 0 0 0

CB & othe debts 7,833 0 0 0 0

Dividends received 584 1,315 0 0 0


Sales of assets 0 0 0 0 0

Current liabilities 17,213 14,218 16,317 16,955 18,198

Interests received 70 69 89 89 89 Others 88 93 0 0 0

Bank loans & leases 0 3,426 3,426 3,426 3,426

Investing cash (76) 477 (741) (767) (866)


FCF (2,688) (7,884) 1,923 2,011 2,603


Issue of shares 2 15,750 0 0 0

MI 0 0 0 0 0

Buy-back 0 0 0 0 0

Non-current liabilities 163 3,623 3,643 3,665 3,688

Minority interests (102) (363) 0 0 0 Dividends paid (9) (9) (4,543) (1,623) (1,974)

Total net assets 11,673 29,573 34,895 41,532 49,162

Net change in bank loans 2,677 2,677 6,032 0 0 Gold loan 984 1,463 1,609 1,770 1,947


Others 94 26 20 22 24

Share capital 700 10,000 12,939 15,939 17,439

Financing cash 6,107 10,531 6 (183) 447

Reserves 10,973 19,573 21,884 25,521 31,651

Net change in cash 3,419 4,355 1,929 1,828 3,050

BVPS (HKD) 1.30 3.19 3.76 4.48 5.30

Exchange rate or other Adj 79 63 63 63 63 Opening cash 2,107 5,605 10,022 12,013 13,904

Total debts 10,714 9,001 9,001 9,001 9,001

Closing cash 5,605 10,022 12,013 13,904 17,016

Net cash/(debts) (5,110) 987 2,916 4,743 7,793

CFPS (HKD) (0.292) (0.719) 0.288 0.300 0.375


Thu, 01 Nov 2012


of 59

Exhibit 70: Peer Group Comparison

Company Ticker Price

Mkt

cap

(US$m)

Weighted

by MKT

Cap

3-mth

avg t/o

(US$m)

PER

Hist

(x)

PER

FY1

(x)

PER

FY2

(x)

EPS

FY1

YoY%

EPS

FY2

YoY%

3-Yr

EPS

Cagr

(%)

PEG

(x)

Div yld

Hist

(%)

Div

yld

FY1

(%)

P/B

Hist

(x)

P/B FY1

(x)

EV/

Ebitda

Hist

EV/

Ebitda

Cur Yr

Net

gearing

Hist

(%)

Gross

margin

Hist

(%)

Net

margin

Hist

(%)

ROE

Hist

(%)

ROE

FY1

(%)

Sh px

1-mth

%

Sh px

3-mth

%

Sh px

1

DAY

3-mth

%

Lvmh Moet Hennes MC FP 125.40 82,588 46% 83.8 20.0 17.3 15.7 15.4 10.6 12.3 1.40 2.1 2.4 2.65 2.53 11.5 10.0 21.1 65.8 13.0 15.6 15.6 4.0 1.6 (1.1)

Burberry Group BRBY LN 1,166.00 8,311 5% 1,762.4 1,930.5 17.6 15.5 9.8 13.1 12.5 1.40 2.4 0.0 5.90 5.03 10.3 9.6 0.0 69.9 14.2 33.3 29.9 15.0 (7.3) (1.2)

Ferragamo Spa SFER IM 15.67 3,422 2% 8.3 32.5 25.7 18.8 26.2 36.9 26.9 0.96 1.8 2.0 12.48 9.40 14.9 12.1 8.0 64.2 8.2 40.2 39.5 (5.1) (1.0) (1.3)

Ppr PP FP 135.65 22,176 12% 29.8 17.3 15.2 13.1 14.2 15.5 14.9 1.02 2.6 3.0 1.55 1.47 11.7 10.8 29.0 50.9 8.1 9.5 9.4 13.0 10.5 0.1

Tod'S Spa TOD IM 90.25 3,582 2% 9.7 20.5 18.6 16.7 10.2 11.0 11.1 1.68 2.8 3.1 4.03 3.67 11.5 10.7 0.0 N/A 15.1 22.2 20.5 3.6 20.2 (1.0)

Prada S.P.A. 1913 HK 63.35 20,916 12% 19.6 62.3 26.7 21.5 38.8 24.2 26.7 1.00 0.8 0.7 8.85 7.06 21.3 15.8 0.0 71.5 16.9 28.5 28.5 9.4 23.0 0.2

Ralph Lauren Cor RL US 153.69 14,009 8% 144.2 20.9 19.7 16.8 6.1 17.3 12.8 1.54 0.8 0.8 4.03 3.63 10.3 9.7 0.0 58.3 9.9 20.7 19.4 1.3 8.0 0.8

Tiffany & Co TIF US 63.22 8,006 4% 118.7 18.3 17.6 15.4 4.2 14.2 11.1 1.58 1.9 2.0 3.34 3.10 10.1 9.4 11.5 59.0 12.1 18.6 18.2 2.8 15.4 1.0

Coach Inc COH US 56.05 15,912 9% 327.8 15.6 14.5 12.6 7.4 14.9 12.4 1.17 1.9 2.0 8.02 6.87 NA NA 0.0 72.8 21.8 54.9 52.7 2.5 12.5 0.3

Average 259.4 18.3 15.6 11.7 16.7 14.3 1.3 2.0 1.9 5.3 4.5 11.5 10.3 8.7 63.0 12.8 26.9 25.7 4.6 7.5 (0.3)


Belle Internatio 1880 HK 14.46 15,737 83% 24.1 23.1 20.6 17.6 12.0 17.0 15.2 1.35 1.4 1.5 4.68 4.35 NA NA 0.0 57.2 14.7 23.2 22.4 3.0 0.0 0.1

Daphne Internati 210 HK 9.25 1,966 10% 4.6 16.2 16.1 13.0 0.9 23.8 14.4 1.12 1.9 2.0 3.47 3.28 NA NA 0.0 61.1 10.9 24.6 22.7 18.9 21.6 (1.1)

Trinity Ltd 891 HK 5.39 1,194 6% 2.1 17.8 16.2 13.9 9.6 16.6 14.3 1.14 4.3 4.2 2.83 2.70 NA NA 0.0 80.7 19.7 16.9 16.3 3.7 7.8 (0.7)

Average 17.8 16.2 13.9 7.5 19.1 14.3 1.1 4.3 NA 2.8 NA NA NA 0.0 80.7 19.7 16.9 NA 3.7 7.8 (0.7)


Parkson Retail 3368 HK 6.61 2,397 17% 3.3 13.3 14.0 12.6 (4.8) 10.8 6.7 2.08 3.3 3.2 2.74 2.56 7.5 8.1 0.0 N/A 25.7 20.6 19.4 1.7 (5.2) 0.8

Golden Eagle Ret 3308 HK 17.34 4,324 30% 9.0 22.4 21.7 18.4 3.4 17.9 13.2 1.64 1.3 1.3 5.77 4.95 15.3 14.0 0.0 76.3 37.7 28.0 25.0 13.9 21.8 2.0

Intime Departmen 1833 HK 9.23 2,383 17% 5.3 17.3 16.7 13.9 3.7 19.7 11.8 1.41 2.3 2.4 2.13 2.07 18.2 13.9 31.5 69.6 26.4 13.9 13.0 9.9 26.1 0.5

Maoye Intl Hldgs 848 HK 1.61 1,116 8% 1.4 10.8 9.7 8.9 11.7 9.0 11.9 0.81 5.7 3.6 1.27 1.10 8.1 9.2 37.6 60.2 19.1 14.8 11.9 17.5 32.0 3.2

Pcd Stores Group 331 HK 0.74 402 3% 1.6 8.1 7.4 5.4 8.1 37.5 20.7 0.36 4.8 6.7 1.05 0.98 5.5 5.1 0.0 80.0 24.5 9.1 13.4 19.4 29.8 1.4

Lifestyle Intl 1212 HK 16.72 3,590 25% 2.6 14.9 14.8 13.2 0.8 11.5 6.3 2.33 2.8 2.7 3.16 2.94 11.2 10.8 0.0 58.5 36.8 23.9 21.2 4.4 (0.6) 1.0

Shirble Departme 312 HK 0.72 232 2% N/A 5.8 N/A N/A N/A N/A N/A N/A N/A N/A 0.95 N/A NA NA 0.0 N/A 15.6 22.3 N/A 0.0 0.0 0.0

Average 13.2 14.0 12.1 3.8 17.7 11.8 1.4 3.4 3.3 2.4 2.4 11.0 10.2 9.9 68.9 26.5 19.0 17.3 9.5 14.8 1.3

Market weighted average 16.6 16.2 14.0 2.2 15.0 10.1 1.7 2.6 2.5 3.5 3.1 12.4 11.4 8.1 55.7 31.4 21.8 19.4 9.1 13.1 1.3

Luk Fook Hldgs I 590 HK 19.48 1,511 10% 10.2 8.2 9.4 8.0 (13.1) 18.1 6.8 1.39 4.8 4.1 2.09 1.82 6.1 6.5 0.0 23.2 11.2 29.6 21.3 (22.9) 4.6 2.1

Chow Sang Sang 116 HK 16.54 1,464 9% 2.5 10.4 10.8 8.7 (4.2) 25.1 11.9 0.91 3.5 3.3 1.79 1.60 8.1 8.9 27.4 19.0 6.4 16.9 15.6 (13.2) 7.2 1.3

Chow Tai Fook Je 1929 HK 9.56 12,361 80% 8.7 14.0 14.4 11.6 (3.1) 24.4 13.0 1.11 1.0 1.4 3.31 2.70 10.8 10.7 16.3 29.1 11.2 31.5 20.8 (13.2) 8.2 0.2

Tse Sui Luen Jew 417 HK 4.15 113 1% 0.0 5.4 N/A N/A N/A N/A N/A N/A 3.7 N/A 0.93 N/A 4.1 N/A 36.0 47.9 4.8 18.6 N/A (13.7) (15.3) 0.0

Average 9.5 11.6 9.4 (6.8) 22.5 10.6 1.1 3.3 3.0 2.0 2.0 7.3 8.7 19.9 29.8 8.4 24.1 19.2 (15.8) 1.2 0.9

Market weighted average 13.0 13.5 10.9 (4.1) 23.7 12.2 1.1 1.7 1.9 3.0 2.5 10.1 10.0 15.9 27.7 10.7 29.8 20.2 (14.2) 7.6 0.5

Emperor Watch & 887 HK 0.76 659 29% 2.4 7.8 9.6 7.9 (18.6) 21.5 5.8 1.65 3.4 3.2 1.29 1.21 6.1 7.1 0.0 28.8 10.7 15.7 13.7 (9.5) 10.1 2.7

Oriental Watch 398 HK 2.32 171 8% 0.5 8.0 6.3 6.3 27.2 (0.3) 14.8 0.43 4.7 4.7 0.63 0.60 6.3 5.6 14.3 21.0 4.2 8.3 10.1 (10.1) (0.9) 0.0

Hengdeli Holding 3389 HK 2.51 1,423 63% 3.3 10.9 11.3 10.2 (3.8) 11.8 7.4 1.54 3.1 3.2 1.71 1.58 8.8 8.0 6.6 25.1 7.2 19.1 15.4 11.6 17.8 2.9

Average 8.9 9.1 8.1 1.6 11.0 9.3 1.2 3.8 3.7 1.2 NA 7.1 NA 7.0 25.0 7.3 14.4 NA (2.7) 9.0 1.9

Market weighted average 9.8 10.5 9.2 (5.8) 13.7 7.5 1.5 3.3 3.3 1.5 1.4 7.8 7.6 5.2 25.9 8.0 17.3 14.5 3.7 14.2 2.6

* Outliners and "N/A" entries are in red and excl. from the calculation of averages


Thu, 01 Nov 2012


of 59

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Oriental Patron, its directors, officers and employees, including persons involved in the preparation or issuance of this report, may, to the extent permitted by law, from time to time participate or invest in financing transactions with the issuer(s) of the securities mentioned in this report, perform services for or solicit business from such issuers, and/or have a position or holding, or other material interest, or effect transactions, in such securities or options thereon, or other investments related thereto. In addition, it may make markets in the securities mentioned in the material presented in this report. Oriental Patron may, to the extent permitted by law, act upon or use the information presented herein, or the research or analysis on which they are based, before the material is published. One or more directors, officers and/or employees of Oriental Patron may be a director of the issuers of the securities mentioned in this report. Oriental Patron may have, within the last three years, served as manager or co-manager of a public offering of securities for, or currently may make a primary market in issues of, any or all of the entities mentioned in this report or may be providing, or have provided within the previous 12 months, significant advice or investment services in relation to the investment concerned or a related investment or investment banking service to the issuers of the securities mentioned in this report.

Regulatory Disclosures as required by the Hong Kong Securities and Futures Commission

Oriental Patron (inclusive of OPSL) which are carrying on a business in Hong Kong in investment banking, proprietary trading or market making or agency broking are not a market maker in the securities of the subject companies mentioned in this report. Unless otherwise specified, Oriental Patron does not have any investment banking relationship with the companies mentioned in this report within the last 12 months. As at the date of this report, Oriental Patron do not have any interests in the subject company(ies) aggregating to an amount equal to or more than 1% of the subject company(ies) market capitalization.

Analyst Certification:

The views expressed in this research report accurately reflect the analyst’s personal views about any and all of the subject securities or issuers; and no part of the research analyst’s compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in the report.

Rating and Related Definitions

Buy (B) We expect this stock outperform the relevant benchmark greater than 15% over the next 12 months. Hold (H) We expect this stock to perform in line with the relevant benchmark over the next 12 months. Sell (S) We expect this stock to underperform the relevant benchmark greater than 15% over the next 12 month. Relevant Benchmark Represents the stock closing price as at the date quoted in this report.

Copyright © 2012 Oriental Patron Financial Group. All Rights Reserved

This report is being supplied to you strictly on the basis that it will remain confidential. Except as specifically permitted, no part of this presentation may be reproduced or distributed in any manner without the prior written permission of Oriental Patron. Oriental Patron accepts no liability whatsoever for the actions of third parties in this respect.

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