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CONSUMER DISCRETIONARY
Initiation on Jewelry and Watch Sector
20 April 2012
Watch this space

Though the long-term outlook for Chinas jewelry and watch industry is unambiguously bright, 2012 is shaping up to be a year of normalized, gradual growth. Year-to-date, share prices of Chow Tai Fook Jewellery (1929 HK) and Luk Fook (590 HK) have corrected around 20% and underperformed the market by 30%, reflecting investor concerns about a slowdown in sales. While long-term value has emerged even on cautious 2012 same-store sales growth (SSSG) assumptions, near-term share price volatility and downside persist as SSSG is likely to see another major leg down in 2HCY12, providing an opportunity for accumulation. We initiate coverage on both names with a Neutral rating. Despite their strong share price performance year-to-date, we favor watch retailers as we believe their sales will be more resilient and their valuations are attractive. We maintain our Outperform rating on Hengdeli (3389 HK) and initiate on Emperor Watch & Jewellery (887 HK), which we also rate Outperform.
Analysts
Forrest Chan, CFA
(852) 2532 6743 forrestchan@ccbintl.com
Claudia Ching
(852) 2532 2528 claudiaching@ccbintl.com
Timothy Sun
(852) 2532 6746 timothysun@ccbintl.com
Please read the analyst certification and other important disclosures on last page
20 April 2012
Table of Contents
Watch this space.......................................................................................................................... 3 A year of slower growth................................................................................................................ 4 More resilient sales from the watch segment ............................................................................. 10 Finding the right valuation .......................................................................................................... 12 Key investment risks .................................................................................................................. 18 Porter and SWOT analysis......................................................................................................... 22 Chow Tai Fook Jewellery (1929 HK) .......................................................................................... 24 Emperor Watch & Jewellery (887 HK)........................................................................................ 43 Hengdeli Holdings (3389 HK)..................................................................................................... 59 Luk Fook Holdings (590 HK) ...................................................................................................... 75 Appendix : Peer comparison ...................................................................................................... 92
20 April 2012

Watch this space
A year of slower growth. Though the long-term outlook for Chinas jewelry and watch industry is unambiguously bright, 2012 will be a year of normalized, slower growth as a result of the more challenging macro environment as well as volatility of gold price. Long-term value has emerged in jewelers Year-to-date, share prices of Chow Tai Fook (1929 HK) and Luk Fook (590 HK) have corrected about 20% and underperformed the market by 30%, reflecting material investor concerns about a considerable sales slowdown in jewelry. Yet long-term value has emerged: Chow Tai Fook and Luk Fook trade on 12x and 8x CY13F P/E, respectively, even if we cautiously assume low-teen SSSG in FY13F (year-to-March 2013) and mid-teen SSSG in FY14F (year-to-March 2014), compared with 35%+ SSSG in FY12F (year-to-March 2012). but the worst is yet to come. Nevertheless, we expect share price volatility and/or downside to persist in the near term as SSSG is likely to see another major leg down into 2HCY12. The price of gold reached its high in September 2011 and has since entered a period of consolidation, ending its rally that began in late 2008. Gold price has risen 20% YoY since the beginning of 2011. CCBIS gold price forecast of US$1,850/oz, equivalent to an 18% rise in the annual average price, also implies less positive trends will be seen over the remainder of 2012 as compared with 2010 and 2011. The absence of a clear uptrend in gold price will cause a worse-than-expected slump in Chinese jeweler SSSG due to the correlation of gold price with both prices of gold jewelry products and volume demand for gold jewelry. Most critically, 3QCY12 is likely to be a quarter of year-on-year gold price decline. Accumulate Chow Tai Fook and Luk Fook in 2HCY12. We initiate coverage of both Chow Tai Fook and Luk Fook with a Neutral rating, and view 2HCY12 as the best opportunity to accumulate the stocks. Of the two, we consider Chow Tai Fook, Greater Chinas largest and most recognized jeweler, as the best-quality proxy for the long-term boom in jewelry consumption in China. Favor Hengdeli (3389 HK) and Emperor Watch & Jewellery (887 HK). We have a clear near-term preference for watch retailers despite their strong share price performance year-to-date. Watch sales will remain resilient in the more challenging retail environment. We maintain our Outperform rating on Hengdeli, Chinas largest mid-to-high end watch retailer. We also initiate coverage on Emperor, a leading Hong Kong-based retail name with an exceptional franchise carrying exclusive European-made ultra-luxury watch labels. Valuations are undemanding, with Hengdeli and Emperor trading on 10x and 7x CY13F P/E, respectively. CCBIS jewelry and watch universe
Share Stock Company Emperor Hengdeli Luk Fook code 887 HK 3389 HK 590 HK price (HK$)* 1.20 3.43 20.90 TP (HK$) 12.50 1.40 4.15 21.80 CCBIS Rating N O O N CY12F CY13F 15.6 9.4 12.3 9.5 12.4 7.2 9.9 8.1 P/E (x)
Chow Tai Fook 1929 HK 11.90
Ratings: O = Outperform; N = Neutral; U = Underperform * Prices as at close on 18 April 2012;
Forrest Chan, CFA

Claudia Ching
Timothy Sun
20 April 2012
A year of slower growth

Phenomenal growth in jewelry and watch sales between 2009 and 2011 Chinas jewelry and watch sales have exhibited unprecedented strength since 2009. The retail market in the country was buoyant and there was a gush of liquidity amidst negative real interest rates which fueled demand for luxury items. Gold product sales saw the biggest increase as the undisrupted uptrend from 2009 to 2011 in gold price stimulated demand from consumers seeking wealth protection. Operators with substantial exposure to Hong Kong benefited materially as the influx of mainland tourists into the city brought about an exceptional surge in their business. China retail sales jewelry and watches vs. non-jewelry and watches (YoY)
60% 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% (5)% 2001 2002 2003 2004 2005 2006 2007 Overall retail sales Jewelry and watch 2008 2009 2010 Non-jewelry and watch 2011
Source: CEIC, CCBIS research
Hong Kong retail sales jewelry and watches vs. non-jewelry and watches (YoY)
50% 40% 30% 20% 10% 0% (10)% 2001 2002 2003 2004 2005 2006 2007 Overall retail sales Jewelry and watch 2008 2009 2010 Non-jewelry and watch 2011
20 April 2012
Swiss watch export value to Hong Kong

CHFm 4,500
4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 2000 2001 2002 1,433 5% 1,508 1,549 1,420 16% 1,642 1,768 1,946 25% 2,433 2,697 3,186
47%
4,086
28%
2,168
11%
8%
10%
3% (8)% (20)%
2003 2004 2005 2006 2007 2008 2009 Total sales value (LHS) Total sales value (RHS) 2010 2011
YoY 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% (5)% (10)% (15)% (20)% (25)%
Source: Swiss Watch Federation
While many of the structural drivers of luxury consumption growth over the long run remain intact, the near-term outlook for jewelry and watch retailers has deteriorated as the latent impact of the economic slowdown and credit tightening is beginning to discourage big-ticket item purchases. Consumers are more reluctant to purchase gold jewelry now that the price of gold has begun to consolidate from its high of US$1,900/oz in September 2011 while Chinas negative real interest rates have begun to narrow. Long-term structural drivers intact Sales of Swiss watches per 1,000 people
10 Italy 5 Saudi Arabia 2 Thailand 1 Turkey South Korea Russia Mexico 0.5 Malaysia China 2018: 0.59/000 people 0.2 Ukraine 0.1 0 100 200 300 China 2013: 0.34/000 people China 2008: 0.23/000 people (Swiss watches worth over RMB10K) Canada Sales of Swiss watches in pieces Market penetration of Swiss watches in China is low and there is huge growth potential China Taiwan Portugal Spain Greece Austria
UK Germany Japan USA Australia Belgium Holland
Source: Hengdeli, Bain & Company, Euromonitor, Watch Association of Switzerland
20 April 2012
China jewelry consumption

RMB b 1,300 1,170 1,040 910 780 650 520 390 260 130 0 45 35 28 30 23 77 45 18 59 2006 2007 2008 Gold products 54 37 94 72 50 130 98 71 184 132 99 258 361 178 138 703 504 240 192
Hong Kong jewelry consumption

HK$b 330
322
2010-2015F CAGR: Gold products = 40% Platinum/karat gold products = 39% Gem-set jewelry = 35%
300 270 240 210 180 150 120 90 60 30 0
2010-2015F CAGR: Gold products = 40% Platinum/karat gold products = 40% Gem-set jewelry = 38% 66 43 29 19 2 3 6 34 2008 8 36 2009 12 50 68 93 168 126
100
266
224
23 2006
30 2007
2009 2010 2011F 2012F 2013F 2014F 2015F Platinum/karat gold products Gem-set jewellery
2010 2011F 2012F 2013F 2014F 2015F Hong Kong Macau
Source: Frost & Sullivan
Further downside to jeweler SSSG
We forecast a material slowdown in the SSSG of jewelry and watch retailers in 2012 in comparison with2011. We expect a more pronounced slowdown from jewelry operators. Our forecast is supported by empirical evidence: During the last two consolidation cycles in gold price (2006 and 2008), retail sales volume growth of jewelry and watches underperformed that of the overall Hong Kong market. Although there is no separate data available for jewelry, we believe the overall weakness was more attributable to reduced consumer appetite for jewelry products during the period. Same-store sales growth (%) of listed jewelry or watch plays
Jan Jun 2010 Chow Tai Fook Hong Kong Chow Tai Fook China Emperor Hong Kong Emperor China Luk Fook Hong Kong Luk Fook China Oriental Watch group Hengdeli Hong Kong* Hengdeli China* * Denotes total sales growth ** 2012F = FY13F, 2013F = FY14F for Chow Tai Fook and Luk Fook Source: Chow Tai Fook, Emperor, Hengdeli and Luk Fook data, CCBIS estimates 32 35 49 17 30 33 41 38 2011 Over 70s Over 40s 36 19 over 40s over 30s 39 46 Jul Sep 2011 Over 70s Over 40s c.30 Teens over 40s over 30s mid 20s mid 30s Oct Dec 2011 c.30 c.30 c.30 teens 27 35 >20 mid 20s mid 20s 2012F** 12 10 16 2013F** 16 15 21
high single digit high single digit 10 13 24 27 12 15 19 23
20 April 2012
Chinas real interest rate trend

5%
3%
2%
0%
(2)%
(3)%
(5)% Mar-08
Jul-08
Nov-08
Mar-09
Jul-09
Nov-09
Mar-10
Jul-10
Nov-10 Mar-11
Jul-11
Nov-11
Mar-12
Source: Bloomberg, CEIC
Weak jewelry and watch sales in Hong Kong during the last two consolidations in gold price
Retail sales volume growth of jewelry and watches vs. Hong Kongs overall retail sales volume growth
50%
25%
0%
(25)% Jan-Feb Jul-06 Dec-06 Jun-07 Nov-07 May-08 Oct-08 Apr-09 Sep-09 Mar-10 Aug-10 Jan-Feb Jul-11 Dec-11 2006 2011 Retail sales volume index Retail sales volume: jewelry, watches, clocks & valuable fift
3QCY12 has the highest comparison base for gold price year-on-year trends
As shown in the following chart, gold price reached its high in September 2011 and has since entered a period of consolidation, ending its rally that began in late 2008. The significance is that increased volatility in gold price is likely to result in contracted purchases of jewelry products, in our view. CCBIS gold price forecast of US$1,850/oz, equivalent to an 18% rise in annual average price, implies less positive trends will be seen over the remainder of 2012 compared with 2010 and 2011. The price of gold has risen 20% YoY since the beginning of 2011. Most critically, given that the price of gold peaked in September 2011 at US$1,900/oz, 3QCY11 is most likely to see a year-on-year decline in gold price.
20 April 2012
Gold price consolidation

US$/oz 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 4-Jan-00
17-Jul-01
28-Jan-03
10-Aug-04
21-Feb-06
4-Sep-07
17-Mar-09
28-Sep-10
10-Apr-12
Source: Bloomberg, CCBIS research
Gold price
US$/oz 1,950 75% 60% 45% 1,370 30% 1,080 15% 790 0% (15)% 17-Mar-12
Historical and forecast average annual gold price

US$/oz 2,200 2,000 1,850 1,565 1,227 872 605 364 410 445 12% 697 974 18% 30% 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012F 2013F 6% 36%
2,000
1,660
24%
500 3-Jan-06
1-Apr-07
27-Jun-08 23-Sep-09 20-Dec-10 Gold price (LHS) YoY (RHS)
Gold price (LHS)
YoY (RHS)
Source: Bloomberg
Source: Bloomberg, CCBIS estimates
Slowing mainland tourist spending in Hong Kong
For companies with a large presence in Hong Kong, slowing mainland tourist arrivals into the city could be another negative factor. After several years of high growth in the number of mainland tourists, we have begun to note a slight deceleration, which we attribute to the higher base and competition from other travel destinations.
20 April 2012
Mainland tourist arrivals into Hong Kong (YoY)

80% 70% 60% 50% 40% 30% 20% 10% 0% (10)% (20)% Jan-Feb 2005 Sep-05 May-06 Dec-06 Aug-07 Apr-08 Nov-08 Jul-09 Mar-10 Oct-10 Jun-11 Jan-Feb 2012
Source: CEIC
20 April 2012
More resilient sales from the watch segment

Demand for gold jewelry is correlated with gold price trends, in our view In the current cycle we expect watch sales to be more resilient than jewelry sales. Consumer sentiment has soured because of eroding macro conditions. Demand for gold jewelry in volume terms is likely to be dented by much slower rises in gold price than what was seen in 2009-2011. Meanwhile, increases in product prices will be considerably lower than in past years due to less favorable gold price trends. Worsening consumer sentiment and the absence of a clear uptrend in gold price is a double whammy jewelry retailers are hoping to avoid. The crux of our argument is that demand for gold products is positively correlated with the medium-to-long-term gold price expectations of consumers. We base our claim on the premise that gold jewelry is no ordinary discretionary consumer product in the eyes of Chinese consumers and as a result, purchase patterns pertaining to gold jewelry do not fit those of other discretionary consumer goods. The following features of gold jewelry explain why it is treated differently than other goods. An accessory. In its role as a decorative accessory, gold jewelry can be considered a normal luxury good. Like many other luxury products, gold jewelry serves the cultural function of signaling wealth and social status. In this respect, there is a long-term, structural growth component to the demand for gold jewelry. As the disposable income of Chinese consumers grows, so too does their desire to own luxury items to communicate their wealth and social standing. This long-term trend aside, in the short term, gold demand will fluctuate according to Chinas general macro health in the same way that other luxury goods tend to do. Event-driven demand. Gold holds considerable symbolic meaning in many cultures, including the Chinese culture. It is often presented as a gift on various Chinese ceremonial occasions and festive events, including Chinese New Year, birthday celebrations, the arrival of a newborn and most notably, at weddings. Frost & Sullivan estimates that over 12m marriages were registered in China in 2010, a year when over 30% of the Chinese population was at the marriageable age of 20 to 39. In spite of the global financial crisis, the number of marriage registrations continued to increase at a CAGR of 9.8% from 2007 to 2009. Looking ahead, the number is forecasted to grow at a CAGR of 9.2% between 2010 and 2015. While such event-driven demand is usually steady over the long run and less affected by short-term changes in the economy, what is often overlooked is that consumers sometimes adjust their purchases according to their expectations of medium-term gold price movements. When consumers anticipate downside to current gold prices or else are uncertain about gold price trends, they tend to defer their purchases. Vice versa, purchases may take place earlier when consumers believe that the price of gold will continue to rise. A common counter argument to this purchasing behavior is that jewelers often see short-term increases in sales volume when gold prices begin to retreat or fluctuate. In our view, such a scenario is usually driven by purchases by consumers who look upon near-term dips as an opportunity to accumulate gold ornaments on the grounds that their gold price uptrend expectations in the medium-to-long term remain unchanged. However, event-driven demand can be delayed in periods when consumers become less certain about what direction the price of gold price is taking in the medium term.
Event-driven demand is adjustable
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20 April 2012
Number of marriages in Hong Kong

'000 70
60 50 50 40 30 20 10 0 2000 2001 2002 47 47

(0.3)%
7.7% 51
10.5% 58 52 51 47 47
(0.3)%
10.5% 58 51
7.7%
52
2.8%
2.8%
(7.0)% (5.7)%
(11.9)%
14% 12% 10% 8% 6% 4% 2% 0% (2)% (4)% (6)% (8)% (10)% (12)% (14)%
2003
2004 2005 2006 No. of marriages (LHS)
2007 2008 YoY (RHS)
2009
2010
2011
Source: CEIC
Gold jewelry provides a tangible way to preserve wealth
Wealth protection. In our view, the market has failed to fully appreciate the importance of gold jewelry as a store of wealth and therefore underestimated its importance as an element in the extraordinary sales growth of gold jewelry in China between 2009 and 2011. To many Chinese consumers, gold jewelry products provide them with a tangible way to preserve wealth while at the same time serving the cultural functions of providing decoration and displaying wealth. Indeed, one can easily draw an analogy between the many ways Chinese value jewelry and the pragmatic and sentimental value they attribute to real estate as both a residence and as a means of preserving and transferring wealth across generations. This goes a long way to explaining why the dire condition of the Chinese property market (and to a lesser extent, the stock market) is behind the shift in wealth-protection demand to gold-related products, including direct holdings of gold and purchases of pure gold jewelry. It follows naturally that such wealth-protection demand is, again, correlated with expectations of medium-to-long-term gold price movements versus those of the property and stock markets. Similar to the aforementioned event-driven demand, near-term demand could contract when gold price trends become unclear.
11
20 April 2012
Finding the right valuation

Peer comparison is our primary valuation metric Except Chow Tai Fook, companies we analyze in this report have a reasonably long history as public companies, but the watch and jewelry space has become liquid and investible only since 2010, thanks to valuation and earnings expansion of listed watch and jewelry players. The listing of Chow Tai Fook in Hong Kong also put this segment under the spotlight. When determining the fair valuation of watch and jewelry companies, historical valuations may not be the best reference given the many structural changes that have taken place in the industry, the impact of mainland spending on Hong Kong retail sales being the most critical. We do not resort to the discounted cash flow (DCF) model as most investors converse in P/E terms and the results from the DCF methodology can change materially even with only small changes in assumptions. This leaves us with peer comparison as the most reliable primary valuation metric. In valuing the companies in our China watch and jewelry universe, we take into account the following factors.
Cyclicality and near-term earnings momentum

Momentum weakens in 2012 Our analysis has already indicated that watch and jewelry demand faces greater cyclicality than ordinary discretionary items due to the big ticket prices involved and correlation with commodity prices and the changing need of Chinese consumers to protect their wealth depending on macro economic environment. We project 2012 to be a challenging year for watch and jewelry retailers as we forecast much slower gold price movement and a mixed macro outlook that will affect consumer sentiment and lead to much slower SSSG. Earnings momentum will, in turn, be significantly weakened, possibly capping valuations for the entire segment. Earnings growth (YoY)
59 53 52 52% 46 36 39 50 43 38 30 26% 25 24 24 16 13% 7 (16) (21) 0% 2009 2010 2011 2012F Chow Tai Fook Emperor Hengdeli 2013F Luk Fook 2014F (35)% 2009 2010 2011 2012F 2013F Chow Tai Fook Emperor Hengdeli Luk Fook 2014F 25 20 19 31 21 24 16 19 0% (1) 35% 13 43 70% 105% 93 96 84 65 66 52 63 4749 2323 21 27 32 21 24
Revenue growth (YoY)

65%
39%
2123 14
20
Source: Chow Tai Fook, Emperor, Hengdeli and Luk Fook data, CCBIS estimates
Source: Chow Tai Fook, Emperor, Hengdeli and Luk Fook data, CCBIS estimates
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20 April 2012
Comparison with Chinese specialty and branded retailers

Different consumption patterns Throughout this report we have repeatedly argued that the big ticket nature of watch and jewelry sales makes them inherently more volatile than those of other discretionary consumer items, such as apparel and footwear. Wealth-protection needs play a significant role in creating demand for jewelry and, hence, complicate the nature of purchases. Jewelry sales are additionally correlated with gold price trends. More importantly, working capital requirements are extremely demanding in watch and jewelry retailing. In conclusion, watch and jewelry retailers have a riskier business model and generally deserve to trade at a discount to specialty and branded retailers selling ordinary discretionary items through a comparable business franchise, other factors being equal. Chow Tai Fook and Hengdeli are widely recognized national leaders in their respective sub-segments and we therefore benchmark their fair valuations at a discount to Belle (1880 HK, Outperform).
Comparison with department stores

Premium valuations justified for department store operators Despite the vastly different business models of department store operators and watch and jewelry retailers, an accurate valuation of the latter should include a comparison with department stores because department stores remain among the best representations of Chinas structural consumption growth, barring the growing challenges from oversupply within the retail space and alternative retail formats, such as online shopping. In our view, department stores are a balanced and diversified proxy for Chinas mid-to-high-end discretionary consumption, whereas watch and jewelry purchases mainly reflect sentiment towards luxury consumption and prevailing wealth protection needs of Chinese consumers. Department stores, in theory, also have greater sales resilience and more favorable working capital requirements than jewelry and watch retailers. On a positive note, the degree of industry consolidation is higher for watch and jewelry retailing where leading operators enjoy strong market positioning and substantial market share at the national level. We therefore believe the best-quality watch and jewelry retailers deserve a small discount to department store operators.
Watch versus jewelry retailers

Jewelry retailers deserve a premium Watch retailers are focused mainly on distributing Swiss watch labels and do not have their own watch brands, while branded jewelry retailers are engaged in brand management, raw material sourcing, product design, production and distribution. A lack of brand ownership and pricing flexibility implies watch retailers rely heavily on differentiated merchandizing to compete, although at times strong relationships with selected suppliers can prove to be a crucial competitive advantage. The extent of involvement in the value chain will result in different valuations. As established earlier, jewelry demand is sensitive to gold price movements while watch demand is not. Yet, demand for luxury watches and jewelry share some similarities. For example, they both represent luxury consumption that also meets the wealth protection needs of consumers. Overall, we believe the watch retailing business deserves a small valuation discount versus branded jewelry retailing.
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20 April 2012
Comparison with global watch and jewelry companies

Comparable global peers include some of the most widely internationally recognized luxury labels that come with long and distinguished histories. They are not single-market players and their diversified geographic exposure provides them with a stable yet generally slower growth profiles than those of China-focused operators. The Chinese market offers strong, structural long-term growth potential, albeit with significantly higher volatility as Chinese consumer sentiment swings with consumer investment needs and views on commodity prices a feature of the Chinese watch and jewelry market that is not found elsewhere in the world. Despite their less attractive growth prospects, we believe global luxury watch and jewelry companies deserve a valuation premium over their Chinese counterparts to reflect their stronger brand equity.
Leader premium
Within the same sub-segment, it is clear that the leader defined as having higher market share and larger scale should trade at a premium to its smaller, niche competitors. In deciding appropriate valuation discounts for Emperor and Luk Fook to Hengdeli and Chow Tai Fook, respectively, we refer to the trading history of Belle versus Daphne (210 HK, Not Rated). Daphne has been trading at an average discount of 32% to Belle since Belle was listed in 2007. The historical average discount of Emperor to Hengdeli is larger at 46%. P/E trends of Belle vs. Daphne
48x 44x 40x 36x 32x 28x 24x 20x 16x 12x 8x 4x May-07 May-08 Daphne (LHS) 64% 60% 56% 52% 48% 44% 40% 36% Average discount = 32% 32% 28% 24% 20% 16% 12% 8% 4% 0% (4)% May-09 Apr-10 Apr-11 Apr-12 Belle (LHS) Daphne's P/E discount to Belle (RHS)
P/E trends of Hengdeli vs. Emperor

29x 72% 64% 24x Average discount = 46% 56% 48% 19x 40% 32% 14x 24% 16% 9x 8% 0% 4x Jan-09 Emperor Feb-10 Hengdeli (8)% Mar-11 Apr-12 Emperor's P/E discount to Hengdeli
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20 April 2012
Stock recommendations
The following table summarizes our target valuations for the listed jewelry and watch retailers covered in this report. CCBI jewelry and watch universe
Target Stock Share price price* CY12F EPS CY13F EPS Company Chow Tai Fook Emperor Hengdeli Luk Fook Source: CCBIS estimates code 1929 HK 887 HK 3389 HK 590 HK (HK$) 11.90 1.20 3.43 20.90 (HK$) 12.50 1.40 4.15 21.80 (YoY, %) 32 31 21 3 (YoY, %) 26 32 21 17 CCBIS rating Neutral (initiation) Outperform (initiation) Outperform (maintained) Neutral (initiation) Implied share price upside (%) 5 17 21 4 P/E (x) 15.6 9.4 12.3 9.5 12.4 7.2 9.9 8.1 Implied target P/E (x) 16.4 11.0 14.9 9.9 13.0 8.4 12.0 8.5 CY12F CY13F CY12F CY13F
* Price as at close on 18 April 2012
Justifications for our valuations are as follows: We value Chow Tai Fook at 13.0x CY13F earnings, compared with current CY13F P/E of 16.7x for Golden Eagle (3308 HK, Not Rated), 17.7x for Belle and 12.6x for Parkson (3368 HK, Not Rated). The discount of Chow Tai Fook to Golden Eagle and Belle that we assign echoes our earlier conclusion that watch and jewelry retailers generally deserve to trade at a discount to specialty and branded retailers as well as department store operators with comparable business franchises. We also hold the view that non-jewelry specialty retailers and department store operators are beginning to see a sales recovery that gives them stronger near-term revenue and earnings momentum than Chow Tai Fook. Our target CY13F P/E for Luk Fook is 8.5x, implying a 35% discount to our target for Chow Tai Fook. It was set after consulting the historical trading history of Belle and Daphne which revealed an average discount of 32%. Chow Tai Fooks earnings outlook is also stronger than that of Luk Fook thanks to Chow Tai Fooks active gold price hedging activities which have availed it of better gross margin stability during the recent period of gold price volatility. We project a 23% rise in Chow Tai Fooks FY13F (year-to-March) earnings, and a 1% decline for Luk Fook. Hengdeli is valued at 12x CY13F P/E versus 13x CY12F P/E previously. As established earlier, we believe a valuation discount is justified for watch retailers versus jewelry retailers to reflect the lack of brand ownership of watch retailers. When we compare Hengdeli and Chow Tai Fook, the discount should not be material since Chow Tai Fook is forecast to see greater earnings deceleration in CY12F as a result of the decline in SSSG. Our target for Emperor is pegged at 8.4x, equivalent to a 30% discount to our target for Hengdeli and an average discount of 46% in the past. We anticipate the valuation discount between the two companies will narrow over time as Emperor continues to build its business franchise and lengthens its track record as a listed company.
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Valuation summary
Share price Company Jewelry and watch retailers Chow Tai Fook* Hengdeli* Chow Sang Sang Luk Fook* Emperor Watch* Oriental Watch Average Department stores Golden Eagle Parkson Intime Dept Store Springland* Maoye NWDS PCD Stores Shirble Dept Stores Average Sportswear brands ANTA* Li Ning* Xtep* China Dongxiang* 361 Degrees* Peak* Average 2020 HK 2331 HK 1368 HK 3818 HK 1361 HK 1968 HK 7.85 7.89 3.58 1.00 2.29 1.86 2,521 1,073 1,003 726 610 502 8 7 1 4 3 2 (7) 9 2 66 (29) (33) 1 7 100 7 64 6 16 33 9.9 16.0 6.4 8.1 4.8 6.1 8.5 9.2 8.0 6.0 4.9 4.5 5.3 6.3 NA 1.9 2.9 0.1 NA NA 1.6 6.4 1.9 7.8 8.7 8.4 4.9 6.3 2.3 1.7 1.4 0.6 0.8 0.7 1.3 23.9 11.4 23.4 8.0 17.6 12.3 16.1 (continued on next page) 28 6 33 106 13 78 Net cash Net cash Net cash Net cash Net cash Net cash 3308 HK 3368 HK 1833 HK 1700 HK 848 HK 825 HK 331 HK 312 HK 19.70 8.62 9.59 5.51 1.83 5.24 0.99 0.72 4,923 3,119 2,462 1,774 1,265 1,138 539 231 10 8 8 1 4 1 3 2 20 15 17 24 13 (10) 21 16 14 28 20 19 22 27 15 28 18 22 21.4 15.2 15.4 15.5 11.0 13.1 8.9 5.8 13.3 16.7 12.6 13.0 12.7 8.7 11.4 7.0 4.9 10.9 0.6 0.6 0.7 0.6 0.3 0.8 0.3 0.3 0.5 1.4 2.9 2.6 2.9 3.1 3.0 3.8 5.5 3.1 5.7 3.2 2.2 2.4 1.2 3.0 1.3 0.8 2.5 28.2 22.7 14.6 16.5 13.3 11.5 15.1 15.1 17.1 7 13 Net debt 11 Net debt 47 9 125 Net cash Net cash 32 Net cash 38 Net cash Net cash Net cash 1929 HK 3389 HK 116 HK 590 HK 887 HK 398 HK 11.90 3.43 19.76 20.90 1.20 3.40 15,271 1,829 1,722 1,585 1,038 250 19 6 3 20 6 2 32 22 19 3 31 15 20 26 24 19 16 31 14 22 15.6 11.6 10.3 9.5 9.4 5.8 10.4 12.4 9.4 8.6 8.1 7.2 5.1 8.5 0.5 0.5 0.5 3.7 0.3 0.4 1.0 1.9 3.0 3.4 4.4 3.0 4.3 3.3 3.5 2.3 1.8 1.9 1.8 3.8 2.5 26.8 18.1 17.9 22.1 18.7 15.2 19.8 5 Net debt Net debt 17 6 15 Net cash 6 27 Net cash Net cash Net cash Stock code (local currency) Market cap (US$m) 3M average value traded (US$m) EPS growth (%)# CY12 CY13 CY12 P/E (x) CY13 PE/G (x) CY12 Yield (%) CY12 P/B (x) CY12 ROAE (%) CY12 Net cash/ Net share (%) gearing (%)
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20 April 2012
Valuation summary (continued from previous page)

Share price Company Supermarkets Sun Art Retail CRE Wumart Lianhua Beijing Jingkelong Average HK retailers Lifestyle Sa Sa* Texwinca Giordano I.T* Bonjour* Average China specialty retailers / other brands Belle* Gome* Bosideng Daphne Trinity* Lilang* Ports Pou Sheng Evergreen Sparkle Roll* Huiyin Average
Market cap (US$m) 12,381 8,666 2,798 1,188 370
3M average value traded (US$m) 10 17 2 4 0
EPS growth (%)# CY12 28 (1) 35 12 15 18 CY13 27 21 21 5 23 19 16 20 14 14 29 27 20 21 47 13 22 23 18 22 30 22 27 23 24 CY12 31.9 24.0 22.1 10.6 9.6 19.7 16.1 18.1 9.9 11.5 9.7 11.3 12.8 21.6 15.4 9.4 16.0 17.9 9.6 10.0 8.5 7.8 6.2 7.8 11.8
P/E (x) CY13 25.2 19.9 18.2 10.1 7.8 16.2 13.9 15.2 8.6 10.1 7.5 8.9 10.7 17.8 10.5 8.3 13.1 14.6 8.1 8.2 6.6 6.4 4.9 6.4 9.5
PE/G (x) CY12 0.9 1.0 0.9 1.9 0.3 1.0 0.9 0.8 0.6 0.7 0.5 0.5 0.7 1.9 NA 0.6 0.6 0.8 0.6 0.4 0.2 0.3 0.2 0.3 0.6
Yield (%) CY12 1.1 1.9 2.0 3.2 4.2 2.5 2.5 5.5 6.3 6.7 3.6 7.2 5.3 1.4 2.0 8.3 1.9 4.0 6.1 6.0 NA 6.5 3.2 NA 4.4
P/B (x) CY12 4.9 1.9 4.5 2.0 1.3 2.9 3.3 7.8 9.1 3.2 2.0 9.9 5.9 4.4 1.3 8.2 3.8 3.3 2.8 2.5 0.7 1.1 1.2 0.4 2.7
ROAE (%) CY12 15.5 8.1 21.6 18.6 13.5 15.5 21.7 45.8 22.6 29.5 18.2 93.4 38.5 22.3 8.5 21.0 25.7 19.1 30.9 26.6 6.0 14.5 19.6 5.0 18.1
Net cash/
Net
Stock code 6808 HK 291 HK 1025 HK 980 HK 814 HK
(local currency) 10.08 28.05 16.96 8.24 6.97
share (%) gearing (%) 9 4 6 94 Net debt Net cash Net cash Net cash Net cash 97
1212 HK 178 HK 321 HK 709 HK 999 HK 653 HK
18.92 4.72 9.45 6.26 4.38 1.13
4,066 1,711 1,656 1,232 693 438
5 4 2 3 2 1
4 22 10 13 20 25 16
6 5 Net debt 13 9 8
Net cash Net cash 3 Net cash 4 Net cash
1880 HK 493 HK 3998 HK 210 HK 891 HK 1234 HK 589 HK 3813 HK 238 HK 970 HK 1280 HK
14.96 1.59 2.28 10.98 6.67 7.19 11.40 0.88 2.24 0.70 0.49
16,246 3,455 2,351 2,329 1,470 1,112 835 483 274 269 65
36 50 4 7 4 2 2 0 1 1 2
11 (24) 11 21 23 17 14 7 18 32 236 33
Net debt 18 25 7 4 18 3 1 66 14 Net debt
20 Net cash Net cash Net cash Net cash Net cash Net cash Net cash Net cash Net cash 34
Prices as at close on 18 April 2012; # Calculated in Hong Kong dollar terms; * Denotes CCBIS estimates
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20 April 2012
Key investment risks

Macro risk
A macro-driven segment High-end consumption is often sensitive to short-term fluctuations in macro conditions and, hence, shows greater volatility than mass-market or low-end consumption. During retail slowdowns due to macro-economic changes, it is not uncommon to see a decline in big-ticket item purchases. Such correlation is due to the discretionary nature of big-ticket consumption. In the case of jewelry retailers, as repeatedly elaborated, their sales are additionally correlated with gold price trends which drive ASP as well as sales volume.
Competition risk
Limited differentiation The jewelry retail market in both Hong Kong and China is generally fragmented and competitive. According to Frost & Sullivan, Chow Tai Fook, the No. 1 jeweler in China, had 12.6% market share in 2010. In the same year, the top-five jewelry brands collectively commanded 42.0% market share. In Hong Kong, Chow Tai Fook dominated the market with 20.1% share in 2010, and together with the No. 2-4 players, had a combined market share of 42.8%. Although major players are expected to increase their market share going forward leading to higher industry concentration, we believe competition will remain intense. Key areas of competition include brand reputation, product offerings, product design, marketing, in-store service, and store network (in terms of number of stores and store locations). Watch retailers, on the other hand, face a slightly different form of competition insofar as they compete mainly on brand portfolio and product offerings rather than product design. Overall, competition is most keen in the jewelry arena, as brand and product differentiation is limited. POS for Emperor
2,378 2,123 106 110 120 95 90 2,268 61 60 40 30 19 15 4 FY08 16 40 24 FY09 FY10 China POS FY11 FY12F FY13F Hong Kong & Macau POS FY14F 21 57 67 79 91 80 23 31 28 110 33 150 124
POS for Chow Tai Fook

2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 FY08 FY09 FY10 FY11 China POS FY12F FY13F Hong Kong POS FY14F FY15F 752 895 821 69 965 70 1,183 85 1,361 84 1,620 92 1,879 100
1,098
1,277
1,528
1,779
2,017
Source: Chow Tai Fook, CCBIS estimates Note: Year to March
Source: Emperor, CCBIS estimates
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20 April 2012
POS for Hengdeli

640 560 480 405 400 320 240 160 80 0 FY08 FY09 FY10 FY11 FY12F FY13F China POS Hong Kong, Macau & Overseas POS FY14F 197 224 204 7 237 13 286 332 377 417 457 350 64 73 453 76 539 496 79 82
POS for Luk Fook

1,300 1,170 1,040 910 780 650 520 390 260 130 0 FY08 FY09 FY10 China POS FY11 FY12F FY13F FY14F Hong Kong, Macau & Overseas POS FY15F 351 385 34 456 37 557 38 699 42 817 45 927 45 1,045 46 1,163 47
419
519
657
772
882
999
1,116
Source: Hengdeli data, CCBIS estimates
Source: Luk Fook data, CCBIS estimates Note: Year to March
Intensive working capital requirements

Working capital most related to new openings Watch and jewelry retailing involves heavy working capital stemming mainly from inventory requirements. In particular, companies expanding their self-operated store network quickly usually see rapid growth in inventory turnover. For instance, each new directly-managed outlet of Chow Tai Fook would require start-up inventory of up to HK$9m. In Chow Tai Fooks case, inventory cycle was 214, 194 and 192 days as at the end of FY09-FY11, respectively. However, Luk Fook has less exposure to direct retail to warrant faster turnover in inventory but its inventory cycle is still well above 100 days on average (146, 132 and 129 as at the end of FY09-FY11). Start-up inventory requirements can be even higher for watch companies carrying ultra-luxury labels. Working capital cycle of companies*
250 251 259 243 219 165 159
180
143 115
110 25 4
40
14 (6)
12
(30)
(35) (100) Chow Tai Fook Average inventory days Emperor Average receivable days (75) Hengdeli Average payable days
(32)
Luk Fook Cash conversion cycle (days)
* Latest balance sheet date Source: Chow Tai Fook, Emperor, Hengdeli and Luk Fook data, CCBIS estimates
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20 April 2012
Rising operating costs, especially rental

Rental risk All companies covered in this report have directly-run operations of meaningful scale in Hong Kong, exposing them to the risk of sharply rising rents. A key difference between the Hong Kong and China operations of these companies is that turnover-linked rental arrangements are less common in Hong Kong than in China. Retail rental has and is expected to continue to grow rapidly in Hong Kong. Any failure to produce high enough SSSG to offset the increases in rents can result in operating margin squeeze. Pressure stemming from rising staff costs in both China and Hong Kong is another concern though it is likely to be mitigated by flexible compensation structures commonly adopted by jewelry and watch companies that link a significant proportion of staff compensation to the performance of individual stores and staff members.
Concentration risk
Exposure to Hong Kong The following charts show the contribution of Hong Kong to turnover and EBIT of the four companies under our coverage. Companies with a strong and extensive presence in the Hong Kong market are highly vulnerable to any adverse changes in Hong Kongs retail environment, which in turn is highly dependent on spending by mainland tourists. To this end, we note that any adjustments to Chinas import tariff and tax policies on imported luxury products would at least marginally affect mainland consumers desire to shop in Hong Kong. In addition, any tightening, while unlikely, in the current individual visit scheme for mainland travelers would affect tourist traffic into Hong Kong. If these events were to take place, companies with solid establishment in China would be better off as they would benefit from increased domestic sales in China. In our view, Emperor and Luk Fook have the highest net exposure to the Hong Kong market. Percentage of EBIT from Hong Kong
90% 76% 80% 70% 60% 44% 50% 40% 28% 30% 20% 10% 0% Chow Tai Fook Emperor Hengdeli Luk Fook Chow Tai Fook Emperor Hengdeli Luk Fook 25% 49% 58% 83%
Percentage of revenue from Hong Kong

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 83%
Source: Chow Tai Fook, Emperor, Hengdeli and Luk Fook data
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20 April 2012
Commodity price risk

Gold exposure can be hedged Jewelers are vulnerable to fluctuations in the price of raw materials, including gold, platinum, diamonds and gemstones, which could cause margin volatility. Some operators actively hedge their gold price exposure through derivatives and/or gold loans but they remain subject to movements in the price of other raw materials, such as diamonds, for which there are no established hedging instruments. On the other hand, there are jewelers which choose not to aggressively hedge the risk of price changes in their gold inventory. Luk Fook, for instance, hedges only 20% of its gold price risk.
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20 April 2012
Porter and SWOT analysis

Porter
Watches Supplier's bargaining power High Supplier concentration is relatively high as the core watch suppliers are from Switzerland. ASPs and supply quantity are determined by the Swiss watch suppliers, and distributors are not allowed to grant discounts to customers. Hengdeli and Emperor are therefore price takers and source watches locally from Swiss watch suppliers. This policy is the same for all exported Swiss watches. Therefore, there is no differentiation between distributors. Low to moderate Watches can be viewed as a necessity in daily life for timekeeping purpose, although they have gradually turned into a popular accessory. The watch market is enormous and fragmented in China; however, there are only few sizable and reputable luxury watch retailers and Hengdeli and Emperor are leaders among them. Hengdeli also owns the largest luxury watch retail network in China and has a large clientele. Buyer inclination to substitute foreign brand watches with local brand watches is minimal, given heightening brand consciousness in China. Jewelry Moderate Jewelers purchase their gold at market prices. For diamonds and gemstones, sizeable operators with good trade reputations, such as Chow Tai Fook, may enjoy sourcing benefits by having access to quality materials at competitive prices.
Threat of substitutes
Moderate In theory, entry barriers to jewelry retailing are not formidably high. However, new player entry has become difficult due to heavy working capital requirements and escalating rental levels in both Hong Kong and China. It can take a long time for a new brand to build a franchise comparable with that of the leading existing brands as consumer recognition and trust do not develop overnight. The growing presence of foreign brands is a valid concern but they are more concentrated in the luxury segment whereas Chow Tai Fook and Luk Fook target the mass segment. Low Buyer's Low bargaining Since all Swiss watches have a unified ASP, there is little room for buyers to Jewelers price their products based on raw material costs plus a mark up. As power bargain for discounts across the board. Buyers of luxury items are relatively a reflection of the mark up, gross margin has been largely stable for the less price sensitive since they have high spending power, and a minor price companies we track. Generally speaking, room for price negotiation is small, increment will not affect their purchasing decisions. especially at times of strong demand. Small discounts may be offered when the market is slow. Source: CCBIS research
Rivalry among Low to moderate existing Many retailers hope for a share in the rapidly growing luxury watch industry in companies China, yet it is quite difficult to establish a scale comparable to Hengdeli. Likewise, Emperor's network already occupies some of the best locations in prime tourist districts in Hong Kong. It would be difficult for peers to build a strategic alliance with top Swiss watch suppliers as they are very cautious in screening distributors. Hengdeli is one of the few that has been able to maintain a solid bond with these top Swiss watch companies, and is therefore given priority in watch supply and deliveries. Emperor's relationships with its suppliers are similarly strong. Moreover, many customers prefer to shop at Hengdelis stores, which offer a diversified brand portfolio of mid-to-high end watches covering all major consumer segments while others have a limited product mix. Emperor, meanwhile, attracts customers seeking top luxury labels. Customers are confident that Hengdeli and Emperor products are authentic with high quality. Threat of new Low entrants It is very difficult for new players to secure distribution rights or access to Swiss watch suppliers. As Swiss watch suppliers are extremely strict in terms of sourcing, they may only supply a limited range of products to local watch retailers. Moreover, brand identity is exceptionally important for luxury watch retailers, since their brand reputation signifies the assurance of quality and authenticity. The creation of brand identity requires a long period of operation in the market where new players may struggle.
Low Unlike in western countries, event-driven purchases are an important driver of jewelry sales in Greater China. It is a Chinese tradition to present gold jewelry as a gift at ceremonial and festive events such as weddings, Mid-autumn Festival, Chinese New Year, birthday celebrations and to celebrate the arrival of newborns. As an accessory, gold jewelry can be substituted by gem-sets, pearls or other metal accessories through jewelry retailers have the flexibility to adjust and expand their product offerings to meet changing consumer needs. Consumers seeking wealth protection, however, may switch to alternative investment options such as real estate or equity when and if the property and stock markets in China start to improve. Moderate to high Mass luxury jewelry retailers compete on branding, product offerings, product designs, marketing, in-store services, and store network (in terms of number of stores and location). At the individual product level, differentiation tends to be limited and design differences subtle. Competition has intensified in recent years following rapid store network expansion of existing operators. For example, the Hong Kong market and the department store channel in higher-tier cities are generally perceived as reasonably crowded. As a result, we expect leading companies to accelerate expansion into lower-tier cities to take advantage of growth opportunities.
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20 April 2012
SWOT
Hengdeli, Emperor Strengths Chow Tai Fook, Luk Fook Good and long relationships with key watch brands Direct retail model, with multi-store format Key suppliers as strategic investors Leading players in their respective market segment, with strong customer recognition Extensive and rapidly growing store network occupying favorable locations in Hong Kong and China Weaknesses Lack of pricing flexibility Limited brand differentiation Use of franchising business model Heavy working capital requirements Opportunities Attractive industry growth supported by disposable income growth of Chinese consumers as well as other favorable macro developments On-going industry consolidation as mom-and-pop stores and regional chains lose market share to leading national operators. This process can be driven by two forces: (1) local retailers with poor operations and/or branding offer acquisition opportunities; and (2) aggressive expansion plans of the national leaders to capture further market share Opportunities in lower-tier cities Threats Possibility of losing distribution licenses to competing chains upon expiry Entry of foreign jewelry labels Possibility of China lowering import tariffs and taxes on luxury items could reduce mainland customers desire to shop in Hong Kong Source: CCBIS research
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20 April 2012
Chow Tai Fook Jewellery (1929 HK)

Diamonds are forever
Chow Tai Fook Jewellery is Greater Chinas largest and most recognized jewelry brand and retailer with over 80 years of history. It has a strong business franchise and an extensive store presence, among other positives. We view the company as the best-quality proxy for the long-term boom in Chinas jewelry consumption. Nevertheless, we believe the stock is fairly valued on 16x CY12F P/E against a notable SSSG deceleration ahead. We initiate coverage with a Neutral rating on the stock.
Company Rating: Neutral

(initiation)
Price: Target:
HK$11.90 HK$12.50
(initiation)
Trading data
52-week range Market capitalization (m) Shares outstanding (m) Free float (%) 3M average daily T/O (m share) 3M average daily T/O (US$m) Expected return (%) 1 year Closing price on 18 April 2012 HK$11.66 15.16 HK$119,000/US$15,331 10,000 11 10.9 18.9 7.3
Strong franchise. Chow Tai Fook is the No. 1 jeweler in terms of retail sales in both Hong Kong (20%) and China (13%). According to various surveys, Chow Tai Fook enjoys the highest customer recognition in both markets. Its extensive yet still rapidly-growing store network comprising over 1,500 POS is among the largest in Greater China. More importantly, the company has strong coverage in Chinas lower-tier cities where consumption is booming. High-quality operator. We see several major advantages in Chow Tai Fook. It has an effective vertically-integrated business model that provides major cost and product quality benefits. Its exposure to franchising is limited. Active hedging of gold price reduces volatility of its gross margin. Initiate with Neutral. Our earnings projection for FY13F is 6% below consensus estimate. In addition, share price performance is likely to be restricted as SSSG is set to slow materially in the coming months. We initiate coverage with a Neutral rating and our target price implies CY12F and CY13F P/E of 16x and 13x, respectively.
Stock price vs. HSI

HK$ 18.0 16.7
15.4 14.1
12.8
11.5 14-Dec-11 1-Jan-12
19-Jan-12 6-Feb-12 24-Feb-12 13-Mar-12 31-Mar-12 18-Apr-12 Chow Tai Fook HSI (rebased)
Source: Bloomberg
Financial forecast
Year to 31 March Revenue (HK$m) Net profit (HK$m) EPS (HK$) EPS (YoY, %) P/E (x) Yield (%) FCF yield (%) ROAE (%) P/B (x) Net gearing (%) FY10 22,934 2,139 0.214 55.6 0.4 29.5 14.3 2.9 FY11 35,043 3,538 0.354 65 33.6 0.7 36.4 10.2 10.3 FY12F 55,615 6,516 0.652 84 18.3 0.7 (2.0) 32.5 4.0 Net cash FY13F 68,937 7,998 0.800 23 14.9 2.3 (1.5) 24.9 3.3 Net cash FY14F 86,205 10,127 1.013 27 11.8 2.9 5.8 25.6 2.6 Net cash
Forrest Chan, CFA

Claudia Ching
Timothy Sun
Source: Company data, CCBIS estimates
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20 April 2012
Investment highlights
Number one player, mass-market focus Chow Tai Fook is Greater Chinas largest and most recognized jewelry brand and retailer with over 80 years of history. The company focuses on the mass-luxury end of the jewelry market, which is the key segment accounting for 57% of the overall jewelry market of China in 2010. Its leading yet growing scale, market leadership and strong customer recognition make it the best proxy for attractive long-term growth in Chinas jewelry consumption. In addition, Chow Tai Fook has a favourable vertically integrated business model featuring balanced exposure to both the China and Hong Kong markets as well as limited franchising. Market position of jewelers
Luxury
Van Cleef & Arpels Bulgari Tiffany Tesiro Chow Sang Sang 3D-Gold Emperor Watch & Jewellery Jovan TSL CHJ Jewellery Daimengde Fuhui Fuqi Jewelry Kimberlite Diamond Ming Jewelry Laofengxiang Chow Tai Seng Lukfook Cartier
Limited geographic coverage
Laomiao First Asia Jewellery
Extensive geographic coverage
Batar Jewellery
Affordable
Retail value of jewelry market in China with breakdown by price range (2010)
Low-end (price less than HK$2,000) 10% High-end (price greater than HK$100,000) 33%
Mass luxury (price ranging from HK$2,000 to HK$100,000) 57%
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20 April 2012
Leader with strong customer recognition and a reputation for quality

A clear market leadership, well-recognized by customers Chow Tai Fook was the No.1 jewelry retailer in value terms in both China and Hong Kong/Macau in 2010, based on Frost & Sullivans estimates. The Chow Tai Fook ( ) brand was ranked along with Tiffany and Cartier as the top-three brands most likely to be purchased in 2010 in China according to consulting firm Bain & Company. Frost & Sullivan ranked Chow Tai Fook first in jewelry brand awareness in China, Hong Kong and Macau. These rankings are strong evidence of the companys branding and market position. Jewelry market share by retail value in China (2010)
14% 12% 10% 8% 6% 4% 2% 0% Chow Tai Lao Feng Chow Tai Lao Miao Beijing First Asia Zhe Jiang Fook Xiang Seng Caishikou Ming Cartier Luk Fook Kimberlite Diamond Chow Sang Sang 4% 4% 3% 3% 2% 2% 9% 7% 7% 6% 13%
Jewelry market share by retail value in Hong Kong and Macau (2010)
22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Chow Tai Chow Sang Luk Fook Fook Sang MaBelle Cartier Tiffany & Co King Fook Seng Feng Qeelin CSS 9% 7% 4% 20%
3%
2%
2%
2%
2%
2%
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20 April 2012
Unaided brand awareness on total market China (2011)

80% 70% 60% 50% 40% 30% 20% 10% 0% Chow Tai Fook Lao Feng Xiang Chow Sang Sang 35% 34%
Unaided brand awareness on total market Hong Kong and Macau (2011)
80% 70% 60% 50% 40% 30% 20% 10% 0% Chow Tai Fook Tsw Sui Luen Chow Sang Sang 58% 49% 74%
74%
Extensive and fast growing store network with strong access to lower-tier cities
Solid presence in lower-tier cities Chow Tai Fook has an extensive store network of over 1,500 self-operated and franchised point of sales (POS) as of end-September 2011 covering over 320 cities in China, Hong Kong, Macau, Taiwan and selected countries in Southeast Asia. The majority of its stores are jewelry specialty stores with the balance being watch POS. Its network is growing fast, achieving a store count CAGR of 18% between March 2008 and March 2011, or an average 179 new POS per annum. Chow Tai Fook intends to maintain a rapid pace of expansion, as it looks to add about 200 net new jewelry POS annually going forward, targeting a total store count of over 2,000 jewelry POS per year. Chow Tai Fook number of POS
2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 FY08 FY09 FY10 FY11 China POS FY12F FY13F Hong Kong POS FY14F FY15F 821 69 965 70 1,183 85 1,361 84 1,620 92 1,879 100 2,123 106 2,378
110
752
895
1,098
1,277
1,528
1,779
2,017
2,268
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20 April 2012
A first mover into lower-tier cities
Chow Tai Fook made an early move into lower-tier cities where market growth is phenomenal. It entered tier-3 and tier-4 cities as early as 2000 and 2002, respectively, and has already established a strong presence. 34% and 18% of its jewelry and watch POS are located in tier-3 or below cities, based on its September 2011 store count. Frost & Sullivan forecasts impressive jewelry market CAGR of 45% in lower-tier cities, versus only 32% and 37% for tier-one and tier-two cities. Retail value of jewelry market in China with breakdown by city tier
100%
Retail value of jewelry market in China with breakdown by city tier

RMB b 1,300 1,170 1,040 910 780 650 520 390 260 130 0 35 26 36 37 28 46 2006 2007 46 48 57 2008 58 61 65 124 85 82 85 115 113 C 181 215 158 150 197 259 338 264 294 401 382
2010-2015F CAGR: Tier-1 cities = 32% Tier-2 cities = 37% Tier-3 cities = 45%
90% 80%
29%
30%
30%
31%
34%
35%
37%
39%
41%
43%
551
70% 60% 50% 40% 30% 20% 10% 0% 2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015F Tier-1 Tier-2 Tier-3
31%
31%
32%
33%
33%
33%
32%
32%
31%
31%
40%
39%
38%
36%
34%
32%
31%
29%
28%
26%
2009 2010 2011F 2012F 2013F 2014F 2015F Tier-1 Tier-2 Tier-3
Contribution from Hong Kong not excessive
Chow Tai Fooks solid presence in China means it can be less dependent on the Hong Kong market. As shown in the following chart, Chow Tai Fook derives a smaller proportion of its sales and EBIT from Hong Kong than Luk Fook or Chow Sang Sang, which suggests smaller concentration risk. Chow Tai Fook EBIT from Hong Kong vs. peers
90% 83%
Chow Tai Fook sales from Hong Kong vs. peers

90% 80% 70% 60% 50% 40% 30% 20% 10% 28% 44% 83% 76% 73%
80% 70% 60% 50% 40% 30% 20% 10% 25% 58% 49%
0% Emperor Watch Luk Fook Chow Sang Sang Chow Tai Fook Hengdeli 0% Emperor Watch Luk Fook Chow Tai Fook Hengdeli
Source: Chow Sang Sang, Chow Tai Fook, Emperor, Hengdeli and Luk Fook data
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20 April 2012
Sourcing advantages and vertical integration

Extensive involvement in every stage of supply chain Chow Tai Fook has an effective vertically integrated business model that allows it to exert significant control over procurement, design, production, marketing and sales processes. The group therefore enjoys high efficiency and cost benefits, and has ability to ensure stable and quality supplies. Key aspects of Chow Tai Fooks vertically integrated business model and procurement strengths are worth further discussion: In-house diamond processing capacity. 40% of its diamond requirement is met by its three diamond cutting and polishing facilities in South Africa and Shunde, China, where rough diamonds are cut and polished. Strong relationships with DTC and Rio Tinto. Chow Tai Fook is a sightholder of the Diamond Trading Company (DTC) through Zlotowskis, one of its wholly-owned subsidiaries. Another of its subsidiary, Chow Tai Fook Hong Kong, is also a DTC Sightholder. In 2009, the group became a Rio Tinto Select Diamantaire. Under the agreements with DTC and Rio Tinto, Chow Tai Fook is supplied with rough diamonds meeting pre-agreed specifications up to a stipulated value and for a specified period. DTC and Rio Tinto account for a significant portion of Chow Tai Fooks demand for rough diamonds. Access to rare stones. Thanks to its reputation, Chow Tai Fook is often invited to auctions to bid for rare and unique diamonds. In 2010, Zlotowski successfully won the bid for the 507-carat Cullinan Heritage rough diamond for US$35.3m, the highest sale price on record for a rough diamond. Successful bidding in rare diamonds or gemstones enhances Chow Tai Fooks global exposure and media publicity. In-house production. As at 30 September 2011, Chow Tai Fook operated a total of 12 factories consisting of nine jewelry factories and three diamond cutting and polishing facilities. The nine jewelry factories together hire over 3,500 employees, occupying a total area of over 42,000 sqm. Since 2008, the group has produced 80% of its gem-set jewelry products in-house, or about 50% if other products are included. The basic rationale behind its outsourcing is to keep its own production capacities focused on gem-set jewelry products, while using external producers for simple or low value products.
Chow Tai Fooks production facilities

Location Hong Kong Shenzhen, China Shunde, China Shunde, China South Africa Source: Company data Number of factories 1 4 4 1 2 Specialization Gem-set jewelry Gem-set jewelry, karat gold and gold products Gem-set jewelry, platinum/karat gold and gold products Diamond cutting and polishing Diamond cutting and polishing
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20 April 2012
Limited franchising
More use of direct retail Unlike the majority of its key competitors, Chow Tai Fook has a relatively low ratio of franchised stores in its store base. All of its outlets in Hong Kong and Macau are self-operated, whereas franchised stores, selling products exclusively supplied by Chow Tai Fook, only account for 32% of its store count in mainland China. Its franchising model is mainly employed in tier-three and tier-four cities. Chow Tai Fook has good control over its franchised stores, and does not often grant any credit terms while setting the same operational standards as its self-managed stores. We regard Chow Tai Fooks limited franchising as a positive. Chow Tai Fook is also in the process of converting some of its franchised stores to joint-venture POS. Chinas jewelry POS by operation model 2010
Chow Tai Fook franchised POS as % of China total

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY08 FY09 FY10 FY11 FY12F FY13F Self-owned Franchised FY14F FY15F
27%
29%
28%
31%
31%
32%
33%
34%
Self-operated 32%
73%
71%
72%
69%
69%
68%
67%
66%
Franchsied 68%
Active hedging of gold price exposure

90% of gold inventory hedged Chow Tai Fook manages commodity price risks mainly by hedging gold price fluctuations through gold loans and bullion forward contracts. Changes in the fair value of gold loans and bullion forward contracts are reflected in the companys COGS to offset price changes in its gold inventory and, hence, provide stability to the gross margin of Chow Tai Fooks gold products. We understand that Chow Tai Fook has one of the most active hedging policies of its peers as it hedges nearly c.90% of its exposure to gold price. For the remainder of its product mix, the company looks to pass on price increases to its customers.
Strong presence in department store channel

As oat end-September 2011, 778 out of Chow Tai Fooks 884 self-operated POS in China were concessionaire counters located within department stores paying turnover-linked commission (i.e. rent). While alternative retail formats such as shopping malls are developing quickly in China, the department store format remains the major channel where mid-to-high end consumption takes place. Chow Tai Fooks significant presence within department stores ensures that it maximizes its exposure to target customer segments. It also reduces operating leverage, providing greater margin stability.
30
20 April 2012
China's jewelry sales breakdown by retail channel (2010)

Others (including the Internet) 2% Specialised markets 10%
Stores in shopping malls 14%
Department stores 44%
Stand-alone branded stores 30%
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20 April 2012
Key earnings drivers

We forecast 25% earnings CAGR for Chow Tai Fook in FY12F-14F to be driven by the following factors:
New openings and SSSG

We estimate c.250 net new openings to be achieved per annum going forward, implying a mid-teen rate of POS growth. Our understanding is that locations have been secured or confirmed via MOU for a majority of Chow Tai Fooks planned openings in FY13F. SSSG of 10-12% and 15-16% is assumed for FY13F and FY14F, respectively. Chow Tai Fook revenue projections
Year to March (HK$m) Total revenue YoY (%) Revenue by market Retail, China Retail, Hong Kong, Macau and others Wholesale, China Wholesale, Hong Kong, Macau and others Revenue growth by market (%) Retail, China Retail, Hong Kong, Macau and others Wholesale, China Wholesale, Hong Kong, Macau and others Revenue mix by market (%) Retail, China Retail, Hong Kong, Macau and others Wholesale, China Wholesale, Hong Kong, Macau and others Revenue by sales channel Retail Wholesale Revenue growth by sales channel (%) Retail Wholesale Revenue mix by sales channel (%) Retail Wholesale Source: Company data, CCBIS estimates 81.1 18.9 85.1 14.9 85.7 14.3 83.5 16.5 83.0 17.0 82.5 17.5 82.9 17.1 31 (2) 54 47 55 83 23 28 24 29 22 19 14,926 3,485 19,523 3,410 30,033 5,009 46,438 9,177 57,215 11,722 71,079 15,126 86,771 17,955 36.7 44.4 17.6 1.3 40.8 44.3 14.3 0.6 41.6 44.1 13.9 0.4 40.1 43.4 16.1 0.4 41.2 41.8 16.6 0.4 41.8 40.6 17.2 0.4 43.0 39.8 16.8 0.3 38 24 1 (42) 56 52 49 (3) 53 56 83 75 27 19 28 15 27 22 29 15 25 19 19 15 6,758 8,168 3,247 238 9,355 10,168 3,274 137 14,595 15,438 4,877 133 22,327 24,111 8,945 232 28,424 28,791 11,455 267 36,075 35,004 14,819 307 45,061 41,710 17,602 353 2009 18,411 2010 22,934 25 2011 35,043 53 2012F 55,615 59 2013F 68,937 24 2014F 86,205 25 2015F 104,726 21
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20 April 2012
Stable gross margin

Upside from business mix improvements Chow Tai Fook actively hedges its gold price exposure using forward contracts and gold loans, and prices its gold products on a daily basis according to prevailing gold price. As a result, its gold products carry a stable gross margin of 10% in Hong Kong and 20-22% in China. Gem-set products are usually priced at a mark-up to their cost of purchase and have higher margin at 35%+. Hence, we believe Chow Tai Fooks overall gross margin is broadly driven by product mix changes, and to a lesser extent, retail discounting level. Share of gold products in Chow Tai Fooks sales mix has increased since FY09 which we attributed to rising gold price, which lifted ASPs and in turn stimulated demand. However, the companys long-term strategic intention is to gradually increase the share of gem-set products in its sales mix since there is better room for consumer to trade-up within the gem-set segment. In the meantime, the mix between direct retail and wholesale in Chow Tai Fooks sales mix is another factor determining Chow Tai Fooks gross margin given the higher gross margin of sales of its directly-managed stores. However, we foresee the mix to be fairly stable in the foreseeable future. Chow Tai Fook sales mix by channel
7%
Chow Tai Fook sales mix by product

100%
6% 7%
100% 90%
19% 15% 14% 17% 17% 18% 17%
80%
80% 70%
60%
64%
64%
67%
60% 50%
85% 86%
40%
40% 30%
81%
83%
83%
82%
83%
20%
30%
20%
29% 26%
10% 0% FY09 FY10 FY11 FY12F FY13F Direct retail Wholesale FY14F FY15F
0% FY09 FY10 Gem-set jewelry Gold items FY11 Watches
Chow Tai Fook gross margin by product

52% 47% 45%
Chow Tai Fook gross margin trend

30.0% 29.6% 29.7% 29.8%
39%
29.5% 27%
29.5%
26% 15% 13%
29.0%
28.9%
28.6% 28.5% 28.3%
0% Gem-set jewelry Platinum/karat gold products Watches Gold products 28.0% FY09 FY10 FY11 FY12F FY13F FY14F FY15F
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20 April 2012
SG&A expenses
Staff cost is modelled as an assumed percentage of turnover. Like most peers, Chow Tai Fook has a compensation scheme linking a substantial portion of staff compensation to individual store and individual member performance. Staff cost expense ratio is expected to decline in years of extremely high SSSG such as FY11 and FY12F, whereas a slower sales environment may see a stable or modestly higher ratio due to structural growth in Chinas wage level. In FY11, concessionaire fees accounted for up to 75% of Chow Tai Fooks total rental and commission expense. This ratio should continue to increase as its China unit, which employs predominantly the department store counter store format, increases contribution to the overall business mix. We project that the average effective commission rate applicable to Chow Tai Fooks concessionaire counters will decrease over time as a result of more openings in lower-tier markets where commission rates are lower. We therefore project slower increases in concessionaire fee per counter than SSSG in China.
Tax rate
The groups effective tax rate is largely as function of changes in its geographic exposure. Most of its subsidiaries based in China are subject to the standard income tax rate of 25%. In Hong Kong, its businesses face a lower profit tax rate of 25.8%. From FY13F and onwards, we expect Chinas business to grow faster aided by more rapid store expansion and we forecast Chow Tai Fooks effective tax rate will rise steadily.
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20 April 2012
Chow Tai Fook key assumptions

Year to March (HK$m) Total POS China sub-total China self-operated jewelry POS China franchised jewelry POS China watch POS Hong Kong/Macau sub-total Hong Kong/Macau jewelry POS Hong Kong/Macau watch POS Total POS YoY change China sub-total China self-operated jewelry POS China franchised jewelry POS China watch POS Hong Kong/Macau sub-total Hong Kong/Macau jewelry POS Hong Kong/Macau watch POS Total POS YoY change (%) China sub-total China self-operated jewelry POS China franchised jewelry POS China watch POS Hong Kong/Macau sub-total Hong Kong/Macau jewelry POS Hong Kong/Macau watch POS SSSG (%) China Hong Kong/Macau Average revenue per franchised store (RMB m) YoY (%) Gross margin (%) Total staff cost as % of retail sales Rental per retail store (HK$m) YoY (%) Commission per concessionaire POS (HK$m) YoY (%) Other expenses as % of retail revenue Source: Company data, CCBIS estimates 12.3 28.9 7.2 4.5 15.2 16.0 10.2 (17) 28.6 6.8 2.3 1.6 4.7 35.2 32.4 12.1 19 28.3 6.1 2.8 21.1 2.0 26.7 4.2 33.5 53.5 17.0 40 29.5 5.8 3.1 12.0 2.5 26.6 3.9 10.2 11.6 17.5 3 29.6 5.8 3.4 10.0 2.6 3.2 3.8 15.0 16.1 18.7 7 29.7 5.9 3.8 11.0 2.8 6.2 3.7 14.7 15.9 18.7 0 29.8 5.8 4.2 10.0 3.1 13.0 3.6 2009 965 895 634 261 0 70 70 0 144 143 87 0 56 1 1 0 18 19 16 27 1 1 0 2010 1,183 1,098 732 302 64 85 81 4 218 203 98 64 41 15 11 4 23 23 15 16 21 16 0 2011 1,361 1,277 815 391 71 84 81 3 178 179 83 7 89 (1) 0 (1) 15 16 11 29 11 (1) 0 (25) 2012F 1,620 1,528 962 474 92 92 88 4 259 251 147 21 83 8 7 1 19 20 18 21 30 10 9 33 2013F 1,879 1,779 1,107 570 102 100 95 5 259 251 145 9 97 8 7 1 16 16 15 20 10 9 8 25 2014F 2,123 2,017 1,238 667 112 106 100 6 244 238 131 10 97 6 5 1 13 13 12 17 10 6 5 20 2015F 2,378 2,268 1,373 772 123 110 103 7 255 251 134 11 105 4 3 1 12 12 11 16 10 4 3 17
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20 April 2012
Chow Tai Fook profit and loss projections

Year to March (HK$m) Total revenue YoY (%) COGS YoY (%) Gross profit YoY (%) Gross margin (%) Other income and gains Staff costs YoY (%) As % of turnover Depreciation YoY (%) As % of turnover Donation YoY (%) As % of turnover Rental cost and concessionaire fees YoY (%) As % of turnover Other expenses YoY (%) As % of turnover Total SG&A and other expenses YoY (%) As % of total turnover EBIT YoY (%) EBIT margin (%) Depreciation and amortization included in SG&A EBITDA YoY (%) EBITDA margin (%) Interest income Interest expense Share of results of an associate Profit before tax YoY (%) As % of turnover Tax Effective tax rate (%) Minority interest 2009 18,411 (13,085) 5,326 28.9 72 (1,076) 5.8 (161) 0.9 (164) 0.9 (1,036) 5.6 (671) 3.6 (3,107) 16.9 2,291 12.4 161 2,130 11.6 89 (157) 1 2,224 12.1 (309) 13.9 (18) 2010 22,934 25 (16,379) 25 6,555 23 28.6 98 (1,320) 23 5.8 (226) 41 1.0 (117) (29) 0.5 (1,370) 32 6.0 (926) 38 4.0 (3,958) 27 17.3 2,695 18 11.8 226 2,469 16 10.8 77 (62) 9 2,719 22 11.9 (512) 18.8 (68) 2,139 13 9.3 2011 35,043 53 (25,115) 53 9,928 51 28.3 164 (1,821) 38 5.2 (247) 9 0.7 (122) 4 0.3 (1,996) 46 5.7 (1,249) 35 3.6 (5,435) 37 15.5 4,656 73 13.3 255 4,402 78 12.6 70 (102) (5) 4,620 70 13.2 (947) 20.5 (135) 3,538 65 10.1 2012F 55,615 59 (39,209) 56 16,406 65 29.5 260 (2,693) 48 4.8 (377) 53 0.7 (120) (2) 0.2 (2,803) 40 5.0 (1,811) 45 3.3 (7,805) 44 14.0 8,861 90 15.9 385 8,475 93 15.2 96 (274) 0 8,683 88 15.6 (1,884) 21.7 (282) 6,516 84 11.7 2013F 68,937 24 (48,531) 24 20,405 24 29.6 233 (3,318) 23 4.8 (527) 40 0.8 (140) 17 0.2 (3,403) 21 4.9 (2,174) 20 3.2 (9,562) 23 13.9 11,076 25 16.1 534 10,541 24 15.3 149 (335) 0 10,890 25 15.8 (2,472) 22.7 (420) 7,998 23 11.6 2014F 86,205 25 (60,602) 25 25,603 25 29.7 273 (4,194) 26 4.9 (676) 28 0.8 (160) 14 0.2 (4,111) 21 4.8 (2,630) 21 3.1 (11,770) 23 13.7 14,106 27 16.4 684 13,422 27 15.6 176 (246) 0 14,036 29 16.3 (3,326) 23.7 (583) 10,127 27 11.7 2015F 104,726 21 (73,518) 21 31,208 22 29.8 305 (5,033) 20 4.8 (802) 19 0.8 (180) 13 0.2 (5,107) 24 4.9 (3,124) 19 3.0 (14,245) 21 13.6 17,268 22 16.5 810 16,458 23 15.7 215 (228) 0 17,255 23 16.5 (4,193) 24.3 (795) 12,267 21 11.7 1H11 13,315 (9,614) 3,701 27.8 66 (752) 5.6 (113) 0.8 (21) 0.2 (832) 6.3 (492) 3.7 (2,210) 16.6 1,557 11.7 35 (30) 0 1,562 0 11.7 (339) 21.7 (48) 1,176 8.8 2H11 21,728 (15,501) 6,226 28.7 98 (1,069) 4.9 (134) 0.6 (101) 0.5 (1,164) 5.4 (757) 3.5 (3,225) 14.8 3,099 14.3 36 73 (5) 3,203 0 14.7 (609) 19.0 (87) 2,507 11.5 1H12 23,875 79 (16,734) 74 7,141 93 29.9 166 (1,370) 82 5.7 (154) 36 0.6 (8) (63) 0.0 (1,235) 48 5.2 (844) 72 3.5 (3,610) 63 15.1 3,697 137 15.5 38 (117) 0 3,618 132 15.2 (797) 22.0 (129) 2,692 129 11.3 2H12F 31,741 46 (22,475) 45 9,266 49 29.2 93 (1,324) 24 4.2 (224) 67 0.7 (112) 11 0.4 (1,568) 35 4.9 (967) 28 3.0 (4,195) 30 13.2 5,164 67 16.3 58 158 0 5,380 68 16.9 (1,087) 20.2 (153) 4,140 65 13.0
Net profit 1,897 YoY (%) Net margin (%) 10.3 Source: Company data, CCBIS estimates
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20 April 2012
Balance sheet and cash flow

Chow Tai Fooks balance sheet has been significantly enhanced by its listing. We estimate its net cash position will exceed HK$8b by end-FY12F. The companys cash flow health is closely related to its expansion pace and the prevailing gold price. Store fitout cost is usually around HK$1-2m per new opening but working capital requirement for each opening can be as high as HK$8-10m at the current gold price. Working capital needs of existing stores also rise in tandem with higher gold price. Sharp rises in gold price during 2010 and 2011 have led to negative operating cash for Chow Tai Fook in FY11 and 1HFY12. Given our assumption of slower gold price growth in FY13 and onwards, we estimate that positive operating cash flow will resume to finance estimated capex of HK$0.9-1.2b per annum. Chow Tai Fook cash flow projections
Year to March (HK$m) EBIT Depreciation and amortization EBITDA Adjustments for other non-cash items Working capital changes: Inventory Receivables Payables Defined benefits paid Gold loans Pledged deposit Tax paid Interest paid Interest received Operating cash flow Capex Free cash flow Other investment cash flows Contribution from minority shareholders Share issue Dividend paid Advance/repayment to/from minority shareholders Net cash flow Source: Company data, CCBIS estimates 2009 2,291 161 2,451 54 (822) 177 (385) (7) 323 (390) (366) (157) 89 968 (485) 483 8 6 5 0 25 526 2010 2,695 226 2,921 473 (1,186) (1,069) 490 (7) (355) 242 (399) (62) 77 1,125 (320) 806 7 14 5 (7) 56 881 2011 4,656 255 4,911 720 (7,508) (675) 677 (7) 984 68 (730) (102) 70 (1,592) (824) (2,416) 24 21 2 (9) 75 (2,304) 2012F 8,861 385 9,246 900 (10,915) (1,037) 1,362 (7) 1,268 (39) (1,535) (274) 96 (935) (900) (1,835) (19) 0 15,500 (4,500) 135 9,281 2013F 11,076 534 11,610 1,050 (2,471) (741) 622 (7) 350 (15) (2,253) (335) 149 7,959 (1,050) 6,909 1 0 0 (1,308) 70 5,672 2014F 14,106 684 14,789 1,200 (6,767) (771) 1,166 (7) 300 (10) (3,008) (246) 176 6,822 (1,200) 5,622 1 0 0 (1,727) 80 3,976 2015F 17,268 810 18,078 1,300 (5,253) (1,178) 1,183 (7) 700 (20) (3,870) (228) 215 10,919 (1,200) 9,719 0 0 0 (2,154) 60 7,626
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20 April 2012
Chow Tai Fook balance sheet projections

Year to March (HK$m) Property, plant and equipment Prepaid lease payments Deposits Interest in an associate Amounts due from related companies Loan receivables Non-current assets total Inventories Trade receivables Other receivables Amounts due from related companies Loan receivables Convertible bonds Derivative financial instruments Taxation recoverable Pledged deposit Cash Current assets total Trade payables Other payables Amounts due to related companies Amounts due to minority shareholders Taxation payable Bank borrowings Gold loans Current liabilities total Retirement benefit obligations Shareholders equity Minority interest Total equity Total assets Total liabilities and equities Gross debt Net debt Net gearing (%) Source: Company data, CCBIS estimates 2009 715 0 86 39 30 35 905 8,094 540 826 2,135 136 0 0 16 468 1,290 13,504 212 603 4,727 28 39 114 2,061 7,784 184 6,343 99 6,442 14,410 14,410 2,174 885 14 2010 835 0 51 48 80 35 1,049 9,275 1,054 1,382 1,782 136 0 0 0 226 2,107 15,962 381 926 4,640 84 131 160 2,189 8,511 164 8,157 179 8,335 17,010 17,010 2,350 243 3 2011 1,165 87 232 45 0 16 1,546 17,101 1,632 1,595 1,278 135 0 0 0 156 5,605 27,503 384 1,666 7,833 165 353 2,881 3,932 17,213 163 11,307 366 11,673 29,049 29,049 6,813 1,208 10 2012F 1,740 99 150 45 0 15 2,049 28,016 2,329 1,947 50 130 25 0 0 195 21,400 54,092 798 2,614 9,000 300 702 7,000 6,100 26,514 200 28,779 648 29,427 56,140 56,140 13,100 (8,300) Net cash 2013F 2,313 80 100 45 0 14 2,552 30,488 2,959 2,068 0 130 25 0 0 210 26,122 62,002 931 3,102 11,000 370 921 4,000 7,500 27,824 220 35,442 1,068 36,510 64,554 64,554 11,500 (14,622) Net cash 2014F 2,887 62 50 45 0 13 3,057 37,254 3,654 2,155 0 130 25 0 0 220 30,598 74,036 1,061 4,138 12,500 450 1,240 3,000 9,000 31,389 240 43,814 1,650 45,465 77,094 77,094 12,000 (18,598) Net cash 2015F 3,285 43 50 45 0 13 3,437 42,508 4,380 2,618 0 130 25 0 0 240 39,224 89,124 1,356 5,027 13,500 510 1,562 3,000 11,000 35,955 260 53,901 2,445 56,346 92,561 92,561 14,000 (25,224) Net cash 1H12 1,619 102 211 49 0 16 1,996 28,878 1,956 1,549 88 134 25 165 0 187 3,205 36,187 755 2,383 8,459 239 757 9,022 4,961 26,575 191 10,927 490 11,417 38,183 38,183 13,983 10,777 94
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20 April 2012
Chow Tai Fook cash conversion cycle and working capital days
250 200 150 100 50 13 0 (7) (50) FY10 FY11 FY12F Average inventory days Average receivable days FY13F Average payable days FY14F FY15F Cash conversion cycle (days) (6) (6) (7) (6) (6) 14 13 14 14 14 194 200 192 200 210 218 220 228 204 212
198
206
Chow Tai Fook operating cash flow, free cash flow and net cash flow projections
HK$m 13,000 11,000 9,000 7,000 5,000 3,000 1,000 (1,000) (3,000) (5,000) FY09 FY10 FY11 Operating cash flow FY12F FY13F FY14F Free cash flow Net cash flow FY15F (1,592) (2,304) (2,416) 968 1,125 806 881 10,919 9,281 7,959 6,909 5,672 6,822 5,622 3,976 483526 9,719 7,626
(935) (1,835)
Chow Tai Fook key financial ratios

Year to March ROAE (%) ROAA (%) ROIC (%) Average inventory days Average receivable days Average payable days Cash conversion cycle (days) Net gearing (%) Gross gearing (%) Source: Company data, CCBIS estimates 2009 13.7 33.8 2010 29.5 14.0 21.2 194 13 7 200 2.9 28.2 2011 36.4 15.9 24.3 192 14 6 200 10.3 58.4 2012F 32.5 16.0 28.1 210 13 6 218 Net cash 44.5 2013F 24.9 13.9 27.2 220 14 7 228 Net cash 31.5 2014F 25.6 15.1 29.7 204 14 6 212 Net cash 26.4 2015F 25.1 15.4 30.9 198 14 6 206 Net cash 24.8
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20 April 2012
Senior management and shareholding structure

Dato Dr. Cheng Yu-Tung Honorary chairman and non-executive director
Dato Dr. Cheng Yu-Tung, age 85, is responsible for advising on overall strategic planning and management of the group. Dr. Cheng joined the group in January 1947 as a trainee and was eventually promoted to become the permanent chairman of Chow Tai Fook Hong Kong in March 1961. Dr. Cheng is the permanent chairman of Chow Tai Fook Enterprise, a sister company of Chow Tai Fook, and a director of CYT Family Holdings, CYT Family Holdings II, Chow Tai Fook Capital and Chow Tai Fook Holding. Dr. Cheng is also the chairman and non-executive director of NWD; non-executive director of Shun Tak Holdings Limited; non-executive director of SJM Holdings Limited; chairman and executive director of Melbourne Enterprises Limited; and chairman and non-executive director of Lifestyle International. Dr. Cheng is the father of Dr. Cheng Kar-Shun, Henry, the grandfather of Mr. Cheng Chi-Kong, Adrian and Mr. Cheng Chi-Heng, Conroy, an uncle of Mr. Cheng Kam-Biu, Wilson and Mr. Cheng Sek- Hung, Timothy and the elder brother of Mr. Cheng Yu-Wai.
Dr. Cheng Kar-Shun, Henry Chairman and executive director

Dr. Cheng Kar-Shun, Henry, age 64, is the chairman and executive director and a member of the companys Nomination Committee and Remuneration Committee. Dr. Cheng is responsible for the strategic direction and overall performance of Chow Tai Fook. He joined the company in 1971 and has served as a director of Chow Tai Fook Hong Kong since May 1971 and as vice-chairman since March 2007. Dr. Cheng is also a director of CYT Family Holdings and Chow Tai Fook Holding and is the vice chairman of Chow Tai Fook Enterprise. He also holds the following positions in other companies including managing director of NWD; chairman and managing director of NWCL; chairman and executive director of NWS; chairman and non-executive director of NWDS; chairman and executive director of International Entertainment Corporation, independent non-executive director of HKR International Limited, and non-executive director of Lifestyle International. In addition, Dr. Cheng was also the chairman and executive director of Taifook Securities Group Limited up to his resignation in 2010. Dr. Henry Cheng is the eldest son of Dato Dr. Chen Yu-Tung, the father of Mr. Cheng Chi Kong, Adrian, an uncle of Mr. Cheng Chi-Heng, Conroy, a cousin of Mr. Cheng Kam-Biu, Wilson, and Mr. Cheng Sek Hung, Timothy and a nephew of Mr. Cheng Yu-Wai.
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20 April 2012
Mr. Wong Siu-Kee, Kent Managing director

Mr. Wong Siu-Kee, Kent, age 55, is responsible for the overall management of the group. He is a member of the companys Nomination Committee and Remuneration Committee. He joined the group in 1977, working initially as a trainee. Mr. Wongs diverse experience in both operations and management led to his appointment as the general manager of the PRC business of the group in 1999, where he was responsible for developing the groups market in mainland China. Since 2002, Mr. Wong has taken the position of director of Chow Tai Fook Hong Kong and Chow Tai Fook Enterprise, and in 2008 he was promoted to managing director of Chow Tai Fook Hong Kong. Mr. Wong is a member of HKTDC Watches and Clocks Advisory Committee, director of welfare of the HK Jewellers & Goldsmiths Association, chairman of the supervising committee of the HK & Kowloon Jewellers & Goldsmiths Employees Association Ltd.
Mr. Cheng Chi-Kong, Adrian Executive director

Mr. Cheng Chi-Kong, Adrian, age 31, is responsible for the marketing of the group as well as customer relationship management and branding and e-commerce operations. Adrian joined the group in 2007 as a director of Chow Tai Fook Hong Kong. Prior to joining the group in April 2007, Mr. Cheng worked at UBS AG in the Corporate Finance group from 2003 to 2006. Mr. Cheng also holds the following positions in companies listed on the Main Board of the Stock Exchange, including executive director of NWD; executive director of NWCL; executive director of NWDS; and executive director of International Entertainment Corporation. He is a director of Chow Tai Fook Holding and Chow Tai Fook Enterprise. Mr. Cheng is a grandson of Dato Dr. Cheng Yu-Tung, a son of Dr. Cheng Kar-Shun, Henry, a cousin of Mr. Cheng Chi-Heng, Conroy, a nephew of Mr. Cheng Kam-Biu, Wilson and Mr. Cheng Sek-Hung, Timothy and a grandnephew of Mr. Cheng Yu-Wai.
Mr. Cheng Chi-Heng, Conroy Executive director

Mr. Cheng Chi-Heng, Conroy, age 33, is responsible for the procurement and production of diamonds and gemstones. He has been a director of Chow Tai Fook Hong Kong since 2007. He is also an executive director of NWD and a director of Chow Tai Fook Enterprise and Chow Tai Fook Holding. Conroy worked at Yu Ming Investment Management Ltd. from 1999 to 2000 as a corporate finance executive. He is a grandson of Dato Dr. Cheng Yu-Tung, a nephew of Dr. Cheng Kar-Shun, Henry, Mr. Cheng Kam-Biu, Wilson and Mr. Cheng Sek-Hung, Timothy, a cousin of Mr. Cheng Chi-Kong, Adrian and a grandnephew of Mr. Cheng Yu-Wai.
Mr. Chan Sai-Cheong Executive director

Mr. Chan Sai-Cheong, age 49, is responsible for the groups PRC and overseas operations. He joined the group in 1985 as a salesman and was appointed director of Chow Tai Fook Hong Kong in July 2005. Mr. Chan has over 31 years of working experience in the jewelry industry.
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20 April 2012
Mr. Chan Hiu-Sang, Albert Executive director

Mr. Chan Hiu-Sang, Albert, age 60, is responsible for the groups diamond procurement and operations of the diamond department. Mr. Chan joined the group in 1977 as a member of the diamond procurement team and was appointed a director of Chow Tai Fook Hong Kong since January 2006.
Mr. Cheng Ping-Hei, Hamilton Executive director

Mr. Cheng Ping-Hei, Hamilton, age 36, is the finance director responsible for the groups financial management and overseeing the groups company secretarial functions. He joined the group in 2004 as a finance manager and subsequently became the Head of Financial Management of the group in February 2011.
Mr. Suen Chi-Keung, Peter Executive director

Mr. Suen Chi-Keung, Peter, age 46, is responsible for the Hong Kong and Macau operations. Mr. Suen joined the group in 1985 as a trainee and was appointed as the administrative manager in 2010. He served as a general manager of the Hong Kong and Macau operations since February 2011. Chow Tai Fooks shareholding structure
Chow Tai Fook (Holdings) Ltd. 89.5%
Public 10.5%
Chow Tai Fook (1929 HK)

Source: HKEx, CCBIS research
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20 April 2012
Emperor Watch & Jewellery (887 HK)

Veni, vidi, vici
Emperor Watch & Jewellery (Emperor) is a leading Greater China retail name carrying European-made ultra-luxury watch labels. Known for stocking classic brands, the company has an exceptional franchise. Its stores have become a must-go destination for affluent Chinese shoppers coming to Hong Kong, while its unique investment story is being further enriched by its growing exposure to the mainland market and to jewelry products. We initiate coverage on the stock with an Outperform rating. Strong ties with suppliers. Emperor has a long-standing partnership with key Swiss watch brand owners which allows it to source a wide range of internationally renowned watches. This avails it of a comprehensive product and brand portfolio. Emperors solid sales track record has helped it gain the confidence and support of brand owners. Jewelry business offers synergies and upside. Emperor has built a strong franchise by offering premium quality jewelry under its own brand. While Emperors jewelry business only accounts for 18% of sales, we believe this high margin business and the cross-selling potential it entails has not been tapped. Emperor has shifted focus to expanding this segment by opening more jewelry stores and through additional marketing. Synergies with sister companies and L Capital. Emperor enjoys significant synergies availed to it by its relationship with Emperor Group and its partnership with L Capital, especially when it comes to negotiating with suppliers and landlords. These relationships make cross-promotional and marketing activities possible. Initiate with Outperform. Our target price of HK$1.40, based on CY13F P/E of 8x, represents a 30% discount to Hengdeli.
Company Rating: Outperform

(initiation)
Price: Target:
HK$1.20 HK$1.40
(initiation)
Trading data
Stock price vs. HSI

HK$ 1.85 1.62
1.39 1.16
0.93 0.70 19-Apr-11
1-Jul-11 12-Sep-11 24-Nov-11 5-Feb-12 Emperor Watch & Jewellery HSI (rebased)
18-Apr-12
Source: Bloomberg
Financial forecast
Year to 31 December Revenue (HK$m) Core net profit (HK$m) EPS (HK$) EPS (YoY, %) P/E (x) Yield (%) FCF yield (%) ROAE (%) P/B (x) Net gearing (%) FY10 4,095 325 0.053 23 22.5 1.5 (5.0) 6.6 5.7 Net cash FY11 5,862 636 0.097 82 12.3 2.3 (8.3) 20.5 5.2 Net cash FY12F 7,607 784 0.128 31 9.4 3.0 1.8 18.7 3.6 Net cash FY13F 9,987 1,031 0.168 31 7.2 3.9 3.5 20.7 2.1 Net cash FY14F 12,355 1,266 0.206 23 5.8 4.8 6.8 21.2 1.8 Net cash
Claudia Ching
Forrest Chan, CFA

Timothy Sun
43
20 April 2012
Emperor is a leading Greater China name in watches and jewelry, known especially for its European-made luxury watches and in-house designed fine jewelry. The company has shops in Hong Kong, Macau and China and targets middle-to-high income earners. Having built its brand over the last 70 years, the company is now a well recognised name, known for stocking classic luxury brands in Hong Kong. Emperor has become one of the must-visit watch and jewelry shops for affluent Chinese shoppers. Offers the finest collection of top-notch European-made luxury watches and premium fine jewelry Besides its wide range of prestigious and luxury European watches, Emperor offers in-housed designed fine jewelry products made of diamonds, jade, pearl, 999.9K fine gold and other precious stones. These are sold under its Emperor brand. Luxury watch sales accounted for 82% of sales in FY11, while the contribution from the jewelry segment is growing. Emperor has the necessary qualities to capture long-term growth in Chinas luxury watch segment, with store network expansion underpinning its market share gains. It operates a direct-retail business model and a dual-format store network of both multi-brand and mono-brand outlets, which we view as a vital to in its long-term success. Over the years, the company has earned strong customer recognition and loyalty, and it now enjoys long-standing relationships with renowned international watch suppliers.
Long-standing relationships with top international brands

Extensive brand mix supported by its long-standing partnership with top Swiss watch brand suppliers Established in 1942, Emperor can claim over 70 years of experience in the watch and jewelry business. During that time, Emperor developed long-term partnerships with major watch brands which now allow it to offer a wide range of internationally renowned Swiss watches. The group has a diversified brand mix, with 19 international watch labels in Hong Kong and Macau, and 32 watch brands. The business relationships with some of these watch suppliers began decades ago. For certain watch labels, the group strategically establishes boutique outlets in order to curry favour with those brands. Emperors watch brand portfolio for its Hong Kong & Macau shops
A. Lange & Sohne Blancpain Chopard Jaeger-LeCoultre Parmigian Rolex Zenith Source: Company Audemars Piguet Breguet Frank Muller Omega Patek Philippe Tudor Baume & Mercier Cartier IWC Panerai Piaget Vacheron Constantin
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Emperors watch brand portfolio for its China shops

A. Lange & Sohne Blancpain Certina Girard Perregaux Hamilton Longines Movado Panerai Raymond Weil Tiffany & Co. Vacheron Constantin Source: Company Audemars Piguet BULGARI Corum Glashtte Original IWC Maurice Lacroix Omega Piaget Rolex Tissot Zenith Baume & Mercier Carl F. Bucherer Cyma Gucci Jaeger-LeCoultre Mido Oris Rado Tag Heuer Tudor
Emperor has a well-earned positive reputation among Swiss brand suppliers and has close partnership with many of them. To cite just a few examples, it is cooperating on advertising campaigns with Tudor, Patek Philippe, Cartier, Audesmars Piguet, Piaget, Breguet, Panerai and Jaeger-LeCoultre. These partnerships give Emperor access to the very latest items, including limited editions and exclusive collections.
Extensive and diversified store network in prime locations

Emperor owns an extensive network of 82 retail outlets in prime locations throughout Hong Kong, Macau and China. Retail network located in prime locations throughout Hong Kong, Macau and China In its core markets of Hong Kong and Macau, Emperor operates 25 outlets occupying total floor area of over 70,686 sq ft. The majority of these stores are located in prime shopping locations that are easily accessible and have heavy customer traffic. Most of its shops in Hong Kong are located in Central, Wanchai, Causeway Bay and Tsim Sha Tsui, all major shopping zones for tourists. Chinese visitors currently account for over 85% of Emperors retail sales in Hong Kong and Macau. China is a key region of growth for the company, which established its PRC headquarters in Beijing in 2008. The group currently manages a total of 57 outlets occupying total floor area of 76,914 sq ft in first- and second-tier cities, including Beijing, Shanghai, Guangzhou, Chongqing and Tianjin. Multi-store formats to capture a wider range of clientele Emperor outlets operate various store formats depending on local conditions. The primary format is that of a multi-brand watch and jewelry POS offering a comprehensive Swiss watch portfolio that caters to the different price sensitivities and brand preferences of its customers. There is also an increasing number of jewelry-only POS that specialize in the finest in-house designed Emperor-branded accessories. In addition to the store formats just mentioned, mono-brand watch boutiques were established to provide comprehensive and exclusive coverage of selective brands. These mono-brand POS enhance the companys synergies with its respective international watch suppliers and foster customer loyalty with the featured brands. For example, the group operates the largest Rolex-Tudor boutique in the world and operates a Patek Philippe and Cartier boutique in Hong Kong and a Cartier and Rolex mono-brand store in Macau.
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Emperors multi-brand store
Emperors multi-brand store
Emperors mono-brand store
Emperors mono-brand store
Source: Company
Direct-retail operation
Eschewing the franchising model to sustain Emperors high-end positioning and to minimize the risk of brand dilution Emperor directly operates all of its stores. Management foresees no changes to this business model. Given its position as a top luxury or high-end watch and jewelry retailer, Emperor believes that its long-term success depends on how well it sustains its brand name and the image of the brands it carries. Management is well aware of the potential dangers to its reputation and the operation risks that could arise from franchising.
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Upside from jewelry exposure

Expand jewelry business to enhance overall profit margin performance Emperor is accelerating expansion of its jewelry operation. Emperors jewelry business covers a full range of luxury jewelry products including diamonds, jade, pearl, ruby and gold with a special emphasis on diamond and jade products. The company is known for its stylish designs, high quality and detailed craftsmanship. All jewelry products sold from Emperor are done so under the Emperor label. The group does not carry other jewelry brands or items in its stores. We believe the move to increase exposure to jewelry products presents Emperor with considerable growth opportunities. It aims to raise its jewelry sales contribution from 18% of total sales at present to 50% in three-to-five years. In the long term, we expect Emperors jewelry business to play a more central role in driving the companys overall earnings growth. We think it will eventually enhance Emperors reputation as one of the leading luxury goods distributors in China. We see four major positives in Emperors jewelry business: Cross-selling potential Emperors jewelry segment enjoys considerable synergies with the companys existing watch business. There are major cross-selling opportunities to be seized by leveraging off the existing customer base of Emperors watch business. Emperor has made the decision to focus on diamond and jade products in order to differentiate itself from the over-crowded gold-jewelry market, and thereby avoid direct competition with the likes of Chow Tai Fook, Luk Fook, Chow Sang Sang, and Tse Sui Luen, which already have high market shares and long histories within the gold-jewelry trade. Jewelry products tend to provide higher gross margins than watches or gold products. It is therefore more sensible for Emperor to concentrate on high-end diamond, pearl and jade products. The additional offering of jewelry products will provide an avenue for Emperor to increase its presence in China since consumption of very high-end luxury watches still tends to take place overseas. Jewelry is a more personalized product than watches and so customers are less reluctant to purchase domestically. The jewelry segment provides higher gross profit margin than watches, with a minimum of 10ppt difference between the two segments. Greater sales of jewelry will enhance Emperors overall profitability.
Targets 50% of overall sales from jewelry in the medium to long term
Focus on non-gold jewelry items to avoid competition from the gold-jewelry market
Enhance Emperors jewelry brand recognition through the use of different marketing campaigns
The group is planning to enhance its Emperor jewelry brand by launching direct marketing events and rolling out different collections on a regular basis. The company is committed to maintaining a high profile at jewelry shows held each year in Hong Kong, Macau and China each year.
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Emperors jewelry store in Hong Kong
Emperors jewelry store in China
Emperors jewelry products
Emperors jewelry products
Source: Company
Strategic partnership with L Capital

Unique relationship with the world-renowned LVMH group Emperor introduced L Capital Asia, an affiliate of the LVMH group (LVMH IM, Not Rated), as a passive investor as well as a strategic partner in 2010 by issuing HK$140m worth of CBs and HK$100m in warrants to L Capital with an exercise price of HK$0.54 and conversion price of about HK$1.00 for the CB. L Capital converted the CBs it held in February 2011 while the warrants are still outstanding. L Capital is now holding around 2% of Emperors stake, which would further increase to about 4% upon full exercise of the warrants. Given LVMHs established reputation and L Capitals expertise in investing in consumer companies in Asias emerging markets, particularly China and India, we believe the involvement in L Capital has major positive implications for Emperors operation, business developments and valuations. Indeed, an MOU was signed at the time of L Capitals investment. The agreement set out the framework for future co-operation between the two parties, stipulating that L Capital would extend professional advice to Emperor regarding sales expansion, brand building, advertising, marketing, retail operations, human resources, distribution and costs management. More specifically, L Capital would: (1) assist Emperor in establishing retail stores in China; (2) assist Emperor in expanding its product portfolio; (3) allow Emperor to launch joint promotions and marketing events with leading LVMH brands; and (4) ensure a stable and competitive diamond supply to Emperor with the support of leading LVMH brands. Most importantly, the support of L Capital stands to enhance Emperors creditability and, hence, its bargaining power when it comes to acquiring watch and diamond resources.
Synergies
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Synergies with the Emperor Group of companies

Emperor enjoys synergies from its membership in the Emperor Group of companies. Obvious benefits include joint marketing events, the sharing of the VIP database as well as access to favourable shop locations and competitive rental rates with sister companies. Synergies Group with the Emperor One-third of Emperors shops in Hong Kong and all stores in Macau are leased from properties owned by Emperor Group (163 HK, Not Rated). We believe Emperor enjoys more competitive rental rates than peers, as reflected by its rental expense to sales ratios of under 8% in FY07-10. Most importantly, the relationship with Emperor Groups property arm provides it with access to prime retail locations. Emperor has access to the VIP database of Emperor Entertainment Hotel (296 HK, Not Rated), which includes casino high-rollers and key business associates. Having these names in Emperors Rolodex presents tremendous cross-selling opportunities. In addition, the entertainment businesses of Emperor Motion Pictures (EMP) and the Emperor Entertainment Group (EEG) provide strong support to Emperors advertising and marketing efforts, especially in China. Emperor benefits from free celebrity endorsements and media coverage of EMP/EEGs promotional campaigns. From time to time, Emperor Watch & Jewellery sponsors various local concerts, art shows, and movies showing in Hong Kong and China. It invariably invites VIPs and other luminaries to these events. During the past few years, Emperors marketing cost ratio has been running at under 1% of total sales.

We forecast a strong earnings CAGR of 27% between FY11 and FY13F.
Hong Kong and Macau

Steady SSSG Business growth in Hong Kong and Macau is expected to be underpinned by a mix of modest store openings and solid SSSG. In Hong Kong, the group has plans to add three-to-four outlets in FY12F, and one-to-two new stores in FY13F. Coupled with our SSSG estimates of 16% in FY12F and 21% in FY13F, we project annual turnover growth to be 30% in FY12F and 32% in FY13F in Hong Kong. Macau is forecast to have a steady uptrend with turnover growth estimated at 52% in FY12F and 38% in FY13F. There are two drivers unique to Macau, namely (1) the influx of Chinese gamblers whose demand for luxury accessories is particularly high, and (2) growing cross-selling opportunities thanks to the sharing of the Emperor Entertainment Hotels casino VIP database. For Macau, we assume two openings in FY12F followed by one addition in FY13F.
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China
Healthy sales growth in China supported by increased penetration and store expansion Despite the on-going trend of mainland consumers preferring to purchase luxury items abroad due to price and product offering differences, we see additional room for Emperor to develop its domestic business as its current operations in China are small. We also believe having a presence in China is critical for marketing purposes and, perhaps more importantly, for positioning the company as the price differential between China and Hong Kong narrows in the long run. We project turnover growth of 17% in FY12F and 19% in FY13F in China. The pace of Emperors network growth in China is forecast to be rapid and we estimate 10-12 new openings per annum in FY12F-13F. As we discussed earlier, we expect more of the openings to be for its jewelry business. Of the planned new stores, there will be openings of three mono-brand watch POS in Shanghai and Shandong in FY12F. The group will also construct a flagship store in Beijing, expected to commence in 2015.
Steady gross margin uptrend

Gross margin improvement mainly driven by increased contribution from jewelry sales Emperor has limited control over the gross margins it earns from selling for the Swiss watch brands as gross margins are watched over and carefully controlled by the Swiss watch suppliers. The implication is that watch gross margins have and will remain largely stable within the range of 23 to 25% going forward. The gemstone jewelry business earns a higher gross margin of about 34% to 35%. Critically, there is upside to jewelrys gross margin in the long run as Emperors brand ownership within this segment provides flexibility for product mix upgrades and ASP increases. Due to jewelrys higher profitability, Emperor is planning to increase the segments contribution from 18% currently to a target of 50% in the medium-to-long term. That said, the change is not likely to be substantial in the coming three years. That said, we believe the groups gross profit margin is set to grow steadily, factoring in a gradual increase in sales contribution from gemstone jewelry and gross margin improvement within the jewelry segment. Emperor sales mix by product
100% 12% 80% 29% 60% 88% 86% 28% 27% 82% 26% 20% 25% 24% 0% FY08 FY09 Watches FY10 Gem-set jewelry FY11 23% FY08 FY09 FY10 FY11 FY12F FY13F FY14F 25.8% 25.6% 27.9% 14% 15% 18%
Emperor gross profit margin trend

31% 30% 28.8% 29.1% 29.9% 29.5%
40%
85%
Source: Company data
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SG&A not a key concern

We see the following factors lending stability to Emperors key SG&A expense ratios. No material pressure from key costs in the medium term Synergies with the Emperor group of companies. Emperor has access to attractive retail locations at competitive rates as one-third of its stores in Hong Kong and Macau are leased from Emperor Group. We forecast rental costs to remain under 7% of total sales in FY12F and FY13F. Our earlier discussion also indicated that Emperor enjoys advertising and marketing synergies with the activities of EMP and EEG. Marketing cost ratio remained under 1% of total sales for the past few years and should remain below 1% of sales in the foreseeable future Turnover-linked staff compensation. A common practice of watch and jewelry retailers is to link a substantial part of their staff compensation to individual store and staff member performance. We expect staff costs to sustain at 4% of total sales in FY12F-13F. High SSSG. High sales growth on a same-store basis tends to offset rising costs.
Emperor key assumptions

Year to December (HK$m) Total POS Hong Kong Macau China Total POS YoY change Hong Kong Macau China Total POS YoY change (%) Hong Kong Macau China SSSG (%) HK/Macau Sales growth YoY (%) Hong Kong Macau China Gross margin (%) Total staff cost as % of total sales Total lease costs as % of total sales Other expenses as % of total sales Source: Company data, CCBIS estimates 16 31 NA 27.9 4.4 5.3 (0.4) 29 75 1393 25.8 4.3 8.0 0.3 51 49 66 25.6 3.8 6.7 1.1 44 42 35 28.8 3.9 6.9 1.2 30 52 17 29.1 4.2 7.2 1.3 32 39 19 29.5 4.3 7.3 1.4 25 24 15 29.9 4.4 7.5 1.5 20 15 49 32 16 21 18 2008 19 11 4 4 10 3 3 4 111 38 300 NA 2009 40 12 4 24 24 4 0 20 111 9 0 500 2010 61 17 4 40 18 2 0 16 53 42 0 67 2011 80 18 5 57 19 1 1 17 31 6 25 43 2012F 95 21 7 67 15 3 2 10 19 17 40 18 2013F 110 23 8 79 15 2 1 12 16 10 14 18 2014F 124 24 9 91 14 1 1 12 13 4 13 15
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Emperor revenue projections

Year to December (HK$m) Total revenue YoY (%) Revenue by market Hong Kong Macau China Revenue growth by market (%) Hong Kong Macau China Revenue mix by market (%) Hong Kong Macau China Source: Company data, CCBIS estimates 93 6 1 83 7 10 82 7 11 83 6 11 83 8 10 83 8 9 84 8 8 16 31 NA 29 75 1,393 51 49 66 44 42 35 30 52 17 32 39 19 25 24 15 1,722 102 19 2,230 179 278 3,366 267 462 4,863 377 622 6,305 574 728 8,325 796 866 10,376 983 996 2008 1,842 18 2009 2,686 46 2010 4,095 52 2011 5,862 43 2012F 7,607 30 2013F 9,987 31 2014F 12,355 24
Emperor profit and loss projections

Year to December (HK$m) Total revenue YoY (%) COGS YoY (%) Gross profit YoY (%) Gross margin Other income and gains Staff costs YoY (%) As % of turnover Depreciation and amortization YoY (%) As % of turnover Rental costs YoY (%) As % of turnover Other costs YoY (%) As % of turnover Total SG&A and other expenses YoY As % of total turnover EBIT YoY (%) EBIT margin (%) 2008 1,842 18 (1,328) 10 514 47 27.9 0 (81) 13 4.4 (14) 49 0.8 (97) 96 5.3 8 48 (0.4) (170) 47 9.2 280 44 15.2 2009 2,686 46 (1,993) 50 694 35 25.8 5 (116) 43 4.3 (22) 62 0.8 (215) 122 8.0 (7) (184) 0.3 (338) 99 12.6 245 (12) 9.1 2010 4,095 52 (3,048) 53 1,048 51 25.6 10 (156) 35 3.8 (42) 85 1.0 (273) 27 6.7 (44) 542 1.1 (472) 40 11.5 413 68 10.1 2011 5,862 43 (4,177) 37 1,686 61 28.8 8 (227) 46 3.9 (66) 60 1.1 (407) 49 6.9 (71) 62 1.2 (705) 49 12.0 764 85 13.0 2012F 7,607 30 (5,397) 29 2,210 31 29.1 8 (319) 41 4.2 (73) 9 1.0 (548) 34 7.2 (99) 39 1.3 (966) 37 12.7 955 25 12.6 2013F 9,987 31 (7,045) 31 2,942 33 29.5 10 (429) 34 4.3 (59) (18) 0.6 (729) 33 7.3 (140) 41 1.4 (1,298) 34 13.0 2014F 12,355 24 (8,666) 23 3,688 25 29.9 12 (544) 27 4.4 (55) (7) 0.4 (927) 27 7.5 (185) 33 1.5 (1,656) 28 13.4
1,254 1,539 31 23 12.6 12.5 (Continued on next page)
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Emperor profit and loss projections (continued from previous page)

Year to December (HK$m) Depreciation and amortization included in SG&A EBITDA YoY (%) EBITDA margin (%) Interest income Interest expense Extraordinary items Profit before tax YoY (%) As % of turnover Tax Effective tax rate (%) Minority interest Net profit YoY (%) Net margin (%) Core net profit YoY (%) Core net margin (%) Source: Company data, CCBIS estimates 2008 14 294 44 15.9 1 (3) (9) 269 40 14.6 (47) 17.5 (0) 223 40 12.1 232 46 12.6 2009 22 268 (9) 10.0 0 (2) 0 243 (10) 9.1 (43) 17.7 5 196 (10) 7.3 196 (16) 7.3 2010 42 454 70 11.1 2 (11) (199) 204 (16) 5.0 (70) 34.5 8 126 (33) 3.1 325 66 7.9 2011 66 831 83 14.2 4 (2) (9) 757 271 12.9 (130) 17.2 (0) 627 368 10.7 636 96 10.9 2012F 73 1,027 24 13.5 4 (3) 0 956 26 12.6 (167) 17.5 4 784 26 10.3 784 23 10.3 2013F 59 1,313 28 13.1 5 (3) 0 1,256 31 12.6 (220) 17.5 5 1,031 31 10.3 1,031 31 10.3 2014F 55 1,593 21 12.9 7 (3) 0 1,542 23 12.5 (270) 17.5 6 1,266 23 10.2 1,266 23 10.2

Lowest inventory turnover days for Swiss watches in the industry Emperors inventory largely consists of finished watches and gem-set inventory, including raw materials and finished goods. Inventory turnover days for Emperor surged from 207 days in FY10 to 243 days in FY11, mainly caused by the Lunar New Year stock building, and the increased proportion for jewelry stocks. Emperor has the lowest inventory turnover days for its watch segment compared with peers, with only 130-150 days by end-2011. Jewelry inventory was at over 400 days in the same period. Going forward, with the tight control on inventory management, we believe Emperors inventory turnover days to maintain under 260 days level, with an average of 16-24% YoY increase p.a. Receivable and payable days were relatively stable in FY08-11 and we believe both will remain constant in FY12F-13F. Capex spending is mainly being put towards retail network expansion, IT system upgrade and regular maintenance. We expect a sum of HK$54-56m on capex in FY12F-13F. Our estimates included an average of HK$2-2.3m starting costs for stores in Hong Kong and Macau, and HK$0.8m capex budget for China openings. Emperor is in a net cash position (HK$464m as at end-December 2011). It is also forecast to generate annual EBITDA of over HK$1b in FY12F-13F. On top of that, Emperor had HK$340m in short-term borrowings at end-2011 to support its heavy working capital requirements. We hence expect the group to have sufficient financial and cash flow strength to support its store openings pipeline, without the immediate funding needs from capital markets in the short term.
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Emperor cash conversion cycle and working capital days

320 280 240 200 160 120 80 40 0 (40) (80) FY08 FY09 Average inventory days (24) (34) (40) (35) (33) (34) (33) 17 23 17 12 11 11 11 276 269 230 243 220 207 184 219 257 235 239 216
228 205
FY10 FY11 FY12F Average receivable days Average payable days
FY13F FY14F Cash conversion cycle (days)
Emperor operating cash flow, free cash flow and net cash flow projections
HK$m 800
604 600 400 200 0 (200) (400) (600) (800) FY08 FY09 FY10 Operating cash flow (248) (272) (80) (346) (403) (592) (669) FY11 FY12F FY13F Free cash flow Net cash flow FY14F (63) 149 198 135 201 92 146 47 334 278 155 550 379
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Emperor balance sheet projections

Year to December (HK$m) Property, plant and equipment Deferred tax assets Others Non-current assets total Inventories Trade receivables and other receivables Tax recoverable Bank balance and cash Total current assets Payables, deposits received and accrued charges Amount due to immediate holding company Amounts due to related companies Amount due to a related party Dividend payable Taxation payable Obligation under a finance lease due within a year Short-term bank loans Total current liabilities Bank borrowings due after one year Deferred taxation Derivative financial instruments Liability component of convertible bond Total non-current liabilities Shareholders equity Minority interest Total equity Total assets Total liabilities and equities Gross debt Net debt Net gearing (%) Source: Company data, CCBIS estimates 2008 34 0 0 34 1,205 133 0 168 1,506 102 0 0 0 0 16 0 4 123 13 1 0 0 14 1,398 5 1,403 1,540 1,540 17 (150) Net cash 2009 75 0 0 75 1,308 205 7 252 1,771 264 0 3 0 0 6 0 4 277 9 0 0 0 10 1,549 10 1,559 1,846 1,846 14 (239) Net cash 2010 85 4 102 191 2,152 171 0 601 2,925 405 0 4 45 0 35 0 67 556 0 0 180 110 290 2,268 3 2,270 3,116 3,116 67 (534) Net cash 2011 97 6 157 260 3,404 199 0 804 4,407 396 0 4 0 0 68 0 340 809 0 0 0 0 0 3,859 0 3,859 4,667 4,667 340 (464) Net cash 2012F 80 6 155 240 4,209 251 0 828 5,288 594 0 1 0 0 70 0 320 985 0 0 0 0 0 4,540 4 4,544 5,529 5,529 320 (508) Net cash 2013F 75 6 155 236 5,002 330 0 979 6,311 705 0 1 0 0 70 0 320 1,096 0 0 0 0 0 5,442 9 5,451 6,546 6,546 320 (659) Net cash 2014F 74 6 155 234 5,806 408 0 1,335 7,549 867 0 1 0 0 70 0 300 1,238 0 0 0 0 0 6,530 15 6,545 7,783 7,783 300 (1,035) Net cash
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Emperor cash flow projections

Year to December (HK$m) EBIT Depreciation and amortization EBITDA Adjustments for other non-cash items Working capital changes: Inventory Receivables Payables Amount due to fellow subsidiary and related companies Tax paid Interest paid Interest received Operating cash flow Capex Free cash flow Other investment cash flows Contribution from minority shareholders Share issue Dividend paid Advance/repayment to/from minority shareholders Net cash flow Source: Company data, CCBIS estimates (403) (44) (32) (1) (53) 3 (1) (248) (25) (272) 15 0 581 (318) 143 149 (105) (71) 162 3 (60) 2 (0) 198 (63) 135 0 0 0 (43) (1) 92 (842) (68) 141 1 (40) 11 (2) (346) (57) (403) 2 0 372 (83) 33 (80) (1,255) (81) (8) 0 (99) 2 (4) (592) (77) (669) 4 (3) 800 (149) (45) (63) (805) (52) 197 (3) (165) 3 (4) 201 (54) 146 4 0 0 (103) 0 47 (793) (79) 111 0 (220) 3 (5) 334 (55) 278 5 0 0 (129) 0 155 (804) (78) 162 0 (270) 3 (7) 604 (54) 550 7 0 0 (178) 0 379 2008 280 14 294 (10) 2009 245 22 268 1 2010 413 42 454 (2) 2011 764 66 831 22 2012F 955 73 1,027 2 2013F 1,254 59 1,313 3 2014F 1,539 55 1,593 5
Emperor key financial ratios

Year to December ROAE (%) ROAA (%) ROIC (%) Average inventory days Average receivable days Average payable days Cash conversion cycle (days) Net gearing (%) Gross gearing (%) Source: Company data, CCBIS estimates 2008 25.3 18.2 26.2 276 17 (24) 269 Net cash 1.2 2009 13.3 11.6 15.7 230 23 (34) 220 Net cash 0.9 2010 6.6 5.1 20.8 207 17 (40) 184 Net cash 3.0 2011 20.5 16.1 24.4 243 12 (35) 219 Net cash 8.8 2012F 18.7 15.4 22.2 257 11 (33) 235 Net cash 7.0 2013F 20.7 17.1 24.3 239 11 (34) 216 Net cash 5.9 2014F 21.2 17.7 25.4 228 11 (33) 205 Net cash 4.6
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Company specific risks

Connected-party transactions
Although we acknowledge that Emperors working relationship with sister companies under the Emperor Group brings operational advantages, the market tends to have a negative perception of any form of connected-party transactions.
Frequent fund-raising activities

Emperor has raised money from the market several times in the past three years as shown in the following table. Not all of these activities were absolutely necessary, in our view. Frequent capital market activities can be a share price overhang and EPS dilutive. Emperor past capital raising activities
Conversion/ Issue date January 2010 March 2010 August 2010 August 2010 September 2010 April 2011 completion date N/A N/A 12 April 2013 12 April 2013 12 April 2013 April 2011 Type Placement Top-up placement Convertible bond to L Capital Convertible bond to D.E.Shaw Warrants Top-up placement No. of shares issued 450,000,000 264,810,000 259,300,000 444,400,000 N/A 800,000,000 Amount/principal amount (HK$m) 230 143 140 240 100 787 HK$/share 0.51 0.54 0.54 0.54 0.62 1

Ms. Cindy Yeung Executive director and Managing director
Ms Yeung joined the group in 1990. She is responsible for the groups strategic planning, business growth and development and for overseeing different operations within the group. She became a director of Emperor Watch & Jewellery (HK) Company Limited, an operating arm of the retail outlets of the group in Hong Kong, in April 1999. The Group has been under her management since then. She obtained the qualification of Graduate Gemologist of GIA in 1988 and since then has accumulated over 20 years of experience within watch and jewelry industry. Prior to joining the group in 1990, she joined the sales department of Anju Jewelry Ltd, a US-based company engaging in trading of jewelry products. Ms. Yeung is the daughter of Dr. Yeung Sau Shing, Albert who is deemed to be a controlling shareholder of the company.
Mr. Chan Hung Ming Executive director

Mr. Chan joined the Group in July 2005 and is now responsible for overseeing the retail outlet operations in Macau and Hong Kong. He has over 30 years of experience within the watch and jewelry industry. Prior to joining the group, he acted as general manager in charge of the retail and watch boutique outlets in Hong Kong and the PRC in the Dickson Watch & Jewellery division under Dickson Concepts (International) Limited (113 HK, Not Rated) for over 20 years.
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Mr. Wong Chi Fai Executive director

Mr. Wong has been involved in the management of the company since November 1998. He is the Chairman of the Remuneration Committee of the company. Mr. Wong is an associate of the HKICPA. He is also a director of Emperor International Holdings Limited (163 HK, Not Rated), Emperor Entertainment Hotel Limited (296 HK, Not Rated) and New Media Group Holdings Limited (708 HK, Not Rated). Having over 20 years of management experience, Mr. Wong has diversified his experience by working in different businesses ranging from manufacturing to watch and jewelry retailing, property investment and development, hotel and hospitality as well as media and publication.
Ms. Fan Man Seung, Vanessa Executive director

Ms. Fan has been involved in the management of the company since late-1998. She is also a director of Emperor International Holdings Limited, Emperor Entertainment Hotel Limited and New Media Group Holdings Limited. Besides having over 21 years of corporate management experience, she possesses diversified experience in different businesses, including watch and jewelry retailing, property investment and development, hotel and hospitality, financial and securities operations as well as media and publication.
Mr. Hanji Huang Non-executive director

Mr. Huang was appointed as non-executive director of the company in August 2010. He is a member of the companys audit committee of the company and has held senior positions in various global investments. He has over 10 years of experience in the equity capital market, particularly in private equity investment. Emperor shareholding structure
Yeungs Family Trust 53.2%
Public 46.8%
Emperor Watch & Jewellery Limited (887 HK)

Source: Company, HKEx
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Hengdeli Holdings (3389 HK)

Still a timeless preposition
Hengdeli is Chinas largest mid-to-high end watch retailer and wholesaler with 35% market share. Increased penetration of the mid-market segment through aggressive network expansion into the second- and third-tier cities will be the companys core earnings driver in the coming years. Given the companys favorable earnings outlook as well as its strengthening financial position, we maintain our Outperform rating on the stock. Market leader. As the leading national mid-to-high end watch retailer with strong store brand recognition in China, Hengdeli is well positioned to tap the countrys burgeoning watch market. The company outshines its peers by virtue of its strategic alliances with major Swiss watch suppliers, that allow Hengdeli to secure and source a wider range of products. We see limited competition risk for the foreseeable future as peers have weaker sales channels and insufficient financial strength to adopt Hengdelis multi-brand strategy or keep up with its aggressive expansion. Tapping the potential of second- and third-tier cities. The booming Chinese economy has spurred the countrys urbanization rate, leading to the emergence of a wealthy middle-class. Hengdeli has moved ahead of its competitors in aggressively expanding into second- and third-tier cities, and is therefore well-positioned to benefit from the favorable market development. Reiterate Outperform. We fine-tune our estimates and slightly lower our EPS estimates by 3% for FY12F-13F. Our target price is raised from HK$3.95 to HK$4.15, now based on CY13F P/E of 12x instead of CY12F P/E of 14x. Despite the near-term hiccup of moderating sales growth, we believe that the long-term prospects for the industry will remain promising. Hengdelis market leadership and FY11-13F earnings CAGR of 21% should support share price performance in the medium-term.
FY10 8,216 554 0.133 41 25.9 1.1 (4.3) 14.9 Net cash FY11 11,375 815 0.185 40 18.5 1.6 (0.6) 16.9 6 FY12F 14,155 0.2 985 (3.4) 0.224 21 15.3 1.8 12.7 18.1 Net cash FY13F 17,019 (1.3) 1,192 (3.0) 0.271 21 12.6 2.2 3.4 19.2 Net cash FY14F 19,729 1,356 0.309 14 11.1 2.5 11.4 19.1 Net cash
Company Rating: Outperform

(maintained)
Price: Target:
HK$3.43 HK$4.15
(up from HK$3.95)
Trading data
Stock price vs. HSI

HK$ 5.0 4.6 4.2 3.8 3.4 3.0 2.6 2.2 19-Apr-11
1-Jul-11
12-Sep-11 Hengdeli
24-Nov-11 5-Feb-12 HSI (rebased)
18-Apr-12
Source: Bloomberg
Financial forecast
Year to 31 December Revenue (RMB m) Rev forecast change (%) Net profit (RMB m) NP forecast change (%) EPS (RMB) EPS (YoY, %) P/E (x) Yield (%) FCF yield (%) ROAE (%) Net gearing (%)
Claudia Ching
Forrest Chan, CFA

Timothy Sun
59
20 April 2012
Leader in watches mid-to-high end Hengdeli is the largest watch retailer in China with 35% market share and the countrys most extensive retail network with close to 405 stores at end-2011. These feature put it in good position to capture growing demand for affordable-luxury watches .in China. Hengdelis strong brand recognition, well-established relationships with key suppliers, multi-brand strategy, and diverse customer base are key competitive advantages that keep the company ahead of its peers. By expanding its strong network in the affluent mid-market segment, Hengdeli stands to strengthen its strong network presence across the second- and third-tier cities. Thanks to its long standing co-operation with major Swiss watch makers over the years, Hengdeli now has close relationships with top Swiss watch suppliers. The Swatch Group (UHR VX, Not Rated) and LVMH Moet Hennessy Group are substantial shareholders of Hengdeli. The companys strategic alliance with major suppliers provides unique advantages, including a more diversified and wide ranging supply of product, an extended credit line, and priority in watch supply and delivery which no other industry player in China can compare with. Supported by its nationally recognized brand name, Hengdeli is a rare luxury watch retailer that has the financial ability and bargaining leverage to operate a multi-brand approach. With its three main brands targeting different customer segments, we believe the company is well positioned to fortify its sales channels and expand its customer pool. Focus on developing tier two-tothree markets in China Eyeing the large market potential for entry-level luxury watches, Hengdeli will accelerate its expansion plans by adding 40-60 stores per annum in FY12F-13F in second- and third-tier cities, from a total store count of 405 at end-2011. Hengdeli is among the few luxury watch chains expanding at such a rapid pace; moreover, it is doing so in regions outside of tier-one cities. We are confident of Hengdelis ability to seize the opportunity to capture additional market share. In 4QCY11-1QCY12, when the overall retail environment in China began to soften, Hengdeli saw some slowdown in its sales of ultra-luxury goods (over RMB50,000). In contrast, mid-end watch sales at Prime Time and With Time stores held up well. Overall, the quarter still saw SSSG in the mid-to-high teens. At the latest results announcement presentation, management indicated a relatively cautious sales target of over 20% YoY growth for FY12F, which we believe is achievable. Despite the near-term hiccup of moderating sales growth, we believe that the long-term prospects for the industry remain promising. Hengdelis market leadership and earnings CAGR of 21% between FY11-13F should support share price performance in the medium-term. Hengdeli offers an attractive investment case that will sustain over the long-term.
Strategic tie-ups with world renowned luxury brand owners
Solid sales performance over the past six months despite weakening consumer sentiment
Market leader with exceptionally strong store brand recognition

Hengdeli was ranked first in Greater China in terms of retail sales of affordable-luxury watches, topping RMB11b in sales in FY11. As the largest player in the luxury watch segment in China with 35% market share, Hengdeli is strongly leveraged to the countrys rapidly growing demand for luxury goods, especially in the wake of rising income levels and its penetration into second- and third-tier cities. On the back of its aggressive expansion plans across China, we anticipate Hengdelis market share will continue to grow.
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20 April 2012
Unmatched competitive advantages to sustain dominance

Besides being a dominant player in China, Hengdeli is the most scalable retailer among Chinas national luxury watch retail chain operators. Hengdelis successful business model is extremely difficult for other industry players to replicate and, hence, it is unlikely others will overtake Hengdelis market leadership in the foreseeable future. The success of Hengdeli is supported by the following factors: Four distinctive competitive advantages A well-established household name within Chinas luxury watch market Strategic tie-ups with suppliers and comprehensive product offerings Extensive customer coverage through effective brand building Room to scale up through aggressive store openings
A well-established household name within Chinas luxury watch market

Wide recognition nationwide One of the first national luxury watch retailers in China, Hengdeli has established sound and exclusive working relationships with various internationally renowned brand owners. Tracing back to 1949 when it became a state-owned enterprise, Hengdeli began distributing Swiss watches in China. The close cooperation over the years has been unrivaled. Hengdelis extensive history distributing luxury watches in China has given it considerable industry know-how. Run by an experienced management team (Chairman Zhang Yupin has over 25 years of experience in the high-end consumable distribution industry in China), we believe Hengdeli will continue to benefit from its management teams expertise and experience retailing luxury watches in China. Hengdeli is consistently viewed as a symbol of authenticity and quality assurance. With the rising awareness of product quality and originality among Chinese consumers, Hengdeli is likely to become a preferred and trusted watch retailer. Its long established reputation in China will help it gain access to more strategic shop locations, and will give it strong bargaining power when negotiating for rental rates.
Experienced management team
Strategic tie-ups and wide ranging product offerings

In order to minimize brand image risk, international luxury brand suppliers have become extremely stringent when selecting distribution partners, especially in China. On the strength of its exclusive product offerings and years of cooperation, Hengdeli has managed to win over the trust of world-class Swiss watch brands, including the worlds largest watch distributors Swatch Group and LVMH. Hengdeli currently distributes over 50 internationally renowned brands. Its strong ties with suppliers mean Hengdeli is able to secure a wider range of model collections as well as more favourable credit terms compared with local peers. In many cases, Hengdeli is also given priority in watch supply and delivery. Unique shareholding structure with suppliers as major shareholders While non-exclusive, distribution partnerships with Swatch Group and LVMH remain guarded in our view, given the ownership status of the major suppliers within Hengdelis shareholding structure. Swatch Group owns a 9.1% stake in the company and is currently the second-largest shareholder, while LVMH is the third-largest shareholder with a 5.9% interest. Such shareholding structures clearly suggest that Hengdeli has a strong vote of confidence from its suppliers; moreover its strategic ties provide it a distinctive competitive advantage.
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20 April 2012
Hengdelis shareholding structure

Best Growth 34.6% Swatch Group (UHR VX) 9.1% LVMH 5.9% Public 50.4%
Hengdeli Holdings (3389 HK)
Source: Bloomberg
Hengdeli and Swatch Group have established a 50:50 JV to wholesale and retail certain watch brands in China since 2003. The JV, which plans to open and operate boutiques that focus on watches, jewelry, and other accessories of the Swatch Group, has already opened an Omega flagship shop on Huaihai Road, Shanghai and a Swatch boutique in Harbin and Qingdao. Providing the hottest brands Leveraging its strong links with various brand owners, Hengdeli has managed to secured exclusive distribution rights for over 18 brands, including those owned by Swatch Group, LVMH, and Richemont. Its close relationship with Swatch Group and LVMH are of particular importance given that these brands are among the top-five best-selling watch brands in China (50% of the market). Hengdelis brand portfolio
Exclusive brands Swatch Group Tissot, Calvin Klein, Certina, Hamilton, Mido, Breguet, Longines Rolex Group LVMH Richemont Independent brands TAG Heuer, Zenith, Christian Dior, Fendi Jaeger-Lecoultre, Baume & Mercier Maurice Lacroix, Carl. F. Bucherer, Claude Bernard Alfred Dunhill, Panerai, Cartier, Vacheron Constantin, IWC Edox, Enicar, Carven, Ball, Gucci, Oris, Raymond Well, Frank Muller, Hermes, Girard Perregaux, Grand Seiko, Jean Richard, MONTBLANC, Parmigiani, Ulysse Nardin, Cyma Source: Company Non-exclusive brands Omega, Rado, Blancpain, Glashutte, Jaquet Droz Rolex, Tudor
Extensive customer coverage through effective brand building

Three distinct store brands to capture different consumer segments and expand sales channels Rare among luxury brand retailers, Hengdeli possesses sufficient scale to handle a multi-brand strategy that allows it to maximize customer exposure. Its retail network can be classified under three main categories of multi-brand shops, namely: Elegant, Prime Time, and With Time. The company also operates several mono-brand boutiques. The multi-brand business model is unparalleled and is a function of Hengdelis leadership within Chinas mid-to-high end watch market. Hengdelis ability to source an extensive range of watch products avails it of a diverse clientele base while supporting the multi-brand operation. Most industry peers operate under single store brand due to network scale restrictions.
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20 April 2012
Hengdelis store brands

Elegant Showcases the most luxurious, internationally renowned brands of top-class watches ASP: RMB50,000 in Mainland; HK$100,000+ in Hong Kong 21 Elegant outlets, with 14 in China, six in Hong Kong and one in Taiwan Prime Time Offers a full range of watch brands under an extensive number of internationally renowned brands targeting middle-to-high end customers Provides one-stop-shop services to customers Selective expansion in tier-two and tier-three cities ASP: RMB15,000 245 Prime Time stores, with 207 in China and 38 in Taiwan With Time The trend setter of watches, bringing fashionable and niche yet classy watches to the youngsters ASP: RMB5,000 63 stores in China Mono-brand boutique Jointly established brand boutiques with brand owners to demonstrate the style of brands, and providing the most comprehensive and rare portfolio. stores 74 brand image boutiques, with 48 in China, 12 in Hong Kong, one in Macau and 13 in Taiwan under various renowned brands, namely Rolex, Tissot, TAG Heuer and Cartier etc. Source: Company, CCBIS Research
Hengdelis Elegant store
Hengdelis Prime Time store
Source: Company website
Hengdeli has committed considerable resources improving sales of its middle-to-high end brands. More than 75% of its retail outlets in China are Prime Time shops, which are positioned to sell mid-to-high end watches. Prime Time and With Time contribute nearly 80% of the companys total retail sales in China and will remain the companys leading store brand in the coming years. Given increasing demand for mid-to-high end watches, Hengdeli will continue to consolidate and expand its retail network in second- and third-tier cities under the Prime Time label.
Leadership by scale
An industry leader for several years With its good reputation and wide product coverage, Hengdeli dominates the other two major Hong Kong-listed luxury watch competitors in terms of sales size and market share. In FY11, Hengdelis sales revenue exceeded Oriental and Emperor by 2.1x and 1.9x, respectively. Its presence in China also over shadows that of its peers, with a network of approximately 332 stores compared with 57 for Emperor and 86 for Oriental at end-2011. The three players target different markets, with Hengdeli focusing on Chinas second- and third-tier cities, Oriental targeting Hong Kong and Emperor focusing on Chinas first-tier cities.
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20 April 2012
Hengdeli dominates Chinas luxury watch industry on the strength of its reputable brand name, long history, large network, and overall sales and profitability. Given their lower sales and smaller market share, other players have insufficient finance ability to ramp up their expansion plans. Thus the threat to Hengdeli from its peers is minimal.
Faster expansion compared to peers

Captures the affluent middle-income customers In view of the growing spending propensity of the expanding middle class, Hengdeli is accelerating its store rollout plan to capture fast growing demand. Already with 332 stores in China, 18 in Hong Kong, 1 in Macau, and 54 in Taiwan at end-2011, management aims to add 40-60 annually in FY12F-13F. Hengdelis store portfolio should reach over 400 outlets, far exceeding other competitors. Hengdeli number of stores
600 500 405 400 300 237 204 200 100 0 FY08 FY09 FY10 China POS FY11 FY12F Hong Kong, Macau & Overseas POS FY13F FY14F 350 496 453 539
82
79
76
73
64 13 286 332 377 457
7 197 224
417
Burgeoning middle class provides a strong sales catalyst
Second-tier city stores have fared well in the past three years, delivering increasing profits the company. We believe Hengdelis reliance on these cities will continue to increase over time to eventually become the companys main growth driver. Hengdeli store space in China by city tier
100%
Hengdeli China revenue mix by city tier

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2006 2007 2008 Tier 1 Tier 2 2009 Tier 3 2010 2011
37% 31% 26% 58% 57% 61% 61% 58% 59% 5% 12% 13% 15% 18%
21%
90% 80% 70% 60% 50% 40% 30% 20%
27%
30%
35%
60%
59%
55%
24%
24%
20%
10% 0%
13%
2009 Tier 1
12%
2010 Tier 2
10%
2011 Tier 3
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20 April 2012
Compared with Hengdeli, most peers have a slower rollout plan with a focus on first-tier cities. Meanwhile, Hengdeli has spotted the enormous growth potential in the mid-market segment. With the aim of extending the coverage of its mid-to-high end product line, the majority of Hengdelis new stores will come under the Prime Time label. Expansion will focus on tier-three and tier-four cities in the North Eastern region, such as Shenyang and Tianjin, Eastern China, like Sichuan, and Southern China regions, including Nanchong and Jiangxi. Well-positioned to capture future growth by penetrating Chinas second- and third-tier cities As urbanization continues, we have a positive view on Hengdelis strategy to extend into second- and third-tier cities. In our view, consumers in those cities make up the bulk of Hengdelis addressable market. We believe that Hengdelis mid-end watch offering will gain traction with the growing number of middle income consumers in these cities.
Expansion into Taiwan to complete Greater China coverage

Hoping to capture the opportunity for additional sales, Hengdeli entered Taiwan through its acquisition of 80% of Taiwan Jing Guang Timepiece for HK$48m, at 6x P/E, in 2009. Taiwan Jing Guang Timepiece owns 31 retail outlets in Taipei, Taichung, Kaohsiung, Hsinchu, and Chiayi. It specialized in selling internationally renowned watch brands. As a result of the acquisition, Hengdeli managed to establish a retail network in the major cities of Taiwan having leading market share. By doing this, Hengdeli laid a sound foundation for the long-term development of the companys overseas business. Benefits from surging mainlander visits In mid-May 2010, Hengdeli opened its Elegant flagship store in Taiwan. The new store sells the worlds top-ten most exclusive watch brands and serves as a grand emporium for building brand image. Hengdelis expansion into Taiwan makes good business sense given that in July 2008, mainland China and Taiwan resumed regular direct flights between the two regions for the first time in six decades. As retail prices for luxury watches in Taiwan are approximately 11% cheaper than in mainland China, many mainlanders visit Taiwan in search of bargains. Acquired Taiwan Jing Guang Timepiece to strengthen foothold in Taiwan Considering the Taiwan market is still at a developing stage, we do not anticipate any material contribution to the company in the near term. Nevertheless, we anticipate the broadened platform will be a long-term driver for Hengdeli in capturing additional market share and sales.
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20 April 2012

Hengdelis revenue is derived from three major segments, with retail business, the largest segment, accounting for over 76% of total sales, followed by the wholesale business (22%). Going forward, we expect the company to continue to rely on the retail segment, which holds greater potential for rapid growth and higher margins. We project the segment to account for 80% of total sales by 2013F. No substantial slowdown in sales momentum despite the weakening retail environment After demonstrating exceptional sales trends in FY11, with growth of 39% YoY, Hengdeli began to see a slowdown in sales of ultra-luxury items mainly due to the less positive macro outlook. However, mid-end watch sales at Prime Time and With Time stores remained robust. Overall, Hengdeli still achieved a double digit sales growth in January and February 2012. Going further into 2012, Hengdelis focus on the mid-market watch segment, in our view, will provide sales resilience amidst the softer retail environment.
China retail sales

We expect the core sales drivers of Hengdelis China business to be high SSSG and accelerated store rollout. Currently, mature stores (defined as stores operating for more than three years) account for 30% of Hengdelis China store count and contribute to approximately 70% of its total China sales. We believe maturing younger stores will help drive strong overall SSSG as growth can be as high as 50-70% in new stores. We are also forecasting 40-45 new store openings or an increase of 11-13% in the store network for China in FY12F-13F. On this measure, our 21-25% YoY retail sales growth projections for China in FY12F-13F, respectively, do not appear to be demanding.
Hong Kong retail sales

Organic sales growth will be the main sales driver as we expect new openings in Hong Kong to be muted. We assume only one store per annum to be added in 2012-2013. Looking ahead, we expect Hengdeli sales in Hong Kong to rise 24% YoY in FY12F and 19% YoY in FY13F.
Wholesale business
Consistent robust sales from the wholesale business Hengdelis China operation currently owns the distribution rights for 50 internationally renowned, of which 18 are on an exclusive basis. Hengdeli is the largest wholesaler of affordable-luxury watches in China with over 400 customers covering approximately 1,000 stores. With its ownership of exclusive distribution rights for a number of best-selling international brands, local retailers that intend to carry these brands must source from Hengdeli. In recent years, the wholesale business was not the fastest growth segment for Hengdeli, yet this segment remains financially important as it generates stable cash inflow and serves as a platform for maintaining close working relationships with its Swiss watch suppliers. The wholesale business outlook is anticipated to remain sound given the healthy industry development in China. We expect sales from this segment to grow steadily by 21% in FY12F and 17% in FY13F and to contribute 21-22% to total sales in FY12F-13F.
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20 April 2012
Uptrend in margins
Widening gross margin on rising contribution from the retail business and mid-market products On a like-for-like basis, Hengdelis gross margin has been fairly stable over the past few years since Swiss watch suppliers dictate ASPs and strictly restrict retailers from offering excessive discounts. Nonetheless, the rising contribution from the retail business in China supports a steady expansion in the groups overall gross margin. Thanks to the higher gross profit margin carried by mid-end watches (34-35% for Prime Time versus 31% for Elegant), the increased sales contribution will enhance the companys overall gross margin. Hengdeli gross profit margin trend
25.8% 25.4% 25.4% 25.1% 25.0% 24.6% 24.2% 23.9% 23.8% 23.4% 23.0% FY08 FY09 FY10 FY11 FY12F FY13F FY14F 23.9% 24.9% 25.3% 25.5%
SG&A expenses and other assumptions

Rental expenses. Hengdelis rent structure in China is similar to most retailers, with a fixed base rental on top of a share of approximately 15% of total sales. 90% of Hengdelis shops are located in department stores and the rest are standalone or boutique stores. Since most new stores will be set up in tier-two and-three cities where rents are relatively lower, we model rental expenses to be well-contained within 7% of total retail sales in FY12F-13F as SSS accelerates. Distribution expenses. Staff costs account for 5% of sales. The company has no direct exposure to changes in the minimum wage as it always pays its workers more than the minimum. Distribution costs remained stable at under 12% of sales in FY10 and FY11. Tax rates. The tax rate imposed to Hengdelis mainland operations is 25% and is expected to remain constant in FY12F-13F. Its Hong Kong business is subject to a tax rate of 17.5%. We forecast the blended effective tax rate for Hengdeli will be 24% in FY12F-13F.
Major cost components remain stable, and able to levy costs pressure through robust SSSG
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20 April 2012
Hengdeli key assumptions

Year to December (RMB m) Sales growth by product (YoY, %) China retail sales Hong Kong retail sales Wholesale revenue After-sales services revenue Gross profit margin (%) Retail store numbers China Hong Kong Taiwan Retail and after-sales service business as % of total sales Wholesale business as % of total sales Other assumptions Distribution expense as % of revenue Rental expense as % of retail revenue Staff expense as % of revenue Administrative expense as % of revenue Effective tax rate (%) Source: Company data, CCBIS estimates 6.8 3.4 19.9 9.5 4.6 21.1 10.0 4.1 24.8 11.5 7.3 5.1 3.4 24.3 11.6 7.3 5.3 3.2 23.4 11.7 7.2 5.4 3.1 24.0 11.9 7.3 5.5 3.1 24.0 12.3 7.4 5.6 3.2 24.0 86 40 41 455 22.5 84 82 2 69 31 36 (3) 13 58 23.9 204 197 7 68 30 17 20 (19) (6) 23.9 237 224 13 75 23 38 41 25 34 24.9 350 286 16 48 78 20 38 31 54 31 25.1 405 332 19 54 76 22 27 24 21 15 25.3 453 377 20 56 76 22 23 19 17 12 25.4 496 417 21 58 77 21 18 15 14 10 25.5 539 457 22 60 77 21 2007 2008 2009 2010 2011 2012F 2013F 2014F
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20 April 2012
Hengdeli profit and loss projections

Year to December (RMB m) Revenue YoY (%) COGS Gross profit YoY (%) Gross margin (%) Government grants Investment income (Distributing JV with SWATCH) Other income sub-total Distribution costs Administrative costs Total SG&A Key SG&A expense ratio (%) Distribution costs Administrative costs EBIT YoY (%) EBIT margin (%) D&A EBITDA YoY (%) EBITDA margin (%) Interest income Effective interest rate on deposits (%) Interest expense Effective interest rate on borrowings (%) Profit before tax Income tax Effective tax rate Minority income Net profit YoY (%) Net margin (%) Source: Company data, CCBIS estimates 6.8 3.4 591 97 12.9 30 621 97 13.6 21 3.3 (60) 7.3 552 (110) 19.9 (25) 418 110 9.1 9.5 4.6 623 6 11.3 37 660 6 12.0 10 2.6 (114) 8.4 619 (131) 21.1 (28) 460 10 8.3 10.0 4.1 613 (2) 10.4 44 656 (1) 11.1 5 2.6 (76) 5.8 514 (128) 24.8 (21) 365 (21) 6.2 11.5 3.4 837 37 10.2 53 890 36 10.8 19 2.6 (83) 3.7 816 (198) 24.3 (63) 554 52 6.7 11.6 3.2 1,267 51 11.1 75 1,342 51 11.8 90 2.0 (178) 4.7 1,198 (280) 23.4 (103) 815 47 7.2 11.7 3.1 1,606 27 11.3 56 1,661 24 11.7 98 1.8 (182) 4.5 1,460 (350) 24.0 (124) 985 21 7.0 11.9 3.1 1,902 18 11.2 41 1,943 17 11.4 98 1.8 (173) 4.5 1,768 (424) 24.0 (150) 1,192 21 7.0 12.3 3.2 2,108 11 10.7 45 2,154 11 10.9 123 1.8 (173) 4.5 2,013 (483) 24.0 (171) 1,356 14 6.9 2007 4,579 90 (3,549) 1,030 83 22.5 13 11 55 (312) (156) (483) 2008 5,516 20 (4,197) 1,319 28 23.9 15 16 50 (522) (253) (774) 2009 5,899 7 (4,490) 1,409 7 23.9 16 16 51 (590) (239) (831) 2010 8,216 39 (6,167) 2,049 45 24.9 9 19 55 (948) (281) (1,230) 2011 11,375 38 (8,518) 2,857 39 25.1 10 28 141 (1,325) (369) (1,697) 2012F 14,155 24 (10,580) 3,575 25 25.3 11 32 156 (1,661) (435) (2,097) 2013F 17,019 20 (12,689) 4,330 21 25.4 13 37 162 (2,033) (527) (2,560) 2014F 19,729 16 (14,705) 5,024 16 25.5 15 42 195 (2,421) (622) (3,043)
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20 April 2012

Improved efficiency in cash conversion cycle Hengdelis operating cash flow turned negative in FY10 mainly due to rapid expansion during the year, which required heavy inventory support. By following a measured pace of store opening, Hengdeli has brought operating cash to positive territory, with an inflow of RMB196m in FY11. Management has implemented more stringent controls over inventory and working capital to ensure positive operating cash flow going forward. Given the expectation of a reasonable expansion pace, we anticipate Hengdeli will be able to generate positive cash flow in FY12F-13F. Inventory management is the key to its retail business expansion with the initial batch of inventory typically accounting Hengdelis for about 90% of its store opening capital requirements. Despite aggressive network expansion in the past years, Hengdeli managed to improve inventory turnover in the last three years. For example, Hengdeli managed to maintain average turnover days at the FY10 level of 165 days in FY11. With the soon-to-be-implemented ERP system, we anticipate further improvements in inventory levels for FY12F. We look for inventory turnover days to remain under control at below 165 days in FY12F-14F. Average payable turnover days was kept under 75 days for the past three years. We expect payable turnover days to remain stable at 75 days in FY12F-14F. Going forward, we anticipate the cash conversion cycle days for FY12F-13F to remain at the reasonable level of 114-115 days. A stable working capital cycle should support healthy growth in operating cash flow as well as free cash flow. Hengdeli cash conversion cycle and working capital days
220 200 180 160 140 120 100 80 60 40 20 0 (20) (40) (60) (80) (100) 197 179 146 155 166 136 115 115 115 114 165 165 165 164
Healthy cash conversion cycle
18
24
23
25
25
25
25
(51)
(66)
(52) (75) (75) (75) (75) FY10 FY11 FY12F Average receivable days Average payable days FY13F FY14F Cash conversion cycle (days)
FY08 FY09 Average inventory days
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20 April 2012
Hengdeli operating cash flow, free cash flow and net cash flow projections
RMB m 2,500
2,000 1,500 1,000 500 0 (500) (1,000) (205) (480) (662) FY08 FY09 (280) (675) FY10 Operating cash flow FY11 Free cash flow FY12F Net cash flow FY13F FY14F (94) (310) 942 625 512 155 115 663 534 174
2,145 1,987 1,713
1,908 1,779 1,416
Hengdeli balance sheet projections

Year to December (RMB m) Property, plant and equipment Intangible assets Investment properties Investment in jointly controlled entity Other investments Deferred tax assets Goodwill Non-current assets total Inventories Trade and other receivables Asset classified held for sale Cash and equivalents Current assets total Bank loans and other loans Trade and other payables Current tax payables CB and embedded financial instruments Liabilities associated with asset classified as held for sale Current liabilities total Long-term borrowing Other NC payables Non-current liabilities total Minorities Equity Total assets Total liabilities and equities Gross debt Net debt (cash) Net gearing (%) Source: Company data, CCBIS estimates 2007 289 43 30 28 0 24 213 628 1,667 560 0 1,071 3,298 245 476 88 0 0 809 995 140 1,134 197 1,785 3,926 3,926 1,240 253 14.2 2008 529 43 28 31 1 40 228 900 2,447 450 0 685 3,581 760 584 70 0 0 1,415 716 18 734 236 2,096 4,481 4,481 1,476 888 42.4 2009 600 43 26 36 1 39 243 988 2,404 591 0 1,191 4,186 824 807 62 0 0 1,692 322 36 358 257 2,867 5,174 5,174 1,146 (5) Net cash 2010 664 26 240 53 122 52 278 1,437 3,198 1,005 0 3,420 7,623 1,077 881 97 0 0 2,055 2,317 41 2,359 329 4,316 9,059 9,059 3,394 (16) Net cash 2011 666 23 256 56 474 78 297 1,849 4,521 1,115 136 3,968 9,740 2,042 1,759 144 48 28 4,022 2,202 35 2,237 440 4,891 11,589 11,589 4,244 302 6.2 2012F 750 41 256 55 474 78 297 1,951 5,044 1,320 136 5,452 11,952 2,042 3,259 346 48 28 5,723 2,000 40 2,040 545 5,595 13,903 13,903 4,042 (1,410) Net cash 2013F 840 40 256 54 474 78 297 2,038 6,428 1,516 136 5,424 13,504 2,042 3,847 614 48 28 6,580 1,800 40 1,840 673 6,449 15,542 15,542 3,842 (1,582) Net cash 2014F 925 40 256 53 474 78 297 2,122 6,786 1,701 136 6,838 15,462 2,042 4,404 933 48 28 7,456 1,800 40 1,840 818 7,469 17,583 17,583 3,842 (2,996) Net cash
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Hengdeli cash flow projections

Year to December (RMB m) EBIT D&A EBITDA Other non-cash adjustment Operating cash flow before changes in working capital Working capital changes: Inventory Trade and other receivables Trade and other payables Total working capital changes Interest received Interest paid Tax paid Operating cash flow Capex for acquisition of: Property, plant and equipment Land use rights Intangibles Total capex Free cash flow Other investing cashflow Changes in pledged deposit Reorganization Proceeds from issue of shares Dividend paid Net cash flow Gross cash flow Source: Company data, CCBIS estimates (60) 0 0 (60) (186) 0 (7) 0 0 (76) (269) (889) (274) 0 (1) (275) (480) 0 (13) 0 (6) (163) (662) (1,272) (110) 0 (2) (112) 512 0 56 0 526 (153) 942 (150) (393) 0 (2) (395) (675) 0 30 0 923 (123) 155 (907) (208) 0 (2) (209) (94) 0 (16) 0 5 (204) (310) (1,602) (140) 0 (18) (158) 1,987 0 26 0 0 (300) 1,713 1,510 (130) 1 (0) (129) 534 1 0 0 0 (361) 174 (26) (130) 1 (0) (129) 1,779 1 0 0 0 (364) 1,416 1,416 (353) (260) 35 (577) 22 (68) (96) (126) (740) 96 72 (572) 10 (82) (157) (205) 42 (105) 215 153 5 (77) (128) 625 (739) (227) 14 (951) 19 (83) (165) (280) (1,281) (256) 664 (873) 90 (171) (247) 115 (523) (205) 1,505 777 98 (182) (149) 2,145 (1,383) (196) 589 (991) 98 (173) (156) 663 (358) (186) 557 13 123 (173) (164) 1,908 2007 621 30 651 (58) 593 2008 660 37 697 (101) 595 2009 656 44 700 (29) 671 2010 890 53 944 (44) 900 2011 1,342 75 1,417 (102) 1,316 2012F 1,661 56 1,717 (117) 1,600 2013F 1,943 41 1,985 (99) 1,885 2014F 2,154 45 2,199 (90) 2,109
Hengdeli key financial ratios

Year to December ROAE (%) ROAA (%) ROIC (%) Average inventory days Average receivable days Average payable days Cash conversion cycle (days) Net gearing (%) Gross gearing (%) Source: Company data, CCBIS estimates 2007 26.9 13.1 26.0 151 32 49 134 14.2 69.4 2008 25.1 10.9 19.5 179 18 51 146 42.4 70.4 2009 15.4 7.6 16.9 197 24 66 155 Net cash 40.0 2010 14.9 7.8 17.8 166 23 52 136 Net cash 78.6 2011 16.9 7.9 20.7 165 25 75 115 6.2 86.8 2012F 18.1 7.7 25.5 165 25 75 115 Net cash 72.2 2013F 19.2 8.1 29.7 165 25 75 115 Net cash 59.6 2014F 19.1 8.2 31.0 164 25 75 114 Net cash 51.4
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Company specific risks

Management shares transaction
Public filings show that the Swatch Group (UHR VX, Not Rated), the second-largest shareholder in Hengdeli, substantially raised its stake in the company, from 9.05% to 20.42%, on 21 July 2011. Chairman Zhang Yuping, with a 35.42% stake in Hengdeli, has personally pledged about 500m shares, or an 11% stake for a fixed term of three years till 2014, in return for US$100m from the Swatch Group. There is no option or obligation for the Swatch Group to acquire the shares and the chairman affirms he has no plan to sell the shares under the pledge. The chairman explained that the funding is purely for personal investments in business ventures unrelated to Hengdelis operations. Management emphasized that there will be no change in Hengdelis board, management or operations after the change in shareholding structure. We believe the pledge arrangement, while only a private agreement between major shareholders, will be viewed cautiously by the market. The on-going corporate governance concerns held by some investors do not help.
Senior management
Board of directors
Mr. Zhang Yuping (Alia, Cheung Yu Ping) Chairman and executive director
Mr. Zhang, who founded the company in 1999, is in charge of overall management and strategic development. He has more than 20 years of experience in the high-end consumables distribution industry for the China market.
Mr. Song Jianwen Executive director

Mr. Song is in charge of finance and investment at Hengdeli. Mr. Song graduated from Zhongnan Finance Economics University with a Masters Degree in Economics. He joined the company in 2001 and has over 10 years of experience in finance and accounting.
Mr. Huang Yonghua Executive director

Mr. Huang is in charge of the companys business coordination and operational supervision. Joined the company in 2001, Mr. Huang has more than 10 years of experience as a manager Chinas watch distribution industry.
Mr. Chen Sheng Non-executive director

Mr. Chen joined the company in 2007 and is responsible for the groups investment activities. He graduated from Fudan University in Shanghai with a Masters Degree in Business Administration.
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Mr. Shen Zhiyuan Non-executive director

Mr. Shen graduated from the Beijing Institute of Business (). Later, he became General Manager of Beijing Yishang Group (). He is currently the Vice Chairman of the Association of PRC Enterprises () and Chairman of the Association of Beijing Enterprises. (). Mr. Shen joined the group in 2004.
Mr. Shi Zhongyang Non-executive director

Mr. Shi graduated from Nanjing University in China and the University of Goetting in Germany with a Masters Degree in Law. Mr. Shi joined The Swatch Group Limited in 2000 and joined Hengdeli in 2006. He is currently legal counsel in the legal department of The Swatch Group Limited.
Mr. Cai Jianmin Independent non-executive director

Mr. Cai joined Hengdeli in 2005. He has held senior financial positions in various companies including Shanghai Hualian (Group) (()). He graduated from University of Edinburgh, Scotland with a Bachelors Degree and a Doctorate Degree in Electrical Engineering. Mr. Wong is currently a professor in the Department of Systems Engineering and Engineering Management at Chinese University of Hong Kong. He obtained his qualification as a Chartered Engineer (CEng) in 1991, and is now a member of the Institute of Electrical Engineers and a professional member of the Association of Computing Machinery.
Senior management
Mr. Zhuang Liming Vice chairman of Shanghai Xinyu
After graduating from Beijing Foreign Trade College, Mr. Zhuang worked for Chinas Light Industry Commodities Import and Export Company before joining Hengdeli in 2000.
Ms. Wang Lingfei Deputy president

Ms. Wang is responsible for brand development. Before joining the company in 2005, she was General Manager of Beijing Yishang Group.
Mr. Lee Wing On, Samuel Deputy president

Mr. Lee is responsible for retailing in Hong Kong. He joined the company in 2006 and has over 20 years of experience in the Hong Kong watch retail industry.
Mr. Stan Lee Deputy president

Mr. Lee is responsible for retailing on the mainland. He joined Hengdeli in 2007, and has over 20 years of experience in watch manufacturing and distribution.
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20 April 2012
Luk Fook Holdings (590 HK)

Losing a bit of glitter
Despite its shorter operating history relative to peers, Luk Fook has grown to become the third-largest gold and jewelry retailer in Hong Kong, where it enjoys high customer recognition and differentiates itself from Chow Tai Fook by having a higher turnover contribution from gem-set products. The major shortcomings of Luk Fook stem from its franchising-driven operation in China. While valuations are compelling, significant near-term challenges arise as SSSG weakens on the back of consolidating gold price. We initiate coverage on this stock with a Neutral rating.
Company Rating: Neutral

(initiation)
Price: Target:
HK$20.90 HK$21.80
(initiation)
Trading data
52-week range Market capitalization (m) Shares outstanding (m) Free float (%) 3M average daily T/O (m share) 3M average daily T/O (US$m) Expected return (%) 1 year Closing price on 18 April 2012 HK$19.2 46.15 HK$12,312/US$1,586 589 55 5.5 19.5 9.3
Wide exposure to gem-set products. Luk Fooks sales from gem-set items contribute to over 40% of its total jewelry sales. Gem-set products have more stable pricing and offer higher margins than gold jewelry. Shortcomings from China operation. Well established and recognized in Hong Kong, Luk Fooks major negatives arise from its China operation which is predominantly franchising-driven. Another negative comes from its weak presence in China. Luk Fook only owns 3% of the market in China. The intense competition in the China market means it can be costly and risky for its franchised store network to scale up. Major near-term challenges. On top of declining SSSG, Luk Fook hedges only 20% of its gold price risk. With gold price moving sideway, gross margin could be under pressure. Initiate with Neutral. Valuations of Luk Fook are undemanding as it trades on 8x CY13F P/E but the stock could further de-rate in the near term before its SSSG troughs out and gold price regains momentum. For now, we value the counter on 8.5x CY13F P/E, a 35% discount to our target valuation for Chow Tai Fook.
Stock price vs. HSI

HK$ 46 42 38 34 30 26 22 18 19-Apr-11
1-Jul-11
12-Sep-11 Luk Fook
24-Nov-11 HSI (rebased)
5-Feb-12
18-Apr-12
Source: Bloomberg
Financial forecast
Year to 31 March Revenue (HK$m) Net profit (HK$m) EPS (HKD) EPS (YoY, %) P/E (x) Yield (%) FCF yield (%) ROAE (%) P/B (x) Net gearing (%) FY10 5,386 531 1.079 93 19.4 2.1 0.0 36.5 7.3 1.6 FY11 8,091 866 1.705 58 12.3 3.3 1.2 34.1 3.6 Net cash FY12F 11,530 1,303 2.303 35 9.1 4.5 3.4 28.1 2.1 Net cash FY13F 13,403 1,283 2.178 (5) 9.6 4.4 6.2 20.1 1.8 Net cash FY14F 15,973 1,594 2.705 24 7.7 5.2 7.7 21.0 1.5 Net cash
Claudia Ching
Forrest Chan, CFA

Timothy Sun
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A well-recognised domestic brand in Greater China Luk Fook began with only one outlet in 1991. Since that humble beginning, it has evolved into one of the most successful jewelry retail brands in Greater China. It sources, designs, retails, wholesales a variety of gold jewelry and ornaments, including gem-set jewelry and gemstones. Over the years, Luk Fook has earned high brand recognition from both domestic and mainland shoppers, who have come to appreciate its high product quality and the diversity in product offering. Luk Fook has an extensive retail network of over 800 POS in Hong Kong, Macau and China, including directly-managed and franchised outlets. The company also runs a number of stores in overseas markets, including Singapore, Canada and the United States. In addition, it has an online business that doubles as a business-to-business trading platform among manufacturers, wholesalers and retailers globally. Looking to increase the sales contribution from gem-set jewelry Luk Fook has expertise in gem-set products and is renowned for its exquisite designs and craftsmanship. This represents an important competitive advantage as gem-set products tend to be high-margin and their sales are less vulnerable to gold price fluctuations. With an anticipated increase in contribution from higher-margin gem-set products, we see potential upside for Luk Fooks gross margins in the long run. Market position of jewelers
Luxury
Van Cleef & Arpels Bulgari Tiffany Tesiro Chow Sang Sang 3D-Gold Emperor Watch & Jewellery Jovan TSL CHJ Jewellery Daimengde Fuhui Fuqi Jewelry Kimberlite Diamond Ming Jewelry Laofengxiang Chow Tai Seng Lukfook Chow Tai Fook Cartier
Limited geographic coverage
Laomiao First Asia Jewellery
Extensive geographic coverage
Batar Jewellery
Affordable
Gold and jewelry icon in Hong Kong

Third-largest gold and jewelry retailer in Hong Kong With only 21 years of operating history, Luk Fook is a younger brand relative to Chow Tai Fook or Chow Sang Sang, both of which have been around for 70 years or more. Despite its relatively short life so far, Luk Fook has developed into a leading Hong Kong-based gold and jewelry retailer targeting middle- to upper-income customers in the market for appealing designs and a wide product range. The company has earned high praise from customers and is considered a trusted household brand in Hong Kong and China. In 2010, it accounted for the third-largest market share of 7% of Hong Kongs jewelry retail market, exceeded only by Chow Tai Fooks 20% and Chow Sang Sangs 9%.
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Stores located in prime tourists shopping areas
Luk Fook is well-known to mainland Chinese shoppers as many of its stores are located in prime tourist shopping destinations in Hong Kong, including Tsim Sha Tsui, Mong Kok and Causeway Bay, in short, the favoured destinations of mainland visitors to Hong Kong. It is currently ranked second among Hong Kong jewelry retailers in the UnionPay market pool, just behind market leader Chow Tai Fook. Luk Fook also won the coveted PRC consumers most favored Hong Kong brand for several years running. Such achievements bespeak of the high regard mainland shoppers have for Luk Fook. Jewelry market share by retail value in China (2010)
14% 12% 10% 8% 6% 4% 2% 0% Chow Tai Lao Feng Chow Tai Lao Miao Beijing First Asia Zhe Jiang Fook Xiang Seng Caishikou Ming Cartier Luk Fook Kimberlite Diamond Chow Sang Sang 4% 4% 3% 3% 2% 2% 9% 7% 7% 6% 13%
Jewelry market share by retail value in Hong Kong and Macau (2010)
22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Chow Tai Chow Sang Luk Fook Fook Sang MaBelle Cartier Tiffany & Co King Fook Seng Feng Qeelin CSS 9% 7% 4% 20%
3%
2%
2%
2%
2%
2%
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Luk Fooks flagship store in Tsim Sha Tsui, Hong Kong
Luk Fooks shop in Beijing
Source: Company presentation
Source: Company presentation
Strength in gem-set jewelry backed by reputation for authenticity, product quality and fashionable designs
Renowned for offering authentic, high quality gold and jewelry items In an industry where product differences are generally subtle, Luk Fook has built an enviable reputation for offering exquisite, creative and stylish designs. Its design excellence has been rewarded by higher-than-average sales contribution from gem-set jewelry products, which tend to provide more room for design variety versus gold jewelry. Luk Fook is a keen participant in various local and international jewelry design competitions, where it has collected more than 140 awards and special mentions at various international and local design competitions. In FY11, Luk Fook generated 41% of its sales from gem-set products, materially higher than that of its peers. Wider exposure to gem-set products is a positive, in our view, since demand is usually stickier and has less correlation with commodity price, and they offer higher margins. Finally, within the gem-set segment, there is more room for product mix upgrades to drive gross margins. Luk Fooks gold products
Luk Fooks gem-set jewelry products
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Gem-set vs. other product sales split between Luk Fook, Chow Sang Sang and Chow Tai Fook
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Luk Fook Chow Tai Fook Gem-set jewelry Other products Chow Sang Sang
48% 59% 74%
52% 41% 26%
Source: Company data, Chow Sang Sang, Chow Tai Fook latest financial data
Luk Fook sales split trend

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY09 FY10 Gem-set jewellery FY11 1H FY11 Gold/platinum jewellery 1H FY12
54%
53%
55%
54%
59%
46%
47%
45%
47%
41%
Increasing self-sufficiency ratio

Adding production plant capacity to support sales growth and enhance margins Luk Fook has its own gem-set jewelry manufacturing plant in Panyu, Guangdong, which supplies around 50% of its gem-set jewelry. Having its own processing plant means that Luk Fook is able to ensure high product standards for its gem-set jewelry products. This also means that cost effectiveness and production efficiency can be enhanced. The group invested approximately RMB100m in 2003 in a large-scale jewelry processing plant in Panyu, Guangdong, with a total site area of over 350,000 sqf. Luk Fook is now expanding its production plant to increase capacity to support sales growth. The construction of the jewelry processing plant phase II, also situated in Panyu, has begun and operations are expected to commence in October 2012. Once phase II becomes fully operational, total production capacity of the group will double. The group expects to increase its in-house supply ratio for gem-set jewelry from 50% currently to 100% in the long run.
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Longest history as a listed company

Luk Fook was listed in 1997 which means it has the longest history as a public company among the four companies we cover in this report. Over the years, management has established a solid track record of achieving satisfactory business development, as shown in the following charts. Luk Fook turnover since FY96
HK$b 9
8 7 6 5 4 3 2 1 0 1.1 1.5 1.7 1.4 1.7 1.6 1.5 1.5 1.6 2.8 2.0 2.1 4.0 3.4 5.4
Luk Fook earnings since FY96

HKm 1,000
900 800 700 600 500 400 300 200 100 0 47 63 78 40 81 70 65 48 78 127 97 199 318 278 537 877
8.1
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Source: Company data, Bloomberg
Source: Company data, Bloomberg
Shortcomings
Relatively low presence in China Under-represented in China. Luk Fook has a strong franchise in the Hong Kong market, but its market share in China is still low. In 2010, it had market share of only 3% in China (versus 12.6% for Chow Tai Fook), and was ranked ninth by retail value. As at end-September 2011, it had 738 POS in China including 686 franchised stores and 52 directly managed outlets, compared with Chow Tai Fooks jewelry store count of 1,505. Considering Chow Tai Fooks market share is three times larger than Luk Fooks, it is clear that Luk Fooks China unit has lower store productivity than that of Chow Tai Fook. As a result of the use of franchising, China contributed only 17% of Luk Fooks total turnover and only 6% of EBIT in FY11. Luk Fooks underexposure to China disqualifies it as a proxy for that market. Indeed, we look at the stock as solely a proxy of the Hong Kongs jewelry market.
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FY11
20 April 2012
Heavy reliance on franchisees
Franchising risk. Unlike Chow Tai Fook, Luk Fook pursues an asset-light expansion model in China where over 93% of its POS are franchised outlets. Luk Fook sales mix by channel
100%
16%
80%
16% 8%
11% 9%
9% 8%
9% 9%
8% 8%
7% 8%
7%
60%
40%
78%
76%
80%
83%
83%
84%
85%
20%
0% FY09 FY10 FY11 Direct retail FY12F Wholesale FY13F Other FY14F FY15F
Luk Fook groups POS breakdown

100%
12%
80%
13%
12%
12%
12%
12%
12%
60%
40%
88%
87%
88%
88%
88%
88%
88%
20%
0% FY09 FY10 FY11 FY12F FY13F Franchse Direct retail FY14F FY15F
Franchising gives Luk Fook the benefit of lower working capital requirements and faster retail network expansion. But there are also major risks and disadvantages inherent in the franchising business model, including limited access to market intelligence, difficulties in monitoring franchisee performance as well as reputation risk. Luk Fook tries to mitigate franchising risk by enforcing strict standards on its franchisees. A key requirement is that all items distributed to licensees are handled over on cash-on-delivery payment terms. New joiners also have to meet certain prerequisites laid down by Luk Fook in order to receive store opening approvals.
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Luk Fook closely monitors its licensees along the following lines: Quality and inventory control over jewelry products conducted by real-time POS and surveillance systems In-house audit team to check POS financials Standardized point-of-sale systems Mysterious shoppers Penalty of RMB50,000, RMB100,000 or RMB200,000 for selling inferior quality jewelry or breaking licensing rules and A reward of 20% on the collection of penalties to any parties who discover and report violations
Most sensitive to gold price fluctuations compared with peers
Near-term margin pressure. Compared with Chow Tai Fook, which hedges 90% of its gold inventory, Luk Fooks margin is more vulnerable to gold price changes given that the company only hedges 20% of its total gold inventory and keeps about three months of gold inventory. In the case of sharp movements in gold prices, particularly falling gold prices, Luk Fooks gross margins suffer. Luk Fooks gross margin also benefited from rising gold price between 2009 and 2011, suggesting that the recent consolidation in gold price could lead to gross margin contraction.

We forecast 22% earnings CAGR for Luk Fook in FY11-13F, with FY13F likely to see an earnings decline as sales momentum weakens and gold price fluctuates.
Hong Kong and Macau

FY13F will be challenging given weakening SSSG in its core markets Luk Fook believes it is already well-represented in the Hong Kong and Macau markets with good store coverage in key shopping areas. The plan is to add two-to-three new stores in Hong Kong and one-to-two outlets in Macau per year going forward. Combined with the SSSG estimates discussed at the beginning of this report, we look for 49% turnover growth in each of Hong Kong and Macau in FY12F, but slower sales growth of only 15% in FY13F on the back of lower SSSG.
China
Luk Fooks China operation is dominated by franchised stores which account for 686 out of its 738 POS there. Its footprint in China will continue to grow as it adds both franchised stores and directly-run retail points. We forecast 12-16% growth, or 100-102 licensed stores added annually. In addition, 10-15 self-run POS will be opened annually, mainly in tier-one or two cities. As a result, we forecast 29-41% China retail turnover growth and 22-27% overall wholesale revenue growth in FY12F-13F, with the latter representing a rough proxy for the companys wholesale business in China given that overseas wholesale contribution is marginal.
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Gross margin dilution in the near term

Gross margin pressure in the short term as gold price trades sideways We see potential downside risk to the gross margin of Luk Fooks gold products in FY13F. As discussed above, Luk Fooks margin is more vulnerable to gold price changes than peers given that the company only hedges 20% of its total gold inventory and keeps about three months of gold inventory. In the event of sharp movements in gold prices, in particularly falling gold prices, Luk Fooks gross margins could fall. We estimate Luk Fooks gross profit margin will decline from 23.9% in FY12F to 22.4% in FY13F. As for the gemstone jewelry business, Luk Fook is hoping to increase the segments contribution in the coming years given the more attractive profitability. The groups gem-set jewelry earns a higher gross margin of about 35% to 39% versus gold/platinum jewelry with around 14% to 15%. In our view, the steady upward trend in diamond and gemstone prices should also favor Luk Fooks operations ahead. That said, we believe Luk Fooks product mix changes will not vary materially in the medium term as most Chinese still prefer to buy gold jewelry as a form of wealth protection and as a status symbol. Therefore, we expect there will only be incremental adjustments in product mix over the long run. Luk Fook gross profit margin trend
25.4% 24.9% 24.0% 23.7% 23.6%
24.5%
23.9% 23.3% 22.4%
23.7%
22.7% 22.1% 21.8%
20.9%
20.0% FY08 FY09 FY10 FY11 FY12F FY13F FY14F FY15F
Rise in key expense ratio for FY12F-13F

We expect Luk Fook to face greater operating cost pressure in FY12F-14F particularly on the rental costs front, as most of the groups stores in Hong Kong are located in prime shopping areas. Management has indicated that rental increments for FY12F will be exceptionally high, not only because of the revision of the renewal contracts, but because the rise has also been caused by high rental rates for its new stores established in Hong Kong during the period. Nonetheless, helped by high SSSG in FY12F, we believe Luk Fooks rental ratio will only increase by 0.1ppt, from 3.1% to 3.2% of total sales in FY12F. Going forward, we expect Luk Fook to see moderating SSSG in FY13F-14F, and with rental hikes for its stores destined to continue, we anticipate a jump in the companys rental ratio, from 3.2% of total sales in FY12F, to 3.4% and 3.5% of total sales in FY13F-14F respectively.
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20 April 2012
Staff costs, representing 4.7% of total sales in FY11, is not a major issue thanks to the significant variable portion of Luk Fooks staff compensation structure. Luk Fook typically spends less than 1% of sales on advertising and promotional expenses. We do not expect a material change in A&P spending for FY12F-13F but expect it to be maintained at less than 1% of total sales. Luk Fook key assumptions
Year to March (HK$m) Total POS China sub-total China self-operated jewelry POS China franchised jewelry POS Hong Kong/Macau sub-total Other markets sub total Total POS YoY change China sub-total China self-operated jewelry POS China franchised jewelry POS Hong Kong/Macau sub-total Other markets sub total Total POS YoY change (%) China sub-total China self-operated jewelry POS China franchised jewelry POS Hong Kong/Macau sub-total Other markets sub total SSSG (%) China Hong Kong/Macau Wholesale (supply of gem set to the licensee) YoY (%) Wholesales per licensee YoY (%) Royalty income YoY (%) Royalty income per licensee YoY (%) Consultancy fee income YoY (%) Gross margin (%) Total staff cost as % of total sales Total lease costs as % of direct retail sales Other expenses as % of total sales Source: Company data, CCBIS estimates 11 160 22.1 6.0 5.3 4.6 126 1 28 9 259 (12) 17 452 74 1 44 154 22 0 1 19 73 24.0 4.9 4.8 4.1 33 30 739 64 1 28 253 64 0 28 22 16 23.7 4.7 3.9 3.4 25 38 937 27 1 11 338 34 0 15 26 21 23.9 5.1 4.1 3.5 13 10 1141 22 1 9 416 23 1 8 29 16 22.4 5.2 4.4 3.7 15 12 1348 18 1 7 487 17 1 4 32 12 23.3 5.3 4.6 3.8 13 13 1549 15 2 5 546 12 1 1 35 9 23.7 5.3 4.6 3.9 2009 456 419 19 400 30 7 46 43 8 35 2 1 18 19 73 18 7 17 2010 557 519 36 483 31 7 76 75 17 58 1 0 22 24 89 21 3 0 2011 699 657 39 618 33 9 117 113 3 110 2 2 25 27 8 28 6 29 2012F 817 772 54 718 34 11 118 115 15 100 1 2 17 18 38 16 3 22 2013F 927 882 64 818 34 11 110 110 10 100 0 0 13 14 19 14 0 0 2014F 1,045 999 79 920 35 11 118 117 15 102 1 0 13 13 23 12 3 0 2015F 1,163 1,116 94 1,022 36 11 118 117 15 102 1 0 11 12 19 11 3 0
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Luk Fook revenue projections

Year to March (HK$m) Total revenue YoY (%) Revenue by market Retail, China Retail, Hong Kong, Macau and others Wholesale, China Scrap of gold and platinum and gold bullion Licensing (royalty fee 2-12%) Revenue growth by market (%) Retail, China Retail, Hong Kong, Macau and others Wholesale, China Scrap of gold and platinum and gold bullion Licensing (royalty fee 2-12%) Revenue mix by market (%) Retail, China Retail, Hong Kong, Macau and others Wholesale, China Scrap of gold and platinum and gold bullion Licensing (royalty fee 2-12%) Revenue by sales channel Retail Wholesale Revenue growth by sales channel (%) Retail Wholesale Revenue mix by sales channel (%) Retail Wholesale Others Source: Company data, CCBIS estimates 78 7 16 76 8 16 80 9 11 83 8 9 83 9 9 84 8 8 85 8 7 (29) 5,991 33 74 57 64 48 27 16 22 20 18 21 15 3,076 259 4,091 452 6,440 739 9,560 937 11,114 1,141 13,369 1,348 16,134 1,549 4 73 7 12 3 5 71 8 12 3 6 74 9 8 3 6 77 8 6 3 6 77 9 5 3 7 77 8 5 3 7 78 8 4 3 (114) (90) 12 5,991 63 31 74 38 26 57 57 64 (5) 59 41 49 27 5 32 29 15 22 5 22 31 19 18 5 17 27 20 15 5 12 177 2,898 259 487 138 289 3,802 452 671 174 454 5,986 739 637 276 641 8,919 937 669 364 826 10,289 1,141 702 445 1,080 12,288 1,348 737 519 1,368 14,766 1,549 774 582 2009 3,959 18 2010 5,386 36 2011 8,091 50 2012F 11,530 43 2013F 13,403 16 2014F 15,973 19 2015F 19,038 19
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20 April 2012
Luk Fook profit and loss projections

Year to March (HK$m) Total revenue YoY (%) COGS YoY (%) Gross profit YoY (%) Gross margin (%) Other income and gains Staff costs YoY (%) As % of turnover Depreciation and amortization YoY (%) As % of turnover Rental costs YoY (%) As % of turnover A&P costs YoY (%) As % of turnover Commission expense to credit cards YoY (%) As % of turnover Total SG&A and other expenses YoY As % of total turnover EBIT YoY (%) EBIT margin (%) Depreciation and amortization included in SG&A EBITDA YoY (%) EBITDA margin (%) Interest income Interest expense Share of results of an associate Profit before tax YoY (%) As % of turnover Tax Effective tax rate (%) Minority interest Net profit YoY (%) Net margin (%) Source: Company data, CCBIS estimates 2009 3,959 18 (3,085) 122 874 4 22.1 32 (239) 5 6.0 (36) 13 0.9 (164) 30 4.2 (33) (7) 0.8 (32) 25 0.8 (587) 11 14.8 318 (14) 8.0 36 355 (12) 9.0 5 (8) 1 316 (15) 8 (38) 12 (3) 275 (12) 7.0 2010 5,386 36 (4,093) 133 1,294 48 24.0 22 (264) 10 4.9 (44) 21 0.8 (197) 20 3.7 (33) 0 0.6 (43) 35 0.8 (680) 16 12.6 635 99 11.8 44 679 91 12.6 0 (4) 2 634 101 12 (98) 15 (5) 531 93 10.0 2011 8,091 50 (6,174) 151 1,917 48 23.7 19 (382) 45 4.7 (51) 16 0.6 (253) 28 3.1 (38) 15 0.5 (68) 59 0.8 (912) 34 11.3 1,024 61 12.7 51 1,075 58 13.3 9 (5) 0 1,029 62 13 (152) 15 (11) 866 63 10.8 2012F 11,530 43 2013F 13,403 16 2014F 15,973 19 2015F 19,038 19 1H11 3,264 56 (2,497) 60 767 46 23.5 5 (149) 28 4.6 (24) 23 0.7 (120) 31 3.7 (19) 6 0.6 (26) 60 0.8 (396) 29 12.1 377 64 11.5 24 401 61 12.3 3 (3) 1 378 64 12 (54) 14 (4) 320 71 9.9 2H11 4,827 46 (3,677) 45 1,150 50 23.8 14 (233) 58 4.8 (27) 10 0.6 (133) 26 2.8 (19) 24 0.4 (42) 59 0.9 (516) 38 10.7 647 59 13.4 27 674 57 14.0 6 (2) (0) 651 61 13 (98) 15 (7) 546 59 11.5 1H12 5,511 69 (4,159) 67 1,353 76 24.5 9 (211) 42 3.8 (33) (38) 0.6 (133) 11 2.4 (23) 20 0.4 (46) 77 0.8 (520) 31 9.4 842 124 15.3 33 875 118 15.9 3 0 3 848 124 15 (120) 14 (8) 720 63 13.2 2H12F 6,019 25 (4,621) 26 1,398 22 23.2 6 (239) 3 4.0 (18) 32 0.3 (236) 77 3.9 (35) 84 0.6 (46) 10 0.8 (701) 36 11.6 703 9 11.7 18 721 7 12.0 4 0 (2) 705 8 12 (113) 16 (9) 583 125 9.8
(8,780) (10,398) (12,250) (14,520) 142 118 118 119 2,751 43 23.9 15 (450) 18 5.1 (52) 1 0.4 (369) 46 3.2 (58) 52 0.5 (92) 36 0.8 (1,221) 34 10.6 1,545 51 13.4 52 1,597 49 13.8 7 0 1 1,553 51 13 (233) 15 (17) 1,303 50 11.4 3,005 9 22.4 12 (532) 18 5.2 (65) 26 0.5 (450) 22 3.4 (80) 39 0.6 (107) 16 0.8 (1,479) 21 11.0 1,538 (0) 11.5 65 1,603 0 12.0 9 0 1 1,547 (0) 12 (248) 16 (17) 1,283 (2) 9.7 3,723 24 23.3 10 (648) 22 5.3 (81) 25 0.5 (563) 25 3.5 (96) 19 0.6 (128) 19 0.8 (1,823) 23 11.4 1,910 24 12.0 81 1,991 24 12.5 11 0 1 1,922 24 12 (308) 16 (21) 1,594 24 10.1 4,518 21 23.7 7 (785) 21 5.3 (96) 18 0.5 (681) 21 3.6 (114) 19 0.6 (152) 19 0.8 (2,212) 21 11.6 2,313 21 12.2 96 2,409 21 12.7 14 0 1 2,328 21 12 (396) 17 (25) 1,907 20 10.1
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Net cash positioning with AMPLE cash on hand of c.HK$2.5b by FY12F The majority of Luk Fooks planned openings will be franchised outlets and meaning that expansion will create only minimal burden to the companys working capital. Luk Fooks capex is mainly for openings of a small number of self-owned stores and regular maintenance. Management is setting a capex target of HK$140-160m for FY12F-13F, mainly to set up 10-15 boutiques across the PRC. These capex targets are not significant considering the companys operating cash flow of HK$500m-plus in FY12F-13F. Moreover, Luk Fook was in a net cash position of HK$318m as at end-September, 2011. More recently, in Janurary 2012, it raised an additional amount of HK$1.3b via a top-up placement. Luk Fook cash conversion cycle and working capital days
180 150 120 90 60 30 3 0 (30) (33) (60) FY09 FY10 Average inventory days (35) (36) (36) (37) (37) (37) 4 4 4 4 4 4 146 132 116 100 97 101 129 133 139 107 139 106 141 109
FY11 FY12F FY13F Average receivable days Average payable days
FY14F FY15F Cash conversion cycle (days)
Luk Fook operating cash flow, free cash flow and net cash flow projections
HK$m 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 (200) (400) FY09 FY10 FY11 Operating cash flow FY12F FY13F FY14F Free cash flow Net cash flow FY15F 340 311 212 311 (4) (136) 244 143 1,000 922 762 561 421 534 1,103 943 719 580 1,025 865
1,563
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Luk Fook balance sheet projections

Year to December (HK$m) Property, plant and equipment Leasehold land and land use rights Investment properties Interests in associate Trading license Rental deposits Deferred tax assets Non-current assets total Inventory Trade receivables Deposits, prepayments and other receivables Amt due from associate Bank balance and cash Total current assets Trade and other payables Short-term bank loans Taxation payable Amount due to an associate Total current liabilities Deferred tax liabilities Employees benefit Long-term bank loans Total non-current liabilities Shareholder equity Minority interest Proposed dividend Total equity Total assets Total liabilities and equities Gross debt Net debt Net gearing (%) Source: Company data, CCBIS estimates 2009 108 17 0 2 1 26 14 168 1,219 37 44 6 280 1,586 259 169 28 0 456 3 23 0 26 1,196 18 59 1,273 1,754 1,754 169 (111) Net cash 2010 380 15 0 5 1 31 14 446 1,736 74 46 8 287 2,151 530 314 50 0 894 7 12 0 19 1,523 23 138 1,683 2,597 2,597 314 27 1.6 2011 370 15 81 5 1 40 19 531 2,631 109 41 5 966 3,751 686 0 90 0 777 19 28 0 46 3,196 35 228 3,458 4,282 4,282 0 (966) Net cash 2012F 459 15 81 6 1 59 19 639 3,775 150 58 5 2,529 6,517 1,054 0 140 0 1,193 19 31 0 49 5,624 52 238 5,914 7,156 7,156 0 (2,529) Net cash 2013F 555 14 81 6 1 72 19 748 4,159 174 67 5 3,063 7,468 1,040 0 149 0 1,188 19 34 0 52 6,671 69 236 6,976 8,216 8,216 0 (3,063) Net cash 2014F 634 14 81 7 1 90 19 846 5,145 208 80 5 3,782 9,219 1,470 0 185 0 1,654 19 37 0 56 7,964 90 300 8,355 10,065 10,065 0 (3,782) Net cash 2015F 699 13 81 8 1 109 19 930 6,098 247 95 5 4,359 10,805 1,452 0 237 0 1,689 19 41 0 59 9,471 115 401 9,986 11,735 11,735 0 (4,359) Net cash 1H11 336 6 82 5 1 33 16 480 2,208 80 47 33 274 2,642 511 0 608 79 1,198 14 12 0 26 1,870 28 0 1,897 3,122 3,122 0 (274) Net cash 1H12 385 40 90 8 1 35 31 592 3,927 145 81 0 413 4,566 865 95 166 1 1,127 27 28 0 55 3,933 44 0 3,977 5,158 5,158 95 (318) Net cash
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Luk Fook cash flow projections

Year to December (HK$m) EBIT Depreciation and amortization EBITDA Adjustments for other non-cash items Working capital changes: Inventory Receivables Payables Tax paid Interest paid Interest received Operating cash flow Capex Free cash flow Other investment cash flows Contribution from minority shareholders Share issue Dividend paid Advance/repayment to/from minority shareholders Net cash flow Source: Company data, CCBIS estimates 29 (3) (26) (48) 8 (0) 340 (30) 311 2 0 0 (101) 0 212 (513) (32) 272 (71) 3 (0) 311 (315) (4) 2 0 0 (133) 0 (136) (870) (36) 156 (108) 5 (1) 244 (101) 143 2 0 1,134 (279) 0 1,000 (1,144) (58) 367 (184) 0 (8) 561 (140) 421 8 0 1,363 (228) 0 1,563 (384) (34) (14) (239) 0 (9) 922 (160) 762 9 0 0 (238) 0 534 (986) (46) 430 (272) 0 (11) 1,103 (160) 943 11 0 0 (236) 0 719 (953) (55) (18) (343) 0 (13) 1,025 (160) 865 13 1 0 (300) 1 580 2009 318 39 355 25 2010 635 44 679 (26) 2011 1,024 51 1,075 24 2012F 1,545 52 1,597 (9) 2013F 1,538 65 1,603 (1) 2014F 1,910 81 1,991 (3) 2015F 2,313 96 2,409 (1)
Luk Fook key financial ratios

Year to December ROAE (%) ROAA (%) ROIC (%) Average inventory days Average receivable days Average payable days Cash conversion cycle (days) Net gearing (%) Gross gearing (%) Source: Company data, CCBIS estimates 2009 23.5 15.9 24.2 146 3 33 116 Net cash 13.3 2010 36.5 24.4 37.5 132 4 35 100 0.0 18.6 2011 34.1 25.2 41.4 129 4 36 97 Net cash 0.0 2012F 28.1 22.8 44.4 133 4 36 101 Net cash 0.0 2013F 20.1 16.7 35.2 139 4 37 107 Net cash 0.0 2014F 21.0 17.4 37.6 139 4 37 106 Net cash 0.0 2015F 21.0 17.5 37.4 141 4 37 109 Net cash 0.0
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Company-specific investment risks

Share disposal risk
Luk Fooks major shareholders and directors have a history of reducing ownership in Luk Fook, exhibited in the below table. Capital raised in the past was mainly used to raise the companys liquidity, purchase inventory and expand. While the companys key shareholders remain the same, we nevertheless view Luk Fooks history of share disposals as a key risk that could trigger short-selling of the stock. Luk Fook past capital raising activities
Issue date December 2010 January 2011 Type Top-up placement Top-up placement # of shares issued 42,000,000 46,600,000 Net proceeds 1,134 1,341 HK$ / share 23.15 29.25

Directors
Mr. Wong Wai Sheung Chief Executive Officer and founder
Mr. Wong has over 43 years of experience in the Hong Kong jewelry industry and is responsible for overall strategic planning and management of the group. Mr. Wong is also the Associate Director of The Kowloon Gold Silver and Jewel Merchants Staff Association, a post he has held since November 1993. He has also been the Honorary Permanent Chairman of Jadeware Traders Industry & Commerce Association and Chairman of the Supervisory Committee of Kowloon Jewellers and Goldsmiths Association since 2001. In 2005 he was elected Honorary Chairman of Macau Goldsmiths Guild and appointed Honorary Chairman of the First General Committee of Guangdong Golden Jewelry and Jade Industrys Association in 2006. He has been a member of the Hong Kong Trade Development Council Jewellery Advisory Committee and the QTSA Governing Council (Retailer Category) and an elected member of the General Committee of the Hong Kong Brand Development Council sine 2008. Mr. Wong is the father of Mr. Wong Ho Lung, Danny and Miss Wong Lan Sze, Nancy, all directors at the company.
Mr. Tse Moon Chuen Director, deputy general manager and co-founder
Mr. Tse has over 37 years of experience in the jewellery retailing business and is responsible for sales operations and administration of the groups retail shops. He has been appointed to various positions over the years including as an executive committee member of the Diamond Federation of Hong Kong, China Ltd. since 2000; an alternate committee member of the Chinese Gold & Silver Exchange Society since July 2004 and Vice-Chairman of the Kowloon Pearls, Precious Stones, Jade, Gold and Silver Ornament Merchants Association since 2005.
Mr. Law Tim Fuk, Paul Director, Company secretary and Financial controller
Mr. Lau joined the group in 1996. He is a member of the ACCA, the CIMA, the HK ICSAN. Mr. Law has over 16 years of accounting and auditing experience and over 19 years of experience in commerce. He is mainly responsible for the accounting and finance of the group. He also handles communications with institutional investors and financial reporters.
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Senior Management
Mr. Au Kwok Kau General manager and co-founder
Mr. Au is one of the co-founders of the company and was the General Manager of the group since 1992. Since 2007 he has served as the group General Manager. Mr Au is responsible for the overall administration of Luk Fook and has over 38 years of experience in Hong Kongs jewelry industry.
Ms. Chung Vai Ping, Icy Senior Product Development Manager

Ms. Chung has over 20 years experience within the jewelry industry. She joined the group in 1990 and is mainly responsible for the product development, jewelry purchasing, wholesaling and retailing business of the group. Ms. Chung frequently visits jewelry exhibitions worldwide in order to explore new products and source the finest jewelry and jewelry parts. In 2001, she won the Best of Show Award with her Flashing design at the 2nd Hong Kong Jewellery Design Competition. She was awarded the title GIA Diamonds Graduate in 2004. Luk Fooks shareholding structure
Luk Fook (Control) Ltd. 39.8%
Public 60.2%
Luk Fook Holdings Ltd. (590 HK)

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Appendix : Peer comparison

Chow Tai Fook (1929 HK) Year to March FY11 Total POS Total POS by region China Hong Kong, Macau & others POS breakdown by format Direct Franchised POS breakdown by format (%) Direct Franchised Total sales (HK$m) Direct retail Wholesale Other Sales mix by channel (%) Direct retail Wholesale Other Sales mix by region (HK$m) China Hong Kong Other Sales mix by region (%) China Hong Kong Other Sales mix by product (HK$m) Gem-set jewelry Platinum/karat gold products Gold items Watches Sales mix by product (%) Gem-set jewelry Gold items Watches Gross profit margin (%) 26 67 7 28.3 29.5 15 85 25.6 18 82 28.8 100 24.9 100 25.1 45 55 23.7 23.9 8,963 4,869 18,725 2,486 633 3,461 1,030 4,832 7,157 9,462 2,898 3,542 56 44 56 44 11 82 7 11 83 6 66 29 5 68 28 4 18 74 8 17 77 6 19,472 15,571 31,272 24,343 462 3,366 267 622 4,863 377 4,731 2,101 325 6,455 2,626 381 1,468 5,986 637 1,942 8,919 669 86 14 83 17 100 100 78 20 2 76 22 2 80 9 11 83 8 9 71 29 35,046 30,033 5,009 71 29 55,615 46,438 9,177 100 4,095 4,095 100 5,862 5,862 100 7,157 5,553 1,447 157 100 9,462 7,145 2,122 196 12 88 8,091 6,440 739 912 12 88 11,530 9,560 937 1,033 970 391 1,146 474 61 80 350 405 81 618 99 718 1,277 84 1,528 92 40 21 57 23 286 64 332 73 657 42 772 45 1,361 FY12F 1,620 Emperor (887 HK) Year to December FY10 61 FY11 80 Hengdeli (3389 HK) Year to December FY10 350 FY11 405 Luk Fook (590 HK) Year to March FY11 699 FY12F 817
(continued on next page)
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Appendix : Peer comparison (continued from previous page)

Chow Tai Fook (1929 HK) Year to March FY11 Key SG&A expense ratio (%) Rental Staff Other operating expense EBIT (HK$m) EBIT margin (%) EBITDA (HK$m) EBITDA margin (%) Net profit (HK$m) Normalised net profit (HK$m) Normalised net profit margin (%) Average inventory days Average receivable days Average payable days Cash conversion cycle (days) Gross debt (HK$m) Net debt (HK$m) Net gearing (%) ROAE (%) ROAA (%) ROIC (%) * As % of direct retail sales Note: Hengdelis data was originally presented in RMB; RMB/HK$ exchange rate of 1.2 was applied to all figures Source: Chow Tai Fook, Emperor, Hengdeli and Luk Fook data, CCBIS estimates 5.7 5.2 4.6 4,656 13.3 4,402 12.6 3,538 3,538 10.1 192 14 6 200 6,813 1,208 10.3 36.4 15.9 24.3 5.0 4.8 4.2 8,861 15.9 8,475 15.2 6,516 6,516 11.7 210 13 6 218 13,100 (8,300) Net cash 32.5 16.0 28.1 6.7 3.8 1.1 413 10.1 454 11.1 134 325 7.9 207 17 (40) 184 67 (534) Net cash 6.6 5.1 20.8 6.9 3.9 1.2 764 13.0 831 14.2 627 636 10.9 243 12 (35) 219 340 (464) Net cash 20.5 16.1 24.4 5.7 5.1 0.8 729 10.2 775 10.8 482 482 6.7 166 23 (52) 136 2,956 (14) Net cash 14.9 7.8 17.8 5.5 5.3 0.9 1,054 11.1 1,117 11.8 678 678 7.2 165 25 (75) 115 3,530 252 6.2 16.9 7.9 20.7 3.1 4.7 3.4 1,024 12.7 1,075 13.3 877 866 10.8 129 4 (36) 97 0 (966) Net cash 34.1 25.2 41.4 3.2 5.1 3.5 1,545 13.4 1,597 13.8 1,320 1,303 11.4 133 4 (36) 101 0 (2,529) Net cash 28.1 22.8 44.4 FY12F Emperor (887 HK) Year to December FY10 FY11 Hengdeli (3389 HK) Year to December FY10 FY11 Luk Fook (590 HK) Year to March FY11 FY12F
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Rating definitions
Outperform (O) expected return >10% over the next twelve months Neutral (N) expected return between -10% to 10% over the next twelve months Underperform (U) expected return < -10% over the next twelve months
Analyst Certification:
The authors of this report, hereby declare that: (i) all of the views expressed in this report accurately reflect their personal views about any and all of the subject securities or issuers; and (ii) no part of any of their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this report; and (iii) they receive no insider information/non-public price-sensitive information in relation to the subject securities or issuers which may influence the recommendations made by them. The authors of this report further confirm that (i) neither they nor their respective associate(s) (as defined in the Code of Conduct issued by the Hong Kong Securities and Futures Commission) has dealt in or traded in the securities covered in this research report within 30 calendar days prior to the date of issue of the report; (ii) neither they nor their respective associate(s) serves as an officer of any of the Hong Kong listed companies covered in this report; and (iii) neither they nor their respective associate(s) has any financial interests in the securities covered in this report.
Disclaimers:
This report is prepared by CCB International Securities Limited. CCB International Securities Limited is a wholly owned subsidiary of CCB International (Holdings) Limited (CCBIH) and China Construction Bank Corporation (CCB). Information herein has been obtained from sources believed to be reliable but CCB International Securities Limited, its affiliates and/or subsidiaries (collectively CCBIS) do not warrant its completeness or accuracy or appropriateness for any purpose or any person whatsoever. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Investment involves risk and past performance is not indicative of future results. Information in this report is not intended to constitute or be construed as legal, financial, business, tax or any professional advice for any prospective investors and should not be relied upon in that regard. This report is for informational purposes only and should not be treated as an offer or solicitation for the purchase or sale of any products, investments, securities, trading strategies or financial instruments of any kind. Neither CCBIS nor any other persons accept any liability whatsoever for any loss arising from any use of this report or its contents or otherwise arising in connection therewith. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. The opinions and recommendations herein do not take into account prospective investors circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to any prospective investors. The recipients of this report shall be solely responsible for making their own independent investigation of the business, financial condition and prospects of companies referred to in this report. Readers are cautioned that actual results may differ materially from those set forth in any forward-looking statements herein. While all reasonable care has been taken to ensure that the facts stated herein are accurate and that the forward-looking statements, opinions and expectations contained herein are based on fair and reasonable assumptions, CCBIS has not been able to verify independently such facts or assumptions and CCBIS shall not be liable for the accuracy, completeness or correctness thereof and no representation or warranty is made, express or implied, in this regard. The recipients must make their own assessments of the relevance, accuracy and adequacy of the information contained in this report and make such independent investigation as they may consider necessary or appropriate for such purpose. Recipients should seek independent legal, financial, business and/or tax advice if they have any doubt about the contents of this report and satisfy themselves prior to making any investment decision that such investment is in line with their own investment objectives and horizons. The recipients should be aware that CCBIS may do business with the issuer(s) of the securities covered in this report or may hold interest in such securities for itself and/or on behalf of its clients from time to time. As a result, investors should be aware that CCBIS may have a conflict of interest that could affect the objectivity of this report and CCBIS will not assume any responsibility in respect thereof. Where applicable and required, any relationship CCBIS may have with the issuers(s) of the securities or interests in such stocks(s) will be disclosed in this section of the report. The information contained herein may differ or be contrary to opinions expressed by other associates of CCBIS or other members of the CCBIH group of companies. CCBI group has an investment banking relationship with Chow Tai Fook Jewellery Group Ltd. (1929 HK) within the past 12 months. This report is for distribution only under such circumstances as may be permitted by applicable law. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. This report is not directed at you if CCBIS is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that CCBIS is permitted to provide research material concerning investments to you under relevant legislation and regulations. In particular, this report is only distributed to certain US Persons to whom CCBIS is permitted to distribute according to US securities laws, but cannot otherwise be distributed or transmitted, whether directly or indirectly, into the US or to any US person. This report also cannot be distributed or transmitted, whether directly or indirectly, into Japan and Canada and not to the general public in the Peoples Republic of China (for the purpose of this report, excluding Hong Kong, Macau and Taiwan). Any unauthorized redistribution by any means to any persons, in whole or in part of this research report is strictly prohibited and CCBIS accepts no liability whatsoever for the actions of third parties in distributing this research report. Copyright 2012 CCBIS. The signs, logos and insignia used in this research report and company name CCB International Securities Limited are the trademarks of CCB and/or CCBIS. All rights are hereby reserved.
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CONSUMER DISCRETIONARY

Initiation on Jewelry and Watch Sector

Watch this space

Initiation on Jewelry and Watch Sector

Initiation on Jewelry and Watch Sector

Initiation on Jewelry and Watch Sector

Chow Tai Fook 1929 HK 11.90

Ratings: O = Outperform; N = Neutral; U = Underperform * Prices as at close on 18 April 2012;

Forrest Chan, CFA

Initiation on Jewelry and Watch Sector

A year of slower growth

Source: CEIC, CCBIS research

Source: CEIC, CCBIS research

Initiation on Jewelry and Watch Sector

Swiss watch export value to Hong Kong

Source: Swiss Watch Federation

UK Germany Japan USA Australia Belgium Holland

Source: Hengdeli, Bain & Company, Euromonitor, Watch Association of Switzerland

Initiation on Jewelry and Watch Sector

China jewelry consumption

Hong Kong jewelry consumption

300 270 240 210 180 150 120 90 60 30 0

2010 2011F 2012F 2013F 2014F 2015F Hong Kong Macau

Source: Frost & Sullivan

Source: Frost & Sullivan

Further downside to jeweler SSSG

high single digit high single digit 10 13 24 27 12 15 19 23

Initiation on Jewelry and Watch Sector

Chinas real interest rate trend

Source: Bloomberg, CEIC

Source: CEIC, CCBIS research

Initiation on Jewelry and Watch Sector

Gold price consolidation

Source: Bloomberg, CCBIS research

Historical and forecast average annual gold price

27-Jun-08 23-Sep-09 20-Dec-10 Gold price (LHS) YoY (RHS)

Gold price (LHS)

Source: Bloomberg, CCBIS estimates

Slowing mainland tourist spending in Hong Kong

Initiation on Jewelry and Watch Sector

Mainland tourist arrivals into Hong Kong (YoY)

Initiation on Jewelry and Watch Sector

More resilient sales from the watch segment

Event-driven demand is adjustable

Initiation on Jewelry and Watch Sector

Number of marriages in Hong Kong

60 50 50 40 30 20 10 0 2000 2001 2002 47 47

2004 2005 2006 No. of marriages (LHS)

2007 2008 YoY (RHS)

Gold jewelry provides a tangible way to preserve wealth

Initiation on Jewelry and Watch Sector

Finding the right valuation

Cyclicality and near-term earnings momentum

Revenue growth (YoY)

Initiation on Jewelry and Watch Sector

Comparison with Chinese specialty and branded retailers

Comparison with department stores

Watch versus jewelry retailers

Initiation on Jewelry and Watch Sector

Comparison with global watch and jewelry companies

P/E trends of Hengdeli vs. Emperor

Source: Bloomberg, CCBIS estimates

Source: Bloomberg, CCBIS estimates