Anchor themes Consumption of jewellery in China is still at a nascent stage and the branded names have still not penetrated lower-tier cities. We believe long-term demographics such as a rising middle class and urbanisation should lead to secular growth for the sector. Nomura vs consensus Our FY15F bottom-line estimates for the three HK jewellery brands are 7-17% lower than consensus as we have built in weakening Chinese spending. Research analysts Hong Kong Retail Tanuj Shori - NIHK [email protected]+852 2252 1407 George Hsu - NIHK [email protected]+852 2252 6187 HK/China jewellery brands EQUITY: CONSUMER RELATED Sector de-rating to continue on bad data Slowing Chinese spending could be a double whammy to high base effect Weak consumer sentiment may continue to impact jewellers’ valuation The retail sales growth of the jewellery category in HK/China slipped into negative territory in March with 8.9% y-y drop in HK and 6% y-y drop in China. Netting out the price change impact, HK still saw a 6.9% y-y drop in volume term during the month. The street has thus become more concerned about the negative magnitude of the growth in April-June quarter, which we believe could worsen over the next couple of months. The current spot gold price is about 15% lower than the level in April 2013, and 5-10% below that in May/June 2013. Assuming HK/China jewellery players can sustain similar gold demand in weight in April-June this year (unlikely), their gold sales (~60% of total sales for CTF, CSS and LF) may still see at least a 10% sales drop, in our view. How negative could the jewellery category be in April-June quarter? The data points may not be out until mid-July when Chow Tai Fook (CTF) and Luk Fook (LF) release their quarterly updates. In this report, we again try to quantify how bad the data could be in the April-June quarter. Our estimates suggest that HK retail sales in jewellery would see a 27% y-y slump in the quarter while China might see a 17% decline during the same period. If Chinese customers’ spending sentiment continues to weaken, the scenario would turn even worse. Per our estimates, CTF could see 30% SSSG decline and 23% sales decline in the Apr-June quarter, while LF could even fare worse with 35-40% decline in SSSG. Chow Sang Sang (CSS) doesn’t disclose quarterly data but we see a similar trend for it, and its 1H SSSG to be 20-25% down. For 3QCY (July-Sep quarter), we may still see negative SSSG, though more moderate than in 2Q. De-rating to continue; Downgrade CSS (116 HK) to Reduce, maintain Reduce on CTF (1929 HK) and Neutral on LF (590 HK) Our forecast for China’s jewellery sales growth in April was negative 29.6% y- y, which is in line with the official number of negative 30% y-y announced on 13 May. HK’s data (to be announced on 3 June) could be negative 40% y-y, which could lead to another leg of de-rating for the sector, in our view. On valuations, CTF is still trading at ~14x CY14F P/E, which we believe is expensive in the current sentiment/data scenario, and should correct. CSS is trading at a 20% premium to LF and should see more downside than LF (which is trading at 8x CY14F P/E, close to its all-time low). Fundamentals remain intact, wait for good price points in 2-3 months Once again, we would like to highlight that the fundamental business for the three jewellery players remains intact, but the high base effect may negatively affect the market’s sentiment and therefore drag down the valuations in the near term. We cut our target P/E multiples for CTF to 12x from 16x, and for both of CSS and LF to 9x from 12x. Hence, we downgrade CSS to Reduce (TP down to HKD15.5 from HKD25.6), and maintain Reduce on CTF (TP down to HKD9.6 from HKD12.4) and Neutral on LF (TP down to HKD21.1 from HKD32.5). Having said that, we believe good price points should emerge Global Markets Research 20 May 2014 See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.
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HK/China jewellery brands - Nomura Holdings · 5/20/2014 · three jewellery players remains intact, but the high base effect may negatively affect the market’s sentiment and therefore
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Anchor themesConsumption of jewellery in China is still at a nascent stage and the branded names have still not penetrated lower-tier cities. We believe long-term demographics such as a rising middle class and urbanisation should lead to secular growth for the sector.
Nomura vs consensusOur FY15F bottom-line estimates for the three HK jewellery brands are 7-17% lower than consensus as we have built in weakening Chinese spending.
Slowing Chinese spending could be a double whammy to high base effect
Weak consumer sentiment may continue to impact jewellers’ valuation The retail sales growth of the jewellery category in HK/China slipped into negative territory in March with 8.9% y-y drop in HK and 6% y-y drop in China. Netting out the price change impact, HK still saw a 6.9% y-y drop in volume term during the month. The street has thus become more concerned about the negative magnitude of the growth in April-June quarter, which we believe could worsen over the next couple of months. The current spot gold price is about 15% lower than the level in April 2013, and 5-10% below that in May/June 2013. Assuming HK/China jewellery players can sustain similar gold demand in weight in April-June this year (unlikely), their gold sales (~60% of total sales for CTF, CSS and LF) may still see at least a 10% sales drop, in our view.
How negative could the jewellery category be in April-June quarter? The data points may not be out until mid-July when Chow Tai Fook (CTF) and Luk Fook (LF) release their quarterly updates. In this report, we again try to quantify how bad the data could be in the April-June quarter. Our estimates suggest that HK retail sales in jewellery would see a 27% y-y slump in the quarter while China might see a 17% decline during the same period. If Chinese customers’ spending sentiment continues to weaken, the scenario would turn even worse.
Per our estimates, CTF could see 30% SSSG decline and 23% sales decline in the Apr-June quarter, while LF could even fare worse with 35-40% decline in SSSG. Chow Sang Sang (CSS) doesn’t disclose quarterly data but we see a similar trend for it, and its 1H SSSG to be 20-25% down. For 3QCY (July-Sep quarter), we may still see negative SSSG, though more moderate than in 2Q.
De-rating to continue; Downgrade CSS (116 HK) to Reduce, maintain Reduce on CTF (1929 HK) and Neutral on LF (590 HK) Our forecast for China’s jewellery sales growth in April was negative 29.6% y-y, which is in line with the official number of negative 30% y-y announced on 13 May. HK’s data (to be announced on 3 June) could be negative 40% y-y, which could lead to another leg of de-rating for the sector, in our view. On valuations, CTF is still trading at ~14x CY14F P/E, which we believe is expensive in the current sentiment/data scenario, and should correct. CSS is trading at a 20% premium to LF and should see more downside than LF (which is trading at 8x CY14F P/E, close to its all-time low).
Fundamentals remain intact, wait for good price points in 2-3 months Once again, we would like to highlight that the fundamental business for the three jewellery players remains intact, but the high base effect may negatively affect the market’s sentiment and therefore drag down the valuations in the near term. We cut our target P/E multiples for CTF to 12x from 16x, and for both of CSS and LF to 9x from 12x. Hence, we downgrade CSS to Reduce (TP down to HKD15.5 from HKD25.6), and maintain Reduce on CTF (TP down to HKD9.6 from HKD12.4) and Neutral on LF (TP down to HKD21.1 from HKD32.5). Having said that, we believe good price points should emerge
Global Markets Research 20 May 2014
See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.
Nomura | HK/China jewellery brands 20 May 2014
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Contents
3 Methodology for estimating HK/China retail sales in jewellery category
Methodology for estimating HK/China retail sales in jewellery category We screen HK and China retail sales in the jewellery category from 2005 to 2012 (excluding numbers in 2013 as they are outliers) and calculate the percentage difference between March and each month of April-June quarter in each year, and then take the averages to get the discrepancy.
We assume the derived average percentage gap as normalized ones between March and each month of April to June. As we have HK/China retail sales in jewellery category in March 2014, we thus can estimate such numbers in April to June for HK and China, respectively.
Fig. 3: Nomura’s estimates to HK/China retail sales in jewellery in April-June quarter
Source: CEIC, Nomura estimates
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Apr-14 7,862 -40.0% 21,308 -29.6%
May-14 8,493 -19.3% 24,660 -8.2%
Jun-14 8,667 -19.2% 21,408 -9.9%
Apr-Jun Quarter 25,022 -27.2% 67,377 -16.7%
Nomura | HK/China jewellery brands 20 May 2014
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Fig. 4: HK & China retail sales in jewellery category & Nomura’s estimates
Rating Remains ReduceTarget price Reduced from 12.40 HKD 9.60
Closing price 16 May 2014 HKD 10.42
Potential downside -7.9%
Anchor themesThe consumption of jewellery in China is at a nascent stage and branded names have still not penetrated lower-tier cities. We believe that long-term demographics such as rising middle class income and urbanisation should lead to secular growth.
Nomura vs consensusOur FY15F earnings are 7% lower than consensus as we factor in weaker-than-expected Chinese spending.
Key company data: See page 2 for company data and detailed price/index chart
Chow Tai Fook Jewellery
1929.HK 1929 HK
EQUITY: CONSUMER RELATED
Still downside to go
Weakening data may put further pressure on valuations, still trading much higher than trough
Weakening data points may continue to pressure the valuation We further revise down CTF’s earnings after our last update in mid-March, to factor in the worse-than-our-expected industry numbers, led by slowing Chinese spending as well as high base impact. We also cut CTF’s target valuation multiple to 12x from 16x as a result of building in the negative growth numbers. We maintain our Reduce rating as it is still trading at a 50% premium to Chow Sang Sang and ~80% premium to Luk Fook. Its current multiple of 14x CY14F P/E is still 70% higher than trough valuations of 8.3x.
Fundamentals remain intact but April-June quarter an overhang Although we still think that, fundamentally, Chow Tai Fook would outperform its rivals, the expected negative growth rates in the April-June quarter may still be an overhang given we anticipate the quantum of decline to be higher than street expectations. We estimate 23% top-line decline, and 30% SSSG decline in the April-June quarter, with turnaround in 2Q (low single digit). We do expect a strong pick-up in 2H, and believe the next quarter would present a good entry point for long-term exposure. CTF has increased A&P on wedding products recently, which we believe can bring long-term benefits to the brand image.
Long term, CTF’s strategy on mass luxury should help business amidst changing macro as lower ticket size helps margin improvement For CTF, the lower-priced products usually offer better margins as customers may request less markdowns. Thus, CTF’s strategy towards more mass luxury and youth line products at lower average ticket sizes should gradually help its margin improvement. Margins in FY15F should improve from FY14F level due to product category normalization (less gold and more gem-set products) and product mix change (more exposure to lower tickets products), in our view.
Liquidity (x)Current ratio 3.18 4.73 3.22 3.72 3.67Interest cover 23.5 22.5 52.9 55.0 60.9LeverageNet debt/EBITDA (x) net cash net cash net cash net cash net cashNet debt/equity (%) net cash net cash net cash net cash net cash
Valuation Methodology We value Chow Tai Fook on a blend of DCF and P/E to arrive at our target price of HKD9.6. For DCF, the WACC assumption is ~10% and the terminal growth assumption is 2%. Cash flows are discounted back to CY14F. For P/E, we cut the valuation multiple from 16x to 12x, in line with CTF’s two year average (33% premium to CSS and LF which we believe is more justified), as the market sentiment and data points continue to weaken. Our revised estimates and key assumptions are exhibited below.
Fig. 5: Key changes to Nomura estimates FYE in March
Source: Nomura estimates
Fig. 6: CTF’s SSSG by geography FYE in March
Source: Company data, Nomura research
Fig. 7: Nomura’s estimates for FY15F quarterly revenues
Rating Down from Neutral ReduceTarget price Reduced from 25.60 HKD 15.50
Closing price 16 May 2014 HKD 18.10
Potential downside -14.4%
Anchor themesConsumption of jewellery (especially diamonds) in China is still at a nascent stage and branded names have still not penetrated lower-tier cities (even for gold). We believe long-term demographics such as a rising middle class and urbanisation should lead to secular growth for the sector
Nomura vs consensusOur FY14F bottom-line estimates are 17% below consensus as we build in weakening mainland Chinese spending.
Key company data: See page 2 for company data and detailed price/index chart
Chow Sang Sang Holdings
0116.HK 116 HK
EQUITY: CONSUMER RELATED
Valuation to de-rate offering more downside
Premium to LF may shrink; retail presence and no quarterly data-point may help cushion fall
We revise estimates to factor in weakening industry sentiment and high base; we view ~20% premium to LF unjustified We tweak down our numbers post FY13 results, mainly driven by the market’s lukewarm performance YTD as well as weakening Chinese spending (mainland Chinese comprised 72% of overall sales in CY13). Like its peers, upcoming data points may continue to put pressure on valuations. CSS is trading at 10x CY14F P/E, still 25% higher than trough valuations and, more importantly, we think CSS’s over-20% premium to Luk Fook’s CY14F P/E multiple may not be justified. At the same time, CSS does not release quarterly data and while CTF and LF will release significantly negative growth in the April-June quarter, no data from CSS may help cushion the correction.
SSSG and earnings growth could slip into negative in CY14F, which could drive down valuations; downgrade to Reduce CSS plans to open around 50 new stores in China in CY14 (vs 22 in CY13) and targets mid-high end customers. Although we believe more flagship or premium stores should benefit CSS in the long term, the store efficiency would inevitably be impacted amid weaker Chinese spending in the short term. We also cut our SSSG estimates in CY14 for HK and China to -7% and -3%, respectively, and expect to see a negative bottom-line growth led by both high base and weakening spending. Downgrade to Reduce.
Over one-third of rent contracts in HK will be renewed in 2014 CSS will have over one-third of its rent contracts coming up for renewal this year, with most falling in 2H. The rentals are expected to rise and, hence, as per management, CSS may move a couple of its ground-floor stores into one building from ground to first/second floor, which can not only offer synergies in advertising but also can save costs. We think this strategy change could help cushion the cost rise but could likely affect the footfalls to stores and influence the top-line growth.
Liquidity (x)Current ratio 3.33 3.46 3.85 4.10 4.41Interest cover 32.1 47.9 46.9 52.2 59.5LeverageNet debt/EBITDA (x) 0.52 0.09 net cash net cash net cashNet debt/equity (%) 10.4 2.0 net cash net cash net cash
Valuation Methodology We continue to value Chow Sang Sang on a blend of DCF and P/E to arrive at our target price of HKD15.5. For DCF, our WACC assumption is ~10% and terminal growth assumption is 2%. Cash flows are discounted back to CY14F. For P/E, we cut the valuation multiple from 12x to 9x, which is in line with its two year average, as the market sentiment and data points continue to weaken. Our revised estimates and key assumptions are exhibited below.
Rating Remains NeutralTarget price Reduced from 32.50 HKD 21.10
Closing price 16 May 2014 HKD 20.65
Potential upside +2.2%
Anchor themesConsumption of jewellery (especially diamonds) in China is still at a nascent stage and the branded names have still not penetrated lower-tier cities (even for gold). We believe long-term demographics such as a rising middle class and urbanisation should lead to secular growth for the sector.
Nomura vs consensusOur FY15F earnings estimate is 13% lower than consensus to factor in the slowing Chinese spending.
Key company data: See page 2 for company data and detailed price/index chart
Luk Fook Holdings 0590.HK 590 HK
EQUITY: CONSUMER RELATED
Trend negative but valuations may support
Trading close to all-time low valuations may help buffer impact from negative data points
We tweak estimates to factor in weakening Chinese spending We cut our SSSG estimates in FY15F for both HK and China to -8% (from 4% and 2%, respectively), and expect to see a negative top-line and bottom-line growth largely due to its extremely high base, as well as the weakening consumer sentiment. Luk Fook’s store opening plan in FY15F would slow to ~180 stores in China (vs ~200 in FY14) and become more prudent in HK/Macau. Although one-fourth of HK stores' rent contracts are to be renewed this year, Luk Fook’s management sees a lower pressure on the rent rise compared to last year.
Valuations close to all-time low; maintain Neutral As we expect the sector to de-rate, we revise down LF’s target P/E multiple to 9x from 12x, in line with other two names (CTF to 12x from 15x; CSS to 9x from 12x). However, as Luk Fook’s stock price has already corrected by 30% YTD and is trading at 8x CY14F P/E (the all-time low is ~7x), at a significant discount to CSS (~10x CY14F P/E) and CTF (~14x CY14F P/E), we believe LF’s valuations may likely have bottomed out. We maintain Neutral.
We still expect significant negative growth numbers in Apr-June quarter As LF had a relatively higher base compared to its peers in the April-June quarter last year (SSSG 83% in HK, 117% in China), we expect it to post the deepest negative number among the three for the quarter. Per our estimates, Luk Fook’s SSSG in the quarter could be a 35-40% slump this year.
VIP spending remains okay; lower ticket-size items should help growth VIP customers account for ~30% of Luk Fook’s overall sales and contribute significantly to the company’s growth. However, the lower ticket-size items (<CNY3,000) have relatively better sell-through, and LF does have a wide range of product offerings in this category. We believe this should continue to be the growth driver for the company.
Liquidity (x)Current ratio 6.03 6.66 5.12 9.68 5.85Interest cover na na na na naLeverageNet debt/EBITDA (x) net cash net cash net cash net cash net cashNet debt/equity (%) net cash net cash net cash net cash net cash
Valuation methodology We continue to value Luk Fook on a blend of DCF and P/E to arrive at our TP of HKD21.1. For our DCF, the WACC assumption is ~12% and our terminal growth assumption is 2%. Cash flows are discounted back to CY14F. For P/E, we cut the valuation multiple from 12x to 9x, in line with its three year average, as the market sentiment and data points continue to weaken. Our revised estimates and key assumptions are exhibited below.
Fig. 12: Key changes to Nomura estimates FYE in March
Source: Nomura estimates
Fig. 13: Luk Fook’s SSSG by geography FYE in March
I, Tanuj Shori, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.
Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.
Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures Chow Sang Sang Holdings 116 HK HKD 18.05 19-May-2014 Reduce N/A Chow Tai Fook Jewellery 1929 HK HKD 10.36 19-May-2014 Reduce N/A Luk Fook Holdings 590 HK HKD 20.50 19-May-2014 Neutral N/A
Chow Sang Sang Holdings (116 HK) HKD 18.05 (19-May-2014) Rating and target price chart (three year history)
For explanation of ratings refer to the stock rating keys located after chart(s)
Valuation Methodology We continue to value Chow Sang Sang on a blend of DCF and P/E to arrive at our target price of HKD15.5. For DCF, our WACC assumption is ~10% and terminal growth assumption is 2%. Cash flows are discounted back to CY14F. For P/E, we use a multiple of 9x to CY14 EPS estimate of HKD1.75 as the stock has re-rated. The benchmark index for this stock is MSCI HK. Risks that may impede the achievement of the target price Key upside risk for CSS may arise from a significant pickup in mainland Chinese spending that leads to a better-than-consensus data points in FY14/15.
Nomura | HK/China jewellery brands 20 May 2014
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Chow Tai Fook Jewellery (1929 HK) HKD 10.36 (19-May-2014) Rating and target price chart (three year history)
For explanation of ratings refer to the stock rating keys located after chart(s)
Valuation Methodology We value Chow Tai Fook on a blend of DCF and P/E to arrive at our target price of HKD9.6. For DCF, the WACC assumption is ~10% and the terminal growth assumption is 2%. Cash flows are discounted back to CY14F. For P/E, we use a multiple of 12x to the CY14 EPS estimate of HKD0.74. The benchmark index for this stock is MSCI HK. Risks that may impede the achievement of the target price Key upside risks for Chow Tai Fook may arise from a significant sales boost (should be even better than April 2013)in China, and better-than-expected sell-through in gem-set products.
Luk Fook Holdings (590 HK) HKD 20.50 (19-May-2014) Rating and target price chart (three year history)
For explanation of ratings refer to the stock rating keys located after chart(s)
Valuation Methodology We continue to value Luk Fook on a blend of DCF and P/E to arrive at our TP of HKD 21.1. For our DCF, the WACC assumption is ~12% and our terminal growth assumption is 2%. Cash flows are discounted back to CY14F. For P/E, we use multiple of 9x to the CY14 EPS of HKD2.5. The benchmark index for this stock is MSCI HK. Risks that may impede the achievement of the target price Key risks for Luk Fook may arise from a significantly economic slowdown in China, weaker consumer sentiment and slowing spending of Chinese tourists to Hong Kong. Luk Fook’s gold hedged position is the lowest among the three HK jewellery brands; hence, if gold price drops substantially from current levels, it would have a significant impact on the company. A significant surge in gem-set sales would bring an upside risk.
Nomura | HK/China jewellery brands 20 May 2014
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Rating and target price changes
Issuer Ticker Old stock rating New stock rating Old target price New target price
Chow Sang Sang Holdings 116 HK Neutral Reduce HKD 25.60 HKD 15.50
Chow Tai Fook Jewellery 1929 HK Reduce Reduce HKD 12.40 HKD 9.60
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Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Japan/Asia ex-Japan: Sector ratings are not assigned. Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan prior to 21 October 2013 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price
Nomura | HK/China jewellery brands 20 May 2014
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