20140618-美银美林-Lack_of_positive_catalysts,_retain_Underperform_12页_634kb

Summary of Chow Tai Fook Jewellery Analysis (June 18, 2014)

Core Content

Chow Tai Fook (CTF) is a leading jeweller in the PRC and Hong Kong/Macau, with a significant market share and a vertically integrated business model. The company's FY14 results showed a 32% increase in Net Profit After Tax (NPAT) to HK$7.3 billion, with a 2.2% growth in 2H14 compared to 92% in 1H14. The analysts from Bank of America Merrill Lynch (BofAML) have rolled over their price objective (PO) to HK$10, which corresponds to a 11.2x FY16E P/E ratio. However, they maintain an Underperform rating due to the current valuation of 12.5x forward P/E being considered rich relative to peers and a lack of positive catalysts expected in the next six to nine months.

Main Points

• FY14 Performance:

  • NPAT increased by 32% to HK$7.3 billion.
  • 2H14 saw a 2.2% growth in NPAT, down from 92% in 1H14.
  • The analysts fine-tuned their FY15/16 EPS estimates by 2% and rolled over the PO to HK$10.

• SSSG Outlook for FY15:

  • SSSG is expected to decline by 25-30% in 1QFY15 due to falling gold sales.
  • SSSG may remain negative in 2QFY15, with flat and SD growth in 3Q/4QFY15, resulting in a 5-8% decline in SSS for the year.
  • Revenue is projected to grow by 5% in FY15, driven by new stores and the contribution of the wholesale segment.

• Product Mix and Margins:

  • A shift from gold to jewelry is expected to improve gross profit margin (GPM) by 170 basis points (bps) to 29.4% from 27.7% in FY14.
  • The analysts estimate that a 1% shift in product mix could lift GPM by 20-30bps.
  • Operating expenses are expected to increase by 120bps to 17% of sales due to deleverage.
  • Net margin is projected to rise by 20bps to 9.6%, leading to a 7.4% higher NPAT in FY15.

• Free Cash Flow (FCF):

  • FCF turned negative in FY14 to HK$-412 million due to rising inventory.
  • Management expects FCF to return positive in FY15 as inventory levels normalize.

• Valuation and Dividend:

  • The current forward P/E is 12.5x, which is considered rich relative to peers.
  • Dividend yield is expected to increase to 3.7% in FY15 and 4.5% in FY17.
  • Free Cash Flow Yield is projected to rise to 3.7% in FY15 and 8.1% in FY16.

Key Information

• Stock Data:

  • Current price: HK$11.02.
  • Price objective: HK$10.00.
  • Market value: HK$110,200 million.
  • Average daily volume: 5,015,386 shares.
  • Investment opinion: C-3-7.
  • Volatility risk: HIGH.
  • 52-week range: HK$7.44 to HK$14.48.
  • Dividend payout ratio: 50%.

• Store Network:

  • Total stores increased to 2,077 from 1,836 in FY14 (+13.1%).
  • CTF expects to open 200 new stores in the PRC in FY15, with 60% being franchised in lower-tier cities.
  • Store-opening in HK/Macau is flexible based on rent and location attractiveness.

• Financial Highlights:

  • Gross margin fell to 27.3% in FY14, down 110bps from FY13.
  • Operating margin decreased to 12.1% in FY14, down 0.8% from FY13.
  • Net margin is expected to rise to 9.6% in FY15.
  • EBIT margin decreased by 70bps to 12% in FY14, mainly due to higher rental expenses.

• Valuation Comparison:

  • CTF's valuation is compared with other China consumer discretionary companies, including luxury hardgoods, sportswear, and footwear and apparel.
  • The P/E ratio for CTF is 14.1x in FY15 and 12.5x in FY16, which is higher than some peers.
  • The analysts note that the current valuation is rich and that the company has few catalysts to drive a share price rerating.

• Key Metrics:

  • ROE is expected to be 19.9% in FY15 and 22.5% in FY17.
  • Net debt-to-equity ratio is projected to be 16.0% in FY15 and 12.2% in FY17.
  • Free cash flow is expected to turn positive in FY15, supported by operating profit.

Conclusion

Despite the company's strong brand equity, industry leadership, and network expansion, the analysts maintain an Underperform rating due to the current rich valuation and limited catalysts. The company is expected to see a decline in SSSG for FY15, driven by the challenging base and falling gold sales, but revenue growth is anticipated from new stores and the wholesale segment. The product mix shift towards jewelry is expected to offset some of the margin pressures, and the company is projected to improve its financial performance in the long term. However, the analysts remain cautious about the valuation and potential for de-rating.