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Summary of HK Retail Analysis

Core Content

This report analyzes the current state of Hong Kong retail, focusing on the impact of tourism trends, valuation of key stocks, and the future outlook for the sector. It emphasizes that while recent retail sales have slowed, the market remains robust due to strong overnight tourist demand and structural growth potential. The report also evaluates the exposure of different retail companies to various tourism segments and provides investment recommendations based on their performance and valuations.

Main Points

1. Tourism Trends and Impact

• Mainland Tourists: Only 10% of mainland Chinese have visited Hong Kong, with 3% holding passports. Despite this, overnight tourism remains a significant growth driver.
• Tourist Growth: Overnight Chinese tourists have grown at a robust rate of 17% YoY, indicating continued demand.
• Day Trippers: Multi-entry day-trippers make up 20% of total visitors but only 5% of retail spending. They are primarily focused on lower-priced items like cosmetics, and their spending is less impactful compared to overnight tourists.
• Tourism Cuts: A 20% cut in individual visitor scheme (IVS) tourists would only result in a 2% impact on retail sales if focused on day-trippers, suggesting the market may be overreacting.

2. Retail Growth Outlook

• Historical Growth: HK retail has historically grown at a mid-teens CAGR, but recent growth has slowed to mid-single digits.
• Normalized Growth: The report forecasts normalized retail sales growth to trend at 6-7% in the coming years, still outperforming markets like South Korea, Singapore, and the US.
• Jewelry Sector: The jewelry sector is expected to recover to positive YoY growth by the end of 2014, with the worst likely behind it.

3. Stock Evaluation and Recommendations

• Buy Recommendations:
  • Luk Fook (0590.HK): Strong exposure to overnight tourism, with a low P/E ratio and high upside potential.
  • Chow Tai Fook (1929.HK): Diversified business model with 54% of revenue from the PRC, supported by a still-robust growth outlook.
  • Lifestyle (1212.HK): Expected to deliver strong earnings growth due to its exposure to higher-margin categories and new store openings.
• Sell Recommendation:
  • Sa Sa (0178.HK): Highly exposed to same-day tourists and cosmetics, which are more sensitive to tourism cuts. Its NTM P/E of 18X is overvalued relative to growth expectations.
• Downgrade:
  • CSS (0116.HK): Valuations are above mid-cycle levels, leading to a downgrade to Neutral.

4. Valuation and Earnings Forecasts

• Sector Valuation: The current P/E ratio of 13X for 2014E is pricing in low-single-digit growth, below the forecasted 6-7% growth.
• Earnings Impact: The report highlights that Sa Sa is likely to experience negative operating leverage, leading to a decline in earnings growth.
• Multiple Expansion: Some stocks, like Luk Fook, show attractive valuations and potential for multiple expansion.

Key Information

• HK Retail Sales:
  • The retail sector has experienced a 5-year low in growth, but the decline in March was followed by a rebound in April.
  • Jewelry contributed the most to the weakness, but excluding it, retail sales grew by 3% YoY.
• Tourist Contribution:
  • Chinese tourists account for 34% of total HK retail sales.
  • Cosmetics and beauty products are heavily purchased by day-trippers due to higher prices in mainland China.
• Rental Costs:
  • Easing rental costs are expected to support margins in 2015, as seen in past downturns like 1997-98 and 2008-09.
• Investor Outlook:
  • The market may be over-worried about the impact of tourism cuts on HK retail.
  • Retailers with less exposure to day-trippers and more to overnight tourists are better positioned for growth.

Investment Recommendations

• Buy CTF (1929.HK): Diversified business model with strong exposure to overnight tourism.
• Buy Luk Fook (0590.HK): Low valuation and less exposure to day-trippers.
• Buy Lifestyle (1212.HK): Expected to deliver strong earnings growth with new store openings.
• Sell Sa Sa (0178.HK): High exposure to same-day tourists and cosmetics, with overvaluation relative to growth.
• Neutral CSS (0116.HK): Valuations are above mid-cycle, leading to a downgrade.

Summary of Key Figures

Outlook and Risks

• Outlook: 2014 is expected to be a tough year, but 2015 growth is forecasted to recover to 5-7%.
• Risks: Policy changes, such as the IVS cuts, could impact day-trippers, but the overall market remains resilient due to strong overnight tourism.

Conclusion

Despite recent challenges, the Hong Kong retail market still presents structural growth opportunities, especially for companies with strong exposure to overnight tourism. The report advises investors to be selective, favoring stocks with diversified exposure and lower sensitivity to day-trippers, while cautioning against overvaluation in sectors more exposed to same-day tourism.