20151130-美银美林-六福集团-00590.HK-Special_dividend_a_positive,_but_fundamental_remains_tough_14页_786kb

Summary of Luk Fook Holdings Analysis

Core Content

Luk Fook (LF) reported a significant drop in its first-half FY16 (1HFY16) Net Profit After Tax (NPAT) and sales, leading to a reiteration of its Underperform rating. The company's performance was affected by a combination of factors including a decline in sales, margin contraction, and challenges in the Hong Kong (HK) jewelry market.

Key Financial Performance

• NPAT: Declined by 42% YoY to HK$463mn.
• Sales: Fell by 7.7% YoY, with a notable -16.4% decline in gemset sales.
• Gold Sales: Increased to 62.6% of total sales, up from 58.7% in 1HFY15.
• Wholesale Revenue: Declined by 13.9% YoY, worse than the retail sales decline of 6.9%.
• Gross Margin: Dropped 120bp to 22.7%, impacted by a product mix shift and weak gemset sales.
• SG&A Expense Ratio: Increased 160bp to 14.6%, driven by higher rental costs in prime HK locations.
• Operating Profit Margin (OPM): Declined to 9.1% in 1HFY16 from 12.0% in 1HFY15, with a 450bp drop due to RMB depreciation and FX losses.
• Free Cash Flow (FCF): Increased to HK$2,036mn in 1HFY16, up from HK$778mn in the previous year, mainly due to inventory destocking.
• Net Debt: Increased to HK$1,812mn, with a net debt-to-equity ratio of -20.1% in 1HFY16.

Earnings Estimates and Price Objective

• Price Objective (PO): Reduced from HK$20.0 to HK$17.8, implying an 8.3x FY17E P/E.
• Revenue Estimates (FY16-18E): Trimmed by 15-17% due to weaker sales and overall wholesale revenue.
• EPS Estimates: Reduced for FY16-18E, with FY16E EPS at HK$1.78, FY17E at HK$2.12, and FY18E at HK$2.36.

Dividend and Shareholder Returns

• Special Dividend: Declared at HK$0.235/share, increasing the dividend yield to 6%.
• Dividend Payout Ratio: Improved to 70% from 40.3% in 1HFY15.
• Absolute Dividend Payment: Maintained at HK$0.55/share, same as the previous year.

Store Network and Strategy

• Store Count: 1,383 POS in China (90% licensed), 63 in HK/Macau and North America.
• Store Performance: 16 of 68 HK/Macau stores were loss-making in 1HFY16, but the company expects most to turn around in 2H.
• Store Optimization: LF plans to add 80 new shops in China (vs. previous plan of 100), with a focus on lower-tier cities.
• Store Closures: Continued in prime HK locations to improve profitability.

Operating Expenses and Cost Management

• Rental Costs: Increased in popular HK locations, offsetting reductions in loss-making stores.
• Staff Costs: Reduced by 6%, contributing to a more conservative cost structure.
• CAPEX: Reduced to HK$55mn in 1HFY16, mainly on shop renovations, compared to HK$187mn in 1HFY15.

Valuation and Metrics

• P/E Ratio: 10.0x for FY16E, 8.4x for FY17E, and 7.6x for FY18E.
• Dividend Yield: Increased to 6.0% in FY16E and is expected to rise to 6.6% in FY18E.
• EV/EBITDA: 6.0x for FY16E, 5.3x for FY17E, and 4.9x for FY18E.
• Free Cash Flow Yield: Increased to 19.4% in FY16E, down to 16.4% in FY17E, and 13.1% in FY18E.
• ROE (Return on Equity): Declined to 12.0% in FY16E, expected to rise to 14.0% in FY18E.
• Operating Margin: Dropped to 9.1% in FY16E, expected to improve to 11.1% in FY18E.

Market and Sector Analysis

• Sector: Luxury Goods.
• Market Conditions: HK jewelry market remains weak, with no signs of recovery.
• Earnings Volatility: LF's minimal hedging against gold price declines could lead to more volatile earnings.
• Competitive Landscape: Compared to other China luxury goods companies, LF's valuation metrics (P/E, EV/EBITDA, etc.) suggest it is relatively undervalued but faces challenges in growth and margin stability.

Investment Rationale and Outlook

• Rating: Underperform.
• Reasons: Continued weak retail sentiment in HK, structural deceleration in sales, margin contraction, and earnings volatility due to lack of hedging.
• Future Outlook: Management expects OPM improvement in 2H, and a more prudent approach to store optimization and cost management.

Additional Notes

• Charts and Tables: Included in the report to illustrate revenue, earnings, and margin trends, as well as store performance and valuation metrics.
• Disclosures: The report is issued by BofA Merrill Lynch and includes important disclosures regarding potential conflicts of interest and the non-US affiliate status of the issuing entity.

Valuation Comparison

• Valuation Metrics:
  • P/E: 10.0x for FY16E, 8.4x for FY17E, and 7.6x for FY18E.
  • EV/EBITDA: 6.0x for FY16E, 5.3x for FY17E, and 4.9x for FY18E.
  • Dividend Yield: 6.0% in FY16E, expected to rise to 6.6% in FY18E.
  • Free Cash Flow Yield: 19.4% in FY16E, 16.4% in FY17E, and 13.1% in FY18E.
• Company Comparison:
  • CHOW TAI FOOK: P/E of 17.4x, Dividend Yield of 8.7%.
  • CHOW SANG SANG: P/E of 13.0x, Dividend Yield of 5.1%.
  • Luk Fook: P/E of 10.0x, Dividend Yield of 7.1%.
  • HENGDELI: P/E of 9.7x, Dividend Yield of 3.6%.
  • ORIENTAL WATCH: P/E of 19.4x, Dividend Yield of 2.2%.

Conclusion

Luk Fook faces continued challenges in the HK jewelry market, with declining sales, margin contraction, and earnings volatility. Despite a special dividend and improved cash flow, the company's cautious outlook and structural issues in its retail performance suggest a continued Underperform rating. The company is expected to optimize its store network and improve operating performance in the second half of the year, but the overall outlook remains uncertain.