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Chow Tai Fook (1929 HK) Summary

Core Content

Chow Tai Fook (CTF) is a leading jewellery retailer in China, Hong Kong, and Macau, with a strong brand and extensive retail network. It is positioned as a good proxy for affordable luxury in the Chinese market due to its significant China exposure and ability to capitalize on the rising demand for middle-class discretionary spending. The company is being initiated with an Accumulate rating and a target price of HK$10.50, reflecting a 14.01% upside from its current share price of HK$9.21.

Main Points

Market Position

• Leading jewellery retailer in China with a strong brand and broad retail presence.
• Good proxy for affordable luxury due to its focus on mid-range products and high demand from the growing middle class.
• High China exposure (58% in 1H15, 54.5% in FY14) offsets the impact of declining mainland tourists in Hong Kong.

Product Mix

• Higher gross margins from gem sets (40–50%) compared to gold products (low to mid teens).
• Gem set sales are expected to grow steadily as demand in China increases.
• China's diamond market share has risen from 3% to 15% in 2013 and is projected to reach 20–25% by 2023.
• CTF's gross margin improved by 5.4 ppts YoY in 1H15 to 31.8%, driven by higher gem set sales.

Business Model

• Vertically integrated from raw material sourcing to retailing, giving it a competitive edge.
• Access to high-quality rough diamonds through its status as a Diamond Trading Company (DTC) Sightholder and a Rio Tinto Select Diamantaire.
• In-house processing and production allow for cost savings and faster response to market changes.

Financial Performance

• Revenue is expected to decline by 14% YoY in FY15, but rebound to 10% in FY16 and 10.2% in FY17.
• Net profit is forecasted to decrease by 20.5% in FY15, then increase by 21% in FY16 and 15.1% in FY17.
• EPS is projected to decline by 21% in FY15, rebound by 21% in FY16, and increase by 15% in FY17.
• P/E ratio is expected to be 15x in FY15, which is a 40% premium over peers' average of 10.8x.

Valuation Metrics

• Forward P/E ratio is 15x, with a target price of HK$10.50.
• EV/EBITDA is projected to be 11.1x in FY15, declining to 8.2x in FY17.
• P/B ratio is expected to decrease from 2.3x in FY15 to 1.9x in FY17.
• Net debt/equity is at 3.25% in FY15, showing a relatively strong financial position.

Key Figures and Trends

Metric	2013	2014	2015E	2016E	2017E
Revenue (HK$ m)	57,434	77,407	66,559	72,812	80,243
Net Profit (HK$ m)	5,505	7,272	5,780	6,996	8,051
EPS (HK$)	0.55	0.73	0.58	0.70	0.81
P/E (x)	16.7	12.7	15.9	13.2	11.4
P/B (x)	2.8	2.5	2.3	2.1	1.9
EV/EBITDA (x)	12.0	9.4	11.1	9.4	8.2

Performance Highlights

• 12M daily turnover: HK$58.94 million.
• 12M volatility: 28.99%.
• PEG (FY15–17E): 0.88.
• RoAE (FY15E): 14.97%.
• Dividend yield: 3.91%.

Shareholders

• Chow Tai Fook Holding: 89.34% of shares.
• Free float: 10.64%.

Investment Highlights

• Affordable luxury growth: Increasing numbers of affluent consumers will drive the affordable luxury market in China.
• China's disposable income: Surged at 11% and 14% CAGR from 2009–2014, with expectations of continued growth.
• Government initiatives: Improvements in social security and universal medical care will reduce savings, increasing discretionary spending.
• SSSG recovery: Expected to improve from -28% in FY15 to -3% in FY16, with gradual recovery.
• Store expansion: A key driver for future growth, with a much larger mainland retail network than peers.

Risks

• Weaker Hong Kong consumer spending and tourist arrivals.
• China SSSG weaker than expected.
• Store expansion slower than expected.
• Margin pressure due to competition and potential price cuts.
• Negative operating leverage affecting opex ratio in FY15.

Peer Comparison

Stock	Bloomberg Code	Price (HK$)	Mkt Cap (HK$ m)	FY1 EPS Growth (%)	FY2 EPS Growth (%)	PEG (x)	Div Yield (%)	FY1 P/E (x)	FY2 P/E (x)
CTF	1929 HK	9.21	92,100	-20.5	21.0	0.88	3.9	15.9	13.2
Luk Fook	590 HK	24.60	14,492	-14.6	4.8	1.19	4.8	9.1	8.7
Chow Sang Sang	116 HK	17.48	11,833	4.8	11.2	1.32	3.5	10.4	9.4
EWJ	887 HK	0.37	2,547	45.0	24.1	0.37	1.6	12.8	10.3
Average (HK)	-	-	-	3.7	15.3	0.94	3.5	12.1	10.4
Average (A-share)	-	-	-	32.6	28.3	1.25	1.1	38.8	30.0

Conclusion

CTF is well-positioned to benefit from the growing middle class in China, which has strong purchasing power and a preference for affordable luxury. Its vertically integrated model, strong brand equity, and extensive mainland presence provide a competitive advantage. While FY15 is expected to be a challenging year due to the decline in Hong Kong tourist spending, the company is projected to recover and grow in FY16 and FY17. The Accumulate rating and target price reflect confidence in its ability to outperform the market over the next six months, driven by its product mix improvements, strong China exposure, and market leadership. However, risks such as slower store expansion and margin pressure remain.