Luk Fook (0590)

Back from vacation in Hong Kong & Macau.

Luk Fook & Chow Tai Fook stores I saw there all had several customers inside, much better filled than other jewelry stores/chains. That despite Hong Kong still has a longer way to go to attract tourists as seen before the troubles of the past years, while Macau was quite crowded. Luk Fook stores in Macau were really well positioned, at least were I walked, even better than CTF stores. Unwarranted in my view, that Luk Fook is priced less than half of CTF on PE basis (TTM).

That is how the 140% reported retail sales increase in HK& Macau in 4Q FY2023 looks like.
https://www1.hkexnews.hk/listedco/listco...300998.pdf

To put that into perspective:

Before the decline in tourist traffic LF reported for HK & Macau in the 'segment results' section:
3/2013: Revenue 10,26 mill, profit 1,005 mill -> 64% of profit -> HKD 1.37 of EPS 2.15
3/2014: Revenue 14,59 mill, profit 2,444 mill -> 68% of profit -> HKD 2.16 of EPS 3.17
(3/2014 was exceptional because of the 'granny gold rush'.)
3/2015: Revenue 11.42 mill, profit 1,175 mill -> 59% of profit -> HKD 1.62 of EPS 2.74



HK/Mac revenues & profits declined since then, and in the past 2 years were:
3/2020: Revenue 3.62 mill, profit -19 mill -> -1% of profit -> HKD -0.02 of EPS 1.11
3/2021: Revenue 5.02 mill, profit 146 mill -> 8% of profit -> HKD 0.20 of EPS 2.37

So a 140% increase may lift HK&Macau revenues back to 3/2013 & 3/2015 level, which generated earnings of approx. HKD 1.50, while profits generated elsewhere, especially in mainland China climbed to approx HKD 2.17 in 2021. With such numbers new record earnings may be achievable next year.

Here is a comment from Goldman Sachs about the annual result:

"The group revealed that same-store sales growth in the mainland from April to June 21 was flat YoY, in line with Goldman Sachs forecasts, while franchise performance was about 2% higher than before the pandemic. Goldman noted that LUK FOOK's performance was worse than its peer CHOW TAI FOOK (01929.HK) +0.280 (+2.029%) Short selling $19.78M; Ratio 19.808% , whose same-store sales in April-May were about 6% higher than the that of the same period before the pandemic. The broker also expected industry sales to weaken in June.
Goldman noted that LUK FOOK management has become more conservative in its view of the recovery of the mainland market this year, and its expansion plan has been lowered to 350 points of sale from the previous 500."
http://www.aastocks.com/en/stocks/analys...275167/all


I totally disagree.


1) Overall CTF revenue decreased, LF revenue increased in 2023

2) CTF's EPS declined more than LF, both for the year and 2nd half.

3) LF's April-June 21 same store sales for mainland do not include its license franchises, which dominate their mainland activity and earnings.
The HSBC analyst at the conference call hence asked, if these revenue from the license shops increased in line with market growth, and LF responded they assume so, though numbers will only be available in mid July.
According to Stats China mainland gold, silver and jewelry sales increased by 44.7% in April 23 and 24.4% in May 2023.

4) CTF leads in opening new branches in mainland China since 31/3/2019.
They increased the number of mainland stores from 3116 to 7519, an increase of 141%,
while LF increased their number of mainland license stores from 1614 to 2793, an increase of 73%

5) On the other side CTF reduced the number of HK/Macau stores from 99 to 85, while LF increased them from 60 to 61.

6) Since 2019 the stock price of CTF doubled relative to LF.
P/B of CTF is now 4.5 times higher than LF.
PE (TTM) of CTF is 2.85 time higher than LF.

Luk Fook and Chow Tai Fook same store sales (as of 31/3/2023) compared with pre-covid (31/3/2019):

I extracted all data by myself. There may be errors, and I also may have made errors in calculations. Do your own research & check.

1) First Hong Kong / Macau, because CTF and LF are directly comparable with data from the annual reports:

SSSG HK/Mac 2020 / 2021 / 2022 / 2023

CTF: -38.7% / -41.3% / +24.7% / +18.3
-> 0.613*0.583*1.247*1.183 * 100% = 52.7%, -> down 47.3%

LF: -33.3% / -47.1% / +42.0% / +34.0%
-> 0.667*0.529*1.42*1.34 * 100% = 67.1%, -> down 32.9%

LF did significantly better than CTF. Luk Fook requries 49% SSSG to restore 2019 levels, CTF requires 111% SSSG.


2) Data from mainland is not exactly comparable, as Luk Fook data covers licensed shops, self operated shops and e-commerce separately. Licensed shops are most important, e-commerce sales have surpassed self operated store sales since 2022.

SSSG Mainland China 2020 / 2021 / 2022 / 2023

CTF: -15.1% / 31.9% / 11.1% / -13.1%
-> 0.849*1.319*1.111*0.869 * 100% = up +8.1%

LF licensed stores: -11.8% / +8.0% / +15.7% / -9.5%
-> 0.882*1.08*1.157*0.905 * 100% = 99.7% -> down 0.3%

LF self operated stores: -20.2% / -4.7% / +40.1% / -16.9%
-> 0.798*0.953*1.401*0.831 * 100% = 88.5% -> down 11.5%

LF mainland e-commerce: +13.9% / +34.2% / +60.2% / +7.5%
-> 1.139*1.342*1.602*1.075 * 100% = +163.2% -> up 163.2%

CTF's SSS are already higher than pre-covid, despite the huge 141% increase in stores, while LF's licensed same store sales are flat. E-commerce skyrocketed and now contributes 63.2% of self operated sales.

The licensed shops still did well imho, as they have very high exposure to gem set jewelry. Headwinds for gem set jewelry were particularly rough and they managed to equalize declining gem set jewelry sales with increasing gold jewelry sales. Gem set jewelry sales declined in Luk Fook's total share of sales from 48.2% to 37.0% between 2019 and 2023.

A closser look at the Gold hedges. How did they work out in the past 10 years?

in [000] HKD
Year gold hedge total oper. op profit ghp/op(excl.hedge)
profit profit excl hedge
2023 -26,569 1,576,175 1,602,744 -0.017
2022 -78,765 1,643,224 1,721,989 -0.046
2021 25,421 1,244,113 1,218,692 0.021
2020 -151,067 1,155,766 1,306,833 -0.116
2019 8,374 1,853,042 1,844,668 0.005
2018 -25,550 1,620,806 1,646,356 -0.016
2017 -26,575 1,289,317 1,315,892 -0.020
2016 -19,547 1,212,152 1,231,699 -0.016
2015 36,535 1,976,211 1,939,676 0.019
2014 63,546 2,308,755 2,245,209 0.028

sum -194,197 15,879,561 16,073,758 -0.012
std 61,274 377,163 342,497

1) Overall, they generated a loss of 194 Mill over 10 years, or 19.4 Mill per year on average, equaling an average 1.2% reduction in operating profits.

2) More importantly, they did not produce the primary desired result, a reduction in profit volatility. Contrary, the standard deviation of operating profits increased from 342 Mill to 377 Mill due to hedging. For example, in the least profitable year 2020, hedging losses made profit even worse, and in the best year, 2014, hedging increased profits even more.

This is contrary to the fact that declining gold prices should lead to lower results, because store inventory loses value during this time.

In reality, there is a bigger factor, which is working in the exact opposite direction:

When gold prices go down, demand typically increases, when they go up, demand decreases. 2014, for example, was the most profitable year due to a gold rush after a price crash.

So, in the last 10 years, gold hedging produced not only a loss, but increased profit volatility.

There may be a point for hedging for highly indebted companies to reduce bankruptcy risk during very extraordinary circumstances, but Luk Fook, Chow Tai Fook or Chow Sang Sang have little or no debt at all, and Luk Fook never produced a loss.

While Luk Fook's total losses from gold hedging were rather small, Chow Tai Fook made more substantial losses over the past 10 years and especially in 3 of the last 4 years. Operating profit was reduced because of gold loans by -7.9% over 10 years, with -19.4% in 2023, -12.3% in 2022, and -26.1% in 2020. CTF made a loss with gold loans in each years since 2016.

Chow Tai Fook 1929 in millions HKD
Year Gold loan operating op. profit prof. reduction
profit profit ex gold loan
2023 -1,798.0 7,446.5 9,244.5 -0.194
2022 -1,255.2 8,983.0 10,238.2 -0.123
2021 -365.4 8,394.6 8,760.0 -0.042
2020 -1,483.1 4,204.5 5,687.6 -0.261
2019 -278.2 6,352.0 6,630.2 -0.042
2018 -168.3 5,831.9 6,000.2 -0.028
2017 -35.8 4,378.4 4,414.2 -0.008
2016 -716.1 3,936.1 4,652.2 -0.154
2015 186.4 6,659.1 6,472.7 0.029
2014 282.2 9,163.0 8,880.8 0.032
sum -5,631.5 65,349.1 70,980.6 -0.079
std 723.0 1,959.8 2,038.5
(CTF gold loan profit = Fair value change + finance costs, source Annual Reports}

Q1 2024 sales data from Luk Fook & Chow Tai Fook

https://www1.hkexnews.hk/listedco/listco...300933.pdf
https://www1.hkexnews.hk/listedco/listco...000264.pdf

Luk Fook added lots of new data, such as RSV (retail sales value), approx. comparison with pre-covid FY2019, and more.

Direct comparison with CTF is now easier:

1) In HK&Macau, LF's & CTF's RSV growth was both impressive with 92% and 64%. As CTF's data also includes (supposedly) not so fast growing 'other markets', the difference is likely smaller.
LF's RSV is now back to "a level comparable to that of FY2019", while CTF not yet.
LF opened 3 new stores in HK, CTF none.

2) In Mainland China, LF's RSV grew by 21%, CTF by 25.2%. LF's new RSV data now finally combines all points of sale, licensed & self-operated & e-commerce. Though LF is 4.2% behind CTF, the difference is surprisingly small, as CTF increased its number of stores in 2023 by impressive 26.5%, versus LF's 10.7%, and LF's licensed stores have a higher percentage of gem-set jewelry, which again underperformed gold sales.
LF's RSV in mainland is now 70% higher than in pre-Covid FY2019.
LF increased the number of Mainland points of sale in Q1 by 1.65%, CTF by 1.3%.

3) LF added an 'outlook' to this quarter's data, including "the Group is looking forward to restoring and exceeding its FY2019 performance in the current financial year."
Adding "exceeding" is a major difference from the annual result presentation 2 weeks ago.

1) The other considerable (mainland) players include Lao Feng Xiang (listed), Chow Tai Seng (listed), and Zhou Liu Fu. Together with CTF and LF, these 5 major players have significantly expanded their footprint in recent years, mainly through franchising. Everyone is racing to capture market share.

2) Over the long term, the mom and pop jewelers will slowly be replaced by these big names. When the market becomes increasingly consolidated, the weaker big name operators will become apparent as they will no longer grow in tandem with the market. So the question is, which of these 5 jeweler franchisor will be the biggest winners?

3) CTF has the biggest market share, and, in my opinion, the best brand position. If you follow Tao Bao livestreams, you will see that CTF has the highest viewership compared to the rest of the competitors. Personally, I find CTF livestreams to be more entertaining. They probably understand how to use social media better than their competitors.

If you do a search on chinese social media, you will find that CTS, LZF, and occasionally even LFX, get complaints of selling fake gold. High quality job seekers are drawn to high quality companies, and the same is probably true in the franchisor-franchisee market.

As all 5 franchisors have been expanding number of franchisees aggressively in recent years, so have revenues from the one-time sign-up fees. But recurring revenue from franchisee will depend on franchisee sales performance. In a growing market, everybody gets some. But as the market growth slows, and/or consolidation accelerates, it will be more difficult for the weaker operators to improve their brand position. CTS and ZLF do not seem likely to be long-term big winners.

4) The only non-franchise operator is CSS, and their choice of taking this route shows how it has limited their footprint expansion; only around 800 compared to 3,000-5,000 for their competitors. But given their 2022 and latest Jan to March 2023 sales data for both mainland and hk, they appear to be growing slightly to moderately faster than the market. And even though their physical presence (store count) in mainland is the smallest, CSS viewership on TB livestreaming is usually second to CTF. It seems that their brand positioning is relatively better.

As CSS owns and operates its own stores, the marked improvement in jewellery retail sales will likely lead to meaningful operating leverage in 2023. The effects will likely be more pronounced in its HK stores, as tourism continues to recover, and HK retailers in general have enjoyed significantly lower rental reversions in recent years.

6) LF's bottom line will also likely be a beneficiary of operating leverage, as its HK stores still contribute a significant portion of its total revenue. CTF much less so. But its market leading position is both HK and mainland is still unmatched.

Zhou Liu Fu is funny... the chinese character is combination of CTF and LF Trying to pull a fast one

Indeed. But what is funnier to me is that PRC intellectual property law is not strong enough to protect CTF, CSS, and LF from these new entrants with strangely similar sounding names.

And there are a lot more of these 'copycats' which do not seem shy at all to imitate likeness to the established brands. So there's probably still a long way to go towards consolidation in the gold jewellery market.

But nonetheless, to build a business with the scale of a thousand stores is no mean feat, even if it was riding on the coat tails of consumer confusion. By improving its service, product design, and consumer trust of the authenticity of its gold, it is not impossible that Zhou Liu Fu may someday build a more popular/legitimate brand than the 'real' Liu Fu.

六 and 大 actually looks similar. Can’t fault their ingenuity 😂 to combine and have the best of both brands

What you said brings to mind a certain shoe company that has yet surpassed the real Nike 😄