Luk Fook (0590)

[bmann025]

Friday, China will announce retail sales for May 2014.

In May 2013, sales of jewelry increased by 38.4%.

Hence, any reduction better than -28% would show an increase versus 2012 data, despite overconsumption in the aftermath of the gold rush and government crackdown on corruption.

[Tiggerbee]

I think the main concern now is that gold sales are definitely going down substantially due to significant drop in speculative demand from the Zhong Guo Da Ma. Those Da Ma who rushed to buy gold at 1400 level and then 1300 level are stuck after catching two falling knives. And it's verily likely that gold might break the 1200 support this year. As the saying goes, once bitten twice shy. Thrice and you are a fool.

Bear in mind that gold sales in HK is also contributed mainly by Chinese tourists. Cheap stock can get cheaper. To me, it's only a compelling buy if the stock price drops to near book value. There are many other retail stocks that are trading near book value.

[bmann025]

I think the main concern now is that gold sales are definitely going down substantially due to significant drop in speculative demand from the Zhong Guo Da Ma. Those Da Ma who rushed to buy gold at 1400 level and then 1300 level are stuck after catching two falling knives. And it's verily likely that gold might break the 1200 support this year. As the saying goes, once bitten twice shy. Thrice and you are a fool.

Bear in mind that gold sales in HK is also contributed mainly by Chinese tourists. Cheap stock can get cheaper. To me, it's only a compelling buy if the stock price drops to near book value. There are many other retail stocks that are trading near book value.

This is true, but will pass.

Last year, there was an overconsumption due to this speculation, this year there will be saturation among those who bought too much in advance. That is why I mainly look at the underlaying trend and compare with 2012 data.

This stock has often been driven by short/medium term influences.

Luk Fook stock price particularly suffered from (almost) not hedging against the gold price, though this is a totally short term influence. Next quarters result will be totally independant of the hedges from previous quarters

There are other retailers trading around book value, but most of them live in an environment of sluggish growth and fast rising cost.

The long term story looks compelling for the jewelry segment. Multi year growth prospects, very little influence of rents/salaries on earnngs, very little inventory aging problems, very little investments aside from expansion, and hence very high payout possible.

[bmann025]

Share Price / Book Value * 100% , PE (TTM)

Luk Fook 163% , 6.96

Chow Sang Sang 166% , 10.72

Chow Tai Fook 328%, 14.94

King Fook 231% , loss

Time Watch 174% , 8.49

Prada 198% , 22.17

Sa Sa 795% , 17.15

Pranda (Thailand) 105%, 14.8

Signet Juwelers (US) 327% , 23.24

All data from here:
(http://markets.ft.com/research/Markets/T...?s=590:HKG)

Luk Fook is among the cheapest luxury stocks around.

What can go wrong may be seen from King Fook and Pranda (Thailand).

King Fook did not even manage to profit from the gold rush last year with unchanged revenues and a substantial loss.
Hence, it is essential for Luk Fook to remain a top brand in China and a place to go for tourists in HK and Macau. Assuming they succeed here, they are significantly undervalued against peers.

Pranda, the only company beating Luk Fook in one of the numbers, had a bad year in 2013 with significant negative cash flow and debt increase.In preceding years, they had steady data but no growth.
Pranda may be an example how such (surviving) stocks will trade and pay dividends, once long term growth is over.

[Tiggerbee]

I think the main concern now is that gold sales are definitely going down substantially due to significant drop in speculative demand from the Zhong Guo Da Ma. Those Da Ma who rushed to buy gold at 1400 level and then 1300 level are stuck after catching two falling knives. And it's verily likely that gold might break the 1200 support this year. As the saying goes, once bitten twice shy. Thrice and you are a fool.

Bear in mind that gold sales in HK is also contributed mainly by Chinese tourists. Cheap stock can get cheaper. To me, it's only a compelling buy if the stock price drops to near book value. There are many other retail stocks that are trading near book value.

This is true, but will pass.

Last year, there was an overconsumption due to this speculation, this year there will be saturation among those who bought too much in advance. That is why I mainly look at the underlaying trend and compare with 2012 data.

This stock has often been driven by short/medium term influences.

Luk Fook stock price particularly suffered from (almost) not hedging against the gold price, though this is a totally short term influence. Next quarters result will be totally independant of the hedges from previous quarters

There are other retailers trading around book value, but most of them live in an environment of sluggish growth and fast rising cost.

The long term story looks compelling for the jewelry segment. Multi year growth prospects, very little influence of rents/salaries on earnngs, very little inventory aging problems, very little investments aside from expansion, and hence very high payout possible.

If I'm not wrong, gold jewelry sales should be a very significant portion of the overall jewelry sales? By assuming that the sluggish demand might be a short - mid term blip, you are assuming that gold price should stabilize and not stop much further. Looking at the trend of gold prices in the last 20 years, gold has enjoyed a 13 year bull run after bottoming out. It had just entered a bear market after declining more than 20% from the peak. Sales of gold had been rising on this underlying bull trend for the past 13 years. Now that gold prices had entered bear market, will it not impact the demand for gold jewelry?

Sales of luxury goods were impacted due to the anti corruption campaign under Xi Jin Ping's rule. This might be a mid term impact that might last only another 1-2 years for all we know. The demand from the high heeled individuals should recover over time but the short term impact is expected to last for the whole of 2014. This will impact the earnings of luxury retailers in 2014 and maybe even up to 2015.

Closure of non performing stores due to the impacts mentioned in point 1 and 2 will likely incur operating losses and impact the bottom line in 2014 and maybe 2015.

Reduced discretionary spending by Chinese as the wealth of most high heeled individuals in China are tied to properties. With home prices already going through correction in China, these wealthy individuals are likely to reduce discretionary spending, especially jewelry.

[bmann025]

Gold price has been a hugely overrated issue in the past.

When prices started to decline, Luk Fook suffered, because they almost did not hedge, despite this is a one time effect.

When they collapsed, Luk Fook suffered, because analysts thought in addition revenues will contract.

However the opposite occurred, revenue and profit reached record highs.

The worst scenario for speculative consumption is probably a slowly declining price or little changes over a long time.

Generally, people tend to buy jewelry for a money budget and not weight budget, therefore gold prices have little influence on average consumer's spending.

Gold may go down to 1000 or even 900. but not more (for an extended period time) due to mining costs and money printing. Money printing cannot end, because governments in the US and Europe are now so heavily indebted that they could not afford free market interest rates.

[bmann025]

Short term / one time are
- gold hedging
- gold price fluctuation while gold travels on a trajectory from price A today to price B in the future
- government interference's effect on future growth rates (though future revenue may remain be affected)

Long term are
- wealth and spending power of citizens
- development of consumer spending preferences (how much percentage on jewelry, proportions of gold and diamond products)
- competition and market share development, brand ranking.

------------------------------------

Recently, markets have focussed almost entirely on those short term factors and forgot about the long term picture.

I also don't think we will see a similar development in the jewelry sector as in other retail sectors, such as the sportswear industry. There are no competitive foreign comanies eating market share, local brands are on top of the hirarchy, there are no inventory issues and sale prices are controlled by the sellers.

And regarding valuation, the Macau business alone, which contributes about 14% of total income, would justify half of Luk Fook's market value, if one would apply the same PE as casinos have over there.

[bmann025]

China Retail Sales May 2014

Jewelry -12.1 versus May 2013

(As there was an increase of 38.4% in 2013, this is an increase of 21.6% versus May 2012)

[bmann025]

EPS 3.17 HK$ (last year 2.11 HK$), far above consensus of 2.72 HK$

First half was 1.64 HK$, therefore second half of the year
EPS 1.53 HK$ versus consensus of 1.08 HK$.

[bmann025]

Considerable attention will shift from Hong Kong to the mainland China business and the attempt to turn around 3D Gold.

Luk Fook's self operated mainland stores are just barely profitable. They do not only have to compete with Chow Tai Fook and similar, but also Luk Fook's franchise partner stores.

If I understood their business models correctly, these franchise stores are led by independent jewelers, business people, not just regular employees, I think, they decide by themselves what and how much to order and how to sell and are particularly keen on high margin jewelry.

It is in Luk Fook's interest not to harm these franchises with the self operated stores, and this is in my view one reason why the self operated stores are selling mainly low margin gold products.

Now 3D Gold offers an elegant venue to overcome this dilemma.

I would guess, that Luk Fook will produce a jewelry line exclusively for 3D Gold, at least for the display windows and advertised products. There may be overlap with Luk Fook stores for under-the-table or catalogue products etc. to profit further from synergies. With that dual brand strategy, cannibalisation of self operated stores by franchise stores will then not happen. Though it will still be a challenge for Mr. Wong's son to revitalize the 3D Gold brand.

It would be very interesting if someone from mainland China could report on the transformation and progress of 3D Gold stores in the coming months.