Chow Tai Fook (1929) delivered better than expected margins in 2H FY13 – Upgrade to BUY

Chow Tai Fook (1929, $8.66) reported FY13 earnings of $5,505mn, down 13.2% yoy. Company declared a final dividend of $0.16 per share implying a full year dividend payout of 40%. Comment : The bottom line was in line with market forecast because lower than expected revenue was offset by higher than expected profit margins. Revenue for FY13 grew 1.5% to $57.4bn (revenue from the PRC market decreased 5.3% whilst revenue from HK, Macau and other Asian markets increased 10.5%). Such increase was mainly fuelled by the expansion of the company’s retail network although the overall same store sales declined 3.3% in FY13 (down 3.0% for the PRC market and 3.7% for HK, Macau and other Asian markets).

Gross margin declined from 29.1% in FY12 to 28.4% in FY13 but improved remarkably from 26.4% in 1H FY13 to 29.9% in 2H FY13. Operating margin shrank from 15.1% in FY12 to 12.9% in FY13 (10.7% in 1H FY13 and 14.7% in 2H FY13) since total operating cost expanded by 12.5% or $1,019mn. Advertising and promotional expenses increased 78% or $349mn. Rental expenses rose 51% or $342mn since the number of self-operated outlets grew 13% in the PRC and 11% in the HK, Macau and other Asian markets. Staff costs added only 4% or $120mn despite an 8% increase in the number of employees. Higher than expected profit margins in 2H FY13 was attributed to efficient management and effective cost control in our view.

Chow Tai Fook plans to open another 200 sales outlets in FY14 bringing a total of more than 2,000 point of sales. Management guided a double-digit revenue growth for FY14 that we think is reasonable. We expect company’s revenue to grow 12% in FY14 to $64.2bn assuming SSSG of 2% for the PRC market and 5% for the HK, Macau and other Asian markets. Operating margin should improve in FY14 given a mild increase in rental expenses and enlarged economies of scale. We expect FY14 net profit to grow 18% to $6.48bn (EPS $0.648) translating into forward PER of 13.4x and dividend yield of 3.0% based on an unchanged dividend payout of 40%. Valuation of Chow Tai Fook becomes attractive again. We therefore upgrade our rating from sell to BUY with a 6-month price target of $10.0 based on FY14 PER of 15.5x. Consensus earnings forecast for FY14 is $6.8bn with price target of $10.9 according to Bloomberg estimates.