|Downgrade Luk Fook (590) to HOLD – the worst is yet to come
Luk Fook (590, $22.35), a leading retailer of jewellery and gold products in Hong Kong and Mainland China, recently announced disappointing sales data. The same store sales growth (“SSSG”) of the company’s retail business was -10% in 4Q FY14 (Jan to Mar period), while that for Mainland China market and Hong Kong & Macau market were 1% and -12% respectively. This compared with SSSG of 9% yoy in 3Q FY14 and 86% yoy in 1Q FY14. According to government statistics, China’s retail sales value of gold, silver and jewellery products surprisingly declined 6.1% yoy in March 2014 and up 4.7% yoy in the first quarter of 2014. We believe the company will continue to record a negative SSSG in 1Q FY15 (Apr to Jun period) given a high base effect in 1Q FY14.
On the other hand, we noticed that company has slowed the pace of expansion in Mainland China. As at 31 March 2014, Luk Fook had 1,125 licensed shops in Mainland China, representing an increase of 19% yoy compared to annual growth rate of 28% in FY11, 23% in FY12 and 25% in FY13. Net addition of self-operated shops in Mainland China also decreased from 22 in FY12 to 17 in FY13 and 5 in FY14.
Share price of Luk Fook dropped 5.1% yesterday and underperformed Hang Seng Index by 13.0%, 17.3% and 9.7% over the past 1-month, 3-month and 6-month period respectively. According to market estimates compiled by Bloomberg, the counter is currently trading at FY15 PER of 7.5x with FY15 EPS growth of 8.0%. Valuation is fair in our view. However, the slowdown in SSSG in the coming months will be an overhang on share price. We therefore downgrade Luk Fook from buy to HOLD and lower price target from $29.6 to $23.9 based on FY15 PER of 8.0x. Analysts’ consensus price target is $28.7.