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China/Hong Kong
Consumer Discretionary
Please read the analyst certification and other important disclosures on last page
Hengdeli (3389 HK) 22 July 2010
Tick Tock taking the spot
Company Rating:
Sector Rating:
Outperform(initiation)
Overweight(maintained)
Hengdeli is China’s largest luxury watch retailer and wholesaler
with 30% market share. Increased penetration towards the
mid-market segment through aggressive network expansion into
the second- and third-tier cities will be the core earnings driver in
the coming years. Given the favourable earnings outlook as well
as its strengthening financial position, we initiate coverage on
Hengdeli with an Outperform rating.
Leading the race. As the leading national luxury watch
retailer with strong store brand recognition in China,
Hengdeli is well positioned to tap the country’s burgeoning
luxury watch market. The company outshines its peers
given its strategic alliance with major Swiss watch
suppliers, which allows it to secure and source a wider
range of products. We see limited competition risk in the
foreseeable future due to peers’ weaker sales channels
and financial strength to adopt Hengdeli’s multi-brand
strategy or chase up its aggressive expansion.
Grasping the potential from second- and third-tiercities. The booming Chinese economy has spurred the
country’s urbanization rate, leading to the emergence of a
wealthy middle-class population. Being the first mover to
the second- and third- tier cites, we foresee Hengdeli sales
to accelerate, boosted by increased consumer spending
propensity and mounting luxury demand from the middle
class segment.
Stock not to miss. We initiate coverage on Hengdeli with
an Outperform rating and target price of HK$4.15 based on
20x FY11F PE, which is equivalent to a PE/G ratio of about
0.5x. We expect a 40% FY09-11F EPS CAGR driven by its
expanded sales network, continuous margin enhancement
and dominance in the tier-two to three markets in China.
Forecast and valuation
Year to 31 Dec 2008 2009 2010F 2011F 2012F
Revenue (RMB m) 5,516 5,899 7,397 9,084 10,952
Net profit (RMB m) 460 365 589 744 931
EPS (RMB) 0.185 0.094 0.145 0.183 0.229
EPS (YoY, %) 10 (49) 54 26 25
PER (x) 16.5 31.3 20.2 15.9 12.8
Yield (%) 1.9 0.9 1.4 2.0 1.7
FCF yield (%) (2.2) (0.6) (1.5) 1.5 2.7
ROAE (%) 23.7 14.7 19.1 21.0 22.6
Net gearing (%) 38 Net cash Net cash Net cash Net cash
Source: Company, CCBIS estimates
Price: HK$3.35
Target: HK$4.15
(initiation)
Trading data
52-week range HK$1.7 – 3.9
Market capitalization (m) HK$13,631/US$1,753
Shares outstanding (m) 4,069
Free float (%) 33
3M average daily T/O (m share) 6.8
3M average daily T/O (US$m) 2.9
Expected return (%) – 1 year 25.3
Closing price on 22 July, 2010
Stock price and HSCEI
0
1
2
3
4
5
22-Jul-09 3-Sep-09 19-Oct-09 2-Dec-09 18-Jan-10 4-Mar-10 21-Apr-10 4-Jun-10 21-Jul-10
HK$
H en gd eli H SC EI
Source: Bloomberg
Claudia Ching(852) 2532 [email protected]
Forrest Chan CFA(852) 2532 [email protected]
Warren Wang(852) 2532 [email protected]
Timothy Sun
(852) 2532 [email protected]
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Hengdeli (3389 HK) 22 July 2010
2
Table of Contents
Tick Tock taking the spot ...............................................................................................................................................1 Investment summary.....................................................................................................................................................3 Throne to the luxury watch kingdom.............................................................................................................................4 Valuation .....................................................................................................................................................................10 Upbeat sales growth outlook in FY10-12F .................................................................................................................12 Luxury watch market outlook in China........................................................................................................................15 Strong financial outlook...............................................................................................................................................19 Appendix 1: Background.............................................................................................................................................28
Appendix 2: SWOT and Porter analysis .....................................................................................................................30 Appendix 3: Management biography..........................................................................................................................32
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Hengdeli (3389 HK) 22 July 2010
3
Investment summary
Being the largest watch retailer in China with 30% market share and owning the most
extensive retail network with 300 stores, Hengdeli is well positioned to capture the
growing demand for luxury watches. On top of that, Hengdeli’s strong brandrecognition, well-established relationship with key suppliers, multi-brand strategy, and
comprehensive clientele are also key competitive advantages that keep the company
ahead of its peers. By expanding its strong network in the affluent mid-market
segment, Hengdeli will further strengthen its strong network presence across the
second- and third-tier cities.
Thanks to the long establishment and co-operation with the major Swiss watch
makers over the years, Hengdeli has secured close relationship with the top Swiss
watch suppliers. The Swatch Group (UHR VX, Not Rated) and LVMH Moet Hennessy
Group (LVMH, MC FP, Not Rated) are also substantial shareholders of Hengdeli. The
strategic alliances with major suppliers provide unique advantages for Hengdeli,
which receives more diversified and comprehensive product offerings, enjoys
extended credit line, and gains priority in watch supply and delivery while no other
industry players in China can compare with.
Supported by its nationwide renowned brand name, Hengdeli is a rare luxury watch
retailer that has the financial ability and bargaining leverage to operate with a
multi-brand approach. With its three main brands targeting different customer
segments, we believe the company is well positioned to fortify its sales channels and
expand its customer pool.
With an eye on the large market potential for entry-level luxury watches, Hengdeli will
accelerate its expansion plan by adding 30-60 stores per annum in FY10F-12F in the
second- and third-tier cities, with total store count expected to reach 400 by 2012. We
view that Hengdeli is the only luxury watch chain to expand in such a rapid pace, andtowards other regions outside of tier-one cities. We believe Hengdeli can utilize this
opportunity to seize additional market share. Besides, network expansion will be
mostly achieved through M&A, which gives instant earnings accretion and limits
operating costs.
Hengdeli saw no slowdown in sales with January-June sales growing by 25-40% YoY
in China and Hong Kong, despite worries over tightened discretionary spending due
to the recent softening property and stock markets. Going forward, China’s rapid
macroeconomic growth, together with the expanding middle class pool, will drive a
large and prosperous luxury watch market demand and hence support our forecast of
24% sales CAGR in FY09-11F.
Hengdeli offers an attractive investment case that will sustain over the long term. On
the back of a rosy earnings outlook with FY09-11F EPS CAGR of 40% as well as an
undemanding valuation, we find this leading luxury goods retailer with a dominant
market position and significant foothold in China will be a major winner within the
consumer universe. We initiate coverage with an Outperform rating. Our target price is
set at HK$4.15 as we peg our target valuation at 20x FY11F PE, equivalent to a PE/G
ratio of about 0.5x, which is at the lower range compared with the industry average
(international luxury watches retailers, Hong Kong-listed luxury watches retailers and
China specialty retail players) of 0.4-0.7x
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Hengdeli (3389 HK) 22 July 2010
4
Throne to the luxury watch kingdom
Hengdeli is our top high-end retail pick as we like its ability to tap into the upswing of
China’s luxury watch market and its foresight to expand its sales channel and market
share through increasing penetration into the second- and third- tier cities. Owing tothe escalating appetite for big ticket items in China, in particular from the growing
middle-class population, Hengdeli is well-positioned to capture the thriving demand.
Hengdeli has set an aggressive store rollout plan for the coming three years mainly
through acquisitions. The strategy not only provides instant earnings accretion, but
also minimizes initial operating losses. With Hengdeli’s unique market positioning and
leadership, we believe the attractive investment case will sustain over the long term.
Market leader with exceptionally strong store brand recognition
Hengdeli was ranked number one in Greater China in terms of retail sales of luxury
watches, topping RMB3.7b in sales in 2008. As the largest player in the luxury watch
segment in China with 30% market share, Hengdeli is set to enjoy the growing
demand for luxury goods, especially in the wake of rising income levels and its deeper
penetration into the second- and third-tier cities. On the back of its aggressive
expansion plan across China, we anticipate Hengdeli’s market share will continue to
expand.
2008 global Swiss watch retailers’ retail revenue (RMB b) 2008 market share of wholesalers/retailers in China
3.7
3.1
2.42.3
2.1
1.5 1.5
1.00.8
0.6 0.5 0. 5 0.4
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
H e n g d e l i
S i g n e t
B u r c h e r e r
P r i n c e
O r i e n t a l
E m p e r o r
T o u r n e a u
K i n g F o o k
H a r m o n y
M o v a d o
T i m e C i t y
F o r m o s a T i m e s
S i n c e r e
RMB b
Oriental
6%
Time City
5%
Harmony
7%
Hengdeli
30%
Others
52%
Source: Company Source: Company
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Hengdeli (3389 HK) 22 July 2010
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Unprecedented competitive advantage to sustain superiority
Besides being a clear dominant player in China, we believe Hengdeli is also the most
scalable retailer among a handful of national luxury watch retail chain operators in the
country. Hengdeli’s successful business model is extremely difficult for other industryplayers to replicate and hence it is unlikely for others to overtake Hengdeli’s market
leadership in the foreseeable future. The success of Hengdeli is supported by the
following factors:
A long-established household name in the luxury watch market.
Strategic tie-ups with suppliers and comprehensive product offerings.
Extensive customer coverage through effective brand building.
Prudent new store opening.
Unique expansion model to maximize chance of success.
A long-established household name in the luxury watch market
Being one of the first national luxury watch retailers in China, Hengdeli has
established sound and exclusive working relationships with various worldwide
renowned brand owners. Tracing back to 1949 when it became a SOE, Hengdeli
began Swiss watch distribution in China. The close cooperation over the years has
been clearly unrivaled.
Hengdeli’s extensive history in the distribution of luxury watches in China has enabled
it to gain thorough industry know-how. Run by an experienced management team,
with chairman Zhang Yupin having more than 20 years of experience in the high-endconsumable distribution industry in China, we believe Hengdeli will continue to benefit
from the management’s competency and experience in the retail of luxury watches in
China.
Hengdeli is usually viewed as a symbol of authentic and quality assurance. With the
rising awareness of product quality and originality nowadays, Hengdeli is likely to be
customers’ most preferred and trusted watch retailer. Moreover, its long establishment
and reputation in China help it gain access to ideal shop locations, as well as strong
bargaining power when negotiating for rental rates.
Strategic tie-ups and comprehensive product offerings
In order to minimize brand image risk, the international luxurious brand suppliers are
extremely stringent in selecting their distribution partners, especially in China.
Nonetheless, as reflected by the exclusive product offerings and years of cooperation,
Hengdeli has managed to win over the trust of world-class Swiss watch brands,
including the world’s largest watch distributors – Swatch Group and LVMH.
The strong ties with suppliers mean Hengdeli is able to secure a wider range of model
collection as well as more favourable credit terms compared to its local peers. In many
cases, Hengdeli is also given the priority in watch supply and delivery.
Five distinctive competitive
edges where competitors are
incomparable
High recognition nationwide
Experienced management team
with proven track record
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Hengdeli (3389 HK) 22 July 2010
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While non-exclusive, we believe the distribution partnerships with Swatch Group and
LVMH remain guarded given the strategic alliance with major suppliers in Hengdeli’s
shareholding structure. Swatch Group owns an 8.9% stake in the company and is
currently the second largest shareholder, while LVMH is the third largest shareholder
with a 6.8% interest. Such shareholding clearly suggests a strong vote of confidencein Hengdeli and the strategic ties provide a distinctive competitive advantage for
Hengdeli.
Hengdeli’s shareholding structure
Zhang Yuping(Chairman)
Public Swatch Group LVMH Group
Hengdeli Holdings Ltd.(3389 HK)
44.75% 39.52% 8.90% 6.83%
Source: Company
Furthermore, Hengdeli and Swatch Group have established a 50/50 JV in the
wholesaling and retailing of some watch brands in China since 2003. The JV, with
plans to open and operate boutiques of watches, jewellery, and other related
accessories of Swatch Group, has already opened an Omega flagship shop on
Huaihai Road, Shanghai and two Swatch boutiques in Harbin and Qingdao.
Leveraging on its strong link with various brand owners, Hengdeli has secured 18
exclusive distribution rights from Swatch Group, LVMH, and Richemont, and these
rights will not expire until 2012. The close relationships with Swatch Group and LVMH
are of particular importance given that they are among the top five best-selling brands
in China (50% of the market).
Hengdeli’s brand portfolio
Exclusive brands Non-exclusive brands
Swatch Group Tissot, Calvin Klein, Certina, Hamilton, Mido,
Breguet, Longines
Omega, Rado, Blancpain, Glashutte,
Jaquet Droz
Rolex Group Rolex, Tudor
LVMH TAG Heuer, Zenith, Christian Dior, Fendi
Richemont Jaeger-Lecoultre, Baume & Mercier Alfred Dunhill, Panerai, Cartier,
Vacheron Constantin, IWC
Independent brands Maurice Lacroix, Carl. F. Bucherer,
Claude Bernard
Edox, Enicar, Carven, Ball, Gucci, Oris,
Raymond Well, Frank Muller, Hermes,
Girard Perregaux, Grand Seiko, Jean Richard,
MONTBLANC, Parmigiani,
Ulysse Nardin, Cyma
Source: Company
Unique shareholding structure
with suppliers being a substantial
shareholder
Providing the hottest brand
offerings
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Hengdeli (3389 HK) 22 July 2010
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Extensive customer coverage through effective brand building
Hengdeli possesses the rare scale required for adopting a multi-brand strategy to
maximize customer exposure. Hengdeli’s retail network is mainly classified under
three categories of multi-brand shops, namely Xinyu Elegant, Xinyu Prime Time, andXinyu Temptation. The company also operates mono-brand boutiques.
The multi-brand business model is another unparalleled example that reflects
Hengdeli’s leadership in the luxury watch market in China. Given Hengdeli’s capability
to source an extensive range of watch products, this enables it to target a wide range
of clientele and support the multi-brand operation. On the other hand, industry peers
usually operate under one store brand due to the network scale restriction.
Hengdeli’s store brands
Elegant Showcasing the most luxurious internationally renowned brands of the top class watches
ASP: RMB50,000
13 Elegant outlets, with 10 in China, 3 in Hong Kong and 1 in TaiwanPrime Time Offering a full range of watch brands under extensive number of internationally renowned brands targeting the middle-to-high end customers
Providing one-stop-shop services to customers
ASP: RMB10,000-20,000
206 Prime Time stores, with 175 in China and 31 in Taiwan
Temptation The trend setter of watches, bringing fashionable and niche yet classy watches for the youngsters
ASP: RMB5,000-8,000
Mono-brand boutique
stores
52 exclusive brand image boutiques, with 40 in China, 10 in HK, 2 in Taiwan under various renowned brands, namely Rolex, Tissot, TAG Heuer and
Cartier etc.
Source: Company
Elegant store Prime Time store
Source: Company website Source: Company website
Hengdeli has committed tremendous efforts to improve sales of middle-to-high end
brands. More than 75% of its retail outlets in China are Prime Time shops, which are
positioned to sell middle-to-high end watches. Prime Time contributes to nearly 80%
of the company’s total retail sales in China and will remain its leading store brand for
the coming years. Given increasing demand for mid-to-high end watches, Hengdeli
will continue to consolidate and expand its retail network in the second- and third-tier
cities under the Prime Time label.
Three distinct store brands to
capture different consumer
segments and expand saleschannels
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Hengdeli (3389 HK) 22 July 2010
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Prudent new stores opening
In view of the growing spending propensity of the expanding middle class, Hengdeli is
accelerating its store rollout plan to capture fast growing demand. Already with 257
stores in China, 13 in Hong Kong, and 33 in Taiwan, management aims to add 50-60stores in FY10F and 30-40 annually in FY11-12F. By 2012, Hengdeli’s store portfolio
should reach over 400 stores, far exceeding other competitors.
Number of stores in 2007-2012F
166210
257315 350 3802
7
20
17
15
13
42
38
35
33
0
50
100
150
200
250
300
350
400
450
2007 2008 2009 2010F 2011F 2012F
Mainland China Hong Kong Taiwan
Source: Company data, CCBIS estimates
Second-tier city stores, in particular, have fared well the past two years and delivered
increasing profit contribution to the company. We predict Hengdeli’s reliance on these
cities will continue increase over time and they will be the main growth driver for the
company.
Revenue by city tiers Number of stores by city tiers
3731
26 24 23 22 21
58
5761 61 62 62 63
512 13 15 15 16 16
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2006 2007 2008 2009 2010F 2011F 2012F
Tier-one Tier-two Tier-three
3223 21 17 15 13 11
57
5955
56 57 58 59
1118
24 27 28 29 30
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2006 2007 2008 2009 2010F 2011F 2012F
Tier-one Tier-two Tier-three
Source: Company data, CCBIS estimates Source: Company data, CCBIS estimates
Capture the affluent
middle-income customers
Burgeoning middle class
provides a strong sales catalyst
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Hengdeli (3389 HK) 22 July 2010
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Compared to Hengdeli, most peers have a relatively slow rollout plan and mainly in
first-tier cities. However, Hengdeli has spotted the enormous growth potential in the
mid-market segment. With the aim of extending the coverage of its middle-to-high-end
product line, the majority of Hengdeli’s new stores will come under the Prime Time
label. Expansion will be centered at second- and third-tier cities in the North Easternregion, e.g. Shenyang and Tianjin, as well as Eastern China, e.g. Sichuan, and
Southern China region, e.g. Nanchong and Jiangxi.
As urbanization continues, we are positive on Hengdeli’s strategy in extending
penetration into the second- and third-tier cities. In our view, consumers in those cities
make up the bulk of Hengdeli’s addressable market, and young people in particular
are increasingly seeking modern and trendy accessories. We believe that the growing
number of middle income consumers in these cities are likely to be attracted to
Hengdeli’s mid-end watches offering.
Unique expansion model to maximize chance of success
It is expected that 80% of Hengdeli’s expansion will be achieved through acquiring
local retailers and the rest the establishment of new stores. We think the M&A strategy
is facilitated by the company’s wholesale business in China, which enables it to
identify suitable acquisitions.
The acquisition of Elegant in 2006 proved to be a big success and we favor Hengdeli’s
expansion approach in the form of M&A as it yields three distinct advantages:
Acquiring existing and operational stores could minimize initial operating losses.
Store acquisition allows Hengdeli to instantly inherit the customer base from the
exiting stores. Hengdeli will initially operate the acquired stores under the old
store brand before changing it into its own brands.
Gain quicker access into the second- and third-tier cities, where the luxury
watch markets are still relatively immature and existing watch retailers are small
and offer old-fashioned models.
Hengdeli’s acquisition price usually ranges from 5x to 8x PE to ensure earnings
accretive transactions. Two acquisitions were made in late May to early June in
Guangzhou (60% interest) and Shenyang (75% interest) at FY10 PE of approximately
5x. The two deals added 30 stores to Hengdeli’s portfolio instantly. Management
indicated that the company is looking at two major M&A opportunities in second-tier
cities in southwest China and hopes the deals will be completed in late 3Q10 or early
4Q10.
Acquisition projects in 2009-2010 YTD
Retail company Location Shop network
No. of
outlets
Stake of
Hengdeli
Acquisition
valuation Major brand portfolio Acquisition date
Taiwan Jing Guang
Timepiece Holdings
Taiwan Taipei, Taichung, Kaohsiung 31 80% 6x Omega, Rado, Tissot October 2009
Guangzhou Rui Yue Guangzhou (Central China) Hubei, Hunan, Tianjin 9 60% ~ 5x Tudor, Longiness, Rado June 2010
Shi Quan Shi Mei Liaoning (NE China) Shenyang 21 75% ~ 5x TAG Heuer, Zenith, Hamilton June 2010
Source: Company, CCBIS estimates
Well-positioned to capture future
growth through penetrating into
second- and third-tier cities
Secured two deals in 1H10
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Hengdeli (3389 HK) 22 July 2010
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Valuation
The current market valuations of 20x FY10F PE and 16x FY11F PE appear
undemanding and we see there is strong re-rating potential for the stock given its 40%
forecast FY09-11F EPS CAGR. Given its RMB1b cash on hand and return to positivefree cash flow, Hengdeli is financially sound to implement its expansion plan and
acquisition strategy to enhance its value.
For comparison, we examine the PEs of international luxury brands listed overseas.
The international jewelry retailers include Bulgari (BUL IM, Not Rated), Swatch Group
(UHR VX, Not Rated), LVMH (MC FP, Not Rated) and Tiffany & Co. (TIF US, Not
Rated). Bulgari, LVMH, and Tiffany & Co. are jewellery retailers with the comparable
target customers and similarly high inventory requirements as Hengdeli while Swatch
is similar to Hengdeli by market segment. At present, these brands have an average
valuation of 17x CY11F PE, on par with Hengdeli. However, these brands, with
exposure to the sluggish US and European markets, trade on a higher average PE/G
ratio of 0.7x on consensus forecast EPS CAGR of 26% in FY09-11F, significantly
lower than Hengdeli. We hence think Hengdeli valuation is not expensive compared to
international peers given its heavy exposure to China, and more exciting business
outlook.
We also benchmark Hengdeli to the valuations of Hong Kong-listed luxury watch and
jewellery retailers – Oriental Watch (398 HK, Not Rated), Emperor Watch & Jewellery
(887 HK, Not Rated), Luk Fook (590 HK, Not Rated), and Chow Sang Sang (116 HK,
Not Rated) – which trade on an average CY11F PE of 10x with a PE/G ratio of 0.4x.
Although these retailers also share the same target customers and high inventory
requirements as Hengdeli, most of their stores are located in Hong Kong, which has
less attractive growth potential compared to China. Moreover, their expansion pace is
also relatively moderate versus Hengdeli’s. Factoring in stronger network and scale
with higher earnings CAGR, we believe Hengdeli deserves to command a premiumvaluation versus the local watch and jewellery retailers.
Similarly, when comparing local watch retailers with China specialty retail players, we
find Hengdeli’s current valuation undemanding. Given its above sector average’s
growth rate, Hengdeli justifies a higher CY11F PE multiple than the peer average of
18x with a sector growth rate of only 28% in FY09-11F.
Our target price is set at HK$4.15 on target valuation of 20x FY11F PE, equivalent to a
PE/G ratio of about 0.5x (forecast EPS CAGR growth of 40% in FY09-11F), which is
the at the lower range compared with the industry average (international luxury watch
retailers, Hong Kong-listed luxury watch retailers, and China high-end retail players) of
0.4-0.7x. Hengdeli has outperformed the HSI by 20% YTD. Given its rosy outlook and
undemanding valuation, we find Hengdeli a preferred play in specialty and luxury retail.
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Hengdeli (3389 HK)
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Valuation summary
Share price Market cap 3M average value traded EPS growth (%) # PE (x) PE/G (x) Yield
Company Ticker (Local currency) (US$m) (US$m) CY10 CY11 CY10 CY11 CY11 CY1
International jewelry & watch
LVMH MC FP 89.68 55,393 168.44 26 15 19.2 16.7 0.8 2.1
Swatch UHR VX 321.20 16,156 61.53 23 15 18.0 15.7 0.8 1.5
Tiffany TIF US 39.21 4,986 128.04 NA 14 15.4 13.5 NA 2.1
Bulgari BUL IM 6.23 2,364 17.83 NA 63 35.0 21.4 NA 1.3
Hengdeli* 3389 HK 3.35 1,749 2.89 54 27 20.2 15.9 0.4 1.4
Average 34 27 21.6 16.6 0.7 1.7
China specialty retailers/other brands
Belle* 1880 HK 11.88 12,859 21.43 23 5 28.1 26.7 1.9 0.9
Gome* 493 HK 2.58 4,985 27.25 33 29 18.3 14.2 0.5 0.0
Golden Eagle 3308 HK 18.20 4,535 5.15 33 26 32.7 25.9 0.9 1.3
Bosideng 3998 HK 2.42 2,414 5.56 NA 12 14.0 12.6 NA 6.1
Hengdeli* 3389 HK 3.35 1,749 2.89 54 27 20.2 15.9 0.4 1.4Daphne 210 HK 7.61 1,600 5.11 17 24 17.9 14.4 0.7 1.3
Ports 589 HK 20.35 1,478 4.37 16 19 18.6 15.6 0.9 3.6
Lilang 1234 HK 8.92 1,374 4.96 49 33 22.6 17.0 0.4 1.8
Trinity 891 HK 4.89 988 3.74 27 40 27.0 19.3 0.6 2.1
China Nepstar NPD US 3.04 317 1.40 (36) 36 23.8 17.5 NA 2.6
Average 24 25 22.3 17.9 0.8 2.1
Hong Kong jewelry & watch
Hengdeli* 3389 HK 3.35 1,749 2.89 54 27 20.2 15.9 0.4 1.4
Chow Sang Sang 116 HK 15.24 1,324 3.94 NA NA NA NA NA NA
Luk Fook 590 HK 12.44 786 1.14 NA NA 19.8 NA NA NA
Emperor Watch 887 HK 0.55 368 0.60 14 41 11.2 8.0 0.4 3.1
Oriental Watch 398 HK 2.25 112 0.20 NA 24 6.2 5.0 NA 2.8
Average 34 31 14.4 9.6 0.4 2.4
# Calculated in HK$ terms
* Denotes CCBIS estimates
Source: Bloomberg, CCBIS estimates
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Hengdeli (3389 HK) 22 July 2010
12
Upbeat sales growth outlook in FY10-12F
Fast expanding retail business drives the growth
Hengdeli’s revenue is derived from three major segments, with retail business beingthe largest contributor to account for 75% of total sales, followed by wholesales
business’s 23%, and customer service and others’ 2%. Going forward, we expect the
company to continue to rely on the retail segment, which yields more rapid growth and
higher margin, and we project the segment to account for 80-82% of total sales in
FY10-12F.
Sales breakdown in FY08 Sales breakdown in FY09
Retail sales
from HK
26%
WholesaleBusiness
30%
Retail sales
from PRC
41%
Customer Service
and Others
3%
Customer Service
and Others
2%
Retail sales
from PRC
46%
Wholesale
Business
23%
Retail sales
from HK
29%
Source: Company data Source: Company data
Riding on the strong demand for luxury items
Given the favourable economic outlook in view of strengthening purchasing power
and demand for quality mid-to-high end watches in China, Hengdeli’s sales outlook is
promising. In addition, the emerging of the middle class signifies a large and still
growing market of an affordable group with increasing disposable income to spend on
the discretionary items. We believe sales from second- and third-tier cities will be the
key driver for Hengdeli in the coming three years.
Superior market size compared to peers in Hong Kong
With a more renowned reputation and wider product coverage, Hengdeli dominates
two major Hong Kong listed luxury watch competitors by sales size and market share.In FY09, Hengdeli’s sales revenue exceeded Oriental and Emperor by 2.3x and 2.5x,
respectively. Its presence in China is also outperforming, with a network of 224 stores
compared to 40 for Emperor and 24 for Oriental at end-09. The three players target
different markets, with Hengdeli focusing on China’s second- and third-tier cities,
Oriental in Hong Kong and Emperor on China’s first-tier cities.
The emerging middle class has
proved to be big spenders
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Hengdeli (3389 HK) 22 July 2010
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Peers comparison – listed Hong Kong luxury watch and jewellery retailers
Hengdeli
(3389 HK, Outperform)
Oriental Watch
(398 HK, Not Rated)
Emperor Watch & Jewellery
(887 HK, Not Rated)
Retail revenue in 2009 (RMB m) 5,899 2,539 2364
Market capital (HK$ m) 13,428 818 2,659
Target market China tier-one to three, more focus on
tier-two to three
China tier-one to two cities (BJ, SH) China tier-one cities (BJ, SH), HK
Total no. of shops by end-09 270 54 40
No. of shops in China 224 40 24
No. of shops in Hong Kong, Macau and Taiwan 46 14 16
Estimated market share (%) 30 6 < 1%
Store addition for 2010 50 2 10 to 20
Gearing ratio (%) 11.2 0.32 0.9
Year of establishment 1927 1961 1942
Source: Company, CCBIS estimates
Hengdeli dominates China’s luxury watch industry with its reputable brand name,longest history, larger network size, and overall sales and profitability. With lower
sales and smaller market share, other players have weaker financial ability to ramp up
their expansion plan. We hence view that peers have a minimal threat to Hengdeli’s
leading position.
Solid growth in Hong Kong
In 2006, Hengdeli acquired Elegant International, a well-known luxury watch retailer in
Hong Kong with four retail outlets. Elegant is one of the major retailers of luxury
watches in the territory selling high-end Swiss timepieces. We believe that the
acquisition has significantly enhanced Hengdeli’s earnings and brand recognition.
Along with four Elegant stores, there are also ten mono-brand boutiques in Hong
Kong.
A significant portion of Elegant’s sales is derived from mainland tourists. While
travelling, mainland tourists take the opportunity to buy luxury watches in Hong Kong,
as the luxury watches are sold at approximately 20-30% discount compared to the
retail price in China due to the absence of VAT tax. With the uptrend in mainland
tourist arrivals in Hong Kong, we expect sales momentum to sustain.
In addition, another trend that benefits Hengdeli is the acceptance of the UnionPay
system for payment settlement. UnionPay is the only domestic credit card
organization in China. Majority of mainland travelers now use UnionPay to settle
payments because it saves them up to 2% in transaction fees. Retailers in Hong Kong
settle payments with shoppers in RMB through UnionPay’s system, hence thecredit-card holders can save the foreign-exchange conversion fee when they repay
the debt. This advantage will continue to entice mainlanders travelling to Hong Kong
to keep up their spending spirit.
Explore the potential of
mainlanders’ rising affluence
amid their soaring overseas
travels
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Expansion to Taiwan to complete Greater China coverage
In view of the opportunity to capture additional sales, Hengdeli has entered into
Taiwan via the acquisition of 80% of Taiwan Jing Guang Timepiece for HK$48m, or at
6x PE, in 2009. Taiwan Jing Guang Timepiece owns 31 retail outlets in Taipei,Taichung, Kaohsiung, Hsinchu, and Chiayi, specializing in selling internationally
renowned watch brands. As a result of the acquisition, Hengdeli has established retail
network in major cities of Taiwan with leading market share, laying a sound foundation
for the long-term development of the company’s overseas business.
In mid-May 2010, Hengdeli opened its first Elegant flagship store in Taiwan. The new
store sells the world’s top ten most exclusive watch brands and serves as a grand
emporium for building brand image. Hengdeli plans to invest HK$40m to open up to
five stores in Taiwan by end-2011.
The expansion into Taiwan makes economic sense because in July 2008, Mainland
China and Taiwan have resumed regular direct flights between the two regions for the
first time in six decades. Given the new flight arrangement, tourist number from
Mainland China has been growing rapidly, and achieved 105% YoY growth to 670,000
in 1H10. As retail prices for luxury watches in Taiwan are approximately 11% cheaper
than those in Mainland China, mainland visitors are taking the opportunity to purchase
luxury watches in Taiwan.
Considering the Taiwan market is still at a developing stage, we do not anticipate any
material contribution to the company in the near term. Nevertheless, we anticipate the
broadened platform will be a long-term driver for Hengdeli in capturing additional
market share and sales.
Wholesale business – stable with strong cash generating
capability
Hengdeli currently owns the distribution rights of 20 renowned international brands in
China, of which 18 are on an exclusive basis and will not expire until 2012. Hengdeli is
the largest wholesaler of luxury watches in China with over 300 customers. With its
ownership of exclusive distribution rights for a number of renowned best-selling
international brands, local retailers intending to carry these brands must source from
Hengdeli.
Although in recent years the wholesale business has not been the fastest growth
driver for Hengdeli, we see this business remains extremely valuable as it is a cash
cow and serves as a platform for maintaining close working relationship with the Swiss
watch suppliers.
Synergy from jewellery business
Hengdeli is also eyeing to broaden its business platform into the high-end jewellery
market. We expect enormous synergy will be created as many high-end brands also
have their own jewellery lines. More importantly, the jewellery market in China is
estimated to be ten times larger than the luxury watch market. The new business is
likely to start through its existing Elegant stores or a joint venture. No detailed
information is disclosed at this time, however, we are confident that the business,
when comes on stream, will be a strong re-rating catalyst given the enormous synergy
between the two business lines.
Benefiting from surging
mainlanders’ visits
Acquired Taiwan Jing Guang
Timepiece to strengthen foothold
in Taiwan
Constant sales deriving from
wholesale business
Potential business to come on
stream in 2011
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Hengdeli (3389 HK) 22 July 2010
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Luxury watch market outlook in China
According to Bain Consultancy, China’s imported watch market is estimated to grow
from RMB14b in 2008 to RMB21b by 2012, or at a CAGR of 11%. The Eastern region
accounts for about one-third of the market.
The financial crisis in 2009 resulted in ~20% YoY drop in export value in the Swiss
watch market. That said, Greater China Region remained one of the most resilient
regions and China is expected to lead a recovery attributable to three major growth
drivers:
Increasingly affluent and growing middle class with high spending power in
China pushes more demand for fashionable watches.
Hong Kong is still the largest luxury watch market in Greater China and has
strong attraction for tourists to purchase as watches are relatively cheaper.
Taiwan sales in watches to be boosted by rising number of China tourists.
Growth potential for Swiss watches is enormous in China as watch ownership and the
penetration rate of Swiss watches are still low, with only five watches purchased per
100 consumers every year in the country, compared to 18 for developing countries
and 27 for developed countries.
Sales of Swiss watches per 1,000 people
Saudi Arabia
China Taiwan
Thailand
Turkey
RussiaMexico
South Korea
Malaysia
Ukraine
PortugalGreece
Spain UK
JapanAustralia
HollandBelgium
Canada
USA
Germany
ItalyAustria
China 2018: 0.59/’000 people
China 2013: 0.34/’000 people
China 2008: 0.23/’000 people
10
5
2
1
0.5
0.2
0.1
Sales of Swiss Watch in pieces
(Swiss Watch worthHigher than RMB10K)
The market penetration
of Swiss Watch in Chinais low and with a hugegrowth potential
0 100 200 300 Source: Company, Bain & Company, Eurominitor, Watch Association of Switzerland
Growing number of wealthy
consumers underpins demand
for luxury products
Enormous market size to explore
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Potential cuts in luxury item tax
In China, luxury watches with a dutiable price of RMB10,000 or higher are levied
20-30% duties. The government is reviewing the policy and considering to reduce
import duties on luxury products. Retailers are expected to pass on the saving tocustomers to attract more sales. The tax reduction may also elevate China sales while
lowering the purchase costs, which would strengthen gross margins. The policy would
also retain a portion of mainland consumers to buy watches within China instead of
Hong Kong. Since the gross margin of the Hong Kong retail operation was lower than
that in China (18.9% vs. 32.1% in FY09), with more sales generated from China, the
overall gross profit margin is expected to improve.
What luxury watches mean to the market now?
The function of watches has changed over time, from mainly for timekeeping to a sign
of social status. At the consumer level, there is a growing perception that famous
foreign-branded watches are status symbols, denoting wealth and success. Precious
timepiece is also gaining popularity among younger generations of consumers, who
attach great importance to branding instead of price. Luxury watches have also turned
to be perfect gifts, in particular for consumers in tier-one cities.
Notably, only a small portion of consumers prefers buying domestic brands or
non-Swiss made imported watches. Most of them still prefer Swiss-made prestigious/
luxury watch products as they embody an image of technical and aesthetic quality that
have been forged over the years.
Swiss brands vs. non-Swiss brands in China
100%
80%
60%
40%
20%
0%Prestige/Luxury High-end Mid-end
Swiss brandSwiss brand
Non-Swiss brand
Non-Swissbrand
Swiss brand
6.8bRMB 4.0b 3.2b Total = 13.9b Mainland
Total non-Swiss brand sales= 1.5b (10%)
Total Swiss brand Sales= 12.9b (90%)
Source: Company
Tapping the resurgence of booming retail demand
The meteoric rise of the middle class pool in China is tied to a dramatic increase in its
per capita income and it is a major driver to consumer spending growth. In 1Q10,
per-capita disposable income for urban people hit RMB5,308, up 10% YoY. We expect
China to sustain its strong economic performance going forward and to accelerate its
expansion into the middle class population.
Perspective towards watch is no
longer for timekeeping only
Preference for foreign brands
over local watches
Population of wealthy consumers
is rapidly increasing
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Disposable income by income group in 2008 Income CAGR for different income groups in 2000-2008
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
Low Lower middle Middle Upper middle High
RMB
0%
2%
4%
6%
8%
10%
12%
14%
16%
Low Lower middle Middle Upper middle High
Source: China Statistical Abstract 2009 Source: China Statistical Abstract 2009
We anticipate Hengdeli will benefit from the improving propensity as more Chinese
consumers trade up for higher quality consumer goods, in lockstep with the uptick of
the economy. We therefore expect the total market size for luxury goods in China to
expand at a rate far quicker than that for mass market products.
China income per capita urban vs. rural in 2000-2009 China urbanization rate in 2002-2010F
8,1779,061
10,12911,321
12,719
14,909
17,068
18,858
3,449 3,582 4,0404,631 5,025
5,7916,701 7,116
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
2002 2003 2004 2005 2006 2007 2008 2009
RMB
Urban Rural
30%
35%
40%
45%
50%
2002 2003 2004 2005 2006 2007 2008 2009 2010F
Source: CEIC Source: CEIC
China and Hong Kong being the largest Swiss watch exportmarket
According to the Federation of the Swiss Watch Industry, China now ranks fourth in
terms of the world distribution of Swiss watch exports, with an aggregate value of
CHF$482.7m in January-Jun 2010, up 91% YoY. China and Hong Kong combined
accounts for 28% of watch exports from Switzerland during the same period. Both
markets came significantly ahead of the US, which accounted for only 11% and was
up only 13% YoY. China and Hong Kong continued to stand out in Swiss watch
imports with the highest YoY growth rate of 69% and 59%, respectively, in Jun.
No signs of market saturation in
tier-one cities
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Top 15 destinations of Swiss watch exports in January-June 2010
Ranking change Country Total value (CHF m) YoY (%)
– Hong Kong 1,408.7 38
– US 757.7 13
- France 504.3 8
+3 China 482.7 91
-1 Italy 469.7 3
+2 Singapore 398.0 49
-1 Japan 361.3 (9)
-3 Germany 356.4 (5)
+1 United Arab Emirates 278.4 24
-1 UK 274.1 8
- Spain 154.5 9
+1 Taiwan 152.2 49
– South Korea 131.3 23
– Saudi Arabia 106.6 25
– Thailand 90.2 18Source: Federation of Swiss Watch Industry
The pace of recovery in Hong Kong and China has picked up markedly. With the
surging demand for luxury watches in the local market and the weakening of
consumer sentiment across the US and Europe, we anticipate China and Hong Kong
will continue to top the chart and will capture additional market share in the watch
export industry.
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Strong financial outlook
A strengthened sales pickup was evident in Hengdeli’s 1Q10 performance, with total
sales up 35% YoY and 10% QoQ. April-June data were also encouraging, with China
and Hong Kong sales surged by 25-40% YoY.
The company indicated there was no setback in total spending by domestic
consumers, despite concerns over wealth effect erosion following the recent flagging
property and stock markets. Average ticket size for China is expected to grow by 10%
per annum. Judging from January-June sales performance, we are confident that
management’s 30% YoY retail sales growth target in FY10F is well within reach.
China sales
We expect the core sales drivers for China for the coming years will be the high
same-store sales (SSS) growth (approximately 10% for matured stores and average
70% SSS increase from the new stores) and the hastened store rollout. Currently,
30% of stores operated for more than three years have contributed to approximately
70% of total sales. The maturing of young stores will deliver strong SSS growth in the
coming years (as high as 50-100%). We believe our 32%, 28% and 25% YoY retail
sales growth projections for China in FY10-12F, respectively, look undemanding and
highly achievable.
Hong Kong sales
Rising tourist arrivals in Hong Kong will benefit Hengdeli’s store traffic. In particular,
China arrivals surpassed the overall growth and expanded 19% YoY in 1Q10 and
18% YoY in April. We foresee the number of tourist arrivals will increase further given
the strong travel and consumption sentiment in China. Looking ahead, we expect
Hengdeli sales in Hong Kong to rise at 26% YoY in FY10F and further expand by21-24% YoY in FY11-12F.
Wholesale business
The wholesale business outlook is anticipated to remain sound given healthy industry
development in China. Sales from this segment are expected to grow steadily by 12%
in FY10F and 8-10% in FY11-12F and to contribute 18-22% to total sales in FY10-12F.
Factoring in a strong organic sales growth assumption of 21-25% YoY in FY10-12F,
we believe the rapid network expansion will further sustain the booming top-line
growth for Hengdeli in FY10-12F. China will continue to be the core market, where we
expect to contribute 71% of total sales, while Hong Kong will account for 29% of total
sales in FY10-12F.
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Sales and earnings projections in FY06-12F
199 418 460 365 589 744 931
2,405
4,579
5,5165,899
7,397
9,084
10,952
0
2,000
4,000
6,000
8,000
10,000
12,000
2006 2007 2008 2009 2010F 2011F 2012F
RMB m
Net profit Group total sales
Source: Company, CCBIS estimates
Uptrend in margins
Gross margins for Hengdeli have trended fairly stable over the past few years since
Swiss watch suppliers unified ASPs and strictly restrict retailers to grant discounts.
Nonetheless, taking into account rising contribution from the retail business in China,
we expect gross margin to steadily expand. In addition, given that mid-end watches
yield higher gross profit margin (34-35% for Prime Time vs. 31% for Elegant), the
increased contribution from mid-end watches will also enhance overall gross profit
margin for the company.
Margin trends in FY06-12F
22.523.9 23.9 24.7 25.1 25.6
15.0 14.7
18.9 18.9 18.9 18.9
33.032.932.832.1 32.132.8
0%
5%
10%
15%
20%
25%
30%
35%
2007 2008 2009 2010F 2011F 2012F
Gross profit margin China retail gross profit margin HK retail gross profit margin
Source: Company, CCBIS estimates
Approximately 80% of the new stores are expected to be brought through M&A,
Hengdeli could thus avoid and minimize initial start-up losses, and hence we foresee
Hengdeli’s operating profit margin to stay stable in the coming years, despite its
aggressive store rollout plan. Overall, we forecast net profit growth of 61%, 26% and
25% in FY10-12F, respectively.
Widening gross margin on rising
contributions from retail business
and mid-market products
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Other earnings assumptions
Rental expenses. Hengdeli’s rent structure in China is similar to most retailers,
with a fixed base rental on top of a share of ~15% of total sales. Ninety percent
of Hengdeli’s shops are located in department stores and the rest arestandalone or boutique stores. Since most new stores will be set up in tier-two
and three cities where rents are relatively lower, we therefore model rental
expenses to be well-contained within 8.2-8.4% of the total retail sales in
FY10-12F as SSS accelerates.
Distribution expenses. Labor costs account for 5% of sales and Hengdeli has
no direct exposure to the minimum wage impact as it has always been paying
higher than minimum required salaries to workers. We have factored in a slight
uptick in distribution costs from 10% of sales in FY09 to 10.1-10.3% in
FY10-12F, due to the extended sales network and higher sales.
Tax rates. The tax rate charged on Hengdeli’s domestic market is 25% and is
expected to remain stable in FY10-12F. The tax rate charged for Hong Kong
business is 17.5%. The blended effective tax rate for Hengdeli will hence be
20.9-21.7% in FY10-12F.
Key assumptions
Year to December 2006 2007 2008 2009 2010F 2011F 2012F
Sales growth by product (YoY, %)
China retail sales – 86 36 17 32 28 25
Hong Kong retail sales – 40 (3) 20 26 24 21
Wholesale revenue – 41 13 (19) 12 10 8
After-sales services revenue – 455 58 (6) 10 10 10
Gross profit margin by product (%)
China retail – 32.1 32.8 32.1 32.8 32.9 33.0
Hong Kong retail – 14.7 18.9 18.9 18.9 18.9 18.9
Wholesale – 23.4 24.8 25.9 27.1 27.7 28.4
After-sales services – 33.8 32.4 33.8 34.0 34.0 34.2
Other assumptions
Number of stores 96 168 217 270 330 367 400
Distribution expense as % of revenue 7.3 6.8 9.5 10.0 10.0 10.2 10.2
Rental expense as % of retail revenue 9.1 6.6 8.5 8.7 8.4 8.3 8.2
Administrative expense as % of revenue 4.1 3.4 4.6 4.1 4.1 4.1 4.1
Effective tax rate (%) 27.3 19.9 21.1 24.8 20.9 21.5 21.7
Source: Company data, CCBIS estimates
Major cost components remain
stable
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Profit and loss projections (RMB m)
Year to December 2006 2007 2008 2009 2010F 2011F 2012F
Revenue 2,405 4,579 5,516 5,899 7,397 9,084 10,952
YoY (%) 90 20 7 25 23 21
COGS (1,842) (3,549) (4,197) (4,490) (5,570) (6,801) (8,150)
Gross profit 563 1,030 1,319 1,409 1,827 2,283 2,802
YoY (%) – 83 28 7 30 25 23
Gross margin (%) 23.4 22.5 23.9 23.9 24.7 25.1 25.6
Government grants 10 13 15 16 20 23 26
Investment income (distributing JV with Swatch) 10 11 16 16 22 31 45
Other income – sub-total 38 55 50 51 63 78 98
Distribution costs (176) (312) (522) (590) (743) (922) (1,121)
Administrative costs (98) (156) (253) (239) (301) (373) (452)
Total SG&A (280) (483) (774) (831) (1,044) (1,295) (1,574)
Key SG&A expense ratio (%)
Distribution costs 7.3 6.8 9.5 10.0 10.1 10.2 10.2
Administrative costs 4.1 3.4 4.6 4.1 4.1 4.1 4.1
EBIT 316 621 660 656 848 1055 1297
YoY (%) - 97 6 -1 29 24 23
EBIT margin (%) 13.1 13.6 12.0 11.1 11.5 11.6 11.8
D&A 16 30 37 35 38 42 47
EBITDA 300 591 623 622 810 1,013 1,250
YoY (%) – 97 6 (0) 30 25 23
EBITDA margin (%) 12.5 12.9 11.3 10.5 10.9 11.2 11.4
Interest income 6 21 10 5 9 12 15
Effective interest rate on deposits (%) 3.5 3.3 2.6 1.5 1.5 1.6 1.7
Interest expense (27) (60) (114) (76) (64) (66) (68)
Effective interest rate on borrowings (%) 18.8 7.3 8.4 5.8 5.8 6.0 6.2
Profit before tax 294 552 619 514 781 999 1,256
Income tax (80) (110) (131) (128) (163) (215) (273)
Effective tax rate (%) 27.3 19.9 21.1 24.8 20.9 21.5 21.7
Net profit 199 418 460 365 589 744 931
YoY (%) – 110 10 (21) 61 26 25
Net margin (%) 8.3 9.1 8.3 6.2 8.0 8.2 8.5
Source: Company, CCBIS estimates
Healthy financial position
Operating cash flow was in negative territory in FY06-08 due to a slow inventory cycle.
Nonetheless, Hengdeli has turned operating cash flow from RMB111m outflow in
FY08 to an inflow of RMB681m in FY09 on tightened inventory control and destocking.
Management has implemented a more stringent control over inventory and working
capital to assure positive operating cash flow going forward.
Improved efficiency in cash
conversion cycle
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Inventory management is the key to its retail business expansion, and initial batch of
inventory accounts for about 90% of its store opening costs. Improving sales demand
will help Hengdeli to clear inventory and keep inventory turnover days low. We
assume Hengdeli’s inventory turnover days to steadily drop from 197 days in FY09 to
174-176 days in FY10-12F.
Payables turnover also benefits from Hengdeli’s ability to sell watches more efficiently.
Payable day has risen from 35 in FY08 to 43 in FY09 as a larger operating sales has
given the company better bargaining power to request for longer credit term. We
expect payable turnover days will improve further to 46-52 in FY10-12F.
Going forward, we anticipate the cash conversion cycle to drop from 186 days in FY09
to 152-162 days in FY10-12F.
Cash conversion cycle and working capital days
174
152
177186
162 157 152
191
151
179
197
176 175 174
56
34 3543 46 49 52
40 36 33 32 32 31 30
0
44
88
132
176
220
2006 2007 2008 2009 2010F 2011F 2012F
Days
Cash conversion cycle Inventory turnover day Trade payable turnover day Trade receivables turnover day Source: Company, CCBIS estimates
Hengdeli budgets RMB130m capex in FY10F to support the addition of 50-60 stores
opening. We forecast capex to be relatively steady at RMB110-120m for FY11-12F.
Expecting Hengdeli will continue to generate positive operating cash flows going
forward, we believe the company has ability to internally fund future capex and
working capital needs. Cash on hand should remain sound at RMB1.1-1.5b in
FY10-12F.
Moreover, China Construction Bank (939 HK, Not Rated), Shenzhen branch has also
granted a RMB2b loan facility to Hengdeli for the next three years. We do not expect
Hengdeli to draw down the facility given its financial position and operating cash flow.However, if any major acquisition opportunity arises, the company will have the
financial ability to exploit.
RMB2b loan facility secured from
CCB
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Operating cash flow, free cash flow and net cash flow projections
544
289
465
758
(172)
431
155
(269)
(662)
861
(23)
83
(126)
(205)
(31)
345
648
159
(186)
(480)
309
(800)
(600)
(400)
(200)
0
200
400
600
800
1,000
2006 2007 2008 2009 2010F 2011F 2012F
RMB m
Operating cash flow Free cash flow Net cash flow
Source: Company data, CCBIS estimates
Key financial ratios
Year to December 2006 2007 2008 2009 2010F 2011F 2012F
ROAE (%) – 25.6 23.7 14.7 19.1 21.0 22.6
ROAA (%) – 13.1 10.9 7.6 10.6 11.7 12.6
ROIC (%) – 26.0 19.5 16.9 20.4 22.0 24.3
Average inventory days 191 151 179 197 176 175 174
Average receivable days 40 36 33 32 32 31 30
Average payable days 56 34 35 43 46 49 52
Cash conversion cycle (days) 174 152 177 186 162 157 152
Net gearing (%) 2 9 38 Net cash Net cash Net cash Net cash
Gross gearing (%) 28 69 70 40 33 29 25Source: Company data, CCBIS estimates
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Balance sheet projections (RMB m)
Year to December 2006 2007 2008 2009 2010F 2011F 2012F
Property, plant and equipment 251 289 529 600 693 772 836
Intangible assets 33 43 43 43 42 42 41
Investment properties 0 30 28 26 26 26 26
Investment in jointly controlled entity 5 28 31 36 35 33 32
Other investments 0 0 1 1 0 0 0
Deferred tax assets 25 24 40 39 39 39 39
Goodwill 181 213 228 243 243 243 243
Non-current assets – total 495 628 900 988 1,079 1,155 1,217
Inventories 1,262 1,667 2,447 2,404 2,952 3,569 4,202
Trade & other receivables 331 560 450 591 749 871 1,000
Cash & equivalents 375 1,071 685 1,191 1,122 1,206 1,515
Current assets – total 1,969 3,298 3,581 4,186 4,823 5,646 6,716
Bank loans & other loans 388 245 760 824 800 800 800Trade & other payables 371 476 584 807 1,103 1,390 1,731
Current tax payables 74 88 70 62 90 164 288
Current liabilities – total 833 809 1,415 1,692 1,993 2,354 2,819
Long term borrowing 22 995 716 322 300 300 300
Other NC payables 0 140 18 36 49 66 88
Minorities 136 197 236 257 268 282 300
Non-current liabilities – total 1,472 1,785 2,096 2,867 3,292 3,800 4,426
Equity 1,472 1,785 2,096 2,867 3,292 3,800 4,426
Total assets 2,464 3,926 4,481 5,174 5,902 6,801 7,933
Total liabilities and equities 2,464 3,926 4,481 5,174 5,902 6,801 7,933
Gross debt 410 1,240 1,476 1,146 1,100 1,100 1,100
Net debt (cash) 35 169 791 (45) (22) (106) (415)
Net gearing (%) 2 9 38 Net cash Net cash Net cash Net cash
Source: Company data, CCBIS estimates
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Cash flow projections (RMB m)
Year to December 2006 2007 2008 2009 2010F 2011F 2012F
EBIT 316 621 660 656 848 1,055 1,297
D&A 16 30 37 35 38 42 47
EBITDA 332 651 697 691 886 1,097 1,344
Other non-cash adjustment (7) (58) (80) (17) (11) (2) 14
Operating cash flow before changes in working capital 324 593 617 674 875 1,096 1,358
Working capital changes:
Inventories (252) (353) (740) 42 (548) (617) (633)
Trade and other receivables (87) (260) 96 (141) (157) (123) (129)
Trade and other payables 72 35 72 222 309 304 364
Total working capital changes (267) (577) (572) 124 (396) (435) (398)
Interest received 6 22 10 5 9 12 15
Interest paid (27) (68) (104) (131) (64) (66) (68)
Tax paid (68) (96) (157) (128) (135) (142) (149)Operating cash flow (31) (126) (205) 544 289 465 758
Capex for acquisition of:
Property, plant and equipment (140) (60) (274) (110) (130) (120) (110)
Intangibles 0 0 (1) (2) 0 0 0
Total capex (140) (60) (275) (112) (130) (120) (110)
Free cash flow (172) (186) (480) 431 159 345 648
Changes in pledged deposit 53 (7) (13) 56 0 0 0
Proceeds from issue of shares 455 0 (6) 526 0 0 0
Dividend paid (181) (76) (163) (153) (182) (262) (339)
Net cash flow 155 (269) (662) 861 (23) 83 309
Net change in borrowings (496) (620) (610) (1,093) (46) 0 0
Gross cash flow (341) (889) (1,272) (231) (69) 83 309
Source: Company data, CCBIS estimates
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Key investment risks
Losing distribution licences. While we do not discount the possibility of losing
distribution licences upon expiry, we rate the chance of this occurring low due to the
company’s large retail network, leading role in the industry, and long-term harmonizedrelationship with major suppliers.
Execution risks. Hengdeli has an aggressive plan to expand its retail network over
the next three years by adding more than 100 stores. If it failed to secure ideal
locations to open new stores or identify M&A targets, the expansion plan might
postpone and sales growth may also be affected.
Competition. Although the company has formed alliances with other leading watch
retailers in China, there is a risk of a breakup of the alliance. In addition, the industry’s
upbeat prospects may attract new entrants into the luxury watch market. Yet, we find
the entry barriers high because luxury watch brands are very cautious in selecting
their retail agents. Hengdeli’s participation in the wholesale business for a number of
watch brands gives the company a competitive edge over other competitors.
Vulnerable to economic downturn. Although Chinese consumers’ spending power
has become increasingly strong over the past few years, luxury watches are not basic
necessities after all and therefore sales could be affected by the volatility of the
economy. Despite this, in the medium to long term, we expect an uptrend in the luxury
watch market segment given the growth of the middle class and change of
consumption pattern.
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Appendix 1: Background
Hengdeli is a Chinese private company engaged in the wholesale and retail of
timepieces of international brands throughout the Greater China region. The company
was founded by Mr. Zhang Yuping, who has accumulated profound knowledge andextensive experience in China’s watch market, having worked with Huzhou Shi Hua
Qiao Merchandises Supplying Company for 12 years. At this state-owned enterprise
involved in the wholesale and retail of electrical appliances, he was responsible for the
sourcing, purchasing, importing and exporting of watches. Mr. Zhang’s family started
the business by investing in Beijing Hengdeli Timepieces in 1997. In 2006, the
company acquired Elegant International, a well-established luxurious watch retail
operator with four shops in Hong Kong, to expand the retail business outside of China.
Through subsequent investments in watch wholesalers and retailers in other cities
and the reorganization of the group, the company has become the leader in China’s
watch industry with a distribution of 300 wholesales customers in over 50 cities and
300 retail outlets throughout China, Hong Kong and Taiwan.
Distribution network
Hengdeli has an extensive retail network in China, comprising 300 retail shops in 20
provinces. Beijing, Zhejiang, Heilongjiang and Shanghai are the four largest markets,
accounting for approximately 60% of total retail space. The company has also formed
strategic alliances with other large watch retail chains, namely Shanghai San Lian
Group, Shanghai Oriental Commercial Building and Shenzhen World Brand Watches,
to maintain a stable market environment and avoid price war.
Distribution network
Xinjiang
GuangdongGuangxi
Sichuan
Yunnan
Guizhou
Hunan
Fujian
Zhejiang
Heilongjiang
Liaoning
Beijing
Tianjin
Shanghai
Jiangxi
Hubei
HenanShaanxi
Anhui
Shandong
Hebei
Shanxi
Jiangsu
Chongqing
<5 stores
5~10 stores
11~20 stores
>20 stores
Source: Company
Well-connected and rich
experienced luxury watch
purveyor
Owning 300 stores across
Greater China
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The company distributes about 50 renowned brands of watches in China, targeting at
the middle-to-high income groups. Selling price ranges between RMB5,000 and
RMB50,000. Currently, Hengdeli owns 20 wholesale rights, of which 18 are on an
exclusive basis. The company sells a range of international brands through its retail
network, including Omega, Rolex, Tissot, Longines, and TAG Heuer. These brandsare not only gaining high traction in China, but also attract different segments of
customers. Hengdeli also has their own brands such as OMAS, OLMA and NIVADA,
with selling price at RMB2,000-7,000 to target the younger generations. As an integral
part of the retail business, the company operates a customer service line to provide
top-notch professional after-sales services.
In-house repair centre to provide professional maintenanceservice
The company always focuses on the provision of after-sale services. Apart from the
establishment of two major service centers in Beijing and Shanghai, Hengdeli also
provides real-time maintenance services in each retail store. Hengdeli’s customer
service department was established in 2007, providing all-round services through
“repair and maintenance service centers”, “repair service stations” and “repair service
points” to all customers in China and Hong Kong. The company has also set up a
Hengdeli Customer Services Hotline dedicated as the unified access by external
parties for the services of the company.
Diversified brand portfolio to
capture different customers
All-round services available
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Appendix 2: SWOT and Porter analysis
SWOT analysis
Strengths
Extensive experience and knowledge of importation and retailing of luxury
watches in China.
Strong brand name recognition and leading market position in China and Hong
Kong.
Good and long relationships with major watch brands.
Established shop network in China; secured prime locations for store
distributions.
Weaknesses
Vulnerable to economic downturn.
Revenue mainly driven from China market.
Opportunities
Rising demand for luxury watches, especially in the second-tier cities, as
urbanization has increased and the middle income group expanded over time.
Local retailers with poor operations offer acquisition or cooperation
opportunities.
Aggressive expansion to capture further market share.
Threats
Keener competition than in the past as the strong watch market prospects may
attract new entrants.
Foreign brand distributors opening their own shops to capture more business
opportunities.
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Porter’s five forces
Suppliers’ bargaining power: High
Supplier concentration is relatively high as the core watch suppliers are fromSwitzerland. ASPs are determined by the Swiss watch suppliers, and distributors are
not allowed to grant discounts to customers. Hengdeli is hence a price taker and
sources watches locally from Swiss watch suppliers. Yet, this policy has set as a
regulation for all exported Swiss watches, no differentiation between other
distributors.
Threat of substitute: Low to moderate
Watch can be viewed as a necessity in daily life for timekeeping purpose, and has
also gradually turned into a popular accessory. The watch market is enormous and
fragmented in China, however, there are only few sizable and reputable luxury watch
retailers and Hengdeli is the leader among them. Hengdeli also owns the largest
luxury watch retail network in China as well as a remarkable clientele over years.
Moreover, buyer inclination to substitute foreign brand watches with local brand
watches is minimal, given the heightening brand consciousness.
Rivalry among existing companies: Low to moderate
Many retailers hope for a share in the fast growing luxury watch industry in China, yet
it is quite difficult for one to establish a sizable scale compared to Hengdeli. It is hard
for peers to build a strategic alliance with top Swiss watch suppliers as they are very
cautious in screening distributors. Hengdeli is one of the few that has been able to
maintain a solid bond with these top Swiss watch makers which has priority in watch
supply and delivery. Moreover, many customers prefer to shop at Hengdeli’s stores
which offer a diversified brand portfolio of mid-to-high end watches covering all majorconsumer segments while others have limited product mix. Customers are also
confident that Hengdeli products are authentic with high quality.
Threat of new entrants: Low
It is very difficult for new players to secure distribution rights or access to Swiss watch
suppliers due to a lack of connection. Since Swiss watch suppliers are extremely strict
in terms of sourcing, they may only supply limited products to local watch retailers.
Moreover, brand identity is exceptionally important for luxury watch retailers, since
their brand reputation signifies the assurance of quality and authenticity. The creation
of brand identity requires a long period of operation in the market where new players
may struggle with.
Buyers’ bargaining power: Low
Since all Swiss watches have a unify ASP, there is little room for buyers to bargain for
discounts across the board. Buyers of luxurious items are relatively less price
sensitive since they have high spending power, and a minor price increment will not
affect their purchasing sentiment.
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Appendix 3: Management biography
Executive Directors
Mr. Zhang Yuping (Alia, Cheung Yu Ping) – Chairman and ExecutiveDirector
Founded the company in 1999, he is in charge of the overall management and
strategic development. He has more than 20 years of experience in the high-end
consumables distribution industry for the China market.
Mr. Song Jianwen – Executive Director
He is in charge of finance and investment of the company. Mr. Song graduated from
Zhongnan Finance Economics University with a master degree in economics. He
joined the company in 2001 and has over 10 years of experience in finance and
accounting.
Mr. Huang Yonghua – Executive Director
He is in charge of the company’s business coordination and operational supervision.
Joined the company in 2001, Mr. Huang has more than 10 years of experience in the
watch distribution industry and management for China’s market.
Senior Management
Mr. Zhuang Liming – Vice Chairman of Shanghai Xinyu
After graduating at Beijing Foreign Trade College, he had worked for China’s Light
Industry Commodities Import and Export Company before joining the company in2000.
Ms. Wang Lingfei – Deputy President
Ms. Wang is responsible for work in brands. Before joining the company in 2005, she
was the deputy general manager of Beijing Yishang Group.
Mr. Lee Wing On, Samuel – Deputy President
Mr. Lee is responsible for retailing in Hong Kong. He joined the company in 2006 and
has over 20 years of experience in the Hong Kong watch retail industry and
management for the Hong Kong market.
Mr. Stan Lee – Deputy President
Mr. Lee is responsible for retailing in the mainland. Joining the company in 2007, he
has over 20 years of experience in watch manufacturing and distribution.
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Rating definitions
Outperform (O) – expected return 10% over the next twelve months
Neutral (N) – expected return between –10% to 10% over the next twelve months
Underperform (U) – expected return < -10% over the next twelve months
Analyst Certification:
Claudia Ching, Forrest Chan, Warren Wang and Timothy Sun the authors of this report, hereby declare that: (i) all of the views expressed in this report accurately reflect
their personal views about any and all of the subject securities or issuers; and (ii) no part of any of their compensation was, is, or will be directly or indirectly related to the
specific recommendations or views expressed in this report; and (iii) they receive no insider information/non-public price-sensitive information in relation to the subject
securities or issuers which may influence the recommendations made by them. Claudia Ching, Forrest Chan, Warren Wang and Timothy Sun further confirm that (i) neither
they nor their respective associate(s) (as defined in the Code of Conduct issued by the Hong Kong Securities and Futures Commission) has dealt in or traded in the
stock(s) covered in this research report within 30 calendar days prior to the date of issue of the report; (ii) neither they nor their respective associate(s) serves as an officer
of any of the Hong Kong listed companies covered in this report; and (iii) neither they nor their respective associate(s) has any financial interests in the stock(s) covered in
this report.
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