Luk Fook (590, $10.36) 6M Target $13.0 BUY

Eric Yuen – ericyuen@guoco.com (852) 2218 2865

Event: Stronger than expected earnings for FY10 may trigger a re-rating of Luk Fook.

• Luk Fook, a leading retailer of jewellery and gold products in Hong Kong, reported FY10 earnings of $531mn, up 93% yoy. EPS was $1.079. The bottom line was substantially above our forecast due to higher than expected revenue and effective cost control.
• Final dividend was $0.28 per share. Full year DPS grew 153% yoy to $0.43 implying a payout ratio of 40% versus 30% in the previous year. Net debt amounted to $27mn as at 31 March 2010 giving a low net debt-to-equity ratio.
• FY10 revenue increased by 36% yoy to $5.39bn of which $3.30bn from retailing business in Hong Kong (+25% yoy), $505mn from retailing business in Macau (+88% yoy), $289mn from retailing business in the PRC (+63% yoy), $452mn from wholesaling business in the PRC (+74% yoy), $671mn from sales of scrap gold and gold bullion (+38% yoy) and $174mn as licensing income derived from the PRC (+26% yoy).
• Operating efficiency improved in FY10 due to economies of scale. Selling and distribution costs as a percentage of revenue declined from 13.1% in FY09 to 11.3% in FY10. Administrative expenses as a percentage of revenue fell from 1.7% in FY09 to 1.3% in FY10.
• The company rapidly expanded its retailing network in the PRC during the reported period. The number of self-operated shops increased from 19 to 36 whilst the number of licensee shops enlarged from 400 to 483. As at 31 March 2010, the company operated 31 retail shops in Hong Kong and 4 retail shops in Macau.
• Over 50% of the company's retailing revenue in Hong Kong were contributed by the PRC tourists. According to the government statistics, Hong Kong’s retail sales value of jewellery, watches and valuable gifts grew 16% yoy during the twelve months period from April 2009 to March 2010. The growth rate in April and May 2010 accelerated to 36% and 48% yoy on the back of strong increase in the number of Mainland tourists by 18% and 47% yoy.
• Given stronger than expected earnings for FY10, we have lifted our earnings forecast for FY11 by 30% to $611mn (EPS $1.24) implying EPS growth of 15%.
• Traded at FY11 PER of 8.4x, Luk Fook remains undervalued. We maintain our BUY rating on Luk Fook and raise 6-month target price from $11.50 to $13.0 based on 10.5x FY11 earnings.