Summary: the King's watch and jewellery results in 2017 further reflect the recovery of Hong Kong's high-end luxury retail market. King's watch and jewellery [887.HK, unrated]
The company's performance from January to February 2018 was even more encouraging, with same-store sales growing by nearly 35% during the period. We believe that the company's operating leverage will be more obvious in 2018. The company has not received market attention for a long time, but we believe this performance may once again attract investors' attention to the company. In view of the sound performance and positive prospects of a number of retail stocks, we reiterate our positive view on other Hong Kong retail stocks.
Company background: founded in the 1940s, King Watch and Jewelry is a luxury watch and jewelry retailer in Hong Kong, accounting for about 80% of revenue. It is one of Hong Kong's leading distributors of high-end watch brands, including Rolex, Cartier and Patek Philippe. Yang Xiucheng's family trust is the largest shareholder, with a 52.76% stake.
It has a certain share in the high-end luxury retail industry in Hong Kong. As of December 31, 2017, the company had 24 stores in Hong Kong and 46 on Chinese mainland. The company has significant retail outlets in prime locations in Hong Kong such as Russell Street in Causeway Bay and Canton Road in Tsim Sha Tsui. Stores located in these places are usually the best-performing stores and help to increase the bargaining power of companies with suppliers such as Rolex. Some of these shops in prime locations are leased from its sister company, 163.HK, which is also owned by Mr. Yang Xiucheng. The company explained that this arrangement provided stability in terms of lease arrangements, but details had to be announced to make the arrangements clearer.
Strong results in the second half of 2017. The company's net profit after tax in 2017 was HK $159.7 million. Compared with the company's loss of HK $64.8 million in 2016, the performance has improved significantly. The company has recorded a pre-tax loss since the first half of 2015 as the Hong Kong retail market began to deteriorate in 2014. As consumer sentiment improved at the end of 2016, the company began to report profits in the second half of 2016, and operating leverage became stronger in the second half of 2017.
The recovery in 2017 can be attributed to: (1) increased income. This is because consumers are willing to buy more expensive models, resulting in an increase in the average selling price and sales volume of watches during the period; (2) the gross margin has improved because customers are less sensitive to price, so a smaller discount can be given; and (3) operating leverage has been improved as a result of reduced rental costs.
With same-store sales growing by more than 30% year-on-year so far this year, the outlook for 2018 looks positive. Management attributed the strong performance in 2017 to an improvement in the retail market and the wealth effect in Hong Kong, which is expected to continue into 2018. In particular, same-store sales grew by about 35 per cent from January to February 2018, reflecting strong consumer demand for high-end watches and jewelry, which is encouraging. Due to the company's increased pricing power, its gross margin is expected to remain at a similar level (26.7% in 2017).
Although sales growth in Hong Kong is solid, management expects rents in Hong Kong to remain flat, especially in street shops. The company points out that there are still vacant shops in some prime locations, so owners tend to be conservative.
As for business outside Hong Kong, in addition to opening more stores in Chinese mainland, which had nine in the first half of 2018, the company will also expand in south-east Asia. As reflected by the company's performance in Singapore (revenue is up 43 per cent year-on-year), business in the region is on the rise. The company will open a store in Kuala Lumpur in 2018 and is looking for opportunities to open more stores in other ASEAN countries.
HK $1.6 billion in net cash can be used for expansion. At the end of 2017, the company had HK $1.6 billion in cash on hand and no debt. Under the expansion plan, the company plans to spend HK $400 million to HK $500 million to open new stores (including refurbishment and procurement of goods) and increase inventory to meet customer demand.
Valuation: the shares are now trading at 19.4 times 2017 earnings after rising more than 18% on March 15. The company plans to pay a final dividend of HK0.58 cents, bringing the total dividend per share in fiscal year 2017 to HK0.75 cents, equivalent to a dividend yield of 1.67%. Assuming a growth rate of 30% per share in 2018, the shares would have a price-to-earnings ratio of 14.9 times 2018. The valuation of the company should be similar to that of other Hong Kong jewellers, but we believe that its profit growth is expected to be higher than that of its large counterparts, given its better operating leverage.