Chow Tai Fook Jewellery

Rate-cut driven gold rally unlikely to mitigate short term weakness

We expect gold price would continue to perform well as the Fed turns more dovish. However, the impact to gold jewellery retailers in China like CTFJ could be mixed. On one hand, we expect CTFJ would record stronger GPM for its gold products. Yet, on the other hand, we expect the sales volume of its gold products could also face headwinds, on top of already weak consumer sentiment. Net-net, we expect CTFJ would still face slower sales momentum in the near term, which could create further operating deleverage. However, we believe CTFJ's current dividend yield may offer some cushion, and we are still positive on CTFJ's distinguished brand image that allows it to outperform when the market is ready to recover. Maintain HOLD.

Key Factors for Rating

We expect a positive gold price momentum in 2024-2025. The Sept 2024 FOMC meeting triggered gold price to soar and hit historical high level. Given a more dovish stance by the Fed, which is also shared by other global central banks, we expect gold price would continue to perform well in 2H24 and 2025 (for CTF it would be 1HFY25 to 1HFY26).

Expect more positive GPM to compensate retail weakness. Gold products accounted for 82% of total sales in FY23, and such ratio may remain high in the near future. Higher gold price could allow CTFJ to enjoy higher GPM as the historical cost of inventory is relatively lower when gold price is under a rising trend. Hence, after the Sept FOMC meeting, we turn more positive on CTFJ's GPM, even when hedging is considered. Also, we believe the hedging loss resulting from higher gold price could eventually be offset in the next fiscal year's GPM, hence this is unlikely an issue to be worried about.

Higher gold price likely to weigh on sales volume. The impact of higher gold price on consumer behaviour could be ambiguous, as some could be tempted to buy more as sort of investment, while some others could buy less volume given limited budget. Given weak consumer sentiment in 2024, we believe the latter would be likely. Hence, we expect CTFJ may continue to see weak sales volume and same-store sales growth (SSSG) in the near term. We expect 1HFY25 SSSG in mainland China would record mid-20s YoY decline, as 2QFY25 may share similar pattern as 1QFY25.

CTFJ may still standout in industry consolidation, in the long run. Gold consumption in China hit multi-year low during Apr-June 2024, which we view as unusual. We expect industry consolidation will accelerate in 2024-2025, while CTFJ itself may also close more stores during this time. However, we are positive on CTFJ's recent effort to introduce new store image and products, which we expect it could lure more consumers and gain market share.

Key Risks for Rating

Downside risks: (1) unsuccessful multi-brand strategy; (2) deteriorated retail sell-through for core brand; (3) unexpected spike in spending, and (4) higher costs related to transactions.

Upside risks: (1) stronger-than-expected demand on gold jewellery; (2) strong gold price that allows higher-than-expected GPM; (3) strong cost control, and (4) unexpected gains related to hedging.

Valuation

We cut our FY25 EPS forecast by 12% to reflect weaker gold consumption during July - Sept 2024 and further operating deleverage. We also cut our FY26-27 EPS by 4% to reflect an even cautious outlook on consumer behaviour.

We lower our TP to HK$6.70, with a lower target multiple of 10x 2025 P/E (previous: 11x). We believe the de-rating may persist for a while, given much weaker-than-expected discretionary consumption in China and gold consumption hitting multi-year low. However, even under our cautious estimates, CTFJ may still offer 9% dividend yield in FY25, which may limit its downside risk after the Sept 2024 Fed rate cut, hence maintain HOLD.