Chow Tai Fook Jewellery Group Limited (1929) Earnings Call Transcript & Summary

Good evening, ladies and gentlemen. Welcome to the live audio webcast of analysts and investor session on Chow Tai Fook Jewelry Group's interim results for the financial year 2023. Let me introduce the management team on the call today. They are Mr. Conroy Cheng, Vice Chairman; Ms. Sonia Cheng, Vice Chairman; Mr. Kent Wong, Managing Director; Mr. Chan Sai-Cheong, Managing Director; Mr. Hamilton Cheng, Executive Director; Mr. Peter Suen, Executive Director; Mr. Bobby Liu, Executive Director; and Ms. Danita On of Investor Relations and Corporate Communications. Firstly, Mr. Conroy Cheng will present the interim results highlights. Then Mr. Hamilton Cheng will talk about financial review. Mr. Chan Sai-Cheong and Mr. Kent Wong will give business updates on Mainland China and Hong Kong, Macau and other markets, respectively. Finally, Ms. Sonia Cheng will conclude the presentation with business outlook and strategies. After that, we will have a Q&A session. This audio webcast will be conducted in English in general. Mr. Chan Sai-Cheong shall present in Mandarin with simultaneous English interpretation. Participants can select floor audio channel or English or Mandarin interpretation in the language bar at the top right corner. Now may I invite Mr. Conroy Cheng to present. Conroy, please.

Good evening, ladies and gentlemen. I am pleased to announce our interim results for our fiscal year 2023. Despite the ongoing impact of the pandemic and challenging market conditions, the group's revenue rose 5.3% to HKD 47 billion in the period, supported by favorable store opening momentum in Mainland China and strength in our differentiated gold products. Revenue of our Mainland business increased 6%, while that of Hong Kong, Macau and other markets was flat year-over-year. Core operating profit declined 2.7% year-on-year to HKD 4.3 billion, mainly due to the increased sales mix for gold products. Profit attributable to shareholders decreased 6.8% to $3.3 billion as a net foreign exchange loss of $269 million was incurred as renminbi weakened during the period versus a net ForEx gain for the same period last year. Basic earnings per share amounted to HKD 0.33. The Board has declared an interim dividend of $0.22 per share. Payout ratio approximated 66% in first half. We expect second half cash flows to improve, and the full year payout shall maintain at 70% to 80%. We have succeeded in gaining market share in Mainland China over the last 3 years, driven by our expansion strategy in lower-tier cities and the success of our gold products. We believe that our current market share is about 10% to 11%, lifted from 7% to 8% 3 years ago. We opened a net of 933 Chow Tai Fook Jewelry stores in the Mainland in the first half, bringing the total number of Chow Tai Fook Jewelry stores to 6,547 at the end of September. Our new Wonderful Life Collection, which combines traditional gold craftsmanship with T MARK diamonds, has received an overwhelming response from customers since launch in July '22, and shall support new sales growth for our gem-set product category. The group has always operated with integrity and an unwavering commitment to maximizing shareholder value. The group joined the ranks of other blue-chip companies as a constituent stock of the Hang Seng Index in September. We are also delighted that the group will be included in the MSCI China Index by the end of November. These milestones will support diversification and institutionalization of our shareholder base and improve trading liquidity. During the period, we established a Strategy and Transformation Committee to determine the group's strategic direction. Five key priorities have been formulated to strengthen our competitiveness, enhance the quality of our earnings and driving sustainable long-term stakeholder value creation, supporting our margin and growth ambitions over the medium term. Now may I turn to Hamilton to go through our financial performance.

Thank you, Conroy. Good evening, everyone. I'll first walk you through some major P&L items and key financial ratios. Despite tough macros, the group's revenue increased 5% to $47 billion in the period, mainly attributable to wholesale and new openings and strength in our gold products. As revenue growth was driven by those lower margin segments, adjusted GP margin contracted by 110 bps to 22.4%. SG&A expenses were under good control, and its ratio improved 20 bps to 13.8%, even though same-store sales declined. It is also worth noting that there was a one-off bad debt written back of $190 million last year. When such is stripped off, the ratio last year should be 14.4%, which imply an operating leverage benefit of 60 bps for this period. Core operating profit dropped 2.7%, mainly due to a lower GP margin amid increased gold mix. At constant currency basis, COP would be flat year-on-year. With so many challenges and macro headwinds in the period, we believe this is a resilient set of results under such a weak market. Revenue breakdown with new openings and stable replenishment by franchise stores opened over the past 2 or 3 years, wholesale revenue in the Mainland expanded by 20% year-on-year, and its share to the Mainland's revenue reached 55%, up by around 6 percentage points from a year ago. By product, thanks to the continued success of CTF • HUÁ Collection and our well-executed market penetration strategy in lower-tier cities, revenue of gold products increased promisingly by more than 12% on top of the high base last year. As a result, gold products contribution to the group's revenue further expanded by nearly 5 percentage points to more than 75%. Gem-set jewelry and watches experienced a decline in revenue during the period as such consumption was more related to economic fundamentals such as GDP per capital and disposable income as well as consumer sentiment. Looking into the past same-store sales growth trend of the 2 major markets. In Mainland China, we saw negative same-store sales growth of 7.8% in the first half, largely due to the pandemic. Same-store sales performance was better in the second quarter as July witnessed a short recovery, yet it worsened again in late August and September until now. So quarter-to-date same-store sales declined by 21%. During the period, we had an average of 7% or 8% stores under temporary closure. And when excluding these stores, the less affected stores would have a slightly negative to slightly positive same-store sales growth during the period. In Hong Kong and Macau, the fifth wave of COVID started in February. This led to a depressed same-store sales growth in the fourth quarter of last year. And the same-store sales growth was still negative in the first quarter this year and turned positive in the second quarter, leading to a slight growth in the period. However, when we look at Hong Kong and Macau separately, Hong Kong experienced solid same-store sales growth of 15%, supported by a stable local demand, while Hong Kong dipped by more than 30%, mainly attributable to the tightened pandemic measures which reduced touristic traffic. And for the quarter-to-date, same-store sales of Hong Kong, Macau further bounced back by 19%, and we are happy to see business in Macau has also recovered to mid-teens growth. This slide shows the adjusted GP margin movements. As explained, we saw a higher sales contribution from our wholesale business, resulting in a 60 bps impact on GP margin. The change in product mix further lower the GP margin by 80 bps. These were partially offset by retail like-for-like margin improvement of 30 bps during the period. This chart is not just an analysis of the past, but it also demonstrates our GP margin improvement opportunities going forward. In the coming 1 to 2 years, we aim at achieving like-for-like margin improvement supported by our initiatives on launching premium products and our efforts on discount control. In medium term, we will seek for mix improvement towards higher-margin gem-set jewelry. We also assume no further dilution of GP margin caused by our wholesale business as we aim to have a quality opening strategy going forward, and we intend to resume the development of self-operated stores. We expect the room for GP margin improvement will be around 2 to 3 percentage points, such that a GP margin of about 25% will be our medium-term target. SG&A analysis. We implemented stringent cost control measures in this challenging period. So the increase in SG&A expenses was very mild, and its ratio dropped versus 1 year ago. On staff costs, the expenses in the Mainland decreased slightly due to lower retail sales. Yet we are strengthening our corporate functions and management capabilities with some professionals and subject matter experts joining the team. Overall, staff costs remained at a similar level as last year. For leases, concessionaire fees decreased because of lower retail sales in Mainland, while rentals stayed largely flat in both Hong Kong, Macau and the Mainland. The increase in depreciation was a natural result of CapEx invested in store openings and production capacity expansion in the past 2 or 3 years. A&P expenses rose by over 30% year-on-year as we resume some more campaigns versus last 2 years. Yet the expense ratio remained relatively low at 0.8%, which used to be around 1% to 1.2% of the group's revenue. For other SG&A, when excluding the bad debts written back last year, the amount would be almost the same. And the operating leverage effect would have been an improvement of about 60 bps despite the negative same-store sales in Mainland during the period. This would be good enough to offset the dilutive effect of our wholesale business on GP margin as demonstrated in the previous slide. Profitability analysis. In Mainland, core operating profit decreased slightly during the period. The reduction in operating margin was mainly due to a lower GP margin resulted from an unfavorable product mix. In medium term, if we could manage to enhance the product mix by restoring the gold mix to 65% to 70%, GP margin will expand to about 24% to 25%, and operating margin would improve to around 12% to 13%. In Hong Kong, Macau and other markets, the decrease in core operating profit and GP margin was also largely due to product mix. With the reopening of border crossing and normalization of business in medium term, we are expecting a GP margin of around 25% to 26%, and OP margin can come back to a mid-high single-digit level. Here are the major items below the COP level. Macro economy, capital markets, currencies and commodities were highly volatile during the period. We have been closely monitoring the related indicators, especially price of diamonds and gold, RMB and also interest rate, and managing our financial position carefully. During the period, RMB depreciated over 10% versus Hong Kong dollar, and led to a ForEx loss of $269 million versus a gain of $47 million for the same period last year. At the same time, gold price dropped around 14%, and our gold loans incurred a mark-to-market gain of over $500 million. The gain was not as significant relative to the decrease in gold price as the decrease of gold price in renminbi terms was much milder, resulting in lesser impact on our Mainland operations. As for finance costs, when we take into consideration of interest income together, we managed to have a net cost similar to last year's level despite an interest rate hike during the period. Inventory and CapEx. Inventory balance increased by around 8% versus March level. When compared to the same period last year, turnover period lengthened by 0.5 month, as we have been building inventory reserves for diamonds amid a volatile commodity market. For full year, we will target to restore turnover to last year's level, that is around 270 to 280 days. CapEx. Other than recurring items and those for POS openings, additional CapEx were mainly for expansion of production capacities and purchase of our staff dormitory. We are carefully revisiting our budget based on the current market environment, and the full year CapEx is estimated to lower to around $2 billion to $2.5 billion. A summary of cash flows. Operating cash flows net with leases paid was nearly $5 billion, similar to last year's level. Our negative free cash flow was not uncommon in the first half as we are normally stocking up for our seasonal cycle. With a prudent inventory management in the second half, we believe full year free cash flow will be around $5 billion to $6 billion. And lastly, capital structure highlights. Net debt increased by more than $6 billion, which was mainly used for inventory and payment of final dividend last year. Our source of funds were mainly from operating cash flows and bank borrowings. Net gearing ratio was at 50% as of September, but it was a mere single digit if gold loans were excluded. With the improvement in cash flows in the second half, we believe that gearing ratio will be back to 30% or lower. So this concludes my part. And I will turn it over to Cheong and Kent for the business update. Thank you.

[Interpreted] Thank you, Hamilton. In the first half of 2023, with the strong support of franchisees, we opened 933 Chow Tai Fook Jewelry stores in Mainland China. Despite a challenging operating environment in the first half, we're pleased to see improved productivity and sales. About 90% of our retail outlets are franchise stores. As of September, the number of our Mainland stores is estimated to be about 75%. In the first half, new store openings and steady improvement in store productivity drove our retail value of franchise stores up by about 29%. In the first half of '23, we exceeded our original store opening target. In the second half of the year, we will expand our retail network more prudently and strategically to expand our market share. We also have a number of stores in the pipeline, and we expect to open 1,200 to 1,300 Chow Tai Fook Jewelry stores throughout the year. In addition, we will continue our efforts to create a massive shopping experience, tailor-made for our customers' needs and preferences. We've launched a new premium store to attract young consumers by offering selected products tailor-made for their taste. During the period, we actively strengthened omnichannel marketing and online interactions. In the midst of the pandemic, we've used social media and social platforms such as Little Red Book and Douyin to stay connected and engage our customers to drive greater flow and traffic to our online channels. During the period, e-commerce channels achieved encouraging retail value, growth of about 15%, with estimated Mainland retail sales remaining at 5% and 13% by volume. The average selling price on e-commerce channel is about HKD 1,800. We also launched our own online product, which gained popularity on social media. We also have live streaming and short videos on TikTok to exert influence and promote our new products. Our heritage series contains the essence and cultural connotation and traditional Chinese craftsmanship. It's been well received by the youngsters in Mainland China. And affirmation affection of young consumers is very important. In the first half, we estimated that the retail value of gold products is about 41%. We vigorously promote inlaid jewelry suitable for everyday wear and important occasions to complement our other gold products. We also launched the new Beautiful Life (sic) [ Wonderful Life ] series, which perfectly combines our traditional gold craftsmanship with our exclusive T MARK. The 4 great moments of life described by Song poet, Wang Zhu, were the design concepts and inspirations. It is very romantic. The series has been very well received since its launch in July and will give impetus to the sales of our other new products. And HEARTS ON FIRE also achieved impressive results with retail sales growing by 63% year-on-year. Ever-green's Aerial and Illa series have achieved great success with the new products, and a continuous regional activities and promotion and publicity projects have increased customers' interest in our products. These results are well reflected in our strong dynamic retail turnover growth. Now I will pass the time to Kent to talk about development in Hong Kong, Macau and other markets.

Okay. Thank you, Cheong. For our Hong Kong and Macau and other markets. Our business in Hong Kong improved with an RSV growth of 12% in the period. However, operation in Macau and duty-free point of sale in Hainan were hit by the pandemic. As a result, share of RSV from Hong Kong contributed to around 75% versus 67% a year ago. We closed a net of 4 point of sale in Hong Kong during the period, mainly in tourist areas such as Mong Kok and Tsim Sha Tsui to enhance operational efficiency. We continue to optimize our network plan, guided by data analytics such as store performance, leasing terms and pace of visitors growth in the next 12 to 18 months. In other markets, we add 2 stores in Macau and Malaysia during the period. We will expand our business selectively and as appropriate, focusing on markets with strongest local retail growth potential. I will conclude here and turn over to Sonia to walk through our business outlook and strategies.

Thank you, Kent. To conclude, the group is cautiously optimistic about the opportunities ahead, and we will stay vigilant while executing our growth strategies. We remain positive on the mid- to long-term growth prospects of the Mainland's economy and jewelry market. While we maintain prudent cost control strategies to mitigate short-term challenges, the group's midterm growth is expected to be driven by a gradual improvement of the economy and consumption. Leveraging on the strong support from our franchise partners, store opening momentum in the Mainland remains favorable. We will continue to adopt a disciplined approach in expanding our retail network strategically, taking into consideration market share growth and the health of store economics and productivity, while penetrating into the areas where we identify growth. At group level, we will focus on elevating our brand positioning, which better differentiates us to customers with varying consumption appetites. In the Mainland, we are well positioned to target the underserved demand for bridal jewelry in the lower tier cities and offerings to appeal to the millennials. In Hong Kong and Macau, we expect pent-up demand for bridal jewelry and a gradual easing of the social distancing measures to drive growth in the second half. Encouraged by the marketing campaigns and member-exclusive events launched, we continue to pursue these efforts to build momentum to boost sales and deepen connections with customers. Besides, we shall double our efforts to target the premium segment. A more significant recovery of our Hong Kong and Macau business will be dependent on further relaxations on the quarantine requirement and border reopening. In the near term, we will closely monitor our store profitability and exercise disciplined cost management. We also remain attentive to expansion opportunities in Southeast Asia, such as Singapore, Malaysia and the Philippines and stay well positioned to capitalize on them as they emerge. The group will stay nimble to mitigate market uncertainties, strengthening our competitiveness while pursuing quality growth. To this end, we are focusing on 5 strategic priorities: number one, elevating our brand positioning to attract new and younger customers; number two, optimizing our product portfolio while reducing inventory levels and turnover days; number three, enhancing operational efficiency to optimize competitiveness and effectiveness; and number four, nurturing a people-first workplace culture and strengthening talent development; and finally, building a data-driven culture and accelerating the use of technology and data analysis to support the business. Striking a balance between caution and confidence, we are well placed to overcome the challenges ahead with our strategic road map for growth and sustainable development. This concludes our presentation today. Thank you. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]