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

Good evening, ladies and gentlemen. I'm Heidi, MC of today's event. Welcome to the investor and analyst presentation of Chow Tai Fook Jewellery Group Limited to discuss our interim results for the financial year 2025. Let me introduce the management team who will conduct the presentation and participate in the Q&A session today. Firstly, Mr. Kent Wong, Managing Director; Mr. Hamilton Cheng, Executive Director and Chief Financial Officer; and Ms. Danita On of Investor Relations and Corporate Communications. Firstly, Mr. Kent Wong will present the interim results highlights and group strategies as well as to give business update. Then Mr. Hamilton Cheng will then talk about financial review and conclude the presentation with market outlook. After that, we will have a Q&A session. This hybrid event will be conducted primarily in English. We will provide simultaneous interpretation services for any content or questions answered in Mandarin. For on-site participants here at Hong Kong CEC requiring translation assistance, please raise your hand and a headset will be provided to you. For online participants, you have 2 options available. You can select English or Mandarin interpretation in language bar locator at the top right corner of the webcast platform. Now I would like to hand the time over to your first presenter, Mr. Kent Wong.

Okay. Thank you. Good afternoon, ladies and gentlemen. Thank you for joining us in our interim results for financial year FY '25. The business environment continued to be affected by macro uncertainties and externalities in the first half. Record gold price, in particular, have continued to impact our consumer sentiment, resulting in a slowdown of demand for gold jewelry. During the period, the group's revenue decreased by 20.4% to HKD 39.4 billion. In order to help the market, better understanding the underlying operational performance of our business and separate the impacts of hedging, we have reclassified the gold loan fair value change, including all settled and unsettled contracts from cost of goods sold to other gains or losses from this financial year. Hamilton will further elaborate on this later session. Operating profit remained resilient at $6.8 billion, up by 4% year-on-year. Profit attributable to shareholders decreased by 44.4% to $2.5 billion. The decrease was mainly due to a HKD 3.1 billion loss arising from the revaluation of gold loan contracts and considerable volatility in gold price under this period. On profitability, the group's GP margins expanded significantly to 31.4% during this period and operating profit margin improved. The resilient performance in the first half validate our diligent execution of the 5 strategic priorities, which have sustained the growth momentum towards quality earnings. The Board has declared an interim dividend of $0.20 per share, representing a payout ratio of nearly 80%. The Board also announced a proposed share buyback with a total amount not exceeding HKD 2 billion from internal resources. This takes into careful account the capital requirement of the business to invest in growth and our commitment to enhance total shareholder returns. This also reflects our confidence in the long-term business prospects. Let me now share our key highlights during the first half of FY '25. Our brand transformation continued to gain positive momentum in this period. We proactively optimized our product portfolio and pricing strategy to suit consumer demand with product offering with different value propositions. The group GP margin was enhanced by 650 bps in the first half year, thanks to gold price increase and a higher contribution of our higher-margin fixed price gold products. We remained disciplined in our cost and CapEx spending. SG&A expense decreased nearly 3% year-on-year. As a result, operating margin grew by 400 bps year-on-year against a challenging macro backdrop. As part of our enduring commitment to preserve Chinese culture and heritage, we announced a strategic partnership with the Hong Kong Palace Museum to launch the 5 years "Chinese Gold Craftmanship Heritage Education Program in Hong Kong". In September, we celebrated the grand opening of our first concept store in Central Hong Kong, marking a significant milestone in our brand transformation journey, showcasing jewelry collection in a gallery-like aesthetic. The concept store embodies refreshed operating standard and an enhanced store ambience that resonates with the essence of our fresh brand. We are delighted to receive positive feedback so far, and we look to efficiently allocate resource for a progressive rollout of refreshed store over the next 5 years. This will be calibrated and aligned in accordance to market condition. We continue to optimize our product portfolio with exquisite design and craftmanship. The new collection was launched in the first half, generated strong sales momentum and traction with the consumers, resulting in the lift of higher-margin fixed price contribution to gold product revenue to 14.2% in Mainland China, doubling its contribution versus a year ago. That validates our pivot in product and pricing strategy in response to market dynamic. In celebration of Chow Tai Fook Jewellery’s 95th anniversary, we unveiled Signature CTF Rogue Collection. This new collection has generated remarkable sales of over $1.5 billion since its debut in April beyond our expectation. In collaboration with the Palace Museum in Beijing, we released the Chow Tai Folk Palace Museum Collection in August. This new collection differentiated with its unique representation of Chinese heritage and craftmanship, featuring jewelry pieces designed for daily use. Building on our expertise in diamond jewelry, we also launched a new line of wedding jewelry, the Chow Tai Fook Bond collection in September. This collection featured a diverse range of jewelry pieces with the highlight being the elegant 2-pronged Bond Ring. Let me use this opportunity to show you videos about our latest Rouge and Palace Museum Collections. [Presentation]

Thank you. We expect to enrich SKU offering in our key collections such as HUA, Palace Museum and CTF Group collection and launch new differentiated collections, spanning fixed-price gold to gem-set. Our strengths in product innovation will sustain our leadership in this industry. Over the years, we have applied and enhanced dedicated techniques and exquisite craftmanship in our jewelry making. This new partnership with Hong Kong Palace Museum aim to preserve the rich traditions, artistic features and cultural significance of Chinese gold craftmanship while educating the young generation about its importance, fostering their understanding and appreciation of Chinese gold artistry. This serves as a testament of our strong commitment to preserving Chinese cultural heritage. Now we'd like to share with our business update. As of September, we have almost 7,000 Chow Tai Fook Jewellery stores in the Mainland, of which 77% were franchised. With an emphasis on improving earning quality, our current priorities are to maximize the overall financial health of our retail network and sustain our market leadership. Due to the softer demand and the gold price volatility, self-operated stores and franchise stores recorded an RSV decrease by 26% and 18%, respectively, in the first half. Year-on-year sales performance was generally similar across different tier of cities. In the Mainland, we net closed 239 Chow Tai Fook Jewellery stores during the first half. Based on the recent trend and market conditions, we expect net store closure to be lower in the second half than this period. We shall remain agile in response to market dynamics and optimize our store network by streamlining underperforming stores while focusing on maximizing store productivity. At the same time, we continue to open new stores on a selective base with 166 new point of sale being added to our retail network in the first half. We adopt a data-driven approach and strategically open store in promising locations where new point of sales can generate higher revenue and profit than the closure of an underperforming point of sale. This strategy not only mitigates revenue shortfall, but also ensures healthy growth on a collective basis to maintain and grow market share. We are committed to enhancing shopping experience for our consumers, which is integral to our brand transformation. During the period, we host customers engagement events to promote our collections and seize festive periods to drive foot traffic. We leverage on AI in digital marketing for tailored content, facilitating sales with bespoke product recommendation to our consumer. Our e-commerce business in this period was largely stable compared to the same period last year. Its contribution to Mainland RSV rose by 1% to 5.6% compared to the same period of last year. ASP growth of e-commerce was impressive with a 14% increase to HKD 2,400 in this period. Now let's turn to Hong Kong, Macau and other markets. In Hong Kong and Macau, business was impacted by uncertain macroeconomic condition, local outbound tourists and changes in Mainland tourist spending pattern and preference. RSV declined by 26% and 42% in Hong Kong and Macau, respectively, in the first half. We closed 3 point of sales in Hong Kong and Macau in the first half. Given the current challenging environment, we stay agile in managing the evolving business dynamic. We continue to evaluate individual store location, scale and productivity to ensure margin resilience. In other markets, we had 61 Chow Tai Fook Jewellery stores as of September with 1 duty free store in China and 2 stores in Japan added in the first half. Excluding China duty-free store, other market RSV delivered an encouraging growth of 8.5% in the first half. Singapore delivered the strongest RSV growth of about 14% year-on-year during this period. Other key markets like Malaysia, Thailand, Japan and Canada also observed steady RSV growth, thanks to the resurgence in travel retail and domestic demand for jewelry products. This further strengthened our confidence in the growth prospect of overseas market. We will proactively seek new growth opportunities in overseas market, led by our recent appointment of the General Manager for International Market in September. She is empowered to drive our growth strategy in Southeast Asia, leveraging her extensive experience in luxury retail. We aim to strategically expand our presence in popular tourist destinations in area with a significant population that appreciate Chinese culture. This builds on the success of our existing investment overseas, of which we share more details of our overseas expand strategy in due course. This concludes my part, and I would like to turn it to Hamilton for financial review and outlook. Thank you.

Thank you, Kent. Good evening, everyone. Let me start with key P&L items and ratios. As mentioned by Kent earlier, the macroeconomic externalities and high gold price volatility weighed on consumer demand in our key markets in the first half this year. The group's revenue declined by 20% year-on-year to HKD 39.4 billion during this period. On the positive side, the increase in gold prices improved GP margin and profitability, coupled with the shift in sales towards our exquisite high-margin fixed price products, the group's gross profit was up slightly to HKD 12.4 billion and its GP margin expanded considerably by 650 bps to 31.4% during this period. We also benefited from our disciplined cost management. The group's operating profit was up 4% to $6.8 billion, and the operating margin expanded 400 bps to 17.2% in the first half, which is a testament to our focus on earnings quality. Revenue in the Mainland declined by 19% in the first half, contributing 83.8% of the group's revenue. Franchise stores outperformed self-operated stores in general. The share of wholesale revenue rose to 58% within the Mainland segment compared to 56% a year ago. Revenue in Hong Kong, Macau and other markets declined 28%, making up 16% of the group's revenue. By product, we continue to execute pricing optimization and launched product offerings with different value propositions to meet customers' preferences despite an overall weakened demand in the first half. The use of exquisite craftsmanship with a meticulous blend of different precious materials in our fixed-price gold jewelry sustained strong sales momentum in this period with this revenue surging 118% year-on-year. On a same-store basis, ASP across product categories in Mainland remained resilient in this first half. Same-store sales growth of Mainland self-operated stores declined by 25% with similar performance across different city tiers. Franchise stores, which represented around 77% of our POS in the Mainland, outperformed self-operated stores with a smaller same-store sales decline of about 20% during the period, thanks to a higher proportion of newer stores. In Hong Kong and Macau, same-store sales growth declined 31% in this first half, with Hong Kong and Macau down by 28% and 41%, respectively. ASP trend across product categories also stayed resilient. Quarter-to-date, we were encouraged to see a lowering decline in same-store sales for both Mainland and Hong Kong, Macau markets. Based on current observations, we expect this momentum to sustain and support our view that operations in the second half of our financial year should improve sequentially. SG&A analysis. Our SG&A expenses declined by 3% in the first half. Aside from staff costs and advertising and promotion, all other expenses line recorded year-on-year decrease, thanks to our effective and disciplined management. We are investing in our brand for the long term, coupled with marketing campaigns for the key collections launched during this period to celebrate our 95th anniversary. The A&P ratio was well managed at 1% of revenue in this first half, remaining largely stable compared to average ratio over the previous financial years. For staff costs, we will elaborate in later slides. And we shall maintain our discipline on cost management and remain agile in response to evolving business dynamics. This ensures that we are maximizing the value on every dollar we spend. We continue to invest in and retain talent for the group's long-term growth. This not only honors the legacy of Chow Tai Fook, but also aligns with our strategic priority on talent cultivation. Staff costs remained relatively flat in the Mainland and Hong Kong, Macau, where the variable component decreased in line with the retail revenue decline. The fixed component increased year-on-year in both markets, mainly because we revised staff remuneration packages for improved welfare and addition of strategic hires essential for driving sustainable business growth. Moving on to concessionaire fees and leases. Mainland's rental cost decreased by 18% in the first half, mainly due to a 24% decline in concession net fees, broadly in line with the retail revenue trend. The concession net fees ratio increased by 20 bps to 8.2% due to a shift of sales mix towards higher-margin products. In Hong Kong, Macau, lease-related expenses declined by 4% with variable rental expenses decreasing by 46% due to the revenue decline in the first half. The rental expense ratio expanded to 5.4% due to operating deleverage. We are observing a trend of rental reductions during the lease renewals in Hong Kong, Macau, and we expect it to materialize from fiscal year '26 onwards as we negotiate with landlords. As mentioned by Kent earlier, starting from this fiscal year, we have reclassified fair value change of gold loans from cost of goods sold to other gains and losses, which is below operating profit. This is part of our preparation for the adoption of IFRS 18 for enhanced disclosure in financial statements. Allow me to provide some background on the reclassification. It's part of the group's usual business practice to use gold loans, which are short positions in gold to mitigate the financial impact of gold price fluctuations on gold inventory, which are long position. Over time, the effects of long and short positions are expected to offset through the sale of gold inventories. Our disciplined execution of hedging over years has proven effective to manage our risk in commodity price movements. Per accounting standard, gold loan contracts are revalued at market price at the end of each financial period end or upon settlement, while gold inventories are not. This disparity leads to temporary accounting gains or losses. Previously, these gains or losses were included in the cost of goods sold, affecting reported growth and operating profit. After the reclassification, the fair value change of gold loan will be moved to other gains or losses, which is below operating profit. EBIT and net profit remain unchanged before and after the reclassification. With this change, we intend to better reflect the core underlying operational performance and separate the impact of hedging. You will note in Appendix 3 on Page 30 that regardless of the reclassification, the underlying trend of key performances indicators stay similar based on the analysis of historical data over the last 5 years. And then the first half movements in GP margin. In this first half, the group's GP margin expanded by 650 bps to 31.4%. And there are 2 key movements. The first, retail like-for-like margin improvement contributed 490 bps, mainly attributable to a surge in gold price. This more than offset the impact from a higher wholesale mix, which weighed down the margin by 80 bps in the first half. Secondly, product mix improvement with an increased share of higher-margin fixed price gold products, leading to 210 bps expansion in GP margin. Then profitability analysis. Despite the slowdown in revenue, the group's operating profit remained resilient, up 4% year-on-year as driven by Mainland China reportable segment. Over a 3-year trend, we are encouraged to see operating margin improvement across all operating markets in this first half. During this period, operating margin increased by 420 bps in the Mainland and 300 bps in Hong Kong, Macau and other markets, respectively. These positive results are driven by our initiatives to enhance earnings quality and maximize value creation for our stakeholders. We are also on track to maintain a relatively stable ROE of about 20% to 25% in the full fiscal year, which continues to represent a sustained improvement over our 5-year historical average levels. This section reconciles the operating profit and profit before tax. A key item to explain is the difference relates to gold loan revaluation loss of $3.1 billion in this period with a 19% cumulative increase in gold price during this first half. For the same period last year, gold price dropped by 5.5% and a gain of $33 million was recorded. And then inventory and CapEx. We continue to adopt prudent inventory and CapEx management amidst market uncertainty. We focused to streamline our SKU offerings and controlled inventory procurement in the first half. By seasonality, we typically increase inventories in September for the peak season in the second half. As of this September, our inventory balance increased by less than $3 billion or 4.6% compared to the March level and gold inventory by weight in September was, in fact, 9% lower than the March level. The inventory balance for gem-set and watches remained relatively stable compared to 6 months ago. Due to the overall weak consumer demand and gold price surge, inventory turnover period extended to 457 days. While we continue to refresh our product portfolio and streamline SKUs to enhance gold inventory turnover with a focus on core collections, we anticipate inventory turnover to shorten to around 330 to 360 days by March next year. While we are executing 5 strategic priorities with a focus on brand transformation, we retain financial discipline on CapEx and defer noncore CapEx. That's why in the first half, CapEx was just about $308 million in the period. And then let's turn to our cash flows. Thanks to the resilient operating profit in the first half, the group continued to generate robust operating and free cash flows amid macro challenges. Operating cash flow, net of lease payment in the first half amounted to $7.3 billion, slightly higher than the same period last year. Pro forma free cash flows amounted to $2.7 billion in this period. We are confident that the robust generation of cash flows from our business will continue to support our ability to deliver steady business growth and sustainable returns to our shareholders. The 2 major cash outflows in this period was due to repayment of gold loans and the payment of fiscal year '24 final dividends. On capital structure highlights. We prudently managed our capital structure to ensure financial stability amidst the macro uncertainty while balancing total shareholders' return. We managed our cash balance at a healthy level of $3.8 billion in bank deposits and cash equivalents in September while reducing bank borrowings to below $4 billion. Net gearing ratio, excluding gold loans, was only 0.4% at period end. We use gold loans to hedge against commodity price risk and also as a financing instrument for our gold inventory and the hedging ratio at period end was below 67%, similar to the level a year ago. Building on the free cash flow generation discussed in earlier slide, the proposed share buyback program reflects our commitment to enhancing total shareholders' return. It will be financed through internal resources and will be carried out progressively from time to time, subject to market conditions. Market outlook. We stay nimble and vigilantly monitor market dynamics and consumption trends, which will inform the ongoing calibration of our growth strategy amidst market uncertainty. This also sees our prioritizing financial and operational resources in strengthening business resilience and competitiveness. Based on our current observations and expectation of a lowering same-store sales decline and moderated POS closure rate for the second half, business fundamentals should improve sequentially from the first half period, barring market externalities and unforeseen circumstances. We will continue to focus on the overall financial health of our retail network to ensure margin resilience and maintain financial discipline in cost management and capital expenditure to deliver high earnings quality. Going forward, we stay confident in the long-term prospects of the industry. We will diligently execute our 5 strategic priorities to further reinforce our market leadership, positioning for sustainable growth in the future and creating long-term value for our stakeholders. This concludes our presentation today. Thank you.

Thank you. Okay. Before we start the Q&A with the reclassification, I'm sure that analysts would have a need to adjust their financial models. So for the interest and benefit of the analysts and investors, Hamilton, can I invite you to illustrate the reclassification with reference to FY 2024 reported figures as outlined in our appendix. Second question is, I noticed that we also enhanced the way we determine the settled and unsettled gain of our gold loans based on the maturity of the gold loans. Can you also briefly elaborate on this?

Sure, sure. So here in Appendix 1, I can elaborate on the reclassification of gold loans impact with illustration of the fiscal year 2024 figures. This simulation of hedge accounting was carried out on certain assumptions for the purpose of helping analysts and investors to understand the change for your modeling updates as necessary. The first 2 columns are from our old definition or classification. For financial reporting basis for the middle column, you will note the total fair value change of gold loans of $3.7 billion loss was included in the cost of goods sold before the reported gross profit line. With the reclassification, this $3.7 billion loss would have moved to below operating profit line. The purpose is to better reflect our underlying performance by separating the hedging from our operating profitability. As mentioned earlier, is also part of our preparation for the adoption of IFRS 18, which is about financial disclosure and presentation, which encourages the separation of operating from nonoperating activities. As you will note from the first column, the $3.7 billion loss that we had in fiscal year '24 comprised $1.2 billion realized loss relating to the gold loans that -- or gold products that were sold and $2.5 billion unrealized loss relating to the gold inventory unsold. We previously introduced the adjusted gross profit metric to help the market to better understand our underlying performance. The adjusted gross profit will take into account the $1.2 billion realized loss relating to gold products sold during the period and translating to an adjusted gross profit of $24.8 billion, while the $2.5 billion unrealized loss relating to the gold inventory unsold is recognized below the core operating profit line. Now with the reclassification for the column on the right, the fair value change of $3.7 billion loss will be accounted for based on the contract status of gold loans, settled or unsettled. And this treatment, I believe, is basically simple and also more straightforward. In conclusion, we want to reiterate that the fair value change of gold loans has the same value of $3.7 billion loss, and there is no change to the profit before tax and also the net profit. You will also note in Appendix 2 that regardless of the reclassification, trends of adjusted GP margin or COP margin relative to the new GP margin or OP margin are similar.