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China/Hong Kong Consumer Discretionary

Hengdeli (3389 HK)

Tick Tock taking the spot
Hengdeli is Chinas largest luxury watch retailer and wholesaler with 30% market share. Increased penetration towards the mid-market segment through aggressive network expansion into the second- and third-tier cities will be the core earnings driver in the coming years. Given the favourable earnings outlook as well as its strengthening financial position, we initiate coverage on Hengdeli with an Outperform rating. Leading the race. As the leading national luxury watch retailer with strong store brand recognition in China, Hengdeli is well positioned to tap the countrys burgeoning luxury watch market. The company outshines its peers given its strategic alliance with major Swiss watch suppliers, which allows it to secure and source a wider range of products. We see limited competition risk in the foreseeable future due to peers weaker sales channels and financial strength to adopt Hengdelis multi-brand strategy or chase up its aggressive expansion. Grasping the potential from second- and third-tier cities. The booming Chinese economy has spurred the countrys urbanization rate, leading to the emergence of a wealthy middle-class population. Being the first mover to the second- and third- tier cites, we foresee Hengdeli sales to accelerate, boosted by increased consumer spending propensity and mounting luxury demand from the middle class segment. Stock not to miss. We initiate coverage on Hengdeli with an Outperform rating and target price of HK$4.15 based on 20x FY11F PE, which is equivalent to a PE/G ratio of about 0.5x. We expect a 40% FY09-11F EPS CAGR driven by its expanded sales network, continuous margin enhancement and dominance in the tier-two to three markets in China. Forecast and valuation
Year to 31 Dec 2008 2009 5,899 365 0.094 (49) 31.3 0.9 (0.6) 14.7 Net cash 2010F 7,397 589 0.145 54 20.2 1.4 (1.5) 19.1 Net cash 2011F 9,084 744 0.183 26 15.9 2.0 1.5 21.0 Net cash 2012F 10,952 931 0.229 25 12.8 1.7 2.7 22.6 Net cash Revenue (RMB m) 5,516 Net profit (RMB m) 460 EPS (RMB) 0.185 EPS (YoY, %) 10 PER (x) 16.5 Yield (%) 1.9 FCF yield (%) (2.2) ROAE (%) 23.7 Net gearing (%) 38 Source: Company, CCBIS estimates

22 July 2010
Company Rating: Outperform

Sector Rating:


Price: Target:

HK$3.35 HK$4.15

Trading data
52-week range Market capitalization (m) Shares outstanding (m) Free float (%) 3M average daily T/O (m share) 3M average daily T/O (US$m) Expected return (%) 1 year Closing price on 22 July, 2010 HK$1.7 3.9 HK$13,631/US$1,753 4,069 33 6.8 2.9 25.3

Stock price and HSCEI

HK$ 5

0 22-Jul-09 3-Sep-09 19-Oct-09 2-Dec-09 18-Jan-10 4-Mar-10 21-Apr-10 4-Jun-10 21-Jul-10 Hengdeli HSCEI

Source: Bloomberg

Claudia Ching
(852) 2532 2528

Forrest Chan CFA

(852) 2532 2743

Warren Wang
(852) 2532 2574

Timothy Sun
(852) 2532 6746

Please read the analyst certification and other important disclosures on last page

Hengdeli (3389 HK)

22 July 2010

Table of Contents

Tick Tock taking the spot...............................................................................................................................................1

Investment summary.....................................................................................................................................................3

Throne to the luxury watch kingdom.............................................................................................................................4

Valuation .....................................................................................................................................................................10

Upbeat sales growth outlook in FY10-12F .................................................................................................................12

Luxury watch market outlook in China........................................................................................................................15

Strong financial outlook...............................................................................................................................................19

Appendix 1: Background.............................................................................................................................................28

Appendix 2: SWOT and Porter analysis .....................................................................................................................30

Appendix 3: Management biography ..........................................................................................................................32

Hengdeli (3389 HK)

22 July 2010

Investment summary
Being the largest watch retailer in China with 30% market share and owning the most extensive retail network with 300 stores, Hengdeli is well positioned to capture the growing demand for luxury watches. On top of that, Hengdelis strong brand recognition, well-established relationship with key suppliers, multi-brand strategy, and comprehensive clientele are also key competitive advantages that keep the company ahead of its peers. By expanding its strong network in the affluent mid-market segment, Hengdeli will further strengthen its strong network presence across the second- and third-tier cities. Thanks to the long establishment and co-operation with the major Swiss watch makers over the years, Hengdeli has secured close relationship with the top Swiss watch suppliers. The Swatch Group (UHR VX, Not Rated) and LVMH Moet Hennessy Group (LVMH, MC FP, Not Rated) are also substantial shareholders of Hengdeli. The strategic alliances with major suppliers provide unique advantages for Hengdeli, which receives more diversified and comprehensive product offerings, enjoys extended credit line, and gains priority in watch supply and delivery while no other industry players in China can compare with. Supported by its nationwide renowned brand name, Hengdeli is a rare luxury watch retailer that has the financial ability and bargaining leverage to operate with a multi-brand approach. With its three main brands targeting different customer segments, we believe the company is well positioned to fortify its sales channels and expand its customer pool. With an eye on the large market potential for entry-level luxury watches, Hengdeli will accelerate its expansion plan by adding 30-60 stores per annum in FY10F-12F in the second- and third-tier cities, with total store count expected to reach 400 by 2012. We view that Hengdeli is the only luxury watch chain to expand in such a rapid pace, and towards other regions outside of tier-one cities. We believe Hengdeli can utilize this opportunity to seize additional market share. Besides, network expansion will be mostly achieved through M&A, which gives instant earnings accretion and limits operating costs. Hengdeli saw no slowdown in sales with January-June sales growing by 25-40% YoY in China and Hong Kong, despite worries over tightened discretionary spending due to the recent softening property and stock markets. Going forward, Chinas rapid macroeconomic growth, together with the expanding middle class pool, will drive a large and prosperous luxury watch market demand and hence support our forecast of 24% sales CAGR in FY09-11F. Hengdeli offers an attractive investment case that will sustain over the long term. On the back of a rosy earnings outlook with FY09-11F EPS CAGR of 40% as well as an undemanding valuation, we find this leading luxury goods retailer with a dominant market position and significant foothold in China will be a major winner within the consumer universe. We initiate coverage with an Outperform rating. Our target price is set at HK$4.15 as we peg our target valuation at 20x FY11F PE, equivalent to a PE/G ratio of about 0.5x, which is at the lower range compared with the industry average (international luxury watches retailers, Hong Kong-listed luxury watches retailers and China specialty retail players) of 0.4-0.7x

Hengdeli (3389 HK)

22 July 2010

Throne to the luxury watch kingdom

Hengdeli is our top high-end retail pick as we like its ability to tap into the upswing of Chinas luxury watch market and its foresight to expand its sales channel and market share through increasing penetration into the second- and third- tier cities. Owing to the escalating appetite for big ticket items in China, in particular from the growing middle-class population, Hengdeli is well-positioned to capture the thriving demand. Hengdeli has set an aggressive store rollout plan for the coming three years mainly through acquisitions. The strategy not only provides instant earnings accretion, but also minimizes initial operating losses. With Hengdelis unique market positioning and leadership, we believe the attractive investment case will sustain over the long term.

Market leader with exceptionally strong store brand recognition

Hengdeli was ranked number one in Greater China in terms of retail sales of luxury watches, topping RMB3.7b in sales in 2008. As the largest player in the luxury watch segment in China with 30% market share, Hengdeli is set to enjoy the growing demand for luxury goods, especially in the wake of rising income levels and its deeper penetration into the second- and third-tier cities. On the back of its aggressive expansion plan across China, we anticipate Hengdelis market share will continue to expand. 2008 global Swiss watch retailers retail revenue (RMB b)
RMB b 4.0 3.7 3.5 3.0 2.5 2.0 1.5 1.5 1.0 1.0 0.5 0.0 Formosa Times King Fook Tourneau Time City Oriental Signet Emperor Harmony Hengdeli Prince Burcherer Movado Sincere 0.8 0.6 0.5 0.5 Others 52% 0.4 Hengdeli 30% 1.5 2.4 2.3 2.1 3.1

2008 market share of wholesalers/retailers in China

Time City 5% Oriental 6% Harmony 7%

Source: Company

Source: Company

Hengdeli (3389 HK)

22 July 2010

Unprecedented competitive advantage to sustain superiority

Besides being a clear dominant player in China, we believe Hengdeli is also the most scalable retailer among a handful of national luxury watch retail chain operators in the country. Hengdelis successful business model is extremely difficult for other industry players to replicate and hence it is unlikely for others to overtake Hengdelis market leadership in the foreseeable future. The success of Hengdeli is supported by the following factors: Five distinctive competitive edges where competitors are incomparable A long-established household name in the luxury watch market. Strategic tie-ups with suppliers and comprehensive product offerings. Extensive customer coverage through effective brand building. Prudent new store opening. Unique expansion model to maximize chance of success.

A long-established household name in the luxury watch market

High recognition nationwide Being one of the first national luxury watch retailers in China, Hengdeli has established sound and exclusive working relationships with various worldwide renowned brand owners. Tracing back to 1949 when it became a SOE, Hengdeli began Swiss watch distribution in China. The close cooperation over the years has been clearly unrivaled. Hengdelis extensive history in the distribution of luxury watches in China has enabled it to gain thorough industry know-how. Run by an experienced management team, with chairman Zhang Yupin having more than 20 years of experience in the high-end consumable distribution industry in China, we believe Hengdeli will continue to benefit from the managements competency and experience in the retail of luxury watches in China. Hengdeli is usually viewed as a symbol of authentic and quality assurance. With the rising awareness of product quality and originality nowadays, Hengdeli is likely to be customers most preferred and trusted watch retailer. Moreover, its long establishment and reputation in China help it gain access to ideal shop locations, as well as strong bargaining power when negotiating for rental rates.

Experienced management team with proven track record

Strategic tie-ups and comprehensive product offerings

In order to minimize brand image risk, the international luxurious brand suppliers are extremely stringent in selecting their distribution partners, especially in China. Nonetheless, as reflected by the exclusive product offerings and years of cooperation, Hengdeli has managed to win over the trust of world-class Swiss watch brands, including the worlds largest watch distributors Swatch Group and LVMH. The strong ties with suppliers mean Hengdeli is able to secure a wider range of model collection as well as more favourable credit terms compared to its local peers. In many cases, Hengdeli is also given the priority in watch supply and delivery.

Hengdeli (3389 HK)

22 July 2010

Unique shareholding structure with suppliers being a substantial shareholder

While non-exclusive, we believe the distribution partnerships with Swatch Group and LVMH remain guarded given the strategic alliance with major suppliers in Hengdelis shareholding structure. Swatch Group owns an 8.9% stake in the company and is currently the second largest shareholder, while LVMH is the third largest shareholder with a 6.8% interest. Such shareholding clearly suggests a strong vote of confidence in Hengdeli and the strategic ties provide a distinctive competitive advantage for Hengdeli. Hengdelis shareholding structure

Zhang Yuping (Chairman) 44.75%

Public 39.52%

Swatch Group 8.90%

LVMH Group 6.83%

Hengdeli Holdings Ltd. (3389 HK)

Source: Company

Furthermore, Hengdeli and Swatch Group have established a 50/50 JV in the wholesaling and retailing of some watch brands in China since 2003. The JV, with plans to open and operate boutiques of watches, jewellery, and other related accessories of Swatch Group, has already opened an Omega flagship shop on Huaihai Road, Shanghai and two Swatch boutiques in Harbin and Qingdao. Providing the hottest brand offerings Leveraging on its strong link with various brand owners, Hengdeli has secured 18 exclusive distribution rights from Swatch Group, LVMH, and Richemont, and these rights will not expire until 2012. The close relationships with Swatch Group and LVMH are of particular importance given that they are among the top five best-selling brands in China (50% of the market). Hengdelis brand portfolio
Exclusive brands Swatch Group Rolex Group LVMH Richemont Independent brands TAG Heuer, Zenith, Christian Dior, Fendi Jaeger-Lecoultre, Baume & Mercier Maurice Lacroix, Carl. F. Bucherer, Claude Bernard Alfred Dunhill, Panerai, Cartier, Vacheron Constantin, IWC Edox, Enicar, Carven, Ball, Gucci, Oris, Raymond Well, Frank Muller, Hermes, Girard Perregaux, Grand Seiko, Jean Richard, MONTBLANC, Parmigiani, Ulysse Nardin, Cyma Tissot, Calvin Klein, Certina, Hamilton, Mido, Breguet, Longines Non-exclusive brands Omega, Rado, Blancpain, Glashutte, Jaquet Droz Rolex, Tudor

Source: Company

Hengdeli (3389 HK)

22 July 2010

Extensive customer coverage through effective brand building

Three distinct store brands to capture different consumer segments and expand sales channels Hengdeli possesses the rare scale required for adopting a multi-brand strategy to maximize customer exposure. Hengdelis retail network is mainly classified under three categories of multi-brand shops, namely Xinyu Elegant, Xinyu Prime Time, and Xinyu Temptation. The company also operates mono-brand boutiques. The multi-brand business model is another unparalleled example that reflects Hengdelis leadership in the luxury watch market in China. Given Hengdelis capability to source an extensive range of watch products, this enables it to target a wide range of clientele and support the multi-brand operation. On the other hand, industry peers usually operate under one store brand due to the network scale restriction. Hengdelis store brands
Elegant Showcasing the most luxurious internationally renowned brands of the top class watches ASP: RMB50,000 13 Elegant outlets, with 10 in China, 3 in Hong Kong and 1 in Taiwan Offering a full range of watch brands under extensive number of internationally renowned brands targeting the middle-to-high end customers Providing one-stop-shop services to customers ASP: RMB10,000-20,000 206 Prime Time stores, with 175 in China and 31 in Taiwan The trend setter of watches, bringing fashionable and niche yet classy watches for the youngsters ASP: RMB5,000-8,000 52 exclusive brand image boutiques, with 40 in China, 10 in HK, 2 in Taiwan under various renowned brands, namely Rolex, Tissot, TAG Heuer and Cartier etc.

Prime Time

Temptation Mono-brand boutique stores Source: Company

Elegant store

Prime Time store

Source: Company website

Source: Company website

Hengdeli has committed tremendous efforts to improve sales of middle-to-high end brands. More than 75% of its retail outlets in China are Prime Time shops, which are positioned to sell middle-to-high end watches. Prime Time contributes to nearly 80% of the companys total retail sales in China and will remain its leading store brand for the coming years. Given increasing demand for mid-to-high end watches, Hengdeli will continue to consolidate and expand its retail network in the second- and third-tier cities under the Prime Time label.

Hengdeli (3389 HK)

22 July 2010

Prudent new stores opening

Capture the affluent middle-income customers In view of the growing spending propensity of the expanding middle class, Hengdeli is accelerating its store rollout plan to capture fast growing demand. Already with 257 stores in China, 13 in Hong Kong, and 33 in Taiwan, management aims to add 50-60 stores in FY10F and 30-40 annually in FY11-12F. By 2012, Hengdelis store portfolio should reach over 400 stores, far exceeding other competitors. Number of stores in 2007-2012F
450 400 350 300 250 200 150 100 50 0 2007 2008 2009 Mainland China 2010F Hong Kong Taiwan 2011F 2012F 166 2 257 210 7 315 350 380 33 35 15 13 38 17 42 20

Source: Company data, CCBIS estimates

Burgeoning middle class provides a strong sales catalyst

Second-tier city stores, in particular, have fared well the past two years and delivered increasing profit contribution to the company. We predict Hengdelis reliance on these cities will continue increase over time and they will be the main growth driver for the company. Number of stores by city tiers

Revenue by city tiers

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2006 2007 2008 Tier-one 2009 Tier-two 2010F Tier-three 2011F 2012F 37 31 58 57 61 61 62 62 63 5 12 13 15 15 16 16

90% 80% 70% 60% 50% 40% 30% 20%








57 59 55 56










10% 0% 2006



17 2009 Tier-two

15 2010F Tier-three

13 2011F

11 2012F


2008 Tier-one

Source: Company data, CCBIS estimates

Source: Company data, CCBIS estimates

Hengdeli (3389 HK)

22 July 2010

Compared to Hengdeli, most peers have a relatively slow rollout plan and mainly in first-tier cities. However, Hengdeli has spotted the enormous growth potential in the mid-market segment. With the aim of extending the coverage of its middle-to-high-end product line, the majority of Hengdelis new stores will come under the Prime Time label. Expansion will be centered at second- and third-tier cities in the North Eastern region, e.g. Shenyang and Tianjin, as well as Eastern China, e.g. Sichuan, and Southern China region, e.g. Nanchong and Jiangxi. Well-positioned to capture future growth through penetrating into second- and third-tier cities As urbanization continues, we are positive on Hengdelis strategy in extending penetration into the second- and third-tier cities. In our view, consumers in those cities make up the bulk of Hengdelis addressable market, and young people in particular are increasingly seeking modern and trendy accessories. We believe that the growing number of middle income consumers in these cities are likely to be attracted to Hengdelis mid-end watches offering.

Unique expansion model to maximize chance of success

It is expected that 80% of Hengdelis expansion will be achieved through acquiring local retailers and the rest the establishment of new stores. We think the M&A strategy is facilitated by the companys wholesale business in China, which enables it to identify suitable acquisitions. The acquisition of Elegant in 2006 proved to be a big success and we favor Hengdelis expansion approach in the form of M&A as it yields three distinct advantages: Acquiring existing and operational stores could minimize initial operating losses. Store acquisition allows Hengdeli to instantly inherit the customer base from the exiting stores. Hengdeli will initially operate the acquired stores under the old store brand before changing it into its own brands. Gain quicker access into the second- and third-tier cities, where the luxury watch markets are still relatively immature and existing watch retailers are small and offer old-fashioned models. Secured two deals in 1H10 Hengdelis acquisition price usually ranges from 5x to 8x PE to ensure earnings accretive transactions. Two acquisitions were made in late May to early June in Guangzhou (60% interest) and Shenyang (75% interest) at FY10 PE of approximately 5x. The two deals added 30 stores to Hengdelis portfolio instantly. Management indicated that the company is looking at two major M&A opportunities in second-tier cities in southwest China and hopes the deals will be completed in late 3Q10 or early 4Q10.

Acquisition projects in 2009-2010 YTD

Retail company Taiwan Jing Guang Timepiece Holdings Guangzhou Rui Yue Location Shop network No. of outlets 31 9 21 Stake of Hengdeli 80% 60% 75% Acquisition valuation 6x ~ 5x Major brand portfolio Acquisition date Omega, Rado, Tissot Tudor, Longiness, Rado October 2009 June 2010 June 2010

Taiwan Taipei, Taichung, Kaohsiung Guangzhou (Central China) Hubei, Hunan, Tianjin Shenyang

Shi Quan Shi Mei Liaoning (NE China) Source: Company, CCBIS estimates

~ 5x TAG Heuer, Zenith, Hamilton

Hengdeli (3389 HK)

22 July 2010

The current market valuations of 20x FY10F PE and 16x FY11F PE appear undemanding and we see there is strong re-rating potential for the stock given its 40% forecast FY09-11F EPS CAGR. Given its RMB1b cash on hand and return to positive free cash flow, Hengdeli is financially sound to implement its expansion plan and acquisition strategy to enhance its value. For comparison, we examine the PEs of international luxury brands listed overseas. The international jewelry retailers include Bulgari (BUL IM, Not Rated), Swatch Group (UHR VX, Not Rated), LVMH (MC FP, Not Rated) and Tiffany & Co. (TIF US, Not Rated). Bulgari, LVMH, and Tiffany & Co. are jewellery retailers with the comparable target customers and similarly high inventory requirements as Hengdeli while Swatch is similar to Hengdeli by market segment. At present, these brands have an average valuation of 17x CY11F PE, on par with Hengdeli. However, these brands, with exposure to the sluggish US and European markets, trade on a higher average PE/G ratio of 0.7x on consensus forecast EPS CAGR of 26% in FY09-11F, significantly lower than Hengdeli. We hence think Hengdeli valuation is not expensive compared to international peers given its heavy exposure to China, and more exciting business outlook. We also benchmark Hengdeli to the valuations of Hong Kong-listed luxury watch and jewellery retailers Oriental Watch (398 HK, Not Rated), Emperor Watch & Jewellery (887 HK, Not Rated), Luk Fook (590 HK, Not Rated), and Chow Sang Sang (116 HK, Not Rated) which trade on an average CY11F PE of 10x with a PE/G ratio of 0.4x. Although these retailers also share the same target customers and high inventory requirements as Hengdeli, most of their stores are located in Hong Kong, which has less attractive growth potential compared to China. Moreover, their expansion pace is also relatively moderate versus Hengdelis. Factoring in stronger network and scale with higher earnings CAGR, we believe Hengdeli deserves to command a premium valuation versus the local watch and jewellery retailers. Similarly, when comparing local watch retailers with China specialty retail players, we find Hengdelis current valuation undemanding. Given its above sector averages growth rate, Hengdeli justifies a higher CY11F PE multiple than the peer average of 18x with a sector growth rate of only 28% in FY09-11F. Our target price is set at HK$4.15 on target valuation of 20x FY11F PE, equivalent to a PE/G ratio of about 0.5x (forecast EPS CAGR growth of 40% in FY09-11F), which is the at the lower range compared with the industry average (international luxury watch retailers, Hong Kong-listed luxury watch retailers, and China high-end retail players) of 0.4-0.7x. Hengdeli has outperformed the HSI by 20% YTD. Given its rosy outlook and undemanding valuation, we find Hengdeli a preferred play in specialty and luxury retail.


Hengdeli (3389 HK)

22 July 2010

Valuation summary
Company International jewelry & watch LVMH Swatch Tiffany Bulgari Hengdeli* Average MC FP UHR VX TIF US BUL IM 3389 HK 89.68 321.20 39.21 6.23 3.35 55,393 16,156 4,986 2,364 1,749 168.44 61.53 128.04 17.83 2.89 26 23 NA NA 54 34 15 15 14 63 27 27 19.2 18.0 15.4 35.0 20.2 21.6 16.7 15.7 13.5 21.4 15.9 16.6 0.8 0.8 NA NA 0.4 0.7 2.1 1.5 2.1 1.3 1.4 1.7 2.8 2.6 2.4 2.3 3.7 2.8 15.2 15.2 16.5 6.8 18.6 14.5 Net debt 7 1 Net debt 0 23 Net cash Net cash 28 Net cash Ticker Share price (Local currency) Market cap (US$m) 3M average value traded (US$m) EPS growth (%) # CY10 CY11 PE (x) CY10 CY11 PE/G (x) CY11 Yield (%) CY10 P/B (x) CY10 ROAE (x) CY10 Net cash / share (%) Net gearing (%)

China specialty retailers/other brands Belle* 1880 HK Gome* 493 HK Golden Eagle 3308 HK Bosideng 3998 HK Hengdeli* 3389 HK Daphne 210 HK Ports 589 HK Lilang 1234 HK Trinity 891 HK China Nepstar NPD US Average Hong Kong jewelry & watch Hengdeli* 3389 HK Chow Sang Sang 116 HK Luk Fook 590 HK Emperor Watch 887 HK Oriental Watch 398 HK Average # Calculated in HK$ terms * Denotes CCBIS estimates Source: Bloomberg, CCBIS estimates

11.88 2.58 18.20 2.42 3.35 7.61 20.35 8.92 4.89 3.04

12,859 4,985 4,535 2,414 1,749 1,600 1,478 1,374 988 317

21.43 27.25 5.15 5.56 2.89 5.11 4.37 4.96 3.74 1.40

23 33 33 NA 54 17 16 49 27 (36) 24

5 29 26 12 27 24 19 33 40 36 25

28.1 18.3 32.7 14.0 20.2 17.9 18.6 22.6 27.0 23.8 22.3

26.7 14.2 25.9 12.6 15.9 14.4 15.6 17.0 19.3 17.5 17.9

1.9 0.5 0.9 NA 0.4 0.7 0.9 0.4 0.6 NA 0.8

0.9 0.0 1.3 6.1 1.4 1.3 3.6 1.8 2.1 2.6 2.1

4.9 2.7 9.3 2.9 3.7 4.3 6.4 4.9 3.6 1.5 4.4

18.9 15.2 31.7 16.8 18.6 28.9 37.8 23.2 13.8 5.3 21.0

7 1 6 34 0 9 7 11 Net debt 28

Net cash Net cash Net cash Net cash Net cash Net cash Net cash Net cash 10 Net cash

3.35 15.24 12.44 0.55 2.25

1,749 1,324 786 368 112

2.89 3.94 1.14 0.60 0.20

54 NA NA 14 NA 34

27 NA NA 41 24 31

20.2 NA 19.8 11.2 6.2 14.4

15.9 NA NA 8.0 5.0 9.6

0.4 NA NA 0.4 NA 0.4

1.4 NA NA 3.1 2.8 2.4

3.7 NA NA 1.4 0.6 1.9

18.6 NA NA 15.0 9.4 14.3

0 Net debt 2 8 Net debt

Net cash 5 Net cash Net cash 16


Hengdeli (3389 HK)

22 July 2010

Upbeat sales growth outlook in FY10-12F

Fast expanding retail business drives the growth
Hengdelis revenue is derived from three major segments, with retail business being the largest contributor to account for 75% of total sales, followed by wholesales businesss 23%, and customer service and others 2%. Going forward, we expect the company to continue to rely on the retail segment, which yields more rapid growth and higher margin, and we project the segment to account for 80-82% of total sales in FY10-12F. Sales breakdown in FY08
Customer Service and Others 3% Wholesale Business 23% Retail sales from PRC 41% Retail sales from PRC 46%

Sales breakdown in FY09

Customer Service and Others 2%

Wholesale Business 30%

Retail sales from HK 26%

Retail sales from HK 29%

Source: Company data

Source: Company data

Riding on the strong demand for luxury items

The emerging middle class has proved to be big spenders Given the favourable economic outlook in view of strengthening purchasing power and demand for quality mid-to-high end watches in China, Hengdelis sales outlook is promising. In addition, the emerging of the middle class signifies a large and still growing market of an affordable group with increasing disposable income to spend on the discretionary items. We believe sales from second- and third-tier cities will be the key driver for Hengdeli in the coming three years.

Superior market size compared to peers in Hong Kong

With a more renowned reputation and wider product coverage, Hengdeli dominates two major Hong Kong listed luxury watch competitors by sales size and market share. In FY09, Hengdelis sales revenue exceeded Oriental and Emperor by 2.3x and 2.5x, respectively. Its presence in China is also outperforming, with a network of 224 stores compared to 40 for Emperor and 24 for Oriental at end-09. The three players target different markets, with Hengdeli focusing on Chinas second- and third-tier cities, Oriental in Hong Kong and Emperor on Chinas first-tier cities.


Hengdeli (3389 HK)

22 July 2010

Peers comparison listed Hong Kong luxury watch and jewellery retailers
Hengdeli (3389 HK, Outperform) Retail revenue in 2009 (RMB m) Market capital (HK$ m) Target market Total no. of shops by end-09 No. of shops in China No. of shops in Hong Kong, Macau and Taiwan Estimated market share (%) Store addition for 2010 Gearing ratio (%) Year of establishment Source: Company, CCBIS estimates 5,899 13,428 China tier-one to three, more focus on tier-two to three 270 224 46 30 50 11.2 1927 Oriental Watch (398 HK, Not Rated) 2,539 818 China tier-one to two cities (BJ, SH) 54 40 14 6 2 0.32 1961 Emperor Watch & Jewellery (887 HK, Not Rated) 2364 2,659 China tier-one cities (BJ, SH), HK 40 24 16 < 1% 10 to 20 0.9 1942

Hengdeli dominates Chinas luxury watch industry with its reputable brand name, longest history, larger network size, and overall sales and profitability. With lower sales and smaller market share, other players have weaker financial ability to ramp up their expansion plan. We hence view that peers have a minimal threat to Hengdelis leading position.

Solid growth in Hong Kong

Explore the potential of mainlanders rising affluence amid their soaring overseas travels In 2006, Hengdeli acquired Elegant International, a well-known luxury watch retailer in Hong Kong with four retail outlets. Elegant is one of the major retailers of luxury watches in the territory selling high-end Swiss timepieces. We believe that the acquisition has significantly enhanced Hengdelis earnings and brand recognition. Along with four Elegant stores, there are also ten mono-brand boutiques in Hong Kong. A significant portion of Elegants sales is derived from mainland tourists. While travelling, mainland tourists take the opportunity to buy luxury watches in Hong Kong, as the luxury watches are sold at approximately 20-30% discount compared to the retail price in China due to the absence of VAT tax. With the uptrend in mainland tourist arrivals in Hong Kong, we expect sales momentum to sustain. In addition, another trend that benefits Hengdeli is the acceptance of the UnionPay system for payment settlement. UnionPay is the only domestic credit card organization in China. Majority of mainland travelers now use UnionPay to settle payments because it saves them up to 2% in transaction fees. Retailers in Hong Kong settle payments with shoppers in RMB through UnionPays system, hence the credit-card holders can save the foreign-exchange conversion fee when they repay the debt. This advantage will continue to entice mainlanders travelling to Hong Kong to keep up their spending spirit.


Hengdeli (3389 HK)

22 July 2010

Expansion to Taiwan to complete Greater China coverage

In view of the opportunity to capture additional sales, Hengdeli has entered into Taiwan via the acquisition of 80% of Taiwan Jing Guang Timepiece for HK$48m, or at 6x PE, in 2009. Taiwan Jing Guang Timepiece owns 31 retail outlets in Taipei, Taichung, Kaohsiung, Hsinchu, and Chiayi, specializing in selling internationally renowned watch brands. As a result of the acquisition, Hengdeli has established retail network in major cities of Taiwan with leading market share, laying a sound foundation for the long-term development of the companys overseas business. Benefiting from surging mainlanders visits In mid-May 2010, Hengdeli opened its first Elegant flagship store in Taiwan. The new store sells the worlds top ten most exclusive watch brands and serves as a grand emporium for building brand image. Hengdeli plans to invest HK$40m to open up to five stores in Taiwan by end-2011. The expansion into Taiwan makes economic sense because in July 2008, Mainland China and Taiwan have resumed regular direct flights between the two regions for the first time in six decades. Given the new flight arrangement, tourist number from Mainland China has been growing rapidly, and achieved 105% YoY growth to 670,000 in 1H10. As retail prices for luxury watches in Taiwan are approximately 11% cheaper than those in Mainland China, mainland visitors are taking the opportunity to purchase luxury watches in Taiwan. Acquired Taiwan Jing Guang Timepiece to strengthen foothold in Taiwan Considering the Taiwan market is still at a developing stage, we do not anticipate any material contribution to the company in the near term. Nevertheless, we anticipate the broadened platform will be a long-term driver for Hengdeli in capturing additional market share and sales.

Wholesale business stable with strong cash generating capability

Constant sales deriving from wholesale business Hengdeli currently owns the distribution rights of 20 renowned international brands in China, of which 18 are on an exclusive basis and will not expire until 2012. Hengdeli is the largest wholesaler of luxury watches in China with over 300 customers. With its ownership of exclusive distribution rights for a number of renowned best-selling international brands, local retailers intending to carry these brands must source from Hengdeli. Although in recent years the wholesale business has not been the fastest growth driver for Hengdeli, we see this business remains extremely valuable as it is a cash cow and serves as a platform for maintaining close working relationship with the Swiss watch suppliers.

Synergy from jewellery business

Potential business to come on stream in 2011 Hengdeli is also eyeing to broaden its business platform into the high-end jewellery market. We expect enormous synergy will be created as many high-end brands also have their own jewellery lines. More importantly, the jewellery market in China is estimated to be ten times larger than the luxury watch market. The new business is likely to start through its existing Elegant stores or a joint venture. No detailed information is disclosed at this time, however, we are confident that the business, when comes on stream, will be a strong re-rating catalyst given the enormous synergy between the two business lines.


Hengdeli (3389 HK)

22 July 2010

Luxury watch market outlook in China

According to Bain Consultancy, Chinas imported watch market is estimated to grow from RMB14b in 2008 to RMB21b by 2012, or at a CAGR of 11%. The Eastern region accounts for about one-third of the market. The financial crisis in 2009 resulted in ~20% YoY drop in export value in the Swiss watch market. That said, Greater China Region remained one of the most resilient regions and China is expected to lead a recovery attributable to three major growth drivers: Growing number of wealthy consumers underpins demand for luxury products Increasingly affluent and growing middle class with high spending power in China pushes more demand for fashionable watches. Hong Kong is still the largest luxury watch market in Greater China and has strong attraction for tourists to purchase as watches are relatively cheaper. Taiwan sales in watches to be boosted by rising number of China tourists. Enormous market size to explore Growth potential for Swiss watches is enormous in China as watch ownership and the penetration rate of Swiss watches are still low, with only five watches purchased per 100 consumers every year in the country, compared to 18 for developing countries and 27 for developed countries. Sales of Swiss watches per 1,000 people
10 Italy 5 Saudi Arabia 2 Thailand 1 Turkey South Korea Russia 0.5 Malaysia China 2018: 0.59/000 people 0.2 Ukraine 0.1 0 100 200 300 China 2013: 0.34/000 people China 2008: 0.23/000 people (Swiss Watch worth Higher than RMB10K) Mexico Canada Sales of Swiss Watch in pieces The market penetration of Swiss Watch in China is low and with a huge growth potential China Taiwan Portugal Spain Greece UK Austria

Germany Japan USA Australia Belgium Holland

Source: Company, Bain & Company, Eurominitor, Watch Association of Switzerland


Hengdeli (3389 HK)

22 July 2010

Potential cuts in luxury item tax

In China, luxury watches with a dutiable price of RMB10,000 or higher are levied 20-30% duties. The government is reviewing the policy and considering to reduce import duties on luxury products. Retailers are expected to pass on the saving to customers to attract more sales. The tax reduction may also elevate China sales while lowering the purchase costs, which would strengthen gross margins. The policy would also retain a portion of mainland consumers to buy watches within China instead of Hong Kong. Since the gross margin of the Hong Kong retail operation was lower than that in China (18.9% vs. 32.1% in FY09), with more sales generated from China, the overall gross profit margin is expected to improve.

What luxury watches mean to the market now?

Perspective towards watch is no longer for timekeeping only The function of watches has changed over time, from mainly for timekeeping to a sign of social status. At the consumer level, there is a growing perception that famous foreign-branded watches are status symbols, denoting wealth and success. Precious timepiece is also gaining popularity among younger generations of consumers, who attach great importance to branding instead of price. Luxury watches have also turned to be perfect gifts, in particular for consumers in tier-one cities. Notably, only a small portion of consumers prefers buying domestic brands or non-Swiss made imported watches. Most of them still prefer Swiss-made prestigious/ luxury watch products as they embody an image of technical and aesthetic quality that have been forged over the years. Swiss brands vs. non-Swiss brands in China
RMB 100% 6.8b 4.0b Non-Swiss brand Non-Swiss brand Total non-Swiss brand sales = 1.5b (10%) 3.2b Total = 13.9b Mainland

Preference for foreign brands over local watches


60% Swiss brand 40% Swiss brand 20% Swiss brand Total Swiss brand Sales = 12.9b (90%)





Source: Company

Tapping the resurgence of booming retail demand

Population of wealthy consumers is rapidly increasing The meteoric rise of the middle class pool in China is tied to a dramatic increase in its per capita income and it is a major driver to consumer spending growth. In 1Q10, per-capita disposable income for urban people hit RMB5,308, up 10% YoY. We expect China to sustain its strong economic performance going forward and to accelerate its expansion into the middle class population.


Hengdeli (3389 HK)

22 July 2010

Disposable income by income group in 2008

RMB 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Low Lower middle Middle Upper middle High

Income CAGR for different income groups in 2000-2008

16% 14% 12% 10% 8% 6% 4% 2% 0% Low Lower middle Middle Upper middle High

Source: China Statistical Abstract 2009

Source: China Statistical Abstract 2009

No signs of market saturation in tier-one cities

We anticipate Hengdeli will benefit from the improving propensity as more Chinese consumers trade up for higher quality consumer goods, in lockstep with the uptick of the economy. We therefore expect the total market size for luxury goods in China to expand at a rate far quicker than that for mass market products. China urbanization rate in 2002-2010F
18,858 17,068 14,909 12,719

China income per capita urban vs. rural in 2000-2009

RMB 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 2002 2003 2004 2005 Urban 2006 Rural 2007 2008 2009 3,449 3,582 4,040 4,631 5,025 8,177 9,061 5,791 6,701 7,116 11,321 10,129




30% 2002 2003 2004 2005 2006 2007 2008 2009 2010F

Source: CEIC

Source: CEIC

China and Hong Kong being the largest Swiss watch export market
According to the Federation of the Swiss Watch Industry, China now ranks fourth in terms of the world distribution of Swiss watch exports, with an aggregate value of CHF$482.7m in January-Jun 2010, up 91% YoY. China and Hong Kong combined accounts for 28% of watch exports from Switzerland during the same period. Both markets came significantly ahead of the US, which accounted for only 11% and was up only 13% YoY. China and Hong Kong continued to stand out in Swiss watch imports with the highest YoY growth rate of 69% and 59%, respectively, in Jun.


Hengdeli (3389 HK)

22 July 2010

Top 15 destinations of Swiss watch exports in January-June 2010

Ranking change Country Hong Kong Total value (CHF m) 1,408.7 757.7 504.3 482.7 469.7 398.0 361.3 356.4 278.4 274.1 154.5 152.2 131.3 106.6 90.2 YoY (%) 38 13 8 91 3 49 (9) (5) 24 8 9 49 23 25 18

US France +3 China -1 Italy +2 Singapore -1 Japan -3 Germany +1 United Arab Emirates -1 UK Spain +1 Taiwan South Korea Saudi Arabia Thailand Source: Federation of Swiss Watch Industry

The pace of recovery in Hong Kong and China has picked up markedly. With the surging demand for luxury watches in the local market and the weakening of consumer sentiment across the US and Europe, we anticipate China and Hong Kong will continue to top the chart and will capture additional market share in the watch export industry.


Hengdeli (3389 HK)

22 July 2010

Strong financial outlook

A strengthened sales pickup was evident in Hengdelis 1Q10 performance, with total sales up 35% YoY and 10% QoQ. April-June data were also encouraging, with China and Hong Kong sales surged by 25-40% YoY. The company indicated there was no setback in total spending by domestic consumers, despite concerns over wealth effect erosion following the recent flagging property and stock markets. Average ticket size for China is expected to grow by 10% per annum. Judging from January-June sales performance, we are confident that managements 30% YoY retail sales growth target in FY10F is well within reach.

China sales
We expect the core sales drivers for China for the coming years will be the high same-store sales (SSS) growth (approximately 10% for matured stores and average 70% SSS increase from the new stores) and the hastened store rollout. Currently, 30% of stores operated for more than three years have contributed to approximately 70% of total sales. The maturing of young stores will deliver strong SSS growth in the coming years (as high as 50-100%). We believe our 32%, 28% and 25% YoY retail sales growth projections for China in FY10-12F, respectively, look undemanding and highly achievable.

Hong Kong sales

Rising tourist arrivals in Hong Kong will benefit Hengdelis store traffic. In particular, China arrivals surpassed the overall growth and expanded 19% YoY in 1Q10 and 18% YoY in April. We foresee the number of tourist arrivals will increase further given the strong travel and consumption sentiment in China. Looking ahead, we expect Hengdeli sales in Hong Kong to rise at 26% YoY in FY10F and further expand by 21-24% YoY in FY11-12F.

Wholesale business
The wholesale business outlook is anticipated to remain sound given healthy industry development in China. Sales from this segment are expected to grow steadily by 12% in FY10F and 8-10% in FY11-12F and to contribute 18-22% to total sales in FY10-12F. Factoring in a strong organic sales growth assumption of 21-25% YoY in FY10-12F, we believe the rapid network expansion will further sustain the booming top-line growth for Hengdeli in FY10-12F. China will continue to be the core market, where we expect to contribute 71% of total sales, while Hong Kong will account for 29% of total sales in FY10-12F.


Hengdeli (3389 HK)

22 July 2010

Sales and earnings projections in FY06-12F

RMB m 12,000 10,000 8,000 6,000 4,579 4,000 2,405 2,000 199 0 2006 2007 2008 Net profit 2009 2010F Group total sales 2011F 2012F 418 460 365 589 744 931 5,516 5,899 7,397 9,084


Source: Company, CCBIS estimates

Uptrend in margins
Widening gross margin on rising contributions from retail business and mid-market products Gross margins for Hengdeli have trended fairly stable over the past few years since Swiss watch suppliers unified ASPs and strictly restrict retailers to grant discounts. Nonetheless, taking into account rising contribution from the retail business in China, we expect gross margin to steadily expand. In addition, given that mid-end watches yield higher gross profit margin (34-35% for Prime Time vs. 31% for Elegant), the increased contribution from mid-end watches will also enhance overall gross profit margin for the company. Margin trends in FY06-12F
35% 30% 25% 20% 15% 15.0 10% 5% 0% 2007 2008 Gross profit margin 2009 2010F 2011F 2012F China retail gross profit margin HK retail gross profit margin 14.7 18.9 18.9 18.9 18.9 22.5 23.9 23.9 24.7 25.1 32.1 32.8 32.1 32.8 32.9 33.0


Source: Company, CCBIS estimates

Approximately 80% of the new stores are expected to be brought through M&A, Hengdeli could thus avoid and minimize initial start-up losses, and hence we foresee Hengdelis operating profit margin to stay stable in the coming years, despite its aggressive store rollout plan. Overall, we forecast net profit growth of 61%, 26% and 25% in FY10-12F, respectively.


Hengdeli (3389 HK)

22 July 2010

Other earnings assumptions

Rental expenses. Hengdelis rent structure in China is similar to most retailers, with a fixed base rental on top of a share of ~15% of total sales. Ninety percent of Hengdelis shops are located in department stores and the rest are standalone or boutique stores. Since most new stores will be set up in tier-two and three cities where rents are relatively lower, we therefore model rental expenses to be well-contained within 8.2-8.4% of the total retail sales in FY10-12F as SSS accelerates. Major cost components remain stable Distribution expenses. Labor costs account for 5% of sales and Hengdeli has no direct exposure to the minimum wage impact as it has always been paying higher than minimum required salaries to workers. We have factored in a slight uptick in distribution costs from 10% of sales in FY09 to 10.1-10.3% in FY10-12F, due to the extended sales network and higher sales. Tax rates. The tax rate charged on Hengdelis domestic market is 25% and is expected to remain stable in FY10-12F. The tax rate charged for Hong Kong business is 17.5%. The blended effective tax rate for Hengdeli will hence be 20.9-21.7% in FY10-12F. Key assumptions
Year to December Sales growth by product (YoY, %) China retail sales Hong Kong retail sales Wholesale revenue After-sales services revenue Gross profit margin by product (%) China retail Hong Kong retail Wholesale After-sales services Other assumptions Number of stores Distribution expense as % of revenue Rental expense as % of retail revenue Administrative expense as % of revenue Effective tax rate (%) Source: Company data, CCBIS estimates 86 40 41 455 36 (3) 13 58 17 20 (19) (6) 32 26 12 10 28 24 10 10 25 21 8 10 2006 2007 2008 2009 2010F 2011F 2012F

32.1 14.7 23.4 33.8

32.8 18.9 24.8 32.4

32.1 18.9 25.9 33.8

32.8 18.9 27.1 34.0

32.9 18.9 27.7 34.0

33.0 18.9 28.4 34.2

96 7.3 9.1 4.1 27.3

168 6.8 6.6 3.4 19.9

217 9.5 8.5 4.6 21.1

270 10.0 8.7 4.1 24.8

330 10.0 8.4 4.1 20.9

367 10.2 8.3 4.1 21.5

400 10.2 8.2 4.1 21.7


Hengdeli (3389 HK)

22 July 2010

Profit and loss projections (RMB m)

Year to December Revenue YoY (%) COGS Gross profit YoY (%) Gross margin (%) Government grants Investment income (distributing JV with Swatch) Other income sub-total Distribution costs Administrative costs Total SG&A Key SG&A expense ratio (%) Distribution costs Administrative costs EBIT YoY (%) EBIT margin (%) D&A EBITDA YoY (%) EBITDA margin (%) Interest income Effective interest rate on deposits (%) Interest expense Effective interest rate on borrowings (%) Profit before tax Income tax Effective tax rate (%) Net profit YoY (%) Net margin (%) Source: Company, CCBIS estimates (1,842) 563 23.4 10 10 38 (176) (98) (280) 2006 2,405 2007 4,579 90 (3,549) 1,030 83 22.5 13 11 55 (312) (156) (483) 2008 5,516 20 (4,197) 1,319 28 23.9 15 16 50 (522) (253) (774) 2009 5,899 7 (4,490) 1,409 7 23.9 16 16 51 (590) (239) (831) 2010F 7,397 25 (5,570) 1,827 30 24.7 20 22 63 (743) (301) (1,044) 2011F 9,084 23 (6,801) 2,283 25 25.1 23 31 78 (922) (373) (1,295) 2012F 10,952 21 (8,150) 2,802 23 25.6 26 45 98 (1,121) (452) (1,574)

7.3 4.1 316 13.1 16 300 12.5 6 3.5 (27) 18.8 294 (80) 27.3 199 8.3

6.8 3.4 621 97 13.6 30 591 97 12.9 21 3.3 (60) 7.3 552 (110) 19.9 418 110 9.1

9.5 4.6 660 6 12.0 37 623 6 11.3 10 2.6 (114) 8.4 619 (131) 21.1 460 10 8.3

10.0 4.1 656 -1 11.1 35 622 (0) 10.5 5 1.5 (76) 5.8 514 (128) 24.8 365 (21) 6.2

10.1 4.1 848 29 11.5 38 810 30 10.9 9 1.5 (64) 5.8 781 (163) 20.9 589 61 8.0

10.2 4.1 1055 24 11.6 42 1,013 25 11.2 12 1.6 (66) 6.0 999 (215) 21.5 744 26 8.2

10.2 4.1 1297 23 11.8 47 1,250 23 11.4 15 1.7 (68) 6.2 1,256 (273) 21.7 931 25 8.5

Healthy financial position

Improved efficiency in cash conversion cycle Operating cash flow was in negative territory in FY06-08 due to a slow inventory cycle. Nonetheless, Hengdeli has turned operating cash flow from RMB111m outflow in FY08 to an inflow of RMB681m in FY09 on tightened inventory control and destocking. Management has implemented a more stringent control over inventory and working capital to assure positive operating cash flow going forward.


Hengdeli (3389 HK)

22 July 2010

Inventory management is the key to its retail business expansion, and initial batch of inventory accounts for about 90% of its store opening costs. Improving sales demand will help Hengdeli to clear inventory and keep inventory turnover days low. We assume Hengdelis inventory turnover days to steadily drop from 197 days in FY09 to 174-176 days in FY10-12F. Payables turnover also benefits from Hengdelis ability to sell watches more efficiently. Payable day has risen from 35 in FY08 to 43 in FY09 as a larger operating sales has given the company better bargaining power to request for longer credit term. We expect payable turnover days will improve further to 46-52 in FY10-12F. Going forward, we anticipate the cash conversion cycle to drop from 186 days in FY09 to 152-162 days in FY10-12F. Cash conversion cycle and working capital days
Days 220


191 174 152 151

179 177

197 186

176 162

175 157

174 152


88 56 44 40 34 36 35 33 43 32 46 32 49 31 52 30

0 2006 2007 2008 Cash conversion cycle Inventory turnover day 2009 2010F Trade payable turnover day 2011F 2012F Trade receivables turnover day

Source: Company, CCBIS estimates

Hengdeli budgets RMB130m capex in FY10F to support the addition of 50-60 stores opening. We forecast capex to be relatively steady at RMB110-120m for FY11-12F. Expecting Hengdeli will continue to generate positive operating cash flows going forward, we believe the company has ability to internally fund future capex and working capital needs. Cash on hand should remain sound at RMB1.1-1.5b in FY10-12F. RMB2b loan facility secured from CCB Moreover, China Construction Bank (939 HK, Not Rated), Shenzhen branch has also granted a RMB2b loan facility to Hengdeli for the next three years. We do not expect Hengdeli to draw down the facility given its financial position and operating cash flow. However, if any major acquisition opportunity arises, the company will have the financial ability to exploit.


Hengdeli (3389 HK)

22 July 2010

Operating cash flow, free cash flow and net cash flow projections
RMB m 1,000 800 600 400 200 0 (200) (400) (600) (800) 2006 2007 (31) (172) (126) (186) (269) (23) (205) (480) (662) 2008 Operating cash flow 2009 2010F 2011F Free cash flow Net cash flow 2012F 155 544 431 289 159 465 345 83 309


758 648

Source: Company data, CCBIS estimates

Key financial ratios

Year to December ROAE (%) ROAA (%) ROIC (%) Average inventory days Average receivable days Average payable days Cash conversion cycle (days) Net gearing (%) Gross gearing (%) Source: Company data, CCBIS estimates 2006 191 40 56 174 2 28 2007 25.6 13.1 26.0 151 36 34 152 9 69 2008 23.7 10.9 19.5 179 33 35 177 38 70 2009 14.7 7.6 16.9 197 32 43 186 Net cash 40 2010F 19.1 10.6 20.4 176 32 46 162 Net cash 33 2011F 21.0 11.7 22.0 175 31 49 157 Net cash 29 2012F 22.6 12.6 24.3 174 30 52 152 Net cash 25


Hengdeli (3389 HK)

22 July 2010

Balance sheet projections (RMB m)

Year to December Property, plant and equipment Intangible assets Investment properties Investment in jointly controlled entity Other investments Deferred tax assets Goodwill Non-current assets total Inventories Trade & other receivables Cash & equivalents Current assets total Bank loans & other loans Trade & other payables Current tax payables Current liabilities total Long term borrowing Other NC payables Minorities Non-current liabilities total Equity Total assets Total liabilities and equities Gross debt Net debt (cash) Net gearing (%) Source: Company data, CCBIS estimates 2006 251 33 0 5 0 25 181 495 1,262 331 375 1,969 388 371 74 833 22 0 136 1,472 1,472 2,464 2,464 410 35 2 2007 289 43 30 28 0 24 213 628 1,667 560 1,071 3,298 245 476 88 809 995 140 197 1,785 1,785 3,926 3,926 1,240 169 9 2008 529 43 28 31 1 40 228 900 2,447 450 685 3,581 760 584 70 1,415 716 18 236 2,096 2,096 4,481 4,481 1,476 791 38 2009 600 43 26 36 1 39 243 988 2,404 591 1,191 4,186 824 807 62 1,692 322 36 257 2,867 2,867 5,174 5,174 1,146 (45) Net cash 2010F 693 42 26 35 0 39 243 1,079 2,952 749 1,122 4,823 800 1,103 90 1,993 300 49 268 3,292 3,292 5,902 5,902 1,100 (22) Net cash 2011F 772 42 26 33 0 39 243 1,155 3,569 871 1,206 5,646 800 1,390 164 2,354 300 66 282 3,800 3,800 6,801 6,801 1,100 (106) Net cash 2012F 836 41 26 32 0 39 243 1,217 4,202 1,000 1,515 6,716 800 1,731 288 2,819 300 88 300 4,426 4,426 7,933 7,933 1,100 (415) Net cash


Hengdeli (3389 HK)

22 July 2010

Cash flow projections (RMB m)

Year to December EBIT D&A EBITDA Other non-cash adjustment Operating cash flow before changes in working capital Working capital changes: Inventories Trade and other receivables Trade and other payables Total working capital changes Interest received Interest paid Tax paid Operating cash flow Capex for acquisition of: Property, plant and equipment Intangibles Total capex Free cash flow Changes in pledged deposit Proceeds from issue of shares Dividend paid Net cash flow Net change in borrowings Gross cash flow Source: Company data, CCBIS estimates 2006 316 16 332 (7) 324 2007 621 30 651 (58) 593 2008 660 37 697 (80) 617 2009 656 35 691 (17) 674 2010F 848 38 886 (11) 875 2011F 1,055 42 1,097 (2) 1,096 2012F 1,297 47 1,344 14 1,358

(252) (87) 72 (267) 6 (27) (68) (31)

(353) (260) 35 (577) 22 (68) (96) (126)

(740) 96 72 (572) 10 (104) (157) (205)

42 (141) 222 124 5 (131) (128) 544

(548) (157) 309 (396) 9 (64) (135) 289

(617) (123) 304 (435) 12 (66) (142) 465

(633) (129) 364 (398) 15 (68) (149) 758

(140) 0 (140) (172) 53 455 (181) 155 (496) (341)

(60) 0 (60) (186) (7) 0 (76) (269) (620) (889)

(274) (1) (275) (480) (13) (6) (163) (662) (610) (1,272)

(110) (2) (112) 431 56 526 (153) 861 (1,093) (231)

(130) 0 (130) 159 0 0 (182) (23) (46) (69)

(120) 0 (120) 345 0 0 (262) 83 0 83

(110) 0 (110) 648 0 0 (339) 309 0 309


Hengdeli (3389 HK)

22 July 2010

Key investment risks

Losing distribution licences. While we do not discount the possibility of losing distribution licences upon expiry, we rate the chance of this occurring low due to the companys large retail network, leading role in the industry, and long-term harmonized relationship with major suppliers. Execution risks. Hengdeli has an aggressive plan to expand its retail network over the next three years by adding more than 100 stores. If it failed to secure ideal locations to open new stores or identify M&A targets, the expansion plan might postpone and sales growth may also be affected. Competition. Although the company has formed alliances with other leading watch retailers in China, there is a risk of a breakup of the alliance. In addition, the industrys upbeat prospects may attract new entrants into the luxury watch market. Yet, we find the entry barriers high because luxury watch brands are very cautious in selecting their retail agents. Hengdelis participation in the wholesale business for a number of watch brands gives the company a competitive edge over other competitors. Vulnerable to economic downturn. Although Chinese consumers spending power has become increasingly strong over the past few years, luxury watches are not basic necessities after all and therefore sales could be affected by the volatility of the economy. Despite this, in the medium to long term, we expect an uptrend in the luxury watch market segment given the growth of the middle class and change of consumption pattern.


Hengdeli (3389 HK)

22 July 2010

Appendix 1: Background
Well-connected and rich experienced luxury watch purveyor Hengdeli is a Chinese private company engaged in the wholesale and retail of timepieces of international brands throughout the Greater China region. The company was founded by Mr. Zhang Yuping, who has accumulated profound knowledge and extensive experience in Chinas watch market, having worked with Huzhou Shi Hua Qiao Merchandises Supplying Company for 12 years. At this state-owned enterprise involved in the wholesale and retail of electrical appliances, he was responsible for the sourcing, purchasing, importing and exporting of watches. Mr. Zhangs family started the business by investing in Beijing Hengdeli Timepieces in 1997. In 2006, the company acquired Elegant International, a well-established luxurious watch retail operator with four shops in Hong Kong, to expand the retail business outside of China. Through subsequent investments in watch wholesalers and retailers in other cities and the reorganization of the group, the company has become the leader in Chinas watch industry with a distribution of 300 wholesales customers in over 50 cities and 300 retail outlets throughout China, Hong Kong and Taiwan.

Distribution network
Owning 300 stores across Greater China Hengdeli has an extensive retail network in China, comprising 300 retail shops in 20 provinces. Beijing, Zhejiang, Heilongjiang and Shanghai are the four largest markets, accounting for approximately 60% of total retail space. The company has also formed strategic alliances with other large watch retail chains, namely Shanghai San Lian Group, Shanghai Oriental Commercial Building and Shenzhen World Brand Watches, to maintain a stable market environment and avoid price war. Distribution network


Liaoning Xinjiang Beijing Tianjin Hebei Shanxi Shandong


Henan Anhui Hubei

Jiangsu Shanghai

Sichuan Chongqing Hunan <5 stores 5~10 stores 11~20 stores >20 stores Yunnan Guangxi Guangdong Guizhou Jiangxi



Source: Company


Hengdeli (3389 HK)

22 July 2010

Diversified brand portfolio to capture different customers

The company distributes about 50 renowned brands of watches in China, targeting at the middle-to-high income groups. Selling price ranges between RMB5,000 and RMB50,000. Currently, Hengdeli owns 20 wholesale rights, of which 18 are on an exclusive basis. The company sells a range of international brands through its retail network, including Omega, Rolex, Tissot, Longines, and TAG Heuer. These brands are not only gaining high traction in China, but also attract different segments of customers. Hengdeli also has their own brands such as OMAS, OLMA and NIVADA, with selling price at RMB2,000-7,000 to target the younger generations. As an integral part of the retail business, the company operates a customer service line to provide top-notch professional after-sales services.

In-house repair centre to provide professional maintenance service

All-round services available The company always focuses on the provision of after-sale services. Apart from the establishment of two major service centers in Beijing and Shanghai, Hengdeli also provides real-time maintenance services in each retail store. Hengdelis customer service department was established in 2007, providing all-round services through repair and maintenance service centers, repair service stations and repair service points to all customers in China and Hong Kong. The company has also set up a Hengdeli Customer Services Hotline dedicated as the unified access by external parties for the services of the company.


Hengdeli (3389 HK)

22 July 2010

Appendix 2: SWOT and Porter analysis

SWOT analysis
Extensive experience and knowledge of importation and retailing of luxury watches in China. Strong brand name recognition and leading market position in China and Hong Kong. Good and long relationships with major watch brands. Established shop network in China; secured prime locations for store distributions.

Vulnerable to economic downturn. Revenue mainly driven from China market.

Rising demand for luxury watches, especially in the second-tier cities, as urbanization has increased and the middle income group expanded over time. Local retailers with poor operations offer acquisition or cooperation opportunities. Aggressive expansion to capture further market share.

Keener competition than in the past as the strong watch market prospects may attract new entrants. Foreign brand distributors opening their own shops to capture more business opportunities.


Hengdeli (3389 HK)

22 July 2010

Porters five forces

Suppliers bargaining power: High
Supplier concentration is relatively high as the core watch suppliers are from Switzerland. ASPs are determined by the Swiss watch suppliers, and distributors are not allowed to grant discounts to customers. Hengdeli is hence a price taker and sources watches locally from Swiss watch suppliers. Yet, this policy has set as a regulation for all exported Swiss watches, no differentiation between other distributors.

Threat of substitute: Low to moderate

Watch can be viewed as a necessity in daily life for timekeeping purpose, and has also gradually turned into a popular accessory. The watch market is enormous and fragmented in China, however, there are only few sizable and reputable luxury watch retailers and Hengdeli is the leader among them. Hengdeli also owns the largest luxury watch retail network in China as well as a remarkable clientele over years. Moreover, buyer inclination to substitute foreign brand watches with local brand watches is minimal, given the heightening brand consciousness.

Rivalry among existing companies: Low to moderate

Many retailers hope for a share in the fast growing luxury watch industry in China, yet it is quite difficult for one to establish a sizable scale compared to Hengdeli. It is hard for peers to build a strategic alliance with top Swiss watch suppliers as they are very cautious in screening distributors. Hengdeli is one of the few that has been able to maintain a solid bond with these top Swiss watch makers which has priority in watch supply and delivery. Moreover, many customers prefer to shop at Hengdelis stores which offer a diversified brand portfolio of mid-to-high end watches covering all major consumer segments while others have limited product mix. Customers are also confident that Hengdeli products are authentic with high quality.

Threat of new entrants: Low

It is very difficult for new players to secure distribution rights or access to Swiss watch suppliers due to a lack of connection. Since Swiss watch suppliers are extremely strict in terms of sourcing, they may only supply limited products to local watch retailers. Moreover, brand identity is exceptionally important for luxury watch retailers, since their brand reputation signifies the assurance of quality and authenticity. The creation of brand identity requires a long period of operation in the market where new players may struggle with.

Buyers bargaining power: Low

Since all Swiss watches have a unify ASP, there is little room for buyers to bargain for discounts across the board. Buyers of luxurious items are relatively less price sensitive since they have high spending power, and a minor price increment will not affect their purchasing sentiment.


Hengdeli (3389 HK)

22 July 2010

Appendix 3: Management biography

Executive Directors
Mr. Zhang Yuping (Alia, Cheung Yu Ping) Chairman and Executive Director
Founded the company in 1999, he is in charge of the overall management and strategic development. He has more than 20 years of experience in the high-end consumables distribution industry for the China market.

Mr. Song Jianwen Executive Director

He is in charge of finance and investment of the company. Mr. Song graduated from Zhongnan Finance Economics University with a master degree in economics. He joined the company in 2001 and has over 10 years of experience in finance and accounting.

Mr. Huang Yonghua Executive Director

He is in charge of the companys business coordination and operational supervision. Joined the company in 2001, Mr. Huang has more than 10 years of experience in the watch distribution industry and management for Chinas market.

Senior Management
Mr. Zhuang Liming Vice Chairman of Shanghai Xinyu
After graduating at Beijing Foreign Trade College, he had worked for Chinas Light Industry Commodities Import and Export Company before joining the company in 2000.

Ms. Wang Lingfei Deputy President

Ms. Wang is responsible for work in brands. Before joining the company in 2005, she was the deputy general manager of Beijing Yishang Group.

Mr. Lee Wing On, Samuel Deputy President

Mr. Lee is responsible for retailing in Hong Kong. He joined the company in 2006 and has over 20 years of experience in the Hong Kong watch retail industry and management for the Hong Kong market.

Mr. Stan Lee Deputy President

Mr. Lee is responsible for retailing in the mainland. Joining the company in 2007, he has over 20 years of experience in watch manufacturing and distribution.


Hengdeli (3389 HK)

22 July 2010

Rating definitions Outperform (O) expected return 10% over the next twelve months Neutral (N) expected return between 10% to 10% over the next twelve months Underperform (U) expected return < -10% over the next twelve months
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