Asia-Pacific Equity Research

Consumer discretionary abc

July 2012

Consumer
discretionary
Consumer discretionary team
Erwan Rambourg* Sean Monaghan*
Head of Consumer Brands & Retail Equity Research Senior Gaming and Southeast Asia Analyst
The Hongkong and Shanghai Banking Corporation Limited The Hongkong and Shanghai Banking Corporation Limited,
+852 2996 6572 erwanrambourg@hsbc.com.hk Singapore Branch
+65 6658 0655 seanmonaghan@hsbc.com.sg
Chris Zee*
Consumer & Retail Analyst, Greater China Permada Darmono*
The Hongkong and Shanghai Banking Corporation Limited Southeast Asia Analyst
+852 2822 2912 chriscmzee@hsbc.com.hk The Hongkong and Shanghai Banking Corporation Limited,
Singapore Branch
Christopher K Leung*
+65 6658 0650 permada.w.darmono@hsbc.com.sg
Consumer & Retail Analyst, Greater China
The Hongkong and Shanghai Banking Corporation Limited Karen Choi*
+852 2996 6531 christopher.k.leung@hsbc.com.hk Consumer Analyst, Korea
The Hongkong and Shanghai Banking Corporation Limited,
Lina Yan*
Seoul Securities Branch
Dept Store and Food Retail Analyst, Greater China
+822 3706 8781 karen.choi@kr.hsbc.com
The Hongkong and Shanghai Banking Corporation Limited
+852 2822 4344 linayjyan@hsbc.com.hk Jena Han*
Associate, Korea
Cathy Chao*
The Hongkong and Shanghai Banking Corporation Limited,
Consumer & Retail Analyst, Greater China
Seoul Securities Branch
The Hongkong and Shanghai Banking Corporation Limited
+822 3706 8772 jenahan@kr.hsbc.com
+852 2996 6570 catherinefchao@hsbc.com.hk
Amit Sachdeva*
Consumer & Retail Analyst, India
HSBC Securities and Capital Markets (India) Private Limited
+91 22 2268 1240 amit1sachdeva@hsbc.co.in

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

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Sector structure

July 2012
Consumer discretionary
Asia-Pacific Equity Research
Consumer Discretionary Asia

Dept Stores Specialty Retail Gami ng Textiles, Apparel and Footwear

Inti me Gome Sands China Belle

Golden Eagle Suning Galaxy Entertainment Daphne
Lotte Shopping SaSa Wynn Macau Fast Retailing
Shinsegae Hengdeli SJM ABC-Mart
Parkson Retail Asia Chow Tai Fook Melco Crown Prada
Lifestyle L uk Fook MGM China Li & Fung
Hyundai Dept Store T itan Industries Genting Si ngapore Yue Yuen
Ks Holdings Kangwon Ports Design
Himart Paradise Li Ning
Mitra Adiperkasa Grand Korea Leisure Anta
Giordano
Source: HSBC

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 Sector price history

July 2012
Consumer discretionary
Asia-Pacific Equity Research
350 Oct-Nov 2009:
Wynn Macau and Sands China list in Hong Nov 2011:
Kong; led to rally in 2010-11 reflecting very China consumer
strong growth in the Macau gaming market confidence reaches
historical low
300 Aug 2010:
Li & Fung
acquires IDS
Aug 2009:
Belle sells Fila brand's Greater
250 China trademark and
operations to Anta Sports

200

150

Regulatory risks cause share price

pressure for Korean dept stores
Jun 2011:
100
Korean dept stores forced to
disclose commission rates
Sept 2011:
Forced to cut rates towards SMEs

50 Dec 2006:
Genting Singapore rallies on the back of Apr 2012:
winning the right to build up casino; share Korean discount stores forced to
price broadly rising leading up to opening of close two Sundays a month
casino in 2010
0
Jan-2000 Jan-2001 Jan-2002 Jan-2003 Jan-2004 Jan-2005 Jan-2006 Jan-2007 Jan-2008 Jan-2009 Jan-2010 Jan-2011 Jan-2012

MSCI Asia ex Japan Index MSCI Asia ex Japan - Consumer Discretionary Index

Source: MSCI, Bloomberg (index base = 100 starting Jan-2000), HSBC

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Consumer Discretionary: EBIT margin asset turnover (2010-11)

July 2012
Consumer discretionary
Asia-Pacific Equity Research
2.8
9.3%

2.6 High asset turn efficient SaSa

volume driven strategies High asset turn and high
margins; profitable industry
2.4 leaders strategies

2.2
Maruti Suzuki India Ltd
2.0 SJM Holdings Ltd.
Kia Motors
1.8 Titan Industries Ltd Hero MotoCorp
LG Electronics
Asset Turnover (x)

TAN Chong Bajaj Auto

1.6
Li Ning Wynn Macau Limited
Mando Corporation UMW Holdings
1.4 Chow Tai
Parkson Retail
Daphne
Gome Electrical Esprit Mitra MGM China
1.2 Merry Electronics Belle
Tata Motors L'Occitane Anta Sports
Pou Sheng Hyundai Mobis
Techtronic Ind 0.93x
1.0
Galaxy Entert Yue Yuen Woongjin Coway Xtep Int'l China Lilang Limited
Hengdeli Holdings Ltd
Shinsegae Geely Auto Great Wall Motor
0.8 Lotte Shopping Ports Design Ltd. Samsonite Intl SA
Prada SPA SM Entertainment High margins; niche
Nexen Tire Corp Hankook Tires players or brands with
Hyundai Motor Sands China Ltd
0.6 strong pricing power
Hathway Cable Brilliance Trinity Ltd Xinyi Glass
Minth Group China Dongxiang
Dish Tv India Ltd Cheil Worldwide Pacific Andes Resources Educomp
0.4 Hyundai Department Golden Eagle
Melco Crown Parkson
Low ROA companies. Mandarin Oriental Intl Genting Singapore
New World Department Stor Genting Malaysia
0.2 Business restructuriung may GAC Group Maoye
Intime Department Store
Shangri-La Asia Ltd
be required Genting Berhad

-
-20% -10% 0% 10% 20% 30% 40% 50% 60%
EBIT Margin (%)

Source: Thomson Reuters Datastream, HSBC

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 Asia-Pacific Equity Research
Consumer discretionary abc
July 2012

Because of the sectors diversity, we split it into three segments consumer discretionary, consumer Erwan Rambourg*
Head of Consumer Brands &
staples and autos. Retail Equity Research
The Hongkong and Shanghai
Sector description Banking Corporation Limited
+852 2996 6572
erwanrambourg@hsbc.com.hk
This sector comprises businesses that sell non-essential goods and services. These include retailers,
*Employed by a non-US affiliate
consumer services and consumer durables as well as apparel and auto manufacturers. Consumer of HSBC Securities (USA) Inc,
discretionary is the opposite of consumer staples, which consists of businesses that sell necessities like and is not registered/ qualified
pursuant to FINRA regulations
food. It includes many small and medium-size market cap retailers, supermarkets, footwear brands, and
apparel companies but the largest companies are car manufacturers such as Hyundai Motor and Hyundai
Mobis in Korea (see separate autos section). Consumer discretionary constitutes 10% of MSCI Asia ex
Japan and is one of Asias best performing sectors in the last decade, outperforming the index by 3.3x.

Key themes
The sector relies on consumers to spend that part of their income that is disposable, so it performs better
when the economy is doing well and generally reflects the prevailing level of consumer confidence. The
savings rate the percentage of disposable income that is not spent is an important determinant of
future household disposable income. An increase in the savings rate means less consumer spending, with
a knock-on effect on GDP and household income. Inflation and rising interest rates are key themes.
Higher rates tend not to be conducive to discretionary spending. Although domestic growth conditions are
a big factor, they show a low correlation with domestic liquidity conditions (M2, the broadest measure of
money supply). This could be a reflection of two factors strong secular growth and the small and mid-
cap nature of many companies.

Sector drivers
Department stores
Drivers include urban development and changes in the competitive landscape as well as choosing the
right expansion strategy.

Gaming
The primary drivers of growth in the gaming industry include:

Regulation: government regulations determine the size, structure growth and profitability of the legal
gaming industry

GDP growth: general economic growth will determine the extent of expenditure by domestic
residents as well as the extent of tourism.

The VIP casino gaming segment for high-rollers. The quality of facilities can also matter.

Luxury goods
Status and brand awareness are big factors as are global travel (the Chinese spend heavily on luxury
goods when abroad) and the increased spending power of women (The future is female is a theme we
have written about extensively).

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Consumer discretionary abc
July 2012

Specialty retail
Rising wages, food quality and the growth of urbanisation and the middle class are important factors.

Manufacturing
Most manufacturers operate on a cost-plus model and their revenue/margin is generated from a
combination of price increases, volume growth and product mix. The primary driver for volume growth is
the demand from the US and Europe, and manufacturers in general are sensitive to the health of the global
economy. Capital expenditure is also key. Mild inflation tends to be positive for manufacturers but higher
inflation typically puts pressure on margins as they have limited pricing power to pass on cost increases.

Apparel and footwear

Urbanisation and rising incomes are the two major growth drivers. In China, urbanisation is the biggest
structural driver for this consumer segment. According to our HSBC Economics Research Team, Chinas
urban middle class is on the rise, with the proportion of the urban population with a household income of
more than RMB55,000 (USD8,500) increasing from 64% in 2006 to 85% in 2010.

Key segments
China Department Stores
Chinese retail is a highly competitive business experiencing strong growth. A combination of urban
development, rising incomes and increased brand awareness is rapidly changing how and where
consumers shop. Growth in supermarkets is slowing as hypermarkets such as Wal-Mart and Carrefour
have emerged to compete with local supermarket chains and department stores.

Korea Department Stores

Retailers and department stores are an important part of the consumer discretionary sector. In Korea this
segment is dominated by Lotte Shopping (market share of 44% in 2011), Shinsegae (19%) and Hyundai
Department Store (21%). Koreans have shown an increasing desire to shop at department stores. Our
analyst Karen Choi believes this relates to status consciousness and a preference for luxury goods even at
the expense of daily necessities. There has been a rise in the number of purchases and the average price
per purchase at department stores. This is why department stores have performed better than discount
stores. But domestic growth is slow and some stores are looking for opportunities outside Korea.
Experiences are mixed as many entered China with the wrong product mix and found it difficult to
become competitive. Some have started to exit the China market.

Gaming
The market cap of the Asian gaming industry is USD100-150bn, with the majority represented by listed
casino companies (e.g. Sands China, Genting). Asia accounts for the largest portion of the total market
cap of the global gaming industry and is the primary earnings driver of large US-listed companies such as
Las Vegas Sands, Wynn Resorts and MGM Resorts International. On a geographic basis the gaming
industry in Asia can be segmented as follows:

Japan: This is largely limited to gaming equipment and game suppliers including listed companies such
as Universal. There are no listed casino operators in Japan.

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 Asia-Pacific Equity Research
Consumer discretionary abc
July 2012

Korea: The largest listed companies are Kangwon, Paradise, and Grand Korea Leisure.

Macau: Macau is the largest casino gaming market in the world and has six casino concessionaires: SJM,
Galaxy, Melco Crown, MGM China, Sands China, and Wynn Macau.

ASEAN: The ASEAN region includes the worlds second largest casino market (Singapore) as well as
new frontiers such as the Philippines and Vietnam. The Genting Group, which is the largest Asia based
gaming company, includes listed companies. Other major listed companies include Naga Corp which is
the largest casino company in Cambodia, Alliance Global, Bell Corp, and Bloomberry Resorts.

Manufacturing
The manufacturing sector is usually broken down according to product segments, as they can have
different raw material pressures and demand-side dynamics. Common product segments include apparel,
footwear, and leather goods. There are also companies that act as sourcing agents (e.g. Li & Fung).

Chinas labour costs have risen sharply in the past five years. This, coupled with structural changes in
environmental, land rights and social policies (pension plans), has increased operating costs for light
manufacturing plants in southern China (e.g. Shenzhen, Dongguan). Many of these plants have moved to
the mid-west of the country (e.g. Anhui province). There has also been continuous industry consolidation
as larger companies seek higher market share. Companies have also been moving from China to countries
which may be more cost-efficient for lower-skill production (e.g. Bangladesh, Vietnam and Indonesia).

China apparel and footwear

The apparel segment is typically broken down into gender/age categories (mens, womens, children) and
style (formal, casual). Footwear can be categorised as brand shoes, casual and athletic shoes. This
segment has enjoyed gradual revenue and margin growth in the past three years, driven by positive
operating leverage (high revenue growth while operating costs were contained). However, on the back of
economic growth concerns and high operating costs (rents, labour, marketing expenditure), margin
pressure emerged in 2012. Selected companies have implemented measures to mitigate the cost pressure.
For example in China, Belle and Daphne have more realistic store opening schedules and have contained
headquarters and administrative expenses.

In footwear, competition is on the rise, especially in sports shoes. This has led to rising inventories and
intensifying promotion and branding activities. In 2011 Li Ning, a leading domestic sports brand, started
to take back old logo products from distributors to speed up the clearance of excess inventory. It is also
opening more discount stores. In the ladies shoes segment, Belle, a market leader in both ladies and
sports shoes in China, is gradually expanding into other shoe categories, such as mens, childrens and
mass market. Foreign brands in China still have a limited presence, likely due to high start-up costs and
the difficulty of establishing a distribution network. Their products so far have only proved suitable for
more affluent consumers in first tier cities.

Luxury goods
This is becoming an increasingly important sub-segment, particularly in China. Growth in Asia-ex Japan
was 35% in 2011 and we expect this to normalise now that the base is bigger thanks to improved
distribution. First-time buyers still account for about 65% of sales of luxury brands in China.

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Consumer discretionary abc
July 2012

Southeast Asia
In Indonesia and Thailand the combination of low household leverage and rising wages makes consumers
much less sensitive to interest rates. Indeed, some of this growth is driven by higher soft commodity
prices, which supports rural income growth in Southeast Asia. As a result, demand for cars and
motorcycles has remained strong despite rising rates.

Valuation
Consumer discretionary has typically traded at 10-15x PE. Even in the 2008 financial crisis valuations
were rarely lower than 10x; in 2007 valuations peaked a touch above 20x. ROEs for the sector are on the
rise, moving to what appears to be a peak of 18% in 2011. Consequently, PB multiples have also moved
higher to over 2.2x. At the trough, the sector traded at 1.2x book value.

Price-to-earnings (PE) is the most common valuation methodology to value Chinese consumer branded
companies as it can better capture the companys earnings growth momentum and is easy to compute.
PEG can also be used when the visibility on growth is high and relevant. Price-to-book (PB) may also be
used for manufacturers, given that their growth momentum is not as high and they hold a significant
amount of property, plant and equipment.

To value companies in the Korean retail sector, we use EV/EBITDA as opposed to PE or PB, as we
believe it best captures the growth momentum of the sectors core business. Retail sales growth is
reflected purely at the operating level for each company; non-operating items are not factored in. The
Korean consumer sectors typical asset holdings (such as the value of the subsidiaries and non-core
assets) require a separate sum-of-the-parts analysis to properly value the enterprise structure.

Consumer Discretionary Growth and profitability (calendarised data)

2008 2009 2010 2011e 2012e
Growth
Sales -2.2% -0.7% -0.9% 21.8% 7.5%
EBITDA -2.6% 5.7% 11.2% 35.9% 13.2%
EBIT -4.7% 22.5% 27.8% 42.1% 13.3%
Net profits 22.1% -1.9% 63% 36.5% 14%
Margins
EBITDA 9.7% 10.3% 11.6% 12.9% 13.6%
EBIT 5.4% 6.7% 8.6% 10.1% 10.6%
Net profit 5.2% 5.2% 8.5% 9.5% 10.1%
Productivity
Capex/sales 8% 6% 5% 5% 5%
Asset turnover (x) 0.8x 0.9x 0.5x 0.4x 0.3x
Net debt/equity 1.3x 0.9x 0.5x 0.4x 0.3x
ROE 19% 18% 19% 21% 20%
Note: based on all HSBC coverage of Consumer Discretionary; each figure represents the market cap-weighted average across the sector
Source: Company data, HSBC estimates

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 Asia-Pacific Equity Research
Consumer discretionary abc
July 2012

Sector snapshot
Key sector stats Core industry driver: Retail sales growth
4,000 35%
Consumer discretionary 31% of MSCI Asia ex Japan
30%
Trading data 3,000 25%

RM B b illio n
ADTV (USDm) 3,121 20%
Aggregated market cap (USDm) 751,842 2,000
15%
Performance since 1 Jan 2000 10%
Absolute 64% 1,000
5%
Relative to MSCI Asia 1.6x
3 largest stocks Hyundai Motor,Kia Motors, - 0%
Hyundai Mobis Jan-10 Jun-10 Nov -10 Apr-11 Sep-11 Mar-12
Correlations (5-year) with Retail sales v alue (China) y oy grow th
MSCI Asia 0.98
Source: China National Bureau of Statistics, HSBC
Source: MSCI, Thomson Reuters Datastream, Bloomberg, HSBC

PE band chart
Top 10 stocks
1000 P rice level 20x
Stock rank Stocks Index weight 900
1 Hyundai Motor 13.0% 800 15x
2 Kia Motors 7.3% 700
3 Hyundai Mobis 6.7% 600
4 Astra International 6.4% 500
10x
5 Li & Fung 4.5% 400
6 Sands China 3.5% 300
7 Belle International Hdg 3.2% 200 5x
8 Genting Singapore 3.0% 100
9 Genting Berhad 2.7% 0
10 Tata Motors 2.7%
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Source: MSCI, Thomson Reuters Datastream, HSBC

Source: MSCI, Thomson Reuters Datastream, HSBC

Country breakdown
Country Weights (%)
PB vs ROE
Korea 37.2
Hong Kong 15.1 20 2.6
China 14.5
India 7.8 18 2.2
Singapore 6.6 16
Indonesia 6.1 1.8
Taiwan 6.1 14
Malaysia 5.6 1.4
Thailand 0.6 12
Philippines 0.4 10 1.0
Source: MSCI, Thomson Reuters Datastream, HSBC
Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Fw d ROE % (LHS) Fw d PB (x )

Source: MSCI, Thomson Reuters Datastream, HSBC