initiation of hengdeli (3389 hk) 22 jul 2010

7/29/2019 Initiation of Hengdeli (3389 HK) 22 Jul 2010

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China/Hong Kong

Consumer Discretionary

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

Hengdeli (3389 HK) 22 July 2010

Tick Tock taking the spot

Company Rating:

Sector Rating:

Outperform(initiation)

Overweight(maintained)

Hengdeli is China’s 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 country’s 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 Hengdeli’s multi-brand

strategy or chase up its aggressive expansion.

Grasping the potential from second- and third-tiercities. The booming Chinese economy has spurred the

country’s 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 2010F 2011F 2012F

Revenue (RMB m) 5,516 5,899 7,397 9,084 10,952

Net profit (RMB m) 460 365 589 744 931

EPS (RMB) 0.185 0.094 0.145 0.183 0.229

EPS (YoY, %) 10 (49) 54 26 25

PER (x) 16.5 31.3 20.2 15.9 12.8

Yield (%) 1.9 0.9 1.4 2.0 1.7

FCF yield (%) (2.2) (0.6) (1.5) 1.5 2.7

ROAE (%) 23.7 14.7 19.1 21.0 22.6

Net gearing (%) 38 Net cash Net cash Net cash Net cash

Source: Company, CCBIS estimates

Price: HK$3.35

Target: HK$4.15

(initiation)

Trading data

52-week range HK$1.7 – 3.9

Market capitalization (m) HK$13,631/US$1,753

Shares outstanding (m) 4,069

Free float (%) 33

3M average daily T/O (m share) 6.8

3M average daily T/O (US$m) 2.9

Expected return (%) – 1 year 25.3

Closing price on 22 July, 2010

Stock price and HSCEI

0

1

2

3

4

5

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

HK$

H en gd eli H SC EI

Source: Bloomberg

Claudia Ching(852) 2532 [email protected]

Forrest Chan CFA(852) 2532 [email protected]

Warren Wang(852) 2532 [email protected]

Timothy Sun

(852) 2532 [email protected]




2

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




3

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, Hengdeli’s strong brandrecognition, 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, andtowards 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, China’s 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




4

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

China’s 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 tothe 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 Hengdeli’s 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 Hengdeli’s market share will continue to

expand.

2008 global Swiss watch retailers’ retail revenue (RMB b) 2008 market share of wholesalers/retailers in China

3.7

3.1

2.42.3

2.1

1.5 1.5

1.00.8

0.6 0.5 0. 5 0.4

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

H e n g d e l i

S i g n e t

B u r c h e r e r

P r i n c e

O r i e n t a l

E m p e r o r

T o u r n e a u

K i n g F o o k

H a r m o n y

M o v a d o

T i m e C i t y

F o r m o s a T i m e s

S i n c e r e

RMB b

Oriental

6%

Time City

5%

Harmony

7%

Hengdeli

30%

Others

52%

Source: Company Source: Company




5

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. Hengdeli’s successful business model is extremely difficult for other industryplayers to replicate and hence it is unlikely for others to overtake Hengdeli’s market

leadership in the foreseeable future. The success of Hengdeli is supported by the

following factors:

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

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.

Hengdeli’s 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-endconsumable distribution industry in China, we believe Hengdeli will continue to benefit

from the management’s 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.

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 world’s 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.

Five distinctive competitive

edges where competitors are

incomparable

High recognition nationwide

Experienced management team

with proven track record




6

While non-exclusive, we believe the distribution partnerships with Swatch Group and

LVMH remain guarded given the strategic alliance with major suppliers in Hengdeli’s

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 confidencein Hengdeli and the strategic ties provide a distinctive competitive advantage for

Hengdeli.

Hengdeli’s shareholding structure

Zhang Yuping(Chairman)

Public Swatch Group LVMH Group

Hengdeli Holdings Ltd.(3389 HK)

44.75% 39.52% 8.90% 6.83%

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.

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).

Hengdeli’s brand portfolio

Exclusive brands Non-exclusive brands

Swatch Group Tissot, Calvin Klein, Certina, Hamilton, Mido,

Breguet, Longines

Omega, Rado, Blancpain, Glashutte,

Jaquet Droz

Rolex Group Rolex, Tudor

LVMH TAG Heuer, Zenith, Christian Dior, Fendi

Richemont Jaeger-Lecoultre, Baume & Mercier Alfred Dunhill, Panerai, Cartier,

Vacheron Constantin, IWC

Independent brands Maurice Lacroix, Carl. F. Bucherer,

Claude Bernard

Edox, Enicar, Carven, Ball, Gucci, Oris,

Raymond Well, Frank Muller, Hermes,

Girard Perregaux, Grand Seiko, Jean Richard,

MONTBLANC, Parmigiani,

Ulysse Nardin, Cyma

Source: Company

Unique shareholding structure

with suppliers being a substantial

shareholder

Providing the hottest brand

offerings




7

Extensive customer coverage through effective brand building

Hengdeli possesses the rare scale required for adopting a multi-brand strategy to

maximize customer exposure. Hengdeli’s retail network is mainly classified under

three categories of multi-brand shops, namely Xinyu Elegant, Xinyu Prime Time, andXinyu Temptation. The company also operates mono-brand boutiques.

The multi-brand business model is another unparalleled example that reflects

Hengdeli’s leadership in the luxury watch market in China. Given Hengdeli’s 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.

Hengdeli’s 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 TaiwanPrime Time 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

Temptation The trend setter of watches, bringing fashionable and niche yet classy watches for the youngsters

ASP: RMB5,000-8,000

Mono-brand boutique

stores

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.

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 company’s 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.

Three distinct store brands to

capture different consumer

segments and expand saleschannels




8

Prudent new stores opening

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 50-60stores in FY10F and 30-40 annually in FY11-12F. By 2012, Hengdeli’s store portfolio

should reach over 400 stores, far exceeding other competitors.

Number of stores in 2007-2012F

166210

257315 350 3802

7

20

17

15

13

42

38

35

33

0

50

100

150

200

250

300

350

400

450

2007 2008 2009 2010F 2011F 2012F

Mainland China Hong Kong Taiwan

Source: Company data, CCBIS estimates

Second-tier city stores, in particular, have fared well the past two years and delivered

increasing profit contribution to the company. We predict Hengdeli’s reliance on these

cities will continue increase over time and they will be the main growth driver for the

company.

Revenue by city tiers Number of stores by city tiers

3731

26 24 23 22 21

58

5761 61 62 62 63

512 13 15 15 16 16

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2006 2007 2008 2009 2010F 2011F 2012F

Tier-one Tier-two Tier-three

3223 21 17 15 13 11

57

5955

56 57 58 59

1118

24 27 28 29 30

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2006 2007 2008 2009 2010F 2011F 2012F

Tier-one Tier-two Tier-three

Source: Company data, CCBIS estimates Source: Company data, CCBIS estimates

Capture the affluent

middle-income customers

Burgeoning middle class

provides a strong sales catalyst




9

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 Hengdeli’s new stores will come under the Prime Time

label. Expansion will be centered at second- and third-tier cities in the North Easternregion, e.g. Shenyang and Tianjin, as well as Eastern China, e.g. Sichuan, and

Southern China region, e.g. Nanchong and Jiangxi.

As urbanization continues, we are positive on Hengdeli’s strategy in extending

penetration into the second- and third-tier cities. In our view, consumers in those cities

make up the bulk of Hengdeli’s 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

Hengdeli’s mid-end watches offering.

Unique expansion model to maximize chance of success

It is expected that 80% of Hengdeli’s 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 company’s 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 Hengdeli’s

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.

Hengdeli’s 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 Hengdeli’s 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 Location Shop network

No. of

outlets

Stake of

Hengdeli

Acquisition

valuation Major brand portfolio Acquisition date

Taiwan Jing Guang

Timepiece Holdings

Taiwan Taipei, Taichung, Kaohsiung 31 80% 6x Omega, Rado, Tissot October 2009

Guangzhou Rui Yue Guangzhou (Central China) Hubei, Hunan, Tianjin 9 60% ~ 5x Tudor, Longiness, Rado June 2010

Shi Quan Shi Mei Liaoning (NE China) Shenyang 21 75% ~ 5x TAG Heuer, Zenith, Hamilton June 2010


Well-positioned to capture future

growth through penetrating into

second- and third-tier cities

Secured two deals in 1H10




10

Valuation

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 positivefree 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 Hengdeli’s. Factoring in stronger network and scale

with higher earnings CAGR, we believe Hengdeli deserves to command a premiumvaluation versus the local watch and jewellery retailers.

Similarly, when comparing local watch retailers with China specialty retail players, we

find Hengdeli’s current valuation undemanding. Given its above sector average’s

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)

11

Valuation summary

Share price Market cap 3M average value traded EPS growth (%) # PE (x) PE/G (x) Yield

Company Ticker (Local currency) (US$m) (US$m) CY10 CY11 CY10 CY11 CY11 CY1

International jewelry & watch

LVMH MC FP 89.68 55,393 168.44 26 15 19.2 16.7 0.8 2.1

Swatch UHR VX 321.20 16,156 61.53 23 15 18.0 15.7 0.8 1.5

Tiffany TIF US 39.21 4,986 128.04 NA 14 15.4 13.5 NA 2.1

Bulgari BUL IM 6.23 2,364 17.83 NA 63 35.0 21.4 NA 1.3

Hengdeli* 3389 HK 3.35 1,749 2.89 54 27 20.2 15.9 0.4 1.4

Average 34 27 21.6 16.6 0.7 1.7

China specialty retailers/other brands

Belle* 1880 HK 11.88 12,859 21.43 23 5 28.1 26.7 1.9 0.9

Gome* 493 HK 2.58 4,985 27.25 33 29 18.3 14.2 0.5 0.0

Golden Eagle 3308 HK 18.20 4,535 5.15 33 26 32.7 25.9 0.9 1.3

Bosideng 3998 HK 2.42 2,414 5.56 NA 12 14.0 12.6 NA 6.1

Hengdeli* 3389 HK 3.35 1,749 2.89 54 27 20.2 15.9 0.4 1.4Daphne 210 HK 7.61 1,600 5.11 17 24 17.9 14.4 0.7 1.3

Ports 589 HK 20.35 1,478 4.37 16 19 18.6 15.6 0.9 3.6

Lilang 1234 HK 8.92 1,374 4.96 49 33 22.6 17.0 0.4 1.8

Trinity 891 HK 4.89 988 3.74 27 40 27.0 19.3 0.6 2.1

China Nepstar NPD US 3.04 317 1.40 (36) 36 23.8 17.5 NA 2.6

Average 24 25 22.3 17.9 0.8 2.1

Hong Kong jewelry & watch

Hengdeli* 3389 HK 3.35 1,749 2.89 54 27 20.2 15.9 0.4 1.4

Chow Sang Sang 116 HK 15.24 1,324 3.94 NA NA NA NA NA NA

Luk Fook 590 HK 12.44 786 1.14 NA NA 19.8 NA NA NA

Emperor Watch 887 HK 0.55 368 0.60 14 41 11.2 8.0 0.4 3.1

Oriental Watch 398 HK 2.25 112 0.20 NA 24 6.2 5.0 NA 2.8

Average 34 31 14.4 9.6 0.4 2.4

# Calculated in HK$ terms

* Denotes CCBIS estimates

Source: Bloomberg, CCBIS estimates




12

Upbeat sales growth outlook in FY10-12F

Fast expanding retail business drives the growth

Hengdeli’s revenue is derived from three major segments, with retail business beingthe largest contributor to account for 75% of total sales, followed by wholesales

business’s 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 Sales breakdown in FY09

Retail sales

from HK

26%

WholesaleBusiness

30%

Retail sales

from PRC

41%

Customer Service

and Others

3%

Customer Service

and Others

2%

Retail sales

from PRC

46%

Wholesale

Business

23%

Retail sales

from HK

29%

Source: Company data Source: Company data

Riding on the strong demand for luxury items

Given the favourable economic outlook in view of strengthening purchasing power

and demand for quality mid-to-high end watches in China, Hengdeli’s 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, Hengdeli’s 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 China’s second- and third-tier cities,

Oriental in Hong Kong and Emperor on China’s first-tier cities.

The emerging middle class has

proved to be big spenders




13

Peers comparison – listed Hong Kong luxury watch and jewellery retailers

Hengdeli

(3389 HK, Outperform)

Oriental Watch

(398 HK, Not Rated)

Emperor Watch & Jewellery

(887 HK, Not Rated)

Retail revenue in 2009 (RMB m) 5,899 2,539 2364

Market capital (HK$ m) 13,428 818 2,659

Target market China tier-one to three, more focus on

tier-two to three

China tier-one to two cities (BJ, SH) China tier-one cities (BJ, SH), HK

Total no. of shops by end-09 270 54 40

No. of shops in China 224 40 24

No. of shops in Hong Kong, Macau and Taiwan 46 14 16

Estimated market share (%) 30 6 < 1%

Store addition for 2010 50 2 10 to 20

Gearing ratio (%) 11.2 0.32 0.9

Year of establishment 1927 1961 1942


Hengdeli dominates China’s 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 Hengdeli’s

leading position.

Solid growth in Hong Kong

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 Hengdeli’s earnings and brand recognition.

Along with four Elegant stores, there are also ten mono-brand boutiques in Hong

Kong.

A significant portion of Elegant’s 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 UnionPay’s system, hence thecredit-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.

Explore the potential of

mainlanders’ rising affluence

amid their soaring overseas

travels




14

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 company’s overseas business.

In mid-May 2010, Hengdeli opened its first Elegant flagship store in Taiwan. The new

store sells the world’s 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.

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

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

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.

Benefiting from surging

mainlanders’ visits

Acquired Taiwan Jing Guang

Timepiece to strengthen foothold

in Taiwan

Constant sales deriving from

wholesale business

Potential business to come on

stream in 2011




15

Luxury watch market outlook in China

According to Bain Consultancy, China’s 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:

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.

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

Saudi Arabia

China Taiwan

Thailand

Turkey

RussiaMexico

South Korea

Malaysia

Ukraine

PortugalGreece

Spain UK

JapanAustralia

HollandBelgium

Canada

USA

Germany

ItalyAustria

China 2018: 0.59/’000 people

China 2013: 0.34/’000 people

China 2008: 0.23/’000 people

10

5

2

1

0.5

0.2

0.1

Sales of Swiss Watch in pieces

(Swiss Watch worthHigher than RMB10K)

The market penetration

of Swiss Watch in Chinais low and with a hugegrowth potential

0 100 200 300 Source: Company, Bain & Company, Eurominitor, Watch Association of Switzerland

Growing number of wealthy

consumers underpins demand

for luxury products

Enormous market size to explore




16

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 tocustomers 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?

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

100%

80%

60%

40%

20%

0%Prestige/Luxury High-end Mid-end

Swiss brandSwiss brand

Non-Swiss brand

Non-Swissbrand

Swiss brand

6.8bRMB 4.0b 3.2b Total = 13.9b Mainland

Total non-Swiss brand sales= 1.5b (10%)

Total Swiss brand Sales= 12.9b (90%)

Source: Company

Tapping the resurgence of booming retail demand

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.

Perspective towards watch is no

longer for timekeeping only

Preference for foreign brands

over local watches

Population of wealthy consumers

is rapidly increasing




17

Disposable income by income group in 2008 Income CAGR for different income groups in 2000-2008

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

Low Lower middle Middle Upper middle High

RMB

0%

2%

4%

6%

8%

10%

12%

14%

16%

Low Lower middle Middle Upper middle High

Source: China Statistical Abstract 2009 Source: China Statistical Abstract 2009

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 income per capita urban vs. rural in 2000-2009 China urbanization rate in 2002-2010F

8,1779,061

10,12911,321

12,719

14,909

17,068

18,858

3,449 3,582 4,0404,631 5,025

5,7916,701 7,116

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

2002 2003 2004 2005 2006 2007 2008 2009

RMB

Urban Rural

30%

35%

40%

45%

50%

2002 2003 2004 2005 2006 2007 2008 2009 2010F

Source: CEIC Source: CEIC

China and Hong Kong being the largest Swiss watch exportmarket

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.

No signs of market saturation in

tier-one cities




18

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

Ranking change Country Total value (CHF m) YoY (%)

– Hong Kong 1,408.7 38

– US 757.7 13

- France 504.3 8

+3 China 482.7 91

-1 Italy 469.7 3

+2 Singapore 398.0 49

-1 Japan 361.3 (9)

-3 Germany 356.4 (5)

+1 United Arab Emirates 278.4 24

-1 UK 274.1 8

- Spain 154.5 9

+1 Taiwan 152.2 49

– South Korea 131.3 23

– Saudi Arabia 106.6 25

– Thailand 90.2 18Source: 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.




19

Strong financial outlook

A strengthened sales pickup was evident in Hengdeli’s 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

management’s 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 Hengdeli’s 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 by21-24% 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.




20

Sales and earnings projections in FY06-12F

199 418 460 365 589 744 931

2,405

4,579

5,5165,899

7,397

9,084

10,952

0

2,000

4,000

6,000

8,000

10,000

12,000

2006 2007 2008 2009 2010F 2011F 2012F

RMB m

Net profit Group total sales


Uptrend in margins

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

22.523.9 23.9 24.7 25.1 25.6

15.0 14.7

18.9 18.9 18.9 18.9

33.032.932.832.1 32.132.8

0%

5%

10%

15%

20%

25%

30%

35%

2007 2008 2009 2010F 2011F 2012F

Gross profit margin China retail gross profit margin HK retail gross profit margin


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

Hengdeli’s 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.

Widening gross margin on rising

contributions from retail business

and mid-market products




21

Other earnings assumptions

Rental expenses. Hengdeli’s 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 Hengdeli’s shops are located in department stores and the rest arestandalone 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.

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 Hengdeli’s 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 2006 2007 2008 2009 2010F 2011F 2012F

Sales growth by product (YoY, %)

China retail sales – 86 36 17 32 28 25

Hong Kong retail sales – 40 (3) 20 26 24 21

Wholesale revenue – 41 13 (19) 12 10 8

After-sales services revenue – 455 58 (6) 10 10 10

Gross profit margin by product (%)

China retail – 32.1 32.8 32.1 32.8 32.9 33.0

Hong Kong retail – 14.7 18.9 18.9 18.9 18.9 18.9

Wholesale – 23.4 24.8 25.9 27.1 27.7 28.4

After-sales services – 33.8 32.4 33.8 34.0 34.0 34.2

Other assumptions

Number of stores 96 168 217 270 330 367 400

Distribution expense as % of revenue 7.3 6.8 9.5 10.0 10.0 10.2 10.2

Rental expense as % of retail revenue 9.1 6.6 8.5 8.7 8.4 8.3 8.2

Administrative expense as % of revenue 4.1 3.4 4.6 4.1 4.1 4.1 4.1

Effective tax rate (%) 27.3 19.9 21.1 24.8 20.9 21.5 21.7


Major cost components remain

stable




22

Profit and loss projections (RMB m)


Revenue 2,405 4,579 5,516 5,899 7,397 9,084 10,952

YoY (%) 90 20 7 25 23 21

COGS (1,842) (3,549) (4,197) (4,490) (5,570) (6,801) (8,150)

Gross profit 563 1,030 1,319 1,409 1,827 2,283 2,802

YoY (%) – 83 28 7 30 25 23

Gross margin (%) 23.4 22.5 23.9 23.9 24.7 25.1 25.6

Government grants 10 13 15 16 20 23 26

Investment income (distributing JV with Swatch) 10 11 16 16 22 31 45

Other income – sub-total 38 55 50 51 63 78 98

Distribution costs (176) (312) (522) (590) (743) (922) (1,121)

Administrative costs (98) (156) (253) (239) (301) (373) (452)

Total SG&A (280) (483) (774) (831) (1,044) (1,295) (1,574)

Key SG&A expense ratio (%)

Distribution costs 7.3 6.8 9.5 10.0 10.1 10.2 10.2

Administrative costs 4.1 3.4 4.6 4.1 4.1 4.1 4.1

EBIT 316 621 660 656 848 1055 1297

YoY (%) - 97 6 -1 29 24 23

EBIT margin (%) 13.1 13.6 12.0 11.1 11.5 11.6 11.8

D&A 16 30 37 35 38 42 47

EBITDA 300 591 623 622 810 1,013 1,250

YoY (%) – 97 6 (0) 30 25 23

EBITDA margin (%) 12.5 12.9 11.3 10.5 10.9 11.2 11.4

Interest income 6 21 10 5 9 12 15

Effective interest rate on deposits (%) 3.5 3.3 2.6 1.5 1.5 1.6 1.7

Interest expense (27) (60) (114) (76) (64) (66) (68)

Effective interest rate on borrowings (%) 18.8 7.3 8.4 5.8 5.8 6.0 6.2

Profit before tax 294 552 619 514 781 999 1,256

Income tax (80) (110) (131) (128) (163) (215) (273)

Effective tax rate (%) 27.3 19.9 21.1 24.8 20.9 21.5 21.7

Net profit 199 418 460 365 589 744 931

YoY (%) – 110 10 (21) 61 26 25

Net margin (%) 8.3 9.1 8.3 6.2 8.0 8.2 8.5


Healthy financial position

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.

Improved efficiency in cash

conversion cycle




23

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 Hengdeli’s inventory turnover days to steadily drop from 197 days in FY09 to

174-176 days in FY10-12F.

Payables turnover also benefits from Hengdeli’s 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

174

152

177186

162 157 152

191

151

179

197

176 175 174

56

34 3543 46 49 52

40 36 33 32 32 31 30

0

44

88

132

176

220

2006 2007 2008 2009 2010F 2011F 2012F

Days

Cash conversion cycle Inventory turnover day Trade payable turnover day 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.

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.

RMB2b loan facility secured from

CCB




24

Operating cash flow, free cash flow and net cash flow projections

544

289

465

758

(172)

431

155

(269)

(662)

861

(23)

83

(126)

(205)

(31)

345

648

159

(186)

(480)

309

(800)

(600)

(400)

(200)

0

200

400

600

800

1,000

2006 2007 2008 2009 2010F 2011F 2012F

RMB m

Operating cash flow Free cash flow Net cash flow


Key financial ratios


ROAE (%) – 25.6 23.7 14.7 19.1 21.0 22.6

ROAA (%) – 13.1 10.9 7.6 10.6 11.7 12.6

ROIC (%) – 26.0 19.5 16.9 20.4 22.0 24.3

Average inventory days 191 151 179 197 176 175 174

Average receivable days 40 36 33 32 32 31 30

Average payable days 56 34 35 43 46 49 52

Cash conversion cycle (days) 174 152 177 186 162 157 152

Net gearing (%) 2 9 38 Net cash Net cash Net cash Net cash

Gross gearing (%) 28 69 70 40 33 29 25Source: Company data, CCBIS estimates




25

Balance sheet projections (RMB m)


Property, plant and equipment 251 289 529 600 693 772 836

Intangible assets 33 43 43 43 42 42 41

Investment properties 0 30 28 26 26 26 26

Investment in jointly controlled entity 5 28 31 36 35 33 32

Other investments 0 0 1 1 0 0 0

Deferred tax assets 25 24 40 39 39 39 39

Goodwill 181 213 228 243 243 243 243

Non-current assets – total 495 628 900 988 1,079 1,155 1,217

Inventories 1,262 1,667 2,447 2,404 2,952 3,569 4,202

Trade & other receivables 331 560 450 591 749 871 1,000

Cash & equivalents 375 1,071 685 1,191 1,122 1,206 1,515

Current assets – total 1,969 3,298 3,581 4,186 4,823 5,646 6,716

Bank loans & other loans 388 245 760 824 800 800 800Trade & other payables 371 476 584 807 1,103 1,390 1,731

Current tax payables 74 88 70 62 90 164 288

Current liabilities – total 833 809 1,415 1,692 1,993 2,354 2,819

Long term borrowing 22 995 716 322 300 300 300

Other NC payables 0 140 18 36 49 66 88

Minorities 136 197 236 257 268 282 300

Non-current liabilities – total 1,472 1,785 2,096 2,867 3,292 3,800 4,426

Equity 1,472 1,785 2,096 2,867 3,292 3,800 4,426

Total assets 2,464 3,926 4,481 5,174 5,902 6,801 7,933

Total liabilities and equities 2,464 3,926 4,481 5,174 5,902 6,801 7,933

Gross debt 410 1,240 1,476 1,146 1,100 1,100 1,100

Net debt (cash) 35 169 791 (45) (22) (106) (415)

Net gearing (%) 2 9 38 Net cash Net cash Net cash Net cash





26

Cash flow projections (RMB m)


EBIT 316 621 660 656 848 1,055 1,297

D&A 16 30 37 35 38 42 47

EBITDA 332 651 697 691 886 1,097 1,344

Other non-cash adjustment (7) (58) (80) (17) (11) (2) 14

Operating cash flow before changes in working capital 324 593 617 674 875 1,096 1,358

Working capital changes:

Inventories (252) (353) (740) 42 (548) (617) (633)

Trade and other receivables (87) (260) 96 (141) (157) (123) (129)

Trade and other payables 72 35 72 222 309 304 364

Total working capital changes (267) (577) (572) 124 (396) (435) (398)

Interest received 6 22 10 5 9 12 15

Interest paid (27) (68) (104) (131) (64) (66) (68)

Tax paid (68) (96) (157) (128) (135) (142) (149)Operating cash flow (31) (126) (205) 544 289 465 758

Capex for acquisition of:

Property, plant and equipment (140) (60) (274) (110) (130) (120) (110)

Intangibles 0 0 (1) (2) 0 0 0

Total capex (140) (60) (275) (112) (130) (120) (110)

Free cash flow (172) (186) (480) 431 159 345 648

Changes in pledged deposit 53 (7) (13) 56 0 0 0

Proceeds from issue of shares 455 0 (6) 526 0 0 0

Dividend paid (181) (76) (163) (153) (182) (262) (339)

Net cash flow 155 (269) (662) 861 (23) 83 309

Net change in borrowings (496) (620) (610) (1,093) (46) 0 0

Gross cash flow (341) (889) (1,272) (231) (69) 83 309





27

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

company’s large retail network, leading role in the industry, and long-term harmonizedrelationship 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 industry’s

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. Hengdeli’s 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.




28

Appendix 1: Background

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 andextensive experience in China’s 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. Zhang’s 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 China’s

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

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

Xinjiang

GuangdongGuangxi

Sichuan

Yunnan

Guizhou

Hunan

Fujian

Zhejiang

Heilongjiang

Liaoning

Beijing

Tianjin

Shanghai

Jiangxi

Hubei

HenanShaanxi

Anhui

Shandong

Hebei

Shanxi

Jiangsu

Chongqing

<5 stores

5~10 stores

11~20 stores

>20 stores

Source: Company

Well-connected and rich

experienced luxury watch

purveyor

Owning 300 stores across

Greater China




29

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 brandsare 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 maintenanceservice

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. Hengdeli’s 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.

Diversified brand portfolio to

capture different customers

All-round services available




30

Appendix 2: SWOT and Porter analysis

SWOT analysis

Strengths

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.

Weaknesses

Vulnerable to economic downturn.

Revenue mainly driven from China market.

Opportunities

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.

Threats

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.




31

Porter’s five forces

Suppliers’ bargaining power: High

Supplier concentration is relatively high as the core watch suppliers are fromSwitzerland. 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 Hengdeli’s stores

which offer a diversified brand portfolio of mid-to-high end watches covering all majorconsumer 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.




32

Appendix 3: Management biography

Executive Directors

Mr. Zhang Yuping (Alia, Cheung Yu Ping) – Chairman and ExecutiveDirector

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 company’s 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 China’s market.

Senior Management

Mr. Zhuang Liming – Vice Chairman of Shanghai Xinyu

After graduating at Beijing Foreign Trade College, he had worked for China’s Light

Industry Commodities Import and Export Company before joining the company in2000.

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.




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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initiation of hengdeli (3389 hk) 22 jul 2010

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