Chow Tai Fook Issues Convertible Bonds For Store Upgrades, Overseas Expansion

The fundraising, even as the Hong Kong jeweler has sufficient financial resources to run its current operation, could hint at plans for its next growth phase

Key Takeaways:

• Chow Tai Fook will use proceeds from a HK$8.8 billion convertible bond to develop its gold jewelry business, including for store upgrades, and overseas expansion
• Revenue from the Hong Kong jeweler's fixed-price gold products more than doubled last year

Chow Tai Fook Jewellery Group Ltd. CJEWF CJEWY is seeing glitter in a new convertible bond issue, its first equity fundraising since its 2011 IPO, as it seeks to seize on recovering global consumer sentiment and record-high gold prices. The Hong Kong jeweler's fundraising, even as it already boasts strong cash reserves and a rising stock price, may look surprising at first. But the move may also shine some light on Chow Tai Fook's vision for its next growth phase.

According to its announcement last week, Chow Tai Fook issued HK$8.8 billion ($1.12 billion) worth of convertible bonds with an annual interest rate of 0.375%, maturing in 2030. When the bonds mature, investors will have the right to convert them to stock for an initial conversion price of HK$17.32, representing a 26% premium over the stock's closing price of HK$13.72 the day before the announcement. The company will use proceeds to develop and finance its gold jewelry business, and for store upgrades and domestic and international expansion.

Chow Tai Fook's stock fell by over 10% at one point the day of the announcement, though it later pared the losses to close down 5% at HK$12.72. The stock has nearly doubled year to date, up by 94%.

Falling performance, rising stock

Sharp jumps in global gold prices have powered Hong Kong-listed jewelry stocks to major gains this year. Shares of Chow Tai Fook rival Luk Fook (0590.HK) are up about 40% year-to-date, while Chow Sang Sang (0116.HK) is up 35.6%. Leading the pack is Mainland China-based Laopu Gold (6181.HK), whose stock has more than tripled, far exceeding the 45% increase in international spot gold prices over the same period.

But high gold prices have also suppressed demand for jewelry made from the precious metal. That's left many industry players in a strange position where their business has stumbled, even as their stock prices have rallied.

China's demand for gold jewelry declined by nearly 27% year-on-year in the first quarter, hitting most major jewelry companies. Luk Fook's profit for its fiscal year through March fell by 40%, while Chow Sang Sang's declined by over 20% over the same period. Chow Tai Fook's revenue declined by 17.5% over the same period, with profits also down by 9%.

Despite the revenue dip, Chow Tai Fook's gross profit margin defied the broader downward trend and rose by 5.5 percentage points to 29.5% for the year, a multiyear high, helping to boost its operating profit by 9.8% to HK$14.7 billion for the fiscal year. The company credited those gains on improved operational efficiency and a better product mix.

The company's recent sales data also shows that the downcycle may have reached bottom. In April and May, Chow Tai Fook reported its same-store sales in Hong Kong and Macao finally ended a year-long decline and returned to positive growth of 1.3%. The decline in same-store sales on the Chinese Mainland also narrowed significantly to 2.7% for those months, indicating consumers have become more accustomed to high gold prices. The recovery could also be getting a boost from initial effects of reforms in Chow Tai Fook's gold jewelry pricing system, as well as its launch of a new store format.

Despite its uneven business, Chow Tai Fook's financial position remains solid. The company had HK$7.5 billion in cash at the end of March, with its free cash flow for the year reaching HK$20.75 billion, a five-year high. With its sales now rebounding and operational efficiency improving, the company's bond issue may reflect a desire to accelerate its pace of expansion and other measures it's taking to make itself more competitive.

Image overhaul

In particular, management is focused on a transformation to shed the brand's stodgy image preferred by an older generation, rolling out a newer store design to appeal to a younger crowd. Over the past year, Chow Tai Fook has opened five such "image stores" on the Chinese Mainland, with single-store sales generally 30% higher than those for existing ones. This year, the company plans to add around 20 more stores with the new format in the Mainland and Hong Kong, aiming to boost single-store productivity and bring in higher spending customers.

Management has also said the chain plans to enter markets like Dubai, Thailand, and Australia. Such an international expansion would help to reduce the company's exposure to geopolitical factors and consumption cycles in China, and quickly capture demand in regions with stronger high-end gold and wedding jewelry markets.

In terms of products, demand for gold jewelry has certainly weakened as gold prices soar. Those rising prices have also led to changes in consumer perceptions and purchasing habits.

Chow Tai Fook's standout performer in the current environment is its fixed-price gold products. Revenue for such products surged 105% year-on-year in the company's latest fiscal year, accounting for 19.2% of its retail sales on the Mainland – up from 7.2% the previous year. Unlike traditional jewelry typically priced based on the weight of the gold it contains, fixed-price gold jewelry is sold at a set price that incorporates design and craftsmanship value. The category can help chains like Chow Tai Fook distinguish themselves from their rivals, and also typically carries higher profit margins.

Laopu Gold has already made that discovery and is using it to win hearts in the mid-price segment and among younger consumers. As the industry leader, Chow Tai Fook must accelerate its own overhaul to appeal to a younger crowed, and also make more efforts to differentiate its products, lest it lose its edge over younger rivals like Laopu. That may be a key factor behind the latest fundraising.

Following its recent rally, Chow Tai Fook shares trade at a price-to-earnings (P/E) ratio of about 22 times, well ahead of Hong Kong rivals Chow Sang Sang at 7.5 times and Luk Fook at 9.3 times, but far behind Laopu Gold's meteoric 84.6 times. While its shares are hardly a bargain at current levels, Chow Tai Fook's industry veteran status and financial savvy show it could also have more to offer investors with its latest initiatives. The company also has an attractive dividend payout ratio of 87% and stable cash flow, making it look attractive for longer-term investors who don't necessarily want gold but perhaps the next best thing.