China luxury primer (dipped in gold) clsa (2011)

Luxury goods

2 [email protected] 19 January 2011

Contents Executive summary .......................................................................... 3

The Red Eight and the Chinese customer........................................... 4

From head to toe ............................................................................36

European brands dominate ..............................................................71

Getting exposed ...............................................................................79

Company profiles

Belle ......................................... 85

Chow Sang Sang ........................ 87

Emperor Watch & Jewellery .......... 89

Evergreen .................................. 91

Golden Eagle Retail ..................... 93

Hengdeli .................................... 95

HK Resources ............................. 97

I.T. ........................................... 99

Lifestyle .................................. 101

L’Occitane ............................... 103

Luk Fook ................................. 105

Oriental Watch ......................... 107

Parkson Retail .......................... 109

Ports Design ............................ 111

Sa Sa International ................... 127

Trinity ..................................... 129

Appendix: International peer group ............................................... 131

All prices quoted herein are as at close of business 13 January 2011, unless otherwise stated

Related consumer research

Aaron Fischer, CFA Regional Head of Consumer and Gaming Research [email protected] (852) 26008256

Mariana Kou (852) 26008190

http://www.clsa.com/member/reports/452588762.pdf




Executive summary Luxury goods

19 January 2011 [email protected] 3

Dipped in gold Luxury goods look set to be the fastest-growing consumer category in China over the next five years, with a 25% Cagr against general consumption at 11%. Luxury sales in Greater China represent 10% of the global market. If we include sales to Chinese tourists abroad, we estimate Greater Chinese consumers to account for 15% of global sales. But we are only at the start of this golden opportunity. Given rising incomes and supportive social factors, we expect Greater Chinese customers to account for 44% of global luxury sales by 2020. Our top picks are Ports Design, Evergreen, L’Occitane, Parkson and Hengdeli.

The Chinese luxury customer is unique in many ways and, in this report, we identify eight differences between the wealthy Chinese and their overseas counterparts. Not surprisingly, they largely have the same tastes in brands as the rest of the world with Louis Vuitton, Hermes, Chanel, Gucci, Rolex, Prada and Cartier being the most desirable. Men’s brands such as Zegna and Dunhill also score well in our China Reality Research proprietary luxury-goods survey.

Luxury-goods companies are expanding rapidly in the Middle Kingdom as China will account for half of global growth over the next 10 years. We expect handbags, leather goods, watches and jewellery to see the fastest growth. Strong demand is already reflected in higher prices with fine wines increasing by 40% in 2010 and waiting lists are growing for many exclusive items.

It is only a matter of time before Chinese luxury brands are established at home. However, we expect this to happen in product categories where China has a perceived fundamental advantage, primarily in the use of materials such as jade, porcelain or precious woods that can be used in jewellery, homeware and furniture. In the meantime, we expect Asian companies to look to acquire European brands and build up manufacturing expertise.

Exposure can be gained via the brand owners listed in Europe and the USA. However, these companies only generate about 10-30% of sales to Chinese customers. We therefore recommend obtaining 100% pure-play exposure to Chinese luxury demand via the Asian-listed high-end companies. These stocks have rerated by 57% during 2010 but we believe valuation is still attractive at an average PE of 22x and PE/G of 1x. Of the stocks we cover, our top picks are Ports Design, Evergreen, L’Occitane, Parkson and Hengdeli. We also like Trinity, Lifestyle, I.T, Emperor Watch & Jewellery and Sa Sa International. Strong sales over the December period will be the necessary catalyst for earnings upgrades and share-price outperformance.

Luxury market size

0

50

100

150

200

250

300

350

400

450

10CL 11CL 12CL 13CL 14CL 15CL 16CL 17CL 18CL 19CL 20CL

% of total

Others56%

GreaterChinese44%

(€bn)% of total

Others85%

GreaterChinese15%

Source: CLSA Asia-Pacific Markets

China should be world’s largest luxury-goods

market by 20CL

Chinese luxury brands to come

Fastest-growing segment

China to account for half of global luxury-

goods growth

Asian pure plays

Eight key differences

Section 1: The Red Eight and the Chinese customer Luxury goods


The Red Eight and the Chinese customer Before we get into the detail of the report, we identify eight differences between wealthy Chinese and their counterparts overseas. Generally, the affluent Chinese are younger with a greater desire to display their wealth and success. They enjoy being given special treatment and have no hesitation in paying a bit more for that privilege. They love to travel overseas and are willing to splash out for their friends and family, with watches and jewellery being the most popular purchases.

1. Younger and richer customers Hurun Research shows that mainland Chinese millionaires are 15 years younger than their overseas peers. As expected, the vast majority live in the coastal regions and top-tier cities. Beijing, Guangdong and Shanghai are home to 48% of China’s millionaires. The number of individuals with more than Rmb1,000m has increased at a 50% annual rate from 24 in 2000 to 1,363 in 2010.

Figure 1

Profile of millionaires in China

Average age 39 Male-female ratio 7:3 Industry Service, property, manufacturing Collections 3 cars and 4.4 luxury watches Geographic distribution Beijing (17%), Guangdong (17%), Shanghai (14%), Zhejiang

(13%), Jiangsu (7%), Others (32%) Favourite brands Fashion: Giorgio Armani, Gucci, Boss

Jewellery: Cartier, Bulgari, Montblanc Overall luxury: Louis Vuitton, Chanel, Hermes, Cartier, Gucci

Hobbies Travel, golf, swimming Favourite destinations International: US, France, Canada

Domestic: Hong Kong, Yunnan, Sanya Number of holidays 16 days a year Drinking and smoking 1/3 don’t drink, about 1/2 don't smoke Source: Hurun Research Institute

Our CLSA proprietary luxury-goods survey shows that people in the 30-40 age group are the drivers of accessories and skincare demand. While for luxury cars, consumers in the 40-50 age group are more dominant.

Figure 2

Luxury customers by age

22

1486

38

44

14

75

7

100

0 20 40 60 80 100

Luxury skincare &makeup

Luxury handbag,clothing, watch &

jewellery

Luxury car

(% of stores)

Above 50

40-50

30-40

20-30

Source: China Reality Research

The rich Chinese are younger and many live

in top-tier cities

The 30-50-year-olds drive luxury demand

Wealthy Chinese differ from overseas

counterparts



2. Display of success and being a VIP Success is highly regarded, so is being rich and famous. It is important that the luxury goods they buy convey that message and show that they are sophisticated and have good taste. Driving a Mercedes Benz and carrying a large Louis Vuitton monogram bag can be one way while wearing a four-carat diamond ring and ordering Rmb10,000 bottles of wine is another. Unlike in the USA and Europe, people in Asia do not show off their houses, which tend to be relatively small on a global basis. It is a lot more important to dress well and enjoy a luxurious life when you are out in public. Watches, jewellery, apparel, cars and wine are good ways to show off and gain respect. Some 24% of people we surveyed that earn around Rmb41,976 per year said they would be willing to spend more than Rmb50,000 on a watch.

It is not enough to be rich. Being a VIP and having the owner of the most expensive restaurant in town serving you personally is just as valuable. Chinese customers like to receive gifts from luxury boutiques. It is not about the gift, but about how important you are, even to luxury companies that are already serving the most elite. Receiving birthday gifts and hand-written cards, attending invitation-only events, and being recognised by the sales staff in luxury stores are especially appreciated. More effort is required by luxury stores in China but the payoff can also be worth it.

3. Luxury “more” for him . . . The luxury market in mainland China is still largely male-dominated given the gifting culture and workforce demographics. Menswear, suitcases, watches and cars are key segments in China. As Leo Lui, president of Hermes China, has said: “Men’s ready-to-wear is […] a top seller, which is quite unusual. In most other markets, it’s women’s ready-to-wear that sells. China is still a men’s market, and more traditional.” However, he sees a shift towards a more balanced demographic combination as successful career women increasingly shop at Hermes to show that they have good taste. Big brands in China include Zegna and Dunhill.

4. . . . and more for others Some luxury brands have also opened more stores in Beijing than other first-tier cities, primarily to cater for the huge demand for gifting and relationship building. For example, Emperor Watch & Jewellery has 15 stores in Beijing compared with five in Shanghai and five in Guangzhou.

Our CRR survey estimates that 16-17% of Chinese consumers bought luxury goods as gifts. Luxury handbags, clothing, watches and jewellery are the most popular gift items. Within the accessories segment, 37% of purchases was for gifting. However, we expect this percentage to come down as the personal-use segment grows.

Figure 3 Figure 4

Consumers said they shopped for . . . Store managers said their customers shopped for . . .

6

16

17

93

0 20 40 60 80 100

Investment/collection

Gifts for businesscontacts

Friends & family

Yourself

(% of consumers who bought luxury goods in the past 12 months)

9875

59

2437

21 51

0

20

40

60

80

100

Luxury car Luxury skincare &makeup


jewellery

Own-use by buyers Gifts Investment purpose

(Average composition %)


Luxury market in China is male-dominated

Living it up to show off and gain respect

Make Chinese consumers feel special



5. Watches and jewellery top luxury wish list Chinese consumers love watches and jewellery for their intrinsic value and accessories are great vehicles to display wealth and success. Gold and jade are the most popular jewellery items. Brand-name watches are also a Chinese favourite for personal use, gifting and collection. Hong Kong is the largest Swiss watch export market in the world. China and Hong Kong together account for 26% for Swiss watch exports in January-November 2010, according to the Federation of the Swiss Watch Industry. There is a robust second-hand market for brand-name watches, especially Rolex, thus some aspirational shoppers also view watches as an inflation hedge/investment. With “girl power” also growing, luxury handbags are rapidly catching up. This is a big positive for top players including watch and jewellery retailers from Hong Kong as well as global brand names such as Hermes, Louis Vuitton, Prada and Gucci.

Figure 5

World distribution of Swiss watch exports (January-November 2010)

France 7%

Italy 6%

United Kingdom 4%

Germany 5%

Japan 5%

Singapore 6%

Hong Kong 19%

Others31% China

7%

USA 10%

Hong Kong/China togeter is 26%

Source: Federation of the Swiss Watch Industry (Nov 2010), CLSA Asia-Pacific Markets

6. Overseas purchases Shopping overseas can be cheaper because of the higher import duties and other taxes in China (see Section 2 for more). It also comes with the luxurious feeling of travelling to shop. It is well-appreciated and will strengthen relationships if you bring home luxury goods for your friends and professional contacts. There may be wider offerings in the country of origin and sometimes there may be limited editions overseas for special occasions. Hermes in China, for example, does not have a central buyer, so the product offering is different for each store. While for cosmetics, because of the time it takes to get import approvals, mainlanders can always buy the newer collections in Hong Kong.

Figure 6

Chinese luxury sales: Domestic versus overseas spend

Overseas56%

Domestic44%


Watches and jewellery are great for displaying

wealth, gifting, and collection

Hong Kong is the world’s largest Swiss

watch market

Travel and shop



7. Willingness to pay a big premium Chinese consumers are willing to pay extra for luxury. As one businessman said, “A price tag of more than one million yuan a bottle - that does more than show off your wealth, it shows you have good taste.” Not everyone may agree with this. The businessman often pays more than Rmb30,000 for a bottle of wine to entertain guests. In October 2010, three bottles of Chateau Lafite’s 1869 vintage sold for a record US$230,000 each in Hong Kong, at 28x Sotheby’s top estimate. Fine wine prices increased 40% during 2010.

Figure 7

Liv-ex Fine Wine 100 Index

80

120

160

200

240

280

320

360

400

Dec 05 Oct 06 Aug 07 May 08 Mar 09 Jan 10 Nov 10

Note: the index is production and supply weighted. Based at 100 in January 2004. Source: Liv-ex.com

8. Local tastes Chinese affluent like famous brands. Expensive brand-name products are oftentimes perceived as of higher quality. Signature collections and large logos that can be easily recognised are also popular. Chinese consumers also love craftsmanship. This is a tradition that the Chinese highly value and at the same time it also says how unique you are. Leather goods, watches, jewellery, porcelain and glassware are a lot more popular and precious if they are hand-made and Chinese consumers are happy to pay a large premium.

There are some luxury products that Chinese customers are very interested in and that are not as popular among the rich in other countries. For example, a pack of premium puerh tea from the 1980s sold for Rmb13,440 in an 2009 auction, which is almost Rmb40 per gram. Another pack that was ultra premium and believed to be more than 80 years old sold for Rmb504,000, or Rmb1800 per gram. Antique furniture is also popular among the Chinese rich. Hainan rosewood, in particular, is very prestigious and a set of four chairs recently sold for Rmb17.7m and a six-column bed frame fetched a record Rmb43.1m.

Figure 8 Figure 9

A set of four Hainan rosewood chairs

Hainan rosewood bed frame

Source: China Guardian Auctions website

Money is not always a key factor

Bigger brands, large logos, hand-made products

Unique product categories like tea and furniture

Fine wine prices keep rising



Luxury boom Growth rates within the consumer sector in mainland China vary across product categories. We expect luxury goods to lead with a 25% Cagr over 09-14CL, ahead of gaming at 20% followed by 17% for communications and 16% for education. Staple products, including alcohol, tobacco, food and beverages lag behind - although at 5-6% growth - this is significantly higher than rate in developed markets, which is in the very low single digits.

Figure 10

China consumer expenditure Cagr growth (2010-15CL)

0 5 10 15 20 25 30

Alcohol and tobaccoFood and beverages

Clothing and footwearHousehold care

Leisure and recreationTotal consumer expenditure

HousingHotels and catering

CosmeticsTransport

HealthcareEducation

CommunicationsGaming

Luxury goods

(%)

Source: Euromonitor, CLSA Asia-Pacific Markets

Luxury goods in China: €9bn market The global luxury-goods market includes items such as apparel (about 25% of the total), prestige cosmetics (about 25%), “hard luxury” items which includes watches and jewellery (about 25%), with accessories, leather goods and others making up the remaining 25%. Consulting firm Bain estimates that China’s domestic luxury market in 2009 was at Rmb68bn, or €9.2bn, which is about 5% of the global market. However, if we add Hong Kong, Macau and Taiwan, the Greater China market is estimated to be about €18bn, which is about 10% of the total global market. Europe makes up 37% of the market, Americas 30%, Japan 11%, Asia Pacific ex-Japan and China 17% and Rest of the World at 5%. If we include travel, Greater Chinese customers should account for about 15% of the global market. Louis Vuitton’s biggest customers are already Chinese buyers.

Figure 11 Figure 12

Geographic breakdown

Category breakdown - global

Taiwan1.9%

Europe 37%Rest of Asia

6.6%

Rest of World5.0%

Rest of Americas

2.6%

Japan 11.0%

Mainland China5.5%

Macau0.4%

HK 2.6%

USA27.4%

Greater China10%

Hard luxury25%

Others25%

Prestige cosmetics

25%

Apparel25%


Fastest growing segment in China

Gambling and shopping lead the way

Dissecting the market



Greater China represents 28% of sales for Swatch, 22% for Richemont, 18% for Gucci, 14% for Bulgari and 11% for Hermes.

Figure 13

Sales exposure to Greater China

0 5 10 15 20 25 30

Tod's

Hermes

Bulgari

Gucci brand

Richemont

Swatch Group

(%)

Source: Cheuvreux, CLSA Asia-Pacific Markets

The luxury-goods sector will focus on China. We estimate that the Chinese luxury market can continue to grow at about 25% per annum for the next five years, followed by about 22% thereafter. This implies a market size of €74bn by 2020, making China the largest domestic market in the world. Including travel spend, we expect Greater Chinese demand will account for 44% of the global luxury-goods market. Underpinning our forecasts for other markets, our economics team expects real GDP growth in the EU to largely stay flat in the next two years, while the USA and Japan should grow at 1.1-1.8% per year.

Figure 14

Luxury market size and growth – by domestic spend

0

50

100

150

200

250

300

350

400

450

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

2010-20 Cagr

Rest of World 11%

Europe7%

Americas 5%

Japan 3%

China23%

(€bn)


We believe the size of Greater Chinese luxury-goods demand in 2020 will be around the same size of the existing global luxury-goods market.

China to be world’s largest luxury goods

market by 20CL



Figure 15

Figure 16

Luxury market comparison

Real GDP growth

050

100150200250300350400450

2010 2020

Others

Greater Chinese demand

(€bn)

0

2

4

6

8

10

12

US EU Japan China

(%) 10CL 11CL 12CL

Source: CLSA Asia-Pacific Markets, Bain

We believe that the domestic mainland China market is well on track to surpass Japan’s luxury market by 2014. Japan’s economy has been stagnant since the early 1990s with YoY GDP growth eventually turning negative in 1998. This contrasts with China’s hyper GDP per capita growth.

Figure 17

Figure 18

Japan’s stagnant economy

GDP per capita growth

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

1980 1984 1988 1992 1996 2000 2004 2008

(¥bn)

(8)(6)(4)(2)024681012GDP

YoY growth (RHS)(%)

(20)

(10)

0

10

20

30

40

1990 1996 2002 2008

Japan China(%)

Source: CEIC, CLSA Asia-Pacific Markets

To confirm that the forecasts are reasonable, we also performed a luxury market/GDP comparison for the key countries and regions. Based on our forecast of €74bn in 2020, China’s luxury market should be about 0.6% the size of the country’s total GDP, roughly in line with Japan’s.

Figure 19

Sanity check

(€bn) GDP 2009 GDP 2020 Luxury market 2009

Luxury market 2020

Luxury/GDP 2009 (%)

Luxury/GDP 2020 (%)

China 3,533 12,340 9 74 0.26 0.60

Japan 3,649 4,529 18 26 0.51 0.58

Europe 14,002 23,425 62 121 0.44 0.52

Americas 14,110 28,123 50 82 0.36 0.29


We made forecasts for each domestic market based on growth for locals, mainland tourists, and others. We expect to see very strong demand from Greater Chinese in the next 10 years.

China leading the game

Japan falling behind



Figure 20

Luxury-goods market estimates

(€bn) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Cagr10-20 (%)

China 9 12 14 18 22 28 34 41 50 61 74 23

% of total 5 6 7 9 10 12 13 14 16 18 19

Japan 18 19 20 20 21 22 22 23 24 25 26 3

% of total 11 11 10 10 9 9 8 8 8 7 7

Japanese 16 17 17 17 17 17 17 18 18 18 18 1

Mainland tourists 1 1 1 2 2 2 3 3 3 4 5 16

Others 1 1 1 2 2 2 2 2 3 3 3 12

Americas 50 53 55 57 60 63 66 70 73 78 82 5

% of total 30 29 28 28 27 26 25 24 23 22 21

Americans 44 45 47 48 50 51 53 54 56 58 59 3


Others 5 5 6 6 7 7 8 9 9 10 11 8

Europe 62 66 69 74 78 84 89 96 103 112 121 7

% of total 37 36 36 36 35 34 34 33 33 32 31

Europeans 47 48 50 51 53 54 56 57 59 61 63 3


Others 10 11 12 13 14 15 16 17 19 20 22 8

Hong Kong 4 5 6 7 8 10 12 14 16 19 23 18

% of total 3 3 3 3 4 4 4 5 5 6 6

HK locals 2 2 2 3 3 3 3 3 4 4 4 8


Others 0 0 0 0 0 0 0 0 0 0 0 7

Taiwan 3 3 4 4 4 4 5 5 5 5 6 6

% of total 2 2 2 2 2 2 2 2 2 2 2

Taiwan locals 3 3 3 3 4 4 4 4 4 4 5 5


Others - - - - - - - - - - - -

Macau 1 1 1 1 2 2 3 4 5 6 7 27

% of total 0 0 1 1 1 1 1 1 1 2 2

Macau locals 0 0 0 0 0 0 0 0 0 0 0 5


Others - - - - - - - - - - - -

South Korea 6 6 7 7 8 9 9 10 11 12 13 8

% of total 3 3 4 4 4 4 4 4 3 3 3

Korea locals 5 6 6 6 7 7 8 8 9 10 10 7


Others 0 0 0 0 0 0 0 0 0 0 0 10

Singapore 3 3 4 4 5 6 6 7 8 9 10 13

% of total 2 2 2 2 2 2 2 2 3 3 3

Singapore locals 3 3 3 4 4 4 5 6 6 7 8 12


Others 0 0 0 0 0 0 0 0 0 0 0 8

Thailand 1 1 1 1 1 2 2 2 2 2 3 11

% of total 1 1 1 1 1 1 1 1 1 1 1

Thailand locals 1 1 1 1 1 1 1 1 1 2 2 8


Others 0 0 0 0 0 0 0 0 0 0 0 10

India 1 1 1 1 1 2 2 2 2 3 3 15

% of total 0 1 1 1 1 1 1 1 1 1 1

India locals 1 1 1 1 1 2 2 2 2 3 3 15

Mainland tourists - - - - - - - - - - - -

Others - - - - - - - - - - - -

Others 10 10 11 11 12 13 13 14 15 15 16 5

% of total 6 6 6 6 5 5 5 5 5 4 4

Global luxury market 168 180 193 207 224 243 264 288 316 348 385 9




Figure 21

Greater Chinese demand (€bn) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Cagr10-20

(%)Domestic market 9 12 14 18 22 28 34 41 50 61 74 23Mainland tourists 12 15 18 22 28 34 41 49 59 71 86 22Mainland Chinese demand 21 26 32 40 50 62 75 91 110 132 160 22% of global luxury market 13 15 17 19 22 26 28 31 35 38 42China 9 12 14 18 22 28 34 41 50 61 74 23Hong Kong 4 5 6 7 8 10 12 14 16 19 23 18Taiwan 3 3 4 4 4 4 5 5 5 5 6 6Macau 1 1 1 1 2 2 3 4 5 6 7 27Greater China domestic markets 18 21 25 30 37 45 53 64 76 92 110 20% of global luxury market 10 12 13 15 16 18 20 22 24 26 29Domestic market 9 12 14 18 22 28 34 41 50 61 74 23Mainland tourists 12 15 18 22 28 34 41 49 59 71 86 22HK locals 2 2 2 3 3 3 3 3 4 4 4 8Taiwan locals 3 3 3 3 4 4 4 4 4 4 5 5Macau locals 0 0 0 0 0 0 0 0 0 0 0 5Greater Chinese demand 26 31 38 46 56 69 82 98 118 141 169 21% of global luxury market 15 17 20 22 25 28 31 34 37 41 44


China is the world’s growth driver We estimate that mainland Chinese will represent half of the growth in the global luxury-goods market over the next 10 years. The mainland China market is only about 5% of the total and we expect that to increase to 19%. As the mainland market expands, its superior growth has an increasing impact on total growth of the luxury-goods sector.

The drivers We discuss the drivers in three segments: a) economic, b) social, and c). supply factors.

a) Economic drivers Mainland China has seen a booming population of high net worth individuals. The Hurun Research Institute estimates that the number of individuals with personal wealth of more than Rmb10m in China has increased 6.1% YoY in 2010 to 875,000 and the “super-rich” group with more than Rmb100m was up 7.8% to 55,000 individuals. Average wealth of the top 1,000 rich individuals in China grew 64% over the past two years and 26% in the past year.

Figure 22 Figure 23

China’s pyramid of wealth (2010)

Much wealth is “hidden” in China

875,000 with Rmb10m

55,000 with Rmb100m

4,000 with Rmb1,000m

700 with Rmb5,000m

200 with Rmb10,000m

875,000 with Rmb10m

55,000 with Rmb100m

4,000 with Rmb1,000m

700 with Rmb5,000m

200 with Rmb10,000m

2,600 with Rmb1,000mn


"Known" wealth 281 with Rmb5,000m

97 with Rmb10,000m

420 with Rmb5,000m

100 with Rmb10,000m

“Hidden" wealth



"Known" wealth 281 with Rmb5,000m

97 with Rmb10,000m

420 with Rmb5,000m

100 with Rmb10,000m

“Hidden" wealth

Source: Hurun Research Institute

The rich are getting richer

Growing from 5% to 19% of the global market



In the past 10 years, the population of ultra affluent individuals with more than Rmb1,000m of wealth in mainland China has skyrocketed, at an annual rate of 50-58%, and so has their wealth. The 50th richest person in China in 1999 had wealth of Rmb50m while the 50th richest in 2010 has Rmb15,500m.

Figure 24 Figure 25

Individuals with Rmb1,000m

Individuals with Rmb10,000m

24

1,363

0

200

400

600

800

1,000

1,200

1,400

1,600

2000 2010

50% Cagr

1

97

0

20

40

60

80

100

120

2000 2010

58% Cagr


Meanwhile, the middle class in China is enjoying increasing salaries and a higher standard of living, especially in the coastal cities. Average remuneration has been growing at 12-19% YoY each quarter for the past 10 years.

Figure 26

Strong GDP and income growth

0

5

10

15

20

25

30

Mar 01 Oct 02 Apr 04 Nov 05 May 07 Dec 08 Jun 10

GDP YoY Avg remuneration YoY(%)


The future remains rosy Mainland China’s per-capita disposable income will grow 11% annually in the next five years, according to Euromonitor estimates. This compares to the world average of 5% and Asia Pacific average of 7%.

The average Mr Chan is also going well

Income growth of 11% in China

Very significant growth in past ten years



Figure 27

Per capita disposable income growth 09-14CL

1

3

3

3

4

5

6

6

6

6

7

7

7

11

11

14

0 2 4 6 8 10 12 14 16

Japan

Germany

France

United Kingdom

USA

World

Singapore

Hong Kong

Thailand

Malaysia

Taiwan

South Korea

Asia Pacific

Indonesia

China

India

(%)


The percentage of households with income of more than US$10,000 has increased from 3.1% in 2000 to 17.2% in 2009, or a 21% Cagr, which is much faster than the lower-income categories. We expect the wealthy group with household income of more than US$10,000 to continue to grow at double-digits in the next eight years, representing 51% of the total in 2020.

Figure 28

Mainland China income distribution

0102030405060708090

100

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

10CL

11CL

12CL

13CL

14Cl

15CL

16CL

17CL

18CL

19CL

20CL

> US$10,000 US$7,500-10,000 US$5,000-7,500US$2,500-5,000 US$500-2,500 < US$500(%)


The rapid urbanisation in China also gives another boost to the luxury-goods market. A larger workforce with growing income will benefit the many high-end brands that are expanding their presence in first and second-tier cities.

Fourfold jump in households earning over

US$10,000 per annum

Chinese people getting wealthier

Outperforming the crowd



Figure 29 Figure 30

Urbanisation in China

Average household income growth (2000-09)

0

20

40

60

80

100

1990 1995 2000 2005 2010 2015 2020

Urban Population Rural Population(%)

0

2

4

6

8

10

12

14

Urban Rural

(%)


We also conducted a detailed proprietary luxury study in the mainland, surveying more than 340 consumers in 65 Tier 1-3 cities and 31 luxury store managers. We found that 53% of consumers surveyed in Tier 1-2 cities spent Rmb10,000 or more on luxury goods in the past 12 months, compared with 39% in Tier-3 cities. On average, among all the consumers we surveyed who have made luxury purchases in the past 12 months, each spent Rmb16,674. On average, they spent an average of 10-12% of their total household income on these items. This underlines the high propensity to spend on luxury goods in China.

While the shoppers in Tier 1-2 cities tame their budgets on luxury purchases, Tier-3 city consumers plan to keep their luxury spending budget at about the same level. We are not concerned about respondents’ desire to spend less on luxury goods next year as we believe that most respondents would typically end up spending more on luxury goods than is planned each year, given the somewhat impulsive nature of this type of purchases.

Figure 31 Figure 32

To those who made luxury purchases: How much did you spend on luxury goods (excluding autos)?

How much do you plan to spend on luxury goods in the next 12 months? (excluding autos)

3

1922

28

36

5339

010

203040

50607080

90100

Tier 1-2 cities Tier-3 cities

Below Rmb1,000 Rmb1,000-4,999

Rmb5,000-10,000 Above Rmb10,000(% of consumers)

16,674

18,543

15,78815,975

16,19615,879

14,000

15,000

16,000

17,000

18,000

19,000

20,000

Overall Tier 1-2 cities Tier-3 cities

Spending in the past 12 months

Budget for the next 12 months

(Rmb/per person)


CLSA proprietary survey



The 31 store managers that we surveyed remain very upbeat and expect overall sales to enjoy a 20% Cagr in the next three years. Luxury auto managers see growth in 2010 as extraordinary and expect a more normalised, yet still very high growth rate of 26%.

Figure 33

Estimated sales growth at luxury stores surveyed

33

48

14

2020

26

1214

0

5

10

15

20

25

30

35

40

45

50

Overall Luxury car Luxury handbag,clothing, watch &

jewellery


YoY growth in 2010

Annual average in the next three years

(%)


Falling savings rate In 2009, mainland Chinese people saved 37% of their disposable income, almost doubled the Asia Pacific average of 20% and more than tripled the world average of 9.8%, according to Euromonitor. Although savings rates remained high in the past five years, we believe that it may have already peaked. Government policies in China actively encourage household consumption to create sustainable growth in the country.

Figure 34 Figure 35

Savings as % of disposable income

China’s savings ratio

(20) (10) 0 10 20 30 40

TaiwanUK

USAIndonesia

JapanWorld

GermanyMalaysia

FranceThailand

South KoreaAsia Pacific

IndiaHong KongSingapore

China

(%)

0

5

10

15

20

25

30

35

40

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(%)


Consumer confidence has made a solid comeback after the financial crisis. Retail sales growth has picked up, particularly robust at 32% in February 2010 and stabilised at 22-24% in March-November 2010.

Government encouraging spending

Store managers are bullish



Figure 36

China consumer confidence and retail sales growth

95

100

105

110

115

120

125

Jan 00 Oct 01 Aug 03 May 05 Mar 07 Jan 09 Oct 10

0

5

10

15

20

25

30

35Consumer Confidence Index Retail sales YoY (RHS) (%)


More consumer credit Another driving force in consumer expenditure is the growing credit in the market. Penetration of credit cards in the cities has increased fourfold since 2005 to 5.4% in 2009, with the number of credit cards in circulation in China skyrocketing to 221 million as of September 2010. MasterCard estimates that there may be about 800-900 million credit cards in circulation in 2020, surpassing the United States, which currently has 700 million. Compared with other Asian countries, China still has a relatively low consumer credit/GDP ratio. We expect further easing of consumer credit as the recovery grows more robust and as more Chinese consumers adopt credit cards.

Figure 37 Figure 38

Number of credit cards issued

Credit card/urban population

0

50

100

150

200

250

2005 2006 2007 2008 2009 Mar10 Jun10 Sep10

(m)

1.31.5

2.7

4.2

5.4

0

1

2

3

4

5

6

2005 2006 2007 2008 2009

(%)

Figure 39

Consumer credit/GDP

0 10 20 30 40 50 60 70 80 90

PhilippinesIndonesia

IndiaChina

ThailandJapanKorea

SingaporeTaiwan

Hong KongMalaysiaAustralia

(%)


Credit cards stimulate luxury sales

A long way to catch up

Chinese out shopping



More aspirational shoppers Growing consumer credit also encourages the middle-income class to make luxury purchases more often than they can afford. Banks in China have been raising credit limits, but payable credit in the country grew even faster. Part of the reason could be consumers getting more comfortable carrying a larger balance on their cards. However, credit card balance outstanding for over six months almost quadrupled since March 2008 to Rmb7.9bn in September 2010, which translates into an average of Rmb36,000 for each issued card. We believe that some Chinese aspirational shoppers are trying hard to match the lifestyles of the newly rich.

Figure 40 Figure 41

Average credit limit per card

Credit limit and payable credit YoY gwth

4,500

5,000

5,500

6,000

6,500

7,000

7,500

8,000

8,500

9,000

Mar 08 Sep 08 Mar 09 Sep 09 Mar 10 Sep 10

(Rmb)

0

20

40

60

80

100

120

Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10

Credit limit Payable credit(%)


Figure 42

Average balance outstanding for six months and over

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Mar 08 Sep 08 Mar 09 Sep 09 Mar 10 Sep 10

(Rmb)

Source: CEIC, Wind, CLSA Asia-Pacific Markets

b) Social drivers Love for luxury With growing disposable income, Chinese consumers have developed a growing appetite for brands. Some 75% of Chinese consumers we surveyed are interested in luxury goods. Although 22% are not able to afford them yet, rising income in China should continue to move consumers into the luxury shopper category. As a proxy to get a sense of how much Chinese love luxury goods, we asked how much they would be willing to spend on a luxury watch. Of our respondents, 12% said they are willing to pay Rmb50,000 and 12%

Growing more comfortable with debt

Some 75% are interested in luxury goods . . .



said Rmb100,000 and above, ie 24% of the people surveyed earning an average of RMB41,976 per year said they would spend more than Rmb50,000 on a watch.

Figure 43 Figure 44

Which category do you fall into?

What's the most you will pay for a watch?

% of CRR Consumer Panel

I have bought/plan to buy

luxury goods53%

I want to buy luxury goods

but can'tafford them

22%

I don't want to buy luxury goods

25%

% of CRR Consumer Panel

Rmb1K39%

Rmb50K12%

Rmb100K4%

No upper limit6%

Zero7%

Rmb200K1%

More than Rmb200K

1%

Rmb10K30%


About 77% of Chinese luxury shoppers believe that high-end goods are of superior quality. Luxury goods are a symbol of success and status. Some 64% of consumers see these purchases as a way to reward themselves, while only 48% confess that they take this as a way to show off to friends and family.

Figure 45

To those that have bought/plan to buy luxury goods: Do you agree with the following?

48

49

58

60

64

64

77

52

51

42

40

36

36

23

0 20 40 60 80 100

I buy luxury goods to give as gifts

I buy luxury goods because people in my social and work circle own them

I buy luxury goods because they are fashionable

I buy luxury goods because they are superior in design

I buy luxury goods to reward myself

Owning luxury goods is a symbol of success and status

I buy luxury brands because they are superior in quality

(% of consumers who have bought or plan to buy luxury goods)

Yes No


Whether it is just to reward themselves or dressing up for friends, luxury store managers confirm that their customers highly value their brands and enjoy the social status their goods convey.

Reasons why Chinese buy luxury goods

Chinese love brands

. . . and willing to spend



Figure 46

To store managers: What are the reasons why consumers buy your brand?

0

0

11

0

0

22

25

21

22

0

7

22

13

57

33

25

7

33

88

93

33

88

86

100

0 20 40 60 80 100

Luxury car


jewellery

Luxury skincare & makeup

(% of stores)

High acceptence among customers High price

Best design Best quality

Fashion Shop environment & service

Social status & high profile High brand name


For those who can afford but decide that luxury goods are not for them, a whopping 97% say they are just being practical. We wonder if these are the same people that spend all their money at Macau’s gaming tables.

Figure 47

To consumers that do not buy luxury goods: Do you agree with the following?

97

52

34

3

48

66

0 20 40 60 80 100

I'm practical and don't want to pay the highprice for luxury goods

Luxury goods are superficial, so I don't wantto buy them

I don't buy luxury goods because there aretoo many fakes for luxury brands in the

Chinese market

(% of consumers who will not buy luxury goods)

Yes No


Some people are practical

Brands drive purchases



Wealth and status are highly valued in Asian culture. Success is often times measured by net worth and social status, and therefore it is important to polish your image - dress well for your social status and better yet dress up to the next level.

Girl power The role of women in China is an increasingly important driver to the luxury-goods market. According to a 2010 MasterCard report, 75% of Chinese women say that they are the ones who control the family purse strings, compared with the Asia-Pacific average of 65%. Meanwhile, women’s labour force participation rate is at 67% in 2010, compared to the Asia-Pacific average of 51%, and 32% of these Chinese working women plan to spend more in the next six months.

Clothing and cosmetics are likely to be the major growth areas. The Women of China magazine’s 2009-10 survey reveals that the top three categories where urban women plan to spend in 2010 are:

Clothing and accessories (62.7%)

Cosmetics (40.7%)

Cell phone (22.0%)

Our survey found that 50% of store managers in the luxury handbag, clothing, watches and jewellery segment said their customers are female and 43% said it was an even mix. Meanwhile, luxury cars are still male-dominated.

Figure 48

Luxury customers by gender

7

88

100

50 43

13

0 20 40 60 80 100



jewellery

Luxury car

(% of stores)

Male Female 50-50


c) Supply We argue that store expansion by luxury-goods companies will also drive demand. As one top executive of a Hong Kong-based luxury retailer said, demand from mainland consumers is only capped by supply. As of now, most luxury stores are still concentrated in Tier-1 and Tier-2 cities in China, based on our review of 24 luxury brands network. We expect the market to continue expanding, not only due to the demand drivers we discussed above, but also from further penetration of luxury brands into Tier-3 cities in China. As mentioned above, we expect mainland Chinese to represent half of global luxury-goods growth over the next 10 years.

Dressed for success

About 75% of Chinese women take care of

household finance

Shopping for nice clothes and cosmetics

Women dominate accessories and

cosmetics segments



As shown in Figure 49, there are still some cities with disposable income per capita above Rmb20,000, but only a handful of luxury brand stores, presenting huge potential for penetration. We expect the data set to move towards the upper right as consumers get richer and luxury brands open more outlets.

Figure 49 Figure 50

Luxury store locations

Store counts vs disposable income (ex Beijing, Shanghai)

17171718192021212223232526283032

39394141

125131

0 20 40 60 80 100 120 140

ChongqingNingbo

ZhengzhouWenzhou

WuxiWuhan

ChangshaXian

NanjingKunming

SuzhouHarbinTianjin

QingdaoDalian

GuangzhouHangzhouShenyangChengdu

ShenzhenShanghai

Beijing

0

5

10

15

20

25

30

35

40

45

0 10,000 20,000 30,000 40,000

(Store count)

Disposable incomeper capita (Rmb)

Source: Company websites, CLSA Asia-Pacific Markets. Brands include Cartier, Alfred Dunhill, Hugo Boss, Cerruti, Ermenegildo Zegna, Salvatore Ferragamo, Canali, Giorgio Armani, Burberry, Coach, Louis Vuitton, Escada, Gucci, Tod’s, Hermes, Bulgari, Versace, Givenchy, Celine, Fendi, Prada, Tiffany, Chanel, and Lanvin.

Unlike most other markets, luxury stores in China are primarily located in department stores, since it is still the preferred method of shopping in the country. For example, we estimate that only about 20% of Ports Design’s more than 300 stores are standalone stores. As such, investors can also get exposure to the luxury-goods sector via mainland department stores such as PCD Stores (331 HK - HK$2.44 - U-PF) and Golden Eagle Retail (3308 HK - HK$21.75 - O-PF) as well as commercial landlords such as Hang Lung Prop (101 HK - HK$36.00 - U-PF) and Kerry Properties (683 HK - HK$43.25 - O-PF).

Domestic versus total demand Luxury goods feature high on the shopping list for Chinese travellers. and total demand is highly geared to tourism. The World Travel & Tourism Council estimates that mainland China’s travel demand in 2010 is the second largest in the world at US$587bn. The council expects demand to increase rapidly at a 9% Cagr in the next 10 years to US$2,304bn in 2020, catching up with the US.

Figure 51 Figure 52

Total travel and tourism demand 2010

Total travel and tourism demand 2020

0 500 1,000 1,500 2,000

AustraliaCanada

SpainItaly

United KingdomFrance

GermanyJapanChina

United States

(US$bn)

0 1,000 2,000 3,000 4,000

Russian FederationItalyIndiaSpain

FranceUnited Kingdom

GermanyJapanChina

United States

(US$bn)

Source: World Travel & Tourism Council, CLSA Asia-Pacific Markets

Further penetration

Department stores dominate in China

http://www.clsa.com/member/company/index.asp?clsa_id=210007983










Total departures from the mainland for private purpose have been enjoying a Cagr 25% since 2000. We expect outbound travel growth to remain very robust over the coming decade. The government expects that 100 million people will travel abroad by 2015, up from 47 million in 2009.

Figure 53

Chinese outbound travel

0

10

20

30

40

50

60

1994 1996 1998 2000 2002 2004 2006 2008

Departure for private purpose Total departures

Private trips at a 25% Cagr

(m person-time m)


The huge travel demand led Airbus to raise its forecast for aircraft sales over the next 20 years. The jet maker’s COO John Leahy said that demand for travel is doubling every 15 years, but in places like India and China, they expect to double in the next six years.

Shorter term, we see growing travelling appetite as 24% of our CRR consumer panel is planning to take a trip in the next 12 months, up from the 16% who travelled in the past year.

Figure 54

Overseas travel aspirations

1624

48

8374

50

1 11

0

10

20

30

40

50

60

70

80

90

100

Past 12 months Plan to in next 12 months Plan to in next three years

Yes No No reply

+52%

+96%

(% of CRR Consumer Panel)


More planning to travel

Mainlanders on vacations

Let’s go abroad




The 31 store managers we surveyed also named overseas demand as the top competitive force in luxury skincare and accessories. The strong demand intensifies competition in the luxury space more than domestic expansion of competitive brands.

Figure 55

Score the following competition your store faces: 0 = not at all, 5 = highly competitive

0.5

2.1

2.2

0.6

1.4

0.8

2.0

3.7

3.6

3.1

2.6

3.2

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

Luxury car


jewellery


(Average score)

Consumers shopping online Counterfeits

Consumers shopping abroad Store opening of other luxury brands


Some 65% of the Chinese customers surveyed bought luxury goods during their last trips abroad. On average, these consumers spent Rmb8,338 during their last trip. This is 50% of the total Rmb16,674 that those who shopped for luxury goods have spent in the past 12 months.

Figure 56

Overseas luxury spending during last trip abroad

(% of consumers who travelled abroad)

0 2 4 6 8 10 12 14

Less than Rmb5,000

Rmb5,000-9,999

Rmb10,000-19,999

Rmb20,000 and more


Overseas luxury-goods market size Mainland Chinese demand for luxury goods overseas is nowhere close to peak. China travel is still very low compared with neighbouring North Asian countries. While the Chinese government puts greater emphasis on developing tourism and relaxing travel policies, foreign countries are also giving warm welcomes to these affluent Chinese travellers. The level of Chinese departures as a percentage of the population is the same as Japan and Taiwan in 1984 and Korea in 1991.

Travel is key threat for retailers

On the cusp of a sustained Chinese

travel boom

Big spenders when travelling

Competing against shops overseas



Figure 57

Departures as a percentage of total population

0

5

10

15

20

25

30

35

40

45

1964 1972 1979 1987 1995 2002 2010

Japan Taiwan Korea China(%)


China’s GDP per capita is comparable to Japan’s in the 1960s and one could argue that the potential of Chinese consumer’s spending power and their tourism demand can be huge.

Figure 58

Comparison of GDP per capita of Japan 1964-2000 and China 2000-2009

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1964 1969 1975 1981 1987 1993 1999

(US$) Japan (1964-2000) China (2000-2009)

China in 2009

Source: CEIC, CLSA Asia-Pacific Markets. Assume 1971 JPY:USD exchange rate of 315:1 for 1964-1970.

Bain estimates the Chinese overseas luxury market at Rmb87bn, which is 27% larger than the Rmb68bn spend domestically. Many large department stores in Japan, Europe and the US have hired Mandarin speakers to ride on this trend. Estee Lauder said airport-related sales rose about 24% in the first nine months of 2010. While Salvatore Ferragamo saw sales doubling forecasts at its new store at Beijing airport.

Hong Kong and Europe are the core luxury overseas market for mainland Chinese.

China’s GDP per capita in 2009 is comparable to

Japan’s in 1973

Ready to boom

Mandarin speakers in demand



Figure 59

Total Chinese luxury demand breakdown by purchase location

Japan5%

US6%

Europe26%

Macau3% HK

10%

Domestic45%

Taiwan1%

Others4%


Reasons for luxury shopping overseas We believe the core reason that drives mainland tourists to purchase luxury goods while travelling is taxes. Import duties are relatively high in China and the government also imposes a consumption tax and the typical VAT.

Figure 60

Taxes on imported luxury goods

Customs duty (Most favoured nation rate) (%)

Perfume and cosmetics 10-18

Jewellery 20-35

Handbags, briefcases, purses, wallets 10-20

Watches 11-23

Whiskey, tequila, vodka, liqueur, rum 10

Consumption tax

Cigars 25-45

Alcohol 5-20

Cosmetics 30

Valuable jewellery and ornaments 5-10

Golf and golfing equipment 10

Yachts 10

High-end watches 20

Standard VAT 17

Source: CMS Legal Services (October 2009)

We have reviewed 10 luxury watches and found the price difference between Hong Kong and mainland China ranges from 12-33%.

High taxes/duties in China



Figure 61

Price comparison between Hong Kong and China

HK$ RMB % difference in HKPatek Philippe Nautilus Stainless Steel Watch model#: 5712/1A 233,000 280,700 (29)

Panerai Men's Radiomir Black Seal Ceramic 45mm Watch model#: PAM 292

58,400 57,200 (12)

Audemars Piguet Men's Royal Oak Offshore Chronograph Steel Watch model#: 26020ST.OO.D001IN.01.A

163,000 171,000 (18)

Lange & Söhne Men's Zerwierk White Gold Watch model#: 140.029 415,400 475,000 (25)

Patek Philippe Men's Calatrava World Timer White Gold Watch model#: 5130G

294,000 354,800 (29)

Patek Philippe Gondolo Serata White Gold Watch model#: 4972G 243,500 293,700 (29)

Cartier Tank Francaise Stainless Steel Watch model#: W51008Q3 28,000 29,800 (19)

Audemars Piguet Women's Dream Watch model#: 67496BC.ZZ.A066SU.01

309,000 323,000 (18)

Rolex Datejust 36mm Diamonds & White Gold Watch model#: 116244-63600

87,000 112,200 (33)

Cartier Ballon Bleu Medium Rose Gold Watch model#: WE9005Z3 285,000 305,000 (20)

Source: Companies, Emperor Watch & Jewellery, CLSA Asia-Pacific Markets

http://www.google.com.hk/imgres?imgurl=http://www.cartier.com/var/cartier/storage/images/media/images/show-me/product-visuals/w51008q3_1-png/1964658-1-eng-MS/w51008q3_1-png1_product_view.png&imgrefurl=http://www.cartier.com/show-me/timepieces/w51008q3-tank-fran%25C3%25A7aise-watch-small-model&usg=__UvpcCfVxMlS83FPuXRhdBy1pUyI=&h=320&w=320&sz=40&hl=zh-TW&start=88&zoom=1&tbnid=m9CZCCqfQuxrqM:&tbnh=118&tbnw=118&prev=/images%3Fq%3Dw51008q3%26start%3D80%26um%3D1%26hl%3Dzh-TW%26sa%3DN%26tbs%3Disch:1%26prmd%3Divns&u

http://www.luxurywatch.ch/pics/cat/b/WAdP_Dream_67496BC.ZZ.A066SU.01 r165.jpg

http://www.google.com.hk/imgres?imgurl=http://www.cartier.com/var/cartier/storage/images/media/images/show-me/product-visuals/we9005z3_1-png/2110663-1-eng-MS/we9005z3_1-png1_product_view.png&imgrefurl=http://www.cartier.com/show-me/timepieces/we9005z3-ballon-bleu-watch-medium-model&usg=__onVlbX_5DOldajvnWcDAuvDuXh8=&h=320&w=320&sz=88&hl=zh-TW&start=20&zoom=1&tbnid=z8E2_46kM6xFNM:&tbnh=118&tbnw=118&prev=/images%3Fq%3Dcartier%2Bwe9005z3%26um%3D1%26hl%3Dzh-TW%26sa%3DN%26tbs%3Disch:1%26prmd%3Divns&um=1&itbs=1



According to LVMH, prices in Shanghai are 35% higher than in Paris.

Figure 62

Price index for Louis Vuitton

0

20

40

60

80

100

120

140

160

Paris NYC Hong Kong Shanghai Tokyo

(Price Index)

Source: LVMH

The secondary effect of this is the re-sale market and gifting culture. Some mainland tourists would shop for luxury items overseas and resell when they return to China at a slight mark-up to subsidise their trips. Getting small gifts for family and friends from foreign countries has also become part of the Asian culture. Accessories like handbags, briefcases and watches and cosmetics are popular items on “friend’s shopping list”. They are easily identifiable by model numbers and colour codes and hence it is also common to ask friends who are going to travel to shop for you. Lastly, consumers just generally have higher propensity to spend while travelling on vacation and during holiday seasons.

Shopping destinations Our proprietary survey found that Hong Kong, Macau, and Taiwan dominate the overseas luxury-goods market.

Figure 63

For those who shopped overseas: where did you make the luxury purchases?

1

8

11

12

67

0 10 20 30 40 50 60 70 80

U.S./Canada

Elsewhere in Asia

Japan/Korea

Europe

HK/Macau/Taiwan

(% of consumers who bought luxury goods overseas in the past 12 months)


Re-sale market and gifting culture

Hong Kong, Macau and Taiwan are the popular

destinations

Substantial price difference



Hong Kong Hong Kong and Macau are the top destinations for Chinese tourists. In 2009, 39% of all departures went to Hong Kong while 32% went to Macau, according to tourism statistics.

Figure 64

Mainland Chinese travelling destinations (2009)

Others14%

Taiwan2%

Macau32%

Thailand1%

Malaysia1%

Russia1%

USA2%

Singapore1%

Korea3%

Hong Kong39%

Japan3%


While Macau continues to be mainlanders’ most favourite destination for gaming, its luxury market is growing rapidly from a small base. As Jimmy Mak, vice-president of Omega for Hong Kong, Macau, and Taiwan pointed out, incremental sales growth is greater in Macau despite Hong Kong being the leading Swiss watch exports market. At about HK1.9bn’s worth in 3Q10, or 25% of total retail sales, watches and jewellery now dominate the retail market in Macau, even greater than clothing (8%), supermarket goods (8%), and motor vehicles (8%) combined. Rolex (Hong Kong) is the second-largest supplier to high-end casino operator Wynn Macau, only after its construction contractor.

However, according to Bain estimates, Hong Kong’s luxury market size is still more than 6x that of Macau. Although the proportion of mainland tourists should be lower in Hong Kong, we estimate that mainlanders still spend 4-5x more in Hong Kong than Macau.

Luxury shopping heavenChinese consumers prefer European brands when it comes to luxury goods. Given the close proximity and its fame as a shopping heaven, Hong Kong still attracts many luxury shoppers. Hong Kong tops the

lists for purchases of luxury cosmetics, jewellery and watches and fashion and accessories, with Japan and Europe as the much weaker competitors on these fronts.

Where to buy luxury cosmetics . . . . . . jewellery and watches . . . . . . fashion and accessories

0 10 20 30 40 50 60

MacauGuangzhouSingaporeT-2 cities

BeijingShanghai

USAS. Korea

EuropeJapan

Hong Kong

(%)

0 10 20 30 40 50 60

South KoreaTier-2 cities

SingaporeGuangzhou

MacauUSA

JapanShanghai

BeijingEurope

Hong Kong

(%)

0 10 20 30 40 50 60

MacauSingapore

South KoreaTier-2 citiesGuangzhou

USAJapan

BeijingEurope

ShanghaiHong Kong

(%)

Source: Albatross/Ruder Finn Asia

Macau is growing fast, but Hong Kong is still the

top overseas luxury market for Chinese

Some 71% of tourists went to Hong Kong

and Macau



Oriental Watch, a large dealer of Rolex and Tudor in Hong Kong, believes that Chinese customers accounted for about 50% of its FY10 HK$3bn group turnover. At Emperor Watch & Jewellery’ flagship store in Tsim Sha Tsui, more than 85% of customers are from mainland China and even in the Central business district, the company estimates 70% of customers are mainlanders. Luk Fook believes 50-60% of its business in Hong Kong comes from Chinese tourists and the jeweller plans to open new shops in Hong Kong in early 2011.

Trinity, which operates luxury menswear brands including Cerruti 1881 and Gieves & Hawkes, also finds 60% of its customers in Hong Kong coming from China.

Figure 65

Revenue contribution by mainlanders for Hong Kong stores

0 10 20 30 40 50 60 70 80 90

Oriental Watch group

Luk Fook (Hong Kong)

Trinity (Hong Kong)

Emperor W&J Central

Emperor W&J TST

(%)

Source: Company estimates, CLSA Asia-Pacific Markets

In 2009, overnight mainland visitors spent HK$2,417 on shopping per capita in Macau, compared with HK$5,051 in Hong Kong. In Hong Kong, mainland tourists spend 76% of their total spending for the trip on shopping, up from 60% in 2002. They spend HK$6,620 per capita in total during their visit, or 15% above average of HK$5,770 and a 66% more than Japanese.

Figure 66 Figure 67

Chinese overnight visitor spending in Hong Kong

Total spend per overnight visitor in Hong Kong

6068 68 65 68

73 7176

14

12 11 1112

11 12914

12 12 13 1210 10 8

127 9 10 9 7 7 7

0

10

20

30

40

50

60

70

80

90

100

2002 2003 2004 2005 2006 2007 2008 2009

Shopping Hotel bills Meals outside hotel Others(%)

3,069

3,733

3,923

3,976

4,040

4,211

4,350

4,592

4,620

4,872

4,875

4,902

5,090

5,117

5,533

5,770

6,620

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000

MacauSouth Korea

IndiaJapan

MalaysiaPhilippinesIndonesiaGermany

FranceUSA

ThailandUnited Kingdom

SingaporeTaiwan

AustraliaAverage

Mainland China

(HK$)


Mainlanders account for 50-85% of revenue at Hong Kong watch and

jewellery shops

Significant contribution from mainlanders at

stores in tourist areas



Mainland tourists allocate a large portion of their spending on shopping, much higher than other tourists in Hong Kong. Interestingly, they only allocate 9% of their spending on hotels, compared to an average of 17% in Hong Kong.

Figure 68

Spending allocation patterns

0% 20% 40% 60% 80% 100%

United KingdomUSA

FranceGermany

IndiaJapan

AustraliaSingapore

South KoreaMalaysia

PhilippinesMacau

IndonesiaThailand

TaiwanAverage

Mainland ChinaShopping Hotel bills Meals outside hotels Others

(%)

0 20 40 60 80 100


An average mainland tourist spends HK$5,051 on shopping, 73% more than the average Taiwan visitor, in second place.

Figure 69

Average spend on shopping by country

903

1,121

1,240

1,254

1,296

1,529

1,569

1,634

1,856

1,968

2,149

2,161

2,232

2,758

2,923

3,6675,051

0 1,000 2,000 3,000 4,000 5,000 6,000

United KingdomUSA

FranceGermany

IndiaJapanMacau

South KoreaMalaysia

PhilippinesAustralia

SingaporeIndonesiaThailand

TaiwanAverage

Mainland China

(HK$)


Japan Some 1.4 million mainland tourists visited Japan in November YTD 2010, accounting for 17% of total tourist arrivals, after South Korea’s 28%. The Japanese government relaxed tourist visa rules for Chinese nationals in July 2010, lowering the income requirement from Rmb250,000 per year to Rmb60,000 per year, in an effort to attract tourists who would prefer not to join a tourist group.

Japan welcomes Chinese tourists

Chinese tourists like shopping in Hong Kong much more than other

tourists

Mainlanders don’t spend much on hotels



Figure 70

Breakdown of tourist arrivals in Japan 2009

Hong Kong7%

Thailand3%

Rest of Asia6%

Singapore2%

South Korea23%North America

13%

Oceania & others4%

China15%

Taiwan15%

Europe12%


Japan Tourism Agency (JTA) expects 1.5 million mainland tourists for this year and aims to more than triple the number of Chinese tourists to 3.9 million by 2013 from 1.01 million in 2009, overtaking South Koreans as the top nationality of tourists to Japan.

Figure 71

Mainland tourist flows to Japan

1.0

1.5

3.9

15.014.8

26.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2009 2010F 2013F

(m)

0

5

10

15

20

25

30Number of mainland Chinese touristsMainland tourists as % of total (RHS)

(%)

Source: JTA, CLSA Asia-Pacific Markets

According to JTA, 93% of mainland Chinese tourists shopped in Japan in April-June 2010. About 70% of them purchased cosmetics, medicine and toiletries, spending an average of ¥37,995 per capita (HK$3,591). And 33% of them bought Western clothing, bags and shoes, spending an average of ¥46,978 per capita (HK$4,440). Japan National Tourism Organization found in 2008 that 50.9% of Chinese tourists went to Japan with shopping in mind.

Union Pay, a Chinese debt care payment service, has seen transactions in Japan rise by nearly 90% YoY to ¥20bn in 2009. According to electronic retailer Bic Camera, the average spending of Chinese tourists is ¥50,000, five times larger than Japanese customers. The overall average spending per tourist at

Chinese tourists spent 5x more than locals

at Bic Camera

South Korea was the largest tourist source . . .

. . . but that may change soon



department stores is nearly ¥60,000 and Chinese tourists top the ranking. The department store association reported that women’s accessories/apparel, luxury brands, and cosmetics top the ranking of popular items.

Figure 72

Popular items among tourists at department stores

Popular categories Items

1 Women’s accessories Handkerchief, accessories, Agnes b, Burberry Blue Label, boots

2 Luxury brands Bulgari, Armani, Prada, Gucci, Louis Vuitton, Hermes

3 Women’s apparel Burberry Blue Label, dress, jacket, sleepwear

4 Cosmetics Shiseido, SK-II, Albion, Fancl

5 Fine arts and jewellery Jewellery, watches, painting

Source: Department store association, CLSA Asia-Pacific Markets

The West The richer Chinese consumers become, the more likely they are to fly to Europe for luxury shopping, especially for clothing, jewellery and watches. Luxury brand Burberry estimates that 30% of its business in the United Kingdom is to a Chinese consumer. At Gucci, in the first nine months of 2010, the number of Chinese customers nearly doubled from a year earlier to almost 22% of sales in Europe. French luxury store chain Galeries Lafayette also received a lot of Chinese customers at its store in Paris, accounting for about one in seven of its visitors with a per-capita spending of about €800. Tax-free shopping specialist Global Blue estimates Chinese tourists spent 99% more in Europe in the first 10 months of 2010, compared to a year ago. The average transaction is €718 at high-end stores that provide tax-refund facilities.

The UK, however, is facing challenges attracting mainland tourists. The country is not part of the Schengen visa system, which gives Chinese tourists access to 25 European countries on one visa including France, Germany, Italy and Spain. As such, the number of Chinese tourists to the UK has only increased by a 3% Cagr since 2003 and is 28% off the peak in 2007.

Figure 73 Figure 74

Asia ex Japan tourist inflow to France

Chinese tourists visiting UK

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2003 2004 2005 2006 2007 2008

('000)

0

50

100

150

200

2003 2004 2005 2006 2007 2008 2009

('000)


Tourist flows to the US saw negative YoY growth in February-July 2009, but has since then been growing at 10-82% YoY each month. The last cycle was similar. There were nine consecutive months of negative tourist inflow growth

Fly to the country of origin

Resilient tourist flow



from China and Hong Kong in 2003 and the flow strongly rebounded soon after. The tourism office in the US only started breaking out mainland tourists this year. For the first three quarters of 2010, 619,865 tourists from China visited the US, or 3% of total overseas tourist arrivals.

Figure 75

US visitor arrivals from China and Hong Kong

(100)

(50)

0

50

100

150

Jan 00 Sep 01 Jun 03 Mar 05 Dec 06 Sep 08 Jun 10

(%)


Very volatile demand component We estimate that 56% of Chinese total demand comes from overseas – this creates great volatility in spending. Specifically, back in the early 2000s, there was as a series of attacks, civil unrest, disease and natural disasters that negatively affected tourism. Sars in 2003, tsunami in 2004, terrorist attack in the UK in 2005 and civil unrest in France in the same year all had an impact on Chinese outbound travel. As an example, we saw a significant decrease and subsequent volatility in mainland tourist flows after the tsunami in 2004 in Thailand and the military recoup there in 2006. Chinese people seem to be more averse to negative events, with tourist flows from the mainland dropping significantly more than average.

Figure 76 Figure 77

Thailand visitor arrivals from China during 2004 tsunami

Thailand visitor arrivals from China during 2006 coup

(80)

(60)

(40)

(20)

0

20

40

Sep 04 Dec 04 Mar 05 Jun 05 Sep 05 Dec 05

Mainland Chinese Total(%)

(40)

(30)

(20)

(10)

0

10

20

30

40

50

Jul 06 Oct 06 Jan 07 May 07 Aug 07 Nov 07

Mainland Chinese Total(%)


Sars and financial crisis

More risk-averse than average



These events had a significant impact on luxury-goods sales and stocks. September 11 in 2001, in particular, weighed on leisure travel and overseas luxury demand.

Figure 78

LVMH stock price

0

20

40

60

80

100

120

140

Jan 01 Sep 02 May 04 Dec 05 Aug 07 Apr 09 Dec 10

Sep 11SARS

Global financial crisis

(€)

Source: Bloomberg, CLSA Asia-Pacific Markets

Sensitive to negative events

Section 2: From head to toe Luxury goods


From head to toe The global luxury-goods market is evenly split among apparel, prestige cosmetics, “hard luxury” items which includes watches and jewellery, and others including accessories and leather goods. China’s market, however, leans more towards hard luxury and accessories, at the expense of apparel. As we previously discussed, watches and jewellery top China’s luxury shopping list and accessories are great for displaying success and wealth.

Figure 79

Luxury market category breakdown

1425

25

25

29

25

3225

0102030405060708090

100

China World

Others, incl. accessories and leather goodsHard luxuryPrestige cosmeticsApparel

(%)

Source: Bain, CLSA Asia-Pacific Markets

We believe hard luxury should continue to lead growth of the luxury-goods market for cultural reasons, although apparel and prestige cosmetics would still expand at very impressive rates.

Figure 80

Luxury segment growth

0

10

20

30

40

50

60

70

80

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Apparel

Prestige cosmetics

Hard luxury

Others (incl. accessories and leather goods)

2010-20Cagr20%

14%

27%

25%

(€bn)


Jewellery Jewellery retail sales in China reached Rmb113.6bn in the first 11 months of 2010, up 56% YoY, according to the National Bureau of Statistics of China. Momentum has been very strong with YoY growth accelerating to 23-82%. Gold prices have increased in the past 10 years, jumping from US$272/oz in 2000 to more than US$1,421/oz in December 2010. Jewellery sales, however, have outpaced the gold price increase.

More hard luxury and accessories for Chinese

Hard luxury and accessories continue to

lead growth

Strong momentum



Figure 81

China jewellery sales (retail value)

0

20

40

60

80

100

120

140

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Annualized10CL

(Rmbbn)

Source: Wind, CLSA Asia-Pacific Markets

Figure 82

Jewellery sales versus gold prices

(10)

0

10

20

30

40

50

60

2001 2002 2003 2004 2005 2006 2007 2008 2009 Annualized10CL

Jewellery sales YoY Gold prices(%)

Source: Wind, Bloomberg, CLSA Asia-Pacific Markets

Gold is popular among Chinese consumers for its intrinsic value and as a symbol of wealth and social status. Gold accessories are often purchased as gifts for special occasions, especially weddings, baby showers and birthdays. The World Gold Council reports that mainland Chinese demand for gold in the 12 months ended 3Q10 reached 526.8 tonnes, up 21% YoY, compared with the global average of 8% YoY. The increase was driven by 70% YoY growth in net retail investment and an 8% YoY rise in jewellery demand. In Hong Kong, demand for gold jewellery supported by mainland tourists jumped by 17% in the same period.

The council estimates in the past five years about 60% of gold demand from China was bought for jewellery. In the past 12 months, 71% of the demand was for jewellery. Nevertheless, our CRR middle-class panel still believes that gold is a good investment option, only after property and domestic stocks. The council expects gold demand in China may double within a decade.

Shining gold

Gold demand may double within a decade

Accelerating growth

Jewellery sales growing faster than gold prices



India continues to dominate world demand for gold. Although India is not a key luxury-goods market, gold demand is very strong so this segment could be one way to play the rising income and consumption story there.

Japan, on the other hand, sees dishoarding gathering pace. As gold prices skyrocket, Japanese investors sold back 68 tonnes of gold in the past 12 months, offsetting the 21 tonnes demanded for jewellery consumption.

Figure 83

Gold consumption demand in value (3Q09-10), including jewellery & retail investment

(1,711)

18

67

591

770

1,118

1,287

1,381

1,631

2,543

2,776

2,801

2,934

4,127

4,197

9,168

9,553

19,616

31,807

(5,000) 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000

JapanFranceTaiwan

South KoreaHong Kong

UKIndonesia

ItalyOther Europe

RussiaVietnam

SwitzerlandThailand

GermanyTurkey

Middle EastUSA

ChinaIndia

(US$m)

Figure 84

Breakdown of consumption demand

820

5667697177

919592

80

4433312923

95

0

10

20

30

40

50

60

70

80

90

100

HongKong

MiddleEast

India China World Turkey USA Vietnam Thailand

Jewellery Net retail investment(%)

Source: World Gold Council, CLSA Asia-Pacific Markets

According to discussions with management of a few large players, rose gold is the new favourite among Chinese consumers. The growing popularity of gemstones and diamond rings in a country that was traditionally more interested in gold and jade also adds to the strong jewellery sales. According to the Ministry of Civil Affairs, more than 11 million couples tied the knot in the mainland in 2009. Industry leader De Beers estimates that nearly half of the couples getting married in Beijing, Shanghai, and Guangzhou are now

Some 71% of Chinese gold demand for jewellery

Indian demand for gold is very strong

Rose gold is the new favourite



buying diamond engagement rings. With the 20-34 age group expected to stay at around 30% of total Chinese population in the next decade, demand for valuable jewellery should continue to be robust.

The jewellery companies we surveyed also said mainland tourists are increasingly looking for larger diamonds. One company said they just recently had a customer asking for a HK$4m pure jade bangle and another one buying a HK$10m diamond. Another large retailer also said mainlanders like to buy two to three-carat diamonds for investment. In 2009, the US accounted for about 40% of global consumer diamond demand.

Figure 85

Diamond demand based on polished wholesale price (2008)

China5%

Gulf8%

USA41%

India8%

Hong Kong2%

Taiwan2%

Italy4%

Rest of world19%

Japan11%

Source: De Beers, CLSA Asia-Pacific Markets

As the world’s largest diamond producer, De Beers forecasts China’s diamond demand to grow from 6-7% of global demand to 16% by 2016 (15% cagr).

Figure 86

Chinese diamond demand as percentage of global demand

16

6

0

2

4

6

8

10

12

14

16

18

2009 2016

(%)


According to Euromonitor data, Chinese consumers have a strong preference for rings, contributing to almost 50% of jewellery sales.

Chinese diamond demand to rise rapidly

Jewellery also good for investment



Figure 87

Sale of jewellery in China by type (2009)

Rings50%

Wristwear8%

Neckwear19%

Earrings23%


There are a handful of big players in the jewellery industry in China, with the big three taking up 32% of real jewellery shares. A number of the top players are listed in Hong Kong, including Luk Fook (590 HK), Chow Sang Sang (116 HK), TSL Jewellery (417 HK) and 3D-Gold (870 HK). Euromonitor estimates that 99.5% of jewellery sales in China were made in retail stores.

Figure 88 Figure 89

3D-Gold’s corporate gift collection

Jewellery and decor designed to cater to Chinese

Source: Company website Source: Chow Tai Fook’s online product catalogue

This strong demand is driving retailers to expand aggressively. Privately-held Chow Tai Fook, for example, is looking to open 1,000 additional outlets on the mainland, doubling its existing network by 2020. It will also add more production lines to its two jewellery processing plants in Guangdong and Shenzhen. Half of the investment planned for the next decade will go to third and fourth-tier cities in rural areas, where management sees enormous potential. Kent Wong, managing director at Chow Tai Fook, said in an interview with a Hong Kong journal, “Consumers in big cities like Beijing and Shanghai now buy jewellery casually when they do their weekend shopping. We expect that will be happening in smaller cities as well in 10 years’ time.”

Few dominant players

Aggressive expansion to capture segment

growth potential

Chinese love rings



The jewellery market is considerably more consolidated than other segments like clothing and drinks. We believe this is partially due to the high inventory that needs to be held on hand, thus creating a high barrier to entry for smaller players. More importantly, Chinese consumers highly value jewellery brands and retailer reputation. News of low-quality gold being sold in the market often encourages consumers to shop at big brand-name stores, which they believe should have a better-developed quality control system. The Chinese Gold & Silver Exchange Society recently said that at least 200 ounces of fake gold was discovered on the Hong Kong gold market and president Haywood Cheung estimates 10x that amount might have infiltrated the retail market.

Figure 90

Real jewellery company shares in China

% retail value (retail selling price) 2005 2006 2007 2008 2009

Company

Chow Tai Fook Jewellery 10.5 10.7 10.9 11.3 11.6

Luk Fook Holdings (International) 9.5 9.6 9.7 9.9 10.1

Chow Sang Sang Holdings International 9.8 9.8 9.8 9.9 10.0

Gallop Jewellery 9.3 9.2 9.2 9.1 8.9

Shanghai Laofengxiang 7.6 7.6 7.7 7.8 7.9

TSL Jewellery (Macau) 5.8 5.8 5.9 6.0 6.2

Chow Tai Seng Jewellery 5.1 5.3 5.5 5.7 6.0

Fujian Fuhui Jewelry 4.3 4.3 4.4 4.5 4.5

3D-Gold Jewellery Holdings 3.6 3.7 3.9 4.1 4.3

Zhejiang Yuewang Jewellery 4.0 4.1 4.1 4.1 4.1

Others 30.6 29.9 29.0 27.5 26.4

Total 100.0 100.0 100.0 100.0 100.0

Source: Euromonitor

Our CRR survey shows that Chow Tai Fook is a brand leader in the jewellery segment in China.

Figure 91

CRR survey: Which jewellery brand did you buy?

1

1

1

2

2

3

3

4

14

0 2 4 6 8 10 12 14 16

Cartier

Hermes

Tiffany

Laofengxiang

Jinboli

King Liu Fook

Chow Sang Sang

Swarovski

Chow Tai Fook

(No. of mentions)


Jewellery market more consolidated than

other sectors

Leading by a wide margin



Figure 92

Chinese millionaires’ favourite jewellery brands

2006 2007 2008 2009 2010

Cartier Cartier Cartier Cartier Cartier

Chanel Bulgari Chanel Van Cleef & Arpels

Bvlgari

Piaget Piaget Tiffany Tiffany Montblanc

Tiffany Dior Van Cleef & Arpels

Bvlgari Tiffany

Bulgari Chanel Piaget Chanel Chanel

Dior Tiffany Bvlgari Piaget Piaget

Van Cleef & Arpels

Adler Mikimoto Mikimoto Van Cleef & Arpels

Adler Van Cleef & Arpels

Harry Winston Harry Winston Mikimoto

na Mikimoto Adler Adler Adler

na na Dior Chaumet Chaumet


Watches The Swiss watch industry is worth SFr15.7bn (US$14.9bn). The industry did contract in 2009 due to the global financial crisis, by 22.8%, the first contraction after five consecutive years of growth. This year so far has been one of growth, up 21.8% to November. The largest buyer of Swiss watches in the world is Hong Kong, accounting for 19% of total Swiss watch exports by value. Hong Kong superseded the US as the largest Swiss watch importer from mid-2007, spurred on by a combination of a healthy financial and property markets (prior to the crisis) and the influx of mainland Chinese tourists. It is also well accepted (without official estimates though) that Hong Kong does serve as a re-export hub, hence some of the direct intake into Hong Kong does find its way to other parts of Asia, including China. As of November 2010, China is currently ranked the fourth-biggest buyer of Swiss watches, up from 10th place in November 2006.

Figure 93

Largest buyers of Swiss watches

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Hong K

ong

USA

Fran

ce

Chin

a

Ital

y

Sin

gap

ore

Ger

man

y

Japan UK

UAE

Spai

n

Tai

wan

Sau

di Ara

bia

Russ

ia

Thai

land

2006 2010(CHF)

Source: CLSA Asia-Pacific Markets, Federation of Swiss Watch Manufacturers. Data is annualised to November 2010

China is currently the fourth-largest imported

Swiss watches

Cartier is the beloved jewellery brand




Figure 94 Figure 95

Swiss watch exports Jan-Nov 2010

Jan-Nov 2010 YoY growth of top-10 export markets

China 7%

USA 10%

Others31%

France 7%

Italy 6%

United Kingdom

4%

Germany 5%

Japan 5%

Singapore 6%

Hong Kong 19%

Hong Kong/China together

is 26%

(10) 0 10 20 30 40 50 60

Germany

Italy

Japan

United Kingdom

USA

France

United Arab Emirates

Singapore

Hong Kong

China

(%)

Source: CLSA Asia-Pacific Markets, Federation of the Swiss Watch Industry (November 2010)

We believe a per-capita comparison is the ideal way to illustrate the significant growth potential of Swiss-watch consumption in China. In doing so, a number of adjustments were needed. Firstly, we assume that 50% of what goes to Hong Kong finds its way to China. As mentioned, there are no official estimates to support this, but an adjustment of size is a reasonable place to start. It is a meaningful adjustment as Hong Kong is the largest Swiss watch importer in the world. Secondly, we assume only the urban population of China are “realistic” consumers. Hence, we assume a population of 594 million.

Figure 96

Global comparison of Swiss watch imports per capita

Consumption per capita (US$)1.4

1.6

4.0

5.0

5.8

5.8

6.9

8.7

8.9

8.7

12.2

14.3

16.8

103.0

183.2

201.5

403.0

2.7

0 50 100 150 200 250 300 350 400 450

Russia

China (unadjusted)

Thailand

China

USA

South Korea

Japan

Spain

Saudi Arabia

UK

Germany

Taiwan

Italy

France

UAE

Singapore

Hong Kong

Hong Kong (unadjusted)

12 mths to 11/2010

See footnote below for adjustmentsmade to China and Hong Kong

Note: Assuming 50% of exports to HK are re-exported to China. This is a meaningful adjustment for the purpose of achieving as conservative a result as possible, as Hong Kong is the largest importer of Swiss made watches in the world (imports are 3x larger than China). We also base our China per capita calculation on an urban population of 594m (not 1.3bn). The data is based on annual data, collected monthly. Source: CLSA Asia-Pacific Markets

Hong Kong (despite the adjustment), Singapore and the UAE significantly lead on a consumption per capita basis, reflecting the “trading hub” nature of these economies, the former two at a staggering US$180 and above. “Old world” economies such as France, Italy, Germany and the UK are between

China’s consumption per capita is low, at only a

third of Europe or Taiwan

China should close much of the gap



US$8.90 and US$17. With the exception of France, the consumption in these economies has been stable for the past five years. The major decline is seen in the US, unsurprisingly, now consuming US$5.0 per capita, compared to US$6.2 five years ago. On the flipside, China is accelerating. Its per-capita consumption of Swiss watches increased by 117% between 2005 and 2010. However, at US$4.0 currently, China still significantly lags more developed (and higher GDP) economies. We believe China should close much of the gap in Swiss watch consumption per capita over the medium to longer term.

Figure 97

China accounts for a 7% share of Swiss watch exports, up from 3% in 2005

0

1

2

3

4

5

6

7

8

9

2004 2005 2006 2007 2008 2009 2010

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000China's share of Top 15 export destinations

Top 15 export value, CHFm (RHS)

(%)

Figure 98

Asia ex-Japan leading the recovery in Swiss watch exports (YoY growth, quarterly)

(60)

(40)

(20)

0

20

40

60

80

100

120

Jun 05 Apr 06 Mar 07 Feb 08 Jan 09 Dec 09 Oct 10

China Asia ex-J Europe USA(%)

Source: CLSA Asia-Pacific Markets, Federation of Swiss Watch Manufacturers (November 2010)

In terms of preferences, Chinese consumers like mechanical watches and also unique watches that require specific craftsmanship, such as enamel, mother-of-pearl engraving. Rolex is almost synonymous with luxury watches in China. When asked what brands come to mind when thinking about luxury watches, 48% of those surveyed in China said Rolex. That is far greater than the second brand Omega at 14%, followed by Vacheron, Cartier, and Longines.

China’s share of Swiss watch exports has

doubled in past five years

China was the quickest to recover from the

financial crisis

Rolex, Rolex, Rolex



Figure 99 Figure 100

Which luxury brand would you like to own?

Which luxury brands did you buy?

Watch

1

1

1

1

4

4

4

5

10

21

0 5 10 15 20 25

Rado

Swatch

Piaget

Tissot

Patek Philippe

Longines

Cartier

Vacheron

Omega

Rolex

(% of consumers)

Watch

1

1

1

2

2

3

3

5

6

7

9

0 2 4 6 8 10

Casio

Calvin Klein

Enigma

Citizen

Tudor

Cartier

Rado

Rolex

Longines

Tissot

Omega

(No. of mentions)


Executives from top luxury watch retailers told us that part of the reason Rolex is so popular is because Chinese consumers view it as almost hard cash given the liquid second-hand market. Its signature crown logo and easy to pronounce name have helped the brand gain recognition in the early days in China.

A lot of mainland customers also pay high regards to the Omega brand thanks to its association with the first moon landing. Trendy designs also help to attract younger customers. Longines is popular for its more affordable price points and it sells very well on the mainland.

The limited supply for some models generates much excitement among the wealthy and it serves as an effective way to display success and power. For example, the market price for the Rolex Daytona watch can reach HK$85,000-90,000, despite a list price at HK$75,000, due to limited supply. Getting one of these limited models is a way to show your influence and connections. “It is about face, not the money (the premium you are paying),” the executive said.

When it comes to picking watch retailers, Chinese consumers are looking for a good selection and a reputable store.

Long waitlist Apply to spend more than HK$1m on a watch We asked management at Emperor Watch & Jewellery, one of the world’s largest buyers at the annual industry fair Baselworld, where we can buy a Patek Philippe minute repeater, one of the hottest collections that is in limited supply. Demand is so strong and the collection is so rare that we learnt each interested buyer would have to file an application form listing his personal information and occupation. To be considered, chances are you would have to be a frequent shopper (ie, have bought more than 10 Patek Philippe watches). Being a professional with a number of certificates may help push your application to the top of the pile as well.

Patek Philippe minute repeater

Source: Company website

Limited editions are even more popular

Retailer reputation is also a key factor



Figure 101

How do you decide which watch retailer to purchase from?

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

Staff knowledge

Brand selections

Staff friendliness

After sales service

Store reputation/image

Model selection

5 is very important

Source: Hengdeli

Clothing Based on Bain’s estimate, the luxury apparel market in the mainland is worth Rmb9.8bn. The potential is huge given that wealthy consumers spend more on clothing as income rises. As consumers get wealthier in China, we expect to see more trading up.

Figure 102

Clothing and footwear spending as percentage of total expenditure

3.7

5.1

5.7

6.26.6

7.07.3

7.68.0

8.5

3

4

5

6

7

8

9

1 2 3 4 5 6 7 8 9 10

(%)

(income by decile)


Menswear is the key component of this market segment. As the luxury market booms, leaders in luxury menswear are aggressively expanding. Trinity, which manages Altea, Cerruti 1881, D'urban, Gieves & Hawkes, Intermezzo and Kent & Curmen, said in April 2010 that it would add 50 or more stores in smaller Chinese cities to its 272-store network on the mainland. Evergreen, which owns V.E. DELURE and TESTANTIN and which went public recently, planned to add 63 new retail stores in China in 2010 and 172 in 2011 to bring total mainland store count to 491.

To accelerate expansion in China, global brands have come up with a variety of strategies. Hugo Boss started a joint venture with local fashion retailer Rainbow Group in July 2010 and planned to open as many as 20 stores in

Spend more on clothing as income rises

Menswear is a key component

Players trying different strategies



China during the remainder of 2010, compared with a worldwide total of 50 additional outlets for the year. Meanwhile, Polo Ralph Lauren took back its Asian distribution rights and Burberry bought back its 50 franchise stores in China. In November 2010, Emporio Armani became the first Western fashion brand to debut on the online China market.


Emporio Armani Online Store, China

Ports Design overcoat selling at Rmb8,999


Being one of the early entrants into the luxury market in China, Ports Design is well-regarded in China as a top female luxury clothing brand. Many surveys in the past have named Ports as a top-five luxury apparel brand in China alongside names such as Chanel, Louis Vuitton, and Christian Dior. Our recent CRR survey found that Ports holds a strong brand presence on the mainland. However, note that there are numerous other strong brands that are not mentioned here - that include Prada, Bottega Veneta, Fendi etc.

With a pair of over-the-knee boots selling at about US$2,500, French shoemaker Christian Louboutin is also eyeing the luxury market in China and plans to operate as many as five stores in China in the next three years. Meanwhile, Salvatore Ferragamo expected its store count in China to reach 44 by the end of 2010, up from nine in 2008. The Italian shoemaker may open as many as eight new stores this year in the country.

Figure 105

Chinese millionaires’ favourite fashion labels

2006 2007 2008 2009 2010 Giorgio Armani Giorgio Armani Giorgio Armani Giorgio Armani Giorgio Armani Louis Vuitton Louis Vuitton Dunhill Louis Vuitton BOSS

Boss Dunhill Valentino Dunhill Versace Dunhill Versace Burberry Zegna Burberry Hermes Hermes Chanel Hermès Zegna

Prada Ports Versace Versace Dior Zegna Hugo Boss Louis Vuitton Dior Louis Vuitton Chanel Montblanc Hermès Givenchy Chanel

Gucci Givenchy Burberry Ports Prada Ports Gucci Givenchy Ermenegildo Zegna Zegna Prada

Gucci Chanel Dior Ports Source: Hurun Research Institute

Luxury shoe brands are also expanding presence



Menswear According to research firm Frost & Sullivan, retail sales of menswear in China increased at a 13.4% Cagr between 2006 and 2009 with sales reaching Rmb300bn (or US$44.2bn) in 2009. Frost & Sullivan expects sales to achieve a 15.8% Cagr over 2009-13.

Figure 106

Retail sales of menswear in China

205.7228.9

262.6

300.3

345.4

399.3

539.9

464.5

11.3

16.315.615.0

14.414.7 16.2

0

100

200

300

400

500

600

2006 2007 2008 2009 10F 11F 12F 13F

(Rmbbn)

0

2

4

6

8

10

12

14

16

18

20(%)Retail value Growth rate (RHS)

Source: Frost & Sullivan

We believe that the increase in disposable income, accelerated urbanisation, a demographic shift in the male population towards the young and middle-aged, rising brand awareness as well as improved product design and quality have and will continue to underpin industry growth.

More importantly, China menswear consumption per capita in urban areas is only about 25% of that in the USA and 20% of European countries.


Menswear consumption per capita in urban areas, 2008

Menswear consumption per capita, 2008

291

1,175

1,489

0

200

400

600

800

1,000

1,200

1,400

1,600

China USA Europeancountries

(US$)

US$15.4bn40.7%

US$10.3bn27.3%

US$5.4bn14.3%

US$6.7 bn17.7%

0

100

200

300

400

500

0 1 2 3 4 5

(US$) First-tier cities

Second-tier citiesThird-tier cities

Fourth-tier cities

US$240

US$378

US$318

US$77

PRC average

(US$bn)

Note: “European countries” refers to 15 countries within European Union as of 1 May 2004. Source: Frost & Sullivan

The consumption behaviour of male consumers in China differs significantly from that of their female counterparts. This results in substantially different operating metrics for menswear versus ladieswear.

We see strong growth in the menswear

market in China

Urbanisation and rising incomes are key drivers

Low menswear consumption per

capita in China

Menswear has different operating metrics from

ladieswear



Figure 109

Comparison of China’s menswear versus ladieswear markets

Menswear business Ladieswear business Brand loyalty High Low Consumers’ price sensitiveness Low High Product ASPs for similar market positioning High Relatively low Average ticket size per purchase High Relatively Low Stay-and-buy ratio High Low Consumers’ purchase frequency Low High Potential for ASP increase High Limited Purchase target More intentional purchases with clear

brand targets in most circumstances More impulse purchases with no clear brand targets in most circumstances

Purchase intention Less show-off factor More show-off factor Retail inventory risk Relatively low Relatively high Fashion risk Low High Product cycle Relatively long Short Market segmentation Relatively broad More defined Consumers’ product focus Product quality, fabrics and functionality Design, colour and trendiness Requirement for raw material procurement High Relatively low Requirements for accessories Low High Number of product SKUs Relatively low High Number of product collections Relatively low High Corporate sales More corporate sales Minimum corporate sales Source: CLSA Asia-Pacific Markets

As shown in our analysis in Figure 109, menswear brands should enjoy more resilient gross margins and more sustainable same-store sales (SSS) growth compared with ladieswear brands.

According to Frost & Sullivan, the business formal (including business suits, shirts and trousers) and smart casual (including casual suits, shirts, jackets and trousers) market accounts for 60.6% of the overall menswear apparel market in China.

Figure 110

China’s menswear market by product, 2009

Accessories4.3%

Business formal and smart casual

60.6%

Fashion casual35.1%


Within the business-formal and smart-casual menswear market, Frost & Sullivan expects the high-end segment (which is defined as a suit retailing for Rmb5,000-15,000) to enjoy slightly higher growth rates (ie, a 17.5% 2009-13F Cagr) than other segments.

Business and smart casual represent 61% of

total menswear market

High-end segment expected to outgrow

other segments

Menswear brands should enjoy more resilient gross

margins and SSS growth



Figure 111

Breakdown and growth of business-formal and smart-casual menswear segment

(Rmbbn) 2006 2007 2008 2009 10F 11F 12F 13F Cagr 06-09

Cagr 09-13F

Luxury-end 13 14 17 19 22 26 31 36

Growth (%) 12.6 15.4 15.8 16.2 17.1 17.7 17.3 14.7 17.1

High-end 9 10 11 13 15 18 21 25

Growth (%) 12.4 15.9 16.0 16.7 17.3 18.0 18.1 14.7 17.5

Mid-to-low-end 100 112 130 150 174 203 238 280

Growth (%) 12.4 15.8 15.4 16.2 16.7 17.4 17.3 14.6 16.9

Total 121 136 158 182 211 247 290 340

Growth (%) 12.5 15.7 15.5 16.2 16.7 17.5 17.3 14.6 17.0

Note: Market segmentation is defined by ASP of a suit: luxury=above Rmb15,000; high-end=Rmb5,000-15,000; low-end=below Rmb5,000. Source: Frost & Sullivan

It should be noted that China’s high-end business-formal and smart-casual menswear market is extremely fragmented, with the top-five brands commanding only a 22% market share (versus 45% for the sportswear sector). As such, we see huge potential for market consolidation in favour of companies with strong brand equity and well-established retail networks such as Evergreen. See our 8 December 2010 report Tailored for success.

Figure 112

Market share of top-five players in China consumer space, 2009

95

75

67

66

65

58

57

50

49

45

45

37

22

0 20 40 60 80 100

Carbonated drinks

Ready-to-drink (RTD) tea

Instant noodles

RTD coffee

Hair care

Beer

Milk

Bottled water

Down apparel

Sportswear

Bath and shower products

Fruit/vegetable juice

High-end business formal & casual menswear (%)

Note: Market share by retail sales value for carbonated drinks, RTD tea, instant noodles, hair care, RTD coffee, milk, bottled water, down apparel, fruit/vegetable juice, bath and shower products and bedding products; by total sales volume for beer, wine and spirits; by wholesale value for sportswear. Source: CLSA Asia-Pacific Markets (milk, down apparel and sportswear), Euromonitor (all others)

Only Satchi and VASTO have 5% or more of the high-end business-formal and smart-casual menswear market. However, Satchi has almost 2x as many stores in the mainland.

Highly fragmented high-end formal business and smart-casual menswear

Lowest concentration in high-end formal business

and smart-casual menswear segment





Market share in terms of retail sales, 1H10

China store networks, 1H10

VSKONNE2%

Auta Son2%Aquascutum

1%

Didiboy3%

Lampo3%

BONI3%

S.D. Spontini4%

V.E. DELURE4%

VASTO5%

Other brands67%

Satchi6%

332

201

180

178

170

168

131

100

100

82

0 50 100 150 200 250 300 350

Satchi

V.E. DELURE

BONI

DIDIBOY

VASTO

Lampo

Aquascutum

S.D. Spontini

VSKONNE

Auta Son (No. of outlets)

V.E. DELURE


The degree of concentration in the high-end business-formal and smart-casual menswear market segment is substantially below that of the China sportswear market.

Figure 115

China high-end business-formal and smart-casual menswear vs sportswear, 2009

6

15

22

33

13

33

45

62

0

10

20

30

40

50

60

70

Top 1 Top 3 Top 5 Top 10

(%) High-end business formal & smart casual menswear

Sportswear

Source: Frost & Sullivan (menswear), CLSA Asia-Pacific Markets (sportswear)

Within the casual fashion menswear market, the middle-upper segment (ie, a jacket together with a pair of trousers retailing for Rmb2,000-5,000) is expected to enjoy a higher growth rate (ie, 16.5% 2009-13F Cagr) than other segments.

Figure 116

Breakdown and growth of casual fashion menswear segment

(Rmbbn) 2006 2007 2008 2009 2010F 2011F 2012F 2013F Cagr 06-09

Cagr 09-13F

High to luxury end 6 7 8 9 10 12 13 15

Growth (%) 11.1 14.3 12.5 14.4 13.6 14.5 14.9 12.5 14.3

Middle upper end 6 7 8 9 10 12 14 16

Growth (%) 12.1 15.6 15.2 15.8 16.2 17.0 16.9 14.3 16.5

Mid to low end 64 70 78 88 99 112 127 144

Growth (%) 9.1 12.4 12.0 12.7 13.0 13.8 13.7 11.2 13.3

Total 76 83 94 105 119 135 154 176

Growth (%) 9.6 12.7 12.3 13.1 13.4 14.1 14.1 11.5 13.7

Note: Market segmentation is defined by ASP of a jacket and a pair of trousers: High to luxury-end=Above Rmb5,000; Middle-upper end=Rmb2,000 to Rmb5,000; Mid to low-end=Below Rmb2,000. Source: Frost & Sullivan

Middle-upper segment outgrows others in casual

fashion menswear

Market concentration below that of China sportswear market

Market share



Handbags and briefcases According to Hurun’s Best of the Best survey, men’s luxury brands dominated the accessory segment in 2008, but the same survey in 2010 shows that there is a shift towards a more balanced list.

Figure 117

Chinese millionaires’ favourite accessory brands

2008 2010 Dior Hermès Emporio Armani Armani BOSS Chanel Montblanc Louis Vuitton Louis Vuitton Dior Chanel Cartier Bally Gucci Dunhill na Source: Hurun Research Institute


Louis Vuitton’s world-class craftsmanship

Dunhill’s leather collection


As we mentioned before, girl power should be growing in China and we expect global premium luxury brands like Prada, Fendi and Tod’s to catch up very quickly. Burberry recently bought back 50 franchise stores in China to take control of its positioning in this key luxury market. Meanwhile, Coach recently made a number of senior appointments and expects its business in China to reach US$250m by FY12 and double by FY15.

Figure 120

Points of sale in China

0 50 100 150 200 250 300 350

LanvinChanel¹TiffanyPradaFendi

CelineGivenchy

VersaceBulgariHermes

Tod'sGucci

EscadaLouis Vuitton

CoachBurberry

Giorgio ArmaniCanali

Salvatore FerragamoErmenegildo Zegna

CerrutiHugo Boss

Alfred DunhillCartier

Ports

¹ Only fashion/accessories. Source: Company websites, CLSA Asia-Pacific Markets

Not as male-dominant

Mens’ brands have a wider store network



Luxury cars Dressed up in luxury clothing with a gold watch and a huge diamond ring, wealthy Chinese consumers are ready to hop into a vehicle to go out - a luxury car with a starting price of about Rmb850,000. Luxury car sales in China are on fire. The Big 3 in China have all recorded impressive growth rates this year, despite high mainland taxes. Sparkle Roll Group (970 HK), which operates Bentley, Rolls-Royce and Lamborghini showrooms in Beijing, estimates that for a car with an engine bigger than four litres, the combined import duties, value-added taxes and consumption taxes add up to more than 140%, compared with about 105% in Hong Kong and 60% in Macau.

Figure 121

Luxury car sales in China

Top brands 2010 YoY (%)

Volkswagen's Audi 227,938 43

BMW 168,998 87

Mercedes-Benz 147,670 115

Source: Company data

Figure 122

Mercedes-Benz is the fastest-growing major luxury brand

115

87

43

820,000

840,000

860,000

880,000

900,000

920,000

940,000

Audi BMW Mercedes-Benz

(Rmb)

0

20

40

60

80

100

120

140Starting price YoY growth (RHS)

A8L

7 Series

S-Class

(%)

Source: Company data, CLSA Asia-Pacific Markets

The Volkswagen China Group sold 1.92 million cars in 2010, up 37% YoY. Audi sold 227,938 cars in 2010, more than the 200,000 units previously forecasted and up 43% YoY. The company plans to sell another one million vehicles there within the next three years. Audi has sold more than one million vehicles in China to date, thanks to an early entry of its parent firm Volkswagen in the 1980s. Audi is also the biggest supplier of official cars in China.

However, BMW and Daimler’s Mercedes-Benz are quickly catching up as Chinese consumers’ appetite for luxury cars continues to grow. BMW’s sales in China almost doubled to September YTD and China is now the BMW Group’s third-largest market.

Meanwhile, Mercedes-Benz is the fastest-growing major luxury auto brand, with sales up 115% yoy in 2010 at 147,670 units, exceeding expectations of 120,000 units. Its parent Daimler expects China to become Mercedes-Benz’ largest market by 2014-16, aiming to sell 300,000 vehicles in China in 2015.

Not discouraged at all by the high taxes and duties

Audi is the largest supplier of official cars

BMW and Mercedes-Benz are catching up

More expensive cars enjoying higher growth



As mentioned before, high-end market leader Audi sold one million units in China to date. We estimate that about 20% of Audi sales in China were from the government. Taking this into account and the Hurun Research Institute’s study which says Chinese millionaires on average own three cars, we believe China’s luxury car market has huge potential.

The super-luxury segment, where executive limousines generally retail at Rmb3,000,000-9,000,000 after taxes, shows strong demand. Volkswagen’s Bentley, BMW’s Rolls-Royce and Daimler’s Maybach are the top choices for these ultra-wealthy individuals.

Bentley China chairman Peter Mak is amazed by the huge demand and rapid income growth on the mainland, since some of these buyers might not even have a car 15 years ago. Unlike buyers in the early days who would have bodyguards bringing in large travel bags filled with cash, buyers today usually pay a 10% deposit with a debit card and settle the balance with a bank transfer.

Figure 123

Super-luxury car sales in China

Top brands October YTD YoY (%)Bentley 569 71Rolls-Royce 156 438Source: SCMP

Our CRR survey shows strong brand preference for BMW and Mercedes-Benz, which we believe explains the impressive September YTD growth of 89% and 98% the carmakers enjoyed.

Figure 124

Which luxury car brands would you like to own?

13

12

10

8

6

6

4

3

2

2

0 2 4 6 8 10 12 14 16

Land Rover

Maybach

Hummer

Bentley

Audi

Porche

Rolls-Royce

Ferrari

Mercedes-Benz

BMW

(% of consumers)


Rich individuals from China also prefer longer cars that appear more extravagant and easier for those who would like to be chauffeured. This demand drove Audi to introduce an extended A6 sedan (13cm longer) in China back in 2000 and an extended A4 last year. BMW and Mercedes-Benz also introduced extended versions, adding 14cm to the BMW 5-Series and Mercedes E-Class sedans.

Volvo, which was purchased by China’s Geely Holding Group last year, plans to hire a team of Chinese designers to cater to local tastes. Rolls-Royce has also outfitted vehicles with options such as gold-plated Spirit of Ecstasy hood

Bentley, Rolls-Royce and Maybach are the top three

for super luxury

Chinese wealthy like longer cars

Gold-plated Spirit of Ecstasy

BMW is the winning brand



ornaments and starlight roofliners that depict astrological signs. Some customers choose red, which is considered to be the lucky colour, and many like to get vehicle identification numbers that contain lucky numbers, with the most popular being “8”. BMW has also offered a Chinese version of its M3 sports car called the Tiger M3, for the year of Tiger (2010), with each of the headrests embroidered with an orange tiger’s head.


Extended A6 exclusively for Chinese consumers

Rolls-Royce’s Spirit of Ecstasy


Premium drinks Euromonitor estimates that the Chinese alcohol market is at 53 billion litres in 2010, compared with 30 billion litres in the US, and expects the overall alcohol market to enjoy a 7% Cagr to 70bn litres by 2014. Consumption of alcoholic drinks per capita (at legal drinking age) has increased by 64% in 2000-10 in China. Beer remains the preferred drink, with each person consuming 38.7 litres in 2009 while the total alcohol consumption per capita in China was 45 litres.


Chinese alcohol market size and growth

Consumption per capita (2009)

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

1998 2002 2006 2010 2014

0

2

4

6

8

10

12

14

16Alcoholic drinks

YoY growth (RHS)(%)(m litres)

3.6 2.7

38.7

05

1015202530354045

Beer Wine Spirits

(litres)


We expect whiskey to lead growth in the drinks segment at 17% annual growth, followed by grape wine at 12% in 2009-14. Sparkling wine is also expanding quickly, but so far China is still a relatively small market for champagne. Despite being the dominant alcohol in the market, beer has been growing only moderately at a 6% Cagr in the past 10 years and we expect this level of growth to continue.

Beer is the dominant alcohol, but the slow

growth segment

Whiskey and grape wine should lead growth at

double digits



Figure 129

Alcohol market growth 09-14CL

17

12

10

10

9

7

7

5

4

0 2 4 6 8 10 12 14 16 18

Brandy and Cognac

Non-grape wine

Average

Beer

Rum

White Spirits

Sparkling wine

Grape wine

Whiskey

(%)


Figure 130

Champagne market breakdown

Other emerging markets

5%

Other mature markets

4%

Mainland China0%

Japan2%

US6%

EU1583%

Source: Cheuvreux

Chinese alcohol consumption is still relatively low compared with the rest of the world and therefore we expect much potential in the drinks segment. As expected, Chinese wine consumption per capita ranks much lower than European counterparts, and spirit consumption per capita much lower than Japanese and Koreans who are big fans of shochu/soju (a very popular distilled beverage in the region).

Figure 131

Beer consumption per capita (2009)

0 20 40 60 80 100 120 140

SingaporeTaiwan

ItalyFranceChina

South KoreaJapan

CanadaUnited Kingdom

USAGermany


Chinese alcohol consumption still low

Still a moderate drinker

About 50% of the EU15’s share is from France




Wine consumption per capita (2009)

Spirits consumption per capita (2009)

0 10 20 30 40 50 60

SingaporeChina

TaiwanJapan

South KoreaUSA


GermanyFrance

Italy

(litres)

0 10 20 30 40

SingaporeTaiwan

ItalyChina


GermanyUSA

FranceJapan

South Korea

(litres)


In terms of channels, restaurants are more important in southern China and bars in the north. Because of the cold weather in the north, Chinese consumers there in general prefer stronger alcohol.

As income rises, we expect consumers to trade up to premium alcohol and this should drive growth in the prestige local spirits and the more expensive wine and spirit segments in general. Also, as economic activities continue to grow in the mainland, local spirits popular among businessmen and government officials should see strong growth. Gifting accounts for about 65% of the market, according to an executive from a premium alcohol company.

We believe this is also a segment where local brands can potentially develop into premium players. According to the executive, China is already in the top 10 globally in terms of wineries and plantation.

Figure 134

Wine consumption and income per capita (2010)

(20)

(10)

0

10

20

30

40

50

60

70

0 20,000 40,000 60,000 80,000 100,000 120,000

Wine consumption (litre per capita)

(US$ per capita)

Correlation = 0.69

Luxembourg

Norway

SwitzerlandDenmarkAustria

FranceItaly

Portugal

Greece

SpainUK

Germany Belgium

Netherlands

Belgium Ireland

USA

FinlandCanada

Japan

SingaporeHong Kong

Sourth Korea

Taiwan

Russia

TurkeyMalaysiaPhils

China


More trading up

Wine consumption should rise as income grows

Just the beginning



Figure 135

Average retail selling price in China

2009 Rmb per litre Taobao Beer 7 Non-grape wine 40 Grape wine 57 Premium local spirits 295

Kweichow Moutai 500ml Rmb115 (US$17)

Rum 402

Bacardi black rum 750ml Rmb97 (US$15)

White Spirits 405

Grey Goose 700ml Rmb370 (US$56)

Brandy and Cognac 464

Hennessy VSOP 750ml Rmb293 (US$44)

Sparkling wine 538

Moet & Chandon NV 750ml Rmb340 (US$52)

Whiskey 727

Chivas Regal 700ml 18 years old Rmb425 (US$64)

Source: Euromonitor, Taobao.com, CLSA Asia-Pacific Markets

Premium local spirits Unlike other luxury segments, premium local spirits brands have a significant presence in China, accounting for 6% of the total spirits market in China. Brands like Jian Nan Chun, Moutai and Wu Liang Ye are very popular nationwide. Together these three brands account for more than 27% of the premium local spirits segment. Average unit price in this segment is almost Rmb300 per litre, with the ultra premium ones priced much higher than top whiskey.


Moutai (500ml) gift set selling at Rmb1,588 on Taobao

500ml of Wu Liang Ye’s 68% selling at Rmb888

Source: Company website, Taobao.com Source: Taobao.com

Premium local spirits are popular

Many premium options



Figure 138

Premium local spirits market in China

50

70

90

110

130

150

170

190

210

230

250

2001 2002 2003 2004 2005 2006 2007 2008 2009(8)

(6)

(4)

(2)

0

2

4

6

8

10Volume YoY (RHS) (%)(m litres)


Imports and global players While beer consumed in China is mostly produced locally with only 28 million litres imported out of the 40.7 billion litres consumed in 2008, imported wine and spirits are common. About 6% of wine and 1.4% of spirits was imported from overseas in 2008. The import share of wine has been growing rapidly. In total, 18% of the wine and 31% of the spirits imported came from France.

Figure 139

Imports as a percentage of total volume

0

1

2

3

4

5

6

7

2000 2001 2002 2003 2004 2005 2006 2007 2008

Wine Spirits(%)


Wine imports in volume (2008)

Spirits imports in volume (2008)

Spain9%

Australia9%

France18%

Chile32%

Argentina16%

Italy6%

Others5%

United States

5%

United Kingdom

33%

Spain10%

France31%

Others9% Japan

2%

Sweden2%

United States

3%

Korea10%


Alcohol imports growing

Steadily growing

France has a large share



These fast-expanding segments together with their growing imports component are driving up sales at global producers. Pernod-Ricard reported 1Q (ended September 2010) sales growth that beat consensus estimates. The company recorded more than 30% YoY growth in China on the back of wholesalers’ restocking on Martell. Its Chivas Regal holds a dominant 33% brand share in the whiskey segment. Absolut is the leader in white spirits and Martell is No.3 among brandy and cognac brands in China.

Diageo is also upbeat about China’s market outlook and sees consumers trading up in general. Its Johnnie Walker brand holds 23% share in the whiskey segment while the Smirnoff brand has 22.5% of the white spirits share in China.

Barcardi & Co’s Barcardi rum significantly dominates this segment with a whopping 72% share.

The surging whiskey demand in China inspired the Royal Salute Whisky group to launch the 62 Gun Salute in the Chinese market. The company said the whiskey tastes rich and complex and it is exactly what Chinese consumers like. Bottled in a hand-crafted decanter made by Dartington Crystal, the whiskey features a Royal Salute crest painted in liquid 24-carat gold, along with a 24-carat gold-plated collar and a crystal stopper set with a 24-carat gold-plated crown. Each bottle sells for Rmb18,000.

Meanwhile, to endear itself to Chinese consumers, Château Lafite-Rothschild also decided to feature an embossed red character for the lucky “eight” on every bottle of its 2008 vintage. According to the online fine-wine exchange LivEx, the price of a case of 2008 Lafite jumped 17% in just 48 hours after the announcement. Similarly, Château Mouton Rothschild also features art work by famous Chinese artists while vodka brand Absolut puts Chinese literary figures on its labels to attract Chinese consumers.


62 Gun Salute at Rmb18,000

Chateau Lafite Rothschild 2008

Source: Company

LVMH has a very strong market presence in the sparkling-wine segment with its Moët & Chandon brand. Its market share is tied with Yantai Changyu Group’s Changyu brand at 19% as the top two players in sparkling wine. Seeing such a strong presence that premium local spirits have in China, LVMH has also started building an Asian luxury spirits brand, Wenjun. The pricing is very much in line with top players Moutai and Wu Liang Ye.

Pernod-Ricard holds a number of high-

ranking brands

Catering to locals

Prices jumped 17% with an embossed red eight

LVMH setting up luxury white spirits brand




Wenjun by LVMH at Rmb600

Special collection at Rmb1,600

Source: Company website, Taobao.com

Figure 146

Top alcoholic drinks brands in China

Brand Company Share (%)Premium local spirits Jian Nan Chun Sichuan Jian Nan Chun (Group) 10.6Moutai Kweichow Moutai 9.9Wu Liang Ye Sichuan Yibin Wuliangye Distillery 6.9Luzhou Lao Jiao Luzhou Lao Jiao 2.5Xiao Hu Tu Xian Guangzhou Pearl River Yunfeng Winery 1.9Grape wine Great Wall China National Cereals, Oils & Foodstuffs Imp & Exp 10.6Changyu Yantai Changyu Group 8.8Weilong Yantai Weilong Grape Wine 4.6Dynasty Dynasty Winery 4.0Suntime Vinisuntime International 3.3Sparkling wine Changyu Yantai Changyu Group 18.9Moët & Chandon LVMH Moët Hennessy Louis Vuitton 18.9Dynasty Dynasty Winery 8.6Piper Heidsieck Rémy Cointreau Group 8.1Weilong Yantai Weilong Grape Wine 7.0Whiskey Chivas Regal Pernod-Ricard Groupe 33.1Johnnie Walker Diageo 23.1Jack Daniel's Brown-Forman Corp 6.1Jim Beam Fortune Brands 3.3Ballantine's Pernod Ricard Groupe 2.0Brandy/Cognac Changyu Yantai Changyu Group 57.1Hennessy LVMH Moët Hennessy Louis Vuitton 14.1Martell Pernod-Ricard Groupe 7.5Rémy Martin Rémy Cointreau Group 6.1Courvoisier Fortune Brands 1.0White Spirits Absolut Pernod-Ricard Groupe 28.1Smirnoff Diageo 22.5Gordon's Diageo 10.6Eristoff Bacardi & Co 5.4Skyy Campari Milano SpA, Davide 4.4Rum Bacardi Bacardi & Co 72.4Havana Club Pernod-Ricard Groupe 6.4Captain Morgan Diageo 3.8

Source: Euromonitor

LVMH’s Asian luxury spirits



Figure 147

Chinese millionaires’ favourite drinks

2008 2009 2010 Best Luxury Imported Drinks Brand Royal Salute Royal Salute Louis XIII Hennessy Hennessy Hennessy Johnnie Walker Louis XIII Royal Salute Rémy Martin Rémy Martin Ballantine Chivas Chivas Rémy Martin Best Super Luxury Whiskey Royal Salute 21 Years Old Royal Salute 21 Years Old Royal Salute 21 Years OldJohnnie Walker Blue Label Johnnie Walker Blue Label Johnnie Walker Blue Label Macallan 40 Years Old Ballantine's 30 Years Old Ballantine's 30 Years Old Royal Salute 38 Years Old Macallan 40 Years Old Best Ultra Luxury Cognac Louis XIII Louis XIII Louis XIII L'Age d'Or de Rémy Martin Richard Hennessy Richard Hennessy Richard Hennessy Best Premium Cognac Hennessy XO Hennessy XO Hennessy X.O Martell XO Rémy Martin XO Martell Cordon Bleu Rémy Martin XO Martell XO Rémy Martin X.O Best Chinese Spirits Moutai Moutai Moutai Wuliangye Wuliangye Wuliangye Luzhou Laojiao Luzhou Laojiao Luzhou Laojiao Best Premium Champagne Veuve Clicquot La Grande Dame Veuve Clicquot La Grande Dame Moět & Chandon Dom Pérignon Moět & Chandon Brut Imperial Vintage Dom Pérignon Moět & Chandon Brut Imperial Vintage Dom Pérignon Veuve Clicquot Piper- Heidsieck Brut Cuvée Rare Piper-Heidsieck Brut Cuvée Rare


Prestige cosmetics We believe China will have the fastest-growing premium cosmetics market in the world over the next four years - we expect a 14% Cagr compared with the global average of 5%. Slowing/declining growth in the cosmetics market in Western economies will largely be offset by expansion in emerging markets, particularly Russia, India, China of what we estimate will be 14-17% per annum. The USA and Japan remain the largest premium cosmetics markets in the world, and sales in these countries are expected to remain flat/slightly decline in 2010-14. We estimate that the Chinese premium cosmetics market will grow from US$3.5bn to US$6bn in 14CL.

Figure 148

Cosmetics and toiletries market 2009-14 Cagr

(5) 0 5 10 15 20

JapanUSA

FranceItaly

United KingdomSpain

CanadaWorldBrazilChinaIndia

Russia

(%)

Source: Euromonitor, CLSA Asia-Pacific markets

Rising demand from emerging economies



Figure 149

Brics market size and growth

(US$m) 2010 % of global 2014 % of global Cagr (%) 10-14

China 3,514 4 5,992 6 14

India 521 1 979 1 17

Russia 1,266 2 2,409 3 17

Brazil 430 1 624 1 10

Total 5,730 7 10,004 10 15


Key trends In China, pale skin traditionally represents feminine beauty, which explains the large sums of money spent on whitening as well as sunscreen products. As people get richer, they are moving from “needs” to “wants”, and women want clean, white skin. As such, cosmetics sales are outstripping GDP growth.

Skincare accounts for 58% of the premium cosmetics market in China, only slightly lower than Japan, where pale skin is also highly valued. Unlike other Western markets, fragrances are not a major segment in China. Fragrances, however, make up 62-76% of the Brazil and Russia markets.

Figure 150

China’s premium cosmetics market breakdown (2010)

Skin care 58%

Sun care 3%

Bath and shower 4%

Hair care 5%

Sets/Kits 8%

Colour cosmetics 10%

Fragrances 11%

Deodorants 0%

Baby care 1%


Skincare as % of premium cosmetics

Fragrance as % of premium cosmetics

0 20 40 60 80

Brazil

India

Russia

USA

UK

Canada

Spain

World

France

Italy

China

Japan

(%)

0 20 40 60 80

Japan

China

India

Canada

World

USA

Italy

UK

France

Spain

Russia

Brazil

(%)


In China, pale skin traditionally represents

feminine beauty

About 58% of market is skincare

Fragrances is a relatively small segment in China



China’s premium cosmetics market enjoyed a strong 24% Cagr over 2000-10, especially in premium skincare, as consumers’ discretionary income rises. But it remains highly fragmented and the lack of premium local Chinese brands creates a tremendous opportunity for foreign companies. China’s premium skincare market is valued at US$2bn, still a fraction of Japan’s US$9bn market but growing very rapidly.

Figure 153

China premium cosmetics segment growth rates (10-14CL)

0 5 10 15 20

Bath and shower

Hair care

Fragrances

Skin care

Sets/Kits

Sun care

Baby care

Colour cosmetics

(%)


Foreign brands are doing well in cosmetics. For example, our US analyst Caroline Levy projects that China would grow to 10% of total Ebit for Estée Lauder by 2020 from 4.5% today. This translates to US$1.6bn of sales and US$273m of Ebit. As we should expect in this fast-growing market, investment levels are high, channels are segmenting, brands are innovating, and distribution is evolving fast. Geographical differences play a role: for example, the drier northern region has a stronger bias towards moisturising products.

Global cosmetics giant Amway Corp holds a dominant share in China with its direct selling and retailing strategy in the country. However, in terms of brand recognition, ultra-premium brands Chanel, Dior, Shiseido, L’Oreal, and Hugo Boss are still the top five that mainland millionaires like. Although domestic firms, like Shanghai Jahwa, are trying to break into the premium segment, their success so far is still primarily coming from the mid-market.

Figure 154

Premium cosmetics brand shares in China

Brand (%) Company 2005 2006 2007 2008 2009Amway Amway Corp 28.9 23.8 22.7 24.9 23.0Shiseido Shiseido 2.9 4.1 4.4 5.1 7.3Lancôme L'Oréal 4.5 5.4 5.5 6.0 6.9Estée Lauder Estée Lauder 2.9 3.8 4.4 4.7 5.0Fancl Fancl Corp 0.3 1.0 2.0 2.9 3.3Clinique Estée Lauder 1.8 2.2 2.3 2.4 2.5Kosé Kosé Corp 2.3 2.6 2.4 2.3 2.3Chanel Chanel SA 1.3 1.7 2.0 2.1 2.2Christian Dior LVMH Moët Hennessy Louis Vuitton 1.6 1.8 1.9 2.0 2.0Biotherm L'Oréal 1.3 1.5 1.6 1.6 1.7Guerlain LVMH Moët Hennessy Louis Vuitton 1.0 1.1 1.3 1.4 1.5SK-II Procter & Gamble 4.2 2.2 1.4 1.1 0.9Others Others 47.1 48.9 48.3 43.6 41.4Total Total 100.0 100.0 100.0 100.0 100.0

Source: Euromonitor

US$2bn premium skincare market

Still a foreign brands’ market



Figure 155

Chinese millionaires’ favourite skincare brands

2008 2009 2010

Shiseido Shiseido Chanel

HUGO BOSS Lancome Dior

Lancôme HUGO BOSS Shiseido

Biotherm Chanel L' Oréal

Chanel Biotherm HUGO BOSS

Shu Uemura L' Oréal La Mer

La Mer Shu Uemura

L' Oréal La Mer Source: Hurun Research Institute

Our proprietary survey’s results also confirm that global foreign brands dominate the prestigious cosmetics market in the mainland.


Which luxury brands would you like to own?

Which luxury brands did you buy?

Skincare & Cosmetics15

8

6

5

5

1

1

1

1

1

0 5 10 15 20

Marubi

VICHY

Clinique

Olay

L'Oreal

Dior

Shiseido

Chanel

Lancome

Estee Lauder

(% of consumers)

Skincare & Cosmetics

2

2

2

3

3

4

4

6

11

14

0 5 10 15

Biotherm

Nivea

Sisley

L'Oreal

Olay

Clinique

Dior

Lancome

Shiseido

Estee Lauder

(No. of mentions)

Perfume

16

15

7

3

2

1

1

1

0

0

0 5 10 15 20

Hermes

Davidoff

Prairie

AnnaSui

Guerlain

Calvin Klein

Lancome

Dior

Chanel

Estee Lauder

(% of consumers)

Perfume

1

1

1

2

2

2

2

4

4

12

0 5 10 15

Hermes

Kenzo

Issey Miyake

Adidas

Burberry

Calvin Klein

Estee Lauder

Dior

Lancome

Chanel

(No. of mentions)


Cosmetics are characterised by high brand loyalty, as our recent China Brands Index report confirms.

Another trend in the cosmetics space in China is the rapid growth of the men’s grooming market. Euromonitor expects the market Cagr for male-grooming products in 2010-14 to be more than double that of the overall beauty and personal care market at 22%, compared with 10%. Unilever and L’Oreal have both invested heavily in this segment in the past four years and built a 32% and 11% market share in men’s toiletries. As the men’s market continues to develop, we expect high-end brands to tap into this fast-growing segment as well.

Foreign brands well-recognised

Men’s grooming market may be the next luxury segment

Everyone likes foreign names




Figure 158

Brand loyalty across sectors

0 20 40 60 80 100

Mobile service

Supermarket

Cosmetics

Insurance

Dept store

Skin care

Camera

Aircon

Wine

Washing machine

Online travel

PC

Instant messaging

Instant noodles

Juice

Refrigerator

Dairy

Mobile handset

Tea beverages

Shampoo

CSD drinks

Beer

Bottled water

TV

Car

Banking

Search engine

Sportswear

Shoes (non-sports)

Clothing (non-sports)(%)


Figure 159

Men’s grooming market growth vs overall beauty and personal-care market

9101011109

1214

1820

2426

2727

38

22

0

5

10

15

20

25

30

35

40

45

2007 2008 2009 2010 2011 2012 2013 2014

(%) Men's grooming market

Beauty and personal care market


Our China Brands Index shows high loyalty for

cosmetics and skincare

Growing at double-digits



Luxury services As the Chinese saying goes, daily life is all about clothes, food, accommodation and travel. Luxury goods, therefore, are only part of the equation. Chinese affluent are also willing to pay to get the best out of other elements of life, including eating, sleeping, and even match-making.

Restaurants Mainland Chinese enjoy high-end services, ranging from gourmet restaurants to match-making services. In Hong Kong, overnight visitors from China spent HK$561 per capita on meals outside hotel, or 8% of their total spending in Hong Kong. However, affluent mainland tourists are spending much more than this average during their trips to Hong Kong.

Miramar group in Hong Kong said they often see travellers walk in to their upmarket Cantonese restaurant with their shopping bags and walk out with a HK$100,000 bill for dinner. A classic lunch party would be a table of 10 mainland travellers washing down a menu of abalone and shark’s fin soup with half a dozen bottles of Chateau Lafite Rothschild. The restaurant’s dinner sets range from HK$8,880-13,880.

With strong brand recognition, Miramar is planning to expand into China. It is aiming to open 20 restaurants by 2017 at a total cost of HK$400m. The company estimates that in Beijing, where its first outlet will open by mid-2011, wealthy Chinese would spend about Rmb1,200 per head. It aims to recover the HK$30m investment cost in two years.

The imperial four In China, the four most prestigious food ingredients are abalone, sea cucumber, shark’s fin, and fish maw. These items are believed to be imperial food ingredients only served at the emperor’s table. Time has changed, however, and the affluent individuals in the mainland

now frequently visit luxury restaurants and order these items for dining along with other delicacies such as bird’s nest, snake soup and hairy crabs. In recent years, Western favourites such as lobsters and truffle are also appearing more often on Chinese menus.

Sample full dinner menus

Chinese French

Roasted whole crispy suckling pig Fresh and smoked salmon tartare

Stir-fried prawns braised with crab roe sauce Chestnut soup with praline cream and chicken mousse dumpling

Braised seasonal green with bamboo fungus and Yunnan ham Seared sea bass with steamed zucchini, tomato, basil and truffle

Braised whole conpoy stuffed in turnip ring Duck breast fillet with caramelized autumn fruit and fig reduction

Braised superior shark’s fin with Chinese cabbage in brown sauce Dessert

Steamed fresh spotted garoupa Coffee or tea

Braised abalone and sea cucumber with premium oyster cause

Deep-fried crispy chicken with osmanthus sauce

Fried rice with dried conpoy, dried fish and roasted duck

Braised e-fu noodles with wild mushrooms

Double-boiled sweetened lotus seed with red dates and dried longans

Chinese petits four

Source: Cuisine Cuisine, Le Jardin de Joel Robuchon

Abalone and shark’s fin soup

Rmb1,200 per head




Shark’s fin and imperial bird’s nest (HK$720 per bowl)

Braised assorted snake soup (HK$880 per bowl)


With more than 50 outlets nationwide, mainland restaurant chain South Beauty Group has also introduced the Lan Club in Beijing and Shanghai to target affluent individuals in the mainland. Bringing in world-class professionals who have designed New York’s Buddakan and the W Hotel Pudong in Shanghai, South Beauty Group feels that the Chinese elite demands sophistication and taste in their dining experience. Meanwhile, one of the world’s most famous chefs Jean-Georges Vongerichten also opened a restaurant in Shanghai featuring appetizers starting from Rmb118-198 and dinner entrees from Rmb248-348.

Hotels Chinese affluent like to maintain their luxurious lifestyle when they are on the road. According to Hurun’s Best of the Best survey, Shangri-La is the top hotel brand among Chinese millionaires. Grand Hyatt, Hyatt Regency and Hilton have also consistently been ranked among the top five.

Figure 162

Chinese millionaires’ favourite hotels

2006 2007 2008 2009 2010

Shangri-La Shangri-La Shangri-La Shangri-La Shangri-La

Grand Hyatt Grand Hyatt Hyatt Regency Grand Hyatt Grand Hyatt

Hyatt Regency Hyatt Regency Grand Hyatt Hyatt Regency Hilton

Hilton Hilton Kempinski Hilton Sheraton

Sheraton Sheraton Sheraton Kempinski Hyatt Regency

JW Marriott Marriott

Kempinski Kempinski


High-end hotel chains have ramped up their expansion plans in China to capture opportunities in this luxury segment. Starwood expects to add 86 hotels to its current network of 62 in China.

Meanwhile, InterContinental aims to double its number of rooms in the Greater China region in the next five years. The company expects China to overtake the US as the world’s largest hotel market by 2025 and become twice the size of the current US market by 2039.

Shangri-La is the top brand

High-end dining taking off in the mainland



Figure 163

Hotel growth rate in mainland China (number of hotels)

(40)

(30)

(20)

(10)

0

10

20

30

40

50

60

1995 1997 1999 2001 2003 2005 2007 2009

Total hotels 5-star hotels(%)


Some luxury hotels in Shanghai are already at a price range comparable with those in financial hubs such as New York and London.

Figure 164

Luxury hotel price comparison

0 100 200 300 400 500 600 700

Intercontinental Beijing Beichen Hotel

St. Regis Shanghai

Westin, Bund Center Shanghai

The Westin Beijing Chaoyang

The Peninsula Beijing

Hilton New York

Grand Hyatt Shenzhen

Sheraton Shenzhen Futian Hotel

Grand Hyatt Shanghai

Grand Hyatt Beijing

Shangri-La China World Hotel, Beijing

JW Marriott Hotel Beijing

Four Seasons London Canary Wharf

Four Seasons Shanghai

Pudong Shangri-La Shanghai

Trump Soho New York

The New York Palace

The Ritz-Carlton Shanghai, Pudong

The Peninsula Shanghai

Mandarin Oriental Hyde Park, London

The Ritz London

Ritz-Carlton New York, Central Park

(US$)

Source: Expedia, CLSA Asia-Pacific Markets

Not only are these hotel chains aggressively building up in major cities, they are also targeting popular tourist spots in China. In November 2010, St. Regis opened the first international luxury hotels in Lhasa, the capital of Tibet. Shangri-La Asia is also targeting to develop one there in 2012 and InterContinental is planning a 2,000-room hotel within three years.

Luxury five-star hotels booming

Hotel prices catching up with global peers . . .

.. . . primarily in Tier-1 cities



Match-making The rapid rise of these Chinese affluent has created a new challenge for themselves and a business opportunity for some. The Chinese Academy of Social Sciences forecasts that by 2020, 24 million Chinese men of marrying age could see a shortage of brides, partly because of the one-child policy.

Figure 165

Mainland population aged 18-34

145

150

155

160

165

170

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Male aged 18-34 Female aged 18-34(m)


Coupled with this macro trend, wealthy Chinese are moving into circles that make it hard for them to find partners, said the founder of a match-making company in China, Diamond Bachelor. Diamond Bachelor, which claims that it has five million clients and a success rate, defined as clients falling in love with their recommendations, of at least 80%, sends “love hunters” out to restaurants and malls to scour for the right women. The company then categorises women based on age, education, height, and looks. According to its website (915915.com, which is a homonym for “just want me, just want me”), the company’s definition for a “diamond bachelor” is an individual with net worth of more than Rmb2m or with “extremely outstanding” profiles.

In 2009, a group of 21 single billionaires and 22 single women attended a match-making ball in Beijing with tickets costing Rmb100,000 a head. In June 2010, jiayuan.com, a large online-dating agency, even held a competition to find the perfect match for 18 of its millionaire members. It was reported that the competition drew 50,000 Chinese applicants including girls from Vancouver, Singapore, New York and Paris.

Figure 166

Diamond Bachelor website featuring its “love hunters”

Source: 915915.com.cn

Rmb100,000 for a match-making ball ticket

VIP match-making service

Hard time finding a bride

Claiming an 80% success rate

Section 3 : European brands dominate Luxury goods


European brands dominate The luxury-goods sector globally has long been dominated by European brands. They are names that have been popular among elites in the West and have for many years been favourites of royal families and tycoons. Over time we expect the emergence of Chinese luxury brands in the product categories, where China has fundamental advantage, primarily from expertise developed over a long period in some product materials such as jade, porcelain or cashmere.

Figure 167

Chinese millionaires’ most favourite luxury brands

2008 2009 2010

BMW Louis Vuitton Louis Vuitton

Louis Vuitton BMW Cartier

Mercedes-Benz Mercedes-Benz Chanel

Cartier Rolls-Royce Hermès

Chanel Rolex Gucci

Rolex Ferrari BMW

Ferrari Cartier Mercedes-Benz

Giorgio Armani Chanel Patek Philippe

Gucci Bentley Montblanc

Vacheron Constantin Porsche Armani


We believe that these successful brands in China still have huge growth potential.

Figure 168

Luxury brands with huge potential in China

Cosmetics Watches

Estee Lauder Rolex

Lancome Omega

Chanel Cartier

Dior Longines

Shiseido Patek Philippe

Handbags Shoes

Louis Vuitton Gucci

Gucci Louis Vuitton

Hermes Tod's

Chanel Prada

Prada Belle

Women's Apparel Men's Apparel

Armani Zegna

Prada Armani

Chanel Dunhill

Ports Design Hugo Boss

Gucci Prada


Chinese look for better product quality and brand image when selecting luxury-goods brands.

Quality and brand image are key

Luxury from the West

Best of the best for Chinese

Brands ready to grab shares



Figure 169

Reasons why people buy luxury goods

0 5 10 15 20 25 30

Friends' recommendation

Customer service

Innovation

Convenience/location

Price/value

Performance

Brand image/design

Quality & reliability

(% of total votes cast)


Product quality The “Made in China” stigma still sticks in some Chinese consumers’ mind. They still remember the days when most operations were state-owned and quality was not well-controlled. Even now, the country is still fine-tuning its quality control systems in categories from food to cosmetics to toys.

In contrast, European products are known to be elegant and carefully hand-crafted. The royal families that are still in place in some countries in Europe also add some spice to the fairy tale. In reality, it does take a long time to finish luxury goods. It takes 18 hours to make a Hermes Birkin bag and four years to train a leather craftsman. Since the company only takes the best part of the crocodile, ie the belly, three different crocodiles are needed for one bag and it takes four years to raise one crocodile.

Brand image The CRR brand survey we conducted in 2009 shows that quality and image determine brand decision making in China. This is what European luxury brands offer - brand image and world-class designers that translate into supreme quality and fashion.

The European luxury brands often come with similar stories and ingredients.

A humble background in the 17-19th century in Europe

Very high-quality products, some of which eventually turn into a signature collection

Talented designers who are frequently publicised in the press

The brand becomes a favourite among celebrities, royal families and other influential figures

Wealthy individuals and aspirational shoppers flock to their boutiques

Brands such as Prada, Hermes, Louis Vuitton, Chanel and Cartier all fit into this storyline. At the end, heritage is a key part of what is so attractive about these luxury brands.

Made in Europe is still more desirable




Catering to Asian tastes Most luxury-goods companies offer the same product range globally and there is not much tailoring to specific markets. This would affect the perceived authenticity of the product - as each product needs to reflect the heritage of that brand including the input of the designers to account for current fashion trends. The product range, however, should account for specific weather conditions in that market.

There are some product categories that need to be localised, for example, cars. Chinese affluent like to be chauffeured and therefore luxury brands Audi, BMW and Mercedes have all introduced extended versions. However, while the products are not dramatically altered, marketing plans are. Early this year, fashion house Christian Dior introduced a limited blue collection in Shanghai. In celebration of the Shanghai Expo, Chanel created accessories with Chinese elements. This year, Ermenegildo Zegna celebrated its 100th anniversary in Shanghai. Anna Wintour, US Vogue editor, also made her first visit to China recently and the prominent fashion magazine featured eight Asian models in its December issue.

As the affluent Chinese may still be new to the world of luxury, brands have recruited celebrities to wear their products at events or simply show up to show support for the brands. A brand consultant estimates that it may cost as much as HK$1m plus gifts to attract an A-list star. Oftentimes, there may be dozens of celebrities from A-list to C-list at one event. The more traditional way of signing up celebrities as spokespersons, however, is still common.

Luxury brands are also increasingly featuring Asian models to build a connection with Chinese consumers. Asian models broke records this season, accounting for 7.1% of all models at New York Fashion Week, according to a seasonal survey by a Jezebel.com. Liu Wen, widely considered to be China’s top model and known as the first Asian model joining the Victoria’s Secret Fashion Show, is working with Estée Lauder to promote its exclusive product line in China.


Asian model Liu Wen

US Vogue December issue featuring eight Asian models

Source: Estee Lauder

Source: Vogue.com

Global collections

Some localisation but depends on product

category

Rise in Asian models



Asian luxury brands The rise of Asian luxury-goods brands is inevitable but we believe the product category will need to be closely aligned to specific areas where there exists some fundamental advantage. We expect this would be traditional crafts, which are associated with the rural past.

This view is echoed by Matthew Crabbe, co-founder of consultancy Access Asia. He believes that local materials and local crafts have an appeal to Chinese consumers. “Chinese [consumers] are increasingly exploring their roots and crafts and bringing them up to date. [Middle and upper-class Chinese] have a romantic view of the rural past and rural culture, and crafts. There is a growing interest. For example, top-notch luxury tea. This fits in with that trend.”

However, one of the challenges is that there is fast becoming a shortage of craftsmen that can produce these various products. According to a 2009 report by the China Arts and Crafts Association, 42% of the 1,865 officially recognised traditional crafts are struggling or in danger of dying out and 6% of those are already lost.

The suggested solution is to upgrade the role of craftsman in society to encourage people into these professions rather than work in less-skilful positions but initially higher-paid jobs. Switzerland faced a similar problem during the 1980s and 1990s when there was a sharp drop in the number of watchmakers and other personnel involved in the watch-making process.

But India might have a solution. In India, Titan Industries, now one of the top-10 watchmakers in the world by volume, overcame the problem in the 1980s. The company recruited boys who had left school with top marks and it provided housing and meals along with “foster fathers” to teach these young men about life. It then provided training by master craftsmen, who also served as foremen once production began. No longer did this help develop the watch-making industry in India, but it also transformed the lives of these boys and helped their families.

Shang Xia by Hermes In September 2010, Hermes launched a Chinese brand, Shang Xia, which means “up-down” in Mandarin. According to their website, Shang Xia offers Chinese and Asian heritage created for a contemporary lifestyle. The brand opened its first store in Shanghai in September.

Figure 172

Shang Xia store in Shanghai

Source: Company

Leveraging product material expertise

Shortage of craftsman

Unique solution in India

The first luxury Chinese brand



The initial product offering includes around 200 designs of furniture, tea and dishware, apparel, jewellery, accessories with price points ranging from Rmb180-50,000. Lynn Zhou, our consumer analyst based in Shanghai, visited the store. According to the salesperson, the best-selling products are jewellery and clothing. One piece of sterling silver bangle bracelet with the “Shang Xia” logo pattern, which costs Rmb3,000, was almost sold out of stock. Their products are not only Chinese. For example, cashmere products are made in Mongolia or Nepal. They try to promote the best craftsmanship of both China and other countries. We liked their eggshell porcelain bowls and cashmere coats. The brand is not doing much advertising in China for now and we do not see much comment in local media or internet communities. But because of its connections with Hermes, they have more media coverage in the West. As a result, a majority of the purchases in this store were made by foreign shoppers. As far as we could see, the people that visited the store were all impressed, by its decoration and delicateness, as well as price tags.


A popular silver bangle bracelet

Lynn’s favourite eggshell porcelain

Source: Shang Xia company website

Potential categories for Asian luxury brands Hermes seems to have recognised that the starting point to develop credibility is to leverage China’s perceived (and actual) expertise in a number of core materials and therefore it is offering five collections featuring the best of these materials.

Figure 175

Materials expertise drives product offerings

Teaware

JewelleryApparel

Zitan Wood

Bamboo

Felt

Cashmere

Eggshell Procelain

Jade & Agate

HomewareFurniture

Source: CLSA Asia-Pacific Markets, Hermes

We believe that Asia has a long history and expertise in areas like porcelain, silk, embroidery and paper, while leather craftsmanship and watch-making skills are very refined in the West. It is the abundance of these materials in the region that has driven the development of expertise. For apparel, furniture, and cosmetics, we would argue that neither region has any fundamental advantage and they don’t require very advanced skills or technology.

Lifestyle product offering

Opportunities for Eastern brands

Leveraging off China’s best

Impressive store and products



In terms of potential for Asia, we believe it is very challenging for China to develop the technology and catch up with automakers in the West and Swiss watch-making professionals. However, with handbags, jewellery and alcohol, China may have a better chance.

Figure 176

Expertise in the East and West

Handbags

Alcohol

Watches

Cars

Jewellery

Furniture

Apparel

Cosmetics

Porcelain

EmbroiderySilk

Paper

HandbagsJewellery

Alcohol(spirits)

West East

Handbags

Alcohol

Watches

Cars

Jewellery

Furniture

Apparel

Cosmetics

Porcelain

EmbroiderySilk

Paper

HandbagsJewellery

Alcohol(spirits)

Handbags

Alcohol

Watches

Cars

Jewellery

Handbags

Alcohol

Watches

Cars

Jewellery

Furniture

Apparel

Cosmetics

Furniture

Apparel

Cosmetics

Porcelain

EmbroiderySilk

Paper

Porcelain

EmbroiderySilk

Paper

HandbagsJewellery

Alcohol(spirits)

HandbagsJewellery

Alcohol(spirits)

West East


The following categories offer good prospects in China:

Alcohol - premium local spirits such as Moutai and Wu Liang Ye are successful examples. The patriotic element makes these good corporate gifts.

Furniture - rare materials coupled with craftsmanship can be a great brand story. Premium wood, bamboo or even cane can link the brand to Chinese heritage.

Porcelain - in China, Jingdezhen is known as the “porcelain capital” thanks to its high-quality porcelain. Shang Xia already has a collection that is affiliated with porcelain techniques from Jingdezhen.

Silk and embroidery - silk was used to make robes for the upper class and sometimes even shoes and embroidery on garment used to show wealth and status. This can be used in both clothing and accessories. Hand-made products and display of success are top priorities for Chinese affluent.

Jewellery - locals are at an advantage in terms of design preferences and product knowledge, especially with gold and jade. This category is currently dominated by Hong Kong jewellers.

Paper - with a rich literary culture and being the origin of paper, China could possibly introduce a luxury brand in this category.

Use of premium woods and bamboo

Long history with jade



Apparel in general - there is no fundamental reason why Chinese apparel cannot be luxury goods. Much of the apparel even for luxury brands is manufactured in China and manufacturing expertise is built up there. The question is how to transfer the design and create a brand. 3.1 Phillip Lim, for example, may be able to leverage its Asian heritage and introduce new collections catering to mainlanders.

Some examples A number of companies have already been trying to establish their brands as an Asian luxury brand.

Shanghai Tang owned by Richemont is known as a niche luxury brand for silk apparel and Chinese-inspired accessories, as well as its made-to-measure service known as “imperial tailoring”.

As an early entrant in the luxury market in China, Ports Design has successfully established itself as a high-end womenswear brand in China. It has consistently been ranked along brands like Chanel and Louis Vuitton.

Taiwan’s Shiatzy Chen is aiming to take Eastern aesthetic to a contemporary era by incorporating poetic design and Suzhou embroidery.

Hong Kong’s Blanc de Chine also tries to redefine Chinese aesthetics: its Blanc de Chine collection focuses on the tranquil and spiritual characteristics in Chinese culture; while its bleu de chine collection is inspired by Chinese martial arts.

Founded by a Hong Kong designer and a French entrepreneur, Qeelin was launched in Paris and the jeweller builds on a similar philosophy of merging East and West. With Maggie Cheung, a popular Chinese actress who has won the Cannes Best Actress and Berlin Best Actress awards, as its face, Qeelin has gained much publicity.


Chinese-inspired jackets by Shanghai Tang

Qeelin’s Wulu¹ collection


¹ A water container in China in the old days. Source: Company website

With communist leaders Mao Zedong, Deng Xiaoping, and Zhou Enlai reportedly having worn its watches, Shanghai Watch has built up brand recognition on the mainland. Management has been repositioning the company to target the luxury segment in the past few years. The company’s gold watches with alligator leather straps retail for about US$17,800 and unlike most luxury watches that are powered by Swiss movements, Shanghai Watches’ timepieces are made entirely in China.

Chinese apparel on the rise

Ports Design - a leading luxury brand in China



Figure 179

Only 100 were produced for each of these five designs


Times are changing and we expect Asian companies will continue to acquire international luxury brands as well as create their own brands.

Trinity has acquired a number of overseas higher-end brands including Cerutti and Kent & Curwen.

Megha Mittal of the Indian Mittal group of companies acquired Escada.

These Asian companies have developed the manufacturing or sourcing expertise for some of these items (not all) so it would seem natural to integrate or acquire brands. This has occurred in many lower or mid-priced segments where the OEM manufacturer transformed into the brand owner. Examples include Daphne and Belle in footwear and Anta in sporting goods. According to a BBC news report, Chinese factories are increasing their manufacturing presence in Italy - they estimate that there are up 5,000 Chinese factories in Prato, Italy. Chinese imported fabrics costs 10% of Italian, which is resulting in much lower sourcing costs for Italian brands. Products are still Made in Italy, but by Chinese factories.

Figure 180

The possible trend

Bought in China Made in China Owned in ChinaBought in China Made in China Owned in China


We do not believe the corporate ownership of brands has any negative implications for consumers. Most consumers recognise that large corporations own a range of brands and that only a few of the larger luxury brands are owned independently. Examples of multibrand groups include LVMH, Richemont, PPR and Swatch. For the mostly mono-brand companies, examples include Bulgari, Hermes, Tod’s, Burberry for the listed companies and then Prada, Rolex, Chanel, Armani and Dolce & Gabbana for the private companies.

We also believe it does not matter where companies are listed. In fact, we would argue there are strong commercial reasons for branded consumer goods to be listed where they generate a significant part of their business – as this will help improve the brand awareness. L’Occitane, which was recently listed in Hong Kong, saw a significant increase in sales in Hong Kong and in Asia around the time of their IPO. Sands China and Wynn Macau recently listed their Asian operations in Hong Kong. We expect a growing trend towards more global consumer companies listing in Asia all or part of their business.

Acquiring luxury brands

More Asian listings

Ownership doesn't impact brand prestige

Section 4 : Getting exposed Luxury goods


Getting exposed In our ideal world, the perfect luxury-goods investment would be one of the major European brands listing their Chinese business on the Hong Kong Stock Exchange - for example Chanel China or LVMH Asia. Back in the real world we need to trade off a number of factors when determining the best way to get exposure to rising luxury good demand by the Chinese.

Key factors include a) percentage of earnings derived by the Chinese (including overseas demand) - as this is the fastest-growth segment; b) brand owner versus distributor - which has an impact on long-term earnings sustainability; c) product mix - weighting to mid- to high-end price points, which will grow faster; d) valuation - determining whether all the good news is priced in; and e) investability - market cap and average trading volume.

Geographic mix: Exposure to Greater China customers Nearly all the leading luxury brands mentioned in the previous section are listed in Europe or the US or form part of private companies. However. most of these brands derive around 10-20% of their sales from Greater China. Swatch and Richemont have the greater China exposure of these names with 22-28% of sales.

The Asian-listed names derive close to 100% of earnings from Greater China, which enjoys the highest growth rates globally. L’Occitane is the exception as the company is currently deriving 17% of sales and about 20-25% of earnings from Greater China.

Product mix: Exposure to the high end Most of the European and US-listed brand owners generate the majority of their earnings (not necessarily sales) from the luxury segment. The larger conglomerates such as LVMH also sell premium drinks and cosmetics, which are exposed to the same drivers. PPR (owner of the Gucci brands) has a general retail business.

The Asian-listed names can be split into a five broad categories:

Apparel brand owners - Ports Design, Trinity and Evergreen. The first two operate in the luxury segment while Evergreen has about 75% of sales in the high end.

Watch and jewellery retailers - Hengdeli, Luk Fook, Chow Sang Sang, Emperor Watch & Jewellery; Oriental Watch and HK Resources (3D Gold), Each of these operators are operating at mid to high price points.

Department stores and fashion retailing - Parkson, Golden Eagle, Lifestyle and I.T. More than half of the sales for these companies are derived from apparel, accessories and prestige cosmetics.

Cosmetics - Sa Sa and L’Occitane.

Footwear specialists - Belle and Daphne, although Daphne is not featured in this report as prices points are more mid end. Belle generates about 50% of sales in high end.

European owned and listed

Picking names to get exposure

Five key categories for Asian-listed names



Business model: Brand owner versus distributor We typically have a preference for brand owners versus retailers as brand owners have better earnings sustainability over the longer run as it is difficult to establish new luxury brands given the brand heritage and positioning. Retailers are subject to greater competitive pressures from other retailers (pricing, store footprint) and may not be able to maintain relationships with key luxury suppliers. Note that the brand owners mostly operate a retail-intensive distribution model (average sales via retail is 60% depending on product category ie watches is more wholesale) so the capital intensity is similar - manufacturing does not always represent the complicated aspect of the value chain and is commonly outsourced.

There are two large listed brand owners - Ports Design and Trinity plus Evergreen which sells at slightly lower price points. I.T Limited is both a retailer and brand owner in the fashion segment.

Luxury exposure via retailers is easier to attain in China as the majority of luxury brands are sold in department stores as against free-standing flagship stores in other markets.

Earnings growth and valuation The European/US luxury-goods names are trading on the same PE multiple as the Asian listed names - about 22x 2011 earnings. Consensus expects around 22% EPS growth for the Asian names against 15% for the US/European names, which implies a lower PE multiple on 2012 earnings and a lower PE/G multiple of 1x for Asian names vs 1.6x for international names.

Invest-ability: Size and liquidity Clearly the European and US names are much larger in market-cap terms and also have greater liquidity. However, we note that the Asian listed names are growing quickly and since 2001 or their IPO, these stocks have shown an average annual share price appreciation of 35%

Figure 181

Average annual share price performance since 2001 or IPO

(20) 0 20 40 60 80 100

Evergreen

Belle

HK Resources (3D Gold)

I.T Limited

Oriental Watch

Ports Design

Lifestyle

Sasa

Parkson

Average

Chow Sang Sang Jewellery

L'Occitane

Emperor Watch & Jewellery

Golden Eagle

Luk Fook

Hengdeli

Trinity

(%)


Brand owners offer better earnings visibility

Department stores are still popular in China for

luxury goods

Asian plays are much cheaper on a PEG basis



Snapshot of Asian-listed names We have written up 16 Asian-listed high-end companies in this report. Of which, CLSA covers and has price targets on seven of the names. We see the most upside for Ports Design, Evergreen, L’Occitane and Parkson. We currently rate Golden Eagle as O-PF. Hengdeli has increased 57% during 2010 and we currently see less upside to our price target. Nonetheless, we have a very positive medium-term view on organic growth and acquisition opportunities.

We also have a positive view on Trinity, Lifestyle, Emperor Watch and Jewellery, I.T Limited and Sa Sa International.

Figure 182

Asian-listed high-end companies

Stock Bbg Rec Price Jan13

Target Upside (%)

Ports Design 589 HK BUY 21.9 29.0 33Evergreen 238 HK BUY 5.3 7.0 31L'Occitane 973 HK BUY 20.5 26.0 27Parkson 3368 HK BUY 13.0 15.9 22Belle 1880 HK BUY 14.0 15.6 11Hengdeli 3389 HK BUY 4.8 5.3 10Golden Eagle 3308 HK O-PF 21.8 22.3 3Source: Bloomberg, CLSA Asia-Pacific Markets

Quick summary of each of the names

Belle: Leading high-end footwear player in China and vertically integrated business model enables better inventory management and full priced sales.

Chow Sang Sang: Top-three jewellery retailer in China trading on only 12x 2011 consensus earnings.

Emperor Watch & Jewellery: One of the biggest watch retailers in Hong Kong with strong relationships with Rolex, LVMH and Patek. Opportunities to grow in China and also in jewellery. Trading on 0.4x PEG.

Evergreen: Targeting more mid-end men’s apparel, which will grow quickly especially in lower-tier cities. We see 31% upside to our price target.

Golden Eagle: Regional department store specialist in lower-tier cities. Good execution track record but valuation looking pricey.

Hengdeli: Largest watch distributor in China with 30% market shares. Plans to more than double its store network to 800-1,000 from 302 now via acquisitions.

HK Resources (3D Gold): Known as the gold boutique. The company is planning to aggressively grow from 300-odd stores to 500 by 2012.

I.T: The fashion specialist in Greater China with extensive experience with more than 300 international brands. Trading on 20x consensus earnings and suspect huge room for further upgrades.

Lifestyle: Operator of SOGO Causeway and five other department stores/malls in Greater China. We expect very strong December Hong Kong retail sales and believe the company will beat consensus estimates.

Hong Kong icon

Well-heeled

Affordable jewellery

Its time has come

Men’s business

Region al specialist

Quality is timeless

Golden grow

Looking good



L’Occitane: One of the few true high-end brands listed in Asia with a global presence. Store expansion globally should drive strong earnings growth. We see 27% upside to our price target.

Luk Fook: Leading jewellery retailer in China with a preference for third-party operators stores under license agreement. Consensus is expecting around 30% earnings growth over the coming years.

Oriental Watch: Leading watch retailer in Hong Kong. Looking to acquire wholesale customers and trading on 11x 2011 earnings. Looks interesting.

Parkson: Largest listed department store operator in China with 83% of sales from high-priced products. We see 22% upside. BUY.

Ports Design: Leading luxury womenswear brand in China ready for a new phase of store growth. An upcoming younger product line may well be a strong catalyst. We see 33% upside. BUY.

Sa Sa International: No.1 cosmetics retailer for Greater China, with more than 34% of the key Hong Kong market. Generates about 40% of sales from its house brands. A tad pricey at 26x.

Trinity: Positive on product category (men’s); brand ownership (Kent & Curwen and Cerruti) and exclusive distributor for Gieves & Hawkes and D’URBAN and potential for more license deals and acquisitions

Figure 183

Luxury companies comparison Stock Bbg Country Industry Brand

owner Greater

China % sales

High-end % sales

Rec Mkt cap

(€m)

PE 11 (x)

PE 12 (x)

EPS gr 11-12

(%)

PE/G 11 (x)

LVMH MC FP France Diversified Yes 15 100 N-R 58,637 19.7 17.4 13.5 1.5Burberry BRBY LN UK Apparel Yes 10 100 N-R 5,704 25.4 20.7 22.3 1.1Swatch UHR VX Switzerland Watches Yes 28 90 N-R 16,827 18.1 15.9 13.6 1.3PPR PP FP France Diversified Yes 6 50% of OP N-R 15,135 13.3 11.9 11.9 1.1Richemont CFR VX Switzerland Watches & jewellery Yes 22 100 N-R 25,688 22.1 19.0 16.5 1.3Hermes RMS FP France Leather goods Yes 11 100 N-R 16,701 35.7 32.2 10.8 3.3Bulgari BUL IM Italy Watches & jewellery Yes 14 100 N-R 2,411 27.4 21.5 27.4 1.0Coach COH US US Leather goods Yes <5 100 N-R 12,217 18.7 16.6 12.6 1.5Tiffany TIF US US Jewellery Yes <5 100 N-R 5,851 21.4 18.8 14.0 1.5Tods TOD IM Italy Shoes & leather goods Yes 3 100 N-R 2,418 19.7 17.9 10.6 1.9Average 22.1 19.2 15.3 1.6Belle 1880 HK HK Footwear Yes 100 50 BUY 11,536 25.0 21.4 17.0 1.5Golden Eagle 3308 HK HK Dept store No 100 75 O-PF 4,122 28.7 22.8 25.4 1.1Parkson 3368 HK HK Dept store No 100 65 BUY 3,570 22.6 17.5 29.1 0.8Lifestyle 1212 HK HK Dept store No 100 50 N-R 3,317 24.2 22.2 9.1 2.7L'Occitane 973 HK HK Cosmetics Yes 17 100 BUY 2,954 27.8 20.8 33.8 0.8Hengdeli 3389 HK HK Watches Exclusive 100 100 BUY 2,063 27.7 23.6 17.2 1.6Luk Fook 590 HK HK Jewellery Yes 100 100 N-R 1,530 20.5 16.7 22.7 0.9Sasa 178 HK HK Cosmetics 40% 100 80 N-R 1,270 26.6 21.1 25.7 1.0Chow Sang Sang 116 HK HK Jewellery Yes 100 100 N-R 1,224 16.3 13.6 19.3 0.8Trinity 891 HK HK Apparel 54% 100 90 N-R 1,137 26.8 20.5 30.3 0.9Ports Design 589 HK HK Apparel Yes 93 100 BUY 1,211 18.0 15.2 18.6 1.0I.T 999 HK HK Apparel 50% 100 100 N-R 725 21.3 17.3 22.6 0.9Emperor W&J 887 HK HK Watches & jewellery 14% 100 100 N-R 640 15.3 10.6 43.4 0.4Evergreen 238 HK HK Apparel Yes 100 75 BUY 512 20.3 15.1 34.4 0.6Oriental Watch 398 HK HK Watches No 100 100 N-R 199 12.8 17.2 (25.6) (0.5)HK Resources (3D Gold) 2882 HK HK Jewellery Yes 100 100 N-R 182 na na na naAverage 22.2 18.4 21.5 1.0Notes LVMH to Greater Chinese customers 18% LV to Greater Chinese customers is 22% with 11% in China and 11% overseas Gucci brand 10% for mainland and 8% in HK etc so 18% for Greater China Richemont is 8% on mainland and 14% in HK etc for 22% in total for Greater China Bulgari is 8% for mainland plus 6% for HK for a total of 14%

Source: Bloomberg, CLSA Asia-Pacific Markets

A natural beauty

Jewellery specialist

Time for a change

Best of luxe

Ready to grow

Pretty in pink

Go your own way

Appendix Luxury goods


Appendix: International peer group LVMH 1H10 sales breakdown by geography and segment

Leading luxury-goods giant holding a portfolio of more than 60 prestigious brands in wines and spirits, fashion and leather goods, cosmetics, watches and jewellery, and retailing.

Brands include Moët & Chandon, Dom Pérignon, Hennessy, Louis Vuitton, Fendi, Donna Karan, Loewe, Marc Jacobs, Céline, Kenzo, Givenchy, Christian Dior, Guerlain, TAG Heuer, Hublot, Zenith, DFS, Sephora, and many others. We estimate that Louis Vuitton contributes to 55% of group Ebit.

Watches and jewellery is the fastest-growing segment at 22% organic growth for 9MFY10, although the segment currently only contributes to about 5% of group sales. This is followed by wines and spirits and fashion and leather goods at 17% and 14%, respectively.

As at June 2010, LVMH had a network of 2,468 stores worldwide. Europe and Asia each accounts for 33-35% of sales. We understand that the Chinese represent about 22% of sales for the Louis Vuitton brand, which is 11% domestic with 35 stores in the mainland and 11% overseas. This is matching the Japanese for the first time this year as the co-No. 1 client base.

LVMH also holds 20.2% of Hermes, but the company said it is not seeking control or a seat on the Hermes board.

Japan9%

Rest of Asia26%

Other markets

9%

United States23%

Rest of Europe19%

France14%

Fashionand leather

goods38%

Selective retailing

27%

Wines and spirits14%

Perfumes and

cosmetics16%

Watches and jewellery

5%

Richemont 1H11 sales breakdown by geography and segment

Richemont owns a number of luxury names including Cartier, Van Cleef & Arpels, Piaget, Vacheron Constantin, Jaeger-LeCoultre, IWC, Panerai and Montblanc.

Richemont is a direct luxury play, with watches and jewellery accounting for 74% of sales. Watches contribute to more than half of sales.

Hong Kong is the largest single market worldwide for Richemont. China and Hong Kong account for 22% of sales. We estimate that exposure to mainland China is at 8%.

As at September 2010, Richemont had 855 directly operated outlets. The company also runs the luxury online shop NET-A-PORTER.COM.

Some 47% of revenue comes from retail.

China/Hong Kong

22%

Japan11%

Other Asia13%

France9%

Other Americas

4%USA11% Germany,

Italy and Spain9%

Other Europe17%

Switzerland4%

Leather goods8%

Jewellery23%

Watches51%

Writing instruments

5%

Clothing & other13%

Source: Company data, Cheuvreux, CLSA Asia-Pacific Markets



Hermes 1H10 sales breakdown by geography and segment

Hermes is known for its top-notch craftsmanship. Its Birkin and Kelly bags and high-quality silk scarves, in particular, are hot items for ladies around the world.

Asia accounts for 46% of the sales with Japan at 19%, while Europe is at 37%. We estimate that exposure to mainland China is at 6% and Greater China is at 11%.

More than 50% of revenue comes from its highly-regarded leather goods.

As of December 2009, the company had 325 retail outlets, of which 304 are exclusive Hermes stores. There are 16 stores in China, eight in Hong Kong, seven in Taiwan and four in Macau.

LVMH holds 20.2% of Hermes, but the company said it is not seeking control or a seat on the Hermes board. Some Hermes family members proposed setting up a holding company to bolster defense. The proposed holding company should have 50.2% of Hermes share and at least as many voting rights, coupled with the first right of refusal on another 12.6% of shares. However, it was reported that some family members opted against this proposal.

Rest of Europe19%

Other2%

Rest ofAsia Pacific

27%

Americas15%

Japan19%

France18%

Other4%

Watches4%

Perfumes6%

Tableware2%

Ready-to-wear and fashion

accessories19%

Other Hermes sectors

3%

Leather goods and saddlery

51%

Silk and textiles11%

Source: Company data, Bloomberg, Cheuvreux, CLSA Asia-Pacific Markets

Bulgari 1H10 sales breakdown by geography and segment

Bulgari is an Italian luxury company focusing on watch, jewellery, and perfumes and cosmetics. Together, these three segments contribute to 89% of sales. Jewellery accounts for the largest portion at 46%.

Asia accounts for 45% of the sales for Bulgari with Japan at 18%, while Europe is at 34%. We estimate that exposure to mainland China is at 8% and Greater China is at 14%.

As of December 2009, the company had 273 stores, of which 166 are company-owned.

Japan18%

America14%

Rest of Europe23%

Italy11%

Other2%Middle East

5%

Rest of Asia27%

Watches20%

Jewellery46%

Accessories8%

Hotel and catering activities

2%

Perfumes and

cosmetics23%

Royalties and other1%

Source: Company data, Cheuvreux, CLSA Asia-Pacific Markets



PPR 1H10 sales breakdown by geography and segment

PPR holds a portfolio of luxury brands but also a number of retailers in home furnishings and computers and books.

Its core luxury brand Gucci accounts for 15% of group revenue. Gucci Group, which includes, Gucci, Bottega Veneta, Yves Saint Laurent, and other brands, contribute to 22% of sales.

The other major businesses include sports brand Puma, diversified retailer Fnac and home-furnishing retailers Redcats and Conforma.

PPR generates 66% of sales from Western Europe, but for the luxury Gucci Group, the breakdown shifts towards Asia.

For Gucci Group, Western Europe leads at 33%, followed by Asia ex-Japan at 31% and North America at 18%. Japan contributes to 13% of Gucci Group sales. We estimate that Gucci brand’s exposure to mainland China is at 10% and Greater China is at 18%.

Gucci Group had 639 directly operated stores at June 2010, of which 190 are in Japan.

PUMA16%

Conforama17%

Redcats21%

Gucci Division

15%

Bottega Veneta

3%

Yves Saint Laurent

1%

Other brands3%

Fnac24%

South America 3%

EEMEA 4%

Japan 5%

North America 14%

Western Europe 65%

Asia Pacific (excl. Japan)

9%

Tod’s 1H10 sales breakdown by geography and segment

Tod’s generates 52% of sales from its core Tod’s brand. The second key brand is Hogan, which sells premium shoes and bags. FAY generates 9.1% and the remaining 2.5% comes from Roger Vivier.

Some 75% of sales comes from shoes and 15% from leather goods.

Italy is the dominant revenue source, contributing to 54% of sales.

As of June 2010, the company had a portfolio of 222 stores, of which 151 are directly owned. The company has 24 stores in China, 14 in Taiwan, nine in Hong Kong and two in Macau. We estimate that exposure to mainland China is at 2% and Greater China is at 3%.

North America

7%

Europe21%

Rest of world18%

Italy54%

Leather goods15%

Apparel10%

Shoes75%




Burberry FY09/10 sales breakdown by geography and segment

Renowned for its trench coats and British origin, Burberry generates 35% of sales from Europe and 24% from Asia Pacific.

The company generates a greater share of sales from apparel at 64% compared with other luxury peers that tend to focus more on leather goods or hard luxury items.

The company amended its apparel license with Sanyo Shokai and Mitsui in Japan in October 2009. The license now ends in June 2015, which was previously at 2020. With better controls on production, inventory and distribution, the company expects profits from licensing to step up going forward.

In China, the company recently acquired 50 franchise stores.

As at June 2010, Burberry had 207 stores in Asia Pacific and 420 globally (excluding Spain which is undergoing restructuring).

Spain9%

Asia Pacific24%

Rest of World5%

Americas27%

Europe35%

Non-apparel36%

Childrens5%

Menswear24%

Womenswear35%

Coach FY09/10 sales breakdown by geography and segment

Coach’s business primarily comes from the US and Japan. About 70% of Coach’s sales comes from the US and 20% from Japan.

However, the company has made several senior appointments and aims to quickly expand in China. Including Hong Kong and Macau, Coach has 41 stores in China.

The company holds 342 retail stores and 121 factory outlets in North America.

Coach also runs an indirect channel (13% of sales) with a network of about 940 wholesale locations in the US and 182 international outlets.

Handbags are the key product line for Coach.

Other

international10%

Japan20%

United States70%

Accessories28%

All other products

9%

Handbags63%




Tiffany FY09 sales breakdown by geography and segment

Tiffany is a US-based luxury company famous for its elegant jewellery design and its signature blue box.

The company generates 52% of sales from the US, with 9% coming from its New York flagship store. Its branch stores in the US contribute to 32% of revenue, with the rest from Canada, Latin America, internet and catalogue, and B2B.

According to its 1H10 interim report, Tiffany has invested in and operates more than 20 stores in Hong Kong, Macau, and mainland China.

Globally, the firm generates 31% of revenue from sterling silver jewellery, 27% from gemstone jewellery excluding engagement jewellery, and 21% from diamond rings/wedding bands.

In Asia Pacific, the sales breakdown is tilted towards the higher-priced gemstone jewellery, with 31% each in engagement and other gemstone jewellery.

Other1%Europe

12%

Japan19%

Asia Pacific16%

Americas52%

All other9%

Non-gemstone,

sterling silver jewellery

31%

Non-gemstone,

gold or platinum jewellery

12%

Diamond rings and wedding bands21%

Gemstone jewellery and band rings,

excl. engagement

jewellery27%

Swatch 1H10 sales by segment and Swiss watch exports data

Swatch owns a number of watch brands with a wide range of price points, including Breguet, Blancpain, Glashütte Original, Jaquet Droz, Léon Hatot, Omega, Longines, Rado, Tissot and Swatch.

Swatch has also formed a strategic alliance with luxury jewellery brand Tiffany.

In the mass market, the company is known for its fashionable design branded under the Swatch name.

The company is a key player in the watch industry. We estimate that sales exposure to Greater China at 28% and mainland China at 15%, in line with the Swiss watch exports data.

Electronic Systems

6%

Production 22%

Watches & Jewellery

72%

China 7%

USA 10%

Others31%

France 7%

Italy 6%

United Kingdom

4%

Germany 5%

Japan 5%

Singapore 6%

Hong Kong 19% Hong Kong/

China togetheris 26%


Luxury goods


Notes

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Philippines CLSA Philippines, Inc 19/F, Tower Two The Enterprise Center 6766 Ayala corner Paseo de Roxas Makati City Tel: (63) 2 860 4000 Fax: (63) 2 860 4051

USA - Boston Credit Agricole Securities (USA) Inc 99 Summer Street Suite 220 Boston, MA 02110 Tel: (1) 617 295 0100 Fax: (1) 617 295 0140

China - Beijing CLSA Limited - Beijing Rep Office Unit 10-12, Level 25 China World Trade Centre Tower 2 1 Jian Guo Men Wai Ave Beijing 100004 Tel: (86) 10 5965 2188 Fax: (86) 10 6505 2209

Indonesia PT CLSA Indonesia WISMA GKBI Suite 901 Jl Jendral Sudirman No.28 Jakarta 10210 Tel: (62) 21 2554 8888 Fax: (62) 21 574 6920

Singapore CLSA Singapore Pte Ltd 80 Raffles Place, No.18-01 UOB Plaza 1 Singapore 048624 Tel: (65) 6416 7888 Fax: (65) 6533 8922

USA - Chicago Credit Agricole Securities (USA) Inc 227 W. Monroe Street Suite 3800 Chicago, IL 60606 Tel: (1) 312 278 3604

China - Shanghai CLSA Limited - Shanghai Rep Office Room 910, 9/F 100 Century Avenue Pudong New Area Shanghai 200120 Tel: (86) 21 2020 5888 Fax: (86) 21 2020 5666

Japan Credit Agricole Securities Asia BVTokyo Branch 15/F, Shiodome Sumitomo Building 1-9-2, Higashi-Shimbashi Minato-ku, Tokyo 105-0021 Tel: (81) 3 4580 5533 (General) (81) 3 4580 5171 (Trading)Fax: (81) 3 4580 5896

Taiwan CLSA Limited Taiwan Branch 27/F, 95 Tun Hwa South Road Section 2 Taipei Tel: (886) 2 2326 8188 Fax: (886) 2 2326 8166

USA - New York Credit Agricole Securities (USA) Inc 15/F, Credit Agricole Building1301 Avenue of The AmericasNew York 10019 Tel: (1) 212 408 5888 Fax: (1) 212 261 2502

China - Shenzhen CLSA Limited - Shenzhen Rep Office Room 3111, Shun Hing Square Di Wang Commercial Centre 5002 Shennan Road East Shenzhen 518008 Tel: (86) 755 8246 1755 Fax: (86) 755 8246 1754

Korea CLSA Securities Korea Ltd 15/F, Sean Building 116, 1-Ka, Shinmun-Ro Chongro-Ku Seoul, 110-061 Tel: (82) 2 397 8400 Fax: (82) 2 771 8583

Thailand CLSA Securities (Thailand) Ltd 16/F, M Thai Tower All Seasons Place 87 Wireless Road, Lumpini Pathumwan, Bangkok 10330 Tel: (66) 2 257 4600 Fax: (66) 2 253 0532

USA - San Francisco Credit Agricole Securities (USA) Inc Suite 850 50 California Street San Francisco, CA 94111 Tel: (1) 415 544 6100 Fax: (1) 415 434 6140

Hong Kong CLSA Limited 18/F, One Pacific Place 88 Queensway Hong Kong Tel: (852) 2600 8888 Fax: (852) 2868 0189

Malaysia CLSA Securities Malaysia Sdn Bhd Suite 20-01, Level 20 Menara Dion 27 Jalan Sultan Ismail 50250 Kuala Lumpur Tel: (60) 3 2056 7888 Fax: (60) 3 2056 7988

United Kingdom CLSA (UK) 12/F, Moor House 120 London Wall London EC2Y 5ET Tel: (44) 207 614 7000 Fax: (44) 207 614 7070

CLSA Sales Trading Team Australia (61) 2 8571 4201 China (Shanghai) (86) 21 2020 5810 Hong Kong (852) 2600 7003 India (91) 22 6622 5000 Indonesia (62) 21 573 9460 Japan (81) 3 4580 5169 Korea (82) 2 397 8512

Malaysia (60) 3 2056 7852 Philippines (63) 2 860 4030 Singapore (65) 6416 7878 Taiwan (886) 2 2326 8124 Thailand (66) 2 257 4611 UK (44) 207 614 7260 US (1) 212 408 5800

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© 2011 CLSA Asia-Pacific Markets ("CLSA"). Key to CLSA investment rankings: BUY = Expected to outperform the local market by >10%; O-PF = Expected to outperform the local market by 0-10%; U-PF = Expected to underperform the local market by 0-10%; SELL = Expected to underperform the local market by >10%. Performance is defined as 12-month total return (including dividends). 01/01/2011

China luxury primer (dipped in gold) clsa (2011)

Economy & Finance

Transcript of China luxury primer (dipped in gold) clsa (2011)