Investment Highlights:
A multi-brand jewelry group proposing to acquire Buccellati, aninternational luxury jewelry brand. In 2012, the Companytransformed itself into a jewelry play by foraying the gold sector via anacquisition of Gansu Daye Geology Mining Co., Ltd. and then set upgold/jewelry enterprises including Gangtai Gold （gold jewelry）， GuodingGold （gold products）， KELA （diamond）， Youna Jewelry. and IGNITE viaM&A or green field projects. In this way, the Company completedmaking presence in multiple jewelry segments and has a portfolio ofjewelry brands. During 1H2016, gold and gold jewelry revenue took up83% of the Company's total revenue while precious metalcollectibles/diamond/colored gemstone revenues took up 8%/5%/1% ofthe total. During 1-3Q2016, the Company's operating income amountedto Rmb7.23bn （+16.1% YoY） and its attributable net profit stood atRmb330mn （+77.5% YoY）。 It announced in Dec 2016 the proposal toacquire Buccellati, the top-notch Italian luxury jewelry brand, to forayinto the international luxury jewelry sphere. The deal remains underwayup to now.
The jewelry sector: sees jewelry design /brand being appreciated inthe era of fashion and dense M&As. During 2003-16, the jewelry sectorposted a revenue CAGR of 13.9% and saw its revenue growth startingslowing down since 2014. Design/brand marketing have become thecore competitive edges of jewelry brands along with consumptionupgrade. For example, Pandora, the fashionable Danish jewelry brandsnatched the surprisingly high gross margin of 75.06% and increasedclients' consumption frequency via the DIY design on the part ofcustomers and dense new arrivals. Its ROE of 56% leaves Tiffany（16%） far behind. For FY 2016, its revenue in the Asia Pacific grew by46% YoY. Starting from 2014, there have been dense M&As in theChinese jewelry sector with most of the acquisition targets being jewelrybrand owners.
Advantages of the Company: a portfolio of brands, shared channelsand presence in consumer and industry finance. Currently, theCompany offers multiple categories of jewelries under five brands to amassive base of mass consumers, including Gangtai （gold jewelry），Guoding （precious metal collectibles）， KELA （diamond）， Myray （coloredgem jewelry） and IGNITE （3D print of karat gold jewelry） In terms ofchannels, all its businesses share the mature O2O channel of KELAand it has been extending the gold jewelry business from 2B （tobusiness） to 2C （to customer）。 We expect retail sales as a percent of itstotal sales to rise to 30% in 2016 from 3% in 2015. Its gross marginsfrom gold jewelry during 2015 and 1H2016 stood at 7.2%/12.4% （withthe influence of gold price factored in）。 In addition, the Companyacquired Reach Glory, which engages in jewelry marketing viaentertainment content by cooperating with the Company's brands, KELA/Guoding, and has made solidpresence in consumer/industry finance. We expect to see synergies between its jewelry business andthis eco-system of media/consumer finance/industry finance.
What's to watch in operation: as the Company has kept improving its portfolio of brands, investors aresuggested to keep a close eye on synergies it would achieve along the entire jewelry value chain. TheCompany has already completed building entry-level jewelry brands and planned to acquire Buccellati togain a presence in the sphere of luxury jewelry. Going ahead, it plans to foray into the entry-level luxuryjewelry segment via Buccellati's advanced jewelry design & craftsmanship or cooperating with others.
According to its announcement, the Company would invest Rmb3.43bn to expand Buccellati's globalmarketing channel （which consists of 12 and 219 retail/wholesale outlets worldwide currently）。 Afterlooking at Richemont Group's acquisition of Van Cleef & Arpels, whose self-run stores expanded to 116from 39 and jewelry and watch business registered operating revenue CAGR of 10% during 2000-2016,we expect Buccellati to beef up its presence in the Asia Pacific/the Middle East/North America and have100 self-run retail outlets worldwide over 5 years to fuel rapid revenue/profit growth. The Company isalso looking to develop into a jewelry e-commerce platform operator based on KELA's O2O channel（which is expected to rake in sales revenue of Rmb3bn for 2016） to achieve synergies along the currentvalue chain.
Potential risks: disappointing performance of acquired brands and synergies along the jewelry valuechain.
Earnings forecast, valuation and investment rating: We forecast the Company's 2016-2018Eoperating incomes to come in at Rmb10.25/Rmb11.37bn/Rmb12.61bn respectively （+15.9%/10.9%/10.9%YoY） and its net profits to be Rmb500mn/Rmb690mn/Rmb880mn （+44.2%/37.2%/27.4% YoY），equivalent to 3-year EPS of Rmb0.34/0.46/0.59. Its proposed acquisition of the top-notch jewelry brandBuccellati and synergies along the jewelry value chain merit close attention. Its last price is slightly lowerthan the price at which its employees bought in and the offering price under the proposed privateplacement of Rmb15.21 and Rmb15.42 respectively. Currently, the median valuation of comparablejewelry plays stands at 2017E PE of 20x. The Company boasts huge growth potential for retail sales ofdiamond/gem jewelries under its clear-cut multiple brand strategy. As a reformer in the jewelry sector,the Company deserves some premium in our opinion. We value its core business, jewelry, at 2017E PEof 25x-28x （equivalent to a market cap of Rmb17.1bn-Rmb19.2bn） and value its 92 tonnes of goldreserve at Rmb9bn （after looking at gold output per tonne/market cap of comparable gold mining plays inthe upstream） to derive a fair market cap range of Rmb26.1bn-Rmb28.2bn （irrespective of the proposedprivate placement）。 Initiate OVERWEIGTH and set its range of TP at Rmb17.5-18.9.
