2H17 Consumer Discretionary Sector Outlook

Transcription

1 Equity Research Consumer Discretionary 2H17 Consumer Discretionary Sector Outlook Select names with re-rating potential driven by accelerating earnings and attractive valuations Albert Yip, CFA SFC CE No. ADT GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Sector view Neutral Jewelry: Given a high comparable base, we expect SSSG to moderate in 4Q17. That said, the rental reversion trend in the HK market remains favorable. Sportswear: We remain positive over the long term in view of favorable government policies and increasing participation in sports. Order book peaked in 1Q-2Q16 and then normalized. Education: Private schools are expected to gain market share from public schools as rising middle-class income supports spending on quality education and as middle-class parents increasingly prefer more well-rounded education offered by private schools. Key themes Jewelry: Gold price, SSSG, sales mix of high-margin gem-set products. Sportswear: SSSG, trade fair results, retail discounts, sales mix of functional products. Education: Number of student enrollment, M&A. Valuation analysis Jewelry: The sector is trading at 16.7x one-year forward P/E, above its five-year historical average of 14.5x. As we expect sector SSSG to moderate in 4Q17, we think sector valuation re-rating is unlikely, if it does not see de-rating at all. Sportswear: The sector is trading at 14.4x one-year forward P/E, above its five-year historical average of 12.0x. We find this valuation to be fair. Education: Maple Leaf is trading at 17.5x FY18 P/E, above its historical average of 14.4x. Wisdom Education is trading at 15.5x FY18 P/E, below sector average of 16.5x FY18 P/E. Investment strategy Bottom-up approach We prefer companies with re-rating potential driven by accelerating earnings and attractive valuations. Top picks Wisdom Education (6068 HK, Buy) Competitor Tung Wah School has recently raised its 2017/2018 school year tuition and boarding fees to 16%-21% above those at Dongguan Guangming School. This should provide upside potential to Dongguan Guangming s tuition fee level. We think consensus FY19 estimates are overly conservative. Going forward, the company will mainly focus on expansion in Guangdong to benefit from the Guangdong-HK- Macau Greater Bay Area initiative. I.T (999 HK, Buy) We expect a re-rating driven by better visibility and accelerated earnings in FY18, thanks to loss stabilization in the HK market and continued momentum in the China and Japan markets. Risks Upside risks: Better-than-expected SSSG and trade fair results, M&A, a gold price rally, decent in mainland tourist arrivals, better-than-expected student enrollment numbers. Downside risks: Lower-than-expected SSSG and trade fair results, a gold price slump, notable decline in mainland tourist arrivals, policy risks, teacher cost pressure and fierce competition.

2 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jan & Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan & Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan & Feb-17 Mar-17 Apr-17 May-17 2H17 Sector Outlook 1H17 sector performance review Jewelry sector outperformed There was a re-rating for the sector driven by SSSG recovery in the China and HK & Macau markets in 1H17. The share prices of Chow Sang Sang, Chow Tai Fook and Luk Fook rose 27%, 39% and 32%, respectively. Sportswear sector underperformed Li Ning was the best performing sportswear stock in 1H17 with share price of 22%. Firstly, Li Ning is estimated to have the strongest net profit CAGR from FY16 to FY18 among peers. Secondly, the share sale by TPG removed an overhang on the stock. Anta s share price rose 11% and underperformed the market (HSI: +17%) as its new share placement surprised the market. Xtep fell 8% during the period as its FY16 net profit missed market consensus. Also, the ongoing restructuring of its kids business might cause A/R provision in FY17. Education sector outperformed Market concerns about the impact of the Revised Law for the Promotion of Private Education on private school development were alleviated, in our view, as several private school operators were approved to become listed between Jan and April The sector saw re-rating in 1H17. Wisdom Education, Yuhua Education and Maple Leaf advanced 59%, 32% and 24%, respectively. Jewelry sector SSSG to moderate in 4Q17 The SSS recovery in China and Hong Kong since Sept 2016 has been due to a low comparable base. Given that we will see a high comparable base in 4Q17 (see Figures 1 and 2), we anticipate SSSG to moderate in 4Q17. According to Chow Tai Fook s management, SSSG in both China and HK & Macau in April-May were better than in 1Q17 (China +12%, HK & Macau +4%). However, their SSSG guidance for China and HK & Macau in FY18 are mid-singledigit, suggesting a softening of SSSG in 2HFY18. Falling rental reversion in HK a positive Leases for shops in HK typically have a term of three years. Given that street shop rentals in tourist areas in HK have fallen after peaking in 2015, rental reversion should decline in 2017 and In addition, jewelry retailers have been optimizing their retail networks by shutting down shops in tourist areas and opening shops in residential areas. Therefore, we expect jewelry retailers rental expenses in HK to decrease. We estimate that Chow Tai Fook s fixed rental expense could drop by 12% in FY18, followed by Chow Sang Sang (-7%) and Luk Fook (-6%). Figure 1: Hong Kong retail jewelry sales have recovered since Sept 2016 Figure 2: China retail jewelry sales have also recovered since Sept (%) 25% 20% 15% 10% 5% 0% -5% -10% -15% Sources: Hong Kong Census & Statistics Department, GF Securities (Hong Kong) Sources: National Bureau of Statistics of the PRC, GF Securities (Hong Kong) 2

3 Figure 3: SSS trend for jewelry companies Calendar Year 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 Apr May Jun Avg gold price (US$) 1,219 1,194 1,126 1,105 1,181 1,259 1,335 1,217 1,218 1,270 1,246 Avg gold price YoY (%) -6% -8% -12% -8% -3% 5% 19% 10% 3% 2% -1% SSS trend Chow Tai Fook (1929 HK) -16% -15% -3% -15% -26% na na na na China -9% -7% 6% -6% -25% -17% -22% 4% 12% HK and Macau -26% -24% -13% -23% -27% -20% -30% -2% 4% Luk Fook (590 HK) -20% -18% -6% -25% -27% -24% -37% -10% 2% China -5% 0% 2% -10% -19% -24% -23% 5% 11% HK and Macau -22% -19% -7% -26% -28% -24% -39% -11% 1% Chow Sang Sang (116 HK) % ve 5% ve 12% ve 26% China +ve sd -11% -ve low to mid-teen mid to high sd hsd 10% mid sd similar to May HK and Macau +ve low sd -ve high-teen ve 34% ve 7% -ve lsd -ve msd -ve lsd a bit better than May SSS trend by category Chow Tai Fook (1929 HK) Gold products -19% -12% 13% -14% -27% na na na na still better than gem-set China -10% -2% 22% -3% -29% -22% -27% 7% 17% HK and Macau -32% -25% 4% -24% -25% -12% -36% 8% 19% Gem-set jewellery -6% -10% -13% -12% -23% na na na na --- lag behind gold SSSG narrowed --- China 3% -4% -4% -7% -24% -12% -17% -4% 5% HK and Macau -17% -16% -24% -16% -22% -27% -23% -17% -17% ve Luk Fook (590 HK) Gold and platinum products -21% -18% 5% -25% -28% -26% -47% -11% -1% China -10% -7% -1% -14% -27% -29% -30% 2% 16% HK and Macau -22% -20% 6% -26% -28% -25% -49% -12% -5% Gem-set jewellery -20% -18% -26% -26% -25% -19% -14% -4% 11% China 11% 23% 13% 2% 4% -8% -3% 20% 6% HK and Macau -22% -19% -28% -27% -27% -20% -14% -5% 12% Chow Sang Sang (116 HK) Gold and platinum products China ve 13% ve 27% ve lsd +ve +ve teens better than gem-set better than gem-set HK and Macau -49% -ve msd +ve better than gem-set better than gem-set better than gem-set Gem-set jewellery China high sd % low-teens dd, less than LF mid-teens +ve sd +ve lsd HK and Macau better than LF -ve low-teen -ve hsd Source: Company data, GF Securities (Hong Kong) estimates Valuation The sector is trading at 16.7x one-year forward P/E, above its five-year historical average of 14.5x. Individually, Chow Sang Sang, Luk Fook and Chow Tai Fook are trading at 13.6x/14.8x/23.5x P/E, based on estimated earnings for the current financial year. As we expect sector SSSG to moderate in 4Q17, we think the likelihood of a sector re-rating (if not a de-rating) in 2H17 is small. Figure 4: Comparison of financial information better than 1Q better than 1Q double-digit slightly positive CTF (1929 HK) CSS (116 HK) LF (590 HK) Financial year FY17 FY16 FY17 Year-end Mar Dec Mar Gold product rev mix 57% 61% 57% Non-gold product rev mix 43% 39% 43% Gold hedge ratio 20-50% 40% 20-25% HK & Macau jewelry rev/jewelry business rev 39% 47% 61% China jewelry rev/jewelry business rev 61% 52% 32% Other regions jewelry rev/jewelry business rev na 1% 2% Gold product rev mix - China retail 56% ~65% 71% Gem-set product rev mix - China retail 39% ~35% 29% HK & Macau and overseas profit/total jewelry profit 23% <30% 46% China profit/total jewelry profit 77% >70% 54% Macau revenue/total revenue na insignificant 12% Macau revenue/hk, Macau & overseas revenue na insignificant 19% HK store number Macau store number China store number Self-operated stores - China Franchised stores - China E-com rev/china jewelry rev 5% 12% 4% Sources: Company data, GF Securities (Hong Kong) 3

4 Sportswear sector Long-term positive According to China s General Administration of Sports, the total size of the domestic sports industry increased by 25% to Rmb1,700bn in Given various supportive policies such as the Mid/Long-Term Soccer Development Plan ( 中国足球中长期发展规划 ) and Winter Sports Development Plan ( 冰雪运动发展规划 ), we think the total size of the sports industry is on track to reach Rmb3trn in Running footwear is the largest footwear category in terms of sales volume for domestic sportswear companies. Based on data provided by the Chinese Athletic Association, 328 marathons were held in China during 2016, representing a YoY increase of 145%. The number of participants also jumped 87% YoY to 2.8m in The rising penetration of running activities should boost the demand of running products. According to Euromonitor s estimates, the revenue of China s sportswear industry rose 12% to Rmb186.6bn in It is expected that the sector will grow at a CAGR of 8% at constant 2016 prices during , with the functional footwear industry to grow at a CAGR of 10%. Figure 5: China s sports industry estimated to be worth Rmb3trn by 2020 (Rmb bn) 6,000 5,000 5,000 4,000 3,000 3,000 2,000 1, ,357 1, E 2025E Sources: General Administration of Sport of China, GF Securities (Hong Kong) Figure 6: Number of marathons and participants in China Number of competitions (LHS) Number of participants (RHS) 10,000,000 10,000,000 9,000, ,000,000 7,000,000 6,000,000 5,000, ,000,000 2,800,000 3,000, ,000, ,500, , , , ,000 1,000, E Sources: Chinese Athletic Association, Xinhuanet, GF Securities (Hong Kong) 4

5 Figure 7: Target number of people regularly participating in sports by 2030 (m people) Figure 8: Per capita sports facility area target by 2030 (sqm per capita) E 2030E E 2030E Sources: State Council, GF Securities (Hong Kong) Figure 9: Peer comparison order book Valuation Domestic sportswear companies order book has returned to positive territory since As is shown in Figure 9 below, most companies order book peaked in 1Q16 or 2Q16 and then normalized. The sector is now trading at 14.4x one-year forward P/E, above its fiveyear historical average of 12.0x. We find this valuation to be fair. Anta (2020 HK) Li Ning (2331 HK) Xtep (1368 HK) Peak 361 Degrees (1361 HK) 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 low doubledigit low double- low double- low double- low double- low double- low double- low single- digit digit digit digit digit digit digit digit digit digit digit mid-twenties mid-teens mid-teens mid-teens high-teens mid-teens low-teens mid-teens mid-teens mid-teens high-teens 10% 10% mid-teens 11% 11% 16% 18% 15% 15% low-teens low-teens decline mid singledigit mid singledigit na na na na low-teens Sources: Company data, GF Securities (Hong Kong) Figure 10: Peer comparison SSSG or retail sell-through Anta* (2020 HK) Li Ning (2331 HK) Xtep (1368 HK) Peak 361 Degrees (1361 HK) 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 low-teen high-teen low-teen digit digit digit digit digit mid singledigit low-teens low single- low single- mid-teen -ve mid digit digit digit digit digit single-digit mid singledigit low single- digit digit digit digit digit digit digit digit mid singledigit digit digit digit flat na na na na 6% 7% 8% 8% 7% 7% 7% 8% 7% Sources: Company data, GF Securities (Hong Kong) * Since 1Q16, Anta has changed to reporting retail sell-through of the Anta core brand and Anta Kids, instead of SSSG of the Anta core brand. Education sector Private schools expected to gain market share While the total number of students at private primary and secondary schools grew at a CAGR of 4.0% to 14.7m in 2015 from 12.1m in 2010, the total number of students at public primary and secondary schools declined at a CAGR of 1.9% during the same period. The market share of private primary and secondary schools increased from 6.9% in 2010 to 9.0% in We believe this trend will continue and that the market share of private schools in primary and secondary school operation will increase as: 1) the rising income of the middle class is expected to lift education spending as better quality of education is sought; 2) middle-class parents increasingly prefer the more well-rounded education offered by private schools over the exam-score-focused education provided by public schools. According to Frost & Sullivan, 5

6 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17 2H17 Sector Outlook student enrollment for private primary and secondary education is expected to grow at a CAGR of 4.7% from 2015 to Figure 11: Student enrollment for private primary and secondary education in China Figure 12: Private school penetration in primary and secondary education by number of student enrollment in China (m) High schools Middle schools Primary schools E 2017E 2018E 2019E 2020E Sources: Frost & Sullivan Report, GF Securities (Hong Kong) 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% High schools Middle schools Primary schools 13.8% 13.3% 12.6% 12.9% 12.2% 11.7% 11.1% 10.4% 12.1% 12.5%12.8% 9.5% 11.2% 11.7% 9.9% 10.8% 8.6% 8.9% 9.5% 9.5% 6.2% 6.7% 7.1% 7.4% 7.6% 7.9% 8.2% E 2017E 2018E 2019E 2020E Wisdom Education s stronger-than-peers expansion plan Based on the expansion plan announced by the company, we expect Wisdom Education to have the strongest expansion among peers from FY17 to FY19. Including the to-be-acquired private school in Jieyang, Guangdong, the company s capacity is likely to grow 59% from FY17 to 61,494 students in FY19. This would be higher than Maple Leaf (41%), Virscend Education (24%) and Yuhua Education (13%). We think Wisdom Education s expansion is supported by its good execution track record. Figure 13: Peer comparison student enrollment capacity Sources: Company data, GF Securities (Hong Kong) estimates * New projects in which Virscend Education has an equity interest of less than 50% have been excluded as we believe these projects cannot be consolidated into the company s income statement. # Assuming the acquisition of a school in Guangdong with 3,200 students is completed. ^ Assuming three new high schools commence operation by FY19E. Valuation Maple Leaf is trading at 17.5x FY18 P/E, above its historical average of 14.4x. Wisdom Education is valued at 15.5x FY18 P/E, which is lower than the sector average of 16.5x FY18 P/E. Figure 14: Maple Leaf s P/E Capactiy in FY17 Estimated capacity in FY19E Growth (%) Wisdom Education # 38,652 61,494 59% Maple Leaf 38,940 54,790 41% Virscend Education * 34,477 42,627 24% Yuhua Education ^ 71,200 80,200 13% (HK$) x 23x 18x 13x 8x 1 Sources: Bloomberg, GF Securities (Hong Kong) 6

7 Figure 15: Valuation table for companies under our coverage Stock Close Target P/E (x) EPS (%) Yield (%) P/B (x) ROE (%) Company code Rating (5 Jul 2017) Price FY17E FY18E FY17E FY18E FY17E FY18E FY17E FY18E FY17E FY18E Wisdom Education 6068 HK Buy na I.T 999 HK Buy Chow Sang Sang 116 HK Buy Li Ning 2331 HK Buy 5.87 Under review Maple Leaf 1317 HK Buy Belle 1880 HK Buy na (6) na 4.0 na 1.6 na 11.0 na Luk Fook 590 HK Accumulate Goodbaby 1086 HK Accumulate Chow Tai Fook 1929 HK Hold Anta 2020 HK Hold Xtep 1368 HK Hold Le Saunda 738 HK Hold na (12) na 8.8 na 0.8 na 6.9 na Daphne 210 HK Hold na na (90) na 0.0 na 0.3 na -2.3 na Sources: Company data, GF Securities (Hong Kong) Note: Updated as of 5 Jul

8 Wisdom Education (6068 HK) Buy (maintained) Target price: HK$3.55 Student enrollment could beat 40,000 target; consensus estimates overly conservative Figure 16: Stock performance Figure 17: Key data 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul 5 close (HK$) 2.70 Shares in issue (m) Major shareholder Liu Xuebin (48.5%) Market cap (HK$ bn) 5.5 3M avg. vol. (m) W high/low (HK$) 2.96/1.61 HSI Wisdom Education Sources: Bloomberg Figure 18: Stock valuation Year-end Turnover Net profit Adjusted net Adjusted EPS EPS YoY Adjusted Yield BPS P/B ROE Aug 31 (Rmb m) (Rmb m) profit (Rmb m) (Rmb) (%) P/E (%) (Rmb) (%) na na na na na na na na na na na na E na E 1, E 1, E 1, Sources: Company data, GF Securities (Hong Kong) Solid academic record Wisdom Education ( WEDU ) has consistently achieved a higher admission rate of high school graduates to the best universities in China compared with the Guangdong provincial average. In FY16 (school year 2015/2016), 23.2% of the company s high school graduates were admitted to first-class universities in China ( 重点本科大学 ), better than Guangdong province s average of 10.0%, according to Frost & Sullivan. The percentage for Dongguan Guangming School ( 东莞市光明中学 ) was even higher at 36%. Strong in students admitted to top universities According to news reports, Dongguan Guangming and Huizhou Guangzheng are likely to have 15 and 5 high school graduates respectively to be admitted to Peking University and Tsinghua University this year. That means the total number of students admitted to these top universities might double to 20 this year. More importantly, this should help attract new students to apply to the company s schools in the 2017/2018 school year. Stronger-than-peers expansion plan WEDU will open a new school in Guang an, Sichuan in FY18 and acquire a school in Guangdong before Sept 2017, and it plans to open new schools in Yunfu, Guangdong and Anyue County of Ziyang, Sichuan in FY19. Assuming the acquisition of the school in Guangdong is completed before Sept 2017, WEDU s capacity could grow 59% from FY17 to FY19, higher than that of Maple Leaf (41%), Virscend Education (24%) and Yuhua Education (13%). Good execution track record We think WEDU s strong expansion plan is supported by its good execution track record. 1) M&A: The number of students at Dongguan Guangzheng Preparatory School (acquired in Aug 2013) more than doubled from 4,151 as at 1 Sept 2013 to 9,094 as at 1 Sept ) School outside Guangdong: The number of students at Weifang Guangzheng Preparatory School, which commenced operation in school year 2016/2017, reached 718 as at 1 Sept This enrollment figure is also greater than those for the Huizhou and Panjin schools in their first year (<300 students). 3) Replication of Dongguan Guangming School s success to Huizhou Guangzheng School: The number of students at Huizhou Guangzheng Preparatory School jumped from 256 in school year 2013/2014 to 3,903 as at 1 Sept The school is sending out its first batch of high school graduates this year. According to the company s website, five of its high school graduates are expected to be admitted to Peking University and Tsinghua University this year. 8

9 Beneficiary of Greater Bay Area initiative The company will mainly focus on expanding its school network in Guangdong province going forward to leverage on the brand equity of Dongguan Guangming school and capture economic opportunities from the Guangdong-HK-Macau Greater Bay Area. With regard to financing, the company thinks its expansion plans could be financed by operating cash flow and debt financing. Comfortably positioned to beat 40,000 student target The company targets to grow its student number from 31,800 to 37,000 at its existing schools and newly opening schools. Meanwhile, the student number at its acquisition target, Huanan Shida Yuedong Preparatory School, might reach 4,500 in Sept Therefore, we expect the company to comfortably beat its 40,000 student target in Sept The company also targets to achieve mid-single-digit ASP in FY18 excluding the acquisition. Tuition fee increase by key competitor a significant positive Tung Wah School, a key competitor of the company s Dongguan Guangming School, has recently raised its tuition and boarding fees by 18%-22% for the 2017/2018 school year. Before the adjustment, the total amount of tuition and boarding fees were similar for the two schools. After the adjustment, the total amount of tuition and boarding fees for Tung Wah School is 16%-21% higher than Dongguan Guangming School. We think this could be the maximum increment for Dongguan Guangming School in the 2018/2019 school year. Consensus FY19 estimates overly conservative We assume a 10% increase in tuition and boarding fees for Dongguan Guangming and Dongguan Guangzheng schools in the 2018/2019 school year, or FY19, and we think our estimates are not aggressive. In FY17, Dongguan Guangming and Guangzheng schools likely contributed 84% of total revenue, according to our estimates. Therefore, any changes in tuition and boarding fees at the Dongguan schools could significantly affect the company s net profit. In short, we find Bloomberg s FY19 net profit estimate (Rmb367m), which is 8% below our estimate (Rmb396m), to be overly conservative. Maintain Buy We forecast adjusted net profit of 29%/34%/23% in FY17/18/19, driven by 40%/25%/22% revenue and a fall in the company s effective tax rate in FY18. Our target price of HK$3.55 represents 20.5x FY18E P/E and is based on 1.0x PEG (assuming 20.5% FY17-20 EPS CAGR). We have cross-checked this with a DCF-based valuation, which comes in at HK$4.32/share, suggesting that our PEG-based target price is not aggressive. Potential catalyst: student enrollment number beating management target of 40,000 in Sept Figure 19: Comparison of tuition and boarding fees between Tung Wah School and Dongguan Guangming School Tung Wah Tung Wah Change (%) Dongguan Guangming Difference (RMB) 2016/17 school year 2017/18 school year 2017/18 school year High school 30,200 36, % 30, % Middle school 27,400 32, % 27, % Primary school (P4-6) 24,600 29, % 24, % Primary school (P1-3) 23,200 28, % 24, % Sources: Company data, GF Securities (Hong Kong) Figure 20: Admission rate of WEDU s high school graduates to first-class universities in China Figure 21: Student enrollment capacity and utilization rate 25.0% 20.0% 15.0% 10.0% 5.0% Wisdom Education Guangdong province 23.2% 21.4% 18.4% 10.0% 8.1% 8.6% 80,000 70,000 60,000 50,000 40,000 30,000 20,000 Number of students (LHS) Utilization rate as at 1 Sep (%) (RHS) 70, % 83.7% 61, % 80.6% 88.8% 90.5% 51, % 33,152 30,552 25,719 23, % 100% 80% 60% 40% 20% 0.0% FY14 FY15 FY16 10,000 FY14 FY15 FY16 FY17E FY18E FY19E FY20E 0% Sources: Company prospectus, Frost & Sullivan Report, xkb.com.cn, company data, GF Securities (Hong Kong) estimates Note: First-class universities are first-tier universities identified in the University Application and Enrollment Guidelines for Guangdong Province issued by the Education Examinations Authority of Guangdong Province for the 2013/2014, 2014/2015 and 2015/2016 school years. 9

10 Figure 22: Peer comparison student enrollment capacity Capactiy in FY17 Estimated capacity in FY19E Growth (%) Wisdom Education # 38,652 61,494 59% Maple Leaf 38,940 54,790 41% Virscend Education * 34,477 42,627 24% Yuhua Education ^ 71,200 80,200 13% Sources: Company data, GF Securities (Hong Kong) estimates * New projects in which Virscend Education has an equity interest of less than 50% have been excluded as we believe these projects cannot be consolidated into the company s income statement. # Assuming the acquisition of a school in Guangdong with 3,200 students is completed. ^ Assuming three new high schools commence operation by FY19E. Figure 23: Key assumptions Year-end Aug 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E FY20E Total revenue ,227 1,494 1,784 % 26.1% 23.2% 39.8% 25.3% 21.7% 19.4% Tuition and boarding fees ,040 1,236 % 25.8% 24.4% 22.4% 27.2% 21.5% 18.8% Others % 27.4% 19.1% 103.5% 21.1% 22.2% 20.9% Gross margin 49.1% 47.1% 46.5% 46.9% 46.9% 46.5% Marketing expense ratio 1.3% 1.9% 2.5% 2.8% 2.7% 2.6% Administrative expense ratio 13.4% 13.4% 13.2% 13.2% 12.9% 12.6% Operating profit margin 35.3% 31.8% 31.5% 31.5% 31.8% 31.9% Adj effective tax rate 14.1% 20.7% 23.0% 15.5% 15.5% 15.5% Net profit % 100.5% -15.3% 46.3% 42.2% 23.3% 18.2% Adj net profit % 45.6% 7.6% 28.8% 34.3% 23.3% 18.2% Net profit margin 30.4% 26.5% 24.4% 26.2% 26.5% 26.2% Payout ratio na na 45.0% 45.0% 45.0% 45.0% Average tuition and boarding fee (Rmb) 19,364 19,900 21,174 20,621 21,520 21,656 % 6.6% 2.8% 6.4% -2.6% 4.4% 0.6% Student enrollment (as of Sept 1) 22,837 27,644 31,788 41,515 48,331 57,062 % 18.0% 21.0% 15.0% 30.6% 16.4% 18.1% Utilization rate 88.8% 90.5% 95.9% 81.7% 77.3% 79.5% Total teachers 1,359 1,666 1,960 2,538 2,958 3,521 Student to teacher ratio Sources: Company data, GF Securities (Hong Kong) estimates 10

11 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 2H17 Sector Outlook Figure 24: Wisdom Education P/E band (HK$) 4 23x 20x x 14x 11x 1 Sources: Company data, GF Securities (Hong Kong) estimates, Bloomberg 11

12 Figure 25: Financial statements Income Statement Balance Sheet Year-end Aug 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E FY20E Year-end Aug 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E FY20E Revenue ,227 1,494 1,784 Fixed assets Cost of sales (289) (370) (524) (651) (794) (954) PPE 1,007 1,344 2,052 2,721 3,168 3,599 Gross profit Prepaid lease payments Investment properties Other income Amounts due from related parties Other gains and losses (2) (8) (2) (2) (2) (2) Intangible assets Selling expenses (8) (13) (24) (34) (41) (47) Deposits Administrative expenses (76) (94) (130) (162) (193) (224) Deferred tax assets Operating profit Prepayments for construction to a related company ,433 1,763 2,520 2,985 3,426 3,852 Net finance income 11 (6) (8) (2) (1) (1) Listing expenses 0 (24) (7) Current assets Change in FV of investment properties Inventories Profit before tax Deposits, prepayments and other receivables Income tax expense (30) (40) (67) (60) (73) (88) Amounts due from related parties 1, Non-controlling interests (0) (0) (0) Prepaid lease payments Net profit Bank balances and cash Adjusted net profit , Adjusted EPS (Rmb) na na Total assets 2,965 2,458 3,093 3,602 4,049 4,550 Growth rates (%) Revenue Current liabilities Adjusted net profit Deferred revenue Adjusted EPS na na na Trade payables Other payables and accrued expenses Margin & ratios (%) Amount due to related parties Gross margin Income tax payable OP margin Bank borrowings Adjusted net margin ,546 1, ,141 1,362 1,590 Effective tax rate Payout ratio na na Non-current liabilities Deferred tax liabilities Cash Flow Statement Interest-bearing bank borrowings Year-end Aug 31 (Rmb m) FY15 FY16 FY17E FY18E FY19E FY20E Profit before tax Equity Depreciation and amortization Shareholders' equity ,775 1,980 2,203 2,464 Net finance income (11) Others (0) Non-controlling interests (0) Change in working capital Tax paid (6) (42) (54) (64) (67) (81) Total liabilities & equity 2,965 2,458 3,093 3,602 4,049 4,550 Operating cash flow Financial Ratios Capex (194) (197) (500) (550) (550) (550) Year-end Aug 31 FY15 FY16 FY17E FY18E FY19E FY20E Acquisition of subsidiaries 0 0 (224) Change in advance to related parties (128) Current ratio Interests received Quick ratio Others Investing cash flow (309) 251 (500) (547) (547) (547) Asset turnover Total assets/total equity Change in borrowings 6 (668) (283) Net cash/(debt) (Rmb m) (210) (293) Change in advance to related parties Interests paid (110) (88) (6) (4) (4) (4) ROE (%) Dividends paid 0 0 (51) (123) (161) (194) ROA (%) Shares issued Others 0 (12) Financing cash flow (11) (497) 419 (2) (166) (199) Net change of cash flow (1) (7) 61 Forex changes Sources: Wind, GF Securities (Hong Kong) 12

13 I.T (999 HK) Buy (maintained) Target price: HK$5.22 Re-rating justified by accelerating earnings and increasing visibility Figure 26: Stock performance Figure 27: Key data 80% 60% 40% 20% 0% -20% Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Jul 5 close (HK$) 3.77 Shares in issue (m) Major shareholder Sham Kar Wai (61.9%) Market cap (HK$ bn) 4.5 3M avg. vol. (m) W high/low (HK$) 3.89/2.26 HSI I.T Sources: Bloomberg Figure 28: Stock valuation YE Feb Turnover (HK$ m) Net profit (HK$ m) Core net profit (HK$ m) Sources: Company data, GF Securities (Hong Kong) Core EPS (HK$) EPS YoY (%) Valuation Share price has risen 18% since June 15 when we lifted our TP to HK$5.22, based on 15x FY18 P/E. We see increasing visibility for FY18 earnings as we expect the loss in the HK market to stabilize, which should accelerate the company s earnings. In FY19, the China/HK revenue split will reach a more favorable level of 54%/32% from 42%/48% in FY17. Looking into 1QFY18, we anticipate that the momentum in the China and Japan markets will continue, and that the SSS decline in the HK market will narrow compared to 4QFY17. In addition, we expect GPM to continue to expand on less retail discounts. We raise our FY18/19 net profit estimates by 9%/17% to factor in higher margin and SSSG assumptions, and estimate a net profit CAGR of 30% during FY FY18-19 profit outlook much better than during 2015 re-rating The stock re-rated from 9x 1-year forward P/E in late Jan 2015 to 15x 1-year forward P/E in April Core net profit improved from -26% in FY14 to 4% in FY15. The stock then de-rated to 8x 1-year forward P/E in late Aug 2015 as core net profit dropped 8% in FY16. As we estimate a 30% net profit CAGR ahead, we think re-rating is justified by stronger profit than in FY15. HK market SSS decline to narrow We expect HK SSSG to improve from -4.2% in FY17 to -1% in FY18 given the following reasons. 1) Apparel retail sales in HK rose 2% YoY both in March and April in 2017, the first time positive was seen for two consecutive months since Sept ) Recent strength in the stock market has produced a positive wealth effect. 3) Store efficiency has improved: store area deceased by 8% YoY and the number of shops dropped from 249 to 230 (netnet basis for store openings and closures) in FY17. Furthermore, the number of new store openings in FY18 is much smaller than in FY17. We estimate that store area might decrease further by a high single-digit in FY18. 4) Unusually warm weather created a low base in 4QFY17. Loss in HK market to stabilize Segment loss widened to HK$185m in FY17 from HK$73m in FY16. While its HK retail business remains the biggest threat to the company s earnings, we anticipate the loss in HK could stabilize in FY18 as: 1) we expect the SSS decline in the market to narrow; 2) the company will see saving of operating costs, especially rental costs, from store area reduction in FY17 and FY18; 3) the company will seek to increase GPM by reducing retail discounts and being prudent about merchandise purchases; 4) rental pressure from shopping malls is easing our channel checks show that rental reversion at shopping malls currently represents flat to low single-digit, softening from mid-to-high-single-digit in P/E Yield (%) BPS (HK$) , , , E 8, E 9, P/B ROE (%) 13

14 Our view reinforced by Bauhaus annual results Bauhaus (483 HK, NR) share price surged 31% on June 23 after the company surprisingly reported a 23% YoY net profit increase in FY17 on June 22 (vs. a widened net loss of HK$60m in 1HFY17). The results turnaround in 2HFY17 was mainly driven by retail network consolidation and significant downsizing of bargain sales events, although HK/China SSS decreased 13%/3% respectively. In the HK market, despite a revenue drop of 19% YoY in 2HFY17, operating profit rose 24% YoY with OPM widening 6.6pp YoY. China market remains key driver China overtook HK to become the largest market for the company in terms of revenue in FY17 (revenue contribution 45% vs. HK s 41%). The company s directly-operated stores (435 stores in FY17) currently cover just 28 cities (vs. 20 cities one year ago), which still represents an underdeveloped retail network in our view. The company only had a 0.2% share of China s apparel market in FY17 (vs. 4.6% in HK), suggesting substantial room for market share expansion. Its China retail business has a good operating leverage. Segment revenue and profit increased 14% and 32% respectively in FY17. Excluding changes in onerous provisions (a non-recurring item), segment profit would have increased 51% while the SG&A expense ratio would have fallen 2.4pp. Japan market momentum continues In FY17, segment revenue jumped 41%, or 27% in local currency terms. Segment profit surged 48% YoY with the segment profit margin expanding 2pp. We estimate revenue of ~24% in local currency terms in 4QFY17, suggesting that strong sales momentum continued in the quarter. Online sales led the as the company expanded its A Bathing Ape online store to the Europe market and added Aape online stores in FY17. Online sales as a proportion of Japan market revenue jumped from 10%+ in FY16 to 17% in FY17. Figure 29: Bauhaus reported improved profitability in 2HFY17 Y/E Mar (HK$ m) 1HFY16 2HFY16 1HFY17 2HFY17 Group rev (%) -14.3% -13.3% GP GPM (%) 60.5% 58.1% 56.5% 66.5% OP (25.0) 87.7 (56.2) OPM (%) -4.3% 9.5% -11.2% 16.2% NP (26.6) 79.6 (60.0) NPM (%) -4.5% 8.6% -12.0% 15.5% HK Rev (%) -18.5% -18.7% HK OP (10.8) 93.7 OPM (%) 5.6% 12.5% -3.1% 19.1% China Rev (%) -8.3% -0.9% China OP (0.3) 4.1 OPM (%) 0.1% 11.4% -0.6% 5.9% Taiwan Rev (%) 1.7% -1.3% Taiwan OP (20.4) 26.4 (16.0) 40.1 OPM (%) -21.1% 10.8% -16.2% 16.6% Sources: Bloomberg, GF Securities (Hong Kong) estimates 14

15 Figure 30: Previous re-rating during Jan-April 2015 HK$ x 18x 15x 12x 8x 2 1 Sources: Bloomberg, GF Securities (Hong Kong) estimates Figure 31: FY17 revenue breakdown by market Figure 32: Profit breakdown by market Japan 10% Others 4% (HK$ m) HK 41% China 45% FY15 FY16 FY17 HK China Japan Others Total Sources: Company data, GF Securities (Hong Kong) Figure 33: Key assumptions Year-end Feb (HK$ m) FY15 FY16 FY17 FY18E FY19E Store square footage (excl. JVs and franchise stores) HK 631, , , , ,266 (%) 1% -5% -8% -7% 0% China 978,854 1,143,002 1,351,168 1,580,867 1,849,614 (%) 12% 17% 18% 17% 17% Japan 46,601 48,026 44,905 44,905 44,905 (%) -12% 3% -6% 0% 0% Taiwan, Macau and others 73,804 72,493 82,481 82,481 82,481 (%) -9% -2% 14% 0% 0% SSSG HK 0.7% -2.0% -4.2% -1.0% -1.0% China 4.5% 3.9% 7.1% 5.0% 5.0% Revenue 7,181 7,541 8,001 8,478 9,170 (%) 6% 5% 6% 6% 8% HK 3,630 3,494 3,280 3,058 2,920 (%) 0% -4% -6% -7% -5% China 2,771 3,159 3,601 4,190 4,926 (%) 17% 14% 14% 16% 18% Japan (%) 3% 22% 41% 12% 10% Taiwan, Macau and others (%) 5% 3% 1% 6% 2% GPM (%) - Overall 62.2% 60.6% 61.6% 62.1% 62.3% HK 60.7% 57.2% 58.8% 59.5% 59.5% China 61.0% 61.4% 60.9% 60.8% 61.0% Japan 76.4% 67.8% 71.1% 72.4% 72.7% Taiwan, Macau and others 68.6% 75.7% 74.1% 74.6% 74.6% SG&A expense ratio (%) 55.3% 54.3% 54.6% 53.4% 52.0% Sources: Company data, GF Securities (Hong Kong) estimates 15

16 Figure 34: P/E band Figure 35: P/B band HK$ x HK$ x 3.3x x 15x 12x x 1.5x 3 8x x Sources: Bloomberg, Company data, GF Securities (Hong Kong) Figure 36: Financial statements Income Statement Balance Sheet Year-end Feb (HK$ m) FY15 FY16 FY17 FY18E FY19E Year-end Feb (HK$ m) FY15 FY16 FY17 FY18E FY19E Turnover 7,181 7,541 8,001 8,478 9,170 Fixed assets HK 3,630 3,494 3,280 3,058 2,920 Furniture and equipment ,089 China 2,771 3,159 3,601 4,190 4,926 Intangible assets Japan Investments in and amounts due from JCEs Others Rental deposits COGS (2,716) (2,975) (3,073) (3,213) (3,458) Deferred tax assets Gross profit 4,464 4,566 4,928 5,266 5,711 Others ,817 1,783 1,710 1,821 1,967 Other income and gains SG&A expenses (3,971) (4,095) (4,368) (4,527) (4,770) Current assets Operating profit Inventories 1,261 1,391 1,536 1,622 1,764 A/C receivable Net finance cost (22) (38) (59) (67) (48) Other prepayments Other gains/losses (19) (64) (14) (5) (5) Others Share of profit of JVs (36) (27) (6) 0 4 Cash and cash equivalents 2,294 1,967 1,818 2,183 1,591 Profit before taxation ,156 4,016 3,995 4,479 4,078 Taxation (124) (146) (192) (272) (394) Non-controlling interests (0) (1) (1) (1) (1) Current liabilities Net Profit A/C payables Core net profit Other payables Others Cash Flow Statement ST borrowings Year-end Feb (HK$ m) FY15 FY16 FY17 FY18E FY19E Income tax liabilities ,495 1,458 1,418 1,511 1,664 Profit before tax Depreciation & amort Non-current liabilities Interest income (64) (41) (15) (15) (14) LT borrowings 1,469 1,262 1,046 1, Interest expenses Others Change of working capital (92) (198) (216) (74) (110) Deferred tax liabilities Others 12 (18) (28) (42) (36) 1,637 1,444 1,248 1, Tax paid (88) (153) (169) (232) (333) Operating cash flow Share capital Reserves 2,716 2,774 2,915 3,201 3,545 Capex (275) (322) (245) (400) (450) Equity 2,839 2,895 3,035 3,321 3,664 Interest received Others (26) (25) (1) 0 0 Non-controlling interests Investing cash flow (238) (302) (234) (385) (436) Financial Ratios Change of bank loans (99) (163) (178) 217 (755) Year-end Feb FY15 FY16 FY17 FY18E FY19E Share issue/buyback (3) (32) (50) 0 0 Buyback of senior notes (120) Turnover 6.4% 5.0% 6.1% 6.0% 8.2% Dividend paid (135) (135) (102) (155) (187) Core net profit 4.4% -7.7% 14.3% 32.5% 26.1% Financing cash flow (357) (329) (330) 61 (942) Gross profit margin 62.2% 60.6% 61.6% 62.1% 62.3% Net Cash Flow (155) 336 1,358 Operating profit margin 7.1% 6.4% 7.3% 9.0% 10.6% Effect of forex change (25) (14) (29) 0 0 Core net profit margin 4.1% 3.6% 3.9% 4.9% 5.7% Sources: Company, GF Securities (Hong Kong) Current ratio Quick ratio Inventory turnover days Core ROE 10.6% 9.6% 10.6% 13.1% 15.0% Core ROA 5.0% 4.7% 5.5% 6.9% 8.5% 16

17 Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 10% Neutral Expected sector relative performance ranges between -10% and 10% Cautious Sector expected to underperform benchmark by more than 10% Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. 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