Li Ning Company [2331.HK]

Transcription

1 Li Ning Company [2331.HK] We believe Li Ning Company (LNC) will be a recovery play in the coming years. This will allow investors to tap into the growing market for Chinese sportswear, as well as the resiliency of LNC s margin recovery. After the exit of TPG in 2017, we expect 2018E to be the first year for LNC to experience a full recovery. LNC s sales momentum is showing good progress, as the Company has dedicated its efforts to improving product design, channel management and marketing. At the same time, LNC has been cautious about spending and inventory management, resulting in a number of healthy indicators. Initiate with BUY. Our target price of HK$11.00 is based on 23.0x 2019E PER. Our EPS estimate implies that LNC s EPS will grow at a CAGR of 32.8% in FY2017FY2020E, so a 23.0x target multiple still implies a PEG <0.8x. We also expect LNC to resume dividend payments in 2018E after years of internal reforms, which will be another milestone in the Company s solid recovery. Investment Highlights Still on the Way to Recovery. Initiate with BUY. 2018E is the First Year of Full Recovery. LNC has been a turnaround story since its eponymous founder Mr. Li Ning returned as Chairman in We expect the recovery story to continue in the years ahead, as most of the indicators are encouraging. We believe the Company structure is now stable, providing a foundation for continued recovery. We believe 2018 will be the first year of a full recovery for two reasons: stabilized corporate structure and normalized advertising and promotional spend (A&P). Sales Continue to Show Resiliency. Despite facing struggles in its inventory and channels, LNC has still managed to increase overall sales since Various indicators show that LNC s sales have become healthier, and almost all of the legacy problems of the Company have been dealt with (e.g. new products in the sellthrough mix accounted for 78% in 2017 compared to 57% in 2013). We expect overall sales to continue to grow moderately. Same store sales growth (SSSG) has remained in positive territory (2017: mid singledigit growth at the group level). Still Huge Room to Raise EBIT Margin. LNC s efforts are reflected in various major key performance indicators, which should help the Company return to normal margins. Going forward, because of the improving operating performance, we expect the EBIT margin to continue to improve. The EBIT margin in FY2018E should see a sharper improvement to 8.3%, thanks to better operating leverage. (2017: 5.) There is still a lot of room for improvement compared with Anta s 23.77%. Initiate with BUY. Currently, we forecast that LNC s EPS for 2018E/2019E/2020E will be RMB0.30/0.39/0.50, suggesting 39.3%/33.7%/29.3% YoY growth. This implies earnings growth acceleration over previous years. Our target price of HK$11.00 is based on 23.0x 2019E PER. We think 23.0x PER is reasonable when PEG is considered. Our EPS estimate suggests that LNC s EPS will grow at a CAGR of 32.8% between FY2017 FY2020E, so a 23.0x target multiple still suggests a PEG <0.8x. We also expect LNC to resume distributing dividends in the near term, which should be another milestone in its business recovery. Key Financials (RMB m) FY2016 FY2017 FY2018E FY2019E FY2020E Revenue 8,015 8,874 10,133 11,408 12,887 YoY Change 13.1% 10.7% 14.2% 12.6% 13. Net Profit After Tax ,242 YoY Change % 19.9% 39.3% 33.7% 29.3% EPS (RMB) YoY Change 676.5% 86.2% % 28.1% ROE 20.2% 12.9% 14.2% 16.6% 19. P/E 60.1x 32.3x 23.4x 17.7x 13.8x Dividend Yield % 1.7% 2.2% BUY Close: HK$8.45 (July 6, 2018) Target Price: HK$11.00 (+30.2%) Price Performance (HK$) Market Cap Shares Outstanding Auditor China Consumer Sector Sporting Goods US$2,354m 2,158.3m PwC Free Float 82.6% 52W range 3M average daily T/O HK$ US$15.7m Major Shareholding Viva China (14.93%) Sources: Company, Bloomberg Tony Li, CFA Analyst (852) tonyli@chinastock.com.hk July 09, 2018 Wong Chi Man, CFA Head of Research (852) Turnover (RHS) cmwong@chinastock.com.hk Price (LHS) (HK$ million) Source: Bloomberg 0 1

2 Key financials Income Statement (RMB m) FY2016 FY2017 FY2018E FY2019E FY2020E Balance Sheet (RMB m) FY2016 FY2017 FY2018E FY2019E FY2020E Revenue 8,015 8,874 10,133 11,408 12,887 Bank Balances and Cash 1,954 2,529 3,208 3,519 4,650 COGS (4,310) (4,697) (5,260) (5,921) (6,688) Restricted Bank Deposits Gross Profit 3,705 4,176 4,873 5,488 6,200 Trade Receivables 1,370 1,138 1,275 1,402 1,542 SG&A (3,393) (3,774) (4,177) (4,530) (4,930) Inventories 965 1,103 1,257 1,638 1,632 Other Operating Items Other Current Assets Operating Profit ,013 1,331 Total Current Assets 4,650 5,110 6,234 7,005 8,440 Finance Costs, Net (108) Other Items PP&E ,022 1,040 Net Profit Before Tax ,129 1,461 Goodwill & Intangible Assets Income Tax (32) (22) (127) (169) (219) Other Non Current Assets 1,020 1,115 1,271 1,425 1,601 Net Profit After Tax ,242 Total Non Current Assets 2,130 2,211 2,434 2,609 2,755 Minority Interest (After Tax) Total Assets 6,780 7,321 8,667 9,614 11,195 EPS (RMB) DPS (RMB) Trade Payables 1,047 1,145 1,383 1,463 1,751 Shortterm Borrowings 200 EBITDA ,255 1,584 1,967 Convertible Bonds 568 EBIT ,144 1,475 Other Current Liabilities ,288 1,375 1,673 Total Current Liabilities 2,674 2,128 2,671 2,837 3,424 Revenue Growth 13.1% 10.7% 14.2% 12.6% 13. Longterm Borrowings Operating Profit Growth 145.6% 15.5% 67.1% % Convertible Bonds Net Profit Growth % 19.9% 39.3% 33.7% 29.3% Other Noncurrent Liabilities EPS Growth 676.5% 86.2% % 28.1% Total Noncurrent Liabilities Total Liabilities 2,783 2,248 2,876 3,078 3,705 Gross Margin 46.2% 47.1% 48.1% 48.1% 48.1% Operating Margin 4.8% % 8.9% 10.3% Total Common Equity 3,995 5,071 5,789 6,533 7,487 Net Profit Margin % 7.1% 8.4% 9.6% Minority Interest Total Equity 3,997 5,074 5,791 6,536 7,490 Total Equity & Liabilities 6,780 7,321 8,667 9,614 11,195 Cash Flow Statement (RMB m) FY2016 FY2017 FY2018E FY2019E FY2020E Ratios FY2016 FY2017 FY2018E FY2019E FY2020E Net Profit After Tax ,242 ROE 20.2% 12.9% 14.2% 16.6% 19. D&A Addback ROA 9.3% 7.6% 9.8% 11.1% 12.9% Net Change in Working Capital (361) 205 Other Operating Items (198) (70) (127) (136) (153) Net Debt / Equity Net Cash Net Cash Net Cash Net Cash Net Cash CFO 995 1,159 1, ,786 EBITDA Interest Coverage 6x 36x 87x 110x 136x CAPEX (383) (389) (469) (469) (469) Rec. Turnover Days Other Investing Items Inventory Turnover Days CFI (320) (343) (378) (363) (353) Payables Turnover Days Other Payables Turnover Days Dividends Paid (215) (288) Net Change in Debt (365) (200) Current Ratio 1.74x 2.40x 2.33x 2.47x 2.46x Issue of Shares 7 17 Quick Ratio 1.38x 1.88x 1.86x 1.89x 1.99x Other Financing Items (144) (32) (14) (14) (14) Valuation FY2016 FY2017 FY2018E FY2019E FY2020E CFF (509) (232) (14) (230) (302) P/E 60.1x 32.3x 23.4x 17.7x 13.8x Total Cash Flow ,131 P/B 3.9x 3.3x 2.9x 2.6x 2.3x Free Cash Flow ,335 Dividend Yield % 1.7% 2.2% Sources: Company, Capital IQ, CGIS Research estimates 2

3 Investment Thesis (1) The Worst is Over. This is the First Year of Full Recovery. Li Ning Company (LNC) has been a turnaround story since its eponymous founder Mr. Li Ning returned as Chairman in We believe the recovery story will continue, as most of the indicators are encouraging. We believe the company structure is now stable, providing a foundation for continued recovery in the coming years. As a reminder, the Company failed in a brand repositioning strategy in 2011, and at the same time faced serious inventory issues at the distributor level. Consequently, it suffered significant losses in , underperforming its domestic peers significantly. It used to be the top domestic sportswear brand in China, but Anta took over the top position during that period. Figure 1: Summary of Different Periods of Li Ning Company Period CEO What Happened and Our View Pre2011 Zhang Zhiyong Used to be the No.1 domestic player. Failed the brand upgrade strategy and lost market share Kim Jingoon (from TPG, as interim CEO) Introduced TPG as strategic investor (through CB) and initiated reforms. Improved product quality and channels. Still failed to turn profitable Mr. Li Ning (as interim CEO) Mr. Li Ning (as interim CEO) Sources: CGIS Research Mr. Li Ning took over the management duties again, and emphasized profitability. Turned profitable again in CB fully converted and TPG exited. On the w ay to recovery Realistically, we believe LNC is likely to remain the second largest domestic sportswear company (behind Anta) for at least a few years, but we believe the Company has the ability to maintain or expand its market share. We think 2018 will be the first year of full recovery for two reasons: stabilized corporate structure and normalized advertising and promotion spend (A&P). 3

4 Stabilized Structure after TPG Exit 2018 will be the first full year without any impact from TPG. We believe this will be meaningful to investors both qualitatively and financially. TPG introduced reforms in On the qualitative side, TPG was introduced as a strategic investor to LNC in 2011 and had an active role in LNC s daily management before TPG management introduced more modern retail management expertise to LNC through a series reforms, but the reforms had yet to make LNC profitable. Therefore, Mr. Li Ning stepped in, acting as the interim CEO of LNC in TPG became a passive financial investor in TPG exited all positions in Jun 2017 Still, TPG s holdings, mostly in convertible bonds (CBs), were an overhang for investors, as TPG held a stake in LNC. The CBs were due in 2017, so the impact of the CB conversion was impactful to the market and the number of shares outstanding as well. TPG exited all its holdings in LNC in June We expect this to help improve investors confidence. Given the diversified shareholder base, LNC can now concentrate its efforts on its reforms. Figure 2: TPG s Position on Li Ning Company (No. of shares held) Figure 3: Finance Expenses of Li Ning Company 180,000, ,000, ,000, ,000, ,000,000 80,000,000 60,000,000 40,000,000 20,000,000 1/3/2012 1/3/2013 1/3/2014 1/3/2015 1/3/2016 1/3/2017 1/3/2018 TPG's Position FY2013 FY2014 FY2015 FY2016 FY2017 FY2018E FY2019E Sources: Bloomberg, CGIS Research estimates This also means finance expenses related to the CBs will fade. Financial expenses in 2017 dropped significantly when the CB was fully converted. We expect finance expenses to continue to fall from FY2018E onwards. This will help margin recovery, which is explained later. 4

5 Normalized A&P Figure 4: LNC as the Official Strategic Partner As LNC has recovered, we note the Company has moderately resumed certain A&P. We consider this to be a good step for longterm growth and the pressure on profitability to be manageable. Sources: Official Website of CBA LNC renewed its sponsorship of the CBA in 2017 Over the years of reforms, LNC has reduced it s A&P. This has helped the Company turn from loss making to profitability. However, as the Company is on the path of expansion, certain investment in A&P is needed. This should allow the Company to compete, given the intensified competition from foreign brands, as well as strong domestic brands like Anta and Xtep. The most notable A&P item in recent years has been the Company s fiveyear sponsorship of the Chinese Basketball Association (CBA). In August 2017, LNC reached a new sponsorship agreement with the CBA for RMB1bn, from 2017 to We believe this sponsorship will continue to make LNC one of the most influential domestic brands in China. The A&P ratio is expected to remain at The amount of the sponsorship is also reasonable. LNC entered into a fiveyear CBA sponsorship in 2012 as well, but the amount was double the current amount, at around RMB2bn. As the sponsorship amortized over 2018E2022E will be lower than that in previous years, we expect A&P to remain at a reasonable level at nearly but the absolute amount will increase as sales increase as well. Figure 5: Advertising and Promotional Expenses of LNC 1,600 1,400 1,200 1,000 1,407 1,227 1, ,052 1, % % % FY2013 FY2014 FY2015 FY2016 FY2017 FY2018E FY2019E Advertising and promotional expenses (LHS, RMB m) as % of sales RHS estimates 5

6 Investment Thesis (continued) (2) Sales Continue to Show Resiliency Despite facing struggles with inventory and channels, LNC has still managed to increase overall sales since Various indicators show that LNC s sales have become healthier, and almost all of the legacy problems of the Company have been dealt with. We expect overall sales to continue to grow moderately. Ecommerce now accounts for 19% of overall sales LNC s problems back in 2011 began with its franchisees (under the wholesale model), but the reforms introduced by LNC have been effective in tackling the problem. Since then, the Company has taken over some franchised stores, making them selfoperated models. In the meantime, LNC has also relied on ecommerce for growth. Ecommerce has become increasingly important to LNC, accounting for 19% of overall sales. We expect ecommerce to continue to maintain at least high doubledigit growth in the coming years. Figure 6: Revenue Breakdown by 10,000 Channel (Unit: RMB m ; Excluding International Markets) 9,000 8,000 7,000 6,000 5,000 4, , , ,357 1,225 2,525 1,689 2,699 3,000 2,000 1,000 3,095 3,344 3,864 4,063 4,216 FY2013 FY2014 FY2015 FY2016 FY2017 estimates Retail Wholesale Ecommerce Sales momentum still positive From the topdown angle, even with the intensified competition with domestic and top foreign brands, LNC has so far maintained SSSG in positive territory (2017: mid singledigit SSSG at the group level). This is particularly true for its directly operated stores, which usually have better locations. The ecommerce channel has also enjoyed high growth (>8 YoY growth) in the past, though it slowed down to the midforties in 2017, given the highbase effect. Still, the ecommerce channel will continue to be an important and wellperforming channel for LNC. 6

7 Figure 7: Full Year SSSG Overall Figure 8: Full Year SSSG Retail 12% 12% 9% 9% 8% 6% 4% +ve high +ve lowteens +ve mid 8% 6% 4% 8% 7% 6% 5% 4% 3% +ve high +ve mid 8% 7% 6% 5% 4% 3% 2% 2% 2% 2% FY2015 FY2016 FY2017 1% flat FY2015 FY2016 FY2017 1% Figure 9: Full Year SSSG Wholesale Figure 10: Full Year SSSG Ecommerce 4% 4% 9 9 3% 2% 1% +ve low +ve low 3% 2% 1% ve loweighties +ve mideighties FY2015 FY2016 FY2017 1% 2% ve low 3% 4% 1% 2% 3% 4% ve lowforties FY2015 FY2016 FY Sales momentum can be seen in the quarterly figures. Overall SSSG in Q remained in the low teens, and all channels recorded positive growth. There were exceptions in certain cases, where LNC recorded negative growth for some channels, but this was mainly due to intense competition in the peak season. Certain brands adopted a pricecutting strategy, which LNC refused to follow, affecting sales. However, the practice adopted by LNC should allow the Company to maintain stable margins. We expect this to continue to be a priority for LNC. 7

8 Figure 11: SSSG by Quarter Period 1Q Q Q Q Q Q Q Q Q 2018 Date 01/01/ /31/ /01/ /30/ /01/ /30/ /01/ /31/ /01/ /31/ /01/ /30/ /01/ /30/ /01/ /31/ /01/ /31/2018 SSSG Overall Platform SSSG Direct Operation SSSG Franchised Distributors Ecommerce +ve low flat flat +ve low sixties +ve high +ve mid +ve mid +ve low seventies +ve high +ve low +ve low +ve low eighties +ve midteens +ve high +ve low +ve midnineties flat ve mid ve mid +ve low fifties +ve high flat +ve low +ve midnineties ve low ve mid ve mid +ve low thirties +ve low teens +ve low teens +ve high +ve highteens +ve low teens +ve low teens +ve mid +ve highthirties Other metrics of LNC also show that the Company s sales momentum is getting healthier. Sellthrough, which reflects sales at the store level, shows that LNC s overall sales have been improving in both offline and online channels. In 2017, sellthrough in all channels grew +9% YoY. The product mix was also healthier. In 2017, only 22% of the sellthrough mix was old products (products launched two seasons ago or earlier). This was significantly better than that in 2013 when 43% of sellthrough comprised old products. Figure 12: Sellthrough Growth of Li Ning Retail End Is Improving 15% 13% 11% 7% 8% 9% 5% 5% 5% 3% 1% 15% 2 19% 19% FY2013 FY2014 FY2015 FY2016 FY2017 Offline Channel Online and Offline Channel Figure 13: Sellthrough Mix (Including All Channels) % 43% 67% 69% 33% 31% 76% 78% 24% 22% FY2013 FY2014 FY2015 FY2016 FY2017 Old Product New Product (Current and Last Season) As a result, inventory on the balance sheet has also improved. As at the end of 2017, 75% of inventory was aged six months or less. This ratio is much higher than that in 2015 and 2016 (55%/56%). This shows that LNC s inventory clearance has improved. 8

9 Figure 14: Inventory Composition by Age % 23% 28% 26% 14% 11% % 21% 17% 18% % 56% 55% 56% 75% FY2013 FY2014 FY2015 FY2016 FY months or less 712 months Over 12 months Investment Thesis (continued) (3) Earnings Show Resiliency from 2018E Onwards The coordinated efforts of various departments, such as product design, channel management and marketing, are reflected in various major key performance indicators, which should help LNC return to normal margins. We expect LNC s margin recovery to continue, allowing the Company to continue to deliver high earnings growth. LNC s margins are still lower than its global peers Compared to its global peers, LNC s margins in 2017 were considerably lower. We view EBIT margin as a good indicator for comparison, as it excludes the impact of taxes and capital structure differences across different jurisdictions. LNC s EBIT margin was 5.02%, much lower than the global average of 10. and the Chinese average of 14.2%. 9

10 Figure 15: EBIT Margin of Sporting Goods Companies Calendar Year EBIT Margin Average of All Companies Average of All Domestic Companies Sources: Capital IQ, CGIS Research LNC used to enjoy an EBIT margin close to the current average level of domestic companies, i.e. 14%. After the Companyspecific problems and industry downturn in 2011, it suffered huge operating losses between FY2012FY2014. Subsequently, its EBIT margin remained in the lowtomid single digits. We expect margins to revert to normal levels thanks improved operating leverage Going forward, because of the improving operating performance, we expect the EBIT margin to continue to improve. We expect the EBIT margin in FY2018E to see sharper improvement to 8.3%, thanks to better operating leverage. Apart from continued sales growth, the mild increase in A&P and administrative expenses will also help. Figure 16: EBIT Margin Trend and Forecast of LNC Sources: Capital IQ, CGIS Research estimates 10

11 Figure 17: Net Profit and NPM of Li Ning 1,500 15% 1, % 5% (500) (1,000) (1,500) (2,000) (2,500) (392) (781) (1,979) FY2011 FY2012 FY2013 FY2014 FY2015 FY2016 FY2017 FY2018EFY2019E 15% 2 25% 3 35% Net Profit / (Loss) (LHS; RMB m) NPM (RHS) estimates Initiate with BUY Currently, we forecast that LNC s EPS for 2018E/2019E/2020E will be RMB0.30/0.39/0.50, suggesting 39.3%/33.7%/29.3% YoY growth. This implies earnings growth acceleration over previous years. As explained earlier, we believe the earnings growth is attributed to: (1) operating leverage and (2) margin normalization. LNC expected to be a recovery play We believe LNC will be a recovery play in the coming years. This will allow investors to tap into the growing market for Chinese sportswear, as well as the resiliency of LNC s margin recovery. Initiate with BUY. Our target price of HK$11.00 is based on 23.0x 2019E PER. The 23.0x PER is reasonable, in our view, when PEG is considered. Our EPS estimate implies that LNC s EPS will grow at a CAGR of 32.8% between FY2017 FY2020E, so a 23.0x target multiple still implies a PEG <0.8x. We expect LNC to resume its dividend payout in 2018E One more positive factor for LNC shares in the near term is that we expect LNC to resume distributing dividends in the near term. LNC s cash flow has been stable for years, and its capital structure has stabilized. We don t expect huge capital needs for expansion or daily operations. Since the Company is on the path to earnings recovery, we believe the earnings will be sufficient to pay out moderate dividends. We therefore expect LNC to start to announce dividends in its 2018 Annual Results. We expect a payout ratio of 3, which translates to a DPS of RMB0.09 in 2018E. 11

12 1/1/ /4/ /7/ /10/2013 1/2/ /5/ /8/ /11/2014 4/3/ /6/ /9/ /12/2015 3/4/ /7/ /10/ /1/2017 4/5/ /8/ /11/ /2/2018 4/6/2018 Figure 18: Forward PER Band of LNC HKD x 28x 23x 18x 4 13x 2 0 Sources: Bloomberg, CGS Research Figure 19: Forward PER of LNC Based on Bloomberg Consensus BEst P/E Ratio (Blended 12 Months) 1 Year Average Sources: Bloomberg, CGS Research 12

13 Risks 1. Slowdown in SSSG Our forecast is based on the assumption that SSSG will continue to remain at a positive level, so overall revenue will continue to expand and operating leverage will continue to improve. Flat or negative SSSG will hurt overall revenue and operating profit. A slowdown in SSSG could be caused by factors such as unsuccessful product launches or marketing campaigns, and intensified competition from other brands. 2. Worsening Inventory Turnover Although LNC s inventory position has improved over past few years, it could worsen in 2018E and onwards, as a result of factors that affect overall sales, such as intensified competition. In addition, some old inventory may not be sold even with deep discounts. This may put pressure on the financial position of the Company s retail stores and franchises. If the problem intensifies, it may have an unfavourable financial impact, such as inventory writeoffs or Company buy backs of inventory from retailers, causing a oneoff loss. 3. Worsethanexpected SG&A Control Our estimate of LNC s turnaround rests on the assumption that the Company is able to control costs well. The sponsorship of the CBA is still a major expense even though the total sponsored amount was cut in half. If the Company has to spend more on promotional and marketing activities to match its competitors, it may cause its SG&A ratio to go up unexpectedly, trimming its OPM. Company Description Headquartered in Beijing, Li Ning Company Limited is a leading Chinese sports brand company, providing mainly sporting goods, including footwear, apparel, equipment and accessories, for professional and leisure purposes, primarily under the LINING brand. In addition to the core LINING brand, LNC distributes various sports products, including Double Happiness (table tennis), AIGLE (outdoor sports), Danskin (fashionable fitness products for dance and yoga), Kason (badminton) and Lotto (sports fashion). These brands are operated through joint ventures/associates with third parties. Viva China [8032.HK], controlled by Mr. Li Ning, is the largest shareholder with a 14.93% stake. 13

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Explanation on Equity Ratings BUY SELL HOLD : : share price will increase by >2 within 12 months in absolute terms share price will decrease by >2 within 12 months in absolute terms : no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL Copyright Reserved No part of this material may be reproduced or redistributed without the prior written consent of China Galaxy International Securities (Hong Kong) Co., Limited. China Galaxy International Securities (Hong Kong) Co. Limited, CE No.AXM459 20/F, Wing On Centre, 111 Connaught Road Central, Sheung Wan, Hong Kong. General line: