Key takeaways from Ningbo plant visit. Buy (unchanged) Shenzhou International (2313 HK) Price Target (Revision) (upside) HKD58.9 (+3.7%) (11.

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1 C H I N A S E C U R I T I ES( I N T L ) R E S E A R C H Equity Research l HK & China l Textile OEM 22 May 2017 Key takeaways from Ningbo plant visit We are more confident in Shenzhou s (SZ) growth outlook beyond 2018, where SZ is planning to further grow its casual wear market share, leveraging on its its strategic development in Vietnam (VN) plant. FY17E order growth from Nike is estimated at c.20-30% YoY (versus prior guidance of +20%), whereas that of Adidas is HSD and Uniqlo is mid-to-high SD percentage YoY. The major challenge this year is expected to be labour cost from its VN plants, while rising raw material cost pressure is limited. We reiterate our BUY rating and revise up our PT to HKD58.9 (prev. HKD56.8), based on 1.0x PEG and a core net profit 3-yr CAGR estimate of 21.7%, as we have upped our earnings estimate for FY19E by 2%. SZ currently trades at 19.1x FY17E PER. Order growth outlook. As measured in terms of SZ s new capacity assigned for a particular client, Nike s orders are expected to grow at c.20-30% YoY in FY17E, higher than its previous guidance of +20% YoY provided during its interim results briefing in March. Meanwhile, orders from Adidas are expected to grow at a HSD (given a high base in FY16) and that of Uniqlo at a mid-high SD percentage YoY. SZ reiterates its capacity growth guidance of 10-15% YoY for FY17E. VN plant expansion to support Shenzhou s growth beyond Given the rapid growth in sportswear in recent years, the revenue contribution from sportswear already accounted for 65% of SZ s total, whereas casual wear accounted for 26% in FY16. Management expects sportswear contribution will continue to grow by a few ppts. in FY17E, before plateauing in FY18E, as SZ s VN plant expansion is paving the way for the future mapping of gaining more casual wear orders. Although the GPM of casual wear is usually lower than that of sportswear, SZ is seeing fundamental market changes in casual wear trends, with more functional elements added in casual wear; hence, the demand for high-quality multi-purpose fabrics will rise. Thus, supporting higher GPM from casual wear orders. Besides, labour and operating costs in VN are comparatively lower than in the PRC. Its VN plant will have a higher competitive edge when dealing with casual wear orders, even casual wear orders command a lower GPM. This will also balance off SZ s overreliance on sportswear customers at present. Hence, we are more confident in its growth outlook after Valuation and earnings revision. We adjusted our revenue growth forecast for casual wear upwards in FY19E to 18% (prev. +8%) as SZ s VN plant is mapping to capture a larger market share in the production of casual wear. Hence, our net profit estimate for FY19E has been adjusted upwards by 2%. Accordingly, we have upped our PT to HKD58.9 (prev. HKD56.8), still pegging to 1.0x PEG and revised core net profit 3-yr CAGR of estimate of 21.7% (prev. 21.0%). SZ currently trades at 19.1x PER for FY17E, on a fully-diluted basis including potential CB conversion. Shenzhou International (2313 HK) Price Target (Revision) (upside) EPS revision Close price Market cap. Buy (unchanged) HKD58.9 (+3.7%) (11.0%) 2017E nil HKD53.05 HKD74.2bn Free float 40.1% 2018E nil 52-week range HKD mth ave. T/O Price as of 22 May 2017 Stock rel HSI performance 60% 40% 20% 0% HKD108mn -20% May-16 Aug-16 Nov-16 Feb-17 SHENZHOU INTL GP HS Index SO Lai Shan, Jennifer (CE No.: AHA295) jenniferso@csci.hk Please read the disclaimer on the last page.

2 Figure 1: Shenzhou s competitive edge: A vertically-integrated supply chain Source: Company data, CSCI Research. Figure 2: Shenzhou s plant in Ningbo, PRC Figure 3: Shenzhou s plant in Ningbo, PRC Source: CSCI Research Source: CSCI Research Slower growth for Nike s Flyknit sales. Nike's Flyknit (shoe-upper business) sales orders to SZ grew 40% YoY in FY16. However, growth is expected to decelerate to +20% YoY in FY17E as market competition for this type of shoe upper knitting has intensified, which we believe has affected Nike's pace of expanding such product categories. SZ currently has 2,500 machines, tailor-made for the manufacture of Flyknit only. The slower growth does not mean these machines are left idle, it means SZ is to scale back the capacity expansion plan of Flyknit machines. Besides, Nike has previously agreed to guarantee Flyknit sales orders to SZ for c.3.5 years (given that SZ expects its investment in the Flyknit machines will take 3.5 years to achieve breakeven). Since SZ has started to produce Flyknit in 2015, we believe orders from Nike will remain stable through Progress of VN factory ramp up. For downstream garment production, the total number of workers recruited has increased to 7k from 6k in March, with utilization rate now at c.60%. SZ targets to recruit a total of 11-12k workers on full ramp-up. It also targets utilization rate to reach 70% by FY17E (versus its prior target of reaching such level by FY18E). Please read the disclaimer on the last page May 2017

3 Figure 4: Peers valuation Source: Bloomberg, CSCI Research ASP still has room to grow in FY17E, albeit a slower pace versus FY16. SZ s ASP increased by c.4% YoY in FY16, primarily due to a product mix upgrade. We believe SZ has room to raise ASP in FY17E, given the rise in yarn prices. However, the pace of increase might be slower versus FY16. Hence, we expect a c.2-3ppt YoY increase in its ASP in FY17E. Labour cost from VN factory is the major challenge in FY17E. SZ expects labour cost to be the major challenge in FY17E, primarily to come from its new garment factory in VN as utilization rate is still comparatively lower versus its plants in China. It does not see much pressure from raw material cost (cotton yarn) increase, despite higher yarn prices, as SZ is pretty strong on cost-pass-through. Valuation We adjusted our revenue growth forecast for casual wear upward in FY19E to 18% (prev. +8%) as SZ s VN plant is mapping to capture a larger market share in the production of casual wear. Hence, our net profit estimate for FY19E has been adjusted upwards by 2%. Accordingly, we have upped our PT to HKD58.9 (prev. HKD56.8), still pegging to 1.0x PEG and revised core net profit 3-yr CAGR of estimate of 21.7% (prev. 21.0%). SZ currently trades at 19.1x PER for FY17E, on a fully-diluted basis including potential CB conversion. Mkt Cap (bn HK$) Currency Last Price FYE 1-yr fwd PER (x) 2-yr fwd PER (x) 1-yr fwd PBR (x) Sales growth Op Profit Margin Cap Ex/ Sales (x) ROIC ROA Dvd Yield Net debt (cash)/ total quity % Name Rating PT Ticker HK listed Upstream: yarn/ fabric Texhong Textile BUY HK 8.5 HKD / Weiqiao Textile NR N/A 2698 HK 6.7 HKD /2015 N/A N/A N/A (12.9) (17.6) Fountain Set NR N/A 420 HK 1.2 HKD /2016 N/A N/A 1.0 (4.9) N/A Pacific Textiles BUY HK 12.5 HKD / (22.9) Best Pacific BUY HK 7.6 HKD / Taiwan Paiho NR N/A 9938 TT 7.6 TWD / N/A 7.0 Sub-Average Up-mid stream: fabric & garment Texwinca HOLD HK 6.2 HKD / (34.9) Shenzhou International BUY HK 74.2 HKD / (6.6) Victory City NR N/A 539 HK 1.2 HKD /2016 N/A N/A 40.1 (4.4) Eclat NR N/A 1476 TT 21.5 TWD / N/A (3.9) N/A (28.1) Sub-Average - excl. Shenzhou (2.7) (7.6) Mid-stream: garment Regina Miracle BUY HK 7.1 HKD / Nameson BUY HK 3.4 HKD / % Win Hanverky NR N/A 3322 HK 1.5 HKD / N/A (24.4) Eagle Nice NR N/A 2368 HK 1.1 HKD /2016 N/A N/A N/A (5.2) Makalot NR N/A 1477 TT 7.3 TWD / N/A (5.3) N/A (14.2) Sub-Average (7.5) Average of all - excl. Shenzhou (0.1) Please read the disclaimer on the last page May 2017

4 Income statement (RMBm) Cash flow statement (RMBm) Year end: Dec E 2018E 2019E Year end: Dec E 2018E 2019E Revenue 12,639 15,099 17,643 20,273 23,067 EBIT 2,764 3,583 4,408 5,339 6,399 COGS (8,790) (10,190) (11,685) (13,153) (14,641) Depreciation & amortisation (522) (675) (789) (907) (1,032) Gross profit 3,849 4,909 5,958 7,121 8,426 Net interest expenses/ (income) Selling & distribution costs (255) (354) (413) (475) (540) Taxes paid (532) (695) (847) (1,025) (1,213) General & administrative expenses (962.1) (1,102.8) (1,288.6) (1,480.7) (1,684.7) Changes in working capital (617) (999) (250) (866) (901) Other income (104.2) (154.3) (180.3) (207.2) (235.7) Others 1,043 1,353 1,579 1,814 2,064 Other losses - net Cash flow from operations 2,259 2,623 4,151 4,438 5,443 EBITDA 3,286 4,258 5,197 6,246 7,431 Depreciation & Amortization ,032 Capex (1,366) (1,463) (1,100) (800) (700) EBIT 2,764 3,583 4,408 5,339 6,399 Acquisitions (258) (492) Disposals (7) Net interest expenses/ (income) (124) (58) (51) (83) (126) Others (1) (0) Non-recurring items (6) Cash flow from investing (1,631) (1,955) (1,100) (800) (700) JVs and associates (1) Pretax profit 2,882 3,640 4,458 5,422 6,525 Dividends (1,104) (1,254) (2,143) (2,609) (3,151) Taxation (532) (695) (847) (1,025) (1,213) Issue of shares Minority interests (0) (0) (0) (0) (0) Change in debt (510) (1,040) Net profit 2,350 2,945 3,611 4,397 5,311 Others 0 (2) Net profit (*adjusted) 2,359 2,946 3,611 4,397 5,311 Cash flow from financing (241) (379) (1,672) (3,119) (4,191) Basic EPS (RMB) Change in cash , Basic EPS (RMB) - (adjusted) Cash and cash equivalents at Beg. of the year 1,428 1,816 2,105 3,484 4,004 Diluted EPS (RMB) Cash and cash equivalents at End of the year 1,816 2,105 3,484 4,004 4,556 Diluted EPS (RMB) - (adjusted) Free cash flow ,000 3,555 4,617 DPS (RMB) Balance sheet (RMBm) Key ratios Year end: Dec E 2018E 2019E Year end: Dec E 2018E 2019E Cash 1,816 2,105 3,484 4,004 4,556 Operating ratios Short term investments 3,064 3,553 3,553 3,553 3,553 Gross margin Accounts receivables 2,002 2,653 2,628 3,020 3,436 EBIT margin Inventory 3,233 3,699 3,923 4,415 4,915 EBITDA margin Other current assets Effective tax rate Total current assets 10,240 12,165 13,744 15,149 16,617 Revenue growth PP&E 5,550 7,013 7,324 7,217 6,885 Net income growth Intangible Assets Net income (adjusted) growth Associates and JVs Basic EPS growth adj Other long term assets 2,458 2,526 2,808 3,100 3,410 DPS growth Total long term assets 8,121 9,651 10,247 10,434 10,415 TOTAL ASSETS 18, , ,991 25,583 27,032 Efficency ratios CROCI Short term debt 657 1,241 1,713 1, ROE Accounts payables ROCE Other current liabilities 817 1,095 1,291 1,502 1,727 Asset turnover (x) Total current liabilities 2,153 3,094 3,798 3,600 2,886 Op cash / EBIT (x) Long term debt 3,117 3,410 3,410 3,410 3,410 Depreciation / CAPEX (x) (0.4) (0.5) (0.7) (1.1) (1.5) Deferred tax Inventory turnover days Convertible bonds Accounts receivable days Other long term liabilities Accounts payable days Total long term liabilities 3,119 3,412 3,412 3,413 3,413 TOTAL LIABILITIES 5,272 6,506 7,210 7,012 6,299 Leverage ratios Net debt/ equity (4.8) Shareholders funds 13,074 15,093 16,564 18,354 20,517 Net debt / EBITDA (x) (0.1) Minority Interests Interest cover (x) (22.3) (62.0) n.a. (64.7) (51.0) TOTAL LIAB AND EQUITY 18, , ,991 25,583 27,032 Current ratio (x) Net cash / (debt) (1,958) (2,546) (1,639) (610) 982 Valuation PER (x) PER (x) - fully-diluted and adj. EPS EV/EBITDA (x) PBR (x) Dividend yield (x) Source: Company, Bloomberg, CSCI Research estimates *Remarks: *Adjusted net profit excludes changes in fair value on redeemable convertible shares, fair value of warrants, gain on cancellation of warrants and listing expenses. Please read the disclaimer on the last page May 2017

5 Research LIU Taisheng, Steven TMT (852) SO Lai Shan, Jennifer Consumer (852) CHAN Ka Yeung, Duncan Commodity (852) TIAN Yang Automotive (852) SUN Lingxiao, Roger Industrials (852) XU Bo, Albert Financials (852) ZHU Kexin Renewable energy (852) YAO Xue, Snowy SHEN Xiangfei, Thomas (852) Institutional Sales & Trading XIANG Xinrong, Ron (852) CAO Xiaogang, Glen (852) HO Wen Hao, Jack (852) WANG Zhuo, Gary (852) HO Hung Wei (852) LEE Ying Ju, Rose (852) LI Jiageng, Mike (852) XIA Tian (852) XU Xiaowei, Vincent (852) LI Tianyi, Miranda (852) XU Qiwen (852) Please read the disclaimer on the last page May 2017

6 Company Rating Definition The Benchmark: Hong Kong Hang Seng Index; Time Horizon: 12 months Buy 12-month absolute total return: >=10% Hold 12-month absolute total return: >-10% but <10% Sell 12-month absolute total return: <=-10% Disclosure of Interests As of the date of this report, 1. The research analysts primarily responsible for the preparation of all or part of this report hereby certify that: (i) the views expressed in this research report accurately reflect the personal views of each such analyst about the subject securities and issuers; and (ii) no part of the analyst s compensation was, is, or will be directly or indirectly, related to the specific recommendations or views expressed in this research report. 2. 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