China / Hong Kong Company Guide Version 4 Bloomberg: 33 HK EQUITY Reuters: 33.HK Refer to important disclosures at the end of this report DBS Group Research. Equity 23 Feb 217 HOLD (Upgrade from Fully Valued) Last Traded Price ( 22 Feb 217):HK$6.24 (HSI : 24,22) Price Target 12-mth: HK$6.35 (2% upside) (Prev HK$6.2) Potential Catalyst: Sales recovery Where we differ: Higher margin assumptions in FY17 Analyst Alice HUI CFA, +852 2971 196 alicehuism@dbs.com What s New 1H17 results above expectations on better-thanexpected margins Sales remained soft; Germany and e-shop underperformed Lifted earnings but expect more challenges for 2H. HOLD Price Relative HK$ 18.9 21 16.9 19 14.9 17 12.9 15 13 1.9 11 8.9 9 6.9 7 4.9 5 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 (LHS) Relative HSI (RHS) Relative Index Forecasts and Valuation FY Jun (HK$ m) 215A 216A 217F 218F Turnover 19,421 17,788 16,128 16,93 EBITDA (2,97) (5) 418 87 Pre-tax Profit (3,667) (585) (71) 362 Net Profit (3,696) 21 (7) 3 Net Profit Gth (Pre-ex) (%) N/A N/A N/A N/A EPS (HK$) (1.9).1..15 EPS Gth (%) N/A N/A N/A N/A Diluted EPS (HK$) (1.9).1..15 DPS (HK$)....8 BV Per Share (HK$) 6.12 5.87 5.86 5.98 PE (X) nm 577.3 nm 4.4 P/Cash Flow (X) nm nm 36.8 14. P/Free CF (X) nm 25.5 152. 2.2 EV/EBITDA (X) nm nm 16. 7.7 Net Div Yield (%)... 1.2 P/Book Value (X) 1. 1.1 1.1 1. Net Debt/Equity (X) CASH CASH CASH CASH ROAE (%) (25.7).2 (.1) 2.6 Earnings Rev (%): nm 15 Consensus EPS (HK$) -.1.15 Other Broker Recs: B: S: 5 H: 1 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX Cost initiatives taking effect Some green shoots, but still challenges ahead. While Esprit s return to profit in 1H17 was encouraging and indicated good progress in its cost cutting initiatives, we still see uncertainties ahead as (i) same-store-sales (SSS) remained negative in its core markets in Germany and Asia Pacific; (ii) there remains ongoing pressure in the wholesale channel; and (iii) there are forex headwinds given the weakening Euro. But due to better gross margins and sharper reduction in OPEX, we have raised our forecast, and lifted TP to HK$6.35. Following underperformance in recent months, the counter is now trading at a modest discount to our TP, hence our upgrade to HOLD. 1HFY17 (FYE June) results beat expectations. Esprit s 1H17 net profit of HK$61m was partly boosted by tax credits. Taking that out, underlying EBIT of HK$2m was still a significant improvement over net loss of HK$238m in 1H16. The improvement was mainly driven by better GP margins (up 2ppts) due to less promotional activities and discounting, as well as impact from closure of non-performing stores (- 11% y-o-y in net retail sales area). The latter, coupled with overhead cost restructuring and lower A&P, led to an 11% reduction in regular OPEX. The HK$583m OPEX cut, against company s target of HK$1bn in two years, was better than expected. Sales uncertainties remain. 1H17 sales declined 1% (in local currency, LCY), dragged partly by unfavourable warm weather in 1Q. Although 2Q showed some improvement (SSS: -3.5%) vs 1Q (SSS: -6.6%), sales remained soft especially in core market Germany (1H SSS: -6.8%) where retail losses widened as closure of non-performing stores was slower given difficulties in terminating longer leases. E-shop also posted a mild 2.4% decline in sales, with strong growth in Asia (up 59%) offsetting slower traffic in Europe during the warmer month in Sept and the festive season. Valuation: As Esprit s margins and earnings have yet to normalise, we use DCF as our basis for valuation. Our HK$6.35 TP translates into c.1.1x P/BV and.75x P/Sales. Key Risks to Our View: Upside risks include a stronger-than-expected recovery in sales momentum and euro appreciation. At A Glance Issued Capital (m shrs) 1,944 Mkt. Cap (HK$m/US$m) 12,132 / 1,563 Major Shareholders Massachusetts Financial Services Company (%) 14. Lone Pine Capital LLC (%) 12.2 Ying Lee Yuen Michael (%) 1.3 Marathon Asset Management (%) 8. Free Float (%) 1. 3m Avg. Daily Val. (US$m) 1.4 ICB Industry : Consumer Services / General Retailers ed-js/ sa- AL
CRITICAL DATA POINTS TO WATCH Earnings Drivers: Resuming top line growth is key. After more than two years of restructuring which involved cost cutting as well as establishing a new Vertical Business Model, Esprit is getting to a stage where rebuilding top-line growth would be crucial for long-term profitability. While some recovery in same-storesales-growth (SSSG) was noted especially in rest of Europe where SSSG was maintained at.1% in 1H17, other regions including core market Germany, which represented around half of the group s revenue, remained soft and volatile. We believe a few quarters of more consistent performance would be needed to confirm a turnaround, considering the volatile market environment and forex headwinds. Space reduction to continue. While the pace of space reduction is expected to moderate following the aggressive store closures during the past few years, we are unlikely to see any material expansion in store space yet. This is especially true for wholesale which store space is expected to remain on a declining trend on continual pressure on this channel. As such, despite some improvement is expected in productivity on a per square metre basis, this would likely be offset by space reduction with limited growth in sales. Margin improvement is the key driver in the near term. On the one hand, the new Vertical Model, which enables faster and more cost-efficient product development and supply chain processes and thus better product, should likely help to reduce markdowns. This coupled with the company s effort in reducing intensity of promotional activities has benefited margins, as indicated by the 2ppt improvement in 1H17 gross margins. On the other hand, the recent weakness in Euro could reduce its cost competitiveness, as over 8% of its revenue is generated from Europe. Rental as % of sales 18 16.3 16 15.7 14.8 15 14.7 14 12 1 8 6 4 2 Staff costs as % of sales 25 2 19.6 18.3 18.1 17.4 15.9 15 1 5 Euro rate 2 1 1.36 1.21 1 1.11 1.6 1.6 1 1 1 At the OPEX level, the company is planning to reduce its opex by at least HK$1bn over the next two years, through closure of loss-making stores and restructuring of underperforming markets, downsizing of wholesale segment as well as reduction in overhead costs via streamlining. We view this strategy as the right one to return to profitability and progress has been better than expected with HK$583m cut in regular OPEX already posted in 1H17. Despite this, 2H is seasonally slower and hence we still expect FY17 to post a small loss overall. Page 2
Balance Sheet: Strong financial position. Following a HK$5bn rights issue in FY13, Esprit has remained in a strong net cash position (HK$4.5bn as of Dec 16). On working capital front, inventory turnover has lengthened to 12 days in 1HFY17 (FY16: 115), due to higher share of retail business vs wholesale while AR turnover had been relatively stable. The company did not propose any dividend in 1H17 due to small profit and we expect this to remain the case for full year. Share Price Drivers: SSSG improvement. While the sales performance of products under the new Vertical Model has shown some improvement, its effectiveness and sustainability has yet to be proven. A few more quarters of consistent improvement in SSSG could give more confidence to a real turnaround of its operation. Leverage & Asset Turnover (x).14.12.1.8.6.4.2. Gross Debt to Equity (LHS) Asset Turnover (RHS) HK$m 7. 6. 5. 4. 3. 2. 1. Capital Expenditure 1.1 1.1 1. 1..9 Euro appreciation. With more than 8% of Esprit s business being generated in Europe, the euro weakness in the past few years has hurt both sales as well as margins. A reversal in the forex rate trend would thus be positive to earnings. Based on our sensitivity analysis, every 1% change in euro rate would translate into a c..9% change in earnings estimates.. 2.5% 2.% 1.5% Capital Expenditure (-) ROE Key Risks: Competition. Risk of losing market share due to intense competition from other global fast-fashion players who have been aggressively expanding their store networks. Forex risk. Esprit s earnings are highly susceptible to forex fluctuations, especially that of the euro, as Europe accounts for more than 8% of its revenue. Execution risk. During a major overhaul of its business model, any hiccups at the execution stage could affect the effectiveness of its strategy. Company Background: Esprit is an international fashion brand. Founded in 1968, the company is currently present in over 4 countries with c.698 directly managed retail stores and 6,161 wholesale points of sales in Asia Pacific and Europe as of December 216. 1.%.5%.% Forward PE Band Share Price (HK$) 12 1 5x 8 39x 6 28x 4 2 18x 7x 1999 22 26 29 212 216 PB Band (x) 2.1 1.9 1.7 +2sd: 1.73x 1.5 1.3 +1sd: 1.5x Avg: 1.28x 1.1 1sd: 1.6x.9 2sd:.84x.7 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Page 3
Key Assumptions FY Jun Rental as % of sales 14.8 16.3 15.7 15. 14.7 Staff costs as % of sales 15.9 18.3 19.6 18.1 17.4 Euro rate 1.4 1.2 1.1 1.1 1.1 Segmental Breakdown (HK$ m) FY Jun Revenues (HK$ m) Retail 15,22 12,425 11,978 11,32 11,223 Wholesale 8,835 6,845 5,658 4,954 4,726 Others 172 151 152 141 144 Total 24,227 19,421 17,788 16,128 16,93 Income Statement (HK$ m) FY Jun Revenue 24,227 19,421 17,788 16,128 16,93 Cost of Goods Sold (12,71) (9,726) (8,859) (7,768) (7,59) Gross Profit 12,156 9,695 8,929 8,36 8,53 Other Opng (Exp)/Inc (11,795) (13,378) (9,525) (8,444) (8,165) Operating Profit 361 (3,683) (596) (84) 338 Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc 18 16 11 13 24 Dividend Income Exceptional Gain/(Loss) Pre-tax Profit 379 (3,667) (585) (71) 362 Tax (169) (29) 66 64 (62) Minority Interest Preference Dividend Net Profit 21 (3,696) 21 (7) 3 EBITDA 1,194 (2,97) (5) 418 87 Growth Revenue Gth (%) (6.5) (19.8) (8.4) (9.3) (.2) EBITDA Gth (%) N/A N/A 99.8 N/A 92.8 Opg Profit Gth (%) N/A N/A 83.8 85.9 N/A Net Profit Gth (%) N/A N/A N/A N/A N/A Margins & Ratio Gross Margins (%) 5.2 49.9 5.2 51.8 52.8 Opg Profit Margin (%) 1.5 (19.) (3.4) (.5) 2.1 Net Profit Margin (%).9 (19.).1. 1.9 ROAE (%) 1.3 (25.7).2 (.1) 2.6 ROA (%).9 (18.2).1. 1.9 ROCE (%) 1.1 (24.3) (4.9) (.7) 2.3 Div Payout Ratio (%) 64.8 N/A. N/A 5. Net Interest Cover (x) NM NM NM NM NM Page 4
Interim Income Statement (HK$ m) FY Jun 1H215 2H215 1H216 2H216 1H217 Revenue 1,716 8,75 9,315 8,473 8,323 Cost of Goods Sold (5,39) (4,417) (4,615) (4,244) (3,952) Gross Profit 5,47 4,288 4,7 4,229 4,371 Other Oper. (Exp)/Inc (5,37) (8,8) (4,947) (4,578) (4,384) Operating Profit 37 (3,72) (247) (349) (13) Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc 9 7 5 6 Exceptional Gain/(Loss) Pre-tax Profit 46 (3,713) (242) (343) (13) Tax 1 (3) 4 62 74 Minority Interest Net Profit 47 (3,743) (238) 259 61 Growth Revenue Gth (%) (16.3) (23.8) (13.1) (2.7) (1.6) Opg Profit Gth (%) (85.4) N/A N/A 9.6 94.7 Net Profit Gth (%) (5.5) N/A N/A N/A N/A Margins Gross Margins (%) 5.5 49.3 5.5 49.9 52.5 Opg Profit Margins (%).3 (42.7) (2.7) (4.1) (.2) Net Profit Margins (%).4 (43.) (2.6) 3.1.7 Balance Sheet (HK$ m) FY Jun Net Fixed Assets 3,972 2,835 2,159 1,97 1,7 Invts in Associates & JVs Other LT Assets 6,62 3,944 3,893 3,893 3,893 Cash & ST Invts 6,31 5,17 5,341 5,42 5,947 Inventory 3,254 2,969 2,745 2,469 2,412 Debtors 2,723 2,8 1,571 1,424 1,421 Other Current Assets 559 64 331 331 331 Total Assets 23,159 17,413 16,4 15,444 15,74 ST Debt 26 Creditors 4,12 3,672 3,495 2,96 2,954 Other Current Liab 1,28 1,244 664 61 652 LT Debt Other LT Liabilities 66 599 484 484 484 Shareholder s Equity 16,911 11,898 11,397 11,39 11,615 Minority Interests Total Cap. & Liab. 23,159 17,413 16,4 15,444 15,74 Non-Cash Wkg. Capital 1,28 71 488 654 559 Net Cash/(Debt) 5,771 5,17 5,341 5,42 5,947 Debtors Turn (avg days) 45.9 44.5 36.7 33.9 32.3 Creditors Turn (avg days) 131.1 157.8 158.2 162.1 151.6 Inventory Turn (avg days) 15. 126. 126.1 131. 125.1 Asset Turnover (x) 1. 1. 1.1 1. 1. Current Ratio (x) 2.2 2.2 2.4 2.7 2.8 Quick Ratio (x) 1.6 1.4 1.7 1.9 2. Net Debt/Equity (X) CASH CASH CASH CASH CASH Net Debt/Equity ex MI (X) CASH CASH CASH CASH CASH Capex to Debt (%) 138.1 N/A N/A N/A N/A Z-Score (X) 3.1 2.5 3.4 3.5 3.6 Page 5
Cash Flow Statement (HK$ m) FY Jun Pre-Tax Profit 379 (3,667) (585) (71) 362 Dep. & Amort. 833 713 591 52 469 Tax Paid (588) (169) (1) 1 (2) Assoc. & JV Inc/(loss) (Pft)/ Loss on disposal of FAs 2,683 (731) Chg in Wkg.Cap. 812 114 531 (14) 33 Other Operating CF 33 28 29 29 2 Net Operating CF 1,469 (298) (175) 33 864 Capital Exp.(net) (359) (349) 651 (25) (263) Other Invts.(net) (124) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF Net Investing CF (359) (349) 528 (25) (263) Div Paid (56) (17) (29) (75) Chg in Gross Debt (26) (26) Capital Issues 31 Other Financing CF Net Financing CF (285) (367) (29) (75) Currency Adjustments 37 Chg in Cash 862 (1,14) 324 8 526 Opg CFPS (HK$).34 (.21) (.36).24.43 Free CFPS (HK$).57 (.33).24.4.31 Target Price & Ratings History HK$ 9. 8.5 8. 7.5 7. 1 2 3 4 S.No. Date Closing 12-mth Rating Price Target Price 1: 24-Feb-16 HK$8.29 HK$6.1 Fully Valued 2: 3-May-16 HK$6.8 HK$6.35 Fully Valued 3: 21-Sep-16 HK$6.72 HK$6.2 Fully Valued 4: 21-Nov-16 HK$6.59 HK$6.2 Fully Valued 6.5 6. 5.5 5. 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 Source: DBS Vickers Analyst: Alice HUI CFA, Page 6
DBSVHK recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>2% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >1% for large caps) HOLD (-1% to +15% total return over the next 12 months for small caps, -1% to +1% for large caps) FULLY VALUED (negative total return i.e. > -1% over the next 12 months) SELL (negative total return of > -2% over the next 3 months, with identifiable catalysts within this time frame) Share price appreciation + dividends Completed Date: 23 Feb 217 1:8:14 (HKT) Dissemination Date: 23 Feb 217 1:26:9 (HKT) GENERAL DISCLOSURE/DISCLAIMER This report is prepared by DBS Vickers (Hong Kong) Limited ( DBSVHK ). This report is solely intended for the clients of DBS Bank Ltd., DBS Vickers Securities (Singapore) Pte Ltd. 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ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The DBS Group has procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports. As of 23 February 217, the analyst(s) and his/her spouse and/or relatives who are financially dependent on the analyst(s), do not hold interests in the securities recommended in this report ( interest includes direct or indirect ownership of securities). 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