Equity Research Consumer Discretionary International (1368 HK) Hold (Initiation) Target price: HK$3.66 Albert Yip, CFA SFC CE No. ADT599 albertyip@gfgroup.com.hk +852 3719 1010 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Stock performance 20% 10% 0% -10% -20% -30% Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Source: Bloomberg Key data Source: Bloomberg HSI Oct 20 close (HK$) 3.36 Shares in issue (m) 2178.085 Major shareholder Ding Shuibo (60.7%) Market cap (HK$ bn) 7.3 3M avg. vol. (m) 0.95 52W high/low (HK$) 4.23/2.99 Recovery behind peers; initiate at Hold Running footwear and e-commerce driving growth is a vertically integrated, fashionable and functional sportswear company. Its running footwear and e-commerce segments led revenue growth in 1H14. By sponsoring its first marathon, the Xi an City Wall International Marathon, in 2007, has been putting marketing and R&D effort into making running footwear its key product category. Running footwear sales outpaced other footwear sales in 1H14, contributing about 30% of overall footwear sales, up from 27.5% in FY13. We expect running footwear growth to outperform going forward underpinned by favorable policies aimed at boosting participation in sports and demand for performance products. Online sales also saw significant growth in 1H14, accounting for about 4% of total sales (vs 1% in FY13). We expect the contribution from online sales to increase going forward. Order book recovery behind peers While peers such as Anta, Peak and 361 Degrees reported low to mid-teen order book growth at 1Q15 sales fairs, saw only low singledigit order book growth. We see two reasons for this: 1) Channel inventory destocking began later than peers amid high inventory levels across the sector, peers began to cut sell-in orders aggressively in 1H12 (core brands reported double-digit revenue declines YoY in China). However, only began to cut its sell-in orders significantly in 1H13 ( brand revenue dropped 21% YoY in 1H13 in China). 2) Strong competition in fashionable sportswear s higher level of sales from fashionable sportswear is its key differentiating factor. Fashionable and functional sportswear footwear accounted for about 60%/40% in 1H14 respectively. In addition, its apparel products are more fashionable than sporty. This means that faces competition from casual wear brands as well as sportswear brands. We believe the emergence of online shopping has lowered entry barriers in the apparel and footwear sectors, especially for the mass-market and mid-end segments. In addition, expansion by Adidas low-price and fashion brand, NEO, as well as international fast-fashion brands such as Uniqlo and H&M within China has intensified competition in the apparel sector, a view reinforced by the negative growth in apparel sales between FY12 and 1H14. We therefore expect s recovery to face greater headwinds than peers given its higher proportion of fashionable sportswear sales. Worsening of overdue A/R balance and inventory turnover days could cap recovery While peers saw an A/R turnover days YoY improvement in 1H14, s remained at 96 days (vs 96/92 days in 1H13/FY13). Including bills receivables, accounts and bills receivables turnover days increased from 96 days to 120 days. Compared to the downward trend at peers, the proportion of s A/R balance aged over three months ( s credit period is three months) also rose from 29% in 1H13 to 47% in 1H14 despite its Rmb24m provision for doubtful debts during the period. Inventory turnover days rose from 86 days in 1H13 to 94 days in 1H14, with the finished goods balance equivalent to 38% of revenue in 2H14E. We are concerned that channel inventory destocking may continue. Initiate at Hold with TP of HK$3.66 We expect its recovery to lag behind peers as channel inventory destocking began later and as its fashionable positioning faces extra competition from casual wear brands. The worsening of its overdue A/R balance and inventory turnover days in 1H14 is also a concern. We expect the company to post a 5% net profit decline in FY14, mainly due to an increase in its A&P expense ratio (+1.5 ppt YoY) and provisions for doubtful debts. We believe this will be followed by 7%/7% net profit growth in FY15/16 driven by 6%/7% revenue growth, a slight GM improvement and a decrease in provisions for A/R impairment. This would mean FY15-16 EPS grows at a below-peer CAGR of 7% (expected peer average 17%). That said, we believe its Rmb2.9bn net cash position in FY14 (48% of market cap) should provide share price support. The company has traded at between 5x and 15x 1-yr forward P/E over the past five years. We value at HK$3.66/share, equal to 10x FY15E P/E, the same as its historical average, to factor in its mild recovery. Stock valuation Turnover (RMB m) Net profit (RMB m) EPS (RMB) EPS YoY (%) P/E Ex-net cash P/E Yield (%) BPS (RMB) P/B ROE (%) 2012 5,550 810 0.372-16 7.3 4.0 8.2 2.0 1.4 19.8 2013 4,343 606 0.278-25 9.6 4.8 5.4 2.1 1.3 13.8 2014E 4,477 578 0.265-5 10.0 5.0 5.1 2.2 1.2 12.4 2015E 4,760 617 0.283 7 9.2 4.4 5.6 2.4 1.1 12.4 2016E 5,071 661 0.303 7 8.4 3.8 6.1 2.5 1.0 12.4
1H14 results review: running footwear and e-commerce leading growth 1H14 net profit (-17% YoY) was weaker than that at Peak (+35% YoY), Anta and 361 Degrees (+28% YoY). Revenue rose 2% YoY. Footwear revenue rose 27% YoY, accounting for 62% of total revenue. Apparel revenue fell 23% YoY, representing 37% of total revenue. GM rose 0.2ppt to 40.4% on cost control and supply chain management for its footwear products. OP fell 11% YoY, and OP margin narrowed 2.7ppt to 19.9% driven by a 3.5ppt increase in A&P expenses ratio to 12.5%. The company made an Rmb24m provision for A/R impairment in 1H14 (Rmb31m in 1H13). Running footwear and e-commerce led revenue growth in 1H14. By sponsoring its first marathon, the Xi an City Wall International Marathon, in 2007, has been putting marketing and R&D effort into making running footwear its key product category. Running footwear sales outpaced other footwear sales in 1H14, contributing about 30% of overall footwear sales, up from 27.5% in FY13. We expect running footwear growth to outperform going forward underpinned by favorable policies aimed at boosting participation in sports and demand for performance products. Online sales also saw significant growth in 1H14, accounting for about 4% of total sales (vs 1% in FY13). We expect the contribution from online sales to increase going forward. Strong competition in fashionable sportswear s higher level of sales from fashionable sportswear is its key differentiating factor. Fashionable and functional sportswear footwear accounted for about 60%/40% in 1H14 respectively. In addition, its apparel products are more fashionable than sporty. This means that faces competition from casual wear brands as well as sportswear brands. We believe the emergence of online shopping has lowered entry barriers in the apparel and footwear sectors, especially for the mass-market and mid-end segments. In addition, expansion by Adidas low-price and fashion brand, NEO, as well as international fast-fashion brands such as Uniqlo and H&M within China has intensified competition in the apparel sector, a view reinforced by the negative growth in apparel sales between FY12 and 1H14. We therefore expect s recovery to face greater headwinds than peers given its higher proportion of fashionable sportswear sales. Figure 1: Apparel sales recorded negative growth between FY12 and 1H14 (Rmb m) FY12 FY13 1H14 Footwear sales 2,700.1 2,246.9 1,326.4 YoY growth (%) 8.5% -16.8% 27.4% Apparel sales 2,746.2 2,011.9 783.0 YoY growth (%) -6.9% -26.7% -23.1% Sources: Company data, GF Securities (HK) estimates Worsening of overdue A/R balance and inventory turnover days could cap recovery While peers saw an A/R turnover days YoY improvement in 1H14, s remained at 96 days (vs 96/92 days in 1H13/FY13). Including bills receivables, accounts and bills receivables turnover days increases from 96 days to 120 days. Compared to the downward trend at peers, the proportion of s A/R balance aged over three months ( s credit period is three months) also rose from 29% in 1H13 to 47% in 1H14 despite its Rmb24m provision for doubtful debts during the period. Inventory turnover days rose from 86 days in 1H13 to 94 days in 1H14, with the finished goods balance equivalent to 38% of revenue in 2H14E. We are concerned that channel inventory destocking may continue. Page 2
Figure 2: Average A/R turnover days 250 Figure 3: Proportion of A/R balance aged over three months 70% 200 150 100 50 0 205 60% 59% 60% 60% 193 48% 51% 165 165 361 Degrees 50% 50% 151 135 38% 47% 119 127 40% 36% 123 36% Peak 32% 29% 29% 97 96 92 96 30% 76 33% 28% 21% 28% 89 88 66 74 78 Li Ning 20% 25% 14% 64 17% Anta 10% 34 38 39 38 5% 12% 15% 9% 26 4% 0% FY11 FY12 FY13 1H13 1H14 FY11 FY12 FY13 1H13 1H14 Li Ning 361 Degrees Peak Anta Figure 4: Average inventory turnover days Figure 5: Inventory and finished goods balance 120 100 80 60 40 73 63 49 40 104 106 96 89 94 86 80 81 85 87 70 79 67 73 59 56 59 58 59 51 Li Ning Peak 361 Degrees Anta (Rmb m) 1H13 FY13 1H14 YoY (%) Inventory balance 596 537 778 31% - finished goods 370 251 534 44% Inventory turnover days 86 79 94 na 38 20 FY11 FY12 FY13 1H13 1H14 Growth outlook We expect the company to post a 5% net profit decline in FY14, mainly due to an increase in its A&P expense ratio (+1.5ppt YoY) and provisions for doubtful debts. We believe this will be followed by 7%/7% net profit growth in FY15/16 driven by 6%/7% revenue growth, a slight GM improvement and a decrease in provisions for A/R impairment. Revenue growth We forecast 3%/6%/7% revenue growth for FY14/15/16, while for the brand, we estimate -1%/5%/5% revenue growth, mostly driven by 5%/6%/5% SSSG but partly offset by -1%/-1%/0% store number changes. For other products, we expect 111%/23%/22% revenue growth driven by online sales. Margin trend We expect GM to rise slightly from 40.2% in FY13 to 40.6% in FY16, assuming a rise in its in-house production ratio. We believe OP margin will decline by 1.7ppt to 18.9% in FY14, mainly driven by a 1.5ppt increase in A&P expenses ratio to 12.7%. We then expect OP margin to improve slightly by 0.2/0.2ppt to 19.1%/19.3% in FY15/16 on a GM increase and a drop in provisions for A/R impairment. Page 3
Figure 6: Key assumptions (RMBm) FY11 FY12 FY13 FY14E FY15E FY16E Total revenue 5,540 5,550 4,343 4,477 4,760 5,071 growth % 24.3% 0.2% -21.8% 3.1% 6.3% 6.5% products 5,375 5,475 4,180 4,134 4,339 4,556 growth % 27.7% 1.9% -23.6% -1.1% 4.9% 5.0% Other products 165 76 163 343 422 515 growth % -33.3% -54.0% 114.8% 110.5% 23.1% 22.1% Gross profit 2,258 2,258 1,748 1,805 1,926 2,059 Gross margin 40.8% 40.7% 40.2% 40.3% 40.4% 40.6% products 40.8% 40.9% 40.8% 41.2% 41.4% 41.6% Other products 39.2% 25.5% 26.9% 29.7% 30.7% 31.8% Selling & distribution expenses ratio 13.2% 13.3% 13.7% 15.5% 15.8% 15.8% Administrative expenses ratio 5.8% 8.2% 9.6% 9.0% 8.5% 8.4% Operating profit margin 22.0% 20.4% 20.6% 18.9% 19.1% 19.3% Effective tax rate 20.3% 27.0% 30.1% 30.0% 30.0% 30.0% Net profit 966 810 606 578 617 661 growth % 18.8% -16.2% -25.2% -4.6% 6.8% 7.1% Net profit margin 17.4% 14.6% 14.0% 12.9% 13.0% 13.0% Payout ratio 50.0% 61.0% 51.3% 51.0% 51.0% 51.0% Sources: Company data, GF Securities (HK) estimates Valuation The company has traded at between 5x and 15x 1-yr forward P/E over the past five years. We value at HK$3.66/share, equal to 10x FY15E P/E, the same as its historical average, to factor in its mild recovery. Figure 7: P/E band 9 (HK$) 8 7 6 5 4 3 2 1 15x 12.5x 10x 7.5x 5x Oct-14 Jun-14 Feb-14 Oct-13 Jun-13 Feb-13 Oct-12 Jun-12 Feb-12 Oct-11 Jun-11 Feb-11 Oct-10 Jun-10 Feb-10 Oct-09 Jun-09 Sources: Bloomberg, GF Securities (HK) estimates Page 4
Figure 8: Valuation comparison for sportswear companies Price TP Mkt Cap P/E (x) EPS growth (%) Revenue growth (%) Yield (%) P/B (x) ROE (%) Company Ticker Rating (Oct 20 2014) (HK$) (HK$ m) FY13 FY14E FY15E FY16E FY14E FY15E FY16E FY14E FY15E FY16E FY14E FY15E FY16E FY14E FY14E Anta 2020 HK Buy 15.38 18.50 38,399 23.1 18.5 14.7 12.3 25 23 17 21 20 17 3.3 4.2 5.0 3.8 22.0 Peak 1968 HK Accumulate 2.34 2.70 4,910 15.9 13.3 10.4 8.9 19 25 14 10 12 12 4.1 5.3 6.2 0.9 7.0 1368 HK Hold 3.36 3.66 7,318 9.6 10.0 9.2 8.4 (5) 7 7 3 6 7 5.1 5.6 6.1 1.2 12.4 Li Ning 2331 HK NR 4.00 na 5,604 na na 54.8 14.0 na na na 9 13 14 0.0 0.4 1.6 2.2 na 361 Degrees 1361 HK NR 2.11 na 4,363 16.4 9.5 8.8 7.6 72 9 16 2 11 13 3.9 4.2 4.8 0.7 7.2 Average 16.3 12.8 19.6 10.3 28 16 13 9 12 13 3.3 3.9 4.7 1.8 12.1 Sources: Bloomberg, GF Securities (HK) estimates Company overview International () designs, manufactures and distributes fashionable and functional sportswear products under its brand. Its fashionable products are endorsed by celebrities including Nicholas Tse ( 谢霆锋 ), Han Geng ( 韩庚 ) and the Day Day Brothers ( 天天兄弟 ). Products for runners, its key functional product category, accounted for 30% of its footwear sales in 1H14. The company sponsors well-known runners such as Justin Gatlin and Chen Ding ( 陈定 ) and several marathons in China and Hong Kong, including the Xiamen International Marathon, Yangzhou Jianzhen International Half Marathon and Standard Chartered Hong Kong Marathon. As of Jun 30 2014, the company had 37 distributors and 7,310 authorized retail outlets for the brand in China. It also had 320 POS for kids. In overseas market, had over 200 POS across the Middle East and Central and Western Europe. Figure 9: Revenue breakdown by product in 1H14 E-commerce 4% Kids 2% Others 1% Risk factors Sources: GF Securities (HK) estimates brand 93% 1) Intensifying competition from international and domestic sportswear and casual wear brands. 2) Sharp slowdown in Chinese retail sales. Page 5
Figure 10: Financial statement Income statement Balance sheet Year ended 31 Dec (RMBm) FY11 FY12 FY13 FY14E FY15E FY16E Year ended 31 Dec (RMBm) FY11 FY12 FY13 FY14E FY15E FY16E Revenue 5,540 5,550 4,343 4,477 4,760 5,071 Fixed assets Cost of sales (3,282) (3,293) (2,596) (2,672) (2,835) (3,012) PPE 257 387 545 646 741 828 Gross profit 2,258 2,258 1,748 1,805 1,926 2,059 Prepaid land lease payments 230 225 221 221 216 211 Intangible assets 1 1 1 1 1 1 Other income 16 68 158 140 143 147 AFS investments 0 33 33 33 33 33 Selling & distribution expenses (734) (739) (595) (694) (754) (801) Deposits 6 17 45 45 45 45 Administration expenses (321) (455) (416) (403) (407) (424) Non-current time deposits 0 0 110 110 110 110 Operating profit 1,219 1,131 895 848 908 981 495 663 955 1,056 1,146 1,228 Net finance cost (8) (25) (32) (22) (24) (30) Current assets Profit before tax 1,211 1,106 863 826 884 951 Inventories 672 583 537 691 733 833 Income tax expense (246) (299) (260) (248) (265) (285) A/C receivables 1,205 1,036 1,151 1,198 1,351 1,482 Non-controlling interests 1 3 3 0 (2) (5) Prepayments 533 421 386 397 423 450 Net profit 966 810 606 578 617 661 Tax recoverable 0 16 0 0 0 0 EPS (RMB) 0.44 0.37 0.28 0.27 0.28 0.30 AFS investments 0 100 0 0 0 0 Pledged bank deposits 522 557 715 900 1,053 1,211 Growth rates (%) Cash and cash equivalents 2,068 3,123 3,563 3,676 3,924 4,170 Revenue 24 0 (22) 3 6 7 5,000 5,836 6,352 6,863 7,484 8,146 Net profit 19 (16) (25) (5) 7 7 EPS 19 (16) (25) (5) 7 7 Total assets 5,495 6,499 7,307 7,919 8,629 9,374 Margin & ratios (%) Current liabilities Gross margin 40.8 40.7 40.2 40.3 40.4 40.6 A/C payables 499 483 601 619 670 726 OP margin 22.0 20.4 20.6 18.9 19.1 19.3 Other payables 227 287 333 342 363 386 Net margin 17.4 14.6 14.0 12.9 13.0 13.0 Bank borrowings 492 511 1,351 1,024 1,330 1,646 Effective tax rate 20.3 27.0 30.1 30.0 30.0 30.0 Tax payables 182 156 72 69 74 80 Payout ratio 50.0 61.0 51.3 51.0 51.0 51.0 1,400 1,437 2,356 2,054 2,437 2,837 Cash flow statement Non-current liabilities Year ended 31 Dec (RMBm) FY11 FY12 FY13 FY14E FY15E FY16E Bank borrowings 0 535 175 776 776 776 Profit before tax 1,211 1,106 863 826 884 951 Deferred tax liabilities 69 133 153 153 153 153 Depreciation and amortization 29 39 49 54 60 68 Deferred tax liabilities 115 115 115 115 115 115 Net finance cost 10 23 32 22 24 30 184 783 443 1,045 1,045 1,045 (Reversal of)/provision for impairment of receivables 0 77 51 33 10 0 Write-down/(reversal write-down) of inventories 0 0 (100) 0 0 0 Equity Others 38 43 14 1 0 0 Shareholders' equity 3,907 4,274 4,506 4,818 5,144 5,483 Change of working capital (955) 329 75 (186) (148) (180) Non-controlling interests 4 5 2 2 4 9 Interest received 25 40 46 41 49 53 3,911 4,280 4,508 4,820 5,148 5,492 Interest paid (30) (51) (65) (63) (72) (82) Tax paid (123) (276) (308) (254) (256) (275) Total liabilities & equity 5,495 6,499 7,307 7,919 8,629 9,374 Operating cash flow 204 1,330 658 474 550 564 Financial ratios Capex (220) (176) (230) (150) (150) (150) Year ended 31 Dec FY11 FY12 FY13 FY14E FY15E FY16E (Acquisition)/disposal of subsidiaries 0 0 4 0 0 0 Current ratio 3.6 4.1 2.7 3.3 3.1 2.9 Receipt of government subsidy 115 0 0 0 0 0 Quick ratio 3.1 3.7 2.5 3.0 2.8 2.6 Increase in pledged deposit (522) (36) (158) (185) (153) (158) Increase in time deposit with maturity over three months 0 0 (110) 0 0 0 A/C receivable turnover days 64 74 92 96 98 102 Change of AFS financial investments 0 (133) 100 0 0 0 A/C payable turnover days 63 54 76 83 83 85 Others 0 0 100 0 0 0 Inventory turnover days 63 70 79 84 92 95 Investing cash flow (627) (345) (294) (335) (303) (308) Asset turnover 1.0 0.9 0.6 0.6 0.6 0.5 Change of borrowings 492 556 503 275 306 316 Total assets/total equity 1.4 1.5 1.6 1.6 1.7 1.7 Capital contributions by a non-controlling s 5 4 0 0 0 0 Net gearing ratio (%) net cash net cash net cash net cash net cash net cash Dividend paid (450) (490) (428) (303) (305) (326) Others 0 (1) 3 0 0 0 ROE (%) 26.6 19.8 13.8 12.4 12.4 12.4 Share issue 1 0 1 3 0 0 ROA (%) 19.8 13.5 8.8 7.6 7.5 7.3 Financing cash flow 48 69 78 (26) 1 (10) Net change of cash flow (375) 1,055 442 113 248 245 Sources: Company data, GF Securities (HK) estimates Page 6
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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The recipients should be aware of relevant disclosures of interests (if any) when reading this report. Copyright GF Securities (Hong Kong) Brokerage Limited. Without the prior written consent obtained from GF Securities (Hong Kong) Brokerage Limited, any part of the materials contained herein should not (i) in any forms be copied or reproduced or (ii) be re-disseminated. GF Securities (Hong Kong) Brokerage Limited. All rights reserved. 29-30/F, Li Po Chun Chambers, 189 Des Voeux Road Central, Hong Kong Tel: +852 3719 1111 Fax: +852 2907 6176 Website: http://www.gfgroup.com.hk Page 7