September 27, 2010
361°(1361 HK)
HK$10.00 COMPANY INSIGHTS Target price
Up/downside +39% Play the Asian Games Current price HK$7.18 Prestige sponsorship of the Asian Games and the launch of kids’ specialty shops to build brand equity and drive sales… 361° ad linking brand to the Asian Games and the Games Town Gymnasium
Matthew Marsden Analyst We initiate coverage on 361° at BUY with at target price of HK$10.00. [email protected] +852 3411 3710 This stock has been on a tear, gaining 99% since listing in June 2009, but we see a series of positive catalysts that will drive the shares even higher: Summer Wang [email protected] Our research shows that the 361° brand is genuinely differentiated, +852 3411 3723 enabling the company to maintain growth in an increasingly competitive sports market. Prestige sponsorship of the Asian Games, to be held this Technical analysis contributed by: November in China for the first time in 20 years, should build brand Seung Min You and Sang Cheol Im [email protected] equity and drive sales. Samsung Securities Korea* 361°‘s launch of specialty kids‘ stores will provide a new leg of growth and gives upside risk to our forecasts; we view this as a ―free option.‖ SAMSUNG vs THE STREET We anticipate that the 1QFY11 (year ends June 30) trading update—to be Stock market fashion in released in late October—will continue to show healthy same-store-sales apparel stock‘s valuation? growth as retail consultant S1MONE helps 361° redesign stores to
No. of Bloomberg estimates 5 enhance efficiency. Target price vs Bloomberg mean +24% We look for 23% YoY bottom line growth in the 1HFY11 results to be FY11 EPS vs Bloomberg mean +3% released in February 2011. FY12 EPS vs Bloomberg mean +5% Bloomberg rating Buy/Hold/Sell 5/0/0 We argue that the market‘s current valuation for some apparel stocks, relative
We cannot help musing on the differential in to sportswear, smacks of irrationality. This will inevitably right itself in the valuation multiples that the market is currently longer-term, much to the benefit of 361° shareholders. apportioning to certain apparel stocks.
The branded kids retailer Boshiwa has IPOed in We apply a P/E target of 14.9x to our calendarized 2011E EPS to reach our 12- HK this month at a P/E of 34.8x 2010. month target price of HK$10.00, representing 39% upside. Longer-term, we HK listed menswear retailers China Lilang and see a bright future for the stock given our forecasted EPS CAGR of 20% across Trinity trade on 2011 P/E multiples of 22.1x and 28.8 x, respectively, according to Bloomberg. FY11-13E. 361° is trading on a CY 2011E P/E of 10.7x. Figure 1: Summary financial data It occurs to us that there is a certain amount of Rmb m, (year ends Jun 30) FY08 FY09 FY10 FY11E FY12E FY13E stock market fashion in these valuations; Revenue (Rmb m) 1,317 3,447 4,331 5,429 6,560 7,846 Menswear and kidswear are “hot”, while YoY growth 252.8% 161.7% 25.7% 25.4% 20.8% 19.6% sportswear is simply not, irrespective of the fact Net profit (Rmb m) 179 632 917 1,100 1,332 1,595 that the majority of sportswear is, in fact, casual YoY growth 681.2% 253.2% 45.0% 19.9% 21.1% 19.7% men’s and kids’ attire (we estimate that around Net profit margin 13.6% 18.3% 21.2% 20.3% 20.3% 20.3% 65% of existing sales at 361° are to men and kids). Diluted EPS (Rmb) 0.12 0.42 0.44 0.53 0.64 0.77 P/E NA 15.0x 14.2x 11.8x 9.8x 8.1x Does all this smack of market irrationality that will Dividend yield NA 2.2% 2.1% 3.4% 4.6% 6.2% inevitably right itself in the long-term, much to the ROE (average) 80.5% 44.7% 30.9% 28.9% 28.3% 27.8% benefit of 361° shareholders? We think so. Note: P/E based on HK$7.18 as of market close Sep 24 Source: Company data, Samsung Securities estimates
This report has been prepared by Samsung Securities (Asia) Limited. *Not licensed in Hong Kong nor carrying on any business in Hong Kong. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES BEGIN ON PAGE 35
361°
THE PITCH RETURN FORECAST 361° is under-covered - only five analysts have forecasts on Bloomberg, compared to 29 for both Li Ning and Anta - and undiscovered - 361° trades on 11.8x FY11E P/E yet offers a FY11-13E earnings CAGR of 20%. Given the strength of the brand, excitement around the company’s sponsorship of the 2010 Asian Games and the 2011 University Games, entry into the kids’ marketplace and the prospects for sustained earnings growth, we think that 361° is fundamentally undervalued and should continue to rerate upwards. ★<15% ★★15-30% ★★★>30% Stars reflect absolute value of up/downside to target price
Fundamentals ★★★ FUNDAMENTALS 361 has good brand differentiation, is entering into the kids’ marketplace and has decent prospects for The 361° brand is differentiated from the competition by embodying a pure sustained earnings growth. love of sport, more about participation than winning. Valuation ★★★ Our P/E based 12-month target price implies 39% O&M’s excellent creative work for two advertising campaigns has helped to upside, and we initiate with a Three-Star-BUY. set a new manifesto for 361° as an everyday brand. Technicals ★★★ We see continuing positive momentum. The company’s prestige sponsorship of the 2010 Asian Games and 2011 University Games increase brand presence and credibility.
VALUATION Moreover, 361° is wholeheartedly entering into the kids’ market. 06-10A 06-11E 06-12E A new series of flagship 361° Town stores, over 1,000 sqm in size is being P/E 14.2x 11.8x 9.8x rolled out across China. P/B 3.8x 3.1x 2.5x EV/EBITDA 10.7x 8.4x 6.9x Our checks at the company’s factory and recent trade fair reveal good Dividend yield 2.1% 3.4% 4.6% operations. ROE 30.9% 28.9% 27.8% FY10 results show decent momentum. We forecast EPS CAGR of 20% across FY10-13E. SAMSUNG vs THE STREET
Samsung Street VALUATION Target Price HK$10.00 HK$8.09 EPS 06-11E Rmb0.53 Rmb0.52 We use a 10% discount to the peer group average 2010 P/E to arrive at a EPS 06-12E Rmb0.64 Rmb0.61 multiple target of 14.9x. Buy/Hold/Sell Buy Buy We use calendar 2011E EPS to arrive at a 12-month price target of AT A GLANCE HK$10.00, representing 39% upside and a Three-Star-BUY rating.
Business summary We cannot help wondering if the market’s current valuation for some 361° is one of the leading mass market sportswear apparel stocks, relative to sportswear, smacks of irrationality. We think that brands in China. The company is the fourth-largest this will inevitably right itself in the longer-term, much to the benefit of 361° listed Chinese sportswear brand by revenue and market cap. shareholders. Sector Consumer Market cap. HK$14,830m TECHNICALS Market cap. US$1,911m Shares out. (float) 2.07bn (29%) With the major resistance level being breached in early August, our 52 week high-low HK$7.20-3.80 technical analysts see a continuing uptrend. Bloomberg 1361 HK Price performance 1M 6M 12M 361° +13% +16% +83% BEAR VIEWS & BLUE SKIES Hang Seng Index +7% +5% +5% In a bear view scenario, assuming slowing top line growth, declining net profit margin (to 18%) and low valuation multiple (11.8x P/E), we arrive at a valuation of HK$5.73, implying 20% downside.
In a blue sky scenario using a DCF valuation, we arrive at a fair value of HK$12.20, implying 70% upside.
The risk/reward scenario for the stock looks attractive.
THREE NUMBERS THAT MATTER
Trade fair YoY Sales Growth Oct-Dec 2010 EPS CAGR FY11-13E ROE FY11E 31% 20% 29% The 2Q FY11 trade fair saw an impressive 31% We see a bright future for the stock given our 361° offers a stable and attractive ROE of 29% in YoY increase in sales, reflecting the benefit of forecasted EPS CAGR of 20% across FY11-13E. FY11E. 361°’s prestige sponsorship of the Asian Games.
September 27, 2010
361°
INDEX
Business fundamentals p3 Valuation p16 Technical analysis p20 Bear Views & Blue Skies p22
Business fundamentals ★★★ 361 has good brand differentiation, is Business Fundamentals entering into the kids’ marketplace and has decent prospects for sustained earnings growth. Power to the people!
361° is one of the leading mass-market sportswear brands in China. Just seven years after inception in 2002, the company listed on the HKEX and has become the fourth- largest listed Chinese sportswear brand by revenue (at end CY09 – see page 15).
Over the past three years, the retail network at 361° has rapidly grown to around 7,000 points of sale. Over 70% of its stores are located in fast-growing tier-3 and 4 cities, with 21% of them in tier-2 cities. The company plans to open a further 600-800 361° stores, plus an additional 300 devoted kidswear stores, per year over 2010-2012.
In this report, we explore the 361° brand and its growth prospects, and conclude that the shares are fundamentally undervalued. Moreover, we identify a series of positive date catalysts that should trigger further gains for the stock.
The power’s in the brand
The 361° brand is The 361° brand is differentiated from its competition. Ogilvy & Mather China (O&M), differentiated, embodying a the company‘s appointed advertising agency, has positioned 361° to embody a pure pure love of sport love of sport, which is about the joy of participation - this approach was chosen as no other brand had occupied this space.
This branding is distinct from other players with a more competitive harder image—eg, Nike: ―Just do it,‖ adidas: ―Impossible is nothing,‖ Peak: ―I can play,‖ etc—which are more about winning.
Figure 2: 361° brand positioning
Source: 361°
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Figure 3: The Vow campaign in outdoor advertising… …and in print
Source: Ogilvy & Mather
O&M has created advertising for 361° that links the brand to both ordinary peoples‘ love of sport, and the company‘s sponsorship of national professional teams and major sporting events. The company‘s strap line is literally translated as ―One love.‖ O&M has created original and impactful advertising for The company has run two campaigns using O&M‘s creative: 361° The Vow
The Vow campaign is based on a set of marriage vows, but instead features both everyday people and professional athletes swearing to be forever faithful to the sport that they love—eg, a boy with his basketball vowing: ―To be with you together, from this day forward. I do,‖ and a professional badminton player vowing: ―To love you for better or for worse. I do.‖
NB: Part of the campaign was based around 361 stories of everyday people and running—the firm‘s website invited people to send in videos of themselves, and the creative work starred everyday runners. The creative was designed to help bridge the gap between everyday people and sport. NB running is at the heart of the brand.
O&M‘s work set a new manifesto for the brand and ran for one year from March 2009, using a fully integrated TV, outdoor, print, on-line, and in-store strategy. The theme was also successfully extended to the firm‘s internal communications.
Figure 4: One Love on TV: The campaign featured 361 stories of everyday people and their love of running
Source: Ogilvy & Mather
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Figure 5: The One Love campaign in retail stores and in the office pantry “You can put down everything here, except love”
Source: Ogilvy & Mather
A 2009 brand tracking report from MillwardBrown, commissioned to measure advertising effectiveness, reveals that the campaign enhanced brand image in several dimensions, including awareness, preference, and purchase rate.
Campaign brand linkage was 80% (10% higher than norm). This measures the percentage of consumers that could recognize the brand from advertising images and is used as a measure of campaign cut through.
79% of the audience had 79% of the audience had better impression towards 361° after the campaign. better impression towards 361° after the campaign Purchase rate among campaign recognizers was 8% higher than non-recognizers. (28% vs 20%).
The Asian Games
This campaign runs December 2009 through to the end of the games in November 2010 and is based on Asia‘s love of sport.
The campaign is in three phases:
1. Focused on training, with adverts running December 2009 - April 2010.
2. On getting equipped and features 361° sponsored national Chinese teams (eg, handball, cycling, triathlon) getting ready, running from May to September 2010.
3. Ads showing everyone sharing the love of sports at the Asian Games, involving athletes, spectators, referees, coaches—everyone. This phase runs October- November 2010 and will be the most advertising media intense part of the campaign.
This first-class marketing execution has enabled the 361° brand to achieve a level of differentiation which should enable the company to maintain growth in an increasingly competitive sports market.
In line with the brand image, 361° sponsors sports at both grass roots and at a national professional level – in fact, 80% of advertising & promotion (A&P) spend this fiscal year is earmarked for sponsorship (A&P is expected to be at around 9.5% of total sales in FY11E).
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Figure 6: 361° ads linking the brand with the Asian Games via equipping the athletes and prestige sponsorship
Source: 361°
Play the Asian Games
The 16th Asian Games will be held over November 12-27 2010 in Guangzhou. This is the first time in 20 years that a Chinese city has hosted the Games, so the event is 12,000 athletes from 45 important for the PRC in the international sporting events arena. Around 12,000 countries will participate in athletes from 45 countries are expected to participate in the Games, making it the the Asian Games largest one in its history.
The Games will be hosted in 53 world-class competition venues in Guangzhou and the neighbouring cities of Foshan, Dongguan, and Shanwei. A total of Rmb15bn (US$2.2bn) is being poured into the construction of new venues and the upgrading of existing ones (we note that Hong Kong is currently bidding for the 2023 Asian Games for an estimated capital and operating cost of US$1.9bn).
Some of the venues that will be purpose-built for the Games include the Guangdong Olympic Aquatics Centre, the Guangzhou Velodrome, and the Asian Games Town Gymnasium.
The opening and closing ceremonies will be held on Haixinsha Island, a new urban development in Guangzhou. Chen Weiya, chief director of the Games‘ ceremonies, is renowned for his work in orchestrating the spectacular ceremonies for the 2008 Beijing Olympics. He was inspired by the shape of the island, which resembles a boat sailing eastwards, and has revealed that water will play a key role in the ceremonies.
Figure 7: The Asian Games Town Gymnasium… Figure 8: …and the Aquatics Centre
Source: www.gz2010.cn
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Figure 9: Torch for the 2010 Asian Games
Source: www.gz2010.cn
The Asian Games will showcase 42 sports, 14 of which are unique to the Games, including the Malaysian kick volleyball game of sepak takraw and the ancient Indian combative sport of kabaddi.
State-of-the-art media centre A new state-of-the-art media centre will accommodate nearly 10,000 media personnel will host 10,000 personnel that are expected to converge in Guangzhou and will broadcast the sporting competitions live around the world.
The torch for the Asian Games is an integral part of the event and is used to light the cauldron, which remains lit throughout the Games. The design of the 2010 torch, named The Tide, uses ivory carving techniques unique to the Guangdong province.
The torch relay will start at the Temple of Heaven in Beijing in October, passing through 21 major cities and over 2,000 torchbearers‘ hands to reach Guangzhou four weeks later.
Figure 10: 361° sponsored events
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Source: Company data
361° has been chosen as the prestige sports brand sponsor of the Asian Games, for an undisclosed sum.
This underscores the arrival of the brand and acceptance from the Chinese Sponsoring the Asian Games authorities and professional sports bodies. has many benefits for 361°, not least by boosting trade This will clearly enhance the profile of 361°, building brand equity. fair orders This will enhance the brand‘s visibility on Chinese media, notably the dedicated sports channel CCTV5, which 361° also sponsors.
The company is fully exploiting the brand building opportunity from the sponsorship in their above-the-line advertising campaign based on the Asian Games, running December 2009-November 2010.
The beneficial impact on sales has already been seen in the pre-orders for the 2Q FY11 (October-December 2010) trade fair. The order book grew by 31% YoY, with footwear ASP and volume increasing by 10% and 13%, and apparel ASP and volume climbing by 17% and 20%, respectively.
We note that 361° has won the prestige sponsorship for both of the major international sporting events to be held in China over the next three years, namely the Asian Games and the summer 2011 University Games to be held in Shenzhen. China is hosting no other international events of this nature until the Junior Olympics in 2014.
“Little emperors” wear trainers too
Another important development at 361° is the launch of a dedicated kids‘ brand. The company currently has around 300 separate kids‘ outlets and intends to build out around 300 per annum for the next three years. Kids‘ specialty outlets will be around 60 sqm on average, vs 93 sqm on average for a regular store today.
Spurred by the one-child policy in China and rising disposable income, Chinese families are willing and able to spend an increasing proportion of family income on their children.
According to Frost & Sullivan, each urban household spent an average of 10% of their disposable income on children‘s products (including apparel, household products like strollers and toys, and FMCG products like diapers) in 2005, which rose to 15% in 2009.
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Figure 11: Annual expenditure on children’s products per urban household in China, 2005-13E
9,000 25% 8,000 7,000 20% 6,000 15% 5,000 4,000 10% 3,000
2,000 5% 1,000 0 0% 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E
Annual expenditure on Children's products per urban households in China (RMB, LHS)
Expenditure on Children's products per urban households YoY growth (RHS)
Source: Frost & Sullivan
China has 251m children (from newborns to 14-year olds), accounting for 18.8% of the 2009 total population.
Expenditure on kids in China On average, the annual expenditure on children‘s products per urban household is should grow at a CAGR of expected to approach Rmb8,000 in 2013E from Rmb4, 500 in 2009, representing a 15.1% 2009-13E CAGR of 15.1%.
Figure 12: The children’s product market is expected to grow at a CAGR of 17% 2009-13E
350 30%
300 25% 250 20% 200 15% 150 10% 100
50 5%
0 0% 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E Chidren's products market in China (RMBbn, LHS) Chidren's products market growth YoY (RHS) Source: Frost & Sullivan
In China, the kidswear sector accounts for about 42% of total apparel products. The market is predicted to grow at a CAGR of 17% over 2009-13E, vs a CAGR of 15% for annual expenditure on all children‘s products over the same period.
By segment, the high-end apparel (winter clothes above Rmb600 and other apparel above Rmb300) accounts for about 70% of the market, and the mid-high end (winter clothes Rmb200-600 and other apparel Rmb100-300) makes up about 20%. The remaining 10% is taken up by the low-end market (winter clothes below Rmb200 and other apparel below Rmb100).
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We note the retail ASP of 361° winter and summer apparel is Rmb180 and Rmb150, respectively.
Figure 13: Children’s apparel market in China 2005-13E
140 50% 45% 120 40% 100 35%
80 30% 25% 60 20% 40 15% 10% 20 5% 0 0% 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E
Children's apparel market in China (RMBbn, LHS) Children's apparel market growth YoY (RHS) Children's apparel as % of the total children products' market (RHS)
Source: Frost & Sullivan
361° intends to tap into the 361° intends to tap into the kids market and has made a firm commitment to develop a specialty kids market distinct kids brand. Management expect that the kids‘ series will contribute 10% of sales by FY15E, driven by the expansion of devoted children‘s stores and product corners within 361° stores.
Figure 14: Kidswear section in 361° Town in Zhengzhou, Henan province
Source: 361°
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Free option
We note that the recent Hong Kong IPO of Boshiwa (1698.HK, NR), a Chinese retailer of branded children‘s clothing which begins trading on Sept 29, has been extremely successful. The company raised HK$2.49bn (US$321m) selling stock at the top of the offer range of HK$3.88 – 4.98 per share. We understand that both the institutional and public tranches are significantly oversubscribed.
According to the prospectus, the company‘s 2010 net profit guarantee is equivalent to Rmb0.125 per share, meaning that the Boshiwa listing has been accepted by the market at a 2010 P/E of 34.8x.
In our view, there is good potential for growth in the children‘s sportswear segment, which is currently extremely fragmented with no dominant player. We view 361°‘s expansion into the kids‘ market as a ―free option‖ for investors in the stock ie we believe that there is likely long-term additional growth and/or valuation benefits from the company‘s venture into the kids‘ specialty outlets.
361° Town
New flagship 361° Town To enhance brand image the company is working with its distributors to build a series stores are being rolled out of flagship stores over 1,000 sqm in size called 361° Town, which are able to display all product categories in a high quality branded space.
The stores are divided into four main areas:
Professional sports; running, training, football, basketball, tennis, table tennis, badminton, cycling and yoga
Leisure fashion products; sports and outdoor
New channel display; kids and lifestyle
Plus an events themed area
361° Towns are currently open in Zhengzhou, Harbin, Wuhan, Baoding and Jinan, and the company has plans to open in another 10 locations over the next two years (in Shengyang, Lanzhou, Changsha, Guangzhou, Quanzhou, Hangzhou, Nanchang, Nanjing, Kunming, and Chengdu).
Figure 15: 361°’s first flagship 361° Town store in Zhengzhou, Henan
Source: 361°
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Notes from the road
We visited the 361°‘s spring/summer trade fair in Jin Jiang in Fujian Province, and spent a day with management in late August.
Two main points from our tour of company facilities:
The company has a unique and impressive 20,000 sqm facility that is used to house three huge annual trade fairs, to train retailers and staff and contains a 361° museum and brand mission display. We think that this provides a competitive advantage in training staff, being able to host large and long- lasting trade fairs and giving the brand a geographical home.
The company‘s factories are clean, modern, and safe. Staff wears 361° uniforms, work in an air-conditioned environment, and have a choice of three enormous canteens - where a two-course meal can be had for Rmb5.
Three main points from our conversations with management:
361° are concentrating on improving store profitability and have hired the retail consultant S1MONE to help to redesign stores. We note that 361° is the only HK- listed sports brand to show positive momentum in same-store-sales growth this year. Reported same-store-sales growth improved from +16.0% YoY in 3QFY10 to +16.9% in 4Q (1QFY11 figures should be available in late October).
Management is committed to the kids‘ initiative, which has a product exclusively designed and marketed for kids, with specially branded stores to be rolled out nationally.
While seeming to wish to guide conservatively, management are confident about the prospects for sustained growth. This is supported by the latest results release.
Figure 16: Factory floor Figure 17: 361° brand mission hall
Source: 361°
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FY10 results highlights (FY ending June 2010, released August 24):
Turnover increased by 25.7% YoY to Rmb4,331m.
Gross profit increased by 42.9% YoY to Rmb1,706m, while gross profit margin increased from 34.6% to 39.4%. This is a very positive achievement considering the market's fears over cost inflation (eg cotton and labour cost hikes).
Net income up 45.0% YoY to Rmb917m
EPS up 5.2% to Rmb44.3 cents. The stock IPOed in June 2009 so weighted average number of shares increased —it's more meaningful to look at the net income line to measure underlying profit growth of the business.
Total dividend of Rmb13.3 cents (equivalent to HK15.2 cents) per share for the year and a total payout of Rmb274.7m, representing a 30% dividend payout ratio, vs 20% promised in the prospectus.
Importantly, A/R days fell to 97 from 139 at December 2009, which we think was a major relief to the market. We expect A/R days to continue to decrease as the company improves its financial discipline going forward.
The company is holding Rmb2.4bn in cash, roughly 18% of market cap.
Net addition of 872 outlets to 6,927 stores. We continue to be impressed at the speed of roll out that China brands can achieve using the distributor system. A discussion of the pros and cons of this system can be found in Appendix III.
Strong FY10 results have The company beat FY10 consensus estimates by 9%, according to Bloomberg, which enabled the stock price to combined with positive guidance, has taken the stock price to new highs during make new highs during September. September Company guidance and our forecasts:
Sales
The company is in an excellent position to capitalize on above-average consumption- growth trends in China‘s sportswear hinterland. The firm has secured a promising market niche in second and third-tier cities thanks to its differentiated branding, strong association with grass roots sports, and sponsorship of major sporting events.
Trade fairs give us good visibility on sales growth for companies like 361° (and Peak Sport, China Lilang, etc) which use the Chinese distributor system.
361° reported that its latest trade fair orders grew by 20% for the spring/summer 2011 season:
Volume for footwear and apparel products increased by 15% and 11%, respectively.
Average selling price for footwear and apparel products improved by 4% and 9%, respectively.
The orders placed for 361° Children‘s Collection amounted to about Rmb130m, representing three times that which were obtained from the inaugural trade fair for children‘s wear in September 2009.
These orders will be filled in the period from November 2010 to June 2011.
Sales should be driven by new store expansion and management focus on store We forecast sales to grow at a CAGR of 20.2% FY11-13E efficiency. We see another 2,700 net new stores, including 900 kids‘ specialty outlets, over FY11-13E and forecast sales to grow at a CAGR of 20.2% during the period.
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Figure 18: 361° EBIT, net profit and net margin estimates
3,000 25.0%
2,500 20.0%
2,000 15.0% 1,500 10.0% 1,000
5.0% 500
0 0.0% FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E FY14E FY15E
EBIT (LHS, RMBm) Net profit (LHS, RMBm) Net margin (RHS)
Source: Company data, Samsung Securities estimates
Margins
Our EBIT margin assumptions rise from 24.0% in FY10 to 25.0% in FY13E, driven by economies of scale pushing gross profit margins plus operational leverage, even as R&D and A&P spend gradually increase as a percentage of sales, as the company continues to invest in brand differentiation.
However, our forecasts for net margin lag EBIT margin expansion, as we assume effective tax rate rises from 12.7% in FY10 to 18.0% in FY11-12E, 20.0% in FY13E and 25.0% in FY14E. That said, we still estimate a respectable net profit CAGR of 20.4% FY11-13E.
Dividend
The company guide that the dividend payout ratio will continue to rise from 30% in FY10 to 50% over the next couple of years. We forecast a dividend payout ratio of 40% in FY11E, rising to 50% by FY13E, resulting in a dividend yield of 3.4% in FY11E, rising to 6.2% in FY13E.
Under-covered and undiscovered
We think that 361° is still This is the most uncovered (just five sell-side analysts follow this stock, according to fundamentally undervalued Bloomberg) and cheapest (FY11E P/E of 11.8x) stock in the Chinese sports sector. and should continue to rerate upwards Given the strength of the brand, entry into the kids‘ marketplace and the prospects for sustained earnings growth, we think that 361° is fundamentally undervalued and should continue to rerate upwards.
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Figure 19: China sportswear sector operation analysis Li Ning Anta Peak 361 Degrees Xtep Dongxiang Established 1989 1994 1992 2002 1999 2002 Listing year 2004 2007 2009 2009 2008 2007 Stock code 2331 HK 2020 HK 1968 HK 1361 HK 1368 HK 3818 HK Market cap (US$ m, 24 Sept 2010) 3,393 5,392 1,581 1,911 1,774 3,395 Focus Performance sports Performance sports Performance sports Performance sports Fashion sports Fashion sports Li Ning, Lotto, Aigle, Z-do, Xtep, Disney Sport, Kappa, RDK, Phoenix, Brand portfolio Anta, Fila Peak 361° Double Happiness, Kasen Koling Inhabitant, X-Nix Badminton, Table tennis, Running, Basketball, Key sports category Basketball, Tennis, Running Basketball Running Football, Skiing Running, Yoga Diving China National Badminton and Chinese Olympic Committee, 2010 Asia Games, Olympic China 11th National Norwegian Olympics table tennis team, Sudirman CBA, CUBA, NBA player Luis NBA, FIBA, NBA players Council of Asia, China Games, Birmingham teams, China Tennis Key sponsorship / partnership Cup, NBA player Shaquille Scola, Tennis player Jelena Shane Battier, WTA etc Table Tennis Super City Football Club, Open, Some Japan O'Neal, Elena Isinba Jankovic, Dalian Int'l Marathon League Xiamen Intl Marathon and Italian soccer club Slogan Make The Change Keep Moving I Can Play One Love Love running, Love Xtep We are One No. of outlets (key brand, as of June 2010) 7,478 7,052 6,796 6,927 6,579 3,820 Total selling space (sqm) NA 776,000 503,098 644,211 555,000 NA Average store size (sqm) NA 110 74 93 84 NA Distribution CY09 Wholesale Footwear ASP (Rmb) 146.5 95.7 84.4 79.8 79.4 179.0 Wholesale Apparel ASP (Rmb) 98.0 60.5 53.5 61.8 62.0 160.0 Wholesale price as % of retail price 51-60% 41-42% 39% 38% 38% 48-52% No. of distributors 128 50 37 32 28 41 Financials CY09 Revenue (US$ m) 1,230 861 454 565 520 582 Revenue split Home market / Intl (%) 99/1 99/1 91/9 100/0 100/0 86/14 Wholesale / Retail / Others (%) 89/11/0 100/0/0 100/0/0 100/0/0 100/0/0 100/0/0 Footwear / Apparel / Others (%) 42/47/11 56/41/3 45/52/3 50/48/2 46/53/1 20/76/4 % Production outsourced 100% 56% 40% 75% 41% 100% Gross margin 47.3% 42.1% 37.5% 38.8% 39.1% 60.4% Footwear gross margin 45.1% 44.4% 38.0% 39.6% 39.1% 54.5% Apparel gross margin 49.8% 39.0% 37.1% 37.9% 39.1% 65.3% Operating margin 16.0% 23.7% 23.2% 25.5% 19.8% 42.7% Net margin 11.3% 21.3% 20.3% 22.3% 18.3% 36.8% Effective tax rate 24.5% 13.6% 10.6% 11.4% 7.8% 18.7% A&P (% of sales) 15.4% 12.7% 11.3% 8.6% 11.8% 7.4% Staff cost (% of sales) 7.5% 9.1% 5.2% 3.1% 5.4% 4.6% R&D cost (% of sales) 2.7% 3.0% 0.3% 0.3% 1.6% 2.3%
Source: Company data, Samsung Securities
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INDEX
Business fundamentals p3 Valuation p16 Technical analysis p20 Bear Views & Blue Skies p22
Valuation ★★★ Valuation Our P/E based 12-month target price implies 39% upside, and we initiate with a Three- Star-BUY. Stock market fashion
in sport stock‘s valuation?
361° has gained 99% since 361° sold 500m new shares, or a 25% stake, for HK$3.61 raising HK$1.8bn (US$232m) listing, but still has good at listing in June 2009. The stock got off to a good start, rising 14% in its trading debut upside on a 12-month view in Hong Kong. 361° has now gained 99% on the listing price, but we believe there is still good upside.
Indentifying date catalysts
We think that strong bottom line growth, decent return metrics eg FY11E ROE of 29% and rising dividend payout ratio, from 30% in FY10 to 50% in FY13E, will justify valuation multiple expansion for the stock.
Moreover, we identify several positive date catalysts:
Our research shows that the 361° brand is genuinely differentiated, which will enable the company to maintain growth in an increasingly competitive sports market. Prestige sponsorship of the Asian Games, to be held in China for the first time in 20 years this November, will help to build brand equity and drive sales.
361°‘s launch of specialty kids stores will provide a new leg of growth and gives upside risk to our forecasts.
We anticipate the 1Q FY11 trading update, likely to be released in late October, will continue to show healthy same-store-sales growth as retail consultant S1MONE helps 361° redesign stores to enhance efficiency.
We look for 23% YoY bottom line growth to be reported at 1H FY11 results to be released in February 2011.
Only five brokers now follow 1361 HK (vs 29 for Anta Sports and Li Ning, according We see valuation multiple to Bloomberg). Given the company‘s decent growth prospects, compelling valuation expansion for the stock, helped by positive date and the catalysts described above, we expect more brokers to cover the stock over catalysts time, which will increase market awareness of the story.
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Figure 20: 361° one-year forward P/E
12.00
HK$ 14x 10.00 12x 8.00 10x
6.00 8x
6x 4.00
2.00
0.00
09 10 11
09 10 10 11
09 10
09 09 09 10 10 10
10 10 11 11
10 11
10 11
09 10
- - -
- - - -
- -
------
- - - -
- -
- -
- -
Jul Jul
Apr Apr
Oct Oct
Jan Jun Jun Jan Jun
Feb Mar Feb Mar
Sep Nov Sep Nov
Aug Dec Aug Dec
May May
Source: Bloomberg, Samsung Securities
Defining the peer group
We define a peer group of six Hong Kong-listed China brands in the sports sector. The peer group simple average 2010 P/E estimate is 16.6x, according to Bloomberg.
Figure 21: Peer group comparison BBG Free Sales YoY EPS YoY Company code Mkt cap float growth growth P/E ROE EBIT margin Dividend yield P/B name (US$ m) CY10e CY11e CY10e CY11e CY10e CY11e CY10e CY11e CY10e CY11e CY10e CY11e CY10e CY11e Li Ning 2331 HK 3,393 63% 17.1% 18.1% 18.9% 19.1% 20.0x 16.8x 37.2% 35.4% 15.8% 15.8% 2.0% 2.4% 6.7x 5.3x Anta 2020 HK 5,392 31% 23.6% 24.0% 20.3% 22.8% 24.0x 19.5x 27.4% 28.9% 24.0% 24.5% 2.5% 3.1% 6.2x 5.4x Dongxiang 3818 HK 3,395 47% 17.5% 15.7% 10.1% 12.7% 14.1x 12.5x 21.0% 21.7% 40.9% 40.8% 5.0% 5.6% 2.7x 2.5x Xtep 1368 HK 1,774 25% 23.2% 21.2% 20.1% 20.1% 15.2x 12.7x 24.4% 25.8% 20.0% 20.1% 3.8% 4.5% 3.7x 3.2x 361D 1361 HK 1,911 29% 25.7% 23.8% 11.0% 17.4% 12.9x 11.0x 29.8% 27.8% 23.6% 23.9% 2.8% 4.0% 3.4x 2.8x Peak Sport 1968 HK 1,581 39% 32.9% 27.6% 5.3% 27.4% 13.3x 10.4x 25.3% 25.8% 22.9% 23.4% 2.8% 3.5% 3.2x 2.6x Sportswear sector mkt cap weighted average 22.2% 21.3% 15.6% 19.7% 18.2x 15.2x 27.8% 28.0% 25.1% 25.4% 3.1% 3.7% 4.8x 4.0x Sportswear sector simple average 23.4% 21.7% 14.3% 19.9% 16.6x 13.8x 27.5% 27.6% 24.5% 24.8% 3.1% 3.8% 4.3x 3.6x
Source: Bloomberg consensus as of Sept 24 market close
P/E based target price implies 39% upside
We feel comfortable applying We feel comfortable applying a discount of 10%, to account for 361°‘s relative illiquidity a target multiple of 14.9x to arrive at a target multiple of 14.9x (361° has three-month average liquidity of US$3.4m per day NB on the last trading day before the publication of this report the stock traded up 7% on volume of US$19m).
If all goes to plan, the stock should re-rate further. We note that Anta Sports, which has a similar distributor based retail model to that of 361°, currently trades at P/E multiples of 24.0x 2010 and 19.5x 2011E.
We take a 12-month view and We take a 12-month view, and thus use the calendar 2011 EPS estimate as the basis for thus use calendar 2011E EPS our P/E based target ie we believe that in late September 2011 this stock should trade on 14.9x calendarized 2011E EPS.
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14.9x our calendar 2011E EPS of HK$0.67 (Rmb0.59) gives us a 12-month target price of HK$10.00, rounding down to the nearest HK dollar.
We note that at our target price the stock would trade on P/E multiples of 16.5x FY11E and 13.6x FY12E.
Our target price of HK$10.00 Our target price is the highest in the market, as our FY12E EPS estimate is 5% above is the highest in the market consensus and our horizon is longer than other brokers covering the stock.
Our target represents 39% upside and we initiate coverage with a Three-Star-BUY rating.
Stock market fashion in sport stock’s valuation?
We cannot help musing on the differential in valuation multiples that the market is currently apportioning to certain apparel and sportswear stocks.
As previously discussed, the branded kids retailer Boshiwa has successfully IPOed at a P/E of 34.8x 2010.
HK listed menswear retailers China Lilang and Trinity trade on 2011 P/E multiples of 22.1x and 28.8 x, respectively, according to Bloomberg (on our estimates, 361° is trading on a CY 2011E P/E 10.7x).
It occurs to us that there is a certain amount of stock market fashion in these valuations. Menswear and kidswear are ―hot‖, while sportswear is simply not, irrespective of the fact that the majority of sportswear is, in fact, casual men‘s and kids‘ attire. We estimate that around 65% of 361°‘s sales are to men and kids.
We understand that the market is concerned about increasing competition in the sportswear sector, and may even have become bored of the Chinese sports story, but should these menswear stocks really be trading at over a 100% valuation premium to 361°?
Moreover, Anta trades on a 2011 P/E of 19.5x, according to Bloomberg. Anta is more established, offers very good liquidity and IR are slick, but is a valuation premium of 82% to 361° really justified?
Does some apparel stock’s Does all this smack of market irrationality that will inevitably right itself, much to the valuation smack of market benefit of 361° shareholders? This remains to be seen, but over the long-term, we think irrationality? We think so! so.
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Figure 22: Samsung forecast vs market consensus FY11-12E FY ending 31 Dec FY11E FY12E Revenue (Rmb m) Consensus 5,448 6,661 Samsung 5,429 6,560 Difference 0% -2%
EBIT (Rmb m) Consensus 1,268 1,535 Samsung 1,322 1,599 Difference 4% 4% EBIT margin Consensus 23.3% 23.0% Samsung 24.4% 24.4%
Net profits (Rmb m) Consensus 1,052 1,255 Samsung 1,100 1,332 Difference 4% 6% Net profit margin Consensus 19.3% 18.8% Samsung 20.3% 20.3%
Diluted EPS (Rmb) Consensus 0.52 0.61 High 0.53 0.65 Low 0.49 0.57 Samsung 0.53 0.64 Difference 3% 5%
DPS (Rmb) Consensus 0.21 0.29 Samsung 0.21 0.29 Difference 0% 1%
Source: Samsung Securities estimates, Bloomberg consensus as of Sep 24 market close
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INDEX
Business fundamentals p3 Valuation p16 Technical analysis p20 Bear Views & Blue Skies p22
Technical analysis ★★★ We see continuing positive momentum. Technical Analysis Virtuous circle
Technical analysis contributed by: Technical Trader rating
Relative Short-term Relatively SeungMin You Medium-term phase Score TA rating [email protected] strength signal OB/OS Full-blown uptrend (U1) Neutral Long Neutral 5 PPP +822 2020 7024 TA ratings: PPP = Triple Positive, PP = Double Positive, P = Single Positive, N = Neutral, NT = Negative Action to be SangCheol Im taken by investor: BUY recommendations = PPP and PP rated stocks, HOLD recommendation = P and N rated stocks, SELL recommendation = NT rated stocks [email protected] Source: Samsung Securities +822 2020 7779 While the time series data is not sufficient for our mid-term technical forecasting methodology (as the stock listed in June 2009), our trend-following model showed a BUY signal at end-August. The BUY signal from the fraction MACD and the stock's rising relative strength vs the HSCEI are positive from a technical perspective.
Figure 23: 361° weekly log, 40-week EMA, fraction MACD, RS
S 7.0 40-Week EMA 7.0 ↓ 6.5 40-Week EMA shifte 5 weeks forward 6.5
6.0 6.0 ↑ 5.5 L 5.5
5.0 5.0
4.5 4.5
4.0 4.0 ↑ L 3.5 3.5
3.0 3.0
1.090 1.085 frac MACD(10,20) 1.080 1.075 1.070 1.065 10WEMA of Relative Strength to HSCEI (RHS) 1.060 1.055 1.050 1.045 1.040 0.0004 1.035 1.030 1.025 1.020 1.015 1.010 1.005 0.0003
2009 Aug Sep Oct Nov Dec 2010 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2011 Feb Mar Apr V
Identifying market trend: When 40-week EMA turn positive and Fraction MACD is above 1, we indicate that the market is in bullish trend. Trading signal: Long signal (L) is indicated when the stock surpasses the weekly high, which formed when the fraction MACD breaches its signal line upward. Conversely, short signal (S) appears when the stock surpasses the weekly low, which formed when the fraction MACD breaches its signal line downward. Source: Bloomberg, Samsung Securities
The stock has traded in a range HK$5.00-HK$7.00 range for most of 2010. We feel that the quality of correction has been good, as the price during corrections has stayed above the mid-term support level at HK$5.00.
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Our technical analysts With the major resistance being breached in early August, we predict a continued predict a continued uptrend gradual uptrend. Corrections tend to last for a long time if the stock price falls below the medium-term line of support derived from our trend-determining SSC model. If the stock price stays above the medium-term line of support, corrections generally prove to be a blip irrelevant to the upward trend. 361° successfully pushed through major resistance around HK$6.00 (determined from our SSC model), which makes us expect a bull trend with rising lows.
The stock may face renewed resistance near the upper end of the ytd trading band (HK$7.00), but we are little worried.
Appendix: Technical Trader 2.0
Taking a three-pronged approach to stock evaluation, our model considers: 1) medium- term trends; 2) medium-term relative strength (RS); and 3) trading signals. The first and last are indicators of absolute attractiveness, while the second shows relative attractiveness.
Among promising stocks with positive ratings, we prefer those rated PPP and PP. Those rated PPP are in medium-term upward trends with above-benchmark performances, but those rated PP are undergoing short-term corrections. In both cases, we recommend accumulation from a medium-term perspective.
The key difference between P and N rated stocks is whether medium-term upward trends will remain intact. While P stocks have an advantage, the two stock groups differ little from a short-term trading perspective.
Stocks with our lowest rating (NT) scored the worst in our evaluation categories. Although selling or reducing exposure to such shares is recommended from a technical perspective, final decision-making should also factor in fundamental analysis.
We assume that the changes between the latest 20-week RS moving average and that of 13 weeks ago-ie, the 13 week sft RS-follow standard normal distribution. Readings belonging to 90%-and-more of the standard normal distribution are defined as overbought, while readings of 10%-and-less of the distribution are defined as oversold. We use such overbought/oversold signals purely as a reference, not as a factor in determining investment opinions on stocks.
Stocks with PPP ratings are scored 5 and above, PP ratings are scored between 3 and 4, P ratings are scored between 0 and 2, an N rating is scored between -1 and -3, and an NT rating is scored below -4.
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INDEX
Business fundamentals p3 Valuation p16 Technical analysis p20 Bear Views & Blue Skies p22
Bear Views & Blue Skies Completing the circle
Markets are all about balance of probability. We provide strong opinions but do not ignore the possibility that events may go against us. Thus, we try to quantify risks if we are wrong. Given two stocks with an identical percentage upside to target, it is critical to know that one has, for example 5% downside and the other 25%. We believe that this is how many investors think, and we attempt to reflect this in our research.
Bear view valuation gives 20% downside
Our bear view quantifies the Our bear view quantifies the risks we see for 361° by factoring a worst-case scenario risks we see for 361° by into our valuation. In our bear view scenario, we assume the following. factoring in a worst-case scenario… Sales slow: Despite a strong growth story, we assume that revenue growth slows to 10% YoY in FY11E and 5% YoY in FY12E. This seems unlikely given the current rate of new store build out and same-store-sales growth.
Margins decline: Margins may shrink if 361° encounters cost inflation amid slowing top-line growth, or if the effective tax rate suddenly jumps. We assume FY11E and FY12E net margin of 18% (vs 21.2% in FY10).
Valuation multiples stagnate: We use 11.8x as our bear view target P/E multiple, the same as the multiple that the stock trades on today for FY11, according to our estimates. NB 361° has the lowest P/E multiple in the Chinese sports sector.
The above leads us to a calendarized 2011E EPS of Rmb0.424 (HK$0.486), 28% below our base case forecast of Rmb0.587.
...which emerges at HK$5.73 Using a P/E multiple target of 11.8x we arrive at a bear view valuation of HK$5.73 per per share, implying 20% share. downside This implies 20% downside from the stock‘s current price of HK$7.18.
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Blue-sky DCF valuation implies 70% upside
For our blue-sky valuation, we use a three-stage DCF model, using a WACC of 11.0%.
We explicitly forecast out for five years to FY2015E. Our DCF blue-sky valuation implies 70% upside In our second stage, we forecast out from FY2016-25E, and smooth our assumed YoY FCF growth rate down from 20.0% in FY2016E to 3.0% in FY2025E.
We then assume a 3.0% terminal FCF growth rate into perpetuity.
Our DCF fair value emerges at HK$12.20 per share, rounding to the nearest ten Hong Kong cents, implying 70% upside.
We note that at our blue-sky valuation the stock could trade on P/E multiples of 20.1x FY11E and 16.6x FY12E.
Figure 24: 361° DCF valuation Explicit forecast (Rmb m) FY11E FY12E FY13E FY14E FY15E NOPAT 1,084 1,311 1,566 1,742 2,041 Depreciation and amortization 35 45 47 50 52 Change in working capital -311 426 -217 220 -216 Capex -300 -300 -100 -100 -100 Free Cash Flow 507 1,482 1,297 1,912 1,776 PV of FCF 469 1,235 974 1,292 1,082 Sum of PV of FCF FY11-13E 5,052 5.8 6.8 7.8 8.8 9.8 10.8 11.8 12.8 13.8 14.8 Implicit forecast (Rmb m) FY16E FY 17E FY 18E FY 19E FY 20E FY 21E FY 22E FY 23E FY 24E FY 25E Free cash flow 2,131 2,517 2,926 3,345 3,761 4,158 4,519 4,825 5,061 5,213 YoY growth 20.0% 18.1% 16.2% 14.3% 12.4% 10.6% 8.7% 6.8% 4.9% 3.0% PV of FCF 1,170 1,245 1,303 1,342 1,360 1,354 1,326 1,275 1,205 1,118 Sum of PV of FCF FY16-25E 12,698 15.8 Terminal forecast (Rmb m) FY 26E Terminal growth 3.0% WACC 11.0% FCF at 2024E 1,152 Terminal value of FCF at FY26E 14,398 PV of terminal forecast 2,783
Enterprise Value (Rmb m) 20,532 Long-term growth rate Net cash 2010E 1,555 HK$ 1.0% 2.0% 3.0% 4.0% 5.0% Intrinsic Market value 22,087 W 9.0% 12.7 13.0 13.4 14.0 14.9 Value per share (Rmb) 10.68 A 10.0% 12.2 12.4 12.7 13.1 13.6 Value per share (HK$) 12.20 C 11.0% 11.9 12.0 12.2 12.5 12.8 Current price (HK$) 7.18 C 12.0% 11.6 11.7 11.9 12.0 12.2 Upside potential 70% 13.0% 11.4 11.5 11.6 11.7 11.9
Source: Samsung Securities estimates
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Appendix I: Corporate profile 361° is one of the leading sportswear brands in China, specializing in sports footwear, sports apparel and related accessories. Just five years after the inception of the 361° brand in 2004, the company listed on the HKEX and has become third-largest listed Chinese sportswear producer.
Operating on a fully vertically-integrated structure, 361° is responsible for the design, development, manufacture, marketing, and distribution of its products. 361° derives roughly half of its revenues from footwear half from apparel. Between 60-70% of its footwear is produced in-house, while all of its apparel and accessories production is outsourced to third parties in FY09 (this is due to change this year as 361° brings some apparel production in-house with new production capacity).
Over the past three years, 361°‘s retail network has grown rapidly to almost 7,000 stores. Over 70% of its stores are located in fast-growing tier-3 and 4 cities, with 21% of them in tier-2 cities. The company plans to open another 600-800 stores per year during 2010-2012, plus an additional 300 devoted kidswear stores.
361° also opened its first flagship store in Zhengzhou, Henan, in January 2010, and since then has added four more flagship 361° Town stores in Harbin, Baoding, Jinan, and Wuhan, with plans to open another 10 361° Towns in the next two years.
The company operates a robust franchise model and distributes its products throughout the mainland via 32 exclusive distributors. Contracts with these distributors are renewed annually and stipulate specific targets and stringent operating requirements.
Figure 25: 361°’s in-house research and technology
Source: 361°
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361°‘s product- and platform-focused marketing plan is integral to the company‘s success. Its most recent campaign, entitled ‗One Love‘, embodies the idea of a pure love of sport and participation, which can be enjoyed by people from all walks of life. The company‘s sponsorship of high profile sporting events such as the 2010 Asian Games and 2010 Shanghai Expo increases its exposure both within the mainland and around the world.
The founding Ding family has a combined experience of over 40 years in the sportswear industry. The Dings are supported by a professional and independent management team with proven execution capabilities, as detailed in the following appendix, allowing the company to continue building on its core strengths and break new ground in the industry.
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Appendix II: Management profiles Executive Directors
Ding Wuhao, aged 45, is president of 361°. He is primarily responsible for the company‘s overall strategies, planning and business development. He has approximately 14 years of experience in the PRC sportswear industry. From 1994 to 2008, he served as a director and the general manager in Bieke Fujian and he was primarily responsible for its daily operation. From 1992 to 2008, he served as a director and the general manager of Wanshile. Mr Ding received his diploma from the MBA Series of Courses for China Entrepreneurs from Guanghua School of Management of Peking University in 2007. Mr. Ding is the son-in-law of Mr. Ding Jiantong, and the brother-in-law of Mr. Ding Huihuang and Mr. Ding Huirong. Mr. Ding is the sole director of Dings International, which is a substantial shareholder of 361°.
Ding Huihuang, aged 44, is Chairman of 361°. He is primarily responsible for overall strategies, operation planning and footwear production. He has approximately 14 years of experience in the PRC sportswear industry. He joined 361° in 2003, prior to which he worked at Bieke Fujian where he was responsible for production management of footwear. He received a diploma from Jinjiang Chendai Town Middle School for Nationalities in 1980. Mr. Ding is a son of Mr. Ding Jiantong, the elder brother of Mr. Ding Huirong and the brother-in-law of Mr. Ding Wuhao. Mr. Ding is the sole director of Ming Rong International, which is a substantial shareholder of 361°.
Ding Huirong, aged 38, is a vice president of 361°. He is primarily responsible for financial management and infrastructure construction management of 361°. He has approximately 14 years of experience in financial management. From 1994 to 2003, he worked as a vice general manager in Bieke Fujian and he was primarily responsible for financial management. Mr. Ding is a son of Mr. Ding Jiantong, the brother of Mr. Ding Huihuang and the brother-in-law of Mr. Ding Wuhao. Mr. Ding is the sole director of Hui Rong International, which is a substantial shareholder of 361°. He received a diploma from Jinjiang Chendai Town Middle School for Nationalities in 1986.
Wang Jiabi, aged 52, is a vice president of 361°. He is primarily responsible for human resources and public relations. Mr. Wang has approximately 14 years of experience in the PRC sportswear industry. From 1994 to 2003, he worked as a vice general manager in Bieke Fujian and he was primarily responsible for the human resources. Mr. Wang is the elder brother of Mr. Wang Jiachen, a member of 361°‘s senior management team. He enrolled in an EMBA programme offered by Peking University in 2008.
Independent non-executive Directors
Mak Kin Kwong, aged 48, has many years of experience in initial public offering, mergers and acquisitions and corporate finance. Mr. Mak is the managing director of Venfund Investment, a boutique investment banking firm specialising in cross-border mergers and acquisitions, corporate restructuring and international financial advisory services for clients in China, which he co-founded in 2001. Prior to that, Mr. Mak was a firm partner of Arthur Andersen Worldwide and managing partner of Arthur Andersen Southern China. Mr. Mak is also an independent non-executive director of China Dongxiang (Group) Co., Ltd. and Pou Sheng International (Holdings) Limited. Mr. Mak is a graduate of the Hong Kong Polytechnic University and a fellow member of the Association of Chartered Certified Accountants, and the HKICPA, and a member of the Institute of Chartered Accountants, in England and Wales.
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Sun Xianhong, aged 47, has over 20 years of experience in the media and marketing industries. From 2002 to 2005, he was a director at Inner Mongolia Little Sheep Catering Chain Co., Ltd. In 1999, he co-founded Inner Mongolia Meng Niu Dairy (Group) with Niu Gensheng and worked as a vice president from 1999. He was a consultant for China Space Foundation in 2003. Mr. Sun received his bachelor‘s degree in industrial autoimmunization from Shanxi Mining College in 1985.
Liu Jianxing, aged 35, has approximately three years of experience in macroeconomics and policy research. From 2005 to 2006, Mr. Liu took part in a series of key planning projects of the National 11th Five-Year Plan organised by the NDRC, including the Regional Planning for Metropolitan Coordinating Regions in Beijing, Tianjing and Hebei and the Regional Planning for Metropolitan Coordinating Regions in Yangtze River Delta. From 2007 to 2008, he completed the program of Specific Industrial Park Planning in Bowang, Ma Anshan, An Hui Province. Mr. Liu received his bachelor‘s degree in management engineering from Nanchang University in 1997, and a doctor‘s degree in national economics from Peking University in 2005.
SENIOR MANAGEMENT
Xia Youqun, aged 41, is a vice president of 361° and is primarily responsible for assisting the president in the company‘s overall operations. Mr. Xia has approximately 13 years of experience in marketing, brand management and retail marketing management in the PRC sportswear industry. He joined 361° in October 2003 as the head of marketing department and was promoted to be the operation head in July 2006. Prior to joining 361°, Mr. Xia was the head of marketing department of Qiaodan (China) Co., Ltd. Mr. Xia received his master‘s degree in business administration from Beijing Zhong-xin College of Business Management in 2005.
Chen Yongling, aged 36, is the head of capital operation department of 361° and is primarily responsible for the company‘s overall financial management. Mr. Chen has approximately 13 years of experience in finance, operation and business management. From 2003 to 2005, Mr. Chen worked as financial manager of Fujian Tian Ce Investment Management Co., Ltd. He received the Certificate of Qualification for International Certified Senior Accountant by International Profession Certification Association in 2008.
Hou Zhaohui, aged 34, is the head of human resources and administration department of 361° and is primarily responsible for human resources management and administration. Mr. Hou has approximately four years of experience in the PRC sportswear industry. From 2003 to 2004, he worked as a project manager in Beijing Alliance PKU Management Consultants Co. Ltd. Mr. Hou received his bachelor‘s degree in science from Ocean University of Qingdao in 1998 and a master‘s degree in business administration from Beijing University of Posts and Telecommunications in 2004.
Zhu Geming, aged 39, is the head of design department of 361°‘s footwear business and is primarily responsible for the overall management of the design and research and development of 361°‘s footwear products. He has approximately 15 years of experience in footwear research and development. From 1998 to 2003, he worked as the design manager of men‘s footwear in Bieke Fujian. Mr. Zhu received his diploma in technology and design for footwear from Jilin Second Light Industry School in 1993.
Wang Zhiqian, aged 38, is the head of the research and development department for 361°‘s footwear business. Mr. Wang has approximately 16 years of experience in the PRC sportswear industry. Prior to joining 361°, he was responsible for the research and development of footwear in Bieke Fujian. Mr. Wang received his diploma from Jilin Second Light Industry School in 1992.
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Yang Guang, aged 43, is the head of design department of 361°‘s apparel business and is primarily responsible for the design and research and development of the company‘s apparel. He has approximately 11 years of experience in the PRC apparel industry. He was the head of the apparel department of Qiaodan (China) Co., Ltd. from 2000 to 2004. Mr. Yang received his bachelor‘s degree in apparel design from Beijing Institute of Fashion Technology in 1990.
Zhao Jingli, aged 52, is the head of sales department of 361° and is primarily responsible for the sales function. Ms. Zhao has approximately 16 years of experience in the PRC sportswear industry. Prior to joining 361°, she was the market head of Fujian Peak Group Co., Ltd. Ms. Zhao received her bachelor‘s degree in business management in Economics Department of Beijing Normal University in 1996.
Ling Jun, aged 35, is the head of 361°‘s brand department and is primarily responsible for the company‘s overall brand management. Mr. Ling has approximately four years of experience in brand management. Prior to joining 361°, he was the senior project manager in Lining (China) Co., Ltd. He received his master‘s degree in business administration from American National University in 2003.
Li Xiang, aged 36, is the head of the equipment and accessories business of 361° and is primarily responsible for the overall management of equipment and accessories. Mr. Li has approximately 11 years of experience in marketing and product management. From 2002 to 2007, he worked in the accessories department in Beijing Lining Sports Products Co., Ltd. Mr. Li received his bachelor‘s degree in art from Hua Zhong Normal University in 1997.
Wang Jiachen, aged 48, is a vice general manager of 361°‘s footwear business and is primarily responsible for the daily operation of the company‘s footwear production and the procurement of the soles. He has approximately 14 years of experience in footwear production management. Prior to joining 361°, Mr. Wang was a deputy manager of production department of the footwear business in Bieke Fujian and was responsible for the procurement of the raw materials for footwear business and the quality control. Mr. Wang is the younger brother of Mr. Wang Jiabi.
Choi Mun Duen, aged 41, is the chief financial officer and company secretary of 361°. She has over 16 years of experience in auditing, finance and accounting. Before joining 361°, she was the chief financial officer in China Agri-Products Exchange Limited. She received her bachelor‘s degree in accounting and finance from University of Glamorgan in the U.K. She is a certified public accountant of the HKICPA and a fellow member of the Association of Chartered Certified Accountants.
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Appendix III: Features and benefits of the distributor system Features of the distributor system
All of 361°‘s sales come from its extensive nationwide distribution network. Thus, an understanding of the features and benefits of the distributor system is crucial to our assessment of the firm‘s chances of success.
361° seeks to build long-term mutually beneficial relationships and currently has 32 distributor partners. Distributors have geographical exclusivity, but are only allowed to sell 361° products at their retail outlets. Agreements are usually for one- year, with performance reviewed annually.
All of 361°’s sales come from Expansion plan is agreed with each distributor annually. its 32 distributors Currently, over 85% of 361°‘s sales come from its three annual sales fairs.
Distributors must maintain the uniform retail pricing and discounting policies for each product, and comply with uniform store display standards.
Distributors bear all of the costs of building out the retail network. We note that, unlike most other Chinese sports brands, 361° does not provide assistance to distributors in refurbishing or opening stores. This underlines the strength and freshness of the brand.
Distributors must provide 361° with sales reports and market information, as well as notifying the company immediately upon the discovery of counterfeit products.
No sale or return. Distributors buy goods on a wholly-owned basis—ie, they take on all of the inventory risk. Distributors, however, may return defective goods.
If distributors fail to comply with such regulations, 361° has the right to immediately terminate their contract.
Figure 26: 361° has an extensive retail network using 32 distributors
Source: 361° * as of 31 December 2009
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Benefits of the distributor system
The distributor system means The system‘s main advantage is that 361° can expand very quickly. In our that 361° can expand very experience, the main constraint upon retail expansion in the PRC is the ability of a quickly firm to find enough decent locations at rentals that will become profitable outlets. By having 32 distributors, 361° has access to 32 retail specialists with expertise in their local markets.
CapEx is limited. Interestingly, 361° does not help its distributors with store refurbishment so heavy-store Capex is borne by the distributor partners. This results in a profitable asset light model.
The system allows 361° to focus on its core competencies of brand management and development of new products.
And risks…
We also acknowledge the We must also acknowledge the risks: risks Even though 361° endeavors to maintain high standards in the outsourced portion of its production and its retail network, it risks loss of control in both production and retail stores, which could damage the brand. We note that Ports Design (589 HK, NR) controls the entire process, from design through to production, marketing, distribution and self-operating its own retail stores. For Ports, we believe that the importance of product quality control, immaculate retail outlets and creating the impression of scarcity is more important than the advantages of outsourcing.
There is a risk that in order to flatter reported numbers, 361° may encourage distributors to take on extra inventory—ie ―stuffing‖ the distributor channels with excess inventory, which will inevitably slow future sales. There is also a risk that slowing inventory sell through at distributors would not immediately be apparent to investors, which could lead to a nasty negative surprise in 361°‘s sales figures.
We note that management convincingly answers these concerns by pointing out that accounts-receivable days are decreasing (we would expect to see an increase in accounts-receivable days if distributors were stuck with excess product). Management also point out that they would be foolish to deliberately stuff inventory into the distributor channel– they would only be able to do this once, the truth would soon come to light and investor confidence would be damaged long-term.
Distributor partners may desert 361° for better (international) brands as new brands are introduced to lower-tier cities in China, possibly putting pressure on 361°‘s top line as it is forced to give more wholesale discount. In such a scenario, the firm may lose some valuable store locations, which after all are controlled by the distributors. The bottom line is that 361° must keep its distributor partners continually interested.
Will the distributor system last forever?
Some argue that distributors There is a school of thought that argues that as the rapid expansion phase of the brand may become squeezed out in comes to an end, in three-to-five years‘ time, then distributors may become squeezed time out. Currently 361° sells to distributors at 38% (a 62% discount) of the recommended retail price (RRP), and the distributors pass the merchandize on to smaller retailers at 49% (a 51% discount) of the RRP. Distributors are currently necessary for the brand‘s rapid growth, but over the longer-term, there is 11 points of margin to be shared between 361° and the end-retailer if the distributor is eventually removed.
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Appendix IV: Financial statements
Figure 27: 361° key ratios Rmb m, Year ending 30 June FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E FY14E FY15E YoY growth Total turnover 42.0% 252.8% 161.7% 25.7% 25.4% 20.8% 19.6% 17.2% 15.9% Gross profit 184.3% 352.4% 243.0% 42.9% 27.8% 22.4% 21.0% 17.8% 16.3% EBIT 140.5% 595.1% 265.3% 40.5% 27.4% 20.9% 22.5% 18.7% 17.1% EBITDA 115.9% 546.6% 261.6% 41.7% 27.9% 21.1% 22.0% 18.3% 16.8% Net profit 108.2% 681.2% 253.2% 45.0% 19.9% 21.1% 19.7% 11.4% 17.2% Diluted EPS (Rmb) 108.2% 681.2% 252.8% 5.3% 19.7% 21.1% 19.7% 11.4% 17.2%
Margins GP margin 10.3% 20.6% 26.4% 34.6% 39.4% 40.2% 40.7% 41.2% 41.4% 41.5% EBIT margin 4.6% 7.8% 15.4% 21.4% 24.0% 24.4% 24.4% 25.0% 25.3% 25.5% EBITDA margin 5.6% 8.6% 15.7% 21.7% 24.5% 25.0% 25.1% 25.6% 25.8% 26.0% PBT margin 4.2% 7.0% 15.0% 21.0% 24.2% 24.7% 24.7% 25.4% 25.7% 26.0% Net margin 4.2% 6.1% 13.6% 18.3% 21.2% 20.3% 20.3% 20.3% 19.3% 19.6%
Returns ROE (average) 15.3% 23.0% 80.5% 44.7% 30.9% 28.9% 28.3% 27.8% 26.5% 26.7% ROA (average) 4.1% 6.9% 23.2% 24.2% 21.2% 21.0% 20.8% 20.6% 19.6% 19.9% ROIC 10.5% 13.5% 39.0% 23.1% 26.4% 26.0% 25.0% 25.1% 24.2% 24.3%
Working capital Inventory days 39 64 47 21 15 15 15 15 15 15 AR days 95 75 86 103 97 90 83 77 77 77 AP days 239 201 133 143 156 150 150 150 150 150
Leverage Current ratio 1.3x 1.3x 1.3x 2.4x 3.4x 2.8x 3.4x 3.1x 3.6x 3.3x Gross debt / Equity 59.9% 47.2% 47.1% 10.6% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Net cash/ Equity -43.5% -28.7% -12.8% 68.4% 45.3% 41.2% 56.5% 59.1% 67.0% 68.6%
Valuation (on current price) P/E 15.0x 14.2x 11.8x 9.8x 8.1x 7.3x 6.2x P/B 3.8x 3.8x 3.1x 2.5x 2.1x 1.8x 1.5x EV/EBITDA 15.2x 10.7x 8.4x 6.9x 5.7x 4.8x 4.1x Dividend yield 2.2% 2.1% 3.4% 4.6% 6.2% 6.9% 8.0% Source: Company data, Samsung Securities estimates, valuation based on HK$7.18 market close as of Sept 24, 2010
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Figure 28: 361° income statement Rmb m, Year ending 30 June FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E FY14E FY15E Total turnover 263 373 1,317 3,447 4,331 5,429 6,560 7,846 9,192 10,650 YoY growth NA 42.0% 252.8% 161.7% 25.7% 25.4% 20.8% 19.6% 17.2% 15.9% Footwear 240 346 866 1,617 1,945 2,309 2,667 3,024 3,429 3,817 Apparel 21 23 433 1,755 2,332 3,057 3,867 4,719 5,655 6,656 Accessories and others 1 5 18 54 75 64 26 104 108 178
COGS -236 -296 -969 -2,253 -2,624 -3,249 -3,892 -4,617 -5,389 -6,226
Gross profit 27 77 348 1,194 1,706 2,180 2,668 3,229 3,803 4,425 YoY growth 0.0% 184.3% 352.4% 243.0% 42.9% 27.8% 22.4% 21.0% 17.8% 16.3% GP margin 10.3% 20.6% 26.4% 34.6% 39.4% 40.2% 40.7% 41.2% 41.4% 41.5%
Other revenue 1 2 2 8 32 16 23 33 43 53 Other net income 0 0 -2 0 2 0 0 0 0 0
Operating expense -16 -49 -146 -462 -689 -858 -1,069 -1,271 -1,480 -1,704 Selling & distribution costs -10 -36 -106 -372 -533 -706 -886 -1,059 -1,241 -1,438 Administration expenses -6 -13 -40 -89 -155 -152 -184 -212 -239 -266
EBIT 12 29 202 739 1,037 1,322 1,599 1,958 2,323 2,721 YoY growth NA 140.5% 595.1% 265.3% 40.5% 27.4% 20.9% 22.5% 18.7% 17.1% EBIT margin 4.6% 7.8% 15.4% 21.4% 24.0% 24.4% 24.4% 25.0% 25.3% 25.5%
Finance expenses -1 -3 -5 -16 -3 0 0 0 0 0
PBT 11 26 197 724 1,049 1,338 1,622 1,991 2,366 2,774 Income tax 0 -3 -18 -92 -134 -241 -292 -398 -591 -693 Effective tax rate NA 12.9% 9.2% 12.7% 12.7% 18.0% 18.0% 20.0% 25.0% 25.0%
Net profit 11 23 179 632 917 1,100 1,332 1,595 1,776 2,082 YoY growth NA 108% 681% 253% 45% 20% 21% 20% 11% 17% Net profit margin 4% 6% 14% 18% 21% 20% 20% 20% 19% 20%
Basic EPS (Rmb) 0.01 0.02 0.12 0.42 0.44 0.53 0.64 0.77 0.86 1.01 Diluted EPS (Rmb) 0.01 0.02 0.12 0.42 0.44 0.53 0.64 0.77 0.86 1.00 DPS (Rmb) 0.00 0.00 0.00 0.14 0.13 0.21 0.29 0.39 0.43 0.50 Dividend payout ratio 0.0% 0.0% 0.0% 33.4% 30.0% 40.0% 45.0% 50.0% 50.0% 50.0%
Source: Company data, Samsung Securities estimates
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Figure 29: 361° balance sheet Rmb m, Year ending 30 June FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E FY14E FY15E Cash and cash equivalents 12 24 109 1,984 1,555 1,716 2,954 3,681 4,828 5,758 Deposits with banks 0 0 0 0 936 936 936 936 936 936 Pledged bank deposits 10 13 39 87 101 101 101 101 101 101 Inventories 35 69 181 84 133 134 186 194 249 263 Trade and other receivables 94 138 674 1,592 1,115 1,782 1,476 2,383 2,043 2,998 Amounts due from related parties 99 107 38 0 0 0 0 0 0 0 Total current assets 249 350 1,040 3,746 3,839 4,943 5,653 7,295 8,158 10,056
PPE 19 17 89 247 566 832 1,086 1,139 1,189 1,238 Interests in leasehold land held for own use under operating leases 0 22 23 87 85 83 81 80 78 76 Deposits and prepayments 0 0 0 0 55 55 55 55 55 55 Deferred tax assets 1 1 0 0 19 19 19 19 19 19 Total non-current assets 20 41 112 333 725 988 1,241 1,292 1,341 1,388
Total assets 269 391 1,152 4,079 4,564 5,931 6,894 8,587 9,499 11,443
Trade and other payables 154 173 535 1,227 1,020 1,651 1,548 2,247 2,182 2,934 Bank loans 43 60 150 267 0 0 0 0 0 0 Amounts due to a shareholder of the company 0 29 142 0 0 0 0 0 0 0 Current taxation 0 2 5 65 110 110 110 110 110 110 Total current liabilities 198 264 831 1,559 1,129 1,760 1,658 2,357 2,292 3,044
Deferred tax liabilities 0 0 4 10 3 3 3 3 3 3 Total non-current liabilities 0 0 4 10 3 3 3 3 3 3
Share capital 52 83 83 176 182 182 182 182 182 182 Reserves 20 44 235 2,334 3,214 3,952 5,020 6,016 6,995 8,189 Non-controlling interests 0 0 0 0 35 33 31 29 27 25 Total equity 72 127 318 2,510 3,432 4,168 5,233 6,227 7,204 8,396
Total liabilities and equity 269 391 1,152 4,079 4,564 5,931 6,894 8,587 9,499 11,443
Source: Company data, Samsung Securities estimates
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Figure 30: 361° cash flows Rmb m, Year ending 30 June FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E FY14E FY15E EBIT 12 29 202 739 1,037 1,322 1,599 1,958 2,323 2,721 D&A 3 3 5 9 23 36 47 49 51 53 Others 0 2 9 3 -6 0 0 0 0 0 Cash from operations before changes in working capital 15 34 216 751 1,054 1,359 1,646 2,007 2,374 2,774 Change in working capital -54 -84 -201 -170 186 -311 426 -217 220 -216 Cash generated from operations -39 -50 15 581 1,240 1,047 2,072 1,791 2,594 2,558 Income tax paid -1 -2 -10 -26 -114 -241 -292 -398 -591 -693 Net operating cash flow -40 -53 5 555 1,125 806 1,780 1,392 2,003 1,864
Capex -2 -7 -98 -152 -358 -300 -300 -100 -100 -100 Disposals 0 0 2 0 0 0 0 0 0 0 Interest received 0 0 0 2 10 16 23 33 43 53 Increase in pledged bank deposits -3 -3 -26 -48 -15 0 0 0 0 0 Increase in deposits with banks 0 0 0 0 -936 0 0 0 0 0 Net investing cash flow -5 -9 -121 -199 -1,299 -284 -277 -67 -57 -47
Proceeds from new bank loans 60 72 150 406 224 0 0 0 0 0 Repayment of bank loans -27 -55 -60 -288 -491 0 0 0 0 0 Proceeds from new shares issued 0 0 0 1,479 201 0 0 0 0 0 Proceeds from capital injection 18 31 0 0 37 0 0 0 0 0 Proceeds from a shareholder of the company 0 29 118 14 0 0 0 0 0 0 Interest paid -1 -3 -5 -16 -3 0 0 0 0 0 Dividends paid 0 0 0 -77 -223 -362 -264 -599 -797 -888 Net financing cash flow 49 74 202 1,518 -255 -362 -264 -599 -797 -888
Net increase / (decrease) in cash and cash equivalents 4 12 85 1,875 -429 161 1,239 726 1,148 929 Cash and cash equivalents (year beginning) 7 12 24 109 1,984 1,555 1,716 2,954 3,681 4,828 Cash and cash equivalents (year end) 12 24 109 1,984 1,555 1,716 2,954 3,681 4,828 5,758
Source: Company data, Samsung Securities estimates
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