Consumer Discretionary 19 October 2015

XTEP International (1368 HK) Internati onal

Target price: HKD4.60

Share price (16 Oct): HKD3.97 | Up/downside: +15.9%

Initiation: a step in the right direction Adrian Chan, CFA (852) 2848 4427  Rerating expected successful rebranding to a functional brand [email protected]  Strengthening e-commerce initiatives and ancillary income streams Anson Chan, CFA (852) 2532 4350  Initiating with Buy (1) rating and 12-month target price of HKD4.60 [email protected]

Investment case: After attending Xtep’s 2Q16 sales fair in September Share price performance

2015, we believe the company is successfully transforming its business (HKD) (%) strategy to become a functional/performance-focused brand. Product-mix 4.1 130 enhancements from functional products (about 40-50% of 2Q16 orders vs. 3.6 113 less than 30% in 2015) carry higher ASPs than casual products and, on our 3.2 95 2.7 78 forecasts, would drive a 2.5pp improvement in the company’s operating 2.2 60 margin to 19.4% in 2017 from 16.9% in 2014. We forecast Xtep’s net profit Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 to see a CAGR of 20% in 2014-17. Based on this transformation in XTEP Inter (LHS) Relative to HSI (RHS) business strategy, we expect the market to rerate the stock from its current 9.9x 2016E PER to around 11.5x. 12-month range 2.20-4.06 Market cap (USDbn) 1.11 Catalysts: 1) Upward revisions to consensus forecasts following better- 3m avg daily turnover (USDm) 2.14 Shares outstanding (m) 2,177 than-forecast 2Q16 sales fair results expected to be announced in the third Major shareholder Mr. Ding Shui Po (60.9%) or fourth week of October 2015; 2) confirmation of better-than-expected SSS growth and margin improvements as a result of its business Financial summary (CNY) transformation strategy, as reflected in the 1Q16 operational update in April Year to 31 Dec 15E 16E 17E 2016 followed by the 1H16 results in August 2016; 3) inclusion in Revenue (m) 5,264 5,835 6,373 Operating profit (m) 939 1,089 1,237 consensus estimates of incremental profit from the Wisdom (1661 HK, not Net profit (m) 615 720 825 rated) JV, which we estimate to be around 1-4% of Xtep’s 2016E EPS. Core EPS (fully-diluted) 0.280 0.328 0.376 Currently, we and the street have not factored in the potential incremental EPS change (%) 28.6 17.1 14.6 Daiwa vs Cons. EPS (%) 3.3 7.9 11.1 profit from the JV due to it still being in the planning stage; and 4) PER (x) 11.6 9.9 8.7 incremental buying in the stock market as Xtep’s market cap now exceeds Dividend yield (%) 4.3 5.1 5.8 USD1bn. DPS 0.141 0.165 0.189 PBR (x) 1.4 1.3 1.2 EV/EBITDA (x) 5.1 4.2 3.5 Valuation: We initiate coverage on the stock with a Buy (1) rating and 12- ROE (%) 12.6 13.7 14.5 month target price of HKD4.60, based on an 11.5x 2016E PER. The stock Source: FactSet, Daiwa forecasts currently looks undervalued to us, trading at 9.9x 2016E earnings (6.4x ex- net cash) and we see grounds for it to be rerated closer to the sector average (around 13x) given its forte in the running/marathon segment. Moreover, we expect the company’s shift to a more functional and professional brand image to continue to support earnings growth.

Risks: Channel inventory build-up on worse-than-expected demand for sportswear products as well as aggressive penetration into lower-tier cities from global sportswear brands are the key risks to our Buy (1) call.

See important disclosures, including any required research certifications, beginning on page 25

XTEP International (1368 HK): 19 October 2015

Table of contents

“Three+” strategy fuels multiple growth drivers ...... 6 Product+ – when fashion meets function ...... 6 Sports+ – monetising ancillary income streams ...... 9 Internet+ – O2O sales platform to buoy growth ...... 10 Operating leverage in sight ...... 13 Expect double-digit YoY profit growth in 2015-17 ...... 13 Robust balance sheet ...... 17 Strong cash balance ...... 17 Valuation and risks ...... 19 Undemanding valuation with visible near-term catalysts ...... 19 Risks to our call ...... 21 Appendix ...... 22 Company background ...... 22

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XTEP International (1368 HK): 19 October 2015

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook Xtep: net-profit forecasts

We expect Xtep to post its first positive YoY net profit (CNYm) growth, of 29% YoY, this year since 2011, off of a low base 1,200 40% 28.6% from bad debt provisions in 2014 and strong sell-through. 18.8% 30% 1,000 18.3% 17.1% 14.6% We forecast growth to remain robust in 2016-17, rising by 14.6% 14.0% 20% 800 10.0% 11.7% 17% YoY in 2016 and 15% YoY in 2017, from product mix- 17.4% 10% 600 12.3% 12.9% enhancements towards higher-margin functional products. 0% 400 We believe the JV profit from event operations could serve -16.2% (10%) as a potential earnings booster in 2016-17. -21.1% 200 -25.2% (20%) 0 (30%) 2010 2011 2012 2013 2014 2015E 2016E 2017E Net Profit YoY (RHS) NPm (RHS)

Source: Company, Daiwa forecasts

Valuation Xtep: 12-month forward PER

The stock is trading currently at a 9.9x 2016E PER, based (x) on our forecasts, which is below the sector 13x average. 18 We believe Xtep deserves to trade closer to its peers as it trends (trades closer) at least in line with the sector (~12x 13 ex-Anta) given structural growth in the sector, driven by urbanisation, increased awareness of health matters, and 8 policy support for the sports industry.

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Jul-12 Jul-13 Jul-14 Jul-15

Jan-12 Jan-13 Jan-14 Jan-15

Mar-12 Mar-14 Mar-13 Mar-15

Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 Sep-15

May-12 May-13 May-14 May-15 XTEP Sector

Source: Bloomberg, Daiwa forecasts

Earnings revisions Xtep: Daiwa v. consensus EPS forecasts

Our 2015-17 earnings forecasts are 3-11% above those of EPS (CNY) 11% 12% the Bloomberg consensus. We expect the street to rerate 0.39 the stock when the 2Q16 trade fair results are announced, 0.37 8% 10% when we believe the company will post a set of 0.35 8% sequentially stronger results due to its increasing mix of 0.33 functional products. 6% 0.31 3% 4% 0.29 0.27 2% 0.25 0% 2015E 2016E 2017E Daiwa Consensus Difference (RHS)

Source: Bloomberg, Daiwa forecasts

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XTEP International (1368 HK): 19 October 2015

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E A&P (% of sales) 11.7 11.3 11.4 11.2 13.1 13.5 13.2 12.9 Staff cost (% of sales) 4.8 5.0 7.3 9.5 9.5 9.0 9.0 9.0 Footwear sales revenue (YoY %) n.a. 27 8 (17) 35 10 12 10 Apparel sales revenue (YoY %) n.a. 22 (7) (27) (16) 8 8 8

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Footwear 1,956 2,490 2,700 2,247 3,043 3,347 3,749 4,124 Apparel 2,421 2,950 2,746 2,012 1,688 1,823 1,968 2,126 Other Revenue 80 100 104 84 47 94 118 124 Total Revenue 4,457 5,540 5,550 4,343 4,778 5,264 5,835 6,373 Other income 15 16 68 158 149 100 75 75 COGS (2,645) (3,282) (3,293) (2,596) (2,831) (3,063) (3,337) (3,623) SG&A (849) (1,055) (1,194) (1,010) (1,287) (1,362) (1,484) (1,589) Other op.expenses 0 0 0 0 0 0 0 0 Operating profit 978 1,219 1,131 895 809 939 1,089 1,237 Net-interest inc./(exp.) 0 (8) (25) (32) (38) (47) (44) (41) Assoc/forex/extraord./others 0 0 0 0 0 0 0 0 Pre-tax profit 978 1,211 1,106 863 770 891 1,044 1,196 Tax (165) (246) (299) (260) (284) (267) (313) (359) Min. int./pref. div./others 0 1 3 3 (8) (9) (11) (12) Net profit (reported) 814 966 810 606 478 615 720 825 Net profit (adjusted) 814 966 810 606 478 615 720 825 EPS (reported)(CNY) 0.374 0.444 0.372 0.278 0.220 0.282 0.331 0.379 EPS (adjusted)(CNY) 0.374 0.444 0.372 0.278 0.220 0.282 0.331 0.379 EPS (adjusted fully-diluted)(CNY) 0.373 0.443 0.372 0.276 0.218 0.280 0.328 0.376 DPS (CNY) 0.165 0.187 0.189 0.143 0.108 0.141 0.165 0.189 EBIT 978 1,219 1,131 895 809 939 1,089 1,237 EBITDA 999 1,248 1,170 944 854 988 1,143 1,295

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 978 1,211 1,106 863 770 891 1,044 1,196 Depreciation and amortisation 21 29 39 49 45 50 54 58 Tax paid (88) (124) (276) (308) (332) (267) (313) (359) Change in working capital (466) (955) 329 75 (417) 40 (125) (115) Other operational CF items 10 43 132 (21) 28 0 0 (0) Cash flow from operations 456 204 1,330 658 95 714 660 781 Capex (15) (85) (176) (229) (106) (100) (100) (100) Net (acquisitions)/disposals 0 0 0 4 0 0 0 0 Other investing CF items (39) (542) (169) (69) (432) (8) 0 0 Cash flow from investing (54) (627) (345) (294) (538) (108) (100) (100) Change in debt 0 492 556 503 301 0 0 0 Net share issues/(repurchases) 7 1 0 1 2 0 0 0 Dividends paid (471) (450) (490) (428) (288) (263) (328) (381) Other financing CF items 0 5 3 3 2 0 0 0 Cash flow from financing (465) 48 69 78 17 (263) (328) (381) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash (63) (375) 1,055 442 (426) 343 231 300 Free cash flow 441 119 1,154 429 (12) 614 560 681 Source: FactSet, Daiwa forecasts

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XTEP International (1368 HK): 19 October 2015

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 2,444 2,068 3,223 3,563 3,587 3,930 4,161 4,461 Inventory 463 672 583 537 569 605 671 733 Accounts receivable 727 1,205 1,036 1,151 1,490 1,500 1,663 1,816 Other current assets 343 1,055 995 1,101 1,301 1,301 1,301 1,301 Total current assets 3,977 5,000 5,836 6,352 6,947 7,337 7,796 8,311 Fixed assets 197 257 387 545 585 636 682 724 Goodwill & intangibles 1 1 1 1 2 2 2 2 Other non-current assets 110 237 276 409 330 330 330 330 Total assets 4,284 5,495 6,499 7,307 7,864 8,304 8,810 9,367 Short-term debt 0 492 511 1,351 1,222 1,222 1,222 1,222 Accounts payable 639 499 483 601 729 816 919 1,020 Other current liabilities 253 409 443 404 400 400 400 400 Total current liabilities 892 1,400 1,437 2,356 2,350 2,437 2,540 2,641 Long-term debt 0 0 535 175 617 617 617 617 Other non-current liabilities 40 184 248 268 186 186 186 186 Total liabilities 932 1,584 2,220 2,799 3,154 3,241 3,344 3,445 Share capital 19 19 19 19 19 19 19 19 Reserves/R.E./others 3,333 3,888 4,255 4,487 4,681 5,034 5,436 5,893 Shareholders' equity 3,352 3,907 4,274 4,506 4,700 5,053 5,456 5,912 Minority interests 0 4 5 2 10 10 10 10 Total equity & liabilities 4,284 5,495 6,499 7,307 7,864 8,304 8,810 9,367 EV 4,642 5,514 4,914 5,050 5,348 5,005 4,774 4,474 Net debt/(cash) (2,444) (1,576) (2,177) (2,038) (1,748) (2,091) (2,322) (2,622) BVPS (CNY) 1.542 1.796 1.964 2.070 2.159 2.321 2.506 2.715

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. 24.3 0.2 (21.7) 10.0 10.2 10.8 9.2 EBITDA (YoY) n.a. 24.8 (6.2) (19.3) (9.5) 15.7 15.6 13.3 Operating profit (YoY) n.a. 24.7 (7.2) (20.9) (9.7) 16.1 16.0 13.6 Net profit (YoY) n.a. 18.8 (16.2) (25.2) (21.1) 28.6 17.1 14.6 Core EPS (fully-diluted) (YoY) n.a. 18.8 (16.2) (25.7) (21.1) 28.6 17.1 14.6 Gross-profit margin 40.6 40.8 40.7 40.2 40.8 41.8 42.8 43.2 EBITDA margin 22.4 22.5 21.1 21.7 17.9 18.8 19.6 20.3 Operating-profit margin 21.9 22.0 20.4 20.6 16.9 17.8 18.7 19.4 Net profit margin 18.3 17.4 14.6 14.0 10.0 11.7 12.3 12.9 ROAE 48.5 26.6 19.8 13.8 10.4 12.6 13.7 14.5 ROAA 38.0 19.8 13.5 8.8 6.3 7.6 8.4 9.1 ROCE 58.3 31.4 23.3 15.8 12.9 14.0 15.3 16.4 ROIC 89.5 59.9 37.2 27.4 18.8 22.1 24.9 26.9 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 16.8 20.3 27.0 30.1 36.9 30.0 30.0 30.0 Accounts receivable (days) 29.8 63.7 73.7 91.9 100.9 103.7 98.9 99.6 Current ratio (x) 4.5 3.6 4.1 2.7 3.0 3.0 3.1 3.1 Net interest cover (x) n.a. 153.6 44.5 27.6 21.1 19.9 24.5 30.3 Net dividend payout 44.2 42.2 50.8 51.5 49.3 50.0 50.0 50.0 Free cash flow yield 6.2 1.7 16.3 6.0 n.a. 8.7 7.9 9.6 Source: FactSet, Daiwa forecasts

Company profile

XTEP was established in 2002 and is a leading fashion sportswear brand in the PRC operating over 7,000 stores nationwide. The group engages in the design, development, manufacturing, sales and marketing and brand management of sports footwear, apparel and accessories. The company was listed on the Hong Kong Stock Exchange on 3 June 2008.

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XTEP International (1368 HK): 19 October 2015

“Three+” strategy fuels multiple growth drivers Product+ – when fashion meets function Impressive product We attended the company’s 2Q16 trade fair in Xiamen on 21 September 2015, and came upgrades planned for back impressed by the quality of its products and the new technology the company has in 2016 should sustain store for 2016. Amid Central Government policy support, accelerating urbanisation in near-double-digit China and lifestyle changes towards health consciousness and physical activity, Xtep has revenue growth off of a taken the initiative to move in the right direction, in our view, focusing on offering functional higher base products. Prior to the 2016 trade fair, our channel checks had led us to believe Xtep’s products were more for show than to support real sports activity by providing breakthrough cutting-edge technology.

Unsurprisingly, management highlighted during the trade fair that the 2Q16 order book was expected to comprise more functional products (1Q16 order book was >30%), and we estimate 2Q16 order book will comprise around 40-50% functional products. A key note to highlight from the table below is the accelerating trend in Xtep’s trade fair results (from low- single-digit YoY growth in 1Q15 to 10% YoY growth in 1Q16), while other domestic peers are seeing positive double-digit/teen growth stabilising – or in 361’s case, decelerating. We believe this accelerating growth trend in order book growth will be sustainable in 2016, given Xtep’s increasing focus on functional/performance products and focus on the fast- growing running category.

China sportswear sector: trade fair results (%) Anta Peak Li Ning Xtep 361 CDX 1Q13 - 20 to 30% flat n/a - 15 to 20% -23% n/a 2Q13 - 15 to 25% - mid-twenties n/a - 15 to 20% -23% n/a 3Q13 - 10 to 20% n/a n/a -20% -19% n/a 4Q13 - 5 to 15% n/a n/a - 15-17% -17% n/a 1Q14 + high single digit n/a n/a - high single digit -11% n/a 2Q14 + high single digit + high single digit n/a - mid single digit -11% n/a 3Q14 + high single digit + mid-teens n/a - low single digit -7% n/a 4Q14 + low double digit + mid-teens n/a flat 8% n/a 1Q15 + low double digit + mid-teens +mid-twenties + low single digit 8% 2Q15 + low double digit + mid-teens + mid-teens + low single digit 11% + low double digit 3Q15 + low double digit + mid-teens + high-teens + low single digit 16% 4Q15 + low double digit + mid-teens +low-teens + low single digit 18% 1Q16 + low double digit + mid-teens + mid-teens 10% 15% n/a 2Q16 + mid-teens + high-teens 15% + low double digit (30-40%)

Source: Companies

China sportswear sector: same-store sales growth (%) Anta Peak Li Ning Xtep 361 CDX 1Q13 flat flat n/a flat -1.5% n/a 2Q13 flat flat n/a flat -0.8% n/a 3Q13 flat + low single digit n/a flat 0.0% n/a 4Q13 + mid single digit + low single digit n/a n/a 1.5% n/a 1Q14 + mid single digit + low single digit n/a + low single digit 1.8% n/a 2Q14 + low double digit + low single digit n/a + mid single digit 2.8% n/a 3Q14 + high single digit + low single digit n/a + mid single digit 4.7% n/a 4Q14 + high single digit + low single digit +mid single digit + mid single digit 5.5% n/a 1Q15 + high single digit +mid single digit +mid single digit + mid single digit 6.3% n/a 2Q15 + high single digit +mid single digit +low teens + high single digit 7.2% 21.5% 3Q15 +high single digit +mid single-digit

Source: Companies

Currently, same-store sales growth (SSSG) is trending at a mid-single digit to high-single digit percentage, according to management, which is in line with that of other domestic peers in the sector in 1Q15-2Q15. We believe the change in product strategy towards more functional products will bear fruit in 2016, and we expect to see sustainable double- digit YoY trade fair order growth for 2Q16 and trade fair orders for the remaining 2 quarters for 2016, as well as accelerating SSSG (high-single digit to low-double digit) in 2016 from strong demand for its functional products; and we would not be surprised if these products achieve a high sell-out ratio.

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XTEP International (1368 HK): 19 October 2015

For 2015-17, we forecast 9-11% per annum sales revenue growth on an improving ASP trend from an increasing mix of functional products sold (>CNY300 vs. casual products at CNY200-250) from 10-30% previously to over 30% of the sales mix now, as well as volume growth on overall structural sector demand growth. Product-mix enhancements from increasing contributions of higher-ASP functional products, as well as increasing online sales contribution (bypassing the 62% wholesale discounts given at trade fairs) from consistently better-performing same-period SSSG than trade fair results, should give rise to gross-profit margin improvements in 2015-17 (from 40.8% in 2014 to 43.2% in 2017E).

Xtep: sales revenue forecasts (CNYm) 7,000 24.3% 30%

6,000 20% 10.0% 10.2% 10.8% 9.2% 5,000 10% 0.2% 4,000 0% 3,000 -10% 2,000 -21.8% 1,000 -20% 0 -30% 2010 2011 2012 2013 2014 2015E 2016E 2017E Footwear Apparel Accessories Total sales revenue YoY (RHS)

Source: Company, Daiwa forecasts

Xtep: gross-profit margin trend vs. peers 50%

45% 42.8% 43.2% 41.8%

40%

35%

30% 2010 2011 2012 2013 2014 2015E 2016E 2017E Anta Peak Li Ning Xtep 361

Source: Companies, Daiwa forecasts

Xtep: gross-profit margins of different product categories 50%

42.8% 43.2% 45% 41.8% 40.7% 40.8% 40.9% 40.2% 40.8% 40%

35%

30%

25% 2010 2011 2012 2013 2014 2015E 2016E 2017E

Footwear Apparel Accessories Total

Source: Company, Daiwa forecasts

Running This activity lies at the core of the Xtep’s positioning, and the company is actively involved in sponsoring various marathons across China. According to the Chinese Athletics Association, there were 56 marathons held in China in 2015, an increase of 5 from 2014 and more than double the 22 held in 2011, when marathons first saw an upswing in

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XTEP International (1368 HK): 19 October 2015

popularity. We believe Xtep, among the domestic sportswear brands, is best positioned to capture this incoming growth given its increasing shift in focus from fashion to function.

Our visit to Xtep’s 2Q16 trade fair left us with a positive impression of its upcoming products, in both footwear and apparel, into which numerous new technologies have been embedded. What is encouraging is that the functional technologies (such as “Air Comfort” and “reactive coil”) have been introduced even into its mid-end offerings, which sell for CNY369-439, while professional marathon running featuring “Dynamic Foam” (which are said to be the lightest professional marathon shoes in the world) are priced at ~CNY599. While the marathon shoes may not a big seller given their relatively high price, approaching international brand pricing territory (CNY500-1,000), we do believe this product is testament to the achievements of Xtep and its commitment both to improving its products’ functionality and to the sport of running.

In our proprietary analysis below on value-for-money offerings (based on various Internet reviews), Xtep consistently ranks fairly high in its price bracket (~CNY250-450), and we expect the company to remain at the forefront of its domestic peers, alongside the likes of Anta, as it moves towards offering more functional/performance sportswear.

China sportswear: running value-for-money comparison

Rating 5.0 Xtep Dynamic foam Nike Flyknit Racer 4.8 Xtep Xtep Nike Free 5.0 4.5 Nike LunarGlide 7 Nike Flyknit Lunar 3 Anta Anta Li-Ning Cloud GII Li-Ning Cloud Energy Boost Adidas Boston Boost 4.3

Adidas Ultra Boost 4.0 Li-Ning 烈骏II Li-Ning Cloud racing 3.8

3.5 250 450 650 850 1,050 1,250 1,450 CNY

Source: various online retail platforms, Daiwa

Football According to management, the company will shortly begin rolling out football products for orders for the upcoming 3Q16 trade fair. Despite the government’s national push for football, Xtep’s chairman, Mr. Ding, remains cautiously optimistic and sees the football category having high potential in the long-run, but believes at the current stage the market size is not big enough to support large investments in mass football products. Xtep’s plan to tap into this segment is through the means of establishing campus/university and school tournaments/leagues, whose consumer base would be more relevant and arguably a better fit for the company’s product and market positioning, and this is expected to pave the way for developing the mass market for football in the future.

Lifestyle/casual We expect Xtep’s fashion focus casual apparel/footwear to remain competitive in this space, despite our preference for functional sportswear. Furthermore, Xtep’s current investments in celebrity endorsements (ie, Hong Kong actor Nicholas Tse, Korean star NANA and Chinese actor Li Yifeng) should continue to help sustain its foothold in the fashion-sports segment.

With the company’s shift in focus to functional products, we expect this segment to account for a smaller contribution of sales, which would be incrementally positive for top-line growth due to the lower ASP of casual products. Management also highlighted that most products sold through its e-commerce channel are lifestyle/casual category products, given the propensity for online shoppers to buy lower-priced goods online. At the same time, online sales tend to carry relatively high margins (Xtep’s e-commerce margins are currently ~50% vs. the group’s overall gross margin of 41.8% in 1H15).

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XTEP International (1368 HK): 19 October 2015

Xtep Kids We remain upbeat on China’s kids market, particularly for sportswear brands, given the policy push involves the implementation of physical education in school curriculums, expanding sports facility coverage in neighbourhoods as well as encouraging more sports services (ie, sport leagues and training schools).

Furthermore, on 21 June 2015, Xtep entered into a strategic cooperation agreement with Qihoo 360 (QIHU US, USD53.65, Outperform [2]) with plans to jointly develop smart wearable devices under “Xtep Kids”. The first product to come out of this cooperation is a children’s smart shoe, featuring a positioning function, which helps ensure children’s safety and allows users to track their children’s location through a mobile app with the help of an embedded smart chip which transmits real-time tracking information.

Sports+ – monetising ancillary income streams Event operation is a The State Council guidelines should be positive for the sportswear brands in terms of the lucrative business model demand for their products, but we think the benefits will go beyond that. The guidelines with high margins, in our focus on the entire sports industry, where we see room for ancillary revenue and income, view especially in areas that complement sportswear brands’ strategies and offerings. Xtep has been at the forefront of this initiative, recognising that as a sportswear brand, sponsorship costs spent on events in order to gain exposure are almost a necessity; and as part of its “Sports+” strategy, it has already set up a JV to leverage this opportunity. While it has only been 3 months since the JV was formed, and the plans for it are still in the preliminary stages, we believe this JV will serve as a positive catalyst for earnings in 2016-17, as it appears the consensus has yet to factor in the incremental profits from the JV.

Revenue and costs of an event operation

Revenue Costs

Registration fees Advertising revenue (participants) from ad space at Sponsorship revenue Operation costs Licensing fee Ticket revenue venue (spectators)

Source: Daiwa

Joint venture with Wisdom Holdings Group On 27 June 2015, Xtep announced it had entered into a Memorandum of Understanding with Wisdom to form a JV in which Xtep has invested CNY8m for a 40% interest. The JV will engage in organising sports competitions and events and business collaboration with an emphasis on marathons. Based on our analysis, events operations is a lucrative business model, as revenue from sponsorships and registration fees far outweighs the minimal costs involved in operating an event. According to management, each marathon generates at least CNY1m in revenue. If we at Wisdom’s own financial filings, event operations yields high gross profit margins of 50-70%.

According to management, 100 marathons have been assigned to the JV for 2016, and Xtep expects all the events to be profitable. Depending on the scale of the events, it is not inconceivable for an event to generate up to CNY1m in profit, in our view, given the low operating costs associated with managing an event (ie, labour costs for a marathon are low, as on-site staff are generally volunteers). For a large-scale marathon, net profit margins can be as high as 40%.

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XTEP International (1368 HK): 19 October 2015

In our simple sensitivity analysis, each event could contribute an incremental CNY50,000- 300,000 if the JV can achieve the lower end of Wisdom’s own event operation gross-profit margin. Assuming 100 events in 2016, this could represent a gross profit of CNY5-30m, which we can reasonably assume would flow straight to its bottom line given the low (if any) operating expenses. Under this assumption, we believe the profit the JV could offer 1- 4% upside potential to our 2016E EPS.

Wisdom Holdings Group: financial summary of its “Wisdom Events” – event operations segment (CNYm) 300 68.7% 70% 250 65.8% 68% 65.1% 200 66% 150 62.6% 64% 100 60.0% 62% 50 57.8% 60% 0 58% (50) 56% (100) 54% (150) 52% 2012 2013 1H14 2H14 2014 1H15 Events revenue Cost of services GPm (RHS)

Source: Company data

Sensitivity analysis: gross profit per JV event (40% interest) Revenue per event (CNY '000s)

250 500 1000 1250 1500 40% 40 80 160 200 240 45% 45 90 180 225 270 50% 50 100 200 250 300

Grossmargin 55% 55 110 220 275 330 60% 60 120 240 300 360

Source: Daiwa estimates

Internet+ – O2O sales platform to buoy growth The right recipe to fuel e- Currently, e-commerce sales make up a high single-digit percentage (~7-8%) of the commerce sales company’s top line, but management guides for robust growth of this segment to drive the revenue contribution into the double digits by next year. We believe that reaching a 10% contribution by end of this year could be possible on a strong “Double Eleven” event in November 2015, the world’s biggest online shopping festival held by Alibaba. According to management, its e-commerce business is profitable and currently generates a gross margin of around 50% (vs. an overall group gross profit margin of 41.8% for 1H15). We believe a faster-than-expected ramp-up of its O2O sales platform would serve as a positive catalyst and prompt upward earnings revisions by consensus. That said, management notes that its online customers are generally more price-sensitive, and as such, there are more casualwear products sold online than functional products.

To avoid cannibalisation of its offline sales, around 70% of online products are different than offline products, and the remaining identical products, which are generally popular functional products, have the same prices as offline. With expectations of booming e- commerce sales from its strong partnerships with key online platforms (T-mall, JD.com, VIPshop, etc), management expects to see the current e-commerce sales mix of a high- single digit reach double-digit territory by 2016, and to over 20% in the next few years.

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XTEP International (1368 HK): 19 October 2015

Xtep: E-commerce sales breakdown by channel

Others 10%

VIPshop 10%

JD.com 20% T-mall 60%

Source: Company

Tmall On 6 August 2015, Xtep announced an extensive cooperation agreement which allows it to use Alibaba’s (BABA US, USD71.81, Buy (1)] extensive sales network and merchandising system for brand and product promotion. Under this agreement, Xtep’s e-commerce and Tmall businesses will work closely together on new product launches, O2O, digital operations, celebrity endorsement, brand promotion and service innovations. Furthermore, Tmall will launch a “Potential Client Campaign”, providing Xtep e-commerce with more operational data and increasing transaction volume as Xtep joins the big data economic era.

Xtep: T-mall store

Source: T-mall

Currently, Xtep ranks No.1 on Tmall in terms of volumes sold among sportswear brands, and its T-mall store has a rating of 4.8/5.0 for both service and delivery speed (vs. peers Anta and Li Ning [2331 HK, HKD3.88, Underperform (4)], both at 4.7/5.0). According to the China Leather Organization, online running shoes sales in 1H15 amounted to just shy of CNY4.1bn in sales value and 19m in sales volume, with Xtep ranking 1st in sales volume (2.3m units) and 3rd in sales value in 1H15.

11

XTEP International (1368 HK): 19 October 2015

Online running shoes ranking Ranking Sales volume Sales revenue 1 XTEP Nike 2 Nike 3 New Balance XTEP

(m units) (CNYm) Total* 19 4,093

Source: China Leather Org Note: Total is inclusive of all brands, survey conducted across 15 online platforms

Partnership with S.F. Express (SF) On 23 July 2015, Xtep announced a partnership with SF, an express delivery giant in Mainland China. With a growing contribution coming from its e-commerce platform, logistics experience has become increasingly important. We believe the SF partnership will allow Xtep to leverage the highly effective warehouse network of SF to support high turnover and provide timely short-distance delivery to create a better online purchasing experience. Previously, deliveries for online orders would take 3-4 days from 1 warehouse in Xiamen, but this partnership has opened up access to SF’s warehouses and effectively narrowed the lead time to same day or next day, according to management.

12

XTEP International (1368 HK): 19 October 2015

Operating leverage in sight Expect double-digit YoY profit growth in 2015-17 Low base in 2014 should yield 29% YoY earnings growth in 2015 We forecast an earnings In 2014, a provision for impaired trade receivables of CNY128m was made (around 2.7% CAGR of 21% in 2014-17 of sales), against market expectations, as 2014 was when most domestic peers entered an earnings recovery phase. However, management noted that, as such a large provision had already been made, 2015 should not see a similar surprise. Despite that, we err on the side of caution, given that AR turnover days increased to 104 days in 1H15 (from 91 in 2014), and continue to factor in a marginal provision for bad debt of ~0.4-0.6% of sales from 2015-17E. That said, we highlight that the absence of bad debt provisions in 2H15- 2017E would represent 3-5% upside to our 2015-17E earnings.

Xtep: net-profit forecasts (CNYm) 1,200 40% 28.6% 1,000 18.8% 30% 18.3% 17.1% 14.6% 14.0% 12.9% 20% 800 10.0% 11.7% 17.4% 10% 600 12.3% 14.6% 0% 400 -16.2% (10%) -21.1% 200 -25.2% (20%) 0 (30%) 2010 2011 2012 2013 2014 2015E 2016E 2017E Net Profit YoY (RHS) NPm (RHS)

Source: Company, Daiwa forecasts

Operating profit margin expected to approach 20% in 2017 Cost ratios should Provisions aside, we expect Xtep’s operating expense ratio (ie, A&P, staff costs and R&D remain stable, operating as a proportion of sales revenue) to be relatively stable in the coming years, as A&P leverage achievable expenses should become more productive with the ongoing company’s shift to marketing via new media (as opposed to traditional formats) and more sponsorships of athletes (rather than celebrities), while staff costs should only see increases from wage inflation and expansion in the number of Xtep Kids outlets. At the same time, we expect increases in R&D expenditure to be kept in check as the company utilises more resources to focus on developing performance/functional products. We forecast operating-profit margins to increase to 17.8% YoY in 2015, 18.7% YoY in 2016 and 19.4% YoY in 2017.

Xtep: operating-profit margin and cost ratios % of sales 25% 21.9% 22.0% 20.4% 20.6% 18.7% 19.4% 20% 16.9% 17.8%

15%

10%

5%

0% 2010 2011 2012 2013 2014 2015E 2016E 2017E

A&P Staff costs R&D OPm

Source: Company, Daiwa forecasts

13

XTEP International (1368 HK): 19 October 2015

DRP system helps detect when channel inventory exceeds 5 months Channel inventory at 4-5 With over 85% of Xtep’s retail outlets covered under its Distribution Resource Planning months, in line with (DRP) system, management is confident that the company can maintain a healthy channel sector average inventory of 4-5 months, as the system triggers an alert when an outlet’s inventory exceeds the Xtep’s 5-month comfort level, allowing the company to address the issue quickly. On the other hand, we think the system is useful in allowing the company to react quickly to the latest trends and demand in the market by adjusting its production schedules, particularly for popular products. Some 58% of Xtep’s footwear production was done in- house in 1H15, which should minimise replenishment order lead times and allow the company to accommodate market demand as necessary.

 Channel inventory at 4-5 months – in line with sector average.

 Increasing proportion of distributor-owned stores – currently, distributor self-owned stores account for 40-50% of Xtep’s store network (up from 20-30% previously), and management aims to increase this proportion to 50-60%.

 Distributor health – 80% of Xtep distributors are healthy (in terms of working capital and profitability) according to management, and given the large provisions for bad debt already made in 2014 (CNY128m), we do not foresee further material provisions for impaired trade receivables in 2015.

 Retail discounts – new products receive 15-20% discounts to retail prices, while off- seasonal products are discounted by about 25%, in both cases in line with peers.

A&P likely to stay steady, but mix of spending set to change Moving with the times by While management has guided for an A&P ratio in 2015 in line with that of 2014 (13.1%), a shifting away from change in A&P strategy is being implemented whereby Xtep is shifting to new media traditional marketing formats (ie, social media). We forecast Xtep’s A&P ratio to be 13.5% in 2015, reflecting the formats company’s continued use of some traditional advertising formats; however, we look for the A&P ratio to decline to 13.2% in 2016 and 12.9% in 2017.

 The company is backing away from some of the less-effective traditional formats (ie, TV ads); it is increasing its use of less-expensive online media, which can gain it more exposure on some measures.

 Xtep’s celebrity sponsorships generally involve 2-year contracts, but management notes that these are not a big part of its A&P budget.

 The company is taking on more athlete sponsorships, in line with its rebranding as a functional sportswear brand.

Xtep: A&P cost ratios vs peers 30%

25%

20%

13.5% 15% 13.1% 13.2% 12.9% 11.7% 11.3% 11.4% 11.2% 10%

5% 2010 2011 2012 2013 2014 2015E 2016E 2017E

Anta Peak Li Ning Xtep 361

Source: Company, Daiwa forecasts

14

XTEP International (1368 HK): 19 October 2015

Stable store network: 7,180 Xtep stores, 530 Xtep Kids stores Net closures over, focus As with the other domestic players, Xtep’s store count has largely stabilised after being on store image revamp scaled down, and management believes the present ~7,100-store network is the right size. As for the Xtep Kids stores, management expects a net increase in the store count to approximately 700 by end-2015 (from 530 as at end-June 2015). Its focus is now on optimising its store formats, whereby management expects to change about 1,000 stores from smaller to larger formats. Currently, the majority of its retail outlets are in the small- store format (~80 sq m); its bigger-store formats are about 200 sq m in size. As of 1H15, management noted that approximately 300-400 stores were remodelled, and is already seeing upbeat performance with ~20% improvement in efficiency.

Xtep: number of outlets in store network

9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2010 2011 2012 2013 2014 2015E 2016E 2017E XTEP Core Xtep Kids

Source: Company, Daiwa estimates

Staff costs should increase, albeit more slowly than top-line growth Staff cost ratio forecast Given that management is guiding for the company’s core store count levels (excluding to increase slightly to Xtep Kids) to remain broadly in line with the 1H15 level, we do not expect a material 9.0% for full-year 2015 change in staff costs. However, we forecast the net openings of Xtep Kids stores and wage inflation to drive up the staff cost ratio by 30bps to 9.0% in 2015 (vs. 8.7% in 1H15).

Xtep: staff cost ratio vs peers 18% 16% 14% 12% 9.3% 9.4% 9.0% 9.0% 9.0% 10% 7.1% 8% 6% 4.7% 4.8% 4% 2% 0% 2010 2011 2012 2013 2014 2015E 2016E 2017E Anta Peak Li Ning Xtep 361

Source: Company, Daiwa forecasts

R&D to increase with focus on functional products We expect the R&D cost We expect the absolute sum that Xtep spends on product R&D to increase as the ratio to trend up to 2.2% company continues to develop new technology for its performance/functional products. this year However, we expect the increase to be modest (8-10% per year in 2015-17E), while we look for the cost ratio to increase by just 20bps to 2.2% in 2015 (vs. 2.0% in 1H15) and hold at that level in 2015-17.

15

XTEP International (1368 HK): 19 October 2015

Xtep: R&D cost ratio vs peers 6%

5%

4%

3% 2.6% 2.2% 2.0% 1.8% 1.8% 1.7% 2%

1%

0% 2010 2011 2012 2013 2014 1H15 Anta Peak Li Ning Xtep 361

Source: Company, Daiwa forecasts

16

XTEP International (1368 HK): 19 October 2015

Robust balance sheet Strong cash balance Cash rich with net cash As at 30 June 2015, Xtep had a net cash position of ~CNY2.2bn, which is equivalent to position of ~CNY2.2bn around 30% of its market cap.

 Putting to bed concerns over share placements. Management is confident that, given the company’s strong cash position, there should be no need for equity financing through share placements and noted that if there are financing needs, it intended to go the debt-financing route.

Xtep: net cash and gearing ratio (CNYm) 23% 4,000 22% 25% 21% 21% 3,500 20% 20% 3,000 16% 2,500 15% 2,000 9% 1,500 10% 1,000 5% 500 0% 0 0% 2010 2011 2012 2013 2014 2015E 2016E 2017E Net Cash Gearing ratio (RHS)

Source: Company, Daiwa forecasts

 Dividend policy at no less than 50% of net profit (2014 DPR of 60%). Given Xtep’s strong cash position, we believe there is upside to its dividend payout in 2015-17. Currently, we forecast dividend yields (excluding any potential special dividends) to reach 4.3% in 2015, 5.1% in 2016, and 5.8% in 2017. As we expect the company to see strong performance and likely return to positive earnings growth, we would not rule out the possibility of special dividends in the coming years. Even if we assume a moderate total dividend payout (including special dividends), ie, in line with that of 2014, we believe Xtep’s 2015-17 dividend yields could reach 5.2-7.0%. On our estimates, the company has scope to increase its payout to 83-86% in 2015-17 while retaining its 2014 net cash position.

Xtep: potential dividend payout (HK cents) 0.35 100% 83.3% 86.2% 86.1% 0.30 80% 0.25 60.6% 60.3% 51.5% 0.20 50.0% 50.0% 50.0% 60% 44.2% 42.2% 0.15 40% 0.10 20% 0.05 0.00 0% 2010 2011 2012 2013 2014 2015E 2016E 2017E DPS (LHS) Special DPS (potential) (LHS) DPR (RHS) Potential DPR (RHS)

Source: Company, Daiwa estimates

 Cash conversion cycle to improve. Over 2011-13, Xtep’s cash conversion cycle deteriorated significantly, from 27 days in 2010 to a peak of 94 days in 2013. While 1H15’s cash conversion days was relatively high, at 85 days, as credit policy was extended to encourage distributors to open self-operated stores. However, we think it is within a reasonable range compared with those of other domestic peers (46-138 days). Management expects the full-year cash conversion cycle to improve in 2015, and we believe ~80 days would be more or less normal and reasonable for its operations.

17

XTEP International (1368 HK): 19 October 2015

Xtep: inventory, accounts receivable and accounts payable turnover vs. peers 2009 2010 2011 2012 2013 2014 1H15 Xtep Inventory turnover days 47 50 63 70 79 71 72 A/R turnover days 54 51 64 74 91 91 104 A/P turnover days 69 74 63 54 76 85 91 Working capital cycle 32 27 64 90 94 77 85 Anta Inventory turnover days 38 36 38 51 59 58 57 A/R turnover days 16 19 26 34 38 35 33 A/P turnover days 35 36 37 47 65 54 42 Working capital cycle 19 19 27 38 32 39 48 Peak Sports Inventory turnover days 36 38 49 80 81 74 77 A/R turnover days 70 63 66 127 135 114 114 A/P turnover days 42 46 48 48 45 41 53 Working capital cycle 64 55 67 159 171 147 138 Li Ning Inventory turnover days 53 52 72 89 104 109 109 A/R turnover days 47 52 76 98 89 71 64 A/P turnover days 70 71 93 112 104 84 90 Working capital cycle 30 33 55 75 89 96 83 Inventory turnover days 44 45 145 277 210 141 131 A/R turnover days 24 37 81 121 131 96 70 A/P turnover days 61 65 91 72 68 76 84 Working capital cycle 7 17 135 326 273 161 117 Inventory turnover days 21 22 40 56 73 77 80 A/R turnover days 103 91 108 149 205 167 149 A/P turnover days 118 108 89 112 158 169 183 Working capital cycle 6 5 59 93 120 75 46

Source: Company, Daiwa

18

XTEP International (1368 HK): 19 October 2015

Valuation and risks Undemanding valuation with visible near-term catalysts We initiate coverage of Xtep with a Buy (1) rating and 12-month TP of HKD4.60, set at an 11.5x 2016E PER (equivalent to a 2016E PEG of 0.67), which we deem reasonable based on our forecast earnings CAGR of 20% in 2014-17.

Currently, the stock is trading at a 9.9x 2016E PER (6x ex-net cash and PEG of 0.62), on our EPS estimates, below the sector average of 14x (ex-Xtep), but offers 17% YoY EPS growth (vs. 13.1% YoY for sector, excluding Xtep) in 2016. (Note: Daiwa data for covered stocks; Bloomberg data for stocks not rated by Daiwa).

We like the company’s shift in strategy to focus on functional/performance products, which we expect will not only allow for industry-leading sales growth but will lead to attractive margin expansion arising from higher-ASP functional products. Indeed, we believe better- than-expected product-mix enhancements will be the main driver of upward revisions to consensus earnings forecasts this year.

Xtep: 12-month-forward PER Xtep: discount to sector PER (x) 30% 20% 18 10% 0% 13 (10%) (20%) -16% 8 (30%) (40%) 3 (50%)

(60%)

Jul-12 Jul-13 Jul-14 Jul-15

Jan-12 Jan-13 Jan-14 Jan-15

Mar-12 Mar-14 Mar-13 Mar-15

Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 Sep-15

May-12 May-13 May-14 May-15

Jul-14 Jul-13 Jul-15

XTEP Sector Jul-12

Jan-12 Jan-13 Jan-14 Jan-15

Mar-12 Mar-13 Mar-14 Mar-15

Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 Sep-15

May-15 May-13 May-14 May-12 Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Xtep: PER band Xtep: ex-net cash PER and PEG valuation (HKD) PX TP 9 2016E 8 Market cap (HKDm) 8,644 10,016 7 Net cash (CNYm) 2,511 2,511 6 Net cash per share (CNY) 1.15 1.15 5 Ex-net cash P/E 6.43 8.01 4 3 PER 9.92 11.50 2 PEG 0.58 0.67 1

0

Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Mar-11 Mar-12 Mar-13 Mar-14 Mar-15

Sep-11 Nov-11 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 Sep-15

May-11 May-12 May-13 May-14 May-15 Xtep 3x 5x 8x 10x 13x Source: Bloomberg, Daiwa: Source: Daiwa forecasts Note: Prices as of 16 October 2015

19

XTEP International (1368 HK): 19 October 2015

China sportswear sector: comparison of key metrics Share Market Net Profit Growth YoY EPS CAGR Sub-sector/Company Stock Rating Price Cons. TP cap PER ratio (x) PEG (%) PBR ratio (x) EV/EBITDA (x) ROE (%) Div yield (%) Sales growth YoY (%) (%) EPS growth YoY (%) (%) code (lcy) (lcy) (USDm) CY14 CY15E CY16E CY17E CY15E CY16E CY15E CY16E CY17E CY15E CY16E CY17E CY15E CY16E CY17E CY15E CY16E CY17E CY15E CY16E CY17E CY15E CY16E CY17E CY15E CY16E CY17E CY15-17E

China Sportswear PRODUCTS LTD 2020 HK Buy 19.4 22.2 6,245 25.5 21.6 18.6 16.4 1.2 (13.8) 5.1 4.5 4.0 13.6 11.5 9.9 24.7 25.8 26.0 2.9 3.3 3.8 21.6 16.4 10.4 18.3 16.0 13.6 18.3 16.0 13.6 14.8 XTEP INTERNATIONAL HOLDINGS 1368 HK Buy 4.0 4.6 1,118 14.8 11.6 9.9 8.7 0.4 (14.6) 1.4 1.3 1.2 5.1 4.2 3.5 12.6 13.7 14.5 4.3 5.1 5.8 10.2 10.8 9.2 28.6 17.1 14.6 28.6 17.1 14.6 15.8 LTD 1968 HK Buy 2.1 2.5 657 11.4 10.7 9.4 8.5 (6.1) (12.1) 0.8 0.8 0.8 1.1 0.7 0.4 8.4 8.7 9.2 7.0 6.6 7.3 8.4 10.3 10.4 21.3 13.8 11.5 6.5 13.8 11.5 12.7 LI NING CO LTD 2331 HK Underperform 3.9 3.7 944 14.3 9.6 1.9 1.7 1.5 14.4 6.9 5.2 9.9 13.0 17.9 15.1 12.0 49.5 49.5 CHINA DONGXIANG GROUP CO 3818 HK NR 2.8 3.8 750 11.8 9.3 7.5 6.1 NA NA 0.9 0.8 0.8 3.1 2.6 2.2 10.1 11.6 12.9 4.3 5.6 6.4 12.8 18.5 18.3 31.0 24.6 20.6 28.2 24.0 22.6 23.3 361 DEGREES INTERNATIONAL 1361 HK NR 1.9 2.6 1,350 7.7 19.6 19.9 20.4 0.9 0.9 0.9 0.8 0.8 6.5 8.9 14.9 4.4 4.1 4.1 4.4 3.8 3.9 17.8 15.4 4.2 (52.4) (1.4) (0.4) (60.7) (1.3) (2.6) (1.9) China Sportswear Simple average 14.3 14.6 13.3 11.6 (0.9) (9.9) 1.8 1.7 1.5 7.3 5.8 6.0 12.0 12.3 13.3 4.6 4.9 5.4 14.8 14.4 10.7 9.4 14.0 18.2 4.2 13.9 18.2 12.9 China Sportswear Weighted average 18.3 17.0 16.2 14.3 0.5 (9.9) 3.4 3.0 2.7 10.5 8.8 8.4 16.9 18.6 19.2 3.3 3.6 4.1 18.3 15.4 10.2 10.2 13.1 15.4 8.1 13.1 15.3 12.1 International Fast-fashion INDUSTRIA DE DISENO TEXTIL ITX SM NR 30.8 31.0 109,352 35.3 38.8 33.0 29.3 2.7 2.3 9.5 8.3 7.5 22.5 19.4 17.3 25.2 26.1 26.3 1.6 1.9 2.2 8.3 14.1 10.4 16.3 16.8 12.2 5.2 7.6 12.7 15.0 HENNES & MAURITZ AB-B SHS HMB Ss NR 313.9 336.7 63,088 24.1 24.1 22.2 19.9 2.1 2.0 9.1 8.1 7.3 15.0 13.7 12.3 39.5 38.5 38.6 3.3 3.5 3.8 20.2 11.5 10.3 7.8 8.2 11.6 (0.1) 8.2 11.4 9.8 FAST RETAILING CO LTD 9983 JP NR 43,400.0 48,862.5 38,543 40.2 34.8 30.7 28.5 1.5 1.3 5.3 4.7 4.1 17.1 15.2 14.3 16.8 17.2 16.7 0.9 1.0 1.1 13.8 12.5 8.6 15.3 12.3 8.8 15.6 13.2 8.0 10.6 GAP INC/THE GPS US NR 26.5 31.4 10,775 9.6 9.5 10.3 9.5 1.0 1.1 4.7 3.9 3.5 4.4 4.8 4.7 42.0 36.3 38.5 3.3 3.5 3.7 1.8 (1.6) 1.9 (8.7) (14.8) 4.3 4.3 (5.4) 7.8 0.1 International Fast-fashion Simple average 26.9 24.5 23.7 21.3 1.2 1.2 6.0 5.2 4.6 13.0 12.0 10.9 30.9 28.5 29.6 1.9 2.0 2.2 11.1 6.8 7.2 35.4 (2.0) 8.3 8.1 2.4 9.9 5.6 International Fast-fashion Weighted average 32.7 33.6 30.0 26.8 2.2 2.0 8.7 7.7 6.9 19.5 17.2 15.4 28.9 28.5 28.8 2.0 2.2 2.4 13.5 12.8 10.4 25.1 10.9 11.7 5.0 6.7 11.9 11.5 International Sportswear NIKE INC -CL B NKE US NR 128.8 138.3 109,754 32.6 36.7 30.4 26.7 2.9 2.4 8.9 7.3 6.5 22.2 19.9 17.2 27.1 28.4 29.7 0.8 0.9 1.0 10.1 7.2 9.2 21.3 14.1 11.8 24.6 8.7 13.9 17.4 ADIDAS AG ADS GR NR 77.3 76.2 18,421 26.8 22.0 19.8 17.0 1.3 1.2 2.7 2.5 2.3 11.9 11.0 9.8 12.6 13.4 14.6 2.0 2.2 2.6 11.8 6.9 6.0 43.9 9.3 14.0 20.4 10.8 16.3 13.6 FOOT LOCKER INC FL US NR 68.6 77.3 9,555 17.3 20.1 16.7 14.9 1.8 1.5 3.9 3.7 3.4 9.5 8.3 7.6 19.7 22.8 23.9 1.3 1.4 1.5 9.9 3.2 5.6 18.8 13.7 8.7 24.9 6.4 11.8 16.2 ASICS CORP 7936 JP NR 3,155.0 3,522.5 5,282 26.4 46.5 24.9 21.8 NA NA 3.0 2.8 2.5 16.6 14.1 12.5 7.1 12.1 12.6 0.7 0.8 0.9 30.7 8.8 8.3 (15.6) 86.1 14.0 (42.0) 86.9 13.9 45.9 SE PUM GR NR 190.6 171.4 3,272 62.1 61.3 42.4 28.6 NA NA 1.7 1.7 1.6 16.9 13.2 10.6 2.9 4.1 5.7 0.3 0.3 0.5 12.6 5.8 6.4 (31.1) 47.5 46.9 0.3 44.7 48.2 46.4 MIZUNO CORP 8022 JP NR 576.0 566.3 644 23.1 22.4 22.2 19.4 NA NA 0.8 0.8 0.8 11.1 11.3 10.2 3.7 3.2 3.6 1.7 1.7 1.8 2.1 4.5 4.0 37.3 (2.7) 14.7 26.1 5.5 14.7 7.4 International Sportswear Simple average 30.6 33.8 25.5 20.9 4.3 2.8 3.4 3.0 2.8 14.3 12.6 11.1 12.1 13.9 14.9 1.2 1.3 1.4 12.9 5.9 6.5 12.4 27.6 18.5 9.2 26.5 20.0 24.3 International Sportswear Weighted average 30.2 33.1 27.0 23.6 3.0 2.4 7.1 5.9 5.3 18.9 16.9 14.8 23.5 24.9 26.2 1.0 1.1 1.3 11.0 6.7 8.2 21.5 16.6 12.5 21.3 12.1 14.6 18.2

Source: FactSet, Bloomberg, Daiwa estimates/forecasts ; prices as of 16 October 2015 Note: Bloomberg data for not-rated companies

20

XTEP International (1368 HK): 19 October 2015

Risks to our call Channel inventory build-up. The key risk to our positive rating on the stock would be sell- through lagging behind sell-in, if demand at retail levels falls behind distributor orders.

Larger-than-expected bad debt provision. While management expects to make little to no provisions in 2015, we are wary of the increase in AR turnover days seen in 1H15 (up to 104 days, from 91 days in 2014). Hence, to be conservative, we factor in marginal (~0.5% of sales) provisioning for impaired trade receivables per annum over 2015-17.

Competition from international peers. Secondary risks to our positive call would be aggressive discounting by international peers and international players penetrating lower- tier cities faster than we expect.

21

XTEP International (1368 HK): 19 October 2015

Appendix Company background Xtep International is a leading fashion sportswear brand in China that was established in 2002. It engages in the design, development, manufacturing, sales and marketing and brand management of sports footwear, apparel and accessories. The group currently has an extensive distribution network, with over 7,000 stores in China. It was listed on the Hong Kong Stock Exchange on 3 June 2008.

Xtep: Management background Name Position Responsibilities Mr. Ding Shui Po Founder, Chairman and Chief Executive Responsible for overall corporate strategies, planning and business development Officer of the Group Ms. Ding Mei Qing Executive Director and Board Deputy Responsible for the management of the footwear operations of the Group, as well Chairman as the design and technology development of the Group Mr. Lin Zhang Li Executive Director and Vice President Responsible for the management of the apparel business of the Group Mr. Ding Ming Zhong Executive Director and Vice President Responsible for the management of the accessories business of the Group Mr. Ye Qi Executive Director and Vice President of Responsible for overall sales and marketing business of the Group Xtep (China) Mr. Ho Yui Pok, Chief Financial Officer, Company Responsible for the Group's overall financial and accounting affairs and investor Eleutherius Secretary and Executive Director relations

Source: Company

Xtep: shareholding structure

Mr. Ding Shui Po Public

60.94% 39%

Xtep International (1368.HK)

Source: Company

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XTEP International (1368 HK): 19 October 2015

Daiwa’s Asia Pacific Research Directory HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Kosuke MIZUNO (852) 2848 4949 / [email protected] Shipbuilding; Steel (852) 2773 8273 Mike OH (82) 2 787 9179 [email protected] Regional Research Co-head Banking; Capital Goods (Construction and Machinery) John HETHERINGTON (852) 2773 8787 [email protected] Iris PARK (82) 2 787 9165 [email protected] Regional Deputy Head of Asia Pacific Research Consumer/Retail Rohan DALZIELL (852) 2848 4938 [email protected] SK KIM (82) 2 787 9173 [email protected] Regional Head of Product Management IT/Electronics – Semiconductor/Display and Tech Hardware Kevin LAI (852) 2848 4926 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional) Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Christie CHIEN (852) 2848 4482 [email protected] Macro Economics (Regional); Banking; Insurance (Taiwan) TAIWAN Junjie TANG (852) 2773 8736 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Macro Economics (China) Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Jonas KAN (852) 2848 4439 [email protected] (Regional) Head of Hong Kong and China Property Steven TSENG (886) 2 8758 6252 [email protected] Cynthia CHAN (852) 2773 8243 [email protected] IT/Technology Hardware (PC Hardware) Property (China) Christine WANG (886) 2 8758 6249 [email protected] Leon QI (852) 2532 4381 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Banking (Hong Kong/China); Broker (China); Insurance (China) Kylie HUANG (886) 2 8758 6248 [email protected] Anson CHAN (852) 2532 4350 [email protected] IT/Technology Hardware (Handsets and Components) Consumer (Hong Kong/China) Helen CHIEN (886) 2 8758 6254 [email protected] Jamie SOO (852) 2773 8529 [email protected] Small/Mid Cap Gaming and Leisure (Hong Kong/China) Dennis IP (852) 2848 4068 [email protected] INDIA Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Power; Utilities; Renewables and Environment (Hong Kong/China) John CHOI (852) 2773 8730 [email protected] Head of India Research; Strategy; Banking/Finance Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Kelvin LAU (852) 2848 4467 [email protected] Capital Goods; Utilities

Head of Automobiles; Transportation and Industrial (Hong Kong/China) SINGAPORE Brian LAM (852) 2532 4341 [email protected] Ramakrishna MARUVADA (65) 6499 6543 [email protected] Transportation – Railway; Construction and Engineering (China) Head of Singapore Research; Telecommunications (China/ASEAN/India) Jibo MA (852) 2848 4489 [email protected] Royston TAN (65) 6321 3086 [email protected] Head of Custom Products Group Oil and Gas; Capital Goods Thomas HO (852) 2773 8716 [email protected] David LUM (65) 6329 2102 [email protected] Custom Products Group Property and REITs

Shane GOH (65) 64996546 [email protected] PHILIPPINES Bianca SOLEMA (63) 2 737 3023 [email protected] Small/Mid Cap (Singapore) Jame OSMAN (65) 6321 3092 [email protected] Utilities and Energy Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

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Daiwa’s Offices Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726 Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, United Kingdom (44) 207 320 8000 (44) 207 410 0129 Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

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DAIWA INSTITUTE OF RESEARCH LTD HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603 MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021

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This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Group Inc., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person.

Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including market making activities, derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures.

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Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship Within the preceding 12 months, the subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Modern Land (China) Co. Ltd (1107 HK); econtext Asia Ltd (1390 HK); Accordia Trust (AGT SP); Hua Hong Semiconductor Ltd (1347 HK); GF Securities Co Ltd (1776 HK); Mirae Asset Life Insurance Co Ltd (085620 KS). *Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd.

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There is no material disciplinary action against Daiwa India by any regulatory authority impacting equity research analysis activities as of the date of this report.

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United Kingdom This research report is produced by Daiwa Securities Co. Ltd. and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange and Eurex. This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

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Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory.

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United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (Tel no. 212-612-7000).

Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

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Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

Disclosure of investment ratings Rating Percentage of total Buy* 63.8% Hold** 22.2% Sell*** 14.0% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 30 September 2015. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.  In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.  In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.  For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.  There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.  There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.  Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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