Company Note Retail│Hong Kong│November 7, 2019

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Hong Kong Xtep International ADD (previously HOLD) Still a black horse after a temporary setback Consensus ratings*: Buy 21 Hold 3 Sell 0 ■ We recently visited Xtep and have turned more positive on its development of new Current price: HK$4.64 business, such as its co-operation with Wolverine Worldwide. ■ We expect its core Xtep brand to maintain strong momentum in FY19F. Target price: HK$5.50 ■ We now forecast lower net profit in FY19F because of one-off items arising from the Previous target: HK$5.60 acquisition, but Xtep’s EPS could still deliver a CAGR of 17% in FY18–21F. Up/downside: 18.5% ■ Upgrade to ADD with a new TP of HK$5.50, based on 14.0x 2020F P/E. CGI / Consensus: -9.1% Progress in developing Saucony & Merrell on track Reuters: 1368.HK Our recent visit to Xtep has make us more positive on its development of new brands. Bloomberg: 1368 HK For Saucony and Merrell, the brands that have been co-developed with Wolverine Market cap: US$1,490m Worldwide since March 2019, Xtep has already started developing products that cater for HK$11,658m the specific needs of Chinese consumers. The progress of Saucony is better than we Average daily turnover: US$6.17m expected, as Xtep is already selling certain products on Tmall. This brand should also HK$48.03m create higher synergy with the core Xtep brand, as it is a running-oriented brand. The two Current shares o/s: 2,175m brands could then share the marketing resources, such as sponsoring marathon races. Free float: 45.9% The Company will open 30 to 40 Saucony stores in FY20F in large cities in China and *Source: Bloomberg gauge whether it will be a profitable brand for distributors. A similar approach will be

Key changes in this note adopted by outdoor brand Merrell, but fewer shops (20 to 30) will be opened. Xtep notes FY19F/20F revenue increased by 3.7/1.0%. that outdoor is still a niche market in China, so the expansion will not be that aggressive FY19F/20F EPS decreased by 9.3%/0.5% compared to the core Xtep brand and Saucony.

The breadwinning Palladium will give some time for K-Swiss Price Close Relative to HSI (RHS) Back in May 2019, we were cautious on the deal to acquire the brands owned by E-land

6.50 125 Footwear USA (K-Swiss, Palladium and Supra), as we felt the deal would have an impact on the near-term financials. We believe the financial impact is now understood by the 5.50 108 market and priced in. Specifically, there are now expected to be one-off costs of about 4.50 91 Rmb100m in FY19F associated with the deal. About Rmb65m will be associated with the 3.50 74 400 impairment related to Supra, as Xtep’s focus will be on K-Swiss and Palladium. 300 200 Regarding operations, Xtep recently closed all the POS of K-Swiss in mainland China as

100 the first step in revamping the brand. In the medium term, K-Swiss will be relaunched in Vol m Vol Nov-18 Feb-19 May-19 Aug-19 China with more stylish apparel products designed by Japanese and Korean designers.

Source: Bloomberg We believe the short-term impact will be offset by the growth of Palladium, which is profit- making. Management said it would open 100–150 POS in the next two years. Xtep’s Price performance 1M 3M 12M distributors have expressed interest in handling Palladium. Under this scenario, Absolute (%) 4.7 -8.9 -1.1 management reiterated that these two brands should break even in operating profit. Relative (%) -2.5 -15.4 -7 Growth should resume after FY19F impacted by one-off items Major shareholders % held Xtep’s same-store-sales growth (SSSG) for the core brand was around 10% yoy in 3Q19 Ding Shui Po & Family 54.1 (Jul–Sep 2019), which is a slight deceleration. But overall retail sales (including e- commerce) were up about 20% yoy for the same period. We therefore expect revenue from the Xtep core brand to deliver ~20% yoy growth in FY19F. We lower our 2019F EPS Insert by 9.3% mainly to reflect the impact of one-off items related to the acquisition, but we still expect Xtep’s EPS to deliver a CAGR of 17% in FY18–21F. Upgrade to ADD with a more favourable risk-reward ratio We slightly lower our TP to HK$5.50 to reflect the forecast change, while our target 2020F P/E multiple of 14.0x (1.s.d. above one-year average) remains unchanged. Despite the earnings cut of 1–9%, we believe the valuation of Xtep has become more attractive. The current valuation of 11x 20F P/E is not demanding considering its medium-term earnings growth. Upgrade to ADD. A key downside risk is worse-than- expected sales in the “Double-11” online shopping event.

Financial Summary Dec-17A Dec-18A Dec-19F Dec-20F Dec-21F Revenue (Rmbm) 5,113 6,383 8,002 9,842 11,267 Operating EBITDA (Rmbm) 793 1,136 1,235 1,508 1,801 Net Profit (Rmbm) 408 657 701 852 1,059 Normalised EPS (Rmb) 0.19 0.30 0.30 0.35 0.41 Normalised EPS Growth (23.1%) 62.2% (1.7%) 18.5% 15.5% FD Normalised P/E (x) 22.27 13.73 13.43 11.65 9.85 DPS (Rmb) 0.19 0.18 0.18 0.21 0.24 Analysts Dividend Yield 4.54% 4.24% 4.29% 5.09% 5.87% EV/EBITDA (x) 7.90 5.80 6.76 5.66 5.19 Tony Li P/FCFE (x) 7.25 NA NA 14.90 14.67 T (852) 3698 6392 Net Gearing (55.1%) (45.7%) (21.3%) (21.2%) (19.6%) E [email protected] P/BV (x) 1.73 1.69 1.43 1.38 1.38 Wong Chi Man ROE 8.0% 12.4% 11.5% 12.1% 14.0% T (852) 3698 6317 % Change In Normalised EPS Estimates (9.28%) (0.47%) (5.80%) E [email protected] Normalised EPS/consensus EPS (x) 0.97 0.94 0.91 SOURCES: CGIS RESEARCH, COMPANY DATA, BLOOMBERG

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Retail│Hong Kong Xtep International│November 7, 2019

Still a black horse after a temporary setback

Figure 1: Earnings revision FY19F FY20F FY21F Rmb m Old New % change Old New % change Old New % change Net revenue 7,713 8,002 3.7% 9,749 9,842 1.0% 11,240 11,267 0.2% Gross margin 27.2% 27.2% 0.0% pts 24.8% 24.8% 0.0% pts 23.6% 23.6% 0.0% pts Operating profit 1,240 1,125 -9.2% 1,440 1,374 -4.6% 1,742 1,649 -5.3% Operating margin 16.1% 14.1% -2.0% pts 11.6% 11.6% 0.0% pts 11.6% 11.6% 0.0% pts Net income 773 701 -9.3% 856 852 -0.5% 1,124 1,059 -5.8% Net margin 10.0% 8.8% -12.6% 8.8% 8.7% -1.4% 10.0% 9.4% -6.0% Reported EPS (Rmb) 0.33 0.30 -9.3% 0.35 0.35 -0.5% 0.43 0.41 -5.8% SOURCES: CGIS RESEARCH, COMPANY DATA, BLOOMBERG

Figure 2: Xtep’s quarterly SSSG figures

16% mid-teens 16%

14% 14%

12% low-teens low-teens 12%

Around 10% 10% high S.D. 10% high S.D. 8% mid S.D. 8% mid S.D.mid S.D.mid S.D.mid S.D. mid S.D. 6% 6% mid S.D.

4% low S.D. 4%

2% 2%

0% 0% 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018 2018 2019 2019 2019

SSSG (in terms of retail value)

SOURCES: CGIS RESEARCH, COMPANY DATA

Figure 3: Forward P/E of Xtep

Title: 16 Source: 15

14 Please fill in the values above to have them entered in your report

13

12

11

10

9

BEst P/E Ratio (Curr Ann) 1-year average +1 s.d. -1 s.d.

SOURCES: CGIS RESEARCH, COMPANY DATA, BLOOMBERG

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Retail│Hong Kong Xtep International│November 7, 2019

BY THE NUMBERS

P/BV vs ROE 12-mth Fwd FD Normalised P/E vs FD 2 13% 17 Normalised EPS Growth 80% 16 68% 2 12% 15 56% 2 11% 14 44% 13 32% 1 10% 12 20% 11 8% 1 9% 10 -4% 1 8% 9 -16% 8 -28% 1 7% 7 -40% Jan-15A Jan-16A Jan-17A Jan-18A Jan-19F Jan-20F Jan-15A Jan-16A Jan-17A Jan-18A Jan-19F Jan-20F

Rolling P/BV (x) (lhs) ROE (rhs) 12-mth Fwd Rolling FD Normalised P/E (x) (lhs) Diluted Normalised EPS Growth (rhs)

Profit & Loss

(Rmbm) Dec-17A Dec-18A Dec-19F Dec-20F Dec-21F Total Net Revenues 5,113 6,383 8,002 9,842 11,267 Gross Profit 2,244 2,828 3,627 4,422 5,104 Operating EBITDA 793 1,136 1,235 1,508 1,801 Depreciation And Amortisation (68) (92) (110) (134) (152) Operating EBIT 725 1,044 1,125 1,374 1,649 Financial Income/(Expense) (54) (68) (83) (97) (102) Pretax Income/(Loss) from Assoc. 0 0 (17) (30) 0 Non-Operating Income/(Expense) 0 0 0 0 0 Profit Before Tax (pre-EI) 671 976 1,025 1,247 1,547 Exceptional Items Pre-tax Profit 671 976 1,025 1,247 1,547 Taxation (224) (306) (308) (374) (464) Exceptional Income - post-tax Profit After Tax 446 670 718 873 1,083 Minority Interests (38) (13) (17) (21) (24) Preferred Dividends FX Gain/(Loss) - post tax Other Adjustments - post-tax Preference Dividends (Australia) Net Profit 408 657 701 852 1,059 Normalised Net Profit 446 670 718 873 1,083

Fully Diluted Normalised Profit 408 657 701 852 1,059

Cash Flow

(Rmbm) Dec-17A Dec-18A Dec-19F Dec-20F Dec-21F EBITDA 793 1,136 1,235 1,508 1,801 Cash Flow from Invt. & Assoc. Change In Working Capital (119) (513) (889) (391) (603) (Incr)/Decr in Total Provisions Other Non-Cash (Income)/Expense Other Operating Cashflow 134 (174) (57) (60) (23) Net Interest (Paid)/Received 9 14 (41) (56) (61) Tax Paid (259) (309) (308) (374) (464) Cashflow From Operations 558 154 (60) 626 651 Capex (127) (75) (91) (112) (128) Disposals Of FAs/subsidiaries Acq. Of Subsidiaries/investments (1,643) 0 0 Other Investing Cashflow 402 (207) (1,602) 41 41 Cash Flow From Investing 275 (281) (3,335) (70) (87) Debt Raised/(repaid) 421 (10) 17 110 147 Proceeds From Issue Of Shares 7 59 1,170 0 0 Shares Repurchased 0 0 0 0 0 Dividends Paid (271) (459) (392) (466) (573) Preferred Dividends Other Financing Cashflow (3) (100) 0 0 0 Cash Flow From Financing 154 (511) 795 (356) (427) Total Cash Generated 987 (637) (2,600) 200 138 Free Cashflow To Equity 1,254 (137) (3,378) 666 711

Free Cashflow To Firm 887 (59) (3,312) 653 667 SOURCES: CGIS RESEARCH, COMPANY DATA, BLOOMBERG

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Retail│Hong Kong Xtep International│November 7, 2019

BY THE NUMBERS… cont’d

Balance Sheet

(Rmbm) Dec-17A Dec-18A Dec-19F Dec-20F Dec-21F Total Cash And Equivalents 4,784 4,381 3,424 3,624 3,762 Total Debtors 1,719 1,953 2,449 3,012 3,448 Inventories 718 836 1,291 1,599 1,818 Total Other Current Assets 661 889 1,064 1,264 1,354 Total Current Assets 7,882 8,060 8,227 9,499 10,382 Fixed Assets 646 641 889 873 854 Total Investments 0 0 155 155 155 Intangible Assets 8 8 1,234 1,234 1,234 Total Other Non-Current Assets 398 490 484 478 473 Total Non-current Assets 1,052 1,139 2,763 2,740 2,716 Short-term Debt 831 1,483 461 1,071 1,218 Current Portion of Long-Term Debt Total Creditors 1,028 879 1,082 1,340 1,523 Other Current Liabilities 630 916 949 1,347 1,275 Total Current Liabilities 2,489 3,278 2,492 3,758 4,016 Total Long-term Debt 1,019 461 1,500 1,000 1,000 Hybrid Debt - Debt Component Total Other Non-Current Liabilities 0 22 22 22 22 Total Non-current Liabilities 1,019 483 1,522 1,022 1,022 Total Provisions 97 107 108 131 163 Total Liabilities 3,605 3,868 4,121 4,911 5,200 Shareholders' Equity 5,221 5,326 6,847 7,286 7,832 Minority Interests 108 5 22 42 66

Total Equity 5,329 5,331 6,869 7,328 7,898

Key Ratios

Dec-17A Dec-18A Dec-19F Dec-20F Dec-21F Revenue Growth (5.2%) 24.8% 25.4% 23.0% 14.5% Operating EBITDA Growth (18.8%) 43.3% 8.7% 22.1% 19.5% Operating EBITDA Margin 15.5% 17.8% 15.4% 15.3% 16.0% Net Cash Per Share (Rmb) 1.35 1.12 0.62 0.64 0.59 BVPS (Rmb) 2.41 2.45 2.90 3.01 3.00 Gross Interest Cover 13.47 15.33 13.61 14.13 16.20 Effective Tax Rate 33.5% 31.4% 30.0% 30.0% 30.0% Net Dividend Payout Ratio 100% 58% 60% 60% 60% Accounts Receivables Days 129.7 105.0 100.4 101.5 104.6 Inventory Days 74.9 79.8 88.7 97.6 101.2 Accounts Payables Days 122.4 97.9 81.8 81.8 84.8 ROIC (%) 30.2% 41.9% 37.2% 25.5% 28.6% ROCE (%) 10.4% 14.2% 13.8% 14.9% 16.6%

Return On Average Assets 5.85% 8.14% 7.93% 8.35% 9.35%

Key Drivers

Dec-17A Dec-18A Dec-19F Dec-20F Dec-21F ASP (% chg, main prod./serv.) N/A N/A N/A N/A N/A Unit sales grth (%, main prod./serv.) N/A N/A N/A N/A N/A No. of POS (main prod/serv) 6,000 6,230 6,431 6,701 6,924 SSS grth (%, main prod/serv) 3.5% 10.0% 25.0% 8.0% 8.0% ASP (% chg, 2ndary prod./serv.) N/A N/A N/A N/A N/A Unit sales grth (%,2ndary prod/serv) N/A N/A N/A N/A N/A No. of POS (2ndary prod/serv) N/A N/A N/A N/A N/A

SSS grth (%, 2ndary prrod/serv) N/A N/A N/A N/A N/A SOURCES: CGIS RESEARCH, COMPANY DATA, BLOOMBERG

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Retail│Hong Kong Xtep International│November 7, 2019

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