Results Review Hong Kong FY16: missed expectations 20 March 2017 Consumer Cyclical | Sportswear Buy (Maintained) Xtep International Holdings Ltd Target Price: HKD4.90 Price: HKD3.72 Still Represents Good Value Market Cap: USD1,064m Bloomberg Ticker: 1368 HK We keep our BUY but with a lower HKD4.90 TP (vs HKD5.20, 32% Share Data downside) due to a weaker sales outlook. We expect FY17 sales growth to Avg Daily Turnover (HKD/USD) 11.2m/1.44m stay in the low single-digits, as Xtep continues to cut trade fair order deliveries, while more provisions (albeit at a smaller quantum) may 52-wk Price low/high (HKD) 3.15 - 4.64 continue to hurt NP. We stay positive on Xtep in the longer term as it still Free Float (%) 40 offers significant value due to its high net cash and free cash flow (FY17F Shares outstanding (m) 2,149 dividend yield: 5.5%). However in the short to mid term, slower sales Estimated Return 32% growth, lower visibility and broker downgrades may keep stock price depressed. Shareholders (%) Mr Ding Shui Po 60.3 FY17 sales to be subdued. Xtep may continue to reduce trade fair deliveries in 2017, after it did so several times in 2016. Our FY17F sales may likely grow by the low single digits (SD) after we apply a discount to 1Q17F, 2Q17F and 3Q17F trade fair orders growth of mid SD, low SD and low SD respectively. Share Performance (%) No more disclosure of trade fair data? It is considering to stop reporting trade YTD 1m 3m 6m 12m fair figures from the 2018 collection onwards, as it regards trade fair numbers as “becoming less representative” due to higher replenishment orders taken, its Absolute 14.1 6.0 8.8 0.0 (5.8) growing e-commerce business and reduced order deliveries. We feel investors Relative 3.6 4.9 (1.6) (4.2) (24.4) may not like the subsequent lower visibility, which would affect sentiment. Source: Bloomberg More provisions to come. We expect Xtep to make more accounts receivable (AR) provisions for Xtep Kids, as 10% of the CNY1.9bn AR pertains to Xtep XTEP International Holdings Ltd (1368 HK) Price Close Relative to Hang Seng Index (RHS) Kids distributors. We deem AR provisions as operational and recurring as Xtep has been impacted by it over the last two years due to sell-through challenges. 4.5 114 We have not, however, factored in provision write-backs, should those 4.0 97 distributors repay their bills. 3.5 81 3.0 64 18 FY16 results announced 17 Mar 2017 – missed expectations 16 14 FYE Dec (HKDm) FY15 FY16A YoY 2H16 YoY Comments 12 10 Sales Revenue 5,295 5,397 2% 2,862 -1% 2H trade fair orders cut 8 6 Gross Profit 2,237 2,331 4% 1,233 0% 4 2 EBIT 921 917 0% 334 -21% AR provisions Volm 16 16 16 16 16 17 - - - - - Net Profit (recurring) 623 528 -15% 148 -47% - Jul Jan Mar Sep Nov May DPS (CNY) 0.17 0.14 -17% 0.05 -40% Source: Bloomberg As % of Sales GP margin 42.2% 43.2% 1.0ppt 43.1% 0.5ppt Functional products drive GPM EBIT margin 17.4% 17.0% -0.4ppt 11.7% -2.8ppt NP margin (recurring) 11.8% 9.8% -2.0ppt 5.2% -4.4ppt Source: Company data, RHB BUY. We cut FY17F-18F EPS by 9% and 11% respectively on the more tepid growth outlook and the likelihood of more provisions. We cut our DCF-based TP to HKD4.90 (from HKD5.20), implying 15x FY17F. Xtep is trading at 11x FY17F P/E, in line with the sportswear sector average. In the near term, its share price may be depressed as the market may focus on the softer FY17 outlook, and we see little positive catalysts for the rest of 2017. However, it offers strong intrinsic value from FCF and high net cash positions (CNY1.30/share) and is supported by a respectable FY17F dividend yield of 5.5%. Forecasts and Valuations Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Total turnover (CNYm) 5,295 5,397 5,591 5,830 6,123 Reported net profit (CNYm) 623 528 666 732 804 Recurring net profit (CNYm) 623 528 666 732 804 Recurring net profit growth (%) 30.3 (15.2) 26.1 9.9 9.9 Recurring EPS (CNY) 0.29 0.24 0.30 0.33 0.36 DPS (CNY) 0.17 0.14 0.18 0.20 0.22 Recurring P/E (x) 11.4 13.9 11.0 10.0 9.1 P/B (x) 1.47 1.48 1.40 1.33 1.25 P/CF (x) 10.6 24.5 10.7 10.0 9.2 Dividend Yield (%) 5.2 4.4 5.5 6.0 6.6 Analyst EV/EBITDA (x) 5.00 5.17 4.39 3.92 3.46 Robin Yuen, CFA Return on average equity (%) 13.0 10.8 13.1 13.6 14.2 Net debt to equity net cash net cash net cash net cash net cash +852 2103 9202 Our vs consensus EPS (adjusted) (%) (11.9) (11.2) (6.7) [email protected] Source: Company data, RHB See important disclosures at the end of this report 1 Powered by the EFA Platform Xtep International Holdings Ltd Hong Kong Results Review 20 March 2017 Consumer Cyclical | Sportswear Financial Exhibits Financial model updated on : 2017-03-19. Asia Financial summary Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Hong Kong Recurring EPS (CNY) 0.29 0.24 0.30 0.33 0.36 Consumer Cyclical EPS (CNY) 0.29 0.24 0.30 0.33 0.36 Xtep International Holdings Ltd DPS (CNY) 0.17 0.14 0.18 0.20 0.22 Bloomberg 1368 HK BVPS (CNY) 2.26 2.24 2.36 2.49 2.64 Buy Weighted avg adjusted shares (m) 2,149 2,210 2,210 2,210 2,210 Valuation basis Valuation metrics Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F DCF Recurring P/E (x) 11.4 13.9 11.0 10.0 9.1 P/E (x) 11.4 13.9 11.0 10.0 9.1 Key drivers P/B (x) 1.47 1.48 1.40 1.33 1.25 i. Product mix upgrade; FCF Yield (%) 8.6 2.8 7.3 7.9 8.8 ii. Improving sports participation rate. Dividend Yield (%) 5.2 4.4 5.5 6.0 6.6 EV/EBITDA (x) 5.00 5.17 4.39 3.92 3.46 Key risks EV/EBIT (x) 5.37 5.55 4.66 4.14 3.64 i. Channel oversupply; ii. Homogenisation; iii. Competitive prices. Income statement (CNYm) Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Total turnover 5,295 5,397 5,591 5,830 6,123 Company Profile Gross profit 2,237 2,331 2,430 2,551 2,696 Xtep is one of the top three domestic sportswear EBITDA 833 878 1,007 1,093 1,193 brands in China, and has over 7,000 stores in its Depreciation and amortisation (57) (59) (59) (59) (59) network. It operates an asset-light wholesale model Operating profit 776 818 949 1,035 1,134 that relies on franchisees to exclusively distribute its Net interest (28) (51) (53) (47) (45) branded goods at retail outlets. Pre-tax profit 893 866 994 1,086 1,187 Taxation (257) (293) (283) (310) (338) Minority interests (14) (45) (45) (45) (45) Recurring net profit 623 528 666 732 804 Cash flow (CNYm) Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Change in working capital 163 (510) (43) (52) (64) Cash flow from operations 669 299 681 731 791 Capex (59) (94) (150) (150) (150) Cash flow from investing activities 397 (567) (160) (160) (160) Proceeds from issue of shares 36 62 0 0 0 Dividends paid (317) (394) (399) (439) (482) Cash flow from financing activities (720) (542) (445) (484) (527) Cash at beginning of period 3,247 3,671 3,447 3,569 3,708 Net change in cash 346 (811) 77 87 103 Ending balance cash 3,600 2,863 3,523 3,656 3,811 Balance sheet (CNYm) Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Total cash and equivalents 4,377 4,245 4,368 4,507 4,663 Tangible fixed assets 863 855 956 1,058 1,159 Intangible assets (8) (12) (18) (23) (29) Total investments 197 97 97 97 97 Total other assets 11 17 23 28 34 Total assets 8,114 8,174 8,488 8,839 9,233 Short-term debt 1,489 1,502 1,502 1,502 1,502 Total long-term debt 121 0 0 0 0 Other liabilities 2 0 0 0 0 Total liabilities 3,242 3,151 3,198 3,258 3,330 Shareholders' equity 4,852 4,953 5,220 5,512 5,834 Minority interests 20 69 69 69 69 Total equity 4,872 5,023 5,289 5,582 5,903 Net debt (2,766) (2,744) (2,866) (3,005) (3,162) Total liabilities & equity 8,114 8,174 8,488 8,839 9,233 Key metrics Dec-15 Dec-16 Dec-17F Dec-18F Dec-19F Revenue growth (%) 10.8 1.9 3.6 4.3 5.0 Recurrent EPS growth (%) 32.0 (17.6) 26.1 9.9 9.9 Gross margin (%) 42.2 43.2 43.5 43.7 44.0 Operating EBITDA margin (%) 15.7 16.3 18.0 18.7 19.5 Net profit margin (%) 11.8 9.8 11.9 12.5 13.1 Dividend payout ratio (%) 59.9 60.5 60.0 60.0 60.0 Capex/sales (%) 1.1 1.7 2.7 2.6 2.4 Interest cover (x) 27.9 15.9 17.8 22.0 25.0 Source: Company data, RHB See important disclosures at the end of this report 2 Xtep International Holdings Ltd Hong Kong Results Review 20 March 2017 Consumer Cyclical | Sportswear FY16 Results Review Net profit missed our estimates by 19% in FY16 (2H16: 45%) due to: i.