Xtep International (1368 HK) Rating Maintain BUY Short term pain makes better future Target price HK$5. 11 From HK$4.86 Current price HK$4.12 Upside.24.0% 1H16 results in-line ; GPM an upside surprise as changes in sales 7 September 2016 mix bear fruit Xtep’s 1H16 revenue and net profit accounted for 43% and 54% of FY16E estimates (1H:2H split ~to FY15). The top line growth was driven by its Hayman Chiu increased sales in footwear (up 16.3% Yoy to RMB1,738mn), while apparel [email protected] sales was down 12.8% Yoy to RMB736.3mn which offset part of the strong growth in footwear. The shortfall in apparel sales was a result of Xtep’s (852) 2235 7677 deliberate reduction in lifestyle sports product offerings, which we believe to face more intense competition, and increased sales in functional apparels to Trading Data align with brand positioning. This can be seen through 1H16’s GPM up 52-Week Range (HK$) 4.83/3.09 150bps to 43.3% (beats our FY16E estimates at 42.4%), led by 260bps GPM 3 Mth Avg Daily Vol (m) 4.50 expansion in apparel (41.7% vs 39.1% in 1H15) and 70bps increase in footwear GPM (1H16: 44.2% vs. 1H15: 43.5%) No of Shares (m) 2,215.04 Market Cap (HK$m) 9,126.0 1Q17 trade order slowed to mid-single digit on changes in apparel Major Shareholders (%) Group Success (59.9%) sales mix and kid’s series; More product offerings from 3Q16 onwards Auditors Ernst & Young Result Due FY16:Mar 2017 Xtep’s 2Q16 SSSG maintained stable at mid-single digit. Though Xtep’s 1Q17 trade fair order growth has slightly moderated to mid-single digit (vs. Company description high-single digit 2H16), looking ahead we believe the upcoming new products Founded in 1999, Xtep is a leading PRC-based pipelines, which includes smart shoes (launch in 3Q16), outdoor products (to fashion sportswear brand enterprise, which be launched in 4Q16), and ladies functional products (such as yoga and principally engages in the design, development, indoor training products in 2Q17) could drive a more diverged sales and could manufacturing, distributing and marketing, as well raise distributors’ appetite in the upcoming trade fair. as brand management of its branded sports footwear, apparel and accessories. As of June 30, Retail channel flattening to be completed by FY17E 2016, Xtep’s retail network comprises of 6,800 Xtep brand POS. Xtep started flattening retail distribution channel to eliminate inefficient layers in 2015, and achieving ~50% of the retail stores directly managed by distributors in 1H16. Xtep expect the transformation to be completed in Price Chart FY17E. As a result of the channel flattening process, Xtep granted temporary support to these distributors, which lifted AR provision to Rmb63.7mn from Rmb2.3mn in 1H15, we expect there will be an AR provision writeback in FY17E upon the completion of channel transformation. Though Xtep’s AR turnover days increased 7 days to 136 days, it was compensated by extended credit terms to the suppliers, hence working capital cash cycle improved to 71 days in 1H16 (vs. 110 days in 1H15). Short term sales slowndown makes better future; A defensive play with 10.3x FY17E PE, Maintain BUY Sources: Bloomberg, CIRL We lowered Xtep’s FY16E/17E EPS by 5.2% and 3.3% respectively to reflect lower apparel sales forecast, and expect Xtep’s EPS to grow at 11.4% CAGR in FY15-FY17E, improving product mix lifting GPM. We believe the temporary slowdown in Xtep’s sales would facilitate a better fundamental continue to improve, hence Xtep’s current valuation of FY17E 10.3x PE (trading at ~39% discount to ANTA) is still undemanding. In addition Xtep’s FY17E 6.2% dividend yield continues to make it a defensive play. We raised Xtep’s TP from HK$4.86 to $5.11 based on 12.7x FY17E PE (25% discount to ANTA). We maintain Xtep’s BUY rating. Page 1 / 6 Exhibit 1: Earnings Forecast Revision for FY16E & FY17E earnings Exhibit 1: FY16(old) FY16(new) Diff FY17(old) FY17(new) Diff RevenuePork 5,834 5,594 -4.1% 6,421 6,091 -5.1% products 2,421 -2.2% 2,649 -3.4% GPsold in 2,475 2,742 supermark GPMet counters 42.4% 43.3% 90bps 42.7% 43.5% 80bps EPS 0.32 0.30 -7.6% 0.36 0.35 -3.3% Source: CIRL estimates Exhibit 2: Xtep trade fair orders maintain stable growth Exhibit 1: 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 LiNing Mid-twenties Mid-teens High-teens low-teens mid-teens mid-teens low-teens high-single high-single DongXiangPork medium-double digit low-double digit 30-40% 30-40% N.A. N.A - Antaproducts low-double low-double low-double low-double low-double low-double High-single low-double mid-single Xtep low-single digit low-single digit low-single digit low-single digit 10.0% 10.0% High-single digit High-single digit Mid-single digit Peaksold in 10.0-20.0% 10.0-20.0% 10.0-20.0% 10.0-20.0% 10.0-20.0% 10.0-20.0% 10.0-20.0% low-single digit drop - 361Degrees 11.0% 11.0% 16.0% 18.0% 15.0% 15.0% +high single digit +high single digit +high single digit supermark Sources: Company Data, CIRL et counters Exhibit 3: Xtep’s SSSG continues to show stable growth Exhibit 1: 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 LiNing mid-single digit high-single digit mid-single digit low-single digit low-single digit high-single digit DongXiangPork 20 21.5% N.A. N.A. N.A - ANTA (SSSG) high single digit high single digit high single digit mid-single digit - - ANTAproducts (retail sales growth) mid-single digit high-single digit Xtepsold in +ve mid-single digit' +ve high-single digit' +ve high-single digit' +ve mid-single digit' +ve mid-single digit' +ve mid-single digit' 361Degrees 6.3% 7.2% 8.1% 7.9% 7.2% 7.0% Peaksupermark mid-single digit mid-single digit high-single digit mid-single digit flat - et counters Sources: Company Data, CIRL Page 2 / 6 Exhibit 4: Xtep’s revenue forecast and GPM breakdown YearExhibit to Dec 1: (RMB mn) FY13A FY14A FY15A FY16E FY17E SegmentPork Revene Shoes 2,247 3,043 3,258 3,626 4,110 Apparelproducts 2,012 1,688 1,927 1,834 1,816 Accessoriessold in 84 47 110 135 166 Group 4,343 4,778 5,295 5,594 6,091 supermark Segmentet counters Growth Shoes -16.8% 35.4% 7.1% 11.3% 13.4% Apparel -26.7% -16.1% 14.2% -4.8% -1.0% Accessories -18.9% -44.0% 133.6% 21.9% 23.1% Group -21.7% 10.0% 10.8% 5.7% 8.9% Segment Gross Margin Shoes 40.9% 42.1% 43.8% 44.2% 44.5% Apparel 39.8% 38.5% 39.7% 41.7% 41.5% Accessories 34.0% 36.8% 39.7% 40.0% 40.0% Group 40.2% 40.8% 42.2% 43.3% 43.5% Source: Bloomberg, CIRL estimates Exhibit 5: Xtep is undergoing retail channel flattening Exhibit 1: Pork products sold in supermark et counters Source: Company data Page 3 / 6 Exhibit 6: Xtep to launch new product series from 3Q16 onwards Exhibit 1: Pork products sold in supermark et counters Source: Company data Exhibit 7: Financial summary Income statement Cash flow Year to Dec (RMB mn) FY13A FY14A FY15A FY16E FY17E Year to Dec (RMB mn) FY13A FY14A FY15A FY16E FY17E Revenue 4,343 4,778 5,295 5,594 6,091 Pre-tax profit 863 770 893 1,015 1,167 Gross profit (reported) 1,748 1,947 2,237 2,421 2,649 Taxes paid (308) (332) (281) (389) (426) EBITDA 944 854 978 1,099 1,249 Depreciation & amortization 57 58 67 63 62 Depreciation 49 45 57 51 52 Associates & Others (11) 43 (37) (32) (41) EBIT 895 809 921 1,048 1,197 CFO bef. WC change 956 871 924 1,045 1,188 Net interest income (exp.) 32 38 28 33 30 Change in working cap 75 (417) 163 148 (66) Associates 0 0 0 0 0 Cashflow from operation 1,031 455 1,087 1,193 1,123 Exceptionals/others 0 0 0 0 0 CAPEX (201) (106) (59) (125) (97) Profit before tax 863 770 893 1,015 1,167 Free cash flow 829 348 1,029 1,068 1,026 Tax expenses 260 284 257 303 349 Dividends (428) (288) (317) (360) (414) Minority interest 0 0 0 23 23 Balance sheet adj. (387) (216) (591) 163 (265) Net profit 606 478 623 688 794 Sharse issued 4 6 42 0 0 Dividends (312) (288) (374) (420) (485) Others 0 0 0 0 0 EPS (RMB) 0.28 0.22 0.29 0.31 0.36 Net cash flow 19 (149) 162 872 347 Net cash (debt) start 2,735 2,754 2,605 2,767 3,638 Balance sheet Net cash (debt) at year-end 2,754 2,605 2,767 3,638 3,985 Year to Dec (RMB mn) FY13A FY14A FY15A FY16E FY17E Cash & equiv 3,563 3,137 3,607 4,186 4,402 Ratios Trade receivables 1,151 1,490 1,892 1,614 1,757 Year to Dec (RMB mn) FY13A FY14A FY15A FY16E FY17E Other receivables 386 424 381 477 519 Growth rate (%) Inventories 537 569 398 546 548 Revenue -21.7% 10.0% 10.8% 5.7% 8.9% Other current assets 716 1,327 772 770 770 EBITDA 1.5% 13.7% 13.0% 16.9% 19.0% Fixed assets 772 857 863 886 914 EBIT -21.7% 10.0% 10.8% 5.7% 8.9% Intangible assets 1 2 3 3 3 Net profit -25.3% -19.4% 31.0% 11.7% 15.0% Investment, associates etc 182 58 197 197 197 Fully diluted EPS -25.2% -21.1% 32.0% 7.7% 15.5% Total assets 7,307 7,864 8,114 8,678 9,109 Margins (%) Gross margin (reported) 40.2% 40.8% 42.2% 43.3% 43.5% Account payables 601 729 896 900 1,005 EBITDA 21.7% 17.9% 18.5% 19.6% 20.5% Other payables 333 323 536 536 536 EBIT 20.6% 16.9% 17.4% 18.7% 19.7% Short-term debt 1,351 1,222 1,489 1,489 1,401 Net margin 13.9% 10.2% 12.0% 12.7% 13.4% Other current liabs 72 77 45 45 45 Other ratios Long-term debts 175 617 121 304 304 ROE (%) 13.7% 10.5% 13.3% 14.1% 15.1% Deferred tax and others 268 186 155 191 207 ROA (%) 8.7% 6.4% 8.0% 8.5% 9.2% Other long-term liabs 0 0 0 0 0 Net gearing (%) Net Cash Net Cash Net Cash Net Cash Net Cash Total liabilities 2,799 3,154 3,242 3,466 3,499 Interest coverage (x) 27.6 21.1 33.1 31.7 39.3 Receivables days 91.9 100.9 116.6 114.4 101.0 Share capital 19 19 19 19 19 Payables days 73.0 76.6 85.7 113.2 97.0 Reserves 4,487 4,681 4,833 5,173 5,571 Inventory days 78.7 71.3 57.7 54.3 58.0 Shareholders' equity 4,506 4,700 4,852 5,193 5,590 Effective