Thu, 11 Aug 2016 Equity Research Sporting goods/ China 361 Degrees (1361 HK) Walter Woo +852 2135 0248 1Q17 wholesales discount reduced [email protected] We estimate 1H16E net profit to grow by 13% yoy to RMB300mn Reduced wholesales discount to 63% drive GPM to 42.7% in FY17E and expect moderate trade fair sales growth onwards Revise down/up FY16E/17E earnings by 5.2%/4.1% to RMB549mn/ Company Update RMB670mn Maintain BUY with TP raised to HK$3.8 based on 10x FY 17 PE BUY We estimate 361 Degrees 1H16E net profit to grow by 13% yoy to UNCHANGED RMB300mn. We expect 361 Degrees 1H16 net profit to grow at 13% yoy to Close price: HK$2.50 RMB300mn driven by 15.6% yoy sales growth (footwear+22.5%, and apparel+ Target Price: HK$3.80 (+52%) 9.5%) and flat margins at 41.1% in 1H16E. And we expect 2H16E net profit to be Prior TP: HK$3.60 RMB249mn mainly due to skewed A&P expenses for Olympics and higher than expected finance costs in 2H16E. Ke y Data Wholesales discount for 1Q17 trade fair improved from 65% to 63% for the HKEx code 1361 first time since 1Q14, positive on margins from FY17E onwards. The 12 Months High (HK$) 3.23 wholesale discount for 361 Degrees had reduced from 65% to 63% for the first 12 Month Low (HK$) 2.01 time in 2.5 years during the latest 1Q17 trade fair (last time was an increase from 3M Avg Dail Vol. (mn) 1.69 63% to 65% in 1Q14) which, we believe, is likely to drive FY17E GP margin to 42.7% from 40.9% in FY15. Issue Share (mn) 2,067.60 Market Cap (HK$mn) 5,169.01 Moderate trade fair sales growth could be sustainable despite discount cut. Fiscal Year 12/2015 We believe this move has minimal impact on distributor’s appetite to order and Major shareholder (s) Ding Wuhao 18.27% expect moderate trade fair sales growth in FY17E given 1) 1Q17 trade fair sales Ding Huihuang 17% at high single-digit growth post the discount cut 2) 361 Degrees still have the Ding Huirong 17.41% highest wholesale discount among its HK listed peers 3) distributors Source: Company data, Bloomberg, OP Research Closing price are as of 10/08/2016 conditions/profitability are healthy as SSSG had stayed positive for 3 years. Price Chart Revise down/up FY16E/17E earnings by 5.2%/4.1% to RMB549mn/ RMB670mn. We revise down our FY16E earnings estimate by 5.2% to 1361 HK MSCI CHINA HK$ RMB549mn to reflect increased size in debt after bond refinancing, and the 3.5 associated one-off admin costs. And we revise up our FY17E earnings estimate 3.0 2.5 by 4.1% to RMB670mn to reflect margin expansions from FY17E onwards driven 2.0 by wholesale discount cut. 1.5 1.0 Reiterate BUY and raise TP to HK$3.80 from HK$3.60 based on rolled forward 0.5 10x FY17 PE (previous 11x FY16E PE), 50% discount to its peers. The counter 0.0 trades at 7.7x/6.3x FY16/17E PE with 4.4% yield. Aug/15 Nov/15 Feb/16 May/16 Risks: 1) unfavourable weather which affects the retail end sales, 2) increasing 1mth 3mth 6mth competition from international brands, 3) serious economic slow down Absolute % 20.8 -2.3 18.4 Rel. MSCI CHINA % 15.1 -13.1 4.8 Exhibit 1: Forecast and Valuation PE Year to Dec (RMB mn) FY14A FY15A FY16E FY17E FY18E Revenue 3,906.3 4,458.7 5,084.2 5,581.5 6,313.8 14 Forward P/E Ratio 12 Growth (%) 9.0 14.1 14.0 9.8 13.1 +1std. 10 Net Profit 397.7 517.6 549.0 669.6 800.2 8 avg. Growth (%) 88.3 30.2 6.1 22.0 19.5 6 -1std. 4 Diluted EPS (HK$) 0.240 0.306 0.324 0.395 0.472 2 EPS growth (%) 83.7 27.1 6.1 22.0 19.5 0 Change to previous EPS (%) (5.19) 4.05 Jan/13 Jul/13 Jan/14 Jul/14 Jan/15 Jul/15 Jan/16 Consensus EPS (HK$) 0.336 0.384 0.445 Company Profile ROE (%) 8.2 10.1 10.1 11.5 12.7 361 Degrees International Ltd. Designs, P/E (x) 10.4 8.2 7.7 6.3 5.3 develops, manufactures, markets and P/B (x) 0.8 0.8 0.8 0.7 0.6 distributes sportswear products, including Yield (%) 3.2 4.1 4.4 5.3 6.4 athletic footwear, apparel and accessories. DPS (HK$) 0.080 0.103 0.109 0.133 0.159 Source: Bloomberg, OP Research Thu, 11 Aug 2016 361 Degrees (1361 HK) Exhibit 2: 361 Degrees’ historical wholesale discount level, 1Q12 – 1Q17 (% off) 70% 65% 60% 55% 50% Wholesales discount Source: Company, OP research Exhibit 3: Peers comparison of wholesale discount with GP margins, FY15 (%) 65% 65.0% 62% 63% 60% 60% 55% 55.0% 46.6% 45.0% 42.7% 45.0% 42.2% 40.9% 38.7% 35.0% 25.0% Li Ning Anta Peak Xtep 361 Degrees - 361 Degrees - after revision before (OP est.) revision GP margins Wholesale discount Source: Company, OP research Page 2 of 9 Thu, 11 Aug 2016 361 Degrees (1361 HK) Exhibit 4: 361 Degrees’s historical trade fair sales growth, 1Q12 – 1Q17 (% ) 30% 20% 10% 0% -10% -20% -30% Trade Fair Sales (yoy%) Source: Company, OP research Exhibit 5: 361 Degrees distributors’ historical SSSG,1Q12 – 2Q16 (%) 10.0% 8.1%7.9% 8.0% 6.9% 7.2% 7.2%7.0% 6.3% 5.5% 6.0% 5.1% 4.7% 4.1%4.3% 4.0% 2.8% 1.8% 2.0% 1.5% 0.0% 0.0% -0.8% -2.0% -1.5% SSSG Source: Company, OP research Page 3 of 9 Thu, 11 Aug 2016 361 Degrees (1361 HK) Exhibit 6: Earnings Revision FY16E FY17E FY18E (RMB mn) New Old % Chg New Old % Chg New Old % Chg We expect the recently announced trade fair Revenue 5,084 5,084 0.0 5,581 5,512 1.3 6,314 0.0 sales growth of HSD in 1Q17 is sustainable, and faster growth from E- commerce sales Gross profit 2,111 2,096 0.7 2,381 2,275 4.6 2,731 0.0 Thanks to the 1) reduction in wholesales Gross margin 41.5% 41.2% 0.3 42.7% 41.3% 1.4 43.3% 0.0 discount, 2) stable raw material costs, and 3) greater sales from E- commerce Opex (1,262) (1,262) 0.0 (1,347) (1,352) (0.4) (1,517) 0.0 EBIT 920 900 2.2 1,112 995 11.8 1,304 0.0 Factor in less A&P in FY2017E Due to the increases in interest costs as size of senior debt jumped from RMB1.5bn to 2.6bn, Net Profit 549 579 (5.2) 670 644 4.1 800 0.0 as well as the one-off redemption fees/ buy backs Diluted EPS (HK$) 0.324 0.342 (5.2) 0.395 0.380 4.1 0.472 0.0 Source: Company, OP Research Exhibit 7: Major Assumptions 2014 2015 2016E 2017E 2018E Sales by Segment (RMB mn) Shoes 1,554 1,885 2,186 2,427 2,792 Clothes 1,754 1,896 2,133 2,304 2,557 Accessories 91 89 94 99 108 361 child 508 589 671 752 857 Total 3,906 4,459 5,084 5,581 6,314 Growth (%) Shoes 2.2% 21.3% 16.0% 11.0% 15.0% Clothes 11.3% 8.1% 12.5% 8.0% 11.0% Accessories 36.6% -1.7% 5.0% 6.0% 9.0% 361 child 20.7% 16.0% 14.0% 12.0% 14.0% Total 9.0% 14.1% 14.0% 9.8% 13.1% Sales network 361 D sports 7,319 7,208 6,699 6,795 6,890 Child 2,142 2,350 2,494 2,659 2,836 GP margins 40.9% 40.9% 41.5% 42.7% 43.3% A & P / sales 16.7% 12.8% 13.8% 13.2% 13.5% Staff / sales 8.4% 8.3% 8.2% 8.2% 8.1% R & D / sales 2.4% 3.1% 3.2% 3.3% 3.4% S & D / sales 19.7% 16.0% 16.8% 16.1% 16.0% Admin / sales 5.2% 8.5% 8.0% 8.0% 8.0% Effective Tax rate 33.3% 32.9% 33.0% 33.0% 33.0% Source: Company data, OP Research Page 4 of 9 Thu, 11 Aug 2016 361 Degrees (1361 HK) Exhibit 8: Trade Fair Sales Growth (yoy%) 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 Low +ve +ve +ve +ve +ve +ve +ve +ve HSD 20-30% 15-25% 10-20% 5-15% +ve +ve +ve Low- +ve Low- +ve +ve Anta >23% 20% 20% 25% -teens +ve HSD Low- Low- Low- Low- Low- Low- LSD LSD drop drop drop drop drop HSD HSD teens teens HSD MSD drop teens teens teens teens teens teens Dong Mid- +ve +ve +ve SD +ve Low- Xiang 11.8% 2.8% -20% Decline teens na na na na na na na na na na Low- Low- Low- 30-40% 30-40% na na drop teens (Kappa) drop teens teens teens High- +ve +ve +ve +ve +ve +ve +ve MSD low +ve Li Ning 5.8% -6% -14% -1% Flat teens na na na na na na na na Mid- High- Low- Mid- high- Low- MSD drop twenties HSD drop teens teens teens teens teens teens Mid- Mid- High- +ve +ve +ve +ve +ve +ve +ve +ve +ve +ve +ve -ve Peak 25% 24% 23.6% 21.1% 9.5% twenties twenties Flat twenties na na na Mid- Mid- Mid- Mid- Mid- Low- HSD HSD Mid-teens Mid-teens Mid-teens LSD drop drop drop teens teens teens teens teens teens 15-20% 15-20% 20% 15-17% -ve -ve +ve +ve +ve +ve +ve Xtep 23% 25% 24% 24% 9% 5% Flat Flat -ve LSD Flat +ve LSD 10% 10% drop drop drop drop HSD MSD LSD LSD LSD HSD HSD 361 +ve +ve +ve 23% 23% -10% -26% -23% -23% -19% -17% -11% -11% -7% 8% 11% 11% 16% 18% 15% 15% Degrees HSD HSD HSD Source: Company Data, OP Research Exhibit 9: Same Store Sales Growth (yoy%) 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 +ve Slower Faster +ve +ve +ve +ve +ve LSD HSD MSD MSD +ve +ve +ve +ve +ve +ve +ve +ve Anta >10% ~10% Flat Flat Flat Flat Low- than than HSD HSD HSD HSD MSD drop drop drop drop MSD HSD HSD HSD HSD HSD HSD MSD teens 4Q15 1Q16 Dong Mid- High- High- High- +ve LSD LSD Xiang 4% 4% 4.7% teens teens teens teens na na na na na na na na na na na 21.5% na na na MSD drop drop (Kappa) drop drop drop drop +ve +ve +ve +ve +ve +ve +ve +ve +ve +ve Li Ning 5% <5% 4% 3.6% na na na na na na na na na na na Low- LSD LSD LSD LSD MSD MSD MSD LSD LSD teens +ve +ve +ve +ve +ve +ve +ve +ve +ve Peak 15.3% 12.5% 13% <10% 13% 12% 6% 1.7% Flat -18.5% Flat Flat Flat Flat Flat Flat LSD LSD LSD LSD LSD MSD MSD HSD MSD +ve +ve Flat to +ve +ve +ve +ve +ve +ve +ve MSD +ve +ve +ve +ve +ve +ve +ve +ve +ve Xtep Low- Low- +ve na Flat Flat Flat Flat HSD HSD LSD LSD MSD LSD LSD drop LSD MSD MSD MSD MSD HSD HSD MSD MSD teens teens LSD 361 15% 18% 14% 9% 7% 5% 4% 4% -2% -1% Flat 2% 2% 3% 5% 5.5% 6.3% 7.2% 8.1% 7.9% 7.2% 7.0% Degrees Source: Company Data, OP Research Page 5 of 9 Thu, 11 Aug 2016 361 Degrees (1361 HK) Financial Summary Year to Dec FY14 FY15 FY16E FY17E FY18E Year to Dec FY14 FY15 FY16E FY17E FY18E Income Statement (RMB mn) Ratios Shoes 1,554 1,885 2,186 2,427 2,792 Gross