Xtep International (1368 HK) Rating Maintain BUY A soft 3Q19 but still on the right track Target price HK$6.34 From HK$6.83 Current price HK$4.44 Upside.+42.7% Soft 3Q19 triggered sell off, still on track to achieve FY19E guidance Company Update Xtep posted a relatively soft 3Q19 operational data, with both SSSG and retail sales slightly decelerated to ~10% and ~20% Yoy (vs. mid-teens/>20% in 2Q19), 23 October 2019 with retail discount widened to 22-25% (vs. 20-25% in 2Q19). Xtep’s share price tumbled 16% after the release. Xtep attributed the mild slow down to warm Hayman Chiu weather, which hurt the retail sales of the newly launched fall winter products. [email protected] Xtep added that retail performance in the first half of October returned to similar levels as in July/August with similar retail discount in 3Q19, while inventory level (852) 2235 7677 continue to stay at a healthy level of ~4 months. Trading Data Though having faced a mild 3Q19, we believe Xtep is still on track to achieve its 52-Week Range (HK$) 6.74/3.81 FY19E revenue growth guidance of ~20%, driven by low teens growth in shoes 3 Mth Avg Daily Vol (m) 10.19 and ~30% growth in apparel, while keeping a stable GM in our view. No of Shares (m) 2,499.7 Market Cap (HK$m) 11,524.9 JV with Wolverine, K-Swiss and Palladium still in ramp up/ restructure Major Shareholders (%) Group Success (54.1%) stage, negligible contribution in the near term Auditors Ernst & Young Result Due FY19: Mar 2020 The acquisition of E-Land Footwear USA (incl. K-Swiss, Palladium and Supra etc.) completed on Aug 1, Xtep expects ~US$70mn sales contribution in FY19E. Company description As mentioned in our last update, Xtep expected a one-off RMB100mn restructure expenses to be incurred in 2H19E (in which RMB 35mn are professional Founded in 1999, Xtep is a leading PRC-based expenses, and the remaining RMB 65mn would be restructure costs mainly fashion sportswear brand enterprise, which consists of inventory provision for one of the brands that would be disposed). principally engages in the design, development, Management reiterated that the both brands are running at profit breakeven, and manufacturing, distributing and marketing, as well will integrate with Xtep’s supply chain and business focus will shift to Asia Pacific, as brand management of its branded sports especially Great China (previously accounted for 20% of K-Swiss and Palladium’s footwear, apparel and accessories. As of June 30, revenue). Meanwhile both brands will undergo re-positioning, with new product 2019, Xtep’s retail network comprises of 6,312 design in the pipeline which include increasing apparel product offerings. Xtep brand POS. For the JV with Wolverine Group, Saucony sales has just begun in July on Tmall Price Chart flagship store, and first standalone store would be opened in Tier 1 cities in China HK$ in 2Q20. For Merrell, Tmall flagship is expected to kick off in early 2020, while 7.0 new standalone stores would be opened in Tier 1 and Tier 2 cities in China in 6.0 2H20. We view this as Xtep taking a bigger step towards outdoor sports and 5.0 4.0 high end sportswear market. 3.0 2.0 1.0 Continue to explore professional basketball shoes segment through 0.0 signing Jeremy Lin as brand spokesperson Oct-17 Oct-18 Oct-16 Apr-17 Apr-18 Apr-19 Xtep appointed Jeremy Lin as Xtep’s brand spokesperson in earlier this month Sources: Bloomberg, CIRL (with sponsorship fee at a total of ~USD7.5mn in 2019-2021). Basketball shoes currently took up ~1% of Xtep revenue. Xtep expects through launching various marketing campaigns, the higher ASP (RMB599/pair vs. RMB 399/pair) would account 15% of total revenue in the long run. We expect basketball products would account for low-single digit of sales in FY20E. Page 1 / 6 Lower FY19E-21E EPS , undemanding FY20E valuation; Maintain BUY We lowered our FY19E-21E EPS by 12.1%/10.5%/11.3%, on lower GM assumption, as K-Swiss and Palladium’s GM was lower than Xtep core brand, we also continue to factor in a higher SG&A ratio during the consolidation of newly acquried brands. We expect Xtep’s EPS to grow 14.9% CAGR in FY18-FY21E (vs.19.0% in our last update). Xtep ’s current FY20E 11.0x PE (trading at ~57% discount to ANTA), 5.6% FY20E yield still looks undemanding to us, as we expect Xtep brand fundamental continue to stay solid, while the newly set up JV,the post-acquisition ramp-up of K-Swiss and Palladium remains yet to be seen. We arrive Xtep’s new TP at HK$6.34 based on 15.7x FY20E PE (40% discount to ANTA). We maintain Xtep’s BUY rating. Exhibit 1: Earnings forecast revision Exhibit 1:FY19(old) FY19(new) Diff FY20(old) FY20(new) Diff FY21E (old) FY21E (new) Diff RevenuePork 7,623 8,120 6.5% 8,986 9,465 5.3% 10,616 11,050 16.7% products GP 3,400 3,557 4.6% 4,027 4,150 3.0% 4,774 4,874 2.1% sold in GPMsupermark 44.6% 43.8% -80bps 44.8% 43.8% -100bps 45.0% 44.1% -90bps et counters Net Profit 783 694 -11.5% 960 859 -10.5% 1,151 1,021 -11.3% EPS 0.32 0.28 -12.1% 0.41 0.37 -10.5% 0.49 0.44 -11.3% Source: CIRL estimates Exhibit 2: Xtep core brand revenue and GM assumption YearExhibit to Dec (RMB1: mn) FY16A FY17A FY18A FY19E FY20E FY21E Segment Revene ShoesPork 3,525 3,258 3,925 4,389 4,932 5,541 Apparelproducts 1,765 1,759 2,327 3,056 3,780 4,674 Accessories 106 96 131 178 208 234 Groupsold in 5,397 5,113 6,383 7,623 8,919 10,449 supermark Segment Growth Shoeset counters 8.2% -7.6% 20.5% 11.8% 12.4% 12.4% Apparel -8.4% -0.3% 32.3% 31.3% 23.7% 23.7% Accessories -3.5% -9.7% 36.5% 35.6% 16.7% 12.5% Group 1.9% -5.2% 24.8% 19.4% 17.0% 17.2% Segment Gross Margin Shoes 44.0% 45.0% 45.6% 45.0% 45.0% 45.2% Apparel 41.7% 42.2% 42.6% 43.5% 43.6% 44.0% Accessories 41.0% 39.2% 35.6% 36.0% 36.0% 36.0% Group 43.2% 43.9% 44.3% 44.2% 44.2% 44.5% Sources: Company Data, CIRL estimates Page 2 / 6 Exhibit 3: Xtep SSSG slightly moderated in 3Q19 Exhibit 1: 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 LiNing (Retail) +ve low teens high single digit high single digit +mid single digit +high single digit +low teens +low teens Pork LiNing (Wholesale) +ve mid single digit +ve low single digit +ve mid single digit +mid single digit +low teens +low teens +low teens LiNing (e-commerce) high 30's mid 30's low 30s "+mid 50s + high 30s + mid 30s + mid 50s products LiNing (blended) +low teens +high single digit +low teens +mid teens +mid teens +mid teens +high teens sold in DX (blended SSSG) -ve low single digit -ve low single digit mid-high single DX (offline SSSG) - mid-low single digit mid-single digit low single digit -ve high single digit -ve high single digit -ve low single digit supermark DX (Online) +35-45% +30-35% mid 50s et counters ANTA (SSSG) - - - - - - - ANTA (ANTA brand retail sales growth) 20-25% low double mid double mid double low teens mid teens mid teens -ANTA core offline high-single high single low teens low double - ANTA core online >40% >30% >20% >25% mid-teens >25% 30-35% - ANTA kids >40% >40% >25% >25% >20% >30% >25% ANTA (non-ANTA brand retail sales growth, mainly from FILA) 80-85% 90-95% 90-95% 80-85% 65-70% 55-60% 50-55% - FILA offline 75% >50% >45% ~40% - FILA online >100% ~100% >80% >80% - FILA kids >100% >70% ~70% ~70% Xtep +low double digit +mid double digit +mid double digit +mid double digit +low double digit +low double digit ~10% 361 Degrees (retail sales growth) high-single high-single mid-single flat low-single low-single low-single 361 Degrees Kids high-single low-double low-double low-double low-single high-single high-single Sources: Company Data, CIRL (ANTA disclosed retail sales value from 1Q16, and 361 Degree began similar move from 2Q17) Exhibit 4: Xtep singed Jeremy Lin as basketball spokesperson Exhibit 1: Pork products sold in supermark et counters Sources: sina.com.cn Page 3 / 6 Exhibit 5: Financial Summary IncomeExhibit statement 1: Cash flow Year to Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E Year to Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E RevenuePork 5,113 6,383 8,120 9,465 11,050 Pre-tax profit 671 976 1,008 1,311 1,550 Gross profit (reported) 2,244 2,828 3,557 4,150 4,874 Taxes paid (259) (309) (416) (480) (573) EBITDAproducts 793 1,135 1,173 1,490 1,745 Depreciation & amortization 78 104 106 122 137 Depreciation 68 92 94 110 125 Associates & Others 92 (75) 81 86 85 EBITsold in 725 1,044 1,078 1,380 1,620 CFO bef. WC change 988 1,031 1,191 1,507 1,752 Net interest income (exp.) 54 68 70 69 70 Change in working cap (119) (513) (330) (339) (695) Associatessupermark 0 0 0 0 0 Cashflow from operation 868 518 861 1,168 1,057 Exceptionals/otherset counters 0 0 0 0 0 CAPEX (123) (72) (108) (116) (141) Profit before tax 671 976 1,008 1,311 1,550 Free cash flow 745 446 753 1,052 916 Tax expenses 224 306 320 418 496 Dividends (271) (459) (465) (607) (720) Minority interest 38 13 13 13 13 Balance sheet adj.