Summary. Maintain BUY and trimmed TP to HK$ 6.72, based on unchanged 16x FY20E P/E. Despite a ~RMB 100mn one-off brand restructuring fees for K-swiss and Pallium which could push down NP growth to just 6% in 2H19E, we do believe it is a necessary move for a more positive long term growth.
- 1H19 profit inline. Xtep’s 1H19 net profit increased by 23% YoY to RMB 463mn, inline with CMBI or 3% above BBG’s est. But note that if we exclude write backs of receivable provisions, adjusted net profit could go up by 14%.
- Apparel growth outperforming footwear. Sales growth of 23% was driven by robust apparel growth of 50%, thanks to stronger product offerings and restocking of channel inventory, while that of footwear was at only 8%. Such polarized performance was only due to timing of delivery. Full year growth should normalize to 35-40%/ 10-15% respectively, guided by mgmt.
- Guidance for Xtep in FY19E/ 20E unchanged. Mgmt believes sales/ NP growth could be 20%+/ double digit for FY19E/ 20E thanks to healthy channel inventory (~ 4months), as sell through rate was 75%+ for 1Q/2Q19.
- …but net profit in 2H19E could be affected by one-off M&A expenses. However, group level net profit may be adversely affected by the restructuring of K-swiss, Palladium and Supra, costing up to ~RMB 100mn.
- Tapping into basketball, by signing Jeremy Lin/林书豪 as brand ambassador. Xtep expanded into the basketball segment by signing Jeremy Lin on 9 Aug 2019. We see this as a great deal, because 1) this iconic Chinese player fits well for both professional and fashion product series and 2) sponsorship fees is justifiable (~ USD 7.5mn for 2019-2021). We also believe the potential is there for Xtep as basketball related products only accounted for less than 1% of total sales in 1H19, vs ~25% for Li Ning.
- Manageable initial losses for the Saucony and MERRELL JV. The team to manage these two brands had just been assembled. We shall see Tmall flagship store go online in Jul 2019/ early 2020 and physical stores (~30-40 stores for each brand) to be opened in 2H20 for Saucony/ MERREL. The JV is expected to record some initial losses of ~ RMB 20-30mn in FY20E.
- Maintain BUY and trim TP to HK$ 6.72. We maintain BUY but cut TP to HK$ 6.72, based on unchanged 16x FY20E P/E, implying a 1.0x 3 years PEG. The counter is trading at 13x FY20E P/E. We adjusted our FY19E/20E/21E EPS estimates by -4.9%/-3.1%/+0.3%, to factor in the 1) slightly faster apparel growth, 2) greater-than-expected M&A related costs.
