Trimmed TP to HK$ 5.09 but maintain BUY due to low valuation, based on a 13x FY20E P/E (down from 16x due to slower growth). We are now more cautious on Xtep’s growth in 4Q19E and FY20E because of 1) diminishing brand momentum and 2) initial investments (losses) for JV and new brands.
- Retail sales growth may soften. We forecast Xtep’s retail sales growth in the next six months (4Q19E and 1Q20E) to soften to 15%-20%, vs about 20% in 3Q19, due to 1) a potentially warmer weather, 2) an early 2020 Chinese New Year (two weeks earlier vs 2019), 3) shift of focus to optimize retail discounts and maintain healthy channel inventory (only ~14% Single Day online sales growth achieved), and 4) less store upgrades as coverage of 6s format already reached 90%+ (trial run of 8th format stores has just started).
- Core brand growth may normalize to low-teens in FY20E but margin may sustain. We forecast a ~12% Xtep core brand sales growth in FY20E, inline with potential future retail slowdown and weakening demand in recent trade fairs. We also expect core brand profitability (both GP and NP margin) to be stable, at ~10.3% in FY20E (vs ~10% in FY19E).
- Investment periods are needed for JV (Saucony & Merrell), K-Swiss, Palladium and others. We estimate about 30-40/ 20-30 new stores for Saucony/ Merrell in FY20E and 100+ stores for each in FY21E. And if store level profit breakeven can be achieved, then expansion may speed up by granting rights to distributors to open more. But before that, we expect ~RMB 10-20mn/ 20-30mn net losses for JV in FY19E/ FY20E. For E-land footwear, We estimate RMB 500mn/ 1,300mn sales in FY19E/ 20E, (vs RMB 1,441mn in FY18) as K-Swiss restructuring may take 18-24 months, while GP margin should be stable at ~38%. Excluding RMB 65mn one-off losses for inventory impairment, operating breakeven should be achievable in FY19E/ 20E.
- Huge potential for the Jeremy Lin franchise but still too early to factor in any expectation. According to Baidu Index, search counts of Jeremy Lin/ 林书豪 in 11M19 was 9,577, which is way higher than Klay Thompson/ 汤普森’s 1,827 and Dwyane Wade/ 韦德’s 3,840, in our view, thanks to his large fan base and stellar performance in CBA (so far this season). We believe there is potential room for Xtep to capitalize the Jeremy Lin Franchise. However, the progressive expansion plan and limited contribution in 4Q19E should be expected. A clearer picture could be obtained later in FY20E.
- Maintain BUY but cut TP to HK$ 5.09. We cut our FY19E/20E/21E EPS estimates by 8.6%/ 6.8%/ 6.1%, to factor in the 1) slower trade fair sales growth, 2) greater-than-expected M&A and new brands related expenses. The counter is trading at 11x FY20E P/E, below its 5 years average of 12x.
