Combining better sales trend and sector re-rating, we find Xtep’s risk reward attractive and upgrade to BUY with TP raised to HK$3.63, based on a 13x FY21E P/E (from 10x for industry re-rating). Note that sportswear leader’s valuation have been re-rated from 25x 2 yrs forward P/E in Dec 2019 to 32x P/E in Nov 2020.
- So far so good in 4Q20E. We now become more optimistic on Xtep’s core brand, as its retail sales growth accelerated to double digit in Sep 2020 and even better in Oct 2020, comparing to MSD in 3Q20. We believe performance from both offline and online channels are encouraging. While the offline were driven by recovery in foot traffic, the online sales were boosted by better growth at Tmall and expansion to more platforms (VIPS and PDD). We attributed the drivers to: 1) the earlier and colder winter, and 2) more active use of wechat store and mini-program in 4Q20E.
- Cash flow is still the priority. Together with better sales, we expect both channel inventory and Xtep’s receivable days to improve healthily in 4Q20E, while the retail discounts may stay the same at 30% to 35% off.
- First multi-brand store “X-STREET” performed well. Xtep opened its first multi-brand store in Xiamen on 8 Nov 2020, which has a store size of 1,500 sq m and sells Xtep (including top series like the Jeremy Lin’s), Palladium, Saucony and Merrell products. Nicolas Tse, as brand ambassador, also joined grand opening and ~RMB 5mn sales was generated in just one day.
- Focusing more on Saucony than on Merrell. Management maintained target to open 30-50 stores in FY20E but most of those shall be under Saucony. Performance of ~20 stores opened YTD are in-line with management’s expectation. However, breakeven may not be achieved until FY22E, and we forecast RMB 36mn and 65mn losses in FY20E and FY21E.
- K-Swiss turnaround may lengthen while Palladium will open more self-owned store. Due to second wave of COVID-19 in US and Europe, we now believe the breakeven period is likely to be longer than 3.5 years for K&P. Also, Xtep plans to open more self-owned stores for Palladium in China as E-land is closing down more under-performing stores. For K&P, we are forecasting a 22% sales drop and US$ 15mn (~RMB 100mn) losses in FY20E.
- Upgrade to BUY and raised TP to HK$ 3.63. We lifted our FY20E/ 21E/ 22E EPS estimates by 1%/ 6%/ 2, to factor in faster core brand growth and better opex control. Given attractive valuation of 10x FY21E P/E, we upgrade the stock to BUY and new TP is based on 13x FY21E P/E (up from 10x).
