CCB International (part of China Construction Bank) has followed the lead of Bocom (Bank of Communications) and Kim Eng by initiating coverage on Chinese sportswear firm Xtep International (HK: 1368) with its top rating.
Meanwhile, JP Morgan said it is keeping its "outperform" call on the Hong Kong-listed firm and raising the target price to 6.35 hkd from 5.50 hkd previously.
Xtep was among the three featured coverage initiations in the second tier brand sportswear firms, which also included 361 Degrees (HK: 1361, outperform) and Peak Sport (HK: 1968, outperform).
Small is beautiful
CCBI said that with affordable pricing, the three Chinese sportswear firms are best positioned to capture opportunities arising in lower-tier markets where it believes growth has and will remain the strongest in the near, medium, and long term.
"On the back of the extremely robust top-line growth and the uptrend in advertising and promotional (A&P) expense ratio over the years, their A&P investment growth has outpaced the established leaders, resulting in significantly enhanced brand recognition and image," CCBI said.
The ongoing maturing process of their relatively new outlet network as well as further upgrades and relocations of existing stores will provide additional boost to sales per outlet, the brokerage added.
"As importantly, their distributors are heading into 2010 with comfortable retail inventory level, providing a basis for a continuation of solid order growth."
It said that notwithstanding the sharp re-rating in the shares lately, valuations remain attractive.
"At 13x 2010F P/E), Xtep offers a uniquely blended exposure to the mass-market sports fashion segment and to the growing popularity of Disney-branded products with its Disney Sport license."
CCBI said there could be a regime change at the top of the heap in China's sportswear sector.
"While short-term upside could be limited, ANTA Sports (HK: 2020, neutral) has the potential to replace Li Ning (HK: 2331, underperform) on a longer-term horizon as China's No.1 domestic brand. In the meantime, the frequency and diversity of acquisitions made by Li Ning indicate a lack of strategic consistency, in our view."
It added that China Dongxiang (HK: 3818, neutral) has the highest-quality operations in the sector but its current risk/reward profile is fairly balanced due to inventory concern and uncertainty on its ability to penetrate markets of lower affordability.
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Second-tier brands to shine this year
CCBI said second-tier brands like Xtep enjoyed a competitive advantage in lower-tier markets.
“The bullish investment case for the up-and-coming second-tier brands first and foremost has much to do with their affordable price points which will continue to greatly facilitate their expansion in lower-tier cities. We believe these cities will continue to offer the best growth prospects in the industry in the short, medium, and long term.”
The brokerage said that by way of background, the China sportswear sector has seen a post-Olympic slowdown beginning in the second half of 2008, particularly in higher-tier cities.
“First, leading international players operating mainly in tier-one and tier-two cities and to a lesser extent, domestic brands, have overestimated sales prospects, resulting in a substantial inventory pile-up in the channels.”
CCBI said that secondly, the macro slowdown has impacted higher-tier cities more acutely.
“Third, the sportswear retail market in higher-tier cities is the most competitive and is well penetrated especially by the leading brands, and the intense competitive landscape has further magnified the impact of the slowdown on individual players.”
By contrast, CCBI said lower-tier cities, where the local economy has remained relatively less prone to impacts from the slowdown and product penetration is lower, have continued to see strong demand growth.
“The consequence of the development is brands will need to increasingly pursue growth outside of higher-tier cities. Players such as Xtep, having a mass-market brand positioning and affordable price points, are best positioned to capture the opportunities arising from the change in industry landscape.”
Sportswear players such as Xtep have retail ASPs at about 50% below that of Nike (Not Rated) and Adidas (Not Rated) and 30% below that of Li Ning.
“While consumer affordability is rising fast in lower-tier cities on the back of continued economic growth and the associated disposable income growth, we believe the price differential will remain material enough to provide effective competitiveness in the foreseeable future for the tier-two brands against their higher-tier rivals.”
Xtep’s nice niche
CCBI is bullish on Xtep due to the Hong Kong-listed firm’s strong market position.
“We like Xtep’s operations in the niche sports fashion segment and find its current valuations of 13x 2010F P/E a compelling entry level given its estimated net profit CAGR of 23% through 2011. Robust earnings outlook and further removal of new listing discount will continue to trigger re-rating relative to the established brand owners.”
CCBI concluded that it believes network upgrades, including relocation of outlets to better locations and openings of larger outlets, are other important drivers for second-tier brands like Xtep.
JP Morgan hikes target to 6.35 hkd
JP Morgan said it is maintaining an “overweight” call on fashion sportswear firm Xtep International (HK: 1368).
It is also raising its price target on the Chinese firm to 6.35 hkd from 5.50 hkd previously.
In a note to investors, the brokerage said it expects Xtep to report 20% and 16% earnings growth in 2009 and 2010, respectively, mainly driven by revenue growth as it also sees the improvement in gross margins to be used for higher A&P spending.
JP Morgan’s vote of confidence in Xtep follows recent coverage initiations by CCBI (Outperform), Kim Eng (Buy) and Bocom (Buy).
“Valuations are still attractive. Top-line growth is driven by store additions. We expect Xtep brand to Hong Kong report 20% revenue growth both in 2009 and 2010. Similar to peers, Apparel, Footwear we expect 70%-80% of the revenue growth to come from store additions while remaining is from improvement in average sales per store,” JP Morgan said.
It added that gross margin expansion is part of the normalization.
“Xtep started out by giving more favorable discount rates to the distributors. Management had indicated that this will normalize as brand awareness increases and we are seeing gross margin improvement as discount rate for footwear is lowered by 2% per annum.”
In the first half of 2009,, Xtep reported 1.8% improvement in gross margin and JP Morgan expects around 1.5% and 1% improvement in gross margin in 2009 and 2010, respectively.
“A&P spending is increasing as expected: We expect the gross HSI (rebased)margin expansion to be put into use for A&P. Xtep had relatively low YTD 1m 3m 12m A&P spending vs. its peers and it is improving that.”
JP Morgan expects A&P spending to be at 12% of sales vs. 9% of sales in FY08.
“Xtep has outperformed the three big-cap sportswear companies by 33% over the past six months and valuation gap has narrowed from 45% down to 30%. We still believe Xtep offers a good growth opportunity at an attractive valuation and remains as our only ‘overweight’ call in the sportswear space.”
JP Morgan’s increase in the target price to 6.35 hkd translates to 17x 2010E earnings, around a 15% discount to big-cap sportswear players.
