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Disclosures & Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Issuer of report: The Hongkong and Shanghai Banking Corporation Limited View HSBC Global Research at: research.hsbc M i F I D I I R esea r c hI s y o u r a c c e s s a g r e e d ?C ON T ACT u s t o d a y We highlight three key sector developments in 2017 A warm welcome to a cold winter: favourable weather condition should boost sector 4Q17 retail sales We see best risk-reward profile in Li Ning (Buy) 2017 was an eventful year. While the China Sporting Goods sector continued to grow at a healthy and steady pace at around two times GDP growth, there were a lot of changes that the number does not tell. We highlight three key themes: 1) Chinese shifting preference in both shoes and stocks: these are indicated by changes in the top five brands by market share and southbound liquidity flow; 2) channel, products, and brand equity drive consolidation: smaller regional players continued to exit the business and while this is an opportunity for other domestic brands, improving customer experience remains key to garner market share; and 3) privatisation of Belle and Pou Sheng points to a need for change: while the two biggest distributors of international brands should benefit from strong top-line momentum, the challenges they faced are a key lesson for all retailers. Its freezing! We believe a colder-than-expected winter has boosted retail sell-through of the sector during 4Q17, which is supported by retail data reported by Pou Sheng (3813 HK, not rated) and Xtep. For Pou Sheng, 4Q sales accelerated to 20% yoy from 13% in 3Q, whereas domestic brand peer Xtep also saw faster same-store-sales growth (SSSG). For 4Q, we expect Antas brand retail sales growth to reach +20% yoy (from mid-teens in 3Q) thanks in part to a successful 11.11 online event promotions. For Li Ning, we forecast an acceleration to high single-digit growth (from low single-digit growth in 3Q). Switch preference from Anta to Li Ning. We see the best risk-reward profile in Li Ning and raise our TP to HKD7.70 (from HKD7.30) after rolling over our valuation from FY18 to FY18-19e, which is partially offset by lower earnings; reiterate Buy. We think the recent share price correction has more than priced in potentially higher opex. Despite having the highest earnings growth in the sector, Li Ning is trading at >20% discount on FY19e PE to Anta. We maintain a Buy and increase our TP for Anta to HKD43.80 (from HKD38.00) from a combination of higher FY19e estimates, higher multiples, and valuation roll-forward. We are 7% ahead of consensus net profit as we see stronger top-line growth. We rate Dongxiang a Buy given potential catalysts on both sportswear and investment segments. We set a higher TP of HKD3.70 for Xtep (from HKD2.80) but maintain a Hold because we think a potential recovery is already in the price. 27 January 2018 Scott Chan*, CFA Analyst The Hongkong and Shanghai Banking Corporation Limited scotttkchanhsbc.hk +852 3941 7005 Erwan Rambourg Global Co-Head Consumer & Retail Research HSBC Securities (USA) Inc. erwanrambourgus.hsbc +1 212 525 8393 Karen Choi* Head of Consumer & Retail Research, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch karen.choikr.hsbc +822 3706 878 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations China Sporting Goods EQUITIES TEXTILES, APPAREL & LUXURY GOODS CHINA China Sporting Goods Target price changes and valuation Company Ticker Current Price TP old (HKD) TP new (HKD) Rating* Up/(down)side FY18e PE FY19e PE Li Ning 2331 HK 6.29 7.30 7.70 Buy 22% 18.1 14.1 Anta Sports 2020 HK 38.40 38.00 43.80 Buy 14% 21.5 18.0 China Dongxiang 3818 HK 1.60 1.80 1.90 Buy 19% 9.6 9.8 Xtep Int'l 1368 HK 3.59 2.80 3.70 Hold 3% 10.0 9.2 Source: Bloomberg, HSBC estimates. Priced as of close on 25 Jan. *No change in ratings Three lessons from 2017 EQUITIES TEXTILES, APPAREL & LUXURY GOODS 27 January 2018 2 China Sporting Goods Estimates revision _ Revenue (RMBm) _ _ vs old _ _ Net profit (RMBm) _ _ vs old _ _ vs consensus _ FY17e FY18e FY19e FY17e FY18e FY19e FY17e FY18e FY19e FY17e FY18e FY19e FY17e FY18e FY19e Li Ning 2331 HK 8,829 9,956 10,675 0% 1% 2% 508 681 872 0% -10% -1% 2% -6% -7% Anta 2020 HK 16,325 20,241 23,721 0% 0% 1% 3,117 3,881 4,638 0% 0% 3% 3% 7% 7% China Dongxiang 3818 HK 1,517 1,612 1,720 0% 0% 0% 865 744 725 0% 0% 0% -7% -9% -8% Xtep 1368 HK 5,001 5,445 5,805 0% 0% 0% 369 578 680 0% 0% 0% -20% 4% 12% Source: Bloomberg, HSBC estimates. China Sporting Goods - Investment thesis in a glance Company Sh price (HKD) TP old (HKD) TP new (HKD) Rating* Upside FY18e PE FY19e PE FY18e EPS growth FY19e EPS growth FY18e div yield FY19e div yield Investment thesis Li Ning 2331 HK Market Cap: USD1,753m 3m ADTV: USD5m 6.29 7.30 7.70 Buy 22% 18.1 14.1 34% 28% 2.1% 2.7% Look past near-term volatility: Addition of kids wear segment, better wholesale business and improving coverage in Southern China should drive further business recovery. Risk-reward profile turned favourable after the share price fell 15% from a peak in 4Q17 on potentially higher A&P and staff costs. With the highest growth in the sector, we believe Li Nings +20% valuation discount to Anta is unwarranted. Li Ning is our top pick in the sector. Anta Sports 2020 HK Market Cap: USD13,188m 3m ADTV: USD20m 38.40 38.00 43.80 Buy 14% 21.5 18.0 25% 20% 3.3% 3.9% Buy the best if you arent sure of the rest: The undisputed domestic leader has continued to widen the market share gap to its domestic peers. We believe there is still room for re-rating as Anta has a higher ROE and yield vs international peers; increasing southbound interest is also supportive. China Dongxiang 3818 HK Market Cap: USD1,162m 3m ADTV: USD1m 1.60 1.80 1.90 Buy 19% 9.6 9.8 -14% -3% 6.3% 6.1% Multiple drivers in the making: New CEO with extensive experience in the sportswear industry should bring forward more reforms to the subdued Kappa business. Investment business remains key to cashflow to our 6% yield assumptions; Ant Financials likely listing still a potential catalyst (Barrons, 15 May 2017). Xtep 1368 HK Market Cap: USD1,021m 3m ADTV: USD1m 3.59 2.80 3.70 Hold 3% 10.0 9.2 1% 8% 5.5% 6.5% Fairly priced for a potentially robust recovery: 2017 was a year of transition as the company moved towards functional sports products while kids wear business saw the last stage of restructuring. A recovery is likely in 2018 after inventory repurchasing on the back of healthy sell-through; but we believe the stock is fairly valued here. Source: Bloomberg, HSBC estimates. *No change in ratings. Priced as of close on 25 Jan. China Sporting Goods Share price performance since 2017 Source: Thomson Reuters Datastream, HSBC - 3 0 %- 2 0 %- 1 0 %0%1 0 %2 0 %3 0 %4 0 %5 0 %6 0 %7 0 %8 0 %J a n - 1 7 F e b - 1 7 M a r - 1 7 A p r - 1 7 M a y - 1 7 J u n - 1 7 J u l- 1 7 A u g - 1 7 S e p - 1 7 O c t - 1 7 N o v - 1 7 D e c - 1 7 J a n - 1 8A n t aH S IL i N in gC h in a D o n g x ia n gX t e p3 EQUITIES TEXTILES, APPAREL & LUXURY GOODS 27 January 2018 Chinese shifting preference in both shoes and stocks Diverging performance: adidas now the favourite, Anta the only local outperformance According to Euromonitor, the China sportswear market grew by 12% in 2017, and continued to track at about two times GDP growth, which is largely on par with the growth rates in the past two years. Going forward, we remain constructive on the sector outlook driven by a 1) positive wealth effect, 2) increasing health consciousness, 3) under-penetration in sportswear spending, and 4) increasing penetration in athleisure trends. While sector growth has been healthy and steady, we have seen diverging performance among brands. Digging deeper into Euromonitor data, we noted a change in dynamics within the international peers and domestics brands: International brands: adidas has overtaken Nike to capture the highest market share. This is consistent with the strong growth reported by the German sportswear brand. The change in market share signifies an increasing penetration of the athleisure trend, in our view. Domestic brands: Anta is the only domestic brand in top 10 that has outperformed industry growth. We believe that this is attributable to improving product offerings, effective channel management and strengthening brand equity domestically and internationally. We also note that Xtep has been surpassed by 361 Degrees (1361 HK, not rated) to be the third biggest domestic brand by market share. China sportswear market share by brands 2012-2017 Source: Euromonitor Southbound holdings signal changing preference, too Not only is Anta brand becoming increasingly popular in China, but also Anta shares are gaining higher traction among mainland-based investors. We note that southbound investors are increasingly showing a shift in preference to Anta from its domestic peers, according to HKEx disclosure. We believe the participation from southbound liquidity is an important driver to share price re-rating. Indeed, reviewing this particular data for stocks in our sportswear and OEM coverage, it appears that the two stocks that have had the best performance in 2017 were Shenzhou and Anta and both had the highest proportion of participation from southbound investors. We believe, going forward, as brands under Anta Group continue to enjoy a higher penetration among Chinese consumers, it would help to re-rate the stock on a longer-term basis. 1 3 . 3 15 1 4 . 8 1 5 . 3 1 6 . 31 9 . 81 3 . 7 14 1 4 . 31 5 . 5 171 6 . 88 . 8 7 . 6 7 . 57 . 87 . 985 . 9 5 . 1 5 . 2 5 . 45 . 45 . 35 . 7 4 . 2 4 . 1 4 . 24 . 246 . 35 . 1 5 . 35 . 24 . 73 . 80102030405060702 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7a d id a s N i k e A n t a L i N in g 3 6 1 D e g r e e s X t e pEQUITIES TEXTILES, APPAREL & LUXURY GOODS 27 January 2018 4 Southbound holdings in HSBC China sportswear and OEM coverage Source: HKEx Channel, products and brand equity drive consolidation Channel management, products and brand equity all count In China: Anatomy of the Consumer (3 November 2017), we surveyed more than 2,000 Chinese millennials (aged 18-34) across major cities. We found out that Xtep remains one of the most preferred domestic brands in China. However, against this result is that, in 2017, Xtep slipped a place in market share and conceded its fifth place to 361 Degrees. We believe this was attributable to the disruption in business during their three-year transformation and the mis-management in channel inventory. In our report Need to repurchase inventory a negative surprise (8 December 2017), we highlighted that Xteps decision to repurchase aged inventory was a negative surprise. We underestimated the ageing structure of the channel inventory, and the build-up of dated products with distributors and retailers led to insufficient procurement of new and potentially popular products from the retailers. This, in return, resulted in missing a sales opportunity just like what we saw during the industry downturn five years ago. Specifically, it took Li Ning close to four years for the inventory structure to return to a healthy level. 0 . 0 0 %0 . 5 0 %1 . 0 0 %1 . 5 0 %2 . 0 0 %2 . 5 0 %J a n - 1 7 F e b - 1 7 M a r - 1 7 A p r - 1 7 M a y - 1 7 J u n - 1 7 J u l- 1 7 A u g - 1 7 S e p - 1 7 O c t - 1 7 N o v - 1 7 D e c - 1 7A n t a L i N in g X t e p C h in a D o n g x ia n gS h e n z h o u L i & F u n g P a c if ic t e x t i le s S t e ll aLi Ning Channel inventory ageing recovery back in 2012-2017 Source: Company data 33% 37%46% 50%56%49%61%54%64% 67%27% 23%15%21%20%23%15%21%14%14%40% 40% 39%29% 24% 28% 24% 25%22% 19%0%1 0 %2 0 %3 0 %4 0 %5 0 %6 0 %7 0 %8 0 %9 0 %1 0 0 %D e c 1 2 J u n 1 3 D e c 1 3 J u n 1 4 D e c 1 4 J u n 1 5 D e c 1 5 J u n 1 6 D e c 1 6 J u n 1 76 m o n t h s o r l e s s ( N e w P r o d u c t ) 7 - 1 2 m o n t h s Ov e r 1 2 mo n t h s5 EQUITIES TEXTILES, APPAREL & LUXURY GOODS 27 January 2018 Regional players leaving the game Once listed in the NASDAQ stock exchange as Exceed Company, domestic brand Xidelong (喜得龙 ) filed for bankruptcy in August 2017, reported by Sohu on 9 September 2017. The company held 3.5% of the market back in 2011 (source: Euromonitor). Separately, according to 163 on 23 January 2018, Fujian-based sportswear brand Deerway (德尔惠 ), which used to own as many as 4,000 stores nationwide, suspended operations due to indebtedness before being taken over by a Jinjiang-based firm. Both of the above, in our view, reflect the challenging operating environment, despite the overall growth in the industry. This, however, means local brands with strong channel management, products and brand equity should consolidate market share with small regional brands. China Sporting Goods Total market share of top 10 brands Source: Euromonitor Privatisation of Belle and Pou Sheng points to a need for change Its not all smooth sailing In July 2017, ladies footwear brand and international sportswear retailer Belle was de-listed from the Hong Kong Stock Exchange after being privatised by Hillhouse Capital, CDH Investments and certain management personnel. Earlier this month, Pou Sheng (3813 HK, not rated) also announced parent company Pou Chen (9904 TT, not rated) has proposed to privatise the retailer (see Proposed retail privatisation should be welcomed, 22 January, for more details). 6 2 . 1 %6 2 . 9 %6 4 . 9 %6 6 . 7 %6 8 . 9 %5 8 %6 0 %6 2 %6 4 %6 6 %6 8 %7 0 %2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7T o p 1 0 b r a n d s a g g r e g a t e m a r k e t s h a r e ( %)China retail sales growth and online goods sales growth Source: CNNIC 0%5%1 0 %1 5 %2 0 %2 5 %3 0 %3 5 %4 0 %J a n - F e b2 0 1 7Ma r - 1 7 A p r - 1 7 Ma y - 1 7 J u n - 1 7 J u l - 1 7 A u g - 1 7 S e p - 1 7 Oc t - 1 7 N o v - 1 7 D e c - 1 7C h in a r e t a il s a le s g r o w t h O n li n e g o o d s a le s g r o w t hEQUITIES TEXTILES, APPAREL & LUXURY GOODS 27 January 2018 6 The rationale for both transactions was similar: they see volatility in financial performance as they carry out restructuring to adapt to a challenging retail landscape. Customer experience remains key Brick-and-mortar sporting goods stores see challenges from online and tougher competition and are evolving. In our report A new shopping experience (30 June 2017), we highlighted three observations of how the physical stores are changing: More specialty stores: Customer experience in retail stores has become key to attracting and retaining new consumers. We are increasingly seeing local and inter
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