We think weak fundamentals might not have been fully priced in Daphne International’s (Daphne) share pr ice has declined 42% YTD but in the pas tthree weeks has rebounded 23% from its recent low. Some investors ask if we haveseen signs of a turnaround recently and question whether weak fundamentals haveb een fully priced in. We continue to believe branding and pricing issues (ratherthan soft demand) are the primary reasons behind the poor performance of mass-market brands in China and we see no quick fix.
One of three potential scenarios could play out
Assuming our thesis that Daphne suffers from branding and pricing issues is valid,we outline three potential scenarios: 1) Daphne recognizes brand weakness as thep rimary issue and spends 5% of sales on marketing, which would lead to a sharpdrop in short-term profitability but a chance for long-term survival; 2) Daphne recognizes pricing as the primary issue and lowers tag prices by 30%, which wouldlead to lower margins but could attract more consumers; 3) without reactivemeasures taken promptly, more shares would be lost to e-commerce (which seems likely to double in scale in three years).
Daphne might be running out of options
We see a need for management to react, either by increasing its marketing budgetor by lowering tag prices. However, Daphne’s recent announcement that its netmargin had contracted to the mid-single digits suggests that the first option (to spend more on brand building) might be less economically feasible.
Valuation: reitera te Sell rating
We have a Sell rating with a DCF/VCAM-b ased price target of HK$4.00. We seedownside risks to our 2014/15E earnings estimates. Daphne will release its 1H13 results on 26 August.