During the meeting we hosted yesterday, the key focus was on why the Japan subsidiary’sgrowth has been so strong, China market growth potential and the challenges for the HKretail market. Management considers its 300+ brand portfolio and strong relationshipswith international brands to be unique in the market, and believes this would be difficultfor peers to replicate. Investors appear to demand stronger growth from the China marketgiven the company’s brand resources and expertise. We maintain our Buy rating andtarget price of HK$3.60, still based on 11.3x FY18E P/E （historical average）。
　　Significant expansion potential in China China will remain the key growth driver in themedium-term. The company’s directly-operated stores （395 stores in 1HFY17） now cover22 cities, with around 60%/40% of its store area in first-tier cities/the other 18 cities.
　　Currently, its franchisees cover another 20+ cities （75 stores in 1HFY17） including certainaffluent coastal cities such as Ningbo, Zhenjiang, Xiamen, Jiaxing etc. For example, thesales performance of franchised stores in Chengdu was stronger than management hadexpected, so the company ended the franchise co-operation when it expired this year andthen opened directly-operated stores. Also, over the last two years, the company hasobserved that customers are focusing more on creating their own unique personal style.
　　This trend should be positive for the company’s trend-setting fashion business.
　　Good operating leverage in China The 5% segment profit growth YoY in 1HFY17 doesnot paint the whole picture. Excluding the HK$23m write-back for onerous provisions in1HFY16, segment profit would have increased by 47% YoY. This represents a 1.2ppincrease in profit margin to 5.1% at a 5% SSSG despite GM narrowing by 0.6pp.
　　Why is the Japan subsidiary’s growth so strong? The strong 28% revenue growth, inlocal currency, in 1HFY17 was driven by growth in inbound tourists and local consumption.
　　A Bathing Ape stores are seen as a “must go” place to visit in Japan. The companydeveloped a sub-brand “AAPE” two years ago and it has been well-received by HKconsumers. The company therefore plans to open one AAPE store in Japan this year. Inthe US, the company will also open its second store in LA （the first was in New York） asA Bathing Ape has been gaining traction in the country. Sales at A Bathing Ape and AAPEstores outside of Japan are also an income source for the Japan subsidiary. Lastly, onlinesales have been performing well and contribute >10% of revenue.
　　HK market still challenging Opex ratio in the HK market increased by 4.6pp to 67.8% in1HFY17 given 1） shop rental costs increased on renewal as most stores are located inshopping malls, 2） salary increases, and 3） operating deleverage. The 3% store areareduction YoY in 1HFY17 improved sales efficiency slightly as retail revenue only dropped2%. Management believes it is difficult to say when the recovery will appear, but it willcontrol retail discounts as well as operating costs and optimize its store network （2-4%YoY drop in store area in FY17）。