Re-rating justified given increasing visibility for FY18 earnings; raise TPto HK$5.22
　　Valuation We lift our TP from HK$3.60 to HK$5.22, based on 15x FY18E P/E （vs 11.3xpreviously）。 We see increasing visibility for FY18 earnings growth as we expect losses inthe HK market to stabilize, which should accelerate earnings growth. The company’srevenue mix for China/HK should improve further to 54%/32% of total revenue in FY19,from 42%/48% in FY17. Looking into 1QFY18, we anticipate growth momentum in Chinaand Japan will continue, and that the SSS decline in HK will narrow compared to 4QFY17.We also expect GPM to continue to expand given less retail discounts. We raise ourFY18/19 net profit estimates by 9%/17% to factor in higher margins and SSSGassumptions, now estimating net profit will grow at a CAGR of 30% during FY17-19.
　　FY18-19 profit growth outlook better than during 2015’s re-rating The stock re-ratedfrom 9x 1-year forward P/E in late Jan 2015 to 15x 1-year forward P/E in April 2015。 Core net profit growth improved from -26% in FY14 to 4% in FY15. The stock then deratedto 8x 1-year forward P/E in late Aug 2015 as core net profit dropped 8% in FY16.As we see a 30% net profit CAGR ahead, we think a re-rating is justified by the strongerprofit growth than in FY15.
　　HK market SSS decline to narrow We expect SSSG to improve from -4.2% in FY17 to-1% in FY18 for the following reasons: 1） Apparel retail sales in HK rose 2% YoY in bothMarch and April 2017, the first two consecutive months of positive growth since Sept 2014;2） The positive wealth effect from the stock market; 3） Store efficiency improvements –store area declined 8% YoY in FY17 and we estimate it will drop 7% in FY18; 4） The lowbase in 4QFY17 due to the unusually warm weather.
　　Losses in HK to stabilize Segment loss widened to HK$185m in FY17, from HK$73mthe previous year. We believe the loss could stabilize in FY18 due to: 1） a narrowing ofthe SSS decline; 2） operating cost savings, especially in rental costs, from store areareductions in FY17 and FY18; 3） efforts by the company to increase GPM by reducingretail discounts and being prudent with merchandise purchases; 4） easing rental pressurein shopping malls. Average rental reversion at shopping malls softened to low single-digitgrowth in FY17, from around high single-digit growth in FY16. Our channel checks showrental reversion at shopping malls is currently at flat to low single-digit growth.
　　China remains the key growth driver The company’s directly-operated retail network（435 stores in FY17） is spread over just 28 cities （vs 20 cities one year ago）， stillunderdeveloped. The company only had a 0.2% share of China’s apparel market in FY17（vs 4.6% in HK）， suggesting room for market share expansion. Its China retail businesshas good operating leverage. Excluding changes in onerous provisions （a non-recurringitem）， segment profit would have increased by 51% in FY17, and SG&A expenses ratiowould have dropped 2.4pp, based on 14% revenue growth.
　　Japan momentum continues FY17 revenue was up 41% （27% based on local currency）。Segment profit rose 48% YoY and segment profit margin expanded 2pp. We estimate~24% revenue growth （local currency） in 4QFY17, suggesting momentum continuedduring the quarter. Online sales led growth as the company extended its A Bathing Apeonline store to Europe and added the Aape online store in FY17. The proportion of onlinesales to total Japan market revenue jumped from 10%+ in FY16 to 17% in FY17.