1Q16 unaudited revenue declined 5.9%, with lower sales inboth the OEM and retail segments
Although OEM orders in 2H16e are expected to increase, wesee limited catalysts as margins see pressure in 1H16e
Maintain Hold rating and unchanged TP of HKD19.50
Limited catalysts in 1H16e: With revenue declining in both the OEM and retailbusinesses, margin expansion will be difficult, we think. Volume for the OEMsegment should start to pick up in 2H16e and some measures are being taken toturnaround the retail segment, but we think margin expansion will be very difficult in1H16e. Until we see volume start to grow again, we expect OEM gross margin todecline by 0.7ppt yoy to 17.8% in 2016e, primarily due to lower utilization.
Lower volume in the OEM segment: The group reported a 6.5% yoy decline inOEM sales in 1Q16, with volume at-4.5% and ASP at -2.3%. The slowdown involume was primarily due to a warmer winter in 2015 affecting orders and lessdemand in the casual category. And while the sports casual segment continues tosee strong demand, it is a smaller contributor and is not sufficient to offset weaknessin the casual category until 2H16e at the earliest. Therefore, lower utilization impliesthat it will be difficult to increase gross margin.
Retail SSS decline stabilizing: On a reported USD basis, revenue from the retailbusiness in China declined by 14.3% yoy and SSS declined by 22.4% yoy. If weexclude the impact of RMB depreciation, then constant FX SSS declined by 18.0%on our estimates, which is at a similar level to -16.2% in 3Q15 and -17.6% in 4Q15.While the retail segment is still in transition this year, management is looking to turnaround the business by improving store locations, refurbishing store interiors,launching franchise stores (10 partners signed in tier 3-4 cities), and continueexpansion in Europe.
Maintain Hold rating with 6% upside to HKD19.5 target price: We maintain ourTP of HKD19.5, which is based on a target multiple of 2.0x 2016e PB. Our TP implies6% upside and we rate the stock Hold as we do not see any positive catalysts in thenear-term. Key upside risks include higher-than-expected orders from brandcustomers, improving product mix and/or higher production efficiency leading tohigher gross margin, and higher-than-expected same-store sales growth (SSSG)and/or lower operating costs in the retail segment. Key downside risks: lower-thanexpectedorders from brand customers, higher-than-expected wage inflation, lowerthan-expected cost savings from shifting production outside of Guangdong, andlower-than-expected SSSG in the retail segment.