Positive product mix and higher raw material prices helped toreverse the ASP trend in 4Q16
Management expects the manufacturing ASP to decline onflat volume going into 2017
Maintain Reduce with an unchanged TP of HKD11.50
4Q16 review: Stella hosted a conference call on the 4Q16 operating statisticsupdate. Manufacturing revenue was -12% y-o-y, narrowed from -18% in 3Q16. Ofthe 1-2m pairs miss in shipment volume (compared to management guidance), about0.5m was due to delayed shipments going into January and February, while the restwas due to cautious confirmations of orders by casual customers. The averageselling price (ASP) was up 2%, reversing the declining trend seen since 2Q15, mainlyhelped by a favourable product mix. Otherwise, the ASP for products on a like-for-likebasis was helped by improving raw materials costs. On the labour side, the companytracked ahead of initial expectations, closing the year with about 68,000 staff (versusa previous expectation of 71,000). Retail revenue saw encouraging growth as thecompany continued to the optimise store network. On a currency-neutral basis,same-store sales would have been up 20% (vs up 12% in USD terms, as reported).
Looking ahead: In 2017, management sees further pressure in manufacturingrevenue as a result of flat volume and a lower ASP. Despite expecting a betterproduct mix (as both sports and athleisure categories outperform) and higher leatherprices, the ASP could go lower, given casual brands’ shift to more mass marketproducts. Margin looks set to be management’s top priority by streamliningefficiencies. With the Trans-Pacific Partnership (TPP) becoming unlikely to bepassed, management believes the impact on Stella is relatively limited, as leathershoes imported into the US are subject to a duty of only 5-10%. On the retail side,Stella is encouraged by the reception of its new collection launched in October 2016and the positive sales momentum continued into January. The disposal announced inOctober 2016 is on track to be completed in mid-April 2017.
Maintain Reduce: We make no change to our estimates. We continue to see lowerrevenue leading to a slower-than-expected recovery in margin, especially with anunexciting ASP trend. Our unchanged target price of HKD11.50 is based on a 14xFY17e PE, the average since 2007. With 8% downside to our target price from thecurrent share price, we reiterate our Reduce rating on Stella, as we see a potentialweakening in casual shoes demand. Key upside risks include higher-than-expectedorders from brand customers, improving product mix and/or higher productionefficiency leading to higher gross margin, and higher-than-expected sales growthand/or lower operating costs in the retail segment.