2Q17 manufacturing revenue normalised to +2% y-o-y from+7% y-o-y in 1Q17, as guided; 2H17 could see a higher base
Retail sales growth in China accelerated; 60% interestdisposal in the China retail business to be completed soon
Maintain Reduce with an unchanged target price of HKD10
2Q17 manufacturing slowed: Total group revenue came in at USD455m, +4% y-o-y,in line with our full-year expectation of +4%. By segment, core businessmanufacturing revenue was +2% y-o-y, down from +7% in 1Q17. Volume growth of5% more than offset a decline in the average selling price （ASP） of 2% due to productmix changes. Management commented that non-sports volume was largely flat y-o-yoverall, as the fashion segment saw a modest pick-up, offsetting a slight decline in thecasual segment. The sports category maintained its strong momentum but could see ahigher base comparison in 2H17, given volume to a fast-growing customer started topick up in 2H16. Also, Stella will closely monitor the impact of a major fashion sportscustomer on the company’s strategy change. Looking forward, management reiterateda low- to mid-single digit growth target in volume for FY17, but Stella now sees risks ofa lower ASP as raw material prices normalise. Stella remains focused on streamliningoperational efficiency and, excluding a USD4-5m negative impact from freight chargesincurred in 1Q17, management continues to target a 6% EBIT margin for FY17.
　　China retail accelerated; disposal to be completed soon: China retail revenuecame in at +20% y-o-y, on the back of same-store sales growth （SSSG） of 4%. Thisrepresents an acceleration vs sales growth of 15% in 1Q17, mainly driven by the newstores ramp-up. In Europe, the company saw 18% growth in sales with SSSG of 14%.Further to Stella’s planned 60% China retail business interest disposal announced inOctober 2016, the company expects the disposal to be completed in the next 10 days.Management previously estimated a cUSD2m one-off non-cash disposal gain.
　　Maintain Reduce: We continue to see margins pressure, driven by: 1） lower ASP, and2） margin dilution from the new factory. Manufacturing ASP should trend lower, given thecasual brands’ shift to more mass products on lower raw material prices. Separately, weremain cautious on margins in FY17e when the new factory commences operationstowards 2H17e. We make no change to our estimates. Our unchanged target price ofHKD10 is based on a 12.7x FY17e PE, 0.5 SD below the average since 2007. With 27%downside from the current share price, we reiterate our Reduce rating on Stella. Keyupside risks include higher-than-expected orders from brand customers, improvingproduct mix and/or higher production efficiency leading to higher gross margin, andhigher-than-expected sales growth and/or lower operating costs in the retail segment.