1H17 net profit -6% as margin hurt by higher opex while grossmargin was flat despite 6% higher revenue
Margin would have to expand 1.4ppt yoy in 2H17e to reachguidance of 6% for FY17e while ASP is under pressure
Maintain Reduce with unchanged TP HKD10.0
Limited improvement in profitability. 1H17 earnings were USD29m or -6%yoy, asnet margin shrunk by 0.4ppt yoy. Core manufacturing business saw 6% growth involume while average selling price (ASP) was down 2% due to more mass productsshipment from casual and fashion customers. Sports and ath-leisure category was up39%yoy and now represents 30% of revenue. Despite higher volume, gross marginwas only flat yoy likely due to price deflation. On operating expenses, adminexpenses to sales ratio was down 0.3ppt yoy as headcount has come down by14%yoy. Selling and distribution costs were up 0.7ppt as a percentage of salesdriven by a one-off freight charge of USD5.4m. Excluding one-offs, the ratio would bestable yoy. Stella declared an interim dividend of HKD30cents/share (flat yoy),implying a c107% payout to reported earnings.
2H17 outlook. Management continues to look for full year shipment of at least 56million pairs, implying c5%yoy expansion in volume in 2H17e. Growth in the sportscategory will likely slow into 2H17 given the higher base comparison as volume for ahigh-growth sports customer ramped up in 2H16. In terms of ASP, Stella sharedconcerns over continuing pressure as customers are shifting towards more massmarket products and expects a 2%yoy decline in 2H17e. Under such a backdrop,together with potential new factory margin dilution into 2H, we believe management’starget of a 6% EBIT for FY17e is overly optimistic as it implies an EBIT marginexpansion of more than 140bps yoy for the remainder of the year
Maintain Reduce: We make no changes to our estimates and remain 10% belowconsensus on FY17e earnings. Our unchanged target price of HKD10.00 is based ona 12.7x FY17e PE, 0.5sd below the average trading level since 2007. With 26.8%downside from the current share price, we reiterate our Reduce rating. Key upsiderisks include higher-than-expected orders from brand customers, improving productmix and/or higher production efficiency leading to higher gross margin, and higherthan-expected sales growth and/or lower operating costs in the retail segment.