2H16 Consumer Discretionary Sector Outlook

Jul 14, 2016 Equity Research | Consumer Discretionary

2H outlook neutral; prefer names with high visibility and expanding margins

Albert Yip, CFA SFC CE No. ADT599 albertyip@gfgroup.com.hk +852 3719 1010 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong

Sector view Neutral

Sportswear: 1Q17 trade fair orders could weaken further as channel inventories may have

risen over the past two quarters (4Q15 and 1Q16) due to the increased difference between order book growth and SSSG.

Jewelry: The decline in sector earnings is expected to narrow. Negative factors: sales of

luxury goods should slow as economic growth softens. Positive factors: the decline in HK street shop rental rates has begun to kick in. The rise in the gold price YoY which began in 2Q16 will help to slow the SSS decline.

Ladies footwear: Negative factors include competition from online channels, the decline in

foot traffic at department stores and consumers’ increasing preference for sporty shoes.

Education: Quality international school operators are benefitting from the increasing

popularity of studying abroad among Chinese students. The industry has high visibility compared to other discretionary categories such as apparel and footwear.

Key themes over next 3-6 months

Sportswear: Trade fair results and SSSG.

Jewelry: SSSG and the gold price trend.

Ladies footwear: SSSG trend.

Education: The amendment of the “Law for Promoting Private Education” and the number

of student enrollments at the end of Sept.

Valuation analysis

Sportswear: The sector is trading at 10.1x 1-yr forward P/E, lower than its historical average

of 10.8x. We are long-term positive but near-term cautious.

Jewelry: The sector is trading at 14.0x 1-yr forward P/E, near its historical average of 15.1x.

We see limited re-rating potential given softening economic growth and the decline in mainland tourist arrivals as well as their weaker purchasing power.

Ladies footwear: Belle is trading at 8.9x 1-yr forward P/E, which is towards the low-end of

its historical range. Its valuation is fair, in our view.

Education: Maple Leaf is trading at 27.9x 1-yr forward P/E, a historical high.

Investment strategy

Bottom-up approach We prefer quality names with high visibility that are also seeing their

margins expand.

Top picks

Maple Leaf (1317 HK, Buy) Quality international school operator whose asset-light approach

is driving growth. Goodbaby International (1086 HK, Buy) Margin expansion continues; overdone share price

correction presents a buying opportunity.

Risks

Upside risks: Better-than-expected SSSG, trade fair results and number of student

enrollments; reversal of the downward trend in mainland tourist arrivals; M&A; amendment of the “Law for Promoting Private Education”. Downside risks: Lower-than-expected SSSG, trade fair results and number of student

enrollments; policy risks, keen competition, exchange rate risks.

Jul 14, 2016

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2H16 Sector Outlook

Sportswear sector Near-term cautious We believe channel inventories have risen in the sector over the past two

quarters (4Q15 and 1Q16) due to the increased difference between order book growth and SSSG. As order book growth rates for 2Q16 and 3Q16 remain relatively high, channel inventories could rise further if SSSG does not improve. Our recent channel checks in Shenzhen (see our Jun 30 report titled “Sportswear Sector: Channel checks reaffirm downside risks”) also indicated weaker store traffic and increasing channel inventories. We believe 1Q17 order book growth data, set to be released in Aug, could show a further weakening. Bloomberg estimates for FY17 revenue estimates have been pretty stable over the past two months, meaning the street is not aware of any possible downside risks for revenue in FY17. Long-term positive We remain positive on the sportswear sector over the long term thanks to

favorable policy support. Firstly, the total size of China’s sports industry is targeted to grow from Rmb1,357bn in 2014 to Rmb3,000bn in 2020, equivalent to a CAGR of 14%. China is expected to release its development plans for outdoor and winter sports this year. Secondly, we believe peoples’ participation in sports will continue to increase, especially in lower-tier cities. For example, the Chinese Athletic Association expects the number of marathons to rise from 134 in 2015 to 800 in 2020, with the number of participants growing from 1.5m in 2015 to 10m in 2020, implying a CAGR of 46%. These trends will support sales growth in functional sportswear products.

Figure 1: China sports industry estimated to be worth Rmb3trn by 2020

Sources: General Administration of Sport of China, GF Securities (HK)

Figure 2: Number of marathons and participants in China

Sources: Chinese Athletic Association, Xinhuanet, GF Securities (HK)

Valuation Looking into FY17, we believe Anta (2020 HK, Hold) could post low-teen revenue growth,

led by no less than mid single-digit order book growth and double-digit growth for its FILA and e-commerce businesses. Net profit growth may soften from 13% in FY16 to ~10% in FY17.

950 1,357

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Jul 14, 2016

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2H16 Sector Outlook

In 1H13, Anta was trading at around 10x 1-yr forward P/E. During that time, SSS was flat and order book growth was declining 5-15% YoY. As Anta was the first domestic brand to invest in new categories such as soccer and winter sports (through its Descente JV) and as it has a strong execution track record, we expect these new categories to support above-domestic-peer growth over the long-term. We therefore think the company fully deserves to trade above 10x 1-yr forward P/E. However, as net profit growth is expected to slow from 20%+ in FY14/15 to low-teens in FY17, we think ~14x 1-yr forward P/E looks fair. As Anta is the leading domestic sportswear brand, a de-rating for the company would cap the re-rating potential of other domestic sportswear brands. Li Ning (2331 HK, Buy) is our top pick in the sector as we expect better SSSG performance in 2Q16 compared to 1Q16, and we expect the YoY improvement in GM to be higher in 2Q16 vs 1Q16, given a higher contribution from new products. We also expect Li Ning to take market share from other domestic brands thanks to its mass-market pricing strategy and strong brand equity.

Figure 3: Anta’s P/E

Sources: Bloomberg, GF Securities (HK)

Jewelry sector Sector outperformed in 1H16 Shares in the sector rose 4-11% in 1H16, mostly outperforming the

Hang Seng Index’s 5% decline. We attribute the outperformance to 1) a soaring gold price (share prices have historically risen when the gold price rallied within a short period of time); 2) relatively stable net profit in the current financial year (net profit growth range: -4% to +12%) compared to the big slump in the previous financial year (net profit decline range: 17-46%). We believe two main factors are stabilizing earnings: 1) the decline in HK street shop rental rates has begun to kick in; 2) the rise in the gold price YoY which began in 2Q16 will help to slow the SSS decline. Valuation We expect demand for jewelry to remain soft given the weakening economic growth

outlook in China and HK. In HK, due to the decline in mainland visitor arrivals and their weakening purchasing power, we expect jewelry sales in the region during 2016-2017 to be similar to the period between 2000 and 2002 (the previous economic down-cycle before the launch of the Individual Visitor Scheme in 2003). Given the sector’s average 1-yr forward has rebounded to 14x, which is close to its historical average of 15.1x, and given the sluggish sales outlook, we see limited further re-rating potential for the sector.

Figure 4: HK retail sales growth and key economic data (2000-2003)

Sources: Hong Kong Census & Statistics Department, GF Securities (HK)

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Retail sales growth (%) 3.8% -1.2% -4.1% -2.3%

Retail sales growth of jewelry and gifts (%) -0.8% -6.8% -4.1% -2.9%

-- Volume growth (%) -2.3% -5.0% -10.1% -9.9%

GDP growth (%) 7.7% 0.6% 1.7% 3.1%

Unemployment rate (%) 4.4% 6.2% 7.2% 7.5%

Jul 14, 2016

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2H16 Sector Outlook

Figure 5: Monthly retail sales growth for the China jewelry sector

Figure 6: Monthly HK retail sales growth for jewelry, watches and valuable gifts

Sources: China Statistical Bureau, GF Securities (HK) Sources: Hong Kong Census & Statistics Department, GF Securities (HK)

Ladies footwear sector Structural challenges to continue We believe the weakness in the footwear business is a

structural trend caused by changing consumer preferences (increased popularity of sporty styles), a decline in store traffic at department stores and competition from online channels (convenient for buying value-for-money products). We found that, on Tmall.com, Skechers has eight of the ten best-selling ladies footwear products priced between Rmb300 and Rmb500, showing that consumer preferences are shifting towards more sporty styles. Belle’s (1880 HK, Underperform) management does not expect a turnaround in footwear segment SSSG in the next two to three years.

Figure 7: Skechers’ shoes have been well-received by Chinese consumers

Sources: Tmall.com, GF Securities (HK)

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2H16 Sector Outlook

Figure 8: Daphne’s quarterly SSSG Figure 9: Le Saunda’s quarterly SSSG and retail revenue growth

Sources: Company data, GF Securities (HK)

Figure 10: Belle’s sportswear segment quarterly SSSG Figure 11: Belle’s footwear segment quarterly SSSG

Sources: Company data, GF Securities (HK)

Valuation We forecast a 19% drop in net profit in FY17 for Belle. The company is currently trading

at 8.9x FY17E P/E, towards the low-end of its historical range. Excluding net cash of Rmb8bn and the value of its sportswear business, its footwear business is priced at 3.6x FY17E P/E. Although we have an Underperform rating, we do not see significant share price downside potential.

Figure 12: Belle’s P/E

Sources: Bloomberg, GF Securities (HK)

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2H16 Sector Outlook

Figure 13: Valuation table for companies under our coverage

Sources: GF Securities (HK)

Closing price

Company Rating (7 Jul 2016) FY16E FY17E FY16E FY17E FY16E FY17E FY16E FY17E FY16E FY17E

Maple Leaf 1317 HK Buy 7.30 32.4 27.2 9 23 1.3 1.5 4.3 4.0 13.7 15.3

Goodbaby 1086 HK Buy 3.50 14.5 11.9 35 22 2.1 2.5 1.5 1.4 10.8 12.0

Li Ning 2331 HK Buy 3.90 23.2 13.8 2,069 70 0.0 2.6 2.0 1.7 10.2 13.8

Xtep 1368 HK Buy 3.97 10.3 9.4 14 11 5.8 6.3 1.3 1.2 14.4 14.9

Peak 1968 HK Buy 2.17 11.1 10.6 (5) 6 6.3 6.5 0.9 0.9 8.0 8.2

Chow Tai Fook 1929 HK Underperform 5.71 17.3 18.9 12 (9) 2.9 2.6 1.7 1.6 9.7 8.1

Belle 1880 HK Underperform 4.43 8.9 9.7 (19) (7) 6.5 6.0 1.2 1.1 13.4 11.6

Anta 2020 HK Hold 15.10 14.0 12.5 13 14 5.0 5.6 3.4 3.1 25.9 26.8

Luk Fook 590 HK Hold 19.52 12.4 12.5 (6) (0) 3.2 3.2 1.3 1.2 10.4 9.8

Chow Sang Sang 116 HK Hold 15.20 12.4 11.2 (4) 11 3.1 3.4 1.1 1.0 8.9 9.3

I.T 999 HK Hold 2.31 11.5 10.4 (11) 11 3.9 4.3 0.9 0.9 8.1 8.5

Le Saunda 738 HK Hold 1.65 9.2 10.1 (16) (7) 8.4 8.2 0.8 0.8 8.2 7.5

Daphne 210 HK Hold 1.20 -84.5 57.6 (88) (247) 0.0 0.0 0.4 0.4 -0.5 0.8

Stock

code

P/E (x) EPS growth (%) Yield (%) P/B (x) ROE (%)

Jul 14, 2016

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2H16 Sector Outlook

Maple Leaf (1317 HK)

Buy (maintained)

Target price: HK$7.50

Quality international school operator; asset-light approach driving growth

Figure 14: Stock performance Figure 15: Key data

Sources: Bloomberg

Figure 16: Stock valuation

Sources: Company data, GF Securities (HK)

Maintain Buy and raise TP to HK$7.50 We have turned more positive on the company following

our NDR in Taipei at the end of June. We revise our FY16/17/18 adjusted net profit estimates by -1%/0%/4% to account for our 25%/20% tuition fee increase assumption at Tianjin Taida schools/Yiwu high school beginning Sept 2016/17, the opening of a high school in Kamloops, Canada, in Sept 2016, and 25% capacity growth at the Tianjin Taida school in Sept 2017 (utilization rate is currently >90%) – however this will be partly offset by a stronger Canadian dollar. We lift our TP from HK$6.80 to HK$7.50, representing 28x FY17E P/E (previously 25x), which is still based on 1.0x PEG at a 28% FY17-18 EPS CAGR. We cross-check this with a DCF-based valuation, which comes in at HK$7.60/share, suggesting our PEG-based TP is not aggressive. Potential catalysts: 1) M&A; 2) encouraging student enrollment data; 3) the possible amendment to “The Law for Promoting Private Education” this year which will set income tax for private schools at <15%. Where’s the upside potential? Maple Leaf’s shares have risen 26% since our initiation on May

12. During our NDR in Taipei in late June, some investors mentioned that share price performance has been stronger than they had expected. We still see upside potential to our earnings estimates given the company 1) has more than ten new school projects in China under negotiation; 2) plans to explore business opportunities in overseas markets such as Canada and Singapore; 3) is looking for acquisitions in China to expand its elementary and middle school student base; 4) may consider increasing tuition fees at its Yiwu and Shanghai schools in Sept 2017; 5) may have a lower tax rate following the amendment of the Law for Promoting Private Education. Impact of possible amendment to “The Law for Promoting Private Education” Although the

expected amendment to the law in June was delayed, we still expect this to be concluded in 2016, based on the Ministry of Education’s 2016 work plan. If the tax rate for schools requiring a reasonable return for sponsors is set at <15%, management will consider changing its registration of international schools from “not requiring a reasonable return” to “requiring a reasonable return”. A long-term tax rate for the company of 15% at the beginning of FY18 would mean potential tax savings in the future. Also, the schools can directly distribute dividends to its holding company, meaning the company can flexibly utilize schools’ cash. Strong academic record Among Maple Leaf’s ~1,500 high school graduates admitted to overseas

universities in the 2014/15 school year, 51% went to the world’s top-100 universities (vs one-third of graduates for its competitor Nord Anglia). According to CollegeNode, Dalian Maple Leaf International School was ranked 40th in its list of China’s top-50 high schools in 2015. For the 2015/16 school year, while the percentage of high school graduates admitted to the world’s top-100

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HSI Maple Leaf

Jul 7 close (HK$) 7.49

Shares in issue (m) 1359.7

Major shareholder Sherman Jen (54.5%)

Market cap (HK$ bn) 10.0

3M avg. vol. (m) 6.14

52W high/low (HK$) 7.49/1.70

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(%)2014 540 40 127 na na na na na na 28.8

2015 653 206 186 0.175 na 33.3 1.3 1.3 4.4 16.3

2016E 833 269 260 0.191 9 32.4 1.3 1.5 4.3 13.7

2017E 1,036 324 320 0.235 23 27.2 1.5 1.6 4.0 15.4

2018E 1,309 435 426 0.313 33 20.8 2.0 1.8 3.6 18.4

Jul 14, 2016

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2H16 Sector Outlook

universities is not yet finalized, management has said the number of graduates admitted to the world’s top-10 universities will be greater than in the previous school year.

Figure 17: Percentage of Maple Leaf’s high school graduates admitted to global top-100 universities

Sources: Company data, GF Securities (HK)

Figure 18: Student enrollments at international schools in China

Figure 19: Student enrollment capacity and utilization rate

Sources: www.chyxx.com, GF Securities (HK) Sources: Company data, GF Securities (HK)

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2H16 Sector Outlook

Figure 20: Key assumptions

Sources: Company data, GF Securities (HK)

Figure 21: DCF analysis

Sources: Company data, GF Securities (HK)

YE Aug 31 (Rmb m) FY13 FY14 FY15 FY16E FY17E FY18E

Total revenue 406 540 653 833 1,036 1,309

growth % 14.0% 14.7% 20.9% 27.5% 24.4% 26.4%

Tuition fees 406 467 555 707 889 1,134

growth % 10.6% 15.0% 18.8% 27.5% 25.7% 27.5%

Others 0 74 98 126 147 176

growth % 33.8% 27.6% 16.8% 19.9%

Gross margin 43.0% 43.5% 45.7% 50.1% 51.2% 53.1%

Marketing expenses ratio 4.4% 4.0% 3.4% 2.9% 2.6% 2.2%

Administrative expenses ratio 11.9% 13.8% 15.6% 15.9% 15.7% 14.5%

Operating profit margin 27.1% 26.2% 27.8% 32.8% 33.9% 37.4%

Adj effective tax rate -7.1% -8.0% -5.2% -7.5% -12.0% -15.0%

Net profit 33 40 206 269 324 435

growth % -64.7% 20.7% 413.4% 30.9% 20.4% 34.3%

Adj net profit 105 127 186 260 320 426

growth % -0.9% 20.9% 45.8% 39.8% 23.1% 33.4%

Net profit margin 22.4% 23.6% 28.5% 31.2% 30.9% 32.5%

Payout ratio na na 43.4% 40.0% 40.0% 40.0%

Average tuition fee (Rmb) 36,563 37,029 37,483 39,732 41,242 42,397

growth % -2.2% 1.3% 1.2% 6.0% 3.8% 2.8%

Student enrollment (end of June) 11,697 13,513 16,078 19,526 23,588 29,891

growth % 11.3% 15.5% 19.0% 21.4% 20.8% 26.7%

Utilization rate 61.6% 60.1% 61.6% 65.0% 66.0% 66.0%

YE Aug (Rmb m) FY17E FY18E FY19E FY20E FY21E FY22E FY23E

Revenue 1,036 1,309 1,488 1,647 1,775 1,863 1,900

growth 24.4% 26.4% 13.6% 10.7% 7.8% 4.9% 2.0%

EBIT 352 490 549 608 655 688 701

Tax paid (33) (61) (82) (90) (97) (102) (104)

NOPAT 319 430 468 518 558 585 597

Capex (160) (160) (170) (175) (180) (186) (191)

Depreciation 71 82 87 97 104 109 111

Change in working capital 314 257 285 316 341 357 365

Free Cash Flow 544 609 670 755 823 866 882

Discounted FCF 544 537 523 520 500 465 4,427

Terminal value @2% growth rate 4,427 Risk-free rate 2.73%

Sum of discounted FCF 7,515 Beta 1.17

Net cash/(debt) in FY16E 1,295 Expected market return 11.72%

Value of company 8,810 WACC 13.25%

No of shares (mil) 1,360

Value per share (HK$) 7.6

Jul 14, 2016

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2H16 Sector Outlook

Figure 22: Financial statements

Sources: Company data, GF Securities (HK)

Year-end Aug 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E Year-end Aug 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E

Revenue 540 653 833 1,036 1,309 Fixed assets

Cost of sales (305) (354) (416) (505) (614) PPE 1,219 1,398 1,613 1,702 1,781

Gross profit 235 299 417 531 695 Prepaid lease payments 192 170 166 162 157

Investment properties 18 17 16 15 14

Other income 4 9 15 11 16 Goodwill 2 12 12 12 12

Marketing expenses (22) (22) (24) (27) (29) Intangible assets 0 1 1 1 1

Administration expenses (75) (102) (132) (162) (190) Available-for-sale investments 0 58 0 0 0

Other expenses (2) (1) (2) (2) (2) Books for lease 3 3 3 3 3

Operating profit 142 182 274 352 490Deposits for construction of property and land

use right3 1 1 1 1

1,437 1,660 1,812 1,896 1,969

Net finance income (14) 5 17 17 22

Listing expenses (23) (7) 0 0 0 Current assets

Other non-recurring items (57) 37 0 0 0 Inventories 0 1 2 2 2

Profit before tax 48 217 291 368 512 Available-for-sale investments 162 100 100 100 100

Income tax expense (8) (11) (22) (44) (77) Deposit, prepayment and other receivables 25 32 28 35 44

Net profit 40 206 269 324 435 Restricted bank deposits 4 0 0 0 0

Adjusted net profit 127 186 260 320 426 Bank balance and cash 380 1,022 1,295 1,744 2,230

Adjusted EPS (Rmb) 0.17 0.18 0.19 0.24 0.31 571 1,156 1,424 1,881 2,377

Growth rates (%) Total assets 2,008 2,816 3,237 3,777 4,346

Revenue 15 21 28 24 26

Adjusted net profit 21 46 40 23 33 Current liabilities

Adjusted EPS na 6 9 23 33 Deferred revenue 500 660 852 1,099 1,274

Other payables and accrued expenses 218 295 346 421 512

Margin & ratios (%) Amount due to related parties 4 0 0 0 0

Gross margin 43.5 45.7 50.1 51.2 53.1 Income tax payable 17 27 44 57 77

OP margin 26.2 27.8 32.8 33.9 37.4 Bank borrowings 224 0 0 0 0

Adjusted net margin 23.6 28.5 31.2 30.9 32.5 962 982 1,242 1,577 1,863

Effective tax rate 17.3 5.2 7.5 12.0 15.0

Payout ratio na 43.4 40.0 40.0 40.0 Non-current liabilities

Deferred tax l iabilities 19 22 22 22 22

Interest-bearing bank borrowings 0 0 0 0 0

Year-end Aug 31 (Rmb m) FY14 FY15 FY16E FY17E FY18E Others 559 0 0 0 0

578 22 22 22 22

Profit before tax 48 217 291 368 512

Depreciation and amortization 39 46 58 74 85 Equity

Net finance income 14 (5) (17) (17) (22) Shareholders' equity 467 1,812 1,974 2,179 2,462

Others 71 (18) 20 23 28

Change of working capital 145 205 246 314 257 Total liabilities & equity 2,008 2,816 3,237 3,777 4,346

Tax paid (4) (1) (17) (33) (61)

Operating cash flow 313 444 582 730 800

Year-end Aug 31 FY14 FY15 FY16E FY17E FY18E

Capex (111) (212) (270) (160) (160)

Change of AFS investments (158) (3) 65 0 0 Current ratio 0.6 1.2 1.1 1.2 1.3

Acquisitions 0 (36) 0 0 0 Quick ratio 0.6 1.2 1.1 1.2 1.3

Others 3 12 1 (2) (2)

Investing cash flow (265) (240) (204) (162) (162) Asset turnover 0.3 0.2 0.3 0.3 0.3

Total assets/total equity 4.3 1.6 1.6 1.7 1.8

Change of borrowings (52) (224) 0 0 0 Net cash/(debt) (Rmb m) (316) 1,022 1,295 1,744 2,230

Interest paid (15) (4) 0 0 0

Dividend paid 0 (27) (105) (119) (152) ROE (%) 28.8 16.3 13.7 15.4 18.4

Share issue 0 750 0 0 0 ROA (%) 6.6 7.7 8.6 9.1 10.5

Others (10) (63) 0 0 0

Financing cash flow (77) 434 (105) (119) (152)

Net change of cash flow (29) 638 272 449 486

Forex changes 0 4 0 0 0

Income Statement Balance Sheet

Cash Flow Statement

Financial Ratios

Jul 14, 2016

11

2H16 Sector Outlook

Goodbaby International (1086 HK)

Buy (maintained)

Target price: HK$4.34

Overdone share price correction presents buying opportunity

Figure 23: Stock performance Figure 24: Key data

Sources: Bloomberg

Figure 25: Stock valuation

Sources: Company data, GF Securities (HK)

Maintain Buy 2016 is a year of integration with the key focus on improving overall profitability. We

believe the company’s margin expansion trend remains intact, driven by a higher own-brand sales mix, product upgrades and the development of service sharing platforms used by all of its brands. The company’s OP margin (4.6% in FY15) is still far below its peers with similar revenue scales (Newell Rubbermaid’s OP margin was 7.9% in FY15), indicating potential for improvement. We maintain our TP of HK$4.34, based on 18x FY16E P/E. The stock is trading at 14.5x FY16E P/E, which is below its international peers’ average of 19.6x. Share price correction overdone The 20%+ share price correction from its high in early June was

mainly due to concern about a revenue slowdown in China and a potential share sale by the CEO, in our view. However, we believe concern about the China market is overdone as it only contributed 19% of total revenue in FY16. In addition, we expect 2H16 YoY sales growth to improve compared to 1H16 due to a low base. The potential share sale by the CEO remains an overhang for the share price but we believe the CEO is unlikely to sell shares at the current level. Rising GM for gb and Evenflo Thanks to product upgrades, we expect a better GM from both gb

(greater sales mix from its platinum and gold series) and Evenflo in FY16. For example, a foldable stroller that can be carried onto flights, the gb Pockit, has been well-received by customers since its launch in 2H15. We believe the full-year contribution from the product (GM >50%) in FY16 could lift gb’s GM (~35% in FY15). For Evenflo, its GM is lower than peers due to long-period of low investment in R&D before it was acquired by the company. We expect its GM to improve in FY16 thanks to product upgrades. Brexit impact In FY15, the proportion of revenue from the UK and Europe was a low single-digit

and 31%, respectively. The depreciation of the British pound and the euro would negatively affect HK$-denominated revenue, but this would be partly offset by better margins. Given most of its cost of sales for its Europe business is denominated in Rmb, the YoY depreciation of the renminbi against the euro in 1H16 will lead to an improvement in GM. Moreover, the negative impact from the depreciation of the euro will be alleviated by the fact that the majority of its European operating expenses are also denominated in euros.

-30%-20%-10%

0%10%20%30%40%50%60%70%80%

Jul-15 Oct-15 Jan-16 Apr-16 Jul-16

HSI Goodbaby

Jul 7 close (HK$) 3.50

Shares in issue (m) 1114.8

Major shareholder Song Zhenghuan (25.8%)

Market cap (HK$ bn) 3.9

3M avg. vol. (m) 4.27

52W high/low (HK$) 4.90/2.55

Year end

Dec

Turnover

(HK$ m)

Net profit

(HK$ m)

Core profit

(HK$ m)

Core EPS

(HK$)

EPS YoY

(%)

P/E Yield

(%)

BPS

(HK$)

P/B ROE

(%)

2013 4,189 171 171 0.171 -6 20.5 1.4 2.0 1.8 9.0

2014 6,116 58 139 0.127 -25 27.5 0.0 2.1 1.7 6.5

2015 6,951 197 197 0.179 41 19.6 1.4 2.1 1.6 8.5

2016E 7,272 268 268 0.241 35 14.5 2.1 2.4 1.5 10.8

2017E 7,515 326 326 0.294 22 11.9 2.5 2.6 1.4 12.0

Jul 14, 2016

12

2H16 Sector Outlook

Figure 26: Revenue breakdown by brand in FY15

Sources: Company data, GF Securities (HK)

Figure 27: GM for the gb Pockit stroller is >50%

Sources: BabiesRus, GF Securities (HK)

Figure 28: Key assumptions

Sources: Company data, GF Securities (HK)

Cybex18%

Evenflo26%

gb14%

Rollplay6%

Other own brands

9%

Dorel7%

Other blue-chip

customers and private

label20%

Year end Dec (HK$ m) FY13 FY14 FY15 FY16E FY17E

Total revenue 4,189 6,116 6,951 7,272 7,515

growth % -8.0% 46.0% 13.7% 4.6% 3.3%

China market 1,358 1,466 1,348 1,397 1,441

growth % 4.2% 8.0% -8.1% 3.7% 3.1%

Gross margin 22.9% 25.1% 29.5% 31.4% 33.6%

Selling & distribution expense ratio 10.7% 12.7% 14.8% 15.8% 16.8%

Administrative expense ratio 8.6% 11.4% 11.4% 11.0% 11.1%

Operating profit margin 4.6% 3.7% 4.6% 5.6% 6.7%

Effective tax rate 12.2% 45.1% 23.3% 27.0% 27.5%

Net profit margin 4.1% 0.9% 2.8% 3.7% 4.3%

Jul 14, 2016

13

2H16 Sector Outlook

Figure 29: Financial statements

Sources: Company data, GF Securities (HK)

Year-end Dec 31 (HK$ m) FY13 FY14 FY15 FY16E FY17E Year-end Dec 31 (HK$ m) FY13 FY14 FY15 FY16E FY17E

Revenue 4,189 6,116 6,951 7,272 7,515 Fixed assets

Cost of sales (3,228) (4,579) (4,901) (4,987) (4,991) PPE 708 921 879 1,050 1,050

Gross profit 961 1,537 2,050 2,285 2,524 Prepaid land lease payments 68 65 60 57 55

Goodwill 0 808 820 820 820

Other income 49 97 95 76 76 Intangible assets 35 712 682 657 625

Selling & distribution expenses (447) (777) (1,030) (1,149) (1,263) Investment in a JV 1 1 1 1 1

Administration expenses (360) (627) (794) (802) (834) Other LT assets 0 0 4 4 4

Other expenses (11) (3) (3) (3) (3) Deferred tax assets 15 20 43 43 43

Operating profit 191 226 318 407 501 827 2,528 2,488 2,632 2,598

Net finance cost 4 (40) (53) (33) (43) Current assets

Share of profit/(loss) of JV (0) (0) (0) (0) (0) Inventories 798 1,535 1,245 1,267 1,268

Other expenses 0 (82) 0 0 0 A/C receivables 738 973 696 728 752

Profit before tax 195 105 264 374 458 Derivative financial instruments 0 27 0 0 0

Income tax expense (24) (48) (62) (101) (126) Due from related parties 236 379 304 344 355

Non-controlling interests (0) 0 5 6 6 Prepayments 129 193 144 150 155

Net profit 171 58 197 268 326 AFS investments 128 206 310 310 310

Core profit 171 139 197 268 326 Pledged deposits 0 166 27 27 27

Core EPS (HK$) 0.17 0.13 0.18 0.00 0.00 Time deposits 0 51 3 3 3

Cash and cash equivalents 608 435 705 782 1,103

Growth rates (%) 2,637 3,965 3,434 3,611 3,973

Revenue (8) 46 14 5 3

Core profit (6) (19) 42 35 22 Total assets 3,464 6,493 5,922 6,243 6,571

Core EPS (6) (25) 41 35 22

Current liabilities

Margin & ratios (%) A/C payables 714 1,131 941 958 958

Gross margin 22.9 25.1 29.5 31.4 33.6 Other payables 242 433 464 485 502

OP margin 4.6 3.7 4.6 5.6 6.7 Bank borrowings 447 1,496 692 742 792

Core margin 4.1 2.3 2.8 3.7 4.3 Tax payables 5 25 68 54 67

Effective tax rate 12.2 45.1 23.3 27.0 27.5 Provision 9 21 37 39 40

Payout ratio 32.2 0.0 28.1 30.0 30.0 Others 0 0 0 0 0

1,417 3,107 2,203 2,278 2,359

Year-end Dec 31 (HK$ m) FY13 FY14 FY15 FY16E FY17E Non-current liabilities

Bank borrowings 0 762 1,006 1,006 1,006

Profit before tax 195 105 264 374 458 Others 0 76 104 104 104

Share of (profit)/loss of JV (0) (0) (0) (0) (0) Deferred tax l iabilities 19 220 201 201 201

Depreciation and amortization 111 157 195 242 282 19 1,058 1,311 1,311 1,311

Net finance cost (4) 40 53 33 43

Others 0 21 44 (2) (1) Equity

Change of working capital (357) (228) 570 (63) (24) Shareholders' equity 1,997 2,297 2,365 2,606 2,846

Tax paid (26) (56) (63) (81) (114) Non-controlling interests 31 31 43 49 55

Operating cash flow (81) 38 1,064 503 644 2,027 2,328 2,408 2,655 2,901

Capex (122) (168) (200) (389) (250) Total liabilities & equity 3,464 6,493 5,922 6,243 6,571

Disposals 4 3 11 0 0

Interest received 9 6 7 8 10

Acquisition of subsidiaries 0 (1,397) (33) 0 0 Year-end Dec 31 FY13 FY14 FY15 FY16E FY17E

Purchase of AFS financial investments (4) (79) (121) 0 0

Others 0 (51) 48 0 0 Current ratio 1.9 1.3 1.6 1.6 1.7

Investing cash flow (114) (1,685) (287) (381) (240) Quick ratio 1.3 0.8 1.0 1.0 1.1

Change of borrowings 216 1,732 (601) 50 50 A/C receivable turnover days 81 69 62 52 53

Change of pledged time deposits 0 (166) 139 0 0 A/C payable turnover days 85 74 77 69 70

Interest paid (7) (38) (50) (40) (52) Inventory turnover days 80 93 104 92 93

Dividend paid (50) (55) 0 (55) (80)

Share issue 11 0 7 0 0 Asset turnover 1.2 0.9 1.2 1.2 1.1

Financing cash flow 171 1,473 (507) (46) (83) Total assets/total equity 1.7 2.8 2.5 2.4 2.3

Net gearing ratio (%) net cash 60% 27% 24% 12%

Net change of cash flow (25) (174) 271 76 321

ROE (%) 9.0 6.5 8.5 10.8 12.0

ROA (%) 5.1 2.8 3.2 4.4 5.1

Income Statement Balance Sheet

Cash Flow Statement

Financial Ratios

Jul 14, 2016

14

2H16 Sector Outlook

Rating definitions

Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months

Company ratings

Buy Stock expected to outperform benchmark by more than 15%

Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15%

Hold Expected stock relative performance ranges between -5% and 5%

Underperform Stock expected to underperform benchmark by more than 5%

Sector ratings

Positive Sector expected to outperform benchmark by more than 10%

Neutral Expected sector relative performance ranges between -10% and 10%

Cautious Sector expected to underperform benchmark by more than 10%

Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report.

Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited (“GF Securities (Hong Kong)”) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies have compensation or mandate for investment banking services received within the preceding 12 months from one of the companies, namely Good Baby International Holdings Limited (Stock Code: 1086) (“Good Baby International”) contained in this research report. GF Securities (Hong Kong) and/ or its affiliated or associated companies have acted as the Independent Financial Advisor of the Good Baby International within the preceding 12 months. GF Securities (Hong Kong) and/or its affiliated or associated companies may receive compensation or mandate for investment banking services from the company in the future. In this connection, investors shall aware that conflict of interest may arise as the objectivity of GF Securities (Hong Kong) in this research report may be affected. (3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial interests or hold any shares of the securities mentioned in this report.

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