AMONG ALL the Hong Kong-listed sportswear and athletic apparel firms, Xtep is currently the sole counter whose current valuation is below its IPO price, raising the strong likelihood that its shares are undervalued.

Xtep, which listed in Hong Kong in June 2008, has like its listed peers witnessed “progressive improvements albeit mild to its retail sales since March,” Credit Suisse said in a note last week to investors.

The brokerage initiated non-rated coverage on the fashion-focused sportswear maker, saying that the Hong Kong-listed firm was a likely beneficiary of more affordable marketing campaigns.

Xtep is also the only sports proxy currently trading below its IPO price, suggesting it may be significantly undervalued.

“We note that to date among the Hong Kong-listed sports proxies, Xtep has continued to trade below its listing price,” Credit Suisse said.

Priced at 4.05 hkd or an implied FY08 price-to-earnings (P/E) ratio of 21.6 times slightly more than a year ago, post its listing in June 2008, Xtep has traded at an average price of 2.06 hkd over 2008. This works out to an implied valuation of 10.1 times FY08 P/E. Based on its last trading price of 3.89 hkd, Xtep is currently valued at 16.4 times FY09 and 13.4 times FY10 P/E.
One of China's first sports apparel makers to use Hong Kong entertainment celebs. From left: Jolin Tsai, Nicolas Tse, Wilber Pan, the Twins in Xtep ad.

After a June 28 meeting with management, the brokerage added that slower June sales over May for Xtep are expected and in line with its findings from other retailing proxies to date.

Credit Suisse said that based on data obtained from the 1,000 plus retail outlets (~20% of its retail network) that are directly managed by its 28 distributors, its lacklustre same-store sales (SSS) growth of less than 5% during Q2 2009 rebounded to more than 5% by April and May.

And recent sales improvement did not result from ratcheting up promotions or low-level price wars.

“More importantly, these improvements were reportedly not stimulated by more discounting and/or promotions. According to management, the intensity of discounting/promotions was actually more subdued during these two months.”

CS said its general sense from the checks with other retailing proxies to date also suggested that on a month-on-month basis, June admittedly is slower but with the distortions from a lower base in May 2008 that resulted in strong growth in May 2009, such a comparison is distorted.

“Like January and February this year, most deem it more appropriate to look at the average SSS for May and June to adjust for the distortions. Exact figures will be reported by the respective companies when they report their results over August and September.”

Costs of marketing mainstream sports brands versus fashion brands? 

One of the notable differences between the mainstream sports brands and sports-inspired fashion brands like Xtep lies with the amount of advertising and promotional (A&P) spending.

Xtep’s (A&P) spending in 2008 stood at 260 mln yuan or 9.1% of its overall sales, Credit Suisse said.

in 2008, Li Ning had spent more than 1.1 bln yuan on A&P (17.5% of overall sales) while Anta’s total expenditure came up to 638.5 mln yuan (13.8% of overall sales).

“As highlighted by CFO Mr. Terry Ho, who was present at our meeting, the greater emphasis of Xtep on fashion essentially drives a lesser focus, but still keeping a presence, on sports association. Hence, it is notable that Xtep has, until 2009, had few, if any, sponsorships of sports teams and/or sports stars but its association with sports is mainly driven by sponsorship of major sports events and activities.

“It also seemingly focuses on entertainment marketing, where it buys airtime on popular entertainment channels in China, namely Hunan Satellite TV and Anhui Satellite TV and CCTV Sports for its commercials, as well as the sponsorship of high rating TV programmes.”

Credit Suisse said these are reportedly working well in the inner provinces of China, like Hunan, Hubei and Anhui where Xtep believes it takes the lead among its sports peers in terms of presence. 

“Indeed, such marketing formats could better suit the tastes of local consumers especially if the level of sports-awareness remains comparatively lower. It would be interesting to monitor how such preferences will change over time. For the time being, such wide disparities in tastes, preferences and sports awareness in our view would likely facilitate the existence of a variety of brands.”

Credit Suisse said that as far as it was concerned, the jury was still out on what worked better in China’s sportswear space: hiring athletes or entertainment figures to be product spokespersons.
Xtep CFO Terry Ho (left) explaining his business to PRC and Taiwanese fund managers. Photo by Terence Wong.

“We are of the view that concerted moves by the mainstream sports brands into the various sports can help facilitate the differentiation of their brands from others, particularly in the crowded Chinese market, if successful.

“On the other hand, the sustainability of buying airtime on popular TV channels, sponsorship of high rating TV programmes, endorsements by entertainment artistes versus sports stars by the more fashion-oriented needs to be monitored.”

Dividend plan of 50% feasible barring M&A activity

“Management appears committed to a 50% dividend payout in 2009, which based on consensus estimates, implies a 3% yield,” CS said. 

As of end-2008, Xtep was sitting on net cash of two bln yuan, more than 82% of its net assets. This works out to an implied 0.80 hkd/share or 21% of its last trading price of 3.89 hkd. 

“While not unlike its peers, who have all indicated they are on the lookout for M&A and/or alliances with foreign brands, such talks appeared to be in the early stages for Xtep. If none of the above occurs, management is looking at a dividend payout of at least 50% which would imply a dividend yield of some 3% at current trading levels.” 

Xtep enjoyed a remarkable FY2008, with net profit surging 129% to 508 mln yuan, and top line growth of 110% to 2.9 bln yuan.

Previous story: Xtep given sporting chance for strong China stats

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