20130919-高盛-Dual_headwinds_dampen_earnings_recovery__Stella_down_to_Neutral_21页_573kb

Summary of China: Textile, Apparel & Footwear Report

Core Content

This report provides an equity research analysis of Stella and Yue Yuen, two major Chinese textile, apparel, and footwear companies, focusing on their earnings recovery, valuation, and key challenges in the industry.

Main Points

1. Earnings Recovery is Prolonged and Muted

• Weak 1H13 Earnings: Both companies reported weak 1H13 earnings, declining by 24% and 29% YoY respectively.
• Slow Volume Growth: Volume growth for 2013-15 is forecasted at a 3% CAGR, significantly lower than the 5%/8% CAGR of 2005-12.
• Margin Pressures: Labor cost inflation continues to weigh on margins, and EBIT margins for both companies are expected to remain below 2012 levels in 2014.
• Delayed Recovery: A meaningful earnings recovery may not be visible until the end of 2014, as both companies face ongoing challenges from end demand and costs.

2. Demand Headwinds

• Soft Retail Demand: Despite positive macroeconomic indicators in the US and EU, retail demand for footwear remains weak.
• Inventory Management: US retailers are cautious in restocking, with inventory growth lagging behind sales. This trend is expected to continue.
• Retailer Performance: Foot Locker, Finish Line, and others show subdued SSSG (Same Store Sales Growth) in Q2, with expectations for low single-digit growth in 2014.
• Global Brands: Nike and Adidas also face challenges, with Nike's future orders growth slowing and Adidas struggling in Europe.

3. Cost Headwinds

• Labor Cost Inflation: Labor costs are rising, particularly in ASEAN, which offsets some of the benefits from moving production inland.
• Capacity Migration: Both companies are relocating production to inland China and ASEAN, but this has not yet significantly reduced costs.
• Productivity Gains: Margins are expected to improve modestly due to increasing productivity and utilization rates in their inland factories.
• ASP Increases: Stella is expected to raise its ASPs more effectively than Yue Yuen, supporting better margin performance.

4. Valuation and Target Prices

• Downgraded Ratings: Stella is downgraded to Neutral from Buy, and Yue Yuen remains at Neutral.
• Target Price Adjustments: Target prices for both are cut, reflecting slower earnings recovery and limited multiple re-rating potential.
  • Stella: New target price of HK$19.1 (down 9% from previous HK$21.0), based on a 9X EV/EBITDA multiple.
  • Yue Yuen: New target price of HK$23.9 (down 8% from previous HK$26.0), based on a 8X EV/EBITDA multiple.
• Valuation Multiples: Target multiples are in line with historical averages since 2007, with Stella's multiple at 9X and Yue Yuen's at 8X.
• Upside/Downside Potential:
  • Stella has a 3% downside potential.
  • Yue Yuen has a 9% upside potential.

5. Key Financial Forecasts

• EPS Forecasts:
  • Stella: 2013-15 EPS estimates adjusted by +4%/-1%/-2%.
  • Yue Yuen: 2013-15 EPS estimates cut by ~30%.
• Margin Forecasts:
  • Both companies expect EBIT margins to remain below 2012 levels in 2014.
  • Gross margin expansion is forecasted at 40bp for both, driven by productivity and utilization gains.
• Dividend and Cash Flow:
  • Stella maintains a strong net cash position and solid FCFs, with a 2013 DPS of HK$1.06 and a 5.5% dividend yield.
  • FCF is expected to cover dividend payments, indicating strong cash return capabilities.

Key Information

• Earnings Recovery Timeline: Expected to be a long-term process, with meaningful recovery possibly only by the end of 2014.
• Growth Rates:
  • Stella: 3% CAGR in volume growth for 2013-15.
  • Yue Yuen: Similar 3% CAGR, but with more pronounced margin and earnings pressure.
• Valuation Metrics:
  • Stella: 9X EV/EBITDA (from 10X), implying a 14X P/E.
  • Yue Yuen: 8X EV/EBITDA, implying a 12X P/E.
• Outlook:
  • Both companies face structural challenges in demand and costs.
  • Stella is expected to outperform Yue Yuen in terms of margin protection and cash returns.

Conclusion

The report highlights the ongoing challenges faced by Stella and Yue Yuen in the context of weak demand and rising costs. While both companies are expected to see limited earnings recovery, Stella is better positioned to maintain margin and cash return leadership. The downgrade to Neutral reflects the current fair valuation and subdued growth expectations.