Initiation: best foot forward China Sportswearasiaresearch.daiwacm.com/.../files/China_Sportswear... · Sportswear Sector with a Positive stance. We expect increasing demand for functional

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■ Investment case We initiate coverage of the China Sportswear Sector with a Positive stance. We expect increasing demand for functional sportswear apparel and footwear to support double-digit YoY order book growth for the mid-priced sportswear players, such as Anta (2020 HK, HKD17.26, Buy [1]) and Peak (1968 HK, HKD2.71, Buy [1]), until 2016. Most companies reported mid-single-digit same-store sales growth (SSSG) for 1Q15, and we look for the growth rate to improve further over 2Q15-4Q15 as the companies shift their focus from reducing the number of retail outlets (which stabilised in 2014) to optimising their stores. New era of growth. The channel “un-stuffing” phase is now mostly completed, in our view, and we highlight increasing demand for functional and mid-range products as the next earnings catalysts for the sportswear companies. We believe the market has yet to recognise the earnings impact of cost savings from lower raw-material prices and

reduced discounts given to wholesalers. Hence, we have above-consensus 2015E EPS growth forecasts for Anta and Peak (24% YoY for both). Wholesale vs. retail. We stand by the tried-and-tested wholesale model adopted by Anta and Peak, where the distributors that place trade-fair orders are well versed in consumers’ preferences in a particular market. In theory, retail business models offer higher gross margins, as the wholesale discounts given to distributors at trade fairs can amount to 60-65%. In practice, though, the impact on operating margins varies, as retail models are prone to higher operating expenses (such as rental and labour), as well as the capital-intensive expenditure needed to establish retail outlets. How we differ. Our 2015 EPS forecasts for Anta and Peak are 6-12% above the Bloomberg consensus, likely as we are more upbeat on the prospects for higher-margin product lines (NBA co-brand and All-star player lines), as well as operating leverage. We believe prevailing share prices and consensus forecasts reflect the recovery in channel inventory levels but do not yet incorporate the longer-term revenue growth drivers (supportive policies, lifestyle changes). However, for Li Ning (2331 HK, HKD3.61,Underperform [4]), we are 11% below the consensus for 2016E EPS, as we are more bearish on its increasing focus on retail, as well as the execution of its transformation plan and visibility on

profitability. Plus, we are cautious on Li Ning’s late entry to the lifestyle segment, whereas Anta and Xtep are established players. ■ Catalysts We expect the market to upgrade its earnings forecasts for Anta and Peak in the coming months as sector earnings growth becomes more visible. And we look for China’s increasing appetite for fitness and health to drive a sector rerating. ■ Valuation Our top pick is Anta, which we believe has the edge in its market positioning and segmentation; we forecast it to see 2015/16E EPS growth of 24%/16% YoY. ■ Risks The main downside risks to our sector rating are a surge in A&P expenses, inventory build-up in the event of weaker-than-expected demand, and market-share losses to international brands.

22 June 2015

Initiation: best foot forward

• We expect a rerating for China sportswear stocks, which look set for a new era of growth yet are trading below 2009-peak levels

• Increasing participation in sports and awareness of fitness and health issues should drive sector revenue growth

• We like Anta and Peak, which are both rated Buy (1); we rate Li Ning Underperform (4) as we expect 2015 EPS to remain in red

China Sportswear Sector

Key stock calls

Source: Daiwa forecasts.

Consumer Discretionary / Hong Kong and China

Positive (initiation)

Neutral

Negative

Adrian Chan, CFA(852) 2848 [email protected]

Anson Chan, CFA(852) 2532 [email protected]

New Prev.Anta Sports Products (2020 HK)Rating BuyTarget 20.00Upside 15.9%

Peak Sport Products (1968 HK)Rating BuyTarget 3.10Upside 14.4%

Li Ning (2331 HK)Rating UnderperformTarget 3.10Downside 14.1%

How do we justify our view?How do we justify our view?

China Sportswear Sector 22 June 2015

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How do we justify our view?

Growth outlook

Valuation

Earnings revisions

Growth outlook China Sportswear Sector: revenue and net profit YoY

We expect the China sportswear brands to deliver top-line growth in 2015 and 2016 (after reporting revenue declines in 2012-13), driven by ongoing urbanisation and growing awareness of health and lifestyle issues, supported by government policies that encourage sports participation. We are upbeat on domestic brands Anta and Peak, which we believe offer products with strong value propositions and the right pricing strategies to deliver higher sales growth. But we expect domestic brand Li Ning to remain loss-making until 2016, as its transition from a wholesale model to a retail-focused model is still under way and its retail-focused costs have led to negative operating leverage.

Source: Daiwa forecasts

Valuation China Sportswear Sector: 12M forward PER

On our forecasts, the Hong Kong-listed China sportswear brands are trading at a 2015E PER of around 14x, a 50% discount to their global peers’ average multiple. We expect the sector to see a rerating, as it is trading well below its past peak PER of around 24x (2009), yet the Bloomberg-consensus forecasts sector-wide EPS growth of 32% YoY this year (vs. 30% in 2009). Our forecasts call for the combined net earnings of Anta and Peak to rise by 24% YoY for 2015. Among the 3, we prefer Anta and Peak, which we believe have the right product offerings and price points to capture the new demand that we expect to arise from the structural growth of the sector.

Source: Bloomberg

Earnings revisions China Sportswear Sector: Daiwa EPS forecasts vs. consensus

Our 2015/16E EPS for Anta and Peak are 6%/9% and 14%/11% above those of the Bloomberg consensus, respectively, likely because we are more upbeat on both companies’ potential for margin-accretive sales mix enhancement and their value-proposition strategies. Conversely, our EPS forecasts for Li Ning are below those of the Bloomberg consensus (at 11% for 2016E), as we do not concur with the upgrades to the market’s forecasts post-2014 results and are more cautious on the likelihood of a turnaround in profitability in 2015 (we forecast a loss-making 2015) and the company’s execution of a retail-focused business model.

Source: Bloomberg, Daiwa forecasts

Positive (initiation)

Neutral

Negative

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Anta (LHS) Peak (LHS) Li Ning (RHS)

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Source: Company data, Daiwa forecasts

Sector stocks: key indicators

China Sportswear Sector: key assumptions 2009 2010 2011 2012 2013 2014 2015E 2016E 2017ESales Anta 5,875 7,408 8,905 7,623 7,281 8,923 10,306 11,643 12,809 YoY 26.1% 20.2% -14.4% -4.5% 22.5% 15.5% 13.0% 10.0%Peak 3,095 4,249 4,647 2,903 2,613 2,841 3,223 3,621 4,035 YoY 37.3% 9.4% -37.5% -10.0% 8.7% 13.4% 12.4% 11.4%Li Ning 8,387 9,479 8,929 6,676 5,824 6,728 7,820 8,917 9,929 YoY 13.0% -5.8% -25.2% -12.8% 15.5% 16.2% 14.0% 11.3% GPm Anta 42.1% 42.8% 42.3% 38.0% 41.7% 45.1% 45.7% 46.1% 47.2%Peak 37.5% 38.0% 39.4% 36.5% 35.5% 38.0% 38.9% 39.5% 39.8%Li Ning 47.3% 47.3% 45.3% 37.7% 44.5% 44.6% 47.0% 49.3% 51.1% A&P (% of sales) Anta 12.7% 13.6% 13.7% 10.5% 11.1% 12.0% 12.0% 12.0% 12.0%Peak 11.3% 10.8% 14.2% 14.0% 10.7% 10.6% 10.2% 11.0% 11.0%Li Ning 15.4% 15.1% 17.6% 19.6% 24.2% 19.3% 19.0% 18.5% 18.5% OPm Anta 23.7% 23.4% 22.6% 20.5% 21.5% 22.6% 24.7% 25.2% 26.4%Peak 23.0% 23.3% 19.8% 13.4% 13.8% 15.9% 17.7% 18.0% 18.5%Li Ning 16.0% 16.3% 7.1% -23.9% -2.9% -7.9% 0.9% 4.8% 6.0% Inventory turnover days Anta 38 36 38 51 59 58 61 62 64 Peak 36 38 49 80 81 74 64 61 62 Li Ning 53 52 72 89 104 109 123 130 136 Trade receivables turnover days Anta 16 19 26 34 38 35 33 34 34 Peak 70 63 66 127 135 114 98 92 80 Li Ning 47 52 76 98 89 71 64 64 65 Trade payables turnover days Anta 35 36 37 47 65 54 41 42 43 Peak 42 46 48 48 45 41 18 16 16 Li Ning 70 71 93 112 104 84 89 90 90 Cash conversion cycle (days) Anta 19 19 27 38 32 39 53 54 55 Peak 64 55 67 159 171 147 144 137 126 Li Ning 30 33 55 75 89 96 98 104 110

Share

Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg

Anta Sports Products 2020 HK 17.26 Buy 20.00 0.842 0.974

Li Ning 2331 HK 3.61 Underperform 3.10 (0.029) 0.146

Peak Sport Products 1968 HK 2.71 Buy 3.10 0.189 0.215

Rating Target price (local curr.) FY1

EPS (local curr.)

FY2


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Best foot forward .......................................................................................................................... 5

Refuelling top-line growth ........................................................................................................ 5

A rising tide lifts (almost) all boats ............................................................................................. 8

Differentiating factors: brand positioning, value proposition ................................................ 8

Increasing market segmentation driven by niche markets focusing on functionality ........... 8

Value-for-money products: this is how domestic brands can flourish .................................. 10

We are positive on value-for-money brands .......................................................................... 13

Weeding out the weak ................................................................................................................ 14

Wholesale model still preferred to the retail business model ................................................ 14

Bad debt risks for Li Ning ....................................................................................................... 16

Supporting wholesalers in store optimisation ........................................................................ 17

Channel “un-stuffing” is over ..................................................................................................... 18

Revival in channel health ........................................................................................................ 18

Paving the way for order books to take off again .................................................................. 20

Valuation and recommendations ............................................................................................... 21

Company Section

Anta Sports Products .............................................................................................................. 25

Peak Sport Products ............................................................................................................... 43

Li Ning .................................................................................................................................... 58

Contents


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Best foot forward

We recommend shifting attention from improving inventory levels to the new era of fitness, driven by consumers’ increasing awareness of health issues and participation in sports. We see these factors continuing to drive revenue growth in the sector from a low base, as evidenced by the strong order book growth for 2015.

Refuelling top-line growth

An artificial spike in sector-wide sales as a result of distributors’ overestimates of demand after the 2008 Beijing Olympics led to a couple of years of painful scaling-back of sportswear companies’ operations through trade fair order cuts, store closures, increasing wholesale discounts and subsidies to distributors, and bad debt and inventory write-offs from 2012-14.

While top-line growth resumed for the sector in 3Q14, this was from a low base resulting from the channel revival period. We believe the prospects for top-line growth in the sector for 2015 are attractive, again due mainly to the low base. Further out, we foresee strong secular revenue growth for the sector, backed by sustainable drivers such as the increasing awareness of health issues and fitness amongst China’s population, and the government’s support for the industry by way of its promotion of fitness and sports participation nationwide. Hence, we forecast the sector to see a near-13% CAGR in sales from its trough in 2013 through to 2017E, which is broadly in line with its recent order book performance (double-digit growth in value for 3Q15/4Q15).

China Sportswear Sector: aggregate top-6 domestic sportswear brand sales and growth outlook

Source: Company data, Bloomberg consensus (non-rated), Daiwa forecasts (rated)

Note: the top-6 list includes: Anta, Peak, Li Ning (all rated); 361 Degrees, Xtep, China Dongxiang (all not rated)

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Fuelling the fitness trend We see 2 contributing factors to the ongoing changes that we are seeing in people’s attitudes to lifestyles: 1) personal desire, and 2) supportive policy measures. Personal desire. Mainland China consumers’ attitudes to lifestyle issues and brands are fast-changing, unsurprisingly, in our view, as urban households’ disposable income per capita saw a 12% CAGR in 2009-13 (source: National Bureau of Statistics). Our research indicates that most consumers who purchase sportswear apparel and footwear use it as casualwear rather than for sports per se. But given consumers’ increasing awareness of health and fitness issues, we expect demand for functional sportswear to expand in step with the growing participation in sports activities. This was evident in the increase in events held by the Chinese Athletic Association (CAA), which held 53 events in the 2014 national running series (up from 12 events in 2010), and according to eRun360, China’s largest online running community, more than 100 running events were held in the Mainland in 2014, with over 2m participants. According to Nielsen China, health surpassed income as the No. 1 concern of urban residents in 2014, and we look for this trend to be reflected in consumption going forward. Further, according to Netherlands-based Sport and Leisure Consulting Group, the number of gyms in China quadrupled between 2004 and 2012, and the Mainland could become the world’s biggest fitness market in the next 20 years as health concerns prompt more and more Chinese to hit the gym. Supportive policy measures. In October 2014, the State Council of China announced guidelines for the development of China’s sports industry, the first time the government has sought to tap into the industry’s economic value. Broadly speaking, we believe the government will step back from over-regulation of the sports market to ensure a fair and competitive environment, and introduce more private capital to the industry in addition to providing its own financial support. These guidelines are designed to boost the value of China’s sports industry to CNY5tn by 2025, from around CNY900bn currently. Within the same time frame, the goal is to have more than 500m regular sports participants annually and all neighbourhoods offering sports facilities (newly established residential areas must provide fitness facilities, and existing residential areas that do not currently have fitness facilities must install them).

Moreover, the guidelines require governmental agencies, enterprises and public institutions, social organisations and schools to offer their employees and students an hour of exercise per day. Also, the government will offer preferential tax treatment to certain sports companies (eg, the rate of corporate income tax for hi-tech sports companies will be reduced from 25% to 15%). State Council guidelines (announced 20 October 2014) General requirements Government to step back from over-regulation of the sports market and limit its role to ensure a fair and competitive market environment Government to introduce more private capital to the sports industry in addition to its own financial support Government to support sports industry as a green and "sunrise" industry with more preferential treatment Goals Sports industry to reach CNY5tn by 2025 500m people regularly participating in sports activities by 2025 100% coverage of new neighbourhoods with sports facilities Primary missions Eliminate pre-approval requirements for holding commercial and mass sports events Change the current operating mechanism of the sports industry in China (ie, encourage the establishment of professional sports leagues, improve the corporate governance sports clubs, and establish a modern enterprise system in this sector Expand the sports service industry (ie, develop fitness clubs, stadium services, competitive sports shows and training agencies) Accelerate the popularisation of mass sports such as soccer, basketball and volleyball (in particular, long-term development plans for soccer and the introduction of private capital to the construction of ice and snow sports sites) Support the growth of athletic rehabilitation business Require governmental agencies, enterprises and public intuitions, social organisations and schools to offer their employees and students one hour of exercise every day Encourage sports companies to introduce private capital via stock-market listings or bond issuesRequire local governments to incorporate public expenditure on sports in their fiscal budgetary outlays Offer preferential tax treatment to certain sports companies (ie, corporate income tax for hi-tech sports companies will be reduced from 25% to 15%) Include demand for land for sports facilities within urban and rural land planning. Newly established residential areas must feature fitness facilities and old residential areas without fitness facilities must be renovated Guideline requires qualifying universities to train students majoring in sports operation and management, sports creative design and sports scientific research. The government will offer financial support to sports start-ups engaged in such areas Take steps to develop and protect intellectual property Relax the rebroadcast rights of sports games and events; each TV station will be allowed to directly purchase or resell their broadcast rights to sports games and events from home and abroad (except for the Olympic Games, Asian Games and FIFA World Cup)

Source: State Council, Daiwa

At look back at similar campaigns in other countries is instructive. One example is Canada’s ParticipACTION programme, one of the longest-running campaigns to promote physical activity. Running from 1971-2001, the programme was designed to prompt Canadians to step up their physical activity by making exercise a part of their daily lives. It was estimated that around 80% of Canadians were aware of the campaign by the time it ended. Elsewhere, South Africa introduced its first set of national guidelines for physical activity in April 1999. At the time, the country was in the middle of a major political transition and its citizens were at risk of


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widespread infectious diseases and morbidity from chronic diseases. However, the government’s efforts to promote physical activity and awareness of health issues proved largely ineffective. We understand that the implementation of related initiatives was fragmented, with a lack of coordination by the central government resulting in insufficient financial support and supporting infrastructure, as well as varying levels of community engagement. We expect China’s policy implementation to be more effective than the South Africa example, as the government has explicitly committed to develop the infrastructure needed for people to increase their physical activity. For example, the State Council is targeting to increase the per capita venue area of sporting grounds to 2 sq m by 2025 (up 41% from 1.46 sq m in 2013). Furthermore, in October 2014, the Ministry of Education and the National Basketball Association (NBA) announced a multi-year partnership to introduce a fitness and basketball development curriculum at elementary, middle and high schools across China. This partnership, the Ministry of Education’s first such arrangement with a US sports league, underlines the government’s interest in raising awareness among Chinese citizens of the importance of being physically fit, in our view. Strategic partnership: officials of the NBA and Ministry of Education of China (October 2014)

Source: National Basketball Association

More broadly, policies that have a positive impact on disposable incomes should be supplementary drivers for the retail and consumption market in China. In January 2015, the Ministry of Human Resources and Social Security announced the first pay rise for civil servants (of up to 50%, we believe) since 2006, with the promise of more regular adjustments to come. We expect this development to trigger changes in consumer behaviour, given that many public-sector workers are low wage earners who fit into the mass consumer profile in China.

After the previous pay hike for civil servants in 2006, there was a spike in disposable income per capita in the following year (up 17% YoY, or 3pp, compared with the prior year’s growth rate). With public-sector wages rising again, we expect 2016 to bring another relatively large YoY rise in disposable incomes, which should be a leading indicator for a pickup in consumer sentiment. China: public-sector wages (2001-13)

Source: National Bureau of Statistics

China: YoY growth in disposable income per capita (urban) (2001-13)

Source: National Bureau of Statistics

In sum, we believe the structural growth story for the sector will be driven by supportive policies, backed by the requisite promotion and investment, to promote sports and physical education. In our view, this policy stance should give new impetus to the ongoing increase in consumers’ awareness of fitness and health issues.

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A rising tide lifts (almost) all boats

We recommend favouring value-for-money brands (Anta) and niche brands (Peak), which we believe are set to draw higher revenue growth than brands that are still finding their feet (Li Ning).

Differentiating factors: brand positioning, value proposition

In our view, recovery is well under way in the China Sportswear Sector, with inventory levels for all players now improving. And, as we have argued, there are numerous structural positives at play for sportswear demand in China, including supportive policies from the central government, rising disposable income levels, urbanisation, and increasing awareness of fitness and health. According to Research and Markets, a global market research provider, China’s athletic footwear market, already the largest in the world in terms of sales volume, is projected to see a CAGR of 9.5% until 2018. As it stands, the market is fragmented, but we expect industry consolidation to continue, allowing the larger players to gain market share as smaller companies exit altogether. We believe that strong brands with clear market positioning are likely to sustain long-term market-share gains. Our main takeaway is that, as consumers become more sophisticated, the sportswear companies will have to raise their game in terms of product segmentation, by introducing new technology to their products. China’s sportswear market remains highly competitive, with the leading international brands, Nike and Adidas, together accounting for only 23% of the market as of 2013. On our estimates, the top 6 Hong Kong-listed China sportswear brands — Anta, Li Ning, Peak, China Dongxiang (CDX), Xtep and 361 Degrees (361) — collectively account for 17% of the market.

In other words, small players account for more than half of the market, which we think presents an opportunity for the large brands to gain ground as they increase their penetration of lower-tier cities. China Sportswear Sector: market share (2013)

Source: Euromonitor, Daiwa

Increasing market segmentation driven by niche markets focusing on functionality

With Chinese consumers becoming more sophisticated, we expect competition in the market to increase, led by niche sportswear and global fast fashion brands as the distinction between the sportswear and casualwear categories becomes clearer. From 2008 to 2013, we saw a rapid expansion of global fast-fashion brands in China, with their store counts increasing at a 54% CAGR during the period. Many fast retail brands have launched sportswear lines that compete directly with traditional sportswear brands. In our view, what global fast fashion brands bring to the table for urban consumers in China is “affordable luxury”, ie, the perception of being associated with an international brand yet priced at a level similar to that of a domestic brand. According to Euromonitor International, the market shares of Zara, H&M, and Uniqlo doubled from 2010 to 2013, with each brand gaining +20bps to claim 0.4% of the apparel brand market in China. But we believe the fast retail brands only pose a challenge to brands highly focused on the apparel segment, a very fragmented marketplace where the No. 1 global brands (Jack & Jones and Bosideng) have only a 0.7% market share in China.

Anta6%

Li Ning5% Peak

3% CDX1%

Xtep4%

3614%

Nike12%

Adidas11%

Others54%


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China: number of points of sale of global fast retail brands

Source: Company, Daiwa

We hold the view that competition from the global fast retail brands is forcing the sportswear companies to be more innovative and adept at product differentiation. But we believe the CNY1.5tn apparel market in China will have enough room to accommodate companies with unique product offerings. For the same reason, we are not so positive on sportswear brands that also feature fashion elements, such as Xtep. Niche sports sub-category markets are also emerging, such as outdoor sports (ie, hiking), yoga, and basketball. According to Euromonitor, China’s outdoor sports market saw a CAGR of 27% from 2007-12, by which time it was worth some CNY16bn. Euromonitor forecasts a 14% CAGR in the outdoor sports apparel market over from 2012-16E, by which time it should account for 15% of the overall sportswear market in China. Growth in the outdoor apparel market is being driven by urbanisation and, we think, consumers’ desire to be closer to nature and the great outdoors. The leading players in the niche outdoor segment are VF Corp (owner of The North Face, Timberland, and licensor of Nautica) and Columbia. China: outdoor sports market

Source: Euromonitor

Consumers’ rising interest in basketball, on the other hand, is being supported by increased investment in professional sports organisations, such as the Chinese Basketball Association (CBA), and domestic sportswear companies’ endorsement of high-profile NBA players (Li Ning has signed up Dwayne Wade while Anta has Rajon Rondo on its books). In October 2014, NBA commissioner Adam Silver announced that Anta would be the organisation’s marketing and merchandising partner in China. The alliance will give China-based basketball fans access to NBA-branded footwear and accessories, as well as new ways to follow their favourite teams. NBA and Anta partnership announcement press conference

Source: Anta

Separately, according to statistics from Channel Signal, annual spending in the US on yoga products in 2012 totalled USD27bn, up 87% from the 2008 level on the back of a 29% rise in the number of people doing yoga. By extension, we believe that as China continues to urbanise and its citizens adopt Western-style views on health and fitness, the adoption rate of niche sports will prove to be a material driver for the sportswear market. In expectation of increased consumer interest in such niche sports in China, we look for the domestic sportswear companies to have ample opportunities tap into this new demand by providing differentiated products offering functionality and value for money. There should also be opportunities for M&A activity as niche sportswear companies seek expansion opportunities.

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US: yoga product spending and participation (2008-12)

Source: Channel Signal

Value-for-money products: this is how domestic brands can flourish

Given the competitive and fragmented domestic sportswear market, players are finding that they need to have a clear market segmentation strategy and aggressively pursue that target market if they want to gain market share. With the growing affluence of the mass population in China, it follows that there would be an increasing desire to purchase international brands such as Nike and Adidas. But this does not mean that the domestic brands will suffer, because we believe some consumers have become loyal to particular domestic brands. Also, the

domestic brands target the low-end to mid-range mass market in China, whereas the international brands target the high end. However, as the mass market tends to comprise more price-sensitive consumers, the domestic brands need to be innovative in terms of the products they offer (functionality, style and value-for-money), and differentiate themselves in order to win a bigger share of the pie. The tier-3 market is the one for domestic brands to target According to a survey carried out by Ipsos in 2014, the percentage of consumers based in China’s tier-3 cities who purchased sports shoes in 2013 (at 50% of the survey participants) was higher than the percentage of those in tier-1 and tier-2 cities who had bought sports shoes (48%). Furthermore, the same survey revealed that the average purchasing frequency for consumers in tier-3 cities was 2.69x a year, higher than the number for tier-2 cities, at between 2.3x and 2.5x but behind the 3.49x a year for tier-1 cities. We believe tier-3 cities remain an attractive market for domestic sportswear brands, such as Anta, Li Ning and Peak, which were ranked among the top-10 brands of sportswear shoes that consumers said they would purchase in the future in the same Ipsos survey.

China Sportswear Sector: market breakdown segmentation

Source: Daiwa

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Anta and Li Ning

1. Focus on the low end2. Has exposure to lower-tier cities

1. Low-end to mid-range focus2. Exposure to the mid-to-top-tier cities3. Broad range of products4. Focus on functional products

1. Mid-range to high-end focus 2. Targets the top-tier cities 3. Has a broad range of

products4. Highly innovative products


- 11 -

International brands vs. local brands In our view, the international brands have been able to better position themselves in the overall China sportswear market than domestic brands due to their greater brand awareness and functionality-driven R&D investment. Despite having higher ASPs than the domestic sportswear brands, the functionality aspect of their products has effectively helped them take market share away from the domestic brands, as consumers have become more interested in niche sports that benefit from the innovative functionality the international companies’ products offer. Another important factor is that with the growing affluence of the mass population, consumers in tier-1 and 2 cities are now more conscious of which brands they associate themselves with, and tend to favour international brands, which have a distinct advantage over domestic brands. Still, the international brands have not yet gained as much traction in lower-tier cities as the domestic brands, because domestic brands are geared up to target low-end to mid-range mass consumers (ie, those who grew up with the domestic names), who have yet to see their spending power grow at the pace of those in tier-1 cities. We note that the channel-stuffing issues of 2009-13 were not confined to the domestic brands; Nike and Adidas also suffered, according to footwear maker Yue Yuen (551 HK, not rated) and sportswear retailer Pou Sheng (3813 HK, not rated). And we think the international brands will continue to face challenges in the sports apparel segment due to the growing popularity of fast-fashion brands in China (ie, Uniqlo, H&M), many of which have their own casual sportswear apparel products, as well as destocking of excess inventory driven by a higher sell-in than sell-out. The positioning of domestic brands We contend that China’s domestic brands will see better top-line growth as they aggressively target a specific segment, which is the low-end to mid-range mass segment in lower tier cities (as opposed to targeting tier-1/2 cities).

Based on our analysis, the ASPs for Nike and Adidas are, on average, at least 30% higher than those of the domestic brands. And we believe it is harder for the international brands with higher ASPs to gain traction with low-end to mid-range price-sensitive consumers. According to a computer-assisted telephone survey carried out by Deloitte in 2012, the top-2 factors driving a purchase in China are brand and value for money. In a different survey conducted by Deloitte on the price of the most expensive pairs of shoes purchased in 2009 in 8 cities in China (Shanghai, Chengdu, Hefei, Jinan, Xiangfan, Zhongshan, Changshu and Xinmin), 78% of respondents (the average for the combined sample group over all 8 cities) said they had bought shoes priced at up to CNY600 (most of this 78%, as per the following chart, bought shoes that cost less than CNY300). We see the results of this survey as strongly supportive of our view that the China domestic sportswear brands (with ASPs below the CNY600 level) have a huge market to aim for, with international brands typically pricing their sports shoes at close to or above CNY600 (ie, Nike Flyknit running shoes, for example, cost around CNY1,000). While the aforementioned survey was carried out back in 2009, based on our market research, we believe the situation is little changed in 2015. First, the price gap between international and domestic brands remains as wide as it was in 2009. While some domestic brands, such as Anta, have launched co-branded products with NBA basketball players or other industry associations, priced at a slight premium to their main products (CNY400-500 per pair vs ~CNY300), the prices of their products are still much lower than those for Nike and Adidas. Second, income levels in tier-2-and-below cities are still much lower than in tier-1 cities, such as Beijing and Shanghai (either present levels or levels seen in 2009).


- 12 -

Top factors driving a purchase (2012)

Source: Deloitte

Price of the most expensive pair of shoes bought in 2009 in various cities in China

Source: Deloitte

Note: In the above chart, tier-1 cities include Shanghai; tier-2 cities comprise Chengdu, Hefei, Jinan; tier-3 cities are Zhongshan; tier-4 cities are Changshu, Xinmin; tier-5 cities include Xiangfan

23%31%

15% 19% 24% 29%41%

34%30%

38% 33%37%

36%

35%

27% 23%30% 30%

25% 22%

15%2% 2% 3% 3%1% 0%

2%11% 11% 11% 12% 10% 8%4%3% 3% 3% 3% 2% 5% 2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Overall Male Female Those who spendCNY1,000-4,999/year on

sportswear

Those who spendCNY5,000-9,999/year on

sportswear

Those who spendCNY10,000-19,999/year

on sportswear

Those who spendCNY20,000+/year on

sportswear

Brand Quality Value-for-money Cost Shopping efficiency Others

37%43%

53% 58%

40%

55%46% 44%

35%32%

26%26%

37%

26%

31% 31%

21% 17%16%

12%16%

15%16% 19%

8% 9% 5% 4% 8% 3% 8% 7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Shanghai Chengdu Hefei Jinan Xiangfan Zhongshan Changshu Xinmin

<CNY300 CNY300-600 CNY601-1000 >CNY1000


- 13 -

We are positive on value-for-money brands

Over past 4 months, we have visited some pedestrian-only shopping areas in Shenzhen (a tier-1 city), stopping in at major sportswear and footwear stores. We noted that the discounts and product offerings of major domestic brands (like Anta and Li Ning) indicated that the pricing level is healthy for mid-range domestic sportswear brands. Number of stores: In the pedestrian-only shopping areas of Shenzhen, we found 1-2 stores for each international brand (eg, Nike, Adidas, Puma, etc.) and just 1 store each for domestic brands (eg, Li Ning, Xtep, 361, Erke etc). The only exception was Anta, for which we came across 3 stores (one being a revamped multi-concept store containing Anta kids). In general, the store count by brand (both domestic and international) was much lower than the peak level of at least 2 stores in the same area back in 2009-11. Discounts: We noted that sportswear brands that are more fashion-oriented (Xtep) or mass-market-focused offered bigger discounts (30-50%) than the mid-to-high end brands like Anta, Li Ning and Nike. Anta was offering a rebate of only CNY50 for every purchase totalling CNY399 or more (effectively a 13% discount) and a 12% discount for Anta Kids. We believe this low discount was due partly to the fact that it is just the beginning of the summer season. Pricing: Overall, we believe the retail prices of most brands (both domestic and international) have been largely consistent with their brand positioning over the past 5 years (before any discount). However, it also seems that over the past 3 years sportswear companies have been adding new production lines with a focus on either functionality or co-branding with international sports stars, as these types of products generally have higher price points. A lot of brands now, including mass-market brands like Erke, Xtep and mid-to-high end brands Anta and Nike, are offering sportswear with increasing functionality – such as those specifically designed for running, training, basketball, etc, which have higher price points. Similarly, Anta’s NBA co-branded products and premium basketball shoes featuring ANTA-endorsed NBA players launched in November 2014 are priced at more than CNY400 per pair, higher than Anta’s other sports shoe products (at around CNY300), but still affordable for the masses when compared with similar

products offered by international brands (which are generally in excess of CNY1,000). Traffic: There was not a lot of foot traffic in many of the stores we visited in Shenzhen, though this was probably because our tour took place on a weekday in the late morning, an offpeak period. However, we did notice families visiting Anta’s kids’ section, and there seemed to be more customers in Anta’s multi-brand (Anta and Anta-kid) store we visited than in a nearby big, 3-storey 361 Degrees store, implying that Anta is doing well. Discounts to wholesalers set to narrow Based on the low discounts we saw at retail shops on our visits, and healthy inventories at the wholesaler level (which currently average between 4 and 5 months for most brands, according to the managements of Anta and Peak), we think wholesale discounts will likely gradually be reduced from 2016 onwards. Based on our recent discussions with Belle, international brands are likely to reduce the subsidies they offer to their retail partners in China, possibly this year, given the channel revival after the slump from 2008-12. We think domestic leaders like Anta would benefit from a reduction in subsidies, and we see a narrower wholesale discount driving Anta’s and Peak’s gross margin, and hence earnings in 2016-17E. Anta, specifically, increased its discounts to wholesalers slightly from 58% in 2009 to 59-61% in 2014, and we expect this discount to be reduced in the near future. For Li Ning, we believe its increasing exposure to the retail segment would partly offset any increase in its net profit in 2015-17E as a result of lower discounts offered to wholesalers in the future.


- 14 -

Weeding out the weak

We expect the sector to post top-line sales growth in 2015-17E, but believe the flow-through to bottom-lines will be better for brands using the wholesale distribution model rather than self-owned retail distribution, as evidenced by their lower bad debts, and quality (efficiency) rather than quantity of stores.

Wholesale model still preferred to the retail business model

Traditionally, China’s sportswear companies have adopted a wholesale model, whereby they rely solely on local wholesalers (distributors) to distribute their products. But ultimately this model results in a disconnect between the brand and the end-user, because it does not put the brand in direct contact with its end-users, as demand is based on trade fair orders placed by distributors. Li Ning, however, is seeking to change all this with its strategy to shift away from a wholesale model to a retail-focused model with self-owned stores. This strategy was announced by the company in 2012, and by the end of 2014, it had 1,202 directly-operated retail stores, equivalent to 21% of its total stores, from just

10% in 2012. Although the retail business model may benefit the sportswear companies in the long run, due to its effectiveness of enhancing brand image and generating high gross margins, we believe the wholesale model is still a more efficient business model for sportswear companies in China, as it allows companies to quickly penetrate lower-tier cities without having to outlay capex on building physical stores. Within our coverage, Anta and Peak follow the wholesale business model, while Li Ning currently operates under a hybrid wholesale-retail model with a focus on expanding the latter business. The wholesale business model In a wholesale model, sportswear brands generally produce their designs in-house and outsource production, after which, samples are showcased at quarterly trade fairs for distributors to order for delivery a year later. For domestic players, trade fair orders account for most of their sales. The main drawback with this business model is that sportswear brands are not able to receive relevant feedback from end users very quickly. As product feedback is generally received at the trade fair, this sometimes leads to an over-reliance on distributors and the brands placing too much of an emphasis on meeting distributor needs, when they could focus on delivering desirable products to the ultimate end user. However, the weakness from an over-reliance on distributors can also be viewed as a strength due to the fragmented domestic sportswear market; as such, local distributors are generally more knowledgeable about consumer preferences in their respective areas, as well as weather and demographics.

China Sportswear Sector: wholesale model channel economics

Source: Daiwa

Sportswear brand

Bad debt Excess channel inventory

Distributors Consumers

Cash Cash

Sell in Sell out

If sell-in > sell-out If sell-in > cash


- 15 -

China Sportswear Sector: wholesale business model

Source: Daiwa

The retail business model The retail business model effectively cuts out the middleman, the distributor, and allows sportswear brands to directly operate self-owned retail stores. The advantage to this model is that it provides sportswear brands with direct access to end-users, allowing them to receive and incorporate consumer feedback in a timely and effective manner, while also allowing them to increase sales and minimise the risks associated with the wholesale business model, such as channel stuffing.

The retail model also lets sportswear brands collect and build data for tracking the sales performance of particular products, and helps them plan their production accordingly. However, the main drawbacks with this model are that it requires significant capex to set up self-owned stores, and exposes the companies to external risks such as rent and labour costs.

China Sportswear Sector: retail business model

Source: Daiwa

In-house and/or outsourced production

Sportswear company

Distributors

Trade fair

Consumer

1. Product designs sent to production

2. Completed products sent back

5. Production to start based on trade fair

orders

3. New product samples displayed at trade; feedback on products from trade fair

6. Products delivered to distributors

4. Distributors place order for new products at trade fair


Sportswear company

Self-owned stores Consumer



6. Data collection 5. Feedback

3. Distribution 4. Sale of goods


- 16 -

Pros and cons of the wholesale and retail business models Wholesale Retail

Pros - Distributors more knowledgeable on local preferences

- Direct feedback from end-user

- Lower opex - Increase in control over production Cons - Disconnect between brand and end-user - Significant capex required

- Exposure to the risk of channel stuffing - Exposure to higher opex (rental & labour)

Source: Daiwa

Li Ning: retail-focused store expansion


What are global players doing? In more developed markets, leaders like Nike and Adidas employ hybrid wholesale-retail models, where they use wholesalers but also operate their own flagship stores, which give them access to good demand-to-design data. What should domestic players do? We are cautious on Li Ning’s pursuit of a retail-focused strategy, as it exposes the company to significant execution risks, which we are not confident management and the company’s balance sheet would be able to support if the ramp-up of directly-operated retail stores were slower than expected. Anecdotally, a retail-oriented business model has a higher gross margin than a wholesale business model, as sales to wholesalers at trade fairs are often made at steep discounts (60-65% off the retail price). However, our analysis shows that the reverse is true at the EBIT level, as a retail model is subject to higher opex from a company running its own stores (ie, store maintenance, rent, staff costs, logistics/transport, etc).

Business model analysis Latest FY reported (LCY) Anta (Wholesale) Li Ning (Retail-focus) Nike (Hybrid)Revenue 8,923 5,824 27,799 COGS (4,896) (3,230) (15,353)GP 4,027 2,594 12,446 GPm 45.1% 44.5% 44.8%Other operating revenue 86 147 -SG&A (2,094) (2,910) (8,766)SG&A as % of Revenue 23% 50% 32%EBIT 2,019 (169) 3,680 EBIT margin 22.6% -2.9% 13.2%


We believe the domestic players should focus on managing their channels and ensuring wholesalers are not being too aggressive in placing orders at trade fairs (as wholesalers tend to over-order to prevent a shortage of inventory during the season and to get more discounts on larger bulk orders). Also, we believe domestic players should provide an effective replenishment system to ensure that wholesalers can always meet end-user demand and to prevent wholesalers from over-ordering at trade fairs in the event demand does not live up to expectations. In our view, Anta has done a good job of showing that a pure wholesale model can still generate higher EBITDA margins than a hybrid model such as that of Nike, with a 22.6% EBIT margin (vs. Nike’s 13.2%) in its latest financial report.

Bad debt risks for Li Ning

As we see distributors being revived, we should also see sportswear brands having healthier balance sheets with fewer bad debts in 2015. Based on the analysis we performed below on the bad debts among our 3 coverage stocks, Li Ning had written down 32% of its A/R as bad debts in 2014, a significant amount considering this is equivalent to 12% of its revenue in the same period. In our view, this is a red flag indicating low revenue quality for Li Ning. At the same time, Anta and Peak have written down less than 10% of their receivables in the past 2 years. China Sportswear Sector: bad debt analysis

Anta Li Ning Peak

Period 2014 2013 2014 2013 2014 2013

Gross trade receivables 900 922 1,857 1,962 914 921 Less: Provision for doubtful debt (24) (70) (597) (591) (45) (15)Net trade receivables 876 852 1,260 1,371 868 906 Provision as % of gross trade receivables 2.7% 7.6% 32.1% 30.1% 4.9% 1.6%


5%7%

9%10%

16%

21%

0%

5%

10%

15%

20%

25%

0

2,000

4,000

6,000

8,000

10,000

2009 2010 2011 2012 2013 2014Directly-operated retail stores (LHS)Franchised retail stores (LHS)Directly-operated retail stores as % of total stores (RHS)


- 17 -

Supporting wholesalers in store optimisation

After a painful scaling-back of operations over 2012-14, the management teams of China sportswear brands have acknowledged that while store network expansion in key areas is still important, store efficiency is their main priority. We would highlight that Anta has outperformed its peers on this metric since 2011, which was the peak of the overexpansion, demonstrating Anta’s execution capabilities as well as its value proposition. We see Anta’s strategy of cleaning up its channels as effective, in terms of helping out quality distributors which have been struggling, or forcing out distributors that would otherwise be an overhang on a company’s return to growth (ie, struggling distributors would have trouble paying back companies and rack up inventories, which would effectively cause deterioration in companies’ working capital and trade fair order growth). China sportswear sector: sales per store*

Source: Companies, Daiwa

*based on average of beginning- and end-of-period store count

China sportswear sector: sales and sales per store* (2014)


*based on average of beginning- and end-of-period store count

0.20

0.40

0.60

0.80

1.00

1.20

2010 2011 2012 2013 2014

(CNYm)

Anta Li Ning Peak

CDX Xtep 361

0.00

0.20

0.40

0.60

0.80

1.00

1.20

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Anta Li Ning Peak CDX Xtep 361

(CNYm/store)(CNYm)

Sales (LHS) Sales per store (RHS)


- 18 -

Channel “un-stuffing” is over

Revival in channel health

Following the 2008 Olympics in Beijing, China’s sportswear sector saw an expansion in sales as consumers had a renewed interest in sports. Over 2008-11, the number of sports stores saw a CAGR of 9%, with the 6 largest Hong Kong-listed sportswear companies opening some 12,300 sportswear stores (equivalent to 11 new stores a day). But demand failed to live up to expectations, which led to intense competition, heavy discounting and an excess of inventory at the distributor and sub-distributor levels, with many distributors experiencing pressure on profitability and cash flows. We saw a sharp increase in inventory turnover days in 2011 across the board, as companies experienced channel stuffing (an excess of channel inventory building up) and racked up significant bad debt (from poor cash generation at the distributor level, with the normal level, ie, for Anta, at 30-90 days back then). Since 2012, the sector has been through a painful but much needed scaling back of its operations, with trade fair orders being cut, stores being closed (about 4,700 outlets were closed in 2012, averaging 13 a day), increasing wholesale discounts, and more inventory buybacks. Since then, the sector has been working on getting the wholesalers back to being profitable, and clearing excess inventory (ie, un-stuffing) has been the priority, with the sportswear brands offering discounts to quality wholesalers (ie, those with strong records prior to the period of inventory stuffing). Wholesalers have had to bear the brunt, with the less profitable wholesalers exiting the industry. Those remaining have benefited from the industry’s recovery post the channel-stuffing days.

China Sportswear Sector: number of retail outlets and YoY


*based on the core brands of the 6 biggest Hong K0ng-listed sportswear companies

Anta, our top pick in the sector, was the first to emerge from the red, with high single-digit growth YoY in trade fair orders for 1Q14. Its peers have followed suit since then. But we have noticed that brands that focus on the high-end segment (China Dongxiang [CDX], Li-Ning) and that operate self-owned retail operations continue to see inventory levels of more than 100 days, which we see as evidence that the recovery for these brands has not been as strong as for the mass-market brands. China Sportswear Sector: inventory


From our discussions with 5 listed sportswear companies (with the exception of CDX), we learned that their current inventory levels at the wholesale level are around 4-5 months. In our view, this is close to the optimal inventory turnover in the China sportswear industry of about 3-4 months (in line with the seasonal patterns of new product launches on a quarterly basis in 2014). Moreover, it marks a significant improvement from the peak of 7-10 months in 2012.

(15%)

(10%)

(5%)

0%

5%

10%

15%

20%

25%

30%

35%

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

2008 2009 2010 2011 2012 2013 2014

0500

1,0001,5002,0002,5003,0003,5004,0004,500

2008 2009 2010 2011 2012 2013 2014

(CNYm)

Anta Peak Li Ning CDX Xtep 361


- 19 -

We believe that inventory and accounts receivable levels are closely related and should be monitored closely, as a high level of accounts receivable turnover days implies that the wholesalers cannot raise enough cash and could suggest that the pace of clearing inventory is slower than expected. In the following table, we highlight that the top-6 China sportswear companies, with the exception of Li Ning, saw their cash-conversion cycles recover in 2014 to levels seen in 2011-12, albeit still at the higher end of those levels. We expect the financial pressure that we are seeing on Li Ning to ease only slightly in 2015-16E, due to the increasing revenue contribution of its working-capital-intensive retail operation.

For Anta, we expect it to maintain its strong cash conversion cycle over 2015-17E, on the back of healthy industry sales growth. Although Anta had a longer working-capital cycle in 2014 compared with previous years, it was still much better by far than its peers’ because the company paid back its creditors faster than peers, at 54 days, or 9 days quicker YoY.

China Sportswear Sector: working-capital cycle comparison

2009 2010 2011 2012 2013 2014Anta Inventory turnover days 38 36 38 51 59 58A/R turnover days 16 19 26 34 38 35A/P turnover days 35 36 37 47 65 54Working capital cycle 19 19 27 38 32 39 Peak Sports Inventory turnover days 36 38 49 80 81 74A/R turnover days 70 63 66 127 135 114A/P turnover days 42 46 48 48 45 41Working capital cycle 64 55 67 159 171 147 LI Ning Inventory turnover days 53 52 72 89 104 109A/R turnover days 47 52 76 98 89 71A/P turnover days 70 71 93 112 104 84Working capital cycle 30 33 55 75 89 96 China Dongxiang* Inventory turnover days 44 45 145 277 210 141A/R turnover days 24 37 81 121 131 96A/P turnover days 61 65 91 72 68 76Working capital cycle 7 17 135 326 273 161 Xtep Inventory turnover days 47 50 63 70 79 71A/R turnover days 54 51 64 74 92 91A/P turnover days 69 74 63 54 76 85Working capital cycle 32 27 64 90 95 77 361 Degrees Inventory turnover days 21 22 40 56 73 77A/R turnover days 103 91 108 149 191 167A/P turnover days 118 108 89 112 158 169Working capital cycle 6 5 59 93 106 75


*China stores only


- 20 -

Store closures appear to have eased off The closure of loss-making stores was a big theme throughout 2012-14, and by the end of 2014, the store count for the big 6 domestic Chinese sportswear brands had been scaled back to levels seen over 2008-09, equivalent to a CAGR of 5% over 2008-11, which we see as a reasonable store network expansion rate. We think a store-network CAGR of a single-to-mid-digit percentage is sustainable over 2015-17E, given the medium- to long-term revenue-growth drivers that we expect. We note that the store count decreased by only 2% YoY for 2014 (from -9% and -8% YoY for 2012 and 2013, respectively), indicating to us that the pace of store closures has begun to stabilise and should be stable for 2015E, which is supported by the respective management guidance. Over 2015-17, we expect the sportswear brands to focus on the image of their stores and product design upgrades, as well relocating stores to locations that will attract more traffic, rather than adding new stores that have low efficiency. China Sportswear Sector: China sportswear companies retail outlets and YoY growth


China sportswear and casual brand store count (2013)


Paving the way for order books to take off again

Trade-fair orders recovering Trade-fair order growth over 1Q14-4Q15 picked up for the sector (although we can’t comment on CDX, which doesn’t report trade-fair order numbers), to either flat or positive YoY, with Anta leading the pack and 1Q14 being an inflection point for this company. We also note that of the 5 companies (CDX and Li Ning, although Li Ning began to disclose quarterly numbers in 1Q15) that report SSSG on a quarterly basis, Anta has been outperforming its peers since 1Q14. Its trade-fair orders from 4Q14-3Q15 reflect double-digit percentage growth. Such strong order-book growth should translate into revenue growth for the sportswear companies of at least a mid-teens percentage for 2015E, in our opinion. For Anta in particular, we do not think its reported trade-fair order-book growth captures the potential revenue growth of its self-operated Fila brand operation and Anta-kids, both of which are seeing fast-growing revenue for 2015, given the low base from 2013. China Sportswear Sector: trade-fair results (%)

Anta Peak Li Ning Xtep 3611Q13 - 20 to 30% flat n/a - 15 to 20% -23%2Q13 - 15 to 25% - mid-twenties n/a - 15 to 20% -23%3Q13 - 10 to 20% n/a n/a -20% -19%4Q13 - 5 to 15% n/a n/a - 15-17% -17%1Q14 + high single digit n/a n/a - high single digit -11%2Q14 + high single digit + high single digit n/a - mid single digit -11%3Q14 + high single digit + mid-teens n/a - low single digit -7%4Q14 + low double digit + mid-teens n/a flat 8%1Q15 + low double digit + mid-teens +mid-twenties + low single digit 8%2Q15 + low double digit + mid-teens + mid-teens + low single digit 11%3Q15 + low double digit + mid-teens + high-teens + low single digit 16%4Q15 + low double digit* + mid-teens +low-teens + low single digit 18%1Q16 tba + mid-teens tba tba tbaSource: Companies

China sportswear sector: SSSG (%)

Anta Peak Li Ning Xtep 3611Q13 flat flat n/a flat -1.5%2Q13 flat flat n/a flat -0.8%3Q13 flat + low single digit n/a flat 0.0%4Q13 + mid single digit + low single digit n/a n/a 1.5%1Q14 + mid single digit + low single digit n/a + low single digit 1.8%2Q14 + low double digit + low single digit n/a + mid single digit 2.8%3Q14 + high single digit + low single digit n/a + mid single digit 4.7%4Q14 + high single digit + low single digit +mid single digit + mid single digit 5.5%1Q15 + high single digit* +mid single digit +mid single digit + mid single digit 6.3%Source: Companies

(20%)(10%)0%10%20%30%40%50%60%

0

10,000

20,000

30,000

40,000

50,000

2007 2008 2009 2010 2011 2012 2013 2014

Anta Li Ning Peak CDXXtep 361 YoY (RHS)

2007-14 CAGR +5%

0 2,000 4,000 6,000 8,000

AntaLi Ning

PeakDX

Xtep361

ZaraH&M

UniqloGAP


- 21 -

Valuation and recommendations Sector’s 2015E PER well below its past peak and the global sector average We initiate coverage of the China Sportswear Sector with a Positive rating. The sector is currently trading at a 2015E PER of 14x (excluding Li Ning), below its peak of 24x reached in August 2009, and at a 50% discount to the 2015E global sector weighted-average PER of 28x (based on Daiwa forecasts for rated companies and the Bloomberg consensus forecasts for non-rated companies). Although the sector has been rerated from a trough of 12-month forward PER of 5x in 2012 to about 14x currently, it is still below its historical peak of 24x. As such, we believe the market leaders (Anta and Peak) deserve further rerating, as: 1) The previous rerating priced in a more normalised inventory level for the industry, but failed to recognise the potential to cut the discounts offered to the wholesalers by the brands and the launch of more value-for-money products, both of which should have a positive impact on revenue and profit margins. Our 2015-17 EPS forecasts for our top pick Anta are 6-11% above consensus. For Peak, we are also 10-14% above the consensus for 2015-17E, as we like its niche segmentation and operating leverage potential on discount cuts to wholesale orders. As for Li Ning, unlike the consensus, we do not expect the company to return to profitability in 2015. 2) In our view, the sector deserves to trade closer to its global peers (15-20x 2015 PER), as we expect sector EPS growth to catch up with global peers in the medium term. We believe the China sportswear brands are advantageously positioned, given China is the largest sportswear market globally and its citizens are shifting to a more health-centric lifestyle. While international brands continue to lead the way in terms of market share, large domestic peers such as Anta are not far behind, and with the correct product positioning and strategy execution, we believe successful domestic brands can hold their own, sharing the podium with the international brands.

3) The sector’s previous peak, at a one-year forward PER of 24x in 2009, was based on EPS growth of about 30% YoY, while the consensus forecasts the aggregate sector EPS to grow by 32% YoY for 2015. We think the current sector valuation should trade closer to its historical peak, driven by a new era of growth from positive State Council guidelines/policy and the increasing health consciousness among Mainland citizens. 4) Most other sub-segments within the China consumer discretionary segments, such as the department stores and apparel, are still feeling the negative effects of China’s ongoing austerity and anti-corruption measures. We believe sportswear is one of the very few sub-segments, supported by the government’s fitness initiative, to be largely immune to the impact of anti-graft measures. However, the sector (excluding Dongxiang) is still trading below the average PER for the China department store sector, because we think the recent news of a decrease in the consumption tax has improved sentiment toward the China department stores. We believe investors will continue to prefer the sportswear segment over the other consumer discretionary companies, given the segment’s better risk/reward profile. China Sportswear Sector: 12-month forward PER

Source: Daiwa, Bloomberg

Dividend analysis On our analysis, the China sportswear brands are good value plays, as their dividend yields are attractive compared with those of their peers – the sector has the second-highest dividend yield for 2015, on our forecasts, at 3.9%, after the China banks. Among the Hong Kong-listed consumer stocks, China’s sportswear brands come in above the average 3.5% 2015E sector dividend yield, behind only Macau Gaming and Apparel/Footwear stocks, both of which have taken share-price hits on the back of China’s anti-corruption clampdowns and policy overhangs.

13.6

18.1

9.2

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Jan-

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09

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May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

Sep-

14

Jan-

15

May

-15

avg sd+1 sd-1

(x)


- 22 -

The average dividend yield for the companies that we cover for 2015-17E is lower than that for Xtep, which we believe is due to the latter’s smaller market cap and its lower-earnings growth outlook (Bloomberg consensus forecasts). Key investment risks to our sector call Price competition from international brands The main downside risk to our positive rating on the China Sportswear Sector would be if the international sportswear brands were to gain more market share through price competition, and if they decided to aggressively target China’s lower-tier cities, and/or if they provide better products as a result of using technology on the back of more developed R&D.

Demand growth falls short of expectations A sharper-than-expected macro-driven slowdown and uncertain economic conditions could adversely affect sportswear wholesale orders. Moreover, if the State Council were to pull back on its policies encouraging people to engage in sports, this would pose a downside risk to our sector call. Channel stuffing re-emerges If the China Sportswear Sector were to overestimate consumer demand, on the back of the government’s pro-sports push, this could result in renewed channel stuffing, whereby distributors would end up placing more orders, resulting in excess inventory at the distributor level and bad debt at the brand level.

Hong Kong-listed sector dividend comparison (2015E)


Hong Kong-listed consumer sub-sector dividend comparison (2015E)


0.0

1.0

2.0

3.0

4.0

5.0

6.0

Bank

s

Spor

tsw

ear

Con

sum

er

Prop

erty

Tele

com

Ener

gy/U

tiliti

es

Mat

eria

ls

Tran

spor

tatio

n

Con

glom

erat

es

Auto

mob

iles

Fina

ncia

ls

Insu

ranc

e

Tech

Hea

lthca

re

Dividend yield (%)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Macau Gaming Apparel and Footwear China Sportswear Department Stores Jewellers Staples

Dividend yield (%)


- 23 -

China Sportswear Sector: dividend comparison (2015-16E)


Anta: dividend payout ratio Peak: dividend payout ratio

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

3.4%

5.4%

2.9%

7.5%

3.7%

4.6%4.0%

6.1%

2.9%

7.9%

4.2%

5.0%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

Anta Peak CDX Xtep 361 Average Anta Peak CDX Xtep 361 Average

2015E 2016E

0%

20%

40%

60%

80%

100%

0.00

0.20

0.40

0.60

0.80

1.00

2009 2010 2011 2012 2013 2014 2015E 2016E 2017E

(HKD)

DPS (LHS) Special div (LHS )

DPR (RHS) DPR incl. of specia l d iv (RHS)

0%

20%

40%

60%

80%

100%

120%

0.00

0.05

0.10

0.15

0.20

2009 2010 2011 2012 2013 2014 2015E 2016E 2017E

(HKD)

DPS (LHS) Special div (LHS )

DPR (RHS) DPR incl. of specia l d iv (RHS)


- 24 -

China and global sportswear, footwear and fast-fashion companies: valuations

Sub-sector/Company Share Price Cons. TP Market cap P/E ratio (x) PEG (x) P/B ratio (x) EV/EBITDA (x) ROE (%) Div yield (%) Sales Growth yoy (%) Net Profit Growth yoy (%) EPS Growth yoy (%) EPS CAGR (%)

Stock code Rating (lcy) (lcy) (USDm) FY14 FY15 FY16 FY17 FY15 FY16 FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY15-17

China Sportswear ANTA SPORTS * 2020 HK Buy 17.2 20.0 5,551 20.2 16.4 14.2 12.3 0.7 0.9 4.0 3.6 3.2 10.8 9.2 7.7 25.7 26.7 27.3 3.8 4.4 5.0 15.5 13.0 10.0 23.9 15.7 15.6 23.9 15.6 15.5 15.6 PEAK SPORT* 1968 HK Buy 2.7 3.1 701 14.3 11.5 10.1 8.9 0.5 0.7 1.0 1.0 0.9 2.6 2.0 1.6 9.1 9.8 10.5 5.4 6.2 7.0 13.4 12.4 11.4 23.8 13.9 12.9 23.8 13.9 12.9 13.2 LI NING* 2331 HK Underperform 3.6 3.1 859 19.7 13.2 1.4 1.3 1.1 16.0 6.9 5.3 8.8 11.7 16.2 14.0 11.3 50.0 50.0 361 DEGREES INTERNATIONAL 1361 HK NR 3.0 3.5 787 12.3 10.7 8.7 7.2 0.7 0.4 0.9 0.8 0.8 4.0 3.4 2.9 8.7 10.0 11.4 3.8 4.7 5.5 16.3 18.8 18.4 11.9 24.3 22.1 14.6 22.7 22.2 22.5 CHINA DONGXIANG GROUP CO 3818 HK NR 2.1 2.2 1,521 10.3 24.0 33.4 32.2 (0.4) (1.2) 0.9 0.9 1.0 19.0 16.5 23.4 3.6 2.8 3.0 2.8 2.2 2.3 12.5 11.9 8.1 (56.8) (29.0) 6.8 (57.2) (28.2) 3.9 (13.6) XTEP INTERNATIONAL HOLDINGS 1368 HK NR 3.2 3.5 899 11.7 10.0 9.2 8.5 0.6 1.1 1.1 1.1 1.0 4.1 3.8 3.6 11.6 11.9 12.2 5.6 6.2 6.6 7.0 7.5 6.6 16.7 8.4 8.8 16.2 8.6 8.7 8.6 POU SHENG INTL HOLDINGS LTD 3813 HK NR 0.9 NA 631 128.8 NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA NA

China Sportswear Simple average 32.9 14.5 15.9 13.7 0.4 0.4 1.6 1.5 1.3 9.4 7.0 7.4 11.8 11.7 12.7 4.3 4.7 5.3 13.5 12.9 11.0 3.9 6.6 19.4 4.2 6.5 18.9 9.3 China Sportswear Weighted average 21.9 14.0 15.4 13.5 0.4 0.5 2.5 2.3 2.0 10.2 8.2 8.2 15.7 16.9 17.7 3.9 4.4 4.9 13.5 12.1 9.7 8.0 7.3 15.9 8.1 7.2 15.5 9.2 International Fast-fashion

INDITEX ITX SM NR 28.7 30.0 101,766 36.4 32.5 29.6 25.8 1.9 3.1 8.1 7.3 6.5 19.1 17.1 15.2 25.8 26.1 26.4 2.0 2.2 2.5 13.8 10.3 10.4 16.9 12.1 12.3 17.1 9.7 14.6 12.1 HENNES & MAURITZ AB-B SHS HMB Ss NR 326.0 343.5 66,800 26.4 24.8 22.7 20.5 2.1 2.4 9.5 8.5 7.7 15.4 13.9 12.6 40.4 39.5 39.0 3.1 3.3 3.6 18.9 11.4 10.4 11.9 9.4 10.6 12.1 9.4 10.5 9.9 FAST RETAILING CO LTD 9983 JP NR 52,200.0 49,552.9 45,108 46.4 41.9 39.6 35.5 0.7 6.8 7.5 6.6 5.8 22.2 20.1 18.3 19.9 18.3 18.3 0.7 0.8 0.8 20.4 14.3 11.2 76.1 6.2 11.7 60.3 5.8 11.5 8.6 GAP INC/THE GPS US NR 38.5 42.4 16,077 13.8 14.0 12.6 11.2 (18.6) 1.1 5.5 5.0 4.7 6.7 6.2 5.7 35.9 41.5 44.9 2.4 2.6 2.7 (0.0) 3.5 5.5 (8.4) 8.0 10.7 (0.8) 11.0 12.9 12.0

International Fast-fashion Simple average 30.1 28.0 26.1 23.3 (9.0) 4.0 6.5 5.8 5.2 14.4 13.2 12.0 27.9 29.9 31.6 1.5 1.7 1.8 10.2 8.9 8.3 33.9 7.1 11.2 29.8 8.4 12.2 10.3 International Fast-fashion Weighted average 33.9 30.8 28.4 25.1 0.3 3.5 8.2 7.3 6.6 17.7 16.0 14.4 29.6 29.5 29.8 2.1 2.3 2.5 15.6 10.9 10.2 25.2 9.9 11.6 22.8 8.9 12.7 10.8 International Sportswear

NIKE INC -CL B NKE US NR 104.8 111.3 90,059 30.4 30.0 26.9 23.0 1.5 2.3 7.3 6.6 5.9 18.2 16.7 14.7 27.1 27.3 29.4 1.0 1.1 1.3 9.8 6.4 9.4 16.5 9.3 14.2 19.8 11.6 16.8 14.2 ADIDAS AG ADS GR NR 68.2 76.2 16,251 24.6 20.3 17.6 15.3 1.7 1.2 2.5 2.3 2.2 10.8 9.7 8.6 12.6 13.6 15.0 2.3 2.4 2.8 10.2 6.9 6.3 43.6 11.7 13.5 11.9 14.9 15.6 15.3 FOOT LOCKER INC FL US NR 63.2 66.5 8,801 17.1 16.0 14.5 13.4 1.1 1.3 3.5 3.2 3.2 7.8 7.3 7.1 22.1 23.5 24.1 1.5 1.7 1.8 2.6 4.9 4.3 7.8 7.4 3.5 14.9 10.8 8.1 9.5 ASICS CORP 7936 JP NR 3,095.0 3,262.5 5,042 33.6 27.2 23.9 21.2 0.7 1.7 2.8 2.6 2.3 15.7 14.0 12.6 11.1 11.7 12.2 0.8 0.8 0.9 29.9 7.6 7.6 42.3 13.9 12.3 38.0 13.8 12.7 13.3 PUMA SE PUM GR NR 142.4 169.1 2,444 39.6 37.5 28.5 19.8 (1.7) 0.9 1.3 1.2 1.1 10.2 8.6 6.8 3.6 4.6 6.2 0.4 0.5 0.8 10.8 6.0 6.4 (12.4) 32.1 41.9 (22.6) 31.6 43.9 37.6 MIZUNO CORP 8022 JP NR 606.0 573.5 656 22.9 23.6 21.1 19.5 110.3 1.7 0.8 0.8 0.8 11.4 10.6 10.0 3.4 3.7 4.0 1.6 1.7 1.7 4.0 2.4 1.8 (3.1) 12.2 7.8 0.2 12.3 7.8 10.0

International Sportswear Simple average 28.0 25.8 22.1 18.7 18.9 1.5 3.0 2.8 2.6 12.3 11.2 10.0 13.3 14.1 15.1 1.3 1.4 1.6 11.2 5.7 6.0 15.8 14.4 15.5 10.4 15.8 17.5 16.6 International Sportswear Weighted average 29.0 27.7 24.7 21.2 2.0 2.0 6.0 5.5 4.9 16.2 14.8 13.1 23.6 24.0 25.8 1.2 1.3 1.5 10.1 6.4 8.4 19.9 10.1 13.8 18.2 12.5 16.4 14.4

Source: *Daiwa forecasts, Bloomberg, Prices as of 18th June


■ Investment case We initiate coverage of Anta, a domestic China sportswear brand, with a Buy (1). We expect the stock to be rerated in 2015, on: 1) 16% YoY revenue growth in 2015, supported by growing demand for its core ANTA brand and side brands Anta Kids and FILA, and 2) operating-margin expansion and EPS growth of 24% and 16% for 2015 and 2016E, respectively, due to lower production costs, reduced wholesale discounts, and improved operating leverage. Anta is our top sector pick for its execution capability and positioning to capture industry growth. New revenue growth phase. With Anta’s channel inventory issues now over, we see the company entering a new phase of revenue growth (11% top-line CAGR for 2015-17E), supported by its value-

for-money focused product portfolio and well-positioned market segmentation (mass market and functional attire) at a time when the fitness trend is taking off in China. We see the industry’s longer-term revenue growth being supported by positive State Council guidelines promoting physical fitness. ■ Catalysts In our view, better-than-expected revenue for Anta Kids and FILA in 2015 would be a share-price catalyst. We forecast 32% and 28% YoY rises in their combined revenue for 2015/2016, on rising sales volumes. Anta also has a strong balance sheet, with net cash of CNY4.7bn at end-2014. Considering our FCF forecast of CNY2.0-2.7bn/year for 2015-17, we expect the company to use these funds for M&A or raise dividends. If Anta were to take the M&A route, we would expect a faster ramp-up of new acquisitions than in 2009 when it bought FILA (the ramp-up of FILA was during the channel-stuffing period of 2010-13). ■ Valuation We initiate coverage on Anta with a Buy (1) rating and 12-month TP of HKD20.0, based on a 2015E PER of 19x (16x ex-net cash PER), as we look for strong EPS growth for 2015-16, outperforming the average of its peers, at 11%, in 2015 (ex-Li Ning,

which we believe will remain loss-making in 2015). ■ Risks The main risk to our call: aggressive expansion by international peers in lower-tier cities and discounting by peers leading to oversupply and channel stuffing.

Consumer Discretionary / China2020 HK

22 June 2015

Anta Sports Products

Initiation: all-star pick

• We forecast earnings growth of 24% and 16% YoY for 2015-16 on margin-accretive sales-mix enhancements and lower costs

• At a 16.4x 2015E PER, its valuation premium to peers could re-emerge on a better earnings growth outlook

• Initiate with a Buy (1) and 12-month TP of HKD20.0; top sector pick for its execution capabilities and strong positioning

Source: FactSet, Daiwa forecasts

Consumer Discretionary / China

Anta Sports Products2020 HK

Target (HKD): 20.00Upside: 15.9%18 Jun price (HKD): 17.26

Buy (initiation)

OutperformHoldUnderperformSell

1

2

3

4

5

90

106

123

139

155

11

13

15

17

20

Jun-14 Sep-14 Dec-14 Mar-15 Jun-15

Share price performance

Anta Sport (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 11.64-19.50Market cap (USDbn) 5.563m avg daily turnover (USDm) 15.29Shares outstanding (m) 2,496Major shareholder Mr. Ding Shizhong (55.3%)

Financial summary (CNY)Year to 31 Dec 15E 16E 17ERevenue (m) 10,306 11,643 12,809Operating profit (m) 2,541 2,933 3,379Net profit (m) 2,107 2,435 2,812Core EPS (fully-diluted) 0.842 0.974 1.124EPS change (%) 23.9 15.6 15.5Daiwa vs Cons. EPS (%) 5.9 8.4 10.6PER (x) 16.4 14.2 12.3Dividend yield (%) 3.8 4.4 5.0DPS 0.521 0.602 0.695PBR (x) 4.0 3.6 3.2EV/EBITDA (x) 10.8 9.2 7.7ROE (%) 25.7 26.7 27.3





- 26 -

Growth outlook Anta: net profit and net profit growth (YoY)

We forecast Anta’s revenue to increase by 16% YoY for 2015 and 13% YoY for 2016, on the back of robust revenue growth for its core and supplementary brands. We look for the operating margin to improve by respective 200bps and 50bps for 2015-16E, on the back of it ramping up sales of higher-margin products, such as its NBA co-branded products, its supplementary brands (Anta Kids and FILA) achieving better economies of scale, as well as lower production costs and A&P expenses. We forecast Anta’s net profit to increase by 24%, 16% and 16% YoY for 2015-17, respectively.

Source: Company, Daiwa forecasts

Valuation Anta: 12-month forward PER

We believe Anta’s 18% valuation premium (versus its Hong Kong-listed domestic peers) is justified given that we forecast EPS growth of 24% and 16% YoY for 2015 and 2016. The stock is trading currently at a 2015E PER of 16x (14x ex-net cash PER), in line with its Hong Kong-listed peer group’s weighted average and below the global peer average of 32x, on Daiwa’s and the Bloomberg consensus forecasts. Our TP of HKD20.0 is based on a 2015E PER of 19x. We expect Anta to be rerated ahead of its Hong Kong-listed peers under our coverage, as we expect it to deliver better earnings growth over 2015-17E (CAGR of 16% over 2015-17E vs. 11% for peers).

Source: Bloomberg, Daiwa

Earnings revisions Anta: Bloomberg-consensus EPS-forecast revisions (x)

The 2015-16 Bloomberg consensus EPS forecasts for Anta have trended up since August 2014, reflecting the company’s faster-than-expected turnaround in the sell-in and sell-through of its inventory. Our EPS forecasts for 2015-16 are 6-9% above consensus, reflecting primarily our more upbeat expectations for the company’s revenue growth and operating leverage potential over the same period.

Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

24%

12%

-21%

-3%

29%

24%

16% 15%

(30%)

(20%)

(10%)

0%

10%

20%

30%

40%

0

500

1,000

1,500

2,000

2,500

3,000

2010 2011 2012 2013 2014 2015E 2016E 2017E

(CNYm)

Net profit (LHS) YoY (RHS)

15.8

21.0

10.6

0

5

10

15

20

25

30

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

Sep-

14

Jan-

15

May

-15

avg sd+1 sd-1

(x)

0.500.550.600.650.700.750.800.850.900.95

Jan-

14

Feb-

14

Mar

-14

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-1

5

May

-15

Jun-

15

CNY

2015E EPS 2016E EPS

Buy (initiation)


1

2

3

4

5


- 27 -

Key assumptions

Profit and loss (CNYm)

Cash flow (CNYm)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017EA&P (% of sales) 13.6 13.7 10.5 11.1 12.0 12.0 12.0 12.0Anta core brand stores 7,549 8,665 8,075 7,757 7,622 7,600 7,550 7,500Anta Kids stores n.a. 632 833 881 1,228 1,600 1,800 2,000FILA stores n.a. 220 300 416 519 600 650 700

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017EFootwear 3,825 4,335 3,706 3,421 4,111 4,624 5,087 5,468Apparel 3,333 4,288 3,677 3,575 4,451 5,230 6,015 6,718Other Revenue 250 282 240 286 361 452 542 623Total Revenue 7,408 8,905 7,623 7,281 8,923 10,306 11,643 12,809Other income 44 74 128 102 86 100 100 100COGS (4,238) (5,142) (4,730) (4,242) (4,896) (5,597) (6,278) (6,763)SG&A (1,477) (1,825) (1,458) (1,576) (2,094) (2,267) (2,532) (2,767)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 1,737 2,011 1,563 1,566 2,019 2,541 2,933 3,379Net-interest inc./(exp.) 106 149 166 187 224 228 261 303Assoc/forex/extraord./others 0 0 0 0 0 0 0 0Pre-tax profit 1,843 2,160 1,730 1,753 2,243 2,769 3,194 3,682Tax (297) (436) (374) (423) (510) (630) (727) (837)Min. int./pref. div./others 5 6 3 (15) (32) (32) (32) (32)Net profit (reported) 1,551 1,730 1,359 1,315 1,700 2,107 2,435 2,812Net profit (adjusted) 1,551 1,730 1,359 1,315 1,700 2,107 2,435 2,812EPS (reported)(CNY) 0.622 0.694 0.545 0.527 0.681 0.844 0.976 1.127EPS (adjusted)(CNY) 0.622 0.694 0.545 0.527 0.681 0.844 0.976 1.127EPS (adjusted fully-diluted)(CNY) 0.620 0.692 0.544 0.526 0.680 0.842 0.974 1.124DPS (CNY) 0.386 0.424 0.390 0.378 0.483 0.521 0.602 0.695EBIT 1,737 2,011 1,563 1,566 2,019 2,541 2,933 3,379EBITDA 1,821 2,101 1,673 1,696 2,178 2,707 3,104 3,555

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017EProfit before tax 1,843 2,160 1,730 1,753 2,243 2,769 3,194 3,682Depreciation and amortisation 84 90 110 130 159 166 171 175Tax paid (224) (387) (446) (367) (522) (630) (727) (837)Change in working capital (295) (454) 430 (421) (68) (180) (174) (152)Other operational CF items 25 38 142 32 (125) 40 40 40Cash flow from operations 1,433 1,448 1,965 1,128 1,686 2,165 2,505 2,908Capex (103) (179) (206) (168) (250) (272) (272) (272)Net (acquisitions)/disposals 0 0 (136) (15) 0 0 0 0Other investing CF items 599 (559) (633) 803 (615) (9) (9) (9)Cash flow from investing 496 (738) (976) 620 (865) (281) (281) (281)Change in debt 0 0 997 (528) 849 0 0 0Net share issues/(repurchases) 6 1 0 4 6 0 0 0Dividends paid (940) (1,055) (996) (878) (1,072) (1,229) (1,381) (1,595)Other financing CF items (5) (5) (4) (5) (4) 0 0 0Cash flow from financing (939) (1,059) (3) (1,408) (220) (1,229) (1,381) (1,595)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 990 (350) 986 341 601 654 843 1,032Free cash flow 1,330 1,269 1,759 960 1,436 1,893 2,233 2,636


- 28 -

Balance sheet (CNYm)

Key ratios (%)


Company profile

ANTA Sports Products Limited is a professional sportswear company established in 1994, in Jinjiang, Fujian. It is involved inthe innovation, design, research, development, manufacturing and retail of sports equipment. The company listed on the Hong Kong Stock Exchange in 2007.

As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ECash & short-term investment 4,291 4,428 4,988 4,839 6,034 6,688 7,531 8,563Inventory 454 618 687 689 867 1,002 1,132 1,245Accounts receivable 990 1,709 1,373 1,933 1,701 1,836 1,968 2,082Other current assets 10 15 1,055 725 745 745 745 745Total current assets 5,745 6,770 8,102 8,187 9,347 10,271 11,376 12,636Fixed assets 653 680 918 935 1,068 1,188 1,297 1,395Goodwill & intangibles 531 541 529 507 489 473 457 442Other non-current assets 125 204 487 489 480 316 316 316Total assets 7,054 8,194 10,036 10,118 11,384 12,248 13,446 14,789Short-term debt 0 0 997 490 1,348 1,348 1,348 1,348Accounts payable 1,071 1,471 1,774 1,889 1,654 1,744 1,831 1,907Other current liabilities 93 133 127 194 182 182 182 182Total current liabilities 1,163 1,604 2,898 2,574 3,185 3,275 3,362 3,438Long-term debt 0 0 0 0 0 0 0 0Other non-current liabilities 160 171 205 195 194 194 194 194Total liabilities 1,324 1,776 3,103 2,769 3,379 3,469 3,557 3,633Share capital 242 242 242 242 242 242 242 242Reserves/R.E./others 5,436 6,130 6,510 6,912 7,553 8,327 9,437 10,705Shareholders' equity 5,678 6,372 6,752 7,154 7,795 8,569 9,680 10,947Minority interests 53 47 180 195 209 209 209 209Total equity & liabilities 7,054 8,194 10,036 10,118 11,384 12,248 13,446 14,789EV 30,257 30,114 30,685 30,342 30,019 29,365 28,522 27,490Net debt/(cash) (4,291) (4,428) (3,991) (4,349) (4,685) (5,340) (6,183) (7,215)BVPS (CNY) 2.277 2.555 2.707 2.868 3.123 3.433 3.878 4.386

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ESales (YoY) 26.1 20.2 (14.4) (4.5) 22.5 15.5 13.0 10.0EBITDA (YoY) 24.9 15.4 (20.4) 1.4 28.4 24.3 14.7 14.5Operating profit (YoY) 24.5 15.8 (22.3) 0.1 29.0 25.9 15.4 15.2Net profit (YoY) 24.0 11.5 (21.5) (3.2) 29.3 23.9 15.6 15.5Core EPS (fully-diluted) (YoY) 23.9 11.5 (21.4) (3.3) 29.2 23.9 15.6 15.5Gross-profit margin 42.8 42.3 38.0 41.7 45.1 45.7 46.1 47.2EBITDA margin 24.6 23.6 21.9 23.3 24.4 26.3 26.7 27.8Operating-profit margin 23.4 22.6 20.5 21.5 22.6 24.7 25.2 26.4Net profit margin 20.9 19.4 17.8 18.1 19.1 20.4 20.9 22.0ROAE 28.8 28.7 20.7 18.9 22.7 25.7 26.7 27.3ROAA 23.6 22.7 14.9 13.0 15.8 17.8 19.0 19.9ROCE 32.0 33.1 21.8 19.9 23.5 26.1 27.5 28.5ROIC 113.0 93.6 49.7 40.0 49.4 58.1 63.4 68.3Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Effective tax rate 16.1 20.2 21.6 24.1 22.7 22.7 22.7 22.7Accounts receivable (days) 37.4 55.3 73.8 82.9 74.3 62.6 59.6 57.7Current ratio (x) 4.9 4.2 2.8 3.2 2.9 3.1 3.4 3.7Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Net dividend payout 62.1 61.1 71.7 71.7 71.0 61.7 61.7 61.7Free cash flow yield 3.9 3.7 5.1 2.8 4.2 5.5 6.5 7.6


- 29 -

All signs point to revenue growth

We believe Anta is well positioned for top-line growth over 2015-17 on the back of the rising fitness trend in China, with its core brand revenue likely to increase by 10% YoY for 2015, and 32% YoY for its side brands.

Clear strategy aimed at sales and market share growth

We forecast Anta’s revenue to rise at a CAGR of 13% for 2015-17E (16%, 13% and 10% YoY for 2015-17E, respectively), largely driven by a recovery in revenue generated by its core ANTA brand, as well as increasing contribution from Anta Kids and FILA. We expect Anta’s revenue to outperform its peers by virtue of: 1) Its core brand having clear-cut mass-segment

positioning (does not compete with international brands). We expect improving SSS growth and healthy sell-through of the core brand over 2015-17, supported by the company’s recent NBA partnership and existing player sponsorships.

2) Supplementary revenue streams (Anta Kids, FILA and e-commerce), which should boost revenue.

3) It having value-for-money products that are both

functional and stylish, as well as being well positioned to capture the growth in incomes evident in low-tier cities.

Anta: revenue


Anta was the first of its China peers to see a turnaround in 1Q14 from negative trade-fair order growth, and its trade fair orders subsequently increased by a high single digit or low double digit throughout 1Q14-4Q15. We believe this trend will continue as Anta captures more market share from its competitors based on the aforementioned factors. China Sportswear Sector: trade-fair results (%)

Anta Peak Li Ning Xtep 3611Q13 - 20 to 30% flat n/a - 15 to 20% -23%2Q13 - 15 to 25% - mid-twenties n/a - 15 to 20% -23%3Q13 - 10 to 20% n/a n/a -20% -19%4Q13 - 5 to 15% n/a n/a - 15-17% -17%1Q14 + high single digit n/a n/a - high single digit -11%2Q14 + high single digit + high single digit n/a - mid single digit -11%3Q14 + high single digit + mid-teens n/a - low single digit -7%4Q14 + low double digit + mid-teens n/a flat 8%1Q15 + low double digit + mid-teens +mid-twenties + low single digit 8%2Q15 + low double digit + mid-teens + mid-teens + low single digit 11%3Q15 + low double digit + mid-teens + high-teens + low single digit 16%4Q15 + low double digit* + mid-teens +low-teens + low single digit 18%1Q16 tba + mid-teens tba tba tba

Source: Companies

China sportswear sector: SSSG (%)

Anta Peak Li Ning Xtep 3611Q13 flat flat n/a flat -1.5%2Q13 flat flat n/a flat -0.8%3Q13 flat + low single digit n/a flat 0.0%4Q13 + mid single digit + low single digit n/a n/a 1.5%1Q14 + mid single digit + low single digit n/a + low single digit 1.8%2Q14 + low double digit + low single digit n/a + mid single digit 2.8%3Q14 + high single digit + low single digit n/a + mid single digit 4.7%4Q14 + high single digit + low single digit +mid single digit + mid single digit 5.5%1Q15 + high single digit* +mid single digit +mid single digit + mid single digit 6.3%

Source: Companies

26%

20%

-14%

-4%

23%

16%13% 10%

(20%)(15%)(10%)(5%)0%5%10%15%20%25%30%

0

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4,000

6,000

8,000

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14,000

2010 2011 2012 2013 2014 2015E 2016E 2017E

(CNYm)

Revenue (LHS) YoY (RHS)


- 30 -

Anta: brand portfolio and market segmentation

Source: Company

Strong core brand

We expect Anta’s core brand revenue to grow by 10%, 7% and 5% YoY for 2015-17E, respectively, on the back of SSS optimisation (ie, improving SSS by improving store experience/store image, etc), healthy sell-through and increasing demand driven by its NBA partnership deal (signed in October 2014, with co-branded products starting to roll out in 4Q14). We also see this growth being supported by the ongoing demand for fitness-related products on the back of consumers opting for more health-conscious lifestyles. Positioned in the right segment Anta’s running shoes are typically priced at CNY200-400, which we believe is the appropriate price range when targeting the mass segment in China (the company’s main target market). In a survey carried out by Deloitte in 2009 (refer to the chart in the sector report), 47% of respondents in different Chinese cities said they had bought shoes for CNY300 or less, and that these were their most expensive pair of shoes purchased in 2009. Thus, we think it is fair to say that the addressable market for Anta’s shoes is fairly large. If we extend the price range to include shoes costing CNY300-600, 78% of the respondents could have been potential customers for Anta, especially with the

introduction in November 2014 of its NBA co-branded shoes, costing CNY399. SSS on the rise Since 2011, Anta has outperformed its China peers in terms of sales per store. We expect Anta’s store count (for its core brand and supplementary brands) to increase slightly to around 9,450-9,700 (9,369 stores as at end-2014), driven by the company’s plan to increase its FILA stores to 600 (from 519 as at the end of 2014) by the end of 2015, and Anta Kids stores to 1,600 (from 1,228 at end-14). We also expect Anta’s SSSG for its core brand over 2015-17 to continue to support its peer-leading high single-digit percentage YoY SSSG over the same period, driven by continuous efforts to improve its store image via its supplementary brands (Anta Kids and FILA), full-store remodelling every 2 years, and improved brand image through increased exposure to sponsorships and endorsements.


- 31 -

China Sportswear Sector: sales per store*

Source: Company, Daiwa forecasts *based on core brand sales for Anta and Li Ning

Healthy sell-through Anta reported its 4Q15 trade fair results and 1Q15 SSSG on 14 May 2015, with 4Q15 trade fair orders up by a low double-digit percentage YoY (wholesale value) and 1Q15 SSSG up by a high single-digit percentage YoY. While this might imply that sell-through is not as strong as sell-in, and investors could start to be concerned about inventory build-up, we note that Anta’s trade fair orders include Anta Kids, and its SSSG excludes Anta Kids. Based on our back-of-the-envelope calculations, trade-fair order growth for Anta’s core brand was in line with its SSSG for 1Q15 (a high single digit), and we expect this trend to continue throughout 2Q-4Q15. NBA partnership and sponsorships In October 2014, Anta and the NBA announced a co-branding partnership that designated Anta as the NBA China’s Official Marketing and Merchandising Partner. Anta and NBA partnership press conference (Adam Silver, NBA Commissioner, NBA Star Kevin Garnett, ANTA Sports Chairman and CEO, Mr. Ding Shizhong)

Source: Company

Through this partnership, Anta is allowed to sell apparel and footwear with the trademark NBA logo on them. And Anta will design a special line for all 30 NBA teams in their respective colours and with their logos. This is significantly different to the deal with the NBA’s previous partner in China, Peak, which was just a marketing partnership. The NBA deal with Anta for co-branded footwear is for products that are more expensive at CNY399, but which offer a higher margin. And as the revenue contribution from this line increases as sales pick up (first full-year effect in 2015), the sales mix is likely to lead to margin enhancement. Furthermore, Anta has a strong portfolio of NBA player sponsorships, such as Kevin Garnett from the Minnesota Timberwolves, and Rajon Rondo and Chandler Parsons from the Dallas Mavericks. In our view, having a book of key player sponsorships will have a positive impact on demand for Anta’s products, particularly in China (the State Council issued guidelines in November 2014, stating that it would relax the broadcast rights for sporting events). We also note that people can watch NBA games on CCTV in China free).

Supplementary revenue growth drivers

Anta’s ‘ex-core’ brand sales are derived from Anta Kids, FILA, overseas and e-commerce sales. This category has historically seen high revenue growth (except for the 20% YoY decline for 2012 due to channel stuffing). Revenue growth in this category was 79% YoY in 2013, and though the figures were not reported for 2014, we estimate the number was around 55% YoY growth. Accordingly, we forecast “other” brand revenue growth of 32%, 28% and 20% YoY for 2015-17E, respectively (which would represent 20% of sales for 2013 and 25% for 2014). We expect this proportion to increase to 30-40% of sales by 2017, driven by: 1) Anta Kids benefiting from the State Council guidelines implementing fitness as a core component of school curriculums in China, 2) FILA continuing to gain traction in the fashionable sportswear market, and 3) exclusive products in e-commerce channels also picking up (previously used as destocking channel).

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Anta Li Ning Peak

CDX Xtep 361


- 32 -

Anta: sales breakdown


*Others include Anta Kids, FILA, e-commerce and overseas sales

Anta: estimated sales breakdown by category (2014)


FILA In 2009, Anta acquired FILA from Belle (1880 HK, not rated), which Belle disposed of to focus on its own brand of ladies footwear and the distribution of Nike and Adidas products. Anta has since focused on ramping up sales volume of the FILA brand. The FILA brand has unique positioning in Anta’s brand portfolio, as an Italian brand aimed at high-end clients, rather than at the mass market. As such, Anta has kept FILA’s operations as separate as possible, with its own product planning and network, to differentiate itself from Anta’s core brand. In 2013, FILA became profitable for Anta, with management saying it had contributed c.10% of the total revenue for that year. Given that 20% of the revenue contribution in 2013 came from brands other than the core Anta brand, we estimate that around CNY725m was generated by FILA. We expect FILA to account for at least 15% of the company’s sales in 2016-17, given that the brand has become more well-known as an international sports brand in China, and has grown in brand awareness within Asia, on the back of some of its high-profile

endorsements (ie, Shu Qi, a famous Chinese actress, and Lee Min Ho, Korean actor). The brand also teamed up with designer Anna Sui in February 2014 to create a line of sportswear called ‘Anna Sui for FILA Collection’, which we think is a big step in terms of getting exposure to the high-end segment. The number of FILA stores in China, Hong Kong and Macau was 519 in 2014, and the company expects this to rise to 600 by the end of 2015. As the sales volume of the FILA brand ramps up, we expect operating leverage to kick in to drive the operating margin of the brand up to the levels of Anta’s core brand (based on our estimate, this would be a mid-20s percentage for each of 2015-17E). Anta Kids We estimate that 9% of the company’s 2014 revenue was derived from Anta Kids (for kids aged 3-14). According to market research company ResearchInChina, China’s children’s wear market grew by 10% YoY, to CNY116bn in 2013, and at a CAGR of 11% over 2009-13. Meanwhile S&P Consulting expects revenue for the national kids wear market to grow by at least 20%+ over the next few years, on the back of China’s improving economic and social stratas, changes in parents’ consumption ideas, changes in taste towards fashionable clothing (rather than merely satisfying basic needs), as well as the introduction of the 2-child policy in 2013 (relaxed from the previous 1-child policy). During our on-the-ground research in Shenzhen in January 2015, we witnessed parents, while shopping at Anta for products for themselves, purchasing Anta Kids products for their children as well. This indicates to us that Anta Kids also serves as an indirect driver of its core brand sales, as brand loyalty among Chinese consumers is very strong (refer to the chart in sector piece); and as children grow up with Anta, they may stick with the brand, while expanding their horizons into more niche and functional sportswear of the same brand. The number of Anta Kids stores stood at 1,228, as at 31 December 2014, and the company expects to continue to expand this number to 1,600 by the end of 2015 to capitalise on this fragmented market and gain more market share. E-commerce as an engagement platform For Anta and its peers alike, e-commerce was mainly used as a destocking channel in 2010-13, when channel stuffing was a concern. Now, we believe the channel-stuffing issues have been largely resolved, and e-

(50%)

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2009 2010 2011 2012 2013 2014 2015E 2016E 2017E

(CNYm)

Anta core brand (LHS) Anta Kids, Fila, E-commerce (LHS)

Others YoY (RHS) Core brand YoY (RHS)

Core Brand75.0%

FILA10.0%

Anta Kids9.0%

E-commerce5.0%

Overseas1.0%


- 33 -

commerce can be used far more effectively as a customer-engagement tool as a way to increase sales revenue. Currently, of the company’s e-commerce SKUs, 10% comprises old stock, 20-30% is in-season products (offering same ticket prices to prevent clash with distributors) and 70% is exclusive products (ie, retro editions). According to management, e-commerce sales represented around 5% of group sales in 2013, and their goal is to increase this to 10% within the next 3 years. However, this goal seems conservative to us, given the substantial growth in online shopping in China over the past 10 years (revenue was up 48.7% for 2014, according to iResearch). First, Anta will launch in-season products, whereby both online and offline channels will see the same product launch at the same time. Second, Anta has expanded its e-commerce channels beyond its own website (Anta.cn) to include major Chinese e-commerce platforms, such as Tmall.com, JD.com, VIP.com, Amazon.cn as well as others in the pipeline. Last, and most importantly, Anta will launch exclusive products online in order to prevent the cannibalisation of its offline channels. According to management, it may offer retro editions (the re-launch of old products, in the style of Nike’s Air Jordan retro editions). The retro-model for the Air Jordan created a major hype in the “sneakerhead” community; and should Anta be able to replicate the same magnitude of hype, or even a fraction of it, it could successfully create a new revenue stream for its brand that is sustainable due to the brand loyalty of so-called sneakerheads.

Value-for-money functional attire

In 2014, Anta led peers in R&D spending with 4.3% of revenue spent on R&D (peers ranged from 2.2-3.6%). We believe continuous investment in developing new technology positions Anta well to address the evolution to a more health-conscious lifestyle, and thus the changing demand for more functional sportswear in China. We also note that Anta was a pioneer in the China sports industry when it set up its sports technology laboratory in 2005, and according to the company, more than 1,800 new shoe designs, 3,000 new apparel designs and 1,500 accessory products were launched in 2014.

Anta: R&D costs (as % of sales)

Source: Company

While Nike and Adidas are excellent examples of “jack of all trades” brands, in that they have a product portfolio that ranges across a number of sports (ie, basketball, football, American football, volleyball), this would be more difficult for the domestic sportswear brands to replicate as their resources are more limited. That said, domestic sportswear brands can differentiate themselves by focusing on quality, functionality and value for money – the main criteria that are valued the most by Chinese consumers when making purchasing decisions (61% of the decision, collectively), according to a survey by Deloitte in 2012. This is where we believe Anta shines over its domestic peers, as Anta’s products emphasise breakthrough technologies (ie, A-Web 2.0) and affordability. Based on Daiwa’s proprietary research on running shoes, Anta ranks at the higher end compared to those of its peers (including even those of Nike) on a value-for-money metric (the rating is based on various online customer review scores vs. each shoe’s respective cost). We would also point out that domestic players, such as Anta, have an edge on international players in the lower-tier cities, where most domestic players have set up shop, as the inhabitants of these lower-tier cities have lower average wages and disposable incomes, and so we believe they tend to be more price-sensitive, being more concerned with value-for-money than brand association/prestige. That said, we believe of the big 6 domestic sportswear brands in China, Anta is the only player with the resources (strong balance sheet and operating cash flows) to continue to support large-scale R&D operations. In our view, this is important, because as the market is moving towards demand for functional attire, R&D to develop technologies will not only allow Anta to further distance itself from its domestic peers, it will drive sales going forward, as functional attire usually has a higher ASP (vs. fashionable attire).

0%

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2010 2011 2012 2013 2014Anta Peak Li NingChina DX Xtep 361


- 34 -

Peer comparison: running shoes



- 35 -

Operating leverage in sight

As sales of Anta Kids and FILA continue to grow, we believe economies of scale will be reached and margins will improve in 2015-17E. We also expect raw-material cost declines and a reduction in discounts to distributors in 2016-17E to be margin-positive.

Optimistic on operating margin improvements

We forecast Anta’s earnings to increase by 24% YoY for 2015, and 16% YoY for each of 2016 and 2017, with the operating margin improving from 22.6% in 2014 to 24.7% in 2015E and 25.2% in 2016E, ahead of peers (below 20% in 2014) on the back of:

1) Supplementary brands (Anta Kids and FILA) reaching economies of scale.

2) Lower raw-material costs and lower-level trade fair discounts.

3) More efficient A&P spending. 4) Lower production costs on increasing in-house

production. Sub-brands reaching economies of scale On our estimates, Anta Kids and FILA represented less than 20% of total sales in 2014, which we see rising to 30% by 2017 for the reasons noted earlier. While the margin breakdown by brand is not reported by the company, management highlighted that Anta Kids’ gross margin remains below that for its core brand due to higher costs and a smaller inventory base. However, we expect the revenue contribution of this division to group sales (we estimate it accounted for 9% of revenue in 2014) to expand as demand for kids wear in China grows on the back of the State Council guidelines of November 2014. We look for this business to reach economies of scale in 2016-17 and achieve a gross margin in line with that of its core brand (a mid-40%, on our estimates).

On the other hand, FILA has a higher gross margin (around 50% in 2014, on our estimates) than Anta’s core brand (given its higher ASP). However, in terms of operating margin, given FILA’s relatively small contribution to sales (only around 10% of revenue in 2014) and that it operates as a distinct entity (apart from Anta’s core brand) under a self-operated retail model (which we highlight in our industry section is exposed to higher opex than a distributor model), the operating margin for this business, as indicated by management, remains below that of Anta’s core brand. However, as FILA’s contribution to sales increases, as we expect it to throughout 2015-17, we see further upside to FILA’s gross margin to around 55% by 2017, while its operating margin could be brought in line with Anta’s core brand. Lower raw-material costs and reduction in trade fair discounts to drive gross margin Given the 26% and 50% declines in cotton and oil prices in the past 12 months, which are among the main raw-material costs for Anta, we estimate a 2.1pp gross margin expansion over the end-2014-17 period, reaching 47.2% by the end of 2017E. Furthermore, the natural selection of stronger distributors, as well as subsidies to help distributors with their working capital over the past year, has given management more confidence in its distributors’ working capital/profitability (demonstrated by the healthy sell-through YTD in 2015). We believe there could be discount reductions in 2016-17E, which would further drive up the gross margin for the FILA brand. Now that Anta’s channel health is back to pre-Olympics levels, we think it could reduce the discounts it gives to distributors at trade fairs (which increased to 59-61% from 57-58% prior to the tough industry conditions in 2012-13), implying potential upside for our gross margin forecasts for the company.


- 36 -

Anta: gross and operating margins (2009-17E)


Anta: core brand value chain among channel participants (on a hypothetical retail price of CNY100 item)


A&P expenses likely to stabilise Management guides for an increase in A&P costs in 2015 to around 12-14% of sales, up from 12% in 2014 (which in turn increased by 0.9pp YoY from 2013 due to sponsoring the Asian Games and Winter Olympics in 2014). However, we believe management’s guidance is conservative, as the Asian Games and Winter Olympics were one-off events in 2014, and we expect 2015’s A&P to stay flat (as a percentage of sales and in line with

management’s guidance, albeit at the lower end) due to the full-year impact of the NBA co-branding partnership, offset by the absence of the sponsorship expenses for the Asian Games and Winter Olympics, as well as having a more efficient A&P spending strategy (as described below).

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2009 2010 2011 2012 2013 2014 2015E 2016E 2017E

GPm OPm

AntaSelling price: CNY39-41

Gross margin: 45%

DistributorsSelling price: CNY46-48

Gross margin: 15%

RetailerTicket price CNY100Retail discount: 25%Selling price: CNY75Gross margin: 37%


- 37 -

Management’s objective going forward is to split A&P between 3 different channels.

1. Sponsorship

2. Advertising: TV, online, digital marketing (ie, WeChat, Weibo, Tudou)

3. Decoration subsidies for store brand image

The increased use of online and digital marketing (the cheaper channels) may yield more effective results than traditional TV-format ads, given the increase use of mobile phones and online media in China, in particular among youngsters, who are important consumers of sportswear.

Increase in in-house production allows for greater control over the supply chain Anta has gradually increased the proportion of in-house production, which accounted for 54.4% of footwear in 2014 (vs. 48.9% in 2013). This allows it to more quickly respond to market conditions and changes in consumer preferences, while enhancing replenishment capabilities and reducing production costs and shortening lead times. Currently, Anta owns 29 shoe production lines, 1 outsole factory and 3 apparel factories.


- 38 -

Strong balance sheet and cash flow

With CNY1.9-2.7bn free cash flow per year (2015-17), we expect either M&A or an increase in dividends.

What to do with its war chest?

Cash position Following its most recent acquisition in 2009, and its policy of keeping its payout ratio at roughly 60%, Anta is currently the most cash-rich among the top-6 Hong Kong-listed domestic sportswear brands, with CNY4.7bn cash on hand at end-2014. It generated a very strong CNY1.7bn in operating cash flow in 2014, the highest among the stocks that we cover. Based on our estimates, Anta should generate free cash flows of CNY1.9-2.7bn per year from 2015-17E, and have a net cash balance in 2017E of CNY7.2bn. We see 2 ways Anta can utilise these funds: 1) M&A, and 2) return capital to shareholders through increased dividends. M&A opportunities around the corner? Anta has remained quiet since its acquisition of FILA from Belle in 2009, focusing on ramping up the brand. Since FILA began to grow its revenue and actually contribute to group earnings in 2014, management had said it is open to more M&A opportunities, particularly international brands, in niche segments such as outdoor, which would complement their existing brand portfolio. In our view, the industry’s secular growth along with management’s experience gained in developing FILA should allow for a faster path to profitability on new acquisitions, given FILA’s ramp-up occurred in the midst of the channel stuffing period.

Dividends While we assume in our forecasts that Anta maintains its historical regular dividend policy (~60-62% of net profit, assume no special dividend) in 2015-17E, any lack of M&A opportunities in 2015-17E would likely result in material increases in its payout ratio and/or special dividends, given our expectation of strong operating cash flow in 2015-17E. As shown below, we believe Anta can raise its payout ratio to near 100% if it keeps its net cash at 2014 levels for working capital purposes (which we estimate would boost its dividend yield to 5-6% in 2015). Anta: dividend per share (CNY) and payout ratio

Source: Company, Daiwa forecast

Healthy working capital

Anta did not buck the trend, and along with its domestic peers suffered from issues that were industry-specific rather than company-specific over 2010-13, such as the sector slowdown and oversupply of products and retail outlets. However, its working-capital management was better than peers during 2011-14, as evidenced by its lower inventory turnover and receivable days (when peers were experiencing channel-stuffing issues). While peers have spent (and are still spending) time fixing the problems that have accumulated over the past 4 years, Anta has been on a fast track to recovery, most notably being the first to report positive trade fair results for 1Q14 (of the 4 companies in the table below that report trade fair results). Also, Anta has the fastest cash conversion cycle among its peers, at 39 days in 2014, far ahead of its peers that range from 75 to 161 days.

62% 62% 62%

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DPS (LHS) Special DPS (potential) (LHS)

Payout ra tio (RHS) Potential payou t ratio (RHS)


- 39 -

Valuation We initiate coverage of Anta with a Buy (1) rating and 12-month target price of HKD20.0, based on a 19x 2015E PER (16x ex-net cash PER), which we deem as still attractive given our expectation of strong earnings growth of 24% and 16% YoY for 2015 and 2016E, respectively. The stock is trading currently at a 2015E PER of 16.4x, slightly above the weighted-average 14x PER of the major Hong Kong-listed China sportswear brands. We argue that rather than trading in line with its peers, Anta’s valuation premium to the peer average is justified due to its brand equity and leading domestic athletic footwear market share position. Meanwhile, we also have confidence in management’s execution capabilities, proven by Anta being the first China sportswear brand to emerge from the channel stuffing issues and report positive trade fair growth. We expect the potential operating leverage in 2015-17E we have discussed to be the main driver of consensus earnings revisions this year. Anta: 12-month rolling PER bands


Anta: 12-month forward PER


Anta: PER valuation premium/discount to sector


Risks

The main risks to our call would be aggressive expansion by the international peers in lower-tier cities, as well as discounting by peers leading to oversupply and channel stuffing. Secondary risks would include seasonality effects that could lead to a mismatch between supply and demand. 0

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- 40 -

Appendix I: company background, management and shareholders

Anta Sports Products Limited is a professional sportswear company established in 1994, in Jinjiang, Fujian. It is involved in the innovation, design,

research, development, manufacturing and retail of sports equipment. The company listed on the Hong Kong Stock Exchange in 2007.

Anta: key management members Name Position Experience

Mr. Ding Shizhong Chief Executive Officer, Executive Director and Board Chairman Responsible for overall corporate strategies, brand management, planning and business development of the Group

Mr. Ding Shijia Executive Director and Board Deputy Chairman Responsible for the management of the Group's footwear operations, with nearly 20 years of experience in China's sporting goods industry

Mr. Lai Shixian Chief Operating Officer, Executive Director and Vice President Responsible for the supply chain and administrative management of the Group

Source: Company

Anta: current shareholding structure

Source: Company

Mr. Ding Shizhong

ANTA Sports Products Limited (2020.HK)

Public

55.39% 37.96%


- 41 -

Appendix II: Technologies

Source: Company


- 42 -

Appendix III: Anta’s production cycle



■ Investment case We initiate coverage of Peak, a popular mass-segment-focused China sportswear brand, with a Buy (1) call. We expect a rerating for the stock in 2H15, on: 1) sustainable demand from secular industry sales growth and operating leverage (we forecast its EPS to rise by 24% for 2015 and 14% for 2016), and 2) productive use of its net cash of CNY2.7bn. We look for Peak, which has spent years establishing itself as the leader in basketball products, to see sustainable revenue growth (12% CAGR for 2014-17E), particularly in tier-3 cities where demand for fitness-related products is taking off, driven by rising incomes. Moreover, we expect it to further monetise its sponsorship of international events and marketing campaigns to drive

sales. We expect a decline in Peak’s in-house production ratio and a more effective advertising and promotion (A&P) strategy to drive up operating leverage (operating margin up 160bps to 17.5% for 2015E). Peak generates strong operating cash flow (CNY440m for 2015E, above our net profit forecast of CNY397m), and currently has net cash of CNY1.29/share (60% of its market cap). It operates under a distributor business model, which means it needs little capital for investment. The company’s dividend yield (5-7% for 2015-17E) is one of the highest among its domestic peers, and we think it offers a risk/ return profile that is superior to its peers’, given its higher EPS growth. ■ Catalysts A potential reduction in the discounts Peak offers its distributors (from 65% currently) would be the main share-price catalyst, in our view. Also, while not factored into our forecasts, M&A opportunities or greater-than-expected dividends driven by a special dividend (to match the c.110% total dividend payout in 2013) in 2015 would likely be positive share-price catalysts. ■ Valuation We initiate coverage with a Buy (1) call and 12-month TP of HKD3.1, set

at a 2015E PER of 13.2x (in line with the sector’s past-5-year average). ■ Risks The main risk is aggressive discounting by peers leading to an oversupply of Peak products and channel stuffing.


22 June 2015

Peak Sport Products

Initiation: eyes on the prize

• Stock could be rerated in 2H15, driven by secular industry sales growth as the fitness wave sweeps China

• We forecast EPS growth of 24% and 14% YoY for 2015-16E, as its operating margin catches up with peers’

• Initiating with a Buy (1) call and 12-month TP of HKD3.1; we recommend Peak for its exposure to lower-tier Chinese cities



Peak Sport Products1968 HK

Target (HKD): 3.10Upside: 14.4%18 Jun price (HKD): 2.71

Buy (initiation)


1

2

3

4

5

90

98

105

113

120

1.8

2.1

2.3

2.6

2.8



Peak Sport (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 1.89-2.80Market cap (USDbn) 0.733m avg daily turnover (USDm) 1.46Shares outstanding (m) 2,098Major shareholder Mr. Xu Jingnan and family (69.0%)

Financial summary (CNY)Year to 31 Dec 15E 16E 17ERevenue (m) 3,223 3,621 4,035Operating profit (m) 569 653 745Net profit (m) 397 452 510Core EPS (fully-diluted) 0.189 0.215 0.243EPS change (%) 23.8 13.9 12.9Daiwa vs Cons. EPS (%) 13.8 11.5 10.4PER (x) 11.5 10.1 8.9Dividend yield (%) 5.4 6.2 7.0DPS 0.118 0.134 0.151PBR (x) 1.0 1.0 0.9EV/EBITDA (x) 2.6 2.0 1.6ROE (%) 9.1 9.8 10.5





- 44 -

Growth outlook Peak: net profit and net profit growth

We forecast Peak’s revenue to rise at a CAGR of 12% over 2015-17, supported by a decline in raw-material costs and a reduction in trade fair discounts starting in 2016. We also expect increased operating leverage, with operating-margin expansion of 2.3pp over 2014-17E, driven by a reduction in staff costs (as a percentage of sales) on an increasing proportion of outsourced production. We forecast Peak’s net profit to rise by 24% YoY to CNY397m for 2015, 14% YoY to CNY452m for 2016, and 13% YoY to CNY510m for 2017.


Valuation Peak: 12-month forward PER

The stock is trading at a 2015E PER of 12x (below the weighted-average for its Hong Kong-listed peer group, at 14x, and the global peer average of 28x, on Daiwa’s and the Bloomberg consensus forecasts). However, we estimate that the stock is trading at a 2015E ex-net cash PER of only 4.7x. Our 12-month target price of HKD3.1 is based on a 2015E PER of 13.2x, in line with the sector’s past-5-year average. We argue that Peak should at least trade in line with its Hong Kong-listed peers, as we forecast it to deliver better EPS growth (EPS growth of 24% in 2015 vs. 8% for peers), and because it focuses on the fast-growing mass-market and functional segments (vs. the high-end segment).


Earnings revisions Peak: Bloomberg-consensus EPS revisions

The 2015-16 Bloomberg-consensus EPS forecasts for Peak have been pretty stable since the start of 2015. Our EPS forecasts for the same period are 12-14% above consensus, which we think reflects our more upbeat expectations for the company’s operating-leverage potential.

Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

31%

-5%

-60%

-21%

31%24%

14% 13%

(80%)

(60%)

(40%)

(20%)

0%

20%

40%

0

100

200

300

400

500

600

700

800

900

2010 2011 2012 2013 2014 2015E 2016E 2017E

(CNYm)


9.8

12.9

6.7

0

2

4

6

8

10

12

14

16

Oct

-09

Jan-

10Ap

r-10

Jul-1

0

Oct

-10

Jan-

11Ap

r-11

Jul-1

1

Oct

-11

Jan-

12

Apr-1

2Ju

l-12

Oct

-12

Jan-

13Ap

r-13

Jul-1

3

Oct

-13

Jan-

14Ap

r-14

Jul-1

4

Oct

-14

Jan-

15Ap

r-15

avg sd+1 sd-1

(x)

0.10

0.12

0.14

0.16

0.18

0.20

0.22

0.24

Jan-

14

Feb-

14M

ar-1

4

Apr-1

4

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15M

ar-1

5

Apr-1

5

May

-15

Jun-

15

CNY

2015E EPS 2016E EPS

Buy (initiation)


1

2

3

4

5


- 45 -

Key assumptions


Cash flow (CNYm)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017EA&P (as % of sales) 10.8 14.2 14.0 10.7 10.6 10.2 11.0 11.0GPm - Footwear (%) 38.0 38.9 36.0 35.2 36.5 37.5 38.5 39.0GPm - Apparel (%) 38.1 40.0 37.1 35.6 39.0 40.0 40.3 40.5

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017EFootwear 1,814 2,041 1,348 1,044 1,150 1,307 1,472 1,642Apparel 2,318 2,487 1,481 1,509 1,633 1,856 2,090 2,332Other Revenue 118 119 74 60 58 60 60 60Total Revenue 4,249 4,647 2,903 2,613 2,841 3,223 3,621 4,035Other income 3 15 21 19 23 26 30 33COGS (2,633) (2,814) (1,845) (1,686) (1,762) (1,969) (2,192) (2,427)SG&A (632) (926) (689) (585) (651) (711) (806) (896)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 988 922 390 360 451 569 653 745Net-interest inc./(exp.) 10 15 16 30 37 36 36 33Assoc/forex/extraord./others 0 0 0 0 0 0 0 0Pre-tax profit 998 937 406 390 489 605 689 778Tax (176) (159) (95) (146) (168) (208) (237) (268)Min. int./pref. div./others 0 0 0 0 0 0 0 0Net profit (reported) 822 778 311 244 321 397 452 510Net profit (adjusted) 822 778 311 244 321 397 452 510EPS (reported)(CNY) 0.392 0.371 0.148 0.116 0.153 0.189 0.215 0.243EPS (adjusted)(CNY) 0.392 0.371 0.148 0.116 0.153 0.189 0.215 0.243EPS (adjusted fully-diluted)(CNY) 0.392 0.371 0.148 0.116 0.153 0.189 0.215 0.243DPS (CNY) 0.146 0.114 0.081 0.127 0.095 0.118 0.134 0.151EBIT 988 922 390 360 451 569 653 745EBITDA 1,010 953 428 403 496 616 698 788

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017EProfit before tax 998 937 406 390 489 605 689 778Depreciation and amortisation 22 32 40 47 50 47 45 43Tax paid (130) (178) (116) (85) (176) (168) (208) (237)Change in working capital 265 (472) (158) 167 55 (8) (131) (140)Other operational CF items 6 (8) 8 (12) (34) (36) (36) (33)Cash flow from operations 1,160 311 180 507 384 440 359 410Capex (122) (119) (109) (37) (21) (1) (4) (5)Net (acquisitions)/disposals 0 0 0 0 0 0 0 0Other investing CF items 470 (192) (387) (818) (512) (76) (160) (175)Cash flow from investing 348 (311) (496) (855) (534) (77) (163) (180)Change in debt 0 161 335 270 286 0 0 0Net share issues/(repurchases) 0 1 0 0 1 0 0 0Dividends paid (349) (227) (272) (217) (200) (257) (264) (300)Other financing CF items 0 (2) (7) (14) (20) (21) (21) (21)Cash flow from financing (349) (67) 56 38 67 (278) (285) (321)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 1,159 (68) (260) (310) (83) 86 (90) (90)Free cash flow 1,038 191 71 470 363 439 355 405


- 46 -


Key ratios (%)


Company profile

Peak Sports is a Chinese sportswear company founded in 1989 in Fujian, China. It is one of the largest sportswear companies in mainland China that designs and manufactures sportswear products, including athletic footwear, apparel and accessories.

As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ECash & short-term investment 2,663 2,697 2,763 3,281 3,752 4,030 4,199 4,378Inventory 335 421 386 366 346 341 387 435Accounts receivable 765 1,089 1,093 978 987 984 1,081 919Other current assets 0 0 0 0 0 0 0 0Total current assets 3,762 4,208 4,242 4,624 5,084 5,355 5,667 5,731Fixed assets 396 482 543 533 506 507 511 516Goodwill & intangibles 14 16 20 23 25 25 26 26Other non-current assets 28 174 244 268 259 198 155 115Total assets 4,200 4,880 5,049 5,448 5,874 6,086 6,359 6,389Short-term debt 0 161 496 530 702 702 702 702Accounts payable 608 562 373 415 419 404 415 161Other current liabilities 63 55 30 65 68 68 68 68Total current liabilities 671 777 899 1,010 1,190 1,175 1,186 932Long-term debt 0 0 0 237 350 350 350 350Other non-current liabilities 47 59 67 80 87 87 87 87Total liabilities 718 836 965 1,327 1,628 1,612 1,623 1,369Share capital 18 18 18 18 18 18 18 18Reserves/R.E./others 3,463 4,025 4,065 4,103 4,228 4,456 4,717 5,001Shareholders' equity 3,482 4,044 4,083 4,122 4,247 4,474 4,736 5,020Minority interests 0 0 0 0 0 0 0 0Total equity & liabilities 4,200 4,880 5,049 5,448 5,874 6,086 6,359 6,389EV 1,890 2,017 2,286 2,038 1,854 1,575 1,406 1,228Net debt/(cash) (2,663) (2,536) (2,266) (2,514) (2,699) (2,978) (3,147) (3,325)BVPS (CNY) 1.660 1.927 1.946 1.965 2.024 2.132 2.257 2.392

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ESales (YoY) 37.3 9.4 (37.5) (10.0) 8.7 13.4 12.4 11.4EBITDA (YoY) 38.7 (5.6) (55.1) (5.8) 23.0 24.3 13.3 12.8Operating profit (YoY) 38.6 (6.7) (57.7) (7.6) 25.4 26.1 14.8 14.0Net profit (YoY) 30.9 (5.4) (60.1) (21.3) 31.3 23.8 13.9 12.9Core EPS (fully-diluted) (YoY) 8.5 (5.4) (60.1) (21.3) 31.1 23.8 13.9 12.9Gross-profit margin 38.0 39.4 36.5 35.5 38.0 38.9 39.5 39.8EBITDA margin 23.8 20.5 14.8 15.4 17.5 19.1 19.3 19.5Operating-profit margin 23.3 19.8 13.4 13.8 15.9 17.7 18.0 18.5Net profit margin 19.4 16.7 10.7 9.3 11.3 12.3 12.5 12.6ROAE 25.4 20.7 7.6 6.0 7.7 9.1 9.8 10.5ROAA 21.6 17.1 6.3 4.7 5.7 6.6 7.3 8.0ROCE 30.5 24.0 8.9 7.6 8.9 10.5 11.5 12.6ROIC 88.8 65.8 18.0 13.2 18.8 24.5 27.8 29.8Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Effective tax rate 17.6 17.0 23.4 37.4 34.4 34.4 34.4 34.4Accounts receivable (days) 69.9 72.8 137.2 144.6 126.2 111.6 104.1 90.5Current ratio (x) 5.6 5.4 4.7 4.6 4.3 4.6 4.8 6.2Net interest cover (x) n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Net dividend payout 37.1 30.7 55.0 108.8 62.2 62.2 62.2 62.2Free cash flow yield 22.8 4.2 1.6 10.3 8.0 9.6 7.8 8.9


- 47 -

Eyes on the prize

We believe Peak’s core basketball offering will support robust sales growth over 2015-17E, driven by its focus on tier-3 and lower cities.

Basketball focus should boost revenue growth

Against the backdrop of growing awareness of health and fitness in China, and the State Council’s guidelines on the development of 3 key sports (basketball, football and volleyball), we look for strong secular industry sales growth going forward. At the company level, we forecast Peak’s revenue to increase by 13% YoY for 2015 and 12% YoY for 2016 (from 9% YoY for 2014), largely driven by the following factors. First, it has significant distribution network exposure in China’s lower-tier cities (tier 3 and below), where BCG forecasts the population of mass-affluent customers will grow by 13% pa between 2010 and 2020. Second, we expect the company’s performance-centric basketball product offerings to allow it to capture the increasing demand for functional and value-for-money products. Third, we like Peak’s relatively large exposure to overseas markets, driven by the monetisation of international sporting events and player sponsorships. Peak: revenue


Peak’s 4Q15 trade fair sales (which it reported on 8 April 2015) increased by a mid-teen percentage YoY, representing the sixth consecutive period of positive YoY order-book growth. We see this as a good sign that sell-through at the distributor level is healthy. Also, because of Peak’s no-inventory returns policy, its distributors have to be prudent when ordering. They have told us that Peak products are in demand and they are confident in their ability to clear these products this year. China Sportswear Sector: trade-fair results (YoY %)

Anta Peak Li Ning Xtep 3611Q13 - 20 to 30% flat n/a - 15 to 20% -23%2Q13 - 15 to 25% - mid-twenties n/a - 15 to 20% -23%3Q13 - 10 to 20% n/a n/a -20% -19%4Q13 - 5 to 15% n/a n/a - 15-17% -17%1Q14 + high single digit n/a n/a - high single digit -11%2Q14 + high single digit + high single digit n/a - mid single digit -11%3Q14 + high single digit + mid-teens n/a - low single digit -7%4Q14 + low double digit + mid-teens n/a flat 8%1Q15 + low double digit + mid-teens +mid-twenties + low single digit 8%2Q15 + low double digit + mid-teens + mid-teens + low single digit 11%3Q15 + low double digit + mid-teens + high-teens + low single digit 16%4Q15 + low double digit* + mid-teens +low-teens + low single digit 18%1Q16 tba + mid-teens tba tba tba

Source: Companies

Peak: trade-fair order results breakdown (YoY%)

1Q15 2Q15 3Q15 4Q15 1Q16 Footwear ASP flat flat +low-double digit +mid-single digit +mid-single digitVolume +mid-teens +mid-20 +mid-teens +mid-40 +high-twenties Apparel ASP flat flat -low-single digit flat -high single digitVolume +mid-teens + high-single digit +low-teens -low-double digit +mid-single digit

Source: Company

China sportswear sector: SSSG (YoY%) Anta Peak Li Ning Xtep 361

1Q13 flat flat n/a flat -1.5%2Q13 flat flat n/a flat -0.8%3Q13 flat + low single digit n/a flat 0.0%4Q13 + mid single digit + low single digit n/a n/a 1.5%1Q14 + mid single digit + low single digit n/a + low single digit 1.8%2Q14 + low double digit + low single digit n/a + mid single digit 2.8%3Q14 + high single digit + low single digit n/a + mid single digit 4.7%4Q14 + high single digit + low single digit +mid single digit + mid single digit 5.5%1Q15 + high single digit* +mid single digit +mid single digit + mid single digit 6.3%

Source: Companies

Mass-market segmentation is key Peak predominantly focuses on tier-3 cities. We believe this strategy is well executed given Peak’s competitive pricing, which is generally the key purchasing criteria in lower-tier cities, rather than brand image. Peak has a bigger footprint than international brands in tier-3 cities. For example, at the end of December 2014, over 86% of Peak’s 6,004 stores were located in tier-3 cities, while Belle (1880 HK, not rated), a distributor of international brands Adidas and Nike,

37%

9%

-38%

-10%

9%13% 12% 11%

(50%)(40%)(30%)(20%)(10%)0%10%20%30%40%50%

0

1,000

2,000

3,000

4,000

5,000

2010 2011 2012 2013 2014 2015E 2016E 2017E

(CNYm)

Revenue (LHS) YoY (RHS)


- 48 -

had 55% of its 6,055 stores in tier-3 cities, according to its annual report. While 361 Sport (1361 HK, not rated) is the only China sportswear company that reports this breakdown, with 70% of its stores in tier-3 cities at end-2014, our market research leads us to believe that Peak has the most exposure to the tier-3 (or lower) cities among its domestic peers.

As we highlighted in the industry section of this report, we believe the mass-market segment of consumers in China is the segment with the greatest potential, especially as disposable incomes are increasing and consumers are becoming more aware of the benefits of fitness. Notwithstanding the lifestyle evolution and changes in consumption led by the fitness trend, China’s central government is also keen to promote sports and physical education among today’s younger generation.

Peak: price point comparisons with Nike

Source: Company

Peak: store breakdown by type of city

Source: Company

5% 6% 6% 5%4% 3%

21% 21% 20%17%

13% 12%

74% 73% 74%77%

84% 86%

0%

10%

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30%

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50%

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70%

80%

90%

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1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2009 2010 2011 2012 2013 2014First-tier city (LHS) Second-tier city (LHS) Third-tier city (LHS)

First tier as % of total (RHS) Second tier as % of total (RHS) Third tier as % of total (RHS)


- 49 -

Basketball: Peak’s differentiating factor among sportswear brands Basketball is now one of the most popular team sports in China. According to the Chinese Basketball Association (CBA), around 300m people play basketball regularly (either recreationally or competitively) in China (out of a total population in China of 1.4bn). With basketball being one of the key sports named in the State Council’s guidelines as a sport it aims to further popularise in China, we believe the fitness trend sweeping China and further supportive policies to develop basketball in China will be positive for the growth of Peak’s sales going forward. An example of some of the positive policies announced recently by the government include its relaxation of the broadcasting rights to sports games and events, whereby each TV station in China is now allowed to directly purchase or resell their broadcast rights to sporting games and events from home and abroad. Currently, CCTV (the predominant state television broadcaster) provides free viewing of all US NBA games. As such, we believe increased overseas investment (through player and/or event sponsorships) would flow through to Peak’s domestic sales, given the exposure such investment would provide. We believe Peak’s focus on basketball will be a key driver for its success – much like the case with Asics, a Japanese sportswear brand that has experienced solid revenue growth (10% sales CAGR from FY10-14) and, like Peak, is a brand that many would consider to be more technical/ functional than its competitors. Asics’ main focus is footwear for running, and it has 4 distinctive categories of running shoes for different purposes (Structured cushioning, Cushioning, Trail and Natural33). While pricing is on a par with Nike’s running shoes (Asics’ Gel-series range typically from USD100-200; Nike’s Flyknit series run around USD120-150), Asics’ running shoes are highly ranked. In Running USA’s 2013 National Runner Survey, its running shoes were ranked No.1 in terms of being the top purchased running shoe brand. While Peak is focused on another niche (basketball), a similar comparison can be drawn with Nike. On average, Peak’s basketball shoes are priced 40% below those of Nike’s (in their respective target segments), while the value proposition determined by customer review ratings and respective prices indicates that its value-for-money offering is higher.

Moreover, Peak’s Tony Parker signature shoe (TP9) was placed 8th in the top-10 list of best sneakers of 2013 on Counterkicks, a popular American “sneakerhead” website, as well as being crowned the most surprising sneakers and “one of the top shoes in almost every category”. Peak: sales breakdown by product category (2014)

Source: Company *Others includes cross training, tennis, outdoor, and casual

Leading overseas exposure Based on our analysis, among the domestic sportswear players under our coverage, Peak has a much higher sales contribution from overseas markets: at 23% of group sales in 2014 (up 3pp YoY), compared with just 3% for Li Ning in the same year. Peak’s overseas revenue expanded by 23% YoY for 2014, compared with 28% YoY for Li Ning in the same year. We expect Peak’s overseas sales growth to continue in 2015, though overseas sales as a percentage of group sales is likely to decline as the company’s domestic sales rise. Also, we foresee forex risks stemming from the Euro’s depreciation against the dollar, given that the company’s Euro-denominated sales made up 45% of its overseas sales last year. Similar to its strategy in China, Peak also targets the lower-tier segment in international markets, which caters to consumers in those markets who are considered price-sensitive. We estimate that Peak’s basketball footwear is on average 55-67% cheaper than Nike’s (55% at the low-end, 67% in mid and high-end). Furthermore, we believe Peak has gained increasing recognition in both domestic and international markets in recent years as a result of its sponsorship of well-known basketball players, like the NBA’s Tony Parker (of the San Antonio Spurs). In turn, its total group sales rose by 9% YoY for 2014, and we look for 13% growth for 2015 and 12% for 2016E.

Basketball25-30%

Running25-30%

Others*40-50%


- 50 -

Peak: sales breakdown by geographical area

Source: Company

Peak vs. domestic peers: overseas sales comparison

Source: Company

*Anta stopped reporting its sales breakdown attributable to overseas in 2012

Peak has strong exposure to Europe, which saw a 133% YoY growth in sales in 2014, accounting for 45% of its total overseas sales and 10% of total group sales in the same period. Management attributed this growth to its successful marketing campaigns in the Netherlands, France, Germany and Slovakia, as well as the major sports events held during that period (ie, the 2014 Winter Olympics). Note also that Peak is the official and exclusive footwear partner of the International Basketball Federation (FIBA), which hosted its first-ever FIBA Basketball World Cup in September 2014 in Spain. We expect the positive impact from this sponsorship to be evident in its 2015 results.

Peak: overseas sales breakdown

Source: Company

Peak is actively expanding the number of international distributors, particularly in Europe. Management expects to expand the number of international distributors from 80 currently to 100 by end-2015.

According to management, the company is actively seeking an all-star level sponsorship in the NBA. If a high-level sponsorship deal materialises, Peak’s sales growth for 2016 could surprise positively, we believe, driven by its increased NBA exposure in overseas markets. We see the overseas market as a key sales growth driver for Peak, given its already established foothold in the US, and believe its value proposition for its basketball shoes is already among the highest vis-à-vis its domestic peers and even international brands.

9% 9% 10% 13%20% 23%

91% 91% 90% 87%80% 77%

0%

20%

40%

60%

80%

100%

0

2,000

4,000

6,000

2009 2010 2011 2012 2013 2014

(CNYm)

Overseas markets (LHS) China market (LHS)

Overseas as % of total sales (RHS) China as % of total sales (RHS)

0%

5%

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100

200

300

400

500

600

700

2009 2010 2011 2012 2013 2014

(As % of sales)(CNYm)

Anta Peak Li Ning*Anta (RHS) Peak (RHS) Li Ning (RHS)*

0

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2009 2010 2011 2012 2013 2014

(CNYm)

Europe Asia North America South America Africa Australia


- 51 -

Operating leverage

We forecast Peak’s operating margin to improve from 15.9% in 2014 to 17.7-18.5% in 2015-17E from a more favourable sales mix as well as lower costs and wholesale discounts.

Margin expansion

We forecast Peak’s earnings to increase by 24% YoY for 2015 and 14% YoY for 2016, driven by operating leverage as a result of: 1) a more profitable sales mix – comprising replenishment orders and in-season products, which carry higher gross margins than out-of-season products, 2) a reduction in wholesale discounts and production costs, 3) stabilisation of A&P expenses offsetting the impact of its loss of the NBA partnership (to Anta), and 4) a potential new all-star sponsorship.

Peak: net profit growth (2010-17E)


Sales-mix margin enhancement on in-season products and replenishment orders We look for Peak’s gross margin to increase in 2014-17E (by 2pp to 40% by 2017E) as its sales mix leans more heavily towards in-season products (to 70-80% of sales versus 40-50% before), which carry a higher ticket price and margin than heavily discounted out-of-season products, promoted in order to clear excess inventory. Peak also now enforces a no-return policy on its distributors, and advises them to order prudently in order to avoid over-ordering. This new initiative had a positive impact on the company’s financials in 2014 as distributors’ replenishment orders (ie, those placed after they sell out of trade fair inventory) on which Peak enjoys a higher margin due to the lower discount on these orders versus trade fair orders, increased to account for between 20% and 30% of sales in 2014. This increase in replenishment orders is positive for both Peak and the distributors alike, as it reduces the risk of channel stuffing (when distributors over-order and get stuck with heavy discounting to clear old inventory). Nevertheless, for the sake of prudency, our forecasts are conservative, because even at a gross profit margin of 40% in 2017E, this is still at the lower end of its 5 peers’ range in 2014 (40.8-45.1%), implying further room for catch-up if Peak can further reduce its order book discounts and production costs. Peak: gross-profit margin versus domestic peers

Source: Daiwa

31%

-5%

-60%

-21%

31%24%

14% 13%

(80%)

(60%)

(40%)

(20%)

0%

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40%

0

100

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300

400

500

600

700

800

900

2010 2011 2012 2013 2014 2015E 2016E 2017E

(CNYm)


30%

35%

40%

45%

50%

55%

60%

65%

2010 2011 2012 2013 2014 2015E 2016E 2017E

Anta Peak Li NingCDX* Xtep 361


- 52 -

Peak: production cycle

Source: Daiwa

Margin upside surprise from reduction in discounts and production costs With the cost of cotton and oil prices declining, both of which constitute large portions of Peak’s cost of goods sold, we expect Peak to see margin expansion in 2016. Management also believes declining discounts to distributors is within sight, and could be reduced from 65% currently to 62% in 2016, effectively bumping up the gross margin by 3pp. While we bake in a more conservative 1.5pp increase in the gross margin from 38% in 2014 to 39.5% in 2016, any incremental cost savings from the declining cost of goods sold above our estimates would be positive catalysts for our call. While staff costs as a percentage of sales increased by 1.9pp YoY to 15.8% in 2014, this was attributed to the increase in in-house production (footwear self-production up 12pp YoY to 84% of footwear production volume; apparel self-production up 11pp YoY to 50% of apparel production volume). While we acknowledge self-production gives the company more control over costs and lead time, management noted that its self-production utilisation rate is already near full capacity at over 90% in 2014. A further increase in demand, which we expect to be driven by the secular industry growth and health awareness in China, would likely lead to the excess production being outsourced. We expect Peak’s staff costs (as a percentage of sales) to decline (to 15.5% in 2015 and 15% in 2016) and drive operating leverage in 2015-17E, as outsourced production generally sees better economies of scale and lower costs, as the fixed costs are usually borne by the OEMs.

Peak: COGS breakdown (2009-14)

Source: Company

A&P budget freed up for more sponsorships According to Peak’s website, the company was ranked No.3 globally in terms of NBA sponsorship in 2014 and currently has a sponsorship roster of 8 NBA players in 8 NBA teams (see Appendix II). According to management, Peak is ranked No.1 among its domestic peers in terms of sales volume of basketball footwear. We believe much of its success previously was supported by its targeted development in the basketball sector. Up until October 2014, Peak was the Official Marketing Partner of the NBA in China, but has since lost that partnership to Anta (2020 HK, HKD17.26, Buy [1]). While this development was no doubt a blow to the company, we believe the silver lining is the freed -up A&P budget the lost NBA partnership has created. As a result, Peak now has the capital to expand its sponsorship roster with all-star level players, which we believe will allow it to increase sales, as signature shoes

Trade fair Selling period

Sales of inventory from trade fair

(70-80% of sales)

Replenishment orders

(20-30% of sales)

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Trade fair orders

Production

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Raw materials Direct labour Overhead

Total % of COGS (RHS)


- 53 -

generally have a higher ticket price and generate higher margins than non-signature shoes. Peak’s A&P expenses in 2014 accounted for 10.6% of its sales (around CNY300m), the lowest among its domestic peers (11-21%). According to Forbes (table below), endorsement costs for NBA players ranged from USD5.5m to USD44m per year in 2014. On our back-of-the-envelope calculation, based on its amount of freed-up capital, Peak could look at an endorsement ranging from USD5-10m/year (which if it materialised in 2016, would lead to a flat-to-80bps YoY increase in the A&P ratio to 10.2-11% of sales, amounting to CNY370-400m in 2016, based on our estimates). In our model, we forecast A&P expenses to increase by 80bps YoY to 11% of sales in 2016, which represents the budget to sponsor 1 player at USD10m/year, or 2 players at USD5m/year. Forbes: NBA player endorsements (2014) Name Brand Endorsement cost (USDm)Stephen Curry Under Armour 5.5Chris Paul Nike (Jordan brand) 6Blake Griffin Nike (Jordan brand) 7Carmelo Anthony Nike (Jordan brand) 8Dwayne Wade Li Ning 12Derrick Rose Adidas 20Kobe Bryant Nike 26Kevin Durant Nike 35LeBron James Nike 44

Source: Forbes

Peak: A&P costs (as % of sales)

Source: Company

5%

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2010 2011 2012 2013 2014Anta Peak Li NingCDX Xtep 361


- 54 -

CNY2.7bn war chest for M&A With a net cash position of CNY2.7bn at end-2014, Peak’s decision not to pay a special dividend in 2014 could mean it is saving up for something big.

Productive use of strong cash position

Despite having only paid out special dividends in 2012 and 2013, the absence of one in 2014 stands out, especially given the company’s strong operating cash flow (CNY440m in 2015E, up 15% YoY, above our earnings forecast of CNY396m for the year), and that it had net cash of CNY1.29/share at end-2014 (60% of its current market cap). We believe the reason for its cash hoarding is that the company is gearing up for M&A activity in 2015. M&A opportunities Management has in the past highlighted that it has been on the lookout for potential acquisitions, likely an international brand. Given the firm’s recent goal to develop a footprint in the football (soccer) space, and a lack of related products available in China for this sport, we suspect the target brand would be an international football brand which would enhance the company’s brand portfolio. We would not expect the target brand to be a high-end brand, due to Peak’s positioning the low-mid end mass segment. Dividends On the dividend side, while we assume Peak only maintains its 2014 dividend payout ratio (62% of net profit) over the 2015-17 period, any lack of M&A deals materialising over 2015-17E would likely result in material increases in its dividend payout ratio and/or special dividends to return capital to shareholders, given our expectation of strong operating cash flow from 2015-17E.

As shown in the following chart, we believe Peak can lift its payout ratio to over 82-90% in 2015-17E if it just keeps its net cash at the 2014 level for working capital purposes. Peak: dividend per share (CNY) and payout ratio


35% 37%31%

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109%

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- 55 -

Valuation We initiate coverage of Peak with a Buy (1) rating and a 12-month target price of HKD3.1, based on a 13.2x 2015E PER, in line with the sector’s past-5-year average. We believe Peak’s ex-net cash 2015E PER of 4.7x should appeal, given our view of the company as a distinctive player targeting basketball, that is set to deliver peer-leading earnings growth in 2015. The stock is trading currently at a 12x 2015E PER, below the weighted-average PER of the major Hong Kong-listed China sportswear brands. We argue that Peak should trade in line with, if not above, its peers, given our forecast for it to record peer-leading EPS growth of 24% YoY for 2015 (vs. peers’ average growth of 8% YoY, on our and the Bloomberg forecasts). Peak: rolling PER bands


Peak: 12-month forward PER


Peak: PER valuation premium/discount to sector


Risks

The main risk to our call on Peak would be aggressive discounting by peers leading to an oversupply of Peak products and channel stuffing. Secondary risks to our view include greater-than-expected price competition among domestic and international brands, as well as seasonal factors resulting in a mismatch between supply and demand. Company-specific risks include a decline in Peak’s sales overseas and unsuccessful attempts to tap into sports such as football. Due to Peak’s exposure to the European market (10% of sales in 2014), the depreciation of the EUR is also a concern given the possibility of translation losses.

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- 56 -


Peak Sports is a sportswear company founded in 1989 in Fujian, China. One of the largest sportswear companies in Mainland China, the company designs and manufactures sportswear products, including athletic footwear, apparel and accessories. Peak: senior management Name Position Experience Mr. Xu Jingnan Founder of the Group, Chairman, and

Executive Director Key decision-maker of the Group, responsible for the operation of the Board as well as the Group's overall strategic planning and management of the Group's business

Mr. Xu Zhihua Chief Executive Officer and Executive Director

Primarily responsible for brand management and marketing, as well as management of distributors and sales channels of the Group

Mr. Xu Zhida Executive Director Primarily responsible for the Group's product sales, production, research and development, and product design

Source: Company

Peak: shareholding structure

Source: Company

Mr. Xu Jingnan and family

Peak Sports Products Limited (1968.HK)

Public

68.84% 31.16%


- 57 -

Appendix II: NBA sponsorships

Peak: sponsorships in the NBA

Source: Daiwa


■ Investment case We initiate coverage of Chinese sportswear brand Li Ning with an Underperform (4) rating, as we expect the stock to be derated in 2015, on the back of: 1) its retail-focused business model dragging down the operating margin, 2) channel-stuffing risks, and 3) more downside than upside on product expansion strategies. With the stock trading currently at a 20x 2016E PER and after its 23% YTD rally, we believe most of the positives have been priced in. 2015 could disappoint. We believe the consensus is too optimistic about the prospect of Li Ning returning to positive earnings in 2015, as its transformation progress faces execution risk. We expect its rental costs to remain high, at 28% of its retail revenue, well above the peer average of 10-20%. Moreover, we see

retail-related operating expenses (logistics, store renovations) offsetting any gains from sales growth and sales-mix margin improvements. We also see a risk of an inventory build-up in its retail and wholesale channels, as Li Ning’s trade fair order-book growth (double-digit YoY) has been much higher than its SSS growth (mid-single digit YoY) in recent quarters. Poor product positioning. Li Ning’s product pricing is expensive relative to its domestic and international peers. Judging from our sample of online product reviews, the company’s value proposition is still lacking. Despite its recent foray into lifestyle products with lower ASPs to cater to mass consumers, Li Ning’s late entrance to this market, along with its exposure to price-sensitive consumers in this segment, exposes it to more risk than needed amid its transformation/recovery plan. ■ Catalysts Potentially negative share-price catalysts include: 1) further earnings disappointment, and 2) a potential sale of TPG’s stake. ■ Valuation We initiate coverage with an Underperform (4) rating and a 12-month TP of HKD3.10, based on a PBR of 1.5x (1SD below the stock’s

past-2-year average) applied to our fully-diluted 2015E BVPS of CNY1.67. ■ Risks A faster-than-expected recovery in profitability and better-than-expected execution of its transformation plan are the key risks to our bearish call.


22 June 2015

Li Ning

Initiation: tripping on its own laces

• Unlike the street, we forecast Li Ning’s net earnings to remain negative in 2015

• Adoption of a retail-focused business model likely margin dilutive; we expect net margin to underperform peers in 2015-17

• Initiating with an Underperform (4) rating and target price of HKD3.10



Li Ning2331 HK

Target (HKD): 3.10Downside: 14.1%18 Jun price (HKD): 3.61

BuyOutperformHoldUnderperform (initiation)

Sell

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Li Ning (LHS) Relative to HSI (RHS)

(HKD) (%)

12-month range 2.77-5.65Market cap (USDbn) 0.733m avg daily turnover (USDm) 7.03Shares outstanding (m) 1,564Major shareholder Mr. Li Ning (29.5%)

Financial summary (CNY)Year to 31 Dec 15E 16E 17ERevenue (m) 7,820 8,917 9,929Operating profit (m) 69 427 596Net profit (m) (59) 298 446Core EPS (fully-diluted) (0.029) 0.146 0.220EPS change (%) n.a. n.a. 50.0Daiwa vs Cons. EPS (%) n.m. (11.2) (16.1)PER (x) n.a. 19.7 13.2Dividend yield (%) 0.0 0.0 0.0DPS 0.000 0.000 0.000PBR (x) 1.4 1.3 1.1EV/EBITDA (x) 16.0 6.9 5.3ROE (%) n.a. 8.8 11.7





- 59 -

Growth outlook Li Ning: net profit and net profit growth

While we forecast Li Ning’s revenue to increase by 16% YoY for 2015, 14% YoY for 2016, and 11% YoY for 2017, we expect its net loss to narrow to CNY59m for 2015E (from CNY781m in 2014). In 2016, we expect Li Ning to return to profitability, posting a net profit of CNY298m. Despite the turnaround, we see earnings growth being dragged down by lower operating margins as a result of its retail-focused model, while sell-through in the distributor and retail channels lags sell-in, pointing to the risk of an inventory build-up.


Valuation Li Ning: PBR

In our view, the PBR is the most appropriate method by which to value Li Ning. We forecast negative earnings and ROE in 2015, and only 9% ROE for 2016 and 12% for 2017. Thus, we believe a PBR of 1.5x (1SD below the stock’s past-2-year-average PBR), applied to our 2015E BVPS of CNY1.67 on a fully-diluted basis is appropriate given the lack of visibility on the company’s near-term prospects. The consensus currently forecasts positive earnings for Li Ning in 2015, but we believe the street’s optimism will fade on the likelihood of further disappointments in the turnaround story, and subsequently see the stock being derated.


Earnings revisions Li Ning: consensus EPS revisions

The Bloomberg consensus EPS forecasts for Li Ning for 2015 and 2016 have trended up since August 2014 on optimism that the transformation plan would take the firm back to break-even status, if not turn it profitable, in 2015. However, we do not believe in this turnaround story, as our analysis indicates that the margins for the retail-focused business model being adopted by Li Ning are lower than those for the wholesale business models followed by its domestic peers. As such, our 2016 and 2017 EPS forecasts are 11-16% below consensus.

Source: Bloomberg


Growth outlook

Valuation

Earnings revisions

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- 60 -

Key assumptions


Cash flow (CNYm)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Li Ning brand retail sales growth (YoY%)

35.5 20.6 (16.4) 27.1 28.2 30.0 25.0 20.0

Li Ning brand wholesale sales growth (YoY%)

9.9 (11.9) (30.5) (26.6) 10.4 10.0 7.5 5.0

Li Ning brand GPm (%) 48.0 46.1 38.7 45.3 45.0 47.5 50.0 52.0

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ELi Ning brand retiail sales 1,293 1,559 1,304 1,657 2,124 2,761 3,451 4,141Li Ning brand wholesale sales 7,319 6,450 4,480 3,289 3,630 3,993 4,293 4,508Other Revenue 867 919 893 879 973 1,066 1,173 1,280Total Revenue 9,479 8,929 6,676 5,824 6,728 7,820 8,917 9,929Other income 195 143 169 147 34 34 34 34COGS (4,997) (4,886) (4,162) (3,230) (3,724) (4,142) (4,520) (4,853)SG&A (3,129) (3,555) (4,282) (2,910) (3,567) (3,643) (4,004) (4,514)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 1,547 631 (1,599) (169) (529) 69 427 596Net-interest inc./(exp.) (37) (82) (202) (150) (143) (95) (54) (54)Assoc/forex/extraord./others 0 (2) (5) 2 7 7 7 7Pre-tax profit 1,510 547 (1,806) (317) (665) (19) 381 550Tax (377) (136) (149) (42) (79) (2) (45) (65)Min. int./pref. div./others (24) (25) (24) (32) (38) (38) (38) (38)Net profit (reported) 1,108 386 (1,979) (392) (781) (59) 298 446Net profit (adjusted) 1,108 386 (1,979) (392) (781) (59) 298 446EPS (reported)(CNY) 1.058 0.367 (1.726) (0.269) (0.500) (0.038) 0.190 0.285EPS (adjusted)(CNY) 1.058 0.367 (1.726) (0.269) (0.500) (0.038) 0.190 0.285EPS (adjusted fully-diluted)(CNY) 1.044 0.366 (1.726) (0.269) (0.500) (0.029) 0.146 0.220DPS (CNY) 0.418 0.110 0.000 0.000 0.000 0.000 0.000 0.000EBIT 1,547 631 (1,599) (169) (529) 69 427 596EBITDA 1,759 892 (1,372) 24 (330) 274 647 828

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017EProfit before tax 1,510 547 (1,806) (317) (665) (19) 381 550Depreciation and amortisation 211 260 225 192 197 205 219 232Tax paid (484) (412) (136) 4 (46) (79) (2) (45)Change in working capital (384) (585) (832) 566 (1) (307) (319) (298)Other operational CF items 138 205 1,617 (459) 119 88 46 46Cash flow from operations 991 16 (932) (14) (394) (112) 326 484Capex (185) (296) (121) (104) (241) (221) (221) (221)Net (acquisitions)/disposals (15) (11) (7) 0 5 6 7 7Other investing CF items (123) (94) (86) (111) (93) (130) (130) (130)Cash flow from investing (323) (400) (214) (215) (329) (345) (344) (344)Change in debt 55 529 1,352 (1,045) 602 (351) 0 0Net share issues/(repurchases) 36 12 2 1,482 3 1,295 0 0Dividends paid (497) (348) (23) (24) (28) (38) (38) (38)Other financing CF items (49) (73) (130) (122) (102) (112) (72) (72)Cash flow from financing (454) 120 1,201 292 475 793 (110) (110)Forex effect/others 0 0 0 0 0 0 0 0Change in cash 213 (265) 55 63 (249) 337 (128) 31Free cash flow 806 (280) (1,053) (117) (635) (333) 105 263


- 61 -


Key ratios (%)


Company profile

Li Ning is a major domestic sportswear company in China, founded in 1990 by former Chinese Olympic Gymnast Mr. Li Ning. Its brand portfolio includes the Li-Ning brand, as well as Double Happiness and others.

As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ECash & short-term investment 1,472 1,210 1,255 1,283 1,034 1,365 1,230 1,253Inventory 806 1,133 901 942 1,289 1,499 1,709 1,903Accounts receivable 1,916 2,439 1,713 1,734 1,639 1,844 2,049 2,239Other current assets 0 0 36 3 0 0 0 0Total current assets 4,194 4,782 3,906 3,962 3,963 4,708 4,988 5,395Fixed assets 721 832 857 791 861 922 974 1,017Goodwill & intangibles 814 752 423 381 446 506 560 610Other non-current assets 834 964 834 883 770 790 811 832Total assets 6,562 7,329 6,020 6,017 6,040 6,926 7,333 7,854Short-term debt 312 838 1,447 200 551 200 200 200Accounts payable 1,837 2,125 1,693 1,751 2,058 2,165 2,262 2,347Other current liabilities 222 100 124 67 70 70 70 70Total current liabilities 2,372 3,063 3,264 2,018 2,679 2,435 2,532 2,617Long-term debt 0 0 652 846 975 876 876 876Other non-current liabilities 631 601 292 262 217 217 217 217Total liabilities 3,002 3,664 4,207 3,125 3,870 3,528 3,625 3,710Share capital 111 112 112 137 142 142 142 142Reserves/R.E./others 3,258 3,360 1,502 2,548 1,810 3,083 3,419 3,903Shareholders' equity 3,369 3,472 1,614 2,684 1,952 3,225 3,561 4,045Minority interests 190 193 199 208 218 173 147 99Total equity & liabilities 6,562 7,329 6,020 6,017 6,040 6,926 7,333 7,854EV 3,550 4,330 5,551 4,477 5,209 4,384 4,494 4,421Net debt/(cash) (1,160) (372) 844 (237) 491 (288) (153) (177)BVPS (CNY) 3.217 3.303 1.407 1.845 1.248 2.062 2.277 2.587

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017ESales (YoY) 13.0 (5.8) (25.2) (12.8) 15.5 16.2 14.0 11.3EBITDA (YoY) 15.4 (49.3) n.a. n.a. n.a. n.a. 135.9 28.0Operating profit (YoY) 15.3 (59.2) n.a. n.a. n.a. n.a. 521.9 39.5Net profit (YoY) 17.4 (65.2) n.a. n.a. n.a. n.a. n.a. 50.0Core EPS (fully-diluted) (YoY) 16.5 (65.0) n.a. n.a. n.a. n.a. n.a. 50.0Gross-profit margin 47.3 45.3 37.7 44.5 44.6 47.0 49.3 51.1EBITDA margin 18.6 10.0 n.a. 0.4 n.a. 3.5 7.3 8.3Operating-profit margin 16.3 7.1 n.a. n.a. n.a. 0.9 4.8 6.0Net profit margin 11.7 4.3 (29.6) (6.7) (11.6) (0.8) 3.3 4.5ROAE 36.7 11.3 n.a. n.a. n.a. n.a. 8.8 11.7ROAA 18.6 5.6 n.a. n.a. n.a. n.a. 4.2 5.9ROCE 44.2 15.1 n.a. n.a. n.a. 1.7 9.2 11.9ROIC 54.5 16.6 (53.8) (6.4) (19.9) 2.4 11.3 14.0Net debt to equity n.a. n.a. 52.3 n.a. 25.2 n.a. n.a. n.a.Effective tax rate 25.0 24.9 n.a. n.a. n.a. n.a. 11.9 11.9Accounts receivable (days) 61.2 89.0 113.5 108.0 91.5 81.3 79.7 78.8Current ratio (x) 1.8 1.6 1.2 2.0 1.5 1.9 2.0 2.1Net interest cover (x) 41.5 7.7 n.a. n.a. n.a. 0.7 7.9 11.1Net dividend payout 39.5 30.1 n.a. n.a. n.a. n.a. 0.0 0.0Free cash flow yield 17.8 n.a. n.a. n.a. n.a. n.a. 2.3 5.8


- 62 -

Investment summary We forecast Li Ning’s revenue to increase by 16% YoY for 2015 and 14% YoY for 2016 (in line with the consensus forecasts), driven by a pick-up in its retail sales (up 30% YoY for 2015, and 25% YoY for 2016, on our forecasts). Management guides for an inflection point in 2015 (with which the consensus concurs) to positive earnings (the consensus forecasts a 2015E net profit of CNY27m), mainly supported by strong revenue growth. However, we are sceptical, and believe Li Ning will remain loss-making in 2015, due to the investment costs of its transformation to a more retail-focused business model potentially lingering for longer than expected. While we estimate the retail business will drive up the company’s overall gross margin, from 45% in 2014 to 47% in 2015, as retail sales contribute more to group sales, we expect the operating expenses associated with its directly-owned retail stores (such as labour and rental expenses) to offset any gross margin gains. Furthermore, we expect provisioning for inventory and bad debts to recur in 2015, albeit at lower levels than in 2014 (which saw non-operating losses of CNY567m that were largely impacted by bad debt provisions). Li Ning: revenue and net profit forecasts


Valuation

We initiate coverage of Li Ning with an Underperform (4) rating and 12-month target price of HKD3.10, based on a PBR of 1.5x (1SD below the stock’s past-2-year average) applied to our 2015E BVPS of CNY1.67 (fully-diluted basis). We believe using a PBR-based valuation is the most appropriate as earnings lack visibility amid the company’s transformation progress, and we expect Li Ning to return to profitability only in 2016. Li Ning: PBR


Li Ning’s share price is up 23% YTD on expectations of it achieving a profitable bottom line in 2015E. The stock is now trading at PERs of 20x for 2016E (a 28% premium to the peer average), despite its bumpy earnings recovery path. Our 12-month target price translates into a 2016E PER of 17.3x, still at a c10% premium to peers. We believe such a premium has priced in the net margin expansion potential of Li Ning.

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14

Apr-1

4

Jul-1

4

Oct

-14

Jan-

15

Apr-1

5

avg sd+1 sd-1

(x)


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Prolonged transformation

We expect Li Ning’s transformation plan to take longer than investors expect, and see execution risks clouding its rebound.

Loss narrowing, but not as quickly as one would think

Our view on the timing of Li Ning’s return to profitability is premised on the following:

1. Despite an increasing contribution from high gross margin retail sales (36% of sales in 2014 to 40% in 2015E) vs. lower-margin wholesale sales, we expect the improvement to be offset by labour and rental costs at the operating margin level.

2. Slow sell-through for its wholesale business in 2014 resulted in Li Ning having the highest channel inventory levels among peers (~8 months as of 2014) and a deteriorating cash conversion cycle with risks of inventory write-offs and bad debt provisions.

3. The company has an unappealing sales growth strategy that we think sets it up for more risks than necessary during its transformation phase (such as targeting the sports-life segment, its partnership with Huami for wearable tech, as well as the collaboration with Marvel).

For 2015, we remain cautious on Li Ning’s recovery in terms of both net profit and operating cash flow to positive territory, as the higher opex associated with a retail-focused business model will likely more than offset any gains Li Ning achieves via sell-through and sales-mix-driven gross-margin improvements. As such, we expect the company’s earnings and cash flow recovery to only be achieved in 2016, with the 2015 net loss narrowing to almost CNY60m, on our forecasts.

Direct-retail is a double-edged sword

At first glance, a retail-focused model looks attractive. It gives the Li Ning brand more autonomy in terms of supply-chain (ie, replenishments, etc.) and big data for direct end-user feedback, which helps with its product design. However, having to bear the costs of setting up self-operated retail outlets requires material capex on an already strained balance sheet. Furthermore, ongoing costs such as for transportation and logistics put further pressure on operating-profit margins, while direct retail sales volume is still ramping up in scale. Pros and cons of wholesale and retail business models

Wholesale Retail Pros - distributors are more knowledgeable on

local preferences - direct feedback from end-user

- lower opex - increase in control over production Cons - disconnect between brand and end-user - significant capex and working capital

requirements - subject to risk of channel stuffing - exposure to higher opex (rental &

labour)

Source: Daiwa

Below, we compare Anta (wholesale model), Li Ning (retail-focused model) and Nike (which globally operates a hybrid type model, including retail flagship stores along with a distributor wholesale model). We identify that while the retail elements (in Li Ning’s and Nike’s models) result in a higher gross-profit margin (44.6% and 44.8%, respectively, for 2014, due to discounting in the wholesale-business model), once we account for the SG&A expenses (higher in retail-business models due to rent, renovations, staff and logistics), a wholesale-business model like that of Anta’s results in a higher operating margin than those for Nike and Li Ning (22.6% vs 13.2%/-7.9%, respectively). Business model analysis Latest FY reported Anta (Wholesale) Li Ning (Retail-focus) Nike (Hybrid)Revenue 8,923 6,728 27,799 COGS (4,896) (3,724) (15,353)Gross profit 4,027 3,004 12,446 Gross margin 45.1% 44.6% 44.8%Other operating revenue 86 34 -SG&A (2,094) (3,567) (8,766)SG&A as % of revenue 23% 53% 32%Operating profit 2,019 (529) 3,680 Operating margin 22.6% -7.9% 13.2%


Note: Anta and Li Ning figures in CNYm; Nike’s in USDm


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Based on our analysis of other sportswear distributors, such as Nike and Adidas (through Belle (1880 HK, not rated), and department-store operators, such as Intime (1833 HK, HKD11.74, Hold [3]) and Golden Eagle (3308 HK, HKD11, Sell [5]), we estimate that rent and labour costs account for about 20% and 10% of the revenue generated by well-performing retail stores (in terms of sales volume, etc) respectively, resulting in lower operating margins for retailers. In Li Ning’s case, however, rent, labour and logistics costs (as a ratio of the Li Ning brand’s retail revenue) were 35%, 39% and 13%, respectively, for 2014 (from 35%, 41% and 14%, respectively for 2013), which we believe was due to its aggressive retail network expansion (with the store count almost doubling from 2012 to 1,202 in 2014) against the backdrop of disappointing SSS (1Q15 SSS growth remained in the mid-to-single-digit YoY, the same level achieved through franchised retail stores). In 2014, Li Ning opened 276 new self-owned retail stores, bringing its total number of self-owned retail stores to 1,202 (up 30% YoY). While management guides for 500 retail stores to be opened in 2015, most of these will be franchised retail stores (which are the equivalent of third party-operated stores under a distributor/wholesale model). However, this figure excludes the closure of unprofitable and/or struggling distributors, and hence, we expect the franchised retail store count in 2015 to be flat on a net-net basis. We expect the company to scale back its aggressive opening of directly operated retail stores, over the next 2 years and focus on optimising store efficiency and making the stores opened in 2014 profitable. While we

forecast the proportion of directly operated stores to the overall number of stores to remain at about 23-25% for Li Ning’s core brand in 2015-17 (21% in 2014), we expect rental costs to remain high at 27-30% of retail revenue, as sales at the new stores take time to ramp up. Li Ning: retail-focused store expansion (number of stores)


We forecast retail’s revenue contribution to Li Ning to increase from 31% in 2014 to 35-42% in 2015-17E. As discussed above, this will likely weigh on Li Ning’s operating margins. Hence, we expect Li Ning’s operating margin to remain very weak (0.9%) in 2015E, excluding inventory write-offs and provisions (or write-backs). More importantly, we see little possibility of Li Ning’s operating margin catching up with its peers’ level of about 25% over the next 3 years, despite its higher retail ASPs and gross margins.

Li Ning: Li-Ning brand sales breakdown (2009-17E)


5%7%

9%10%

16%

21%23%

0%

5%

10%

15%

20%

25%

0

2,000

4,000

6,000

8,000

2009 2010 2011 2012 2013 2014 2015EFranchised retail stores (LHS)Directly-operated retail stores (LHS)Directly-operated retail stores as % of total stores (RHS)

12% 15%19% 22%

33% 36%40% 43%

46%

-40%

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-20%

-10%

0%

10%

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2009 2010 2011 2012 2013 2014 2015E 2016E 2017E

(CNYm)

Retail sales (LHS) Wholesale sales (LHS) International sales (LHS) Retail as % of total

Retail sales YoY (RHS) Wholesale sales YoY (RHS) International sales YoY (RHS)


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In a distributor (wholesale) model, we believe distributors are now much more prudent in placing orders at trade fairs, after being impacted by the channel stuffing issues of 2010-13 (in terms of profitability and working capital). In Li Ning’s case, we believe its retail-focused model is a double-edged sword. On the one hand, it enables the brand to recognise customer demand and preferences quickly, and thus be able to adjust its product mix quickly. But on the other hand, it could lead to miscommunication, with store managers/regional sales heads that make the merchandising decisions misjudging local demand, or in some cases even ordering more than necessary to give the perception of robust store performances, and thus theoretically earn higher bonuses/appraisals. We see a risk of Li Ning over-ordering as it is: 1) pushing new products in a wide range of sports segments, trying to increase its presence in sports lifestyle products, and 2) pushing into 3rd and below tier cities. As we discuss later, we think management may have underestimated the competitive pressure in these new areas for the company, and see the risk of the company over-stocking inventory in new products.

Wholesale sell-through not particularly strong either

Channel inventory levels among major domestic brands peaked in 2011. Since then, distributors have taken a step back, focused on improving working capital and clearing old inventory with the help of brands offering discounts and subsidies. However, Li Ning’s channel inventory turnover was still at 7-8 months in 2014 (vs. 4-5 months on average for peers). Such a high level of channel inventory is a cause for concern, in our view, as it indicates that Li Ning’s sell-through at the distributor level is weak and trade fair orders may see a slowdown as distributors continue to hold old inventory and suffer from poor liquidity. Li Ning’s 2014 bad debt provision stood at ~32% of gross trade receivables (vs. Anta and Peak’s 3% and 5%), and it reaffirms our conviction that its recovery to profitability will not occur this year.

Li Ning: inventory and bad debt provisions (2009-14)


China sportswear sector: bad debt analysis

Anta Li Ning Peak

Period 2014 2013 2014 2013 2014 2013Gross trade receivables 900 922 1,857 1,962 914 921 Less: Provision for doubtful debt (24) (70) (597) (591) (45) (15)Net trade receivables 876 852 1,260 1,371 868 906 Provision as % of gross trade receivables 2.7% 7.6% 32.1% 30.1% 4.9% 1.6%


Given the approximate 3 quarters lead time required from the date a trade fair is held to when the products are produced and delivered to distributors, we compare the SSSG and trade fair figures for the respective quarters (in the following table). SSSG vs. trade fair order book growth (YoY %)

Li Ning Anta Peak

SSSG Trade fair order

book growth SSSG

Trade fair order book

growth SSSG

Trade fair order book

growth

Distributors’

stores

Self-owned stores

1Q14 negative positive negative + mid single + high single + low single n/a 2Q14 negative negative negative + low double + high single + low single + high single 3Q14 positive negative positive + high single + high single + low single + mid-teens

4Q14 + mid single

+ high single positive + high single + low double + low single + mid-teens

1Q15 + mid single

+ mid single

mid-twenties + high single + low double +mid single + mid-teens

2Q15 mid-teens + low double + mid-teens

3Q15 high-teens + low double + mid-teens

4Q15 Low-teens + low double + mid-teens

1Q16 + mid-teens

Source: Company

Based on the latest SSSG update for Li Ning, we see a risk of increasing inventory at both the company’s level and its distributors’ level. The company’s SSSG was only a mid-single digit percentage in 1Q15, versus mid-20% order book growth for the 1Q15 trade fair (which took place in 2Q14). When comparing the difference in growth rates between trade fair orders and SSSG (high single-digit SSSG and low double-digit trade fair order growth for 1Q15) for both Anta and Li Ning, the former’s is

0%

20%

40%

60%

0

200

400

600

800

1,000

2009 2010 2011 2012 2013 2014

(CNYm)

Inventory provision (LHS)Bad debt provision (LHS)Inventory provision (% of inventory)Bad debt provision (% of accounts receivable)


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significantly less than the difference seen for Li Ning, and we think can be explained by the fact that Anta’s trade fair orders include those of Anta Kids, while its SSSG excludes its standalone kids stores, notwithstanding the occasional off-season sale or moderate discounting. But we expect the gap for Li Ning to continue to widen. For the 2Q-3Q15 trade fairs, Li Ning reported mid-to-high teens order book growth from distributors, but we believe SSSG will continue to be at or below a mid-single-digit level, similar or slightly lagging peers’ due to Li Ning’s lack of competitiveness against international brands (in terms of brand recognition) and domestic brands (in terms of pricing). Hence, we forecast Li Ning’s inventory turnover days to increase to over 120 days in each of 2015-17E, from 109 currently. This 120-day level would be largely in line with the turnover days for Li Ning’s distributors (about 4-5 months) and that of other sportswear distributors (eg, Belle’s 120-130 days for its sportswear segment). Li Ning: cash conversion cycle

2010 2011 2012 2013 2014 2015E 2016E 2017EInventory turnover days 52 72 89 104 109 123 130 136 Receivable turnover days 52 76 98 89 71 64 64 65 Payable days 71 93 112 104 84 89 90 90 Cash conversion cycle 33 55 75 89 96 98 104 110

Source: Company, Daiwa estimates

With such high inventory levels, Li Ning’s revenue and trade fair order-book growth looks likely to decelerate over the coming quarters. In our view, distributors are likely to be more prudent in terms of their purchasing of Li Ning products at Li Ning’s 2016 trade fairs, which are being held in 2015. This is already evident in the slowdown in Li Ning’s trade fair order growth, from a mid-20% YoY in 1Q15 to a low-teens percentage YoY in 4Q15. This compares with peers Anta and Peak, which have maintained stable trade fair orders throughout 1Q-4Q15, at a low double-digit percentage YoY and mid-teens percentage YoY, respectively. As such, we forecast Li Ning’s revenue to rise by 14% YoY for 2016 and 11% YoY for 2017, down from 16% YoY in 2014-15E.

Li Ning: revenue and revenue growth (YoY)

Source: Company, Daiwa forecast

Struggling to position itself in a profitable niche

We are cautious of Li Ning’s growth strategy given our view that it is still finding its feet after incorrectly positioning itself in the wrong markets (higher-tier cities in China) for a number of years, and trying to compete with international peers. Furthermore, during its 2014 annual results briefing, on 19 March 2015, management announced some of the company’s near-term initiatives, such as an increasing its focus on the “sports-life” segment, as well as entering the wearable tech market (in conjunction with Xiaomi’s Mi Band), and a collaboration with Marvel. While we do not believe that any single one of these initiatives will make or break Li Ning’s top-line figures given its small contribution (our forecasts of 16% and 14% YoY revenue growth for 2015 and 2016, respectively are in line with consensus), we believe a series of failures in the aforementioned initiatives would result in negative sentiment toward the stock. Product positioning and market segmentation flawed, in our view From inception until the results briefing this year, at which Li Ning said it plans to begin targeting the mass sports lifestyle segment, it targeted tier-1 and 2 cities with the aim of competing with international brands (the likes of Nike and Adidas) for market share. However, this strategy did not work out as management had expected, with it acknowledging (during the 2014 annual results briefing) that the top-tier cities were basically occupied by the international brands and ultimately were not bottom-line accretive (given the higher rents, wages, etc.) for the company. As a result, management has now shifted its focus to tier-3 and lower cities.

-30%

-20%

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0%

10%

20%

0

2,000

4,000

6,000

8,000

10,000

12,000

2009 2010 2011 2012 2013 2014 2015E 2016E 2017E

(CNYm)

Revenue (LHS) Revenue YoY (RHS)


- 67 -

However, in our view, this move has come too late. First, the company’s domestic peers have already established their brands and retail outlets in these areas already. For example, Peak already has 86% of its 6,000 stores located in tier-3 or lower cities. Even Belle, the distributor of Adidas and Nike products, has 55% of its 6,429 (as of Feb-15) sportswear stores located there. Second, we note that Li Ning’s product pricing needs adjustment as the prices of some of its products, particularly its signature line, Way of Wade, range from CNY1,000-1,500, which is in line with Nike’s signature lines (ie, Kobe Bryant, LeBron James and Kevin Durant). As discussed in our industry section, we believe Li Ning’s current product portfolio (and pricing) will not prove to be popular in tier-3 or below tier cities given the weaker consumption power there versus in tier-1 cities. Based on our analysis, Li Ning’s pricing is too close to, if not in some cases, high than, Nike’s, while the perceived value (determined by online ratings) reveal that its value proposition to consumers is not in line with the prices it charges. As a result, we expect Li Ning to lose market share to: 1) Anta or other domestic brands with functional products targeting the mass market, and 2) international brands targeting tier-1 and 2 cities in China. We believe that even if Li Ning resets its strategy by relocating more stores to lower-tier cities, it is already behind its peers that have targeted those cities a number of years ago. We expect international brands to continue to take the lead in the tier 1-3 cities, and will grow in terms of market share as consumer disposable incomes rise, while Anta remains in 3rd place, and the gap between them and Li Ning widens on the back of

their better product positioning, pricing and market segmentation. Based on Daiwa’s proprietary research, Li Ning generally ranks below peers such as Nike, Anta and Peak in mid-to-high end basketball shoes, and in line with peers for low-end basketball shoes (in terms of value-for-money – based on Internet review scores vs. respective product prices). Notwithstanding the pricing compared to international peers, if the brand is really aiming to target tier-3 or lower cities, the price point may be out of reach or more than what consumers typically spend for a pair of shoes in this segment, especially for high-end signature editions (ie, Li Ning Way of Wade 3 which costs over CNY1,111, versus Peak’s TP9 at about CNY659). Admittedly, Li Ning remains one of the more recognised domestic Chinese sportswear brands given the reputation of its founder and Olympics Gold Medallist Mr. Li Ning. This is precisely why we believe its brand value is of importance for the company; and while the notion of changing its pricing strategy may seem easy, the resulting tarnishing of its brand value may have serious repercussions, in our view. As such, we do not expect a significant divergence in its pricing strategy going forward (with the exception of its mass segment sports-life category), which we think puts the company at risk of losing market share to its domestic peers, who are better positioned to take this market share given their already established footholds in lower-tier cities, where sporting pursuits are set to grow on the back of the government’s promotion of fitness and healthy lifestyles.

Peer comparison: basketball shoes

Source: Daiwa

*Internet reviews range from 10-200 reviews per product


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“New product” strategies Sports life segment: During the 2014 annual results analyst briefing on 19 March 2015, interim CEO Mr. Li Ning shared his plan to capture a piece of the mass market “sport-life” segment that was previously overlooked and then subsequently captured by competitors like Anta. The sport-life category contributed 33% of Li Ning’s retail revenue in 2014, versus 29% in 2013. The mass market segment is generally one that can be categorized as consisting of price-sensitive consumers. We see more downside than upside potential associated with management’s push into the mass end of this segment, given the sports lifestyle segment is fragmented and exhibits little to no brand loyalty. Even among entry-level running shoes with a planned introduction price of CNY200, the competition is fierce (eg, from more fashion-oriented Xtep) in a more commoditized market that exhibits price-sensitivity rather than desire for high brand value. Admittedly, the Li Ning brand is widely recognised as somewhat of a “national treasure”, however, we do not believe the sports lifestyle offerings will be a large contributor to the group’s sales growth in the coming years. Smart shoes: In March 2015, Li Ning announced a strategic partnership with Huami to jointly launch “Smart” running shoes, which pair with Xiaomi’s Mi band. The objective of this partnership is to introduce wearable technology to students and the younger generation without placing a burden on them in terms of pricing. As these products will not be launched until July 2015, we believe they will have a minimal impact on group sales in 2015/16E. Li Ning is not the first sportswear brand to enter the wearable tech market. In 2006, Nike partnered up with Apple to launch the Nike+ iPod Sports Kit, while subsequently releasing its own FuelBand in 2012 (discontinued in April 2014). Under Armour has also teamed up with HTC (announced in January 2015, to launch Spring 2015) to release branded fitness tracking devices. We think there are 2 types of sportswear consumers:

1. Professional 2. Recreational/leisure

For professionals, the type of data demanded from wearable tech differs, depending on the sports they play. Currently, Nike manufactures tailor-made sports shoes, which are essentially niche products that cater to the different needs of athletes. Since the Li Ning/Mi Band partnership is targeted at students/younger generation, we do not believe this category applies to Li Ning.

For recreational/leisure users, functionality (lightweight, cushioning, etc.) and pricing are important, but data-tracking is already being offered in the market by the likes of FitBit, which can track distance and heart rate. We believe that unless the Li Ning X Mi Band can offer something else, for someone that is using a competitor’s wearable tech product, or does not already own a Mi Band, it would be a tough sell given the higher entry price of having to purchase both the Li Ning shoes and the Xiaomi Mi Band together (the Mi Band on its own is CNY79). Li Ning: HUAMI Mi band strategic partnership

Source: Company

Marvel collaboration. With the introduction of sports-lifestyle products in collaboration with US Publisher Marvel, such as Iron Man, Captain America, and The Hulk colourway shoes) in May 2015, management aims to target primary-school students with these products. However, we believe that only children and elementary school students would be the plausible target market for these shoes, and this segment is already highly fragmented, with no true player dominating.

At the same time, the Marvel tie-up could lead to an increase to Li Ning’s A&P cost ratio. The company cut its A&P expenses by 8% in 2014 to save costs, resulting in its A&P cost ratio coming down to 19% in 2014 (from 24% in 2013). In our model, we assume the A&P cost ratio remains at 19% over 2015-17E as increasing revenue implies a higher A&P budget. However, in our model we have only allowed for an increase every year of CNY150-200m, which may not be sufficient for all the new products, in particular the co-branded products with international partners (such as Marvel). Hence, we see a risk that our A&P cost assumptions for 2015-17 could be too low.


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A&P expenses (CNYm) and cost ratio (%)


Catalysts

Disappointing financial results While management and the consensus remain optimistic about a 2015 bottom line recovery to at least break-even, we remain cautious and do not expect an earnings turnaround until 2016. On our below-consensus operating margin assumptions, we expect Li Ning to be slightly loss-making in 2015E (versus management’s expectation of a turnaround), suggesting investors could be disappointed by Li Ning’s 2015 results. Moreover, we see further downside risks to earnings from more provisions and write-offs (not included in our model in 2015-17E). In 2014, when Li Ning took a provision of CNY860m (vs. around CNY970m and CNY1.5bn in 2013 and 2012, respectively), it seemed as if the transformation process was on track and that these one-offs would come to an end. However, we believe that these one-offs may recur if sell-through of new products continues to lag inventory build-up. There could also be a negative surprise in terms of greater-than-expected capex and investment costs to pay for the company’s shift to a retail-focused model. This could result in higher provisions having to be made for inventory building up and bad debt. Given the lower margins associated with a retail model, it may be difficult for Li Ning to support its transformation process financially, despite the recent round of fundraising (in 1Q15) which raised HKD1.55bn. The negative operating cash flow in 2014

is a cause for concern, and we suspect investors could be in for a negative surprise if the company’s retail-model fails to succeed amidst a fragmented sportswear market in China, and results in the company’s reversion back to a distributor/wholesale model. However, we see a low likelihood of this occurring given that it would involve severing relationships and potentially tarnishing the brand. Potential TPG stake sale Jin-Goon Kim, a partner at Texas Pacific Group (TPG), a global private investment firm, stepped down from his role as interim CEO in November 2014. Mr. Kim was largely viewed by the market as being an instrumental figure in helping Daphne International Holdings (210 HK, not rated) transform itself. So, in our view, the fact that he stepped down from Li Ning in November 2014, before the company managed to see a profit recovery, is a sign that TPG could sell its stake in Li Ning in the near future. We note that TPG reduced its stake from 16.3% to 15% in January 2015.

Risks

The main upside risk stems from better-than-expected execution of its channel transformation plan resulting in a faster-than-expected return to profitability. We also see better product positioning and pricing as risks to our Underperform [4] call due to potentially faster-than-expected sales growth. For 1H15 in particular, we expect Li Ning to remain loss-making but significantly narrow its loss from CNY508m in 1H14 on the absence of one-off expenses (CNY301m). While, we believe such a big improvement would be a one-off and Li Ning’s operating margin would continue to be inferior to peers’ over 2015-17E, such a recovery could lead to short-term share-price volatility when the company announces its 1H15 results in August 2015. Secondary risks on the upside would include securing a permanent CEO with a proven track record which would help ease investor concerns. On the flip side, TPG further decreasing its stake in Li Ning would represent a source of share-price overhang.

18%20%

24%

19% 19% 19% 19%

0%

5%

10%

15%

20%

25%

30%

0

500

1,000

1,500

2,000

2011 2012 2013 2014 2015E 2016E 2017E

A&P expenses (LHS) As a ratio of revenue (RHS)


- 70 -

Appendix


Li Ning is a major domestic sportswear company in China, founded by former Olympic Gymnast Mr. Li Ning. Its brand portfolio includes the Li-Ning brand, as well as Double Happiness, Lotto, AIGLE and others. Li Ning: key management members Name Position Experience

Mr. Li Ning Executive Chairman and Executive Director Responsible for the external affairs and relationships of the GroupMr. Jin-Goon Kim Executive Vice Chairman and Executive Director Manages the internal affairs and operations of the GroupSource: Company

Li Ning: current shareholding structure

Source: Company

Appendix II: retail business model

Li Ning: current shareholding structure


Mr. Li Ning

Li Ning Co. Ltd. (2331.HK)

Public

29.53% 55.47%

TPG

15%


Sportswear company

Self-owned stores Consumer



Data collection Feedback

Distribution


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Appendix III: Li Ning’s net change of major P&L items for 2014 (CNYm)

Source: Company


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Daiwa’s Asia Pacific Research Directory

HONG KONG

Takashi FUJIKURA (852) 2848 4051 [email protected] Regional Research Head

Kosuke MIZUNO (852) 2848 4949 / (852) 2773 8273

[email protected]

Regional Research Co-head

John HETHERINGTON (852) 2773 8787 [email protected] Regional Deputy Head of Asia Pacific Research

Rohan DALZIELL (852) 2848 4938 [email protected] Regional Head of Product Management

Kevin LAI (852) 2848 4926 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional)

Christie CHIEN (852) 2848 4482 [email protected] Macro Economics (Regional); Banking; Insurance (Taiwan)

Junjie TANG (852) 2773 8736 [email protected] Macro Economics (China)

Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong and China Property

Cynthia CHAN (852) 2773 8243 [email protected]

Property (China)

Leon QI (852) 2532 4381 [email protected] Banking (Hong Kong/China); Broker (China); Insurance (China)

Anson CHAN (852) 2532 4350 [email protected] Consumer (Hong Kong/China)

Jamie SOO (852) 2773 8529 [email protected] Gaming and Leisure (Hong Kong/China)

Dennis IP (852) 2848 4068 [email protected] Power; Utilities; Renewables and Environment (Hong Kong/China)

John CHOI (852) 2773 8730 [email protected]

Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap

Becky HAN (852) 2848 4464 [email protected] Small/Mid Cap (Regional)

Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong/China); Transportation (Regional)

Brian LAM (852) 2532 4341 [email protected] Transportation – Aviation (Hong Kong/China); Railway; Construction and Engineering (China)

Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group

Thomas HO (852) 2773 8716 [email protected] Custom Products Group

PHILIPPINES

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TAIWAN

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Helen CHIEN (886) 2 8758 6254 [email protected] Small/Mid Cap

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SINGAPORE

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Royston TAN (65) 6321 3086 [email protected] Oil and Gas; Capital Goods

David LUM (65) 6329 2102 [email protected] Property and REITs

Evon TAN (65) 6499 6546 [email protected] Property and REITs

Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)


- 73 -

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Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

Daiwa Capital Markets America Inc. New York Head Office Financial Square, 32 Old Slip, New York, NY10005, U.S.A. (1) 212 612 7000 (1) 212 612 7100

Daiwa Capital Markets America Inc. San Francisco Branch 555 California Street, Suite 3360, San Francisco, CA 94104, U.S.A. (1) 415 955 8100 (1) 415 956 1935

Daiwa Capital Markets Europe Limited, London Head Office 5 King William Street, London EC4N 7AX, United Kingdom (44) 20 7597 8000 (44) 20 7597 8600

Daiwa Capital Markets Europe Limited, Frankfurt Branch Neue Mainzer Str. 1, 60311 Frankfurt/Main, Germany (49) 69 717 080 (49) 69 723 340

Daiwa Capital Markets Europe Limited, Paris Representative Office 17, rue de Surène 75008 Paris, France (33) 1 56 262 200 (33) 1 47 550 808

Daiwa Capital Markets Europe Limited, Geneva Branch 50 rue du Rhône, P.O.Box 3198, 1211 Geneva 3, Switzerland (41) 22 818 7400 (41) 22 818 7441

Daiwa Capital Markets Europe Limited, Moscow Representative Office

Midland Plaza 7th Floor, 10 Arbat Street, Moscow 119002, Russian Federation

(7) 495 641 3416 (7) 495 775 6238

Daiwa Capital Markets Europe Limited, Bahrain Branch 7th Floor, The Tower, Bahrain Commercial Complex, P.O. Box 30069, Manama, Bahrain

(973) 17 534 452 (973) 17 535 113

Daiwa Capital Markets Hong Kong Limited Level 28, One Pacific Place, 88 Queensway, Hong Kong (852) 2525 0121 (852) 2845 1621

Daiwa Capital Markets Singapore Limited 6 Shenton Way #26-08, OUE Downtown 2, Singapore 068809, Republic of Singapore

(65) 6220 3666 (65) 6223 6198

Daiwa Capital Markets Australia Limited Level 34, Rialto North Tower, 525 Collins Street, Melbourne, Victoria 3000, Australia

(61) 3 9916 1300 (61) 3 9916 1330

DBP-Daiwa Capital Markets Philippines, Inc 18th Floor, Citibank Tower, 8741 Paseo de Roxas, Salcedo Village, Makati City, Republic of the Philippines

(632) 813 7344 (632) 848 0105

Daiwa-Cathay Capital Markets Co Ltd 14/F, 200, Keelung Road, Sec 1, Taipei, Taiwan, R.O.C. (886) 2 2723 9698 (886) 2 2345 3638

Daiwa Securities Capital Markets Korea Co., Ltd. 20 Fl.& 21Fl. One IFC, 10 Gukjegeumyung-Ro, Yeongdeungpo-gu, Seoul, Korea

(82) 2 787 9100 (82) 2 787 9191

Daiwa Securities Co. Ltd., Beijing Representative Office Room 301/302，Kerry Center，1 Guanghua Road，Chaoyang District， Beijing 100020, People’s Republic of China

(86) 10 6500 6688 (86) 10 6500 3594

Daiwa (Shanghai) Corporate Strategic Advisory Co. Ltd. 44/F, Hang Seng Bank Tower, 1000 Lujiazui Ring Road, Pudong, Shanghai China 200120 , People’s Republic of China

(86) 21 3858 2000 (86) 21 3858 2111

Daiwa Securities Co. Ltd., Bangkok Representative Office 18th Floor, M Thai Tower, All Seasons Place, 87 Wireless Road, Lumpini, Pathumwan, Bangkok 10330, Thailand

(66) 2 252 5650 (66) 2 252 5665

Daiwa Capital Markets India Private Ltd 10th Floor, 3 North Avenue, Maker Maxity, Bandra Kurla Complex, Bandra East, Mumbai – 400051, India

(91) 22 6622 1000 (91) 22 6622 1019

Daiwa Securities Co. Ltd., Hanoi Representative Office Suite 405, Pacific Palace Building, 83B, Ly Thuong Kiet Street, Hoan Kiem Dist. Hanoi, Vietnam

(84) 4 3946 0460 (84) 4 3946 0461

DAIWA INSTITUTE OF RESEARCH LTD

HEAD OFFICE 15-6, Fuyuki, Koto-ku, Tokyo, 135-8460, Japan (81) 3 5620 5100 (81) 3 5620 5603

MARUNOUCHI OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6756 (81) 3 5555 7011 (81) 3 5202 2021

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Disclaimer

This publication is produced by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, and distributed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. This publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Any use, disclosure, distribution, dissemination, copying, printing or reliance on this publication for any other purpose without our prior consent or approval is strictly prohibited. Neither Daiwa Securities Group Inc. nor any of its respective parent, holding, subsidiaries or affiliates, nor any of its respective directors, officers, servants and employees, represent nor warrant the accuracy or completeness of the information contained herein or as to the existence of other facts which might be significant, and will not accept any responsibility or liability whatsoever for any use of or reliance upon this publication or any of the contents hereof. Neither this publication, nor any content hereof, constitute, or are to be construed as, an offer or solicitation of an offer to buy or sell any of the securities or investments mentioned herein in any country or jurisdiction nor, unless expressly provided, any recommendation or investment opinion or advice. Any view, recommendation, opinion or advice expressed in this publication may not necessarily reflect those of Daiwa Securities Group Inc., and/or its affiliates nor any of its respective directors, officers, servants and employees except where the publication states otherwise. This research report is not to be relied upon by any person in making any investment decision or otherwise advising with respect to, or dealing in, the securities mentioned, as it does not take into account the specific investment objectives, financial situation and particular needs of any person. Daiwa Securities Group Inc., its subsidiaries or affiliates, or its or their respective directors, officers and employees from time to time have trades as principals, or have positions in, or have other interests in the securities of the company under research including derivatives in respect of such securities or may have also performed investment banking and other services for the issuer of such securities. The following are additional disclosures. Japan Daiwa Securities Co. Ltd. and Daiwa Securities Group Inc. Daiwa Securities Co. Ltd. is a subsidiary of Daiwa Securities Group Inc. Investment Banking Relationship

Within the preceding 12 months, The subsidiaries and/or affiliates of Daiwa Securities Group Inc. * has lead-managed public offerings and/or secondary offerings (excluding straight bonds) of the securities of the following companies: Modern Land (China) Co. Ltd (1107 HK); econtext Asia Ltd (1390 HK); Neo Solar Power Corp (3576 TT); Accordia Golf Trust (AGT SP); Hua Hong Semiconductor Ltd (1347 HK); GF Securities Co Ltd (1776 HK).

*Subsidiaries of Daiwa Securities Group Inc. for the purposes of this section shall mean any one or more of: Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司), Daiwa Capital Markets Singapore Limited, Daiwa Capital Markets Australia Limited, Daiwa Capital Markets India Private Limited, Daiwa-Cathay Capital Markets Co., Ltd., Daiwa Securities Capital Markets Korea Co., Ltd. Hong Kong This research is distributed in Hong Kong by Daiwa Capital Markets Hong Kong Limited (大和資本市場香港有限公司) (“DHK”) which is regulated by the Hong Kong Securities and Futures Commission. Recipients of this research in Hong Kong may contact DHK in respect of any matter arising from or in connection with this research. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationship For “Investment Banking Relationship”, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Relevant Relationship (DHK) DHK may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage. DHK market making DHK may from time to time make a market in securities covered by this research.

Singapore This research is distributed in Singapore by Daiwa Capital Markets Singapore Limited and it may only be distributed in Singapore to accredited investors, expert investors and institutional investors as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time. By virtue of distribution to these category of investors, Daiwa Capital Markets Singapore Limited and its representatives are not required to comply with Section 36 of the Financial Advisers Act (Chapter 110) (Section 36 relates to disclosure of Daiwa Capital Markets Singapore Limited’s interest and/or its representative’s interest in securities). Recipients of this research in Singapore may contact Daiwa Capital Markets Singapore Limited in respect of any matter arising from or in connection with the research. Australia This research is distributed in Australia by Daiwa Capital Markets Stockbroking Limited and it may only be distributed in Australia to wholesale investors within the meaning of the Corporations Act. Recipients of this research in Australia may contact Daiwa Capital Markets Stockbroking Limited in respect of any matter arising from or in connection with the research. Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. India This research is distributed by Daiwa Capital Markets India Private Limited (DAIWA) which is an intermediary registered with Securities & Exchange Board of India. This report is not to be considered as an offer or solicitation for any dealings in securities. While the information in this report has been compiled by DAIWA in good faith from sources believed to be reliable, no representation or warranty, express of implied, is made or given as to its accuracy, completeness or correctness. DAIWA its officers, employees, representatives and agents accept no liability whatsoever for any loss or damage whether direct, indirect, consequential or otherwise howsoever arising (whether in negligence or otherwise) out of or in connection with or from any use of or reliance on the contents of and/or omissions from this document. Consequently DAIWA expressly disclaims any and all liability for, or based on or relating to any such information contained in or errors in or omissions in this report. Accordingly, you are recommended to seek your own legal, tax or other advice and should rely solely on your own judgment, review and analysis, in evaluating the information in this document. The data contained in this document is subject to change without any prior notice DAIWA reserves its right to modify this report as maybe required from time to time. DAIWA is committed to providing independent recommendations to its Clients and would be happy to provide any information in response to any query from its Clients. This report is strictly confidential and is being furnished to you solely for your information. The information contained in this document should not be reproduced (in whole or in part) or redistributed in any form to any other person. We and our group companies, affiliates, officers, directors and employees may from time to time, have long or short positions, in and buy sell the securities thereof, of company(ies) mentioned herein or be engaged in any other transactions involving such securities and earn brokerage or other compensation or act as advisor or have the potential conflict of interest with respect to any recommendation and related information or opinion. DAIWA prohibits its analyst and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analyst cover. This report is not intended or directed for distribution to, or use by any person, citizen or entity which is resident or located in any state or country or jurisdiction where such publication, distribution or use would be contrary to any statutory legislation, or regulation which would require DAIWA and its affiliates/ group companies to any registration or licensing requirements. The views expressed in the report accurately reflect the analyst’s personal views about the securities and issuers that are subject of the Report, and that no part of the analyst’s compensation was, is or will be directly or indirectly, related to the recommendations or views expressed in the Report. This report does not recommend to US recipients the use of Daiwa Capital Markets India Private Limited or any of its non – US affiliates to effect trades in any securities and is not supplied with any understanding that US recipients will direct commission business to Daiwa Capital Markets India Private Limited. Taiwan This research is distributed in Taiwan by Daiwa-Cathay Capital Markets Co., Ltd and it may only be distributed in Taiwan to institutional investors or specific investors who have signed recommendation contracts with Daiwa-Cathay Capital Markets Co., Ltd in accordance with the Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers. Recipients of this research in Taiwan may contact Daiwa-Cathay Capital Markets Co., Ltd in respect of any matter arising from or in connection with the research. Philippines This research is distributed in the Philippines by DBP-Daiwa Capital Markets Philippines, Inc. which is regulated by the Philippines Securities and Exchange Commission and the Philippines Stock Exchange, Inc. Recipients of this research in the Philippines may contact DBP-Daiwa Capital Markets Philippines, Inc. in respect of any matter arising from or in connection with the research. DBP-Daiwa Capital Markets Philippines, Inc. recommends that investors independently assess, with a professional advisor, the specific financial risks as well as the legal, regulatory, tax, accounting, and other consequences of a proposed transaction. DBP-Daiwa Capital Markets Philippines, Inc. may have positions or may be materially interested in the securities in any of the markets mentioned in the publication or may have performed other services for the issuers of such securities. For relevant securities and trading rules please visit SEC and PSE Link at http://www.sec.gov.ph/irr/AmendedIRRfinalversion.pdf and http://www.pse.com.ph/ respectively. Thailand

This research is distributed to only institutional investors in Thailand primarily by Thanachart Securities Public Company Limited (“TNS”).

This report is prepared by analysts who are employed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates. While the information is from sources believed to be reliable, neither the information nor the forecasts shall be taken as a representation or warranty for which Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees incur any responsibility. This report is provided to you for informational purposes only and it is not, and is not to be construed as, an offer or an invitation to make an offer to sell or buy any securities. Neither Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees accept any liability whatsoever for any


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direct or consequential loss arising from any use of this research or its contents.

The information and opinions contained herein have been compiled or arrived at from sources believed reliable. However, Thanachart Securities Public Company Limited, Daiwa Securities Group Inc. nor any of their respective parent, holding, subsidiaries or affiliates, nor any of their respective directors, officers, servants and employees make no representation or warranty, express or implied, as to their accuracy or completeness. Expressions of opinion herein are subject to change without notice. The use of any information, forecasts and opinions contained in this report shall be at the sole discretion and risk of the user.

Daiwa Securities Group Inc. and/or its non-U.S. affiliates perform and seek to perform business with companies covered in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates, their respective directors, officers, servants and employees may have positions and financial interest in securities mentioned in this research. Thanachart Securities Public Company Limited, Daiwa Securities Group Inc., their respective parent, holding, subsidiaries or affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this research. Therefore, investors should be aware of conflict of interest that may affect the objectivity of this research. United Kingdom This research report is produced by Daiwa Capital Markets Europe Limited and/or its affiliates and is distributed in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority (“FCA”) and is a member of the London Stock Exchange, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and/or its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and/or its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients. This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available. Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-regulatory . Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Germany This document is distributed in Germany by Daiwa Capital Markets Europe Limited, Niederlassung Frankfurt which is regulated by BaFin (Bundesanstalt fuer Finanzdienstleistungsaufsicht) for the conduct of business in Germany. Bahrain

This research material is distributed by Daiwa Capital Markets Europe Limited, Bahrain Branch, regulated by The Central Bank of Bahrain and holds Investment Business Firm – Category 2 license and having its official place of business at the Bahrain World Trade Centre, South Tower, 7th floor, P.O. Box 30069, Manama, Kingdom of Bahrain. Tel No. +973 17534452 Fax No. +973 535113

This material is provided as a reference for making investment decisions and is not intended to be a solicitation for investment. Investment decisions should be made at your own discretion and risk. Accordingly, no representation or warranty, express or implied, is made as to and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this document, Content herein is based on information available at the time the research material was prepared and may be amended or otherwise changed in the future without notice. All information is intended for the private use of the person to whom it is provided without any liability whatsoever on the part of Daiwa Capital Markets Europe Limited, Bahrain Branch, any associated company or the employees thereof. If you are in doubt about the suitability of the product or the research material itself, please consult your own financial adviser. Daiwa Capital Markets Europe Limited, Bahrain Branch retains all rights related to the content of this material, which may not be redistributed or otherwise transmitted without prior consent. United States This report is distributed in the U.S. by Daiwa Capital Markets America Inc. (DCMA). It may not be accurate or complete and should not be relied upon as such. It reflects the preparer’s views at the time of its preparation, but may not reflect events occurring after its preparation; nor does it reflect DCMA’s views at any time. Neither DCMA nor the preparer has any obligation to update this report or to continue to prepare research on this subject. This report is not an offer to sell or the solicitation of any offer to buy securities. Unless this report says otherwise, any recommendation it makes is risky and appropriate only for sophisticated speculative investors able to incur significant losses. Readers should consult their financial advisors to determine whether any such recommendation is consistent with their own investment objectives, financial situation and needs. This report does not recommend to U.S. recipients the use of any of DCMA’s non-U.S. affiliates to effect trades in any security and is not supplied with any understanding that U.S. recipients of this report will direct commission business to such non-U.S. entities. Unless applicable law permits otherwise, non-U.S. customers wishing to effect a transaction in any securities referenced in this material should contact a Daiwa entity in their local jurisdiction. Most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as a process for doing so. As a result, the securities discussed in this report may not be eligible for sales in some jurisdictions. Customers wishing to obtain further information about this report should contact DCMA: Daiwa Capital Markets America Inc., Financial Square, 32 Old Slip, New York, New York 10005 (telephone 212-612-7000). Ownership of Securities For “Ownership of Securities” information please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationships For “Investment Banking Relationships” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions. Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report.

"1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months. Disclosure of investment ratings

Rating Percentage of total

Buy* 61.0% Hold** 26.1% Sell*** 12.9%

Source: Daiwa

Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 March 2015. * comprised of Daiwa’s Buy and Outperform ratings.


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** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.) If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in

the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the

amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices,

real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants.

*The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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