China Sportswear Companies: Approaching end of de-stocking

Store visits in Xiamen. We visited retail outlets of Li Ning, Anta, Xtep, Kappa, China Hongxing and 361 at Zhongshan Road, the busiest shopping area in Xiamen, between 7pm and 9pm on 2 Sep09. We were surprised to see substantial product discounts across all brands at all outlets.

Industry-wide de-stocking is likely to end before Nov09. The big discounts are meant to clear summer inventories before the full-scale launch of winter products, in our view. Thus, price discounting should not extend into November.

Industry prospects are improving. Retail sales growth in China is on an uptrend on a y-o-y basis, and the Business Climate Index for clothing and footwear showed a strong rebound in 2Q09 after 6 quarters of decline from its peak in 3Q07.

Upgrade China Hongxing to BUY, TP raised to S$0.31, based on 12x FY10 P/E or 30% discount to Anta’s FY10 P/E, with no change in earnings estimates, for we expect the valuation discount to continue to narrow to its normalized level as we have correctly foreseen in May09.

Maintain BUY on China Sports, TP raised to S$0.33, based on 6x FY10 P/E or 40% discount to Xtep’s FY10 P/E, in anticipation of normalizing valuation discount along with economic recovery.

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Delong - New Deal For CB Holders

As the company will not be able to meet their convertible bondholders (CB) requests when the CB holders have the option to require the company to redeem their bonds (worth RMB1.532bln) on 8 June 2010 the company is proposing to amend the terms and conditions of the bonds.

The new bonds will be similar to the existing bonds except that the new bonds will repay 100% of the principal at maturity in June 2012 and will not allow bondholders to force the company to redeem by June 2010, but in return, the company will pay an annual interest of 5% (paid semi-annually). As well, the old conversion price of S$4.455 will be reset to the equivalent to the average price from 17 Aug ’09 to the trading day prior to the closing date and there is no restriction on the convertibility of the new bonds.

An EGM is expected to be held on 2 Oct ’09 for shareholders to vote and at least 75% of positive votes are required to put the deal through.

The new deal sounds like a good deal for existing CB holders as they would be able to gain 5% annual interest as well as lower conversion price. The only downside is that if business at Delong remains in the doldrums, the CB holders would only be able to get the 5% annual interest and not be able to participate in the rise in share price and remain stuck with their CB until June 2012. However, this sounds like a better deal than see the company go into receivership for not being able to meet their debt obligations.

While Delong has underperformed most other SChips by rising the least from its low (shown in our table yesterday) we maintain that at 1.8x price to book it remains overvalued compared to China’s largest steel producer (Baoshan) which trades at 1.4x and the industry remains in the bad books of the government given overcapacity & pollution problems, hence maintain SELL.

China XLX Fertiliser - 2Q09: The worst has passed

Worse-than-expected 2Q09 results due to lower product prices and one-off loss. We expect profit to recover in 2H09 given the production ramp-up at new plant. Maintain BUY with target price of S$0.57 based on 8x 2010F PE.
China XLX Fertiliser’s (XLX) turnover was up 7% yoy to Rmb545m, mainly due to the launch of the new urea plant in mid-Apr 09. Gross margin and EBIT margin slid 13ppt yoy to 10.8% and 6.7% respectively, due to declines in the prices of urea, methanol and compound fertilisers, as well as one-off start-up costs for the new plant. Net profit plummeted 75% and 60% yoy respectively to Rmb23m in 2Q09 and Rmb82m in 1H09 (vs our full-year forecast of Rmb226m).


We believe the worst to be over in 2Q09, and earnings could recover in 2H09, due to the smooth launch of the new plant, as well as the stabilisation of urea prices and methanol prices. In 2Q09, the company registered substantial one-off start-up costs for the launch of Phase III in mid-April. The start-up costs will not be repeated in 2H09. With the production ramp-up at the new plant, the company’s urea capacity has increased from 0.72m tonnes to 1.25m tonnes. The company expects the new plant’s utilisation rate to increase throughout the year and reach full capacity next year. Unit cost is lower than that of the two old plants, which helps to drag down overall cost. Urea prices in China have stabilised at Rmb1,600-1,700/tonne due to a rebound in international urea prices and the reduction of urea export tariff, which opens the profit window for Chinese urea exports.

The loss from the methanol segment will narrow as XLX is streamlining facilities to produce less methanol and more urea, as well as reduce the cost of production. Adding to the boost is the rebound in methanol prices. Though net profit for 1H09 reached only 36% of our full-year forecast of Rmb226m, we maintain our profit forecast for 2009, due to the aforementioned factors. Management is going to hold a conference call today so we will provide updates later.

XLX is trading at 6.9x 2010F PE, much lower than the over 10.0x for domestic and global peers. Despite the industry headwinds in the near term, we remain upbeat on XLX, given its strong position amid industry consolidation in the medium to long term. Maintain BUY with a target price of S$0.57 based on 8x 2010F PE.