China Hongxing Sports - Signs of a reversal in operating figures; upgrade to Buy

Recent operating figures show encouraging signs -- a reversal in the SSS trend and an improvement in the macro environment. CHHS is trading at a 64% discount within the sportswear sector, a wider-than-average discount to its peers. We expect this valuation gap to narrow in the near term on signs of improved operating conditions. We revise our earnings estimates for the next two years on expected improved operating conditions. Upgrade to Buy and raise TP to S$0.22.

The sportswear industry is showing signs of improved operating conditions with better SSS in May compared to April and cutbacks on product discounts at the retail level. The SSS trend has reversed and demonstrates improved operating performance at the distributor level.

Prepayments from distributors have been reduced by a third from RMB900m and appear on track for repayment by the end of the year. We believe that conditions could continue to recover in 2H. Signs of an improvement in the cash conversion cycle, higher operating cash flows, and continued repayments from its distributors could be key catalysts for the stock to rerate. The stock is currently trading at a 19% discount to assessed net cash per share of S$0.17.

We raise our earnings by 36% and 57% in FY10-11E and our target price from S$0.18 to S$0.22 on our DCF analysis (COE at 14.5% and TG of 2%). Risks include: 1) intense competition in the sportswear industry leading to a price war; 2) a slowdown in consumer spending; and 3) risks from changes in fashion.

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