China Sport - Expansion looks like coming to a halt

China Sports FY08 earnings were 8% below our expectation due to weaker-than-expected revenue and a decline in 4Q08 earnings. The poor 4Q08 showing was caused by weak gross margins (fell from 22.4% to 16%) and hefty operating expenses led by higher A&P expenditure. The group recommended a first & final dividend of RMB0.0275 per share. However, the dividend payout is a modest 10%.

Both gross margins and pre-tax margins fell sharply in 4Q08. Gross margins of the Yeli footwear (down from 21% to 14%) and OEM footwear (down from 19% to 7%) saw the steepest decline. Lower margins from Yeli footwear were attributable to higher subcontracting costs while lower margins from its accessories products were due to initial start up and development cost. Pre-tax margins were also dragged down by hefty A&P expenses. Going forward, we expect margins to stay depress as competition intensifies and A&P expenditure remains high.

Store expansion seems to have come to a halt as there is only a slight increase in POS from 2250 to 2260 during the quarter. Growth will be challenging into the next 2 years as expansion slows and margin pressure looms. The group may also face rising competition as bigger sportswear brand players move into 2nd, third and fourth tier cities in China to target mass market demand to cope with the downturn.

We have lowered our earnings estimates for FY08 and FY09 by 30-40% to reflect lower margins. Our target price is lowered accordingly from 18 cents to 11 cents based on 4x FY09 PER. The lack of earnings catalysts and rising business risks ahead offer little upside for the share price. As such, we are ceasing coverage on the stock.

Sponsored Links