Beijing Toread Outdoor Products:Earnings to bottom on destocking;watch new business model transition

Outdoor sportswear growth is slowing

    As a leading outdoor brand with the largest sales, Toread's advantages are its strongbrand awareness and R&D capacity. However, its growth has slowed with the end ofacross-the-board industry growth. We believe the company will continue to focus ondestocking and adjust its physical stores against the backdrop of subdued departmentstore sales and promotions by rivals over the next 6-9months. With its channel andproduct transition in the last two years and gradually stronger momentum of newbrands (especially Discovery Expedition), we estimate its outdoor segment revenuegrowth will bottom out in 2017when destocking is largely done.

    Inventory likely to be put under control

    Sharp inventory rise in 2015was caused by overstock of out of season items (especiallythe lacklustre sales of winter items with high unit prices due to a warm winter) and ahigher share of direct sales (including self-owned stores, e-commerce and acquisition offranchisees). The company has taken destocking as the business focus for outdoorsegment in 2016, including existing inventory closeout, reduction of forward ordersand increasing the share of repeat orders. We believe its inventory will decline YoY in2016with earnings quality improvement; acquisition of stake in franchisees could alsohelp control channel inventory.

    New business in place, but the effect of business transition yet to be watched

    Toread has set up three divisions (outdoor, travel and sports), aiming to shift from pureoutdoor products to related experience-driven services and build a user-centred"healthy lifestyle community". It has integrated its online and offline outdoor travelresources. We believe the new business will be loss-making in 2016given investment inIT, team building and marketing, but will contribute c10% of total earnings in 2017.

    Valuation: Downgrade to Neutral; PT to Rmb17.30from Rmb23

    Given weak retail market and higher expense ratios due to ongoing offline channeladjustment, normalised operations of the new Innovation Center and investment innew business, we are cutting our 2016-18E EPS by c40%; considering c15% dilutionfrom Toread's share issuance, we are cutting 2016-18E EPS to Rmb0.36/0.47/0.59. Ournew DCF-based price target is Rmb17.30(WACC=8%). Its current valuation is 16%higher than historical average, but we see limited downside risks and assign a Neutralrating, considering: 1) new business value; and 2) likely revenue growth and grossmargin improvement in 2017-18with current margin at trough level.