A dominating force in textile, initiating with Buy

Deutsche Bank Markets Research Rating Buy Asia China Consumer Textiles & Apparel Company Shenzhou Date 26 September 2016 Initiation of Coverage A dominating force in textile, initiating with Buy Reuters Bloomberg Exchange Ticker 2313.HK 2313 HK HSI 2313 Forecasts And Ratios Year End Dec 31 2014A 2015A 2016E 2017E 2018E Sales (CNYm) 11,131.5 12,639.6 15,328.5 17,874.8 20,310.2 DB EPS FD(CNY) 1.45 1.61 2.02 2.42 2.78 DB EPS growth (%) 7.4 11.7 24.9 20.0 14.9 PER (x) 13.3 17.6 23.2 19.4 16.9 Yield (net) (%) 7.0 5.0 2.9 3.4 3.9 Source: Deutsche Bank estimates, company data 1 DB EPS is fully diluted and excludes non-recurring items Most effective textile platform adding more innovation elements; Buy ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Price at 23 Sep 2016 (HKD) 54.50 Price target - 12mth (HKD) 62.00 52-week range (HKD) 55.05 - 35.30 HANG SENG INDEX 23,760 John Chou Research Analyst (+852 ) 2203 6196 john.chou@db.com Anne Ling Research Analyst (+852 ) 2203 6177 anne.ling@db.com Price/price relative 1020304050609/143/159/153/16ShenzhouHANG SENG INDEX (Rebased) Performance (%) 1m 3m 12m Absolute 11.5 49.3 40.8 HANG SENG INDEX 3.3 13.9 11.5 Source: Deutsche Bank Shenzhou (SZ) is a dominant textile platform due to its strong execution and dominant scale. Also, its unique exposure to China allows both cyclical and structural tailwinds. We view SZ’s growth sustainable in the long term due to effective capacity expansion and efficiency improvement. With cost and lead-time advantage, SZ started to conduct more innovations. Flyknit will be a sustainable yet significant driver, while SZ’s other innovative products like Tech Fleece will fuel its long-term growth. We forecast SZ to deliver earnings CAGR of 17% from 2015-2020, initiating with Buy. One of the strongest textile platforms with unique China exposure SZ’s focus on leading sporting goods brands (Nike, Adidas and Puma) and has successfully become their core supplier & partner (Figure 9). We expect SZ’s dominance to be reinforced by its further expansion in scale and product upgrades (Figure 12). We, thus, are less worried about intensifying competition following industry capacity addition. Cyclically, SZ’s unique exposure to China allows SZ to enjoy the ongoing inventory restocking to Nike and Adidas’ local distributors (which has been under inventory shortage) (Figure 17). The China exposure also allows SZ to structurally upgrade its products along with the market. We forecast SZ’s China revenue contribution to rise to 32% by 2020 from 24% in 2015. We believe SZ’s timely capacity expansion and efficiency improvement will support its growth in the long term (Figure 23). Flyknit and textile innovations to contribute to long-term growth We forecast Flyknit order growth to accelerate in 2016 and 2017 (Figure 29) We also forecast SZ to maintain a dominant market share due to superior yield rate and execution. As a result, we estimate Shenzhou to enjoy 42% CAGR for its Flyknit revenue from 2015-2020, with Flyknit representing 14% gross profit by 2020 (vs. 6% in 2015) (Figure 27). In addition, SZ is adding more innovative elements to its platform model, with Tech Fleece an important milestone (Figure 39). Such initiatives support SZ’s long-term growth. DCF-based target price of HKD62 supported by PER, downside risks We use discounted cash flow (DCF) as our primary approach to value SZ’s shares. We adopt the DCF methodology as we expect investors to focus more on SZ’s long-term value creation (detailed assumptions in Figure 4). Downside risks: sharp increase in competition and raw material volatility. This report is published in conjunction with our sector report – Greater China Sporting Goods: Giant Steps Distributed on: 26/09/2016 16:00:00 GMTDistributed on: 26/09/2016 14:55:00 GMT 26 September 2016 Textiles & Apparel Shenzhou Page 2 Deutsche Bank AG/Hong Kong Model updated:23 September 2016 Running the numbers Asia China Textiles & Apparel Shenzhou Reuters: 2313.HK Bloomberg: 2313 HK Buy Price (23 Sep 16) HKD 54.50 Target Price HKD 62.00 52 Week range HKD 35.30 - 55.05 Market Cap (m) HKDm 76,246 USDm 9,830 Company Profile Shenzhou International Group Holdings Limited is the largest vertically integrated manufacturer of knitwear and the largest exporter in China.