Improving Fundamentals

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1 : Daphne (21 HK) Jerry Peng 彭港祥 公司报告 : 达芙妮 (21 HK) penggangxiang@gtjas.com Improving Fundamentals 基本面正在改善 GTJA Research 国泰君安研究 Daphne is principally engaged in the retailing and distribution of its core brand business ( Daphne and Shoebox ), and other brand business mainly consist of mid- to high-end self-owned and licensed brands. We favor the company due to: 1) benefit from stronger income growth in lower tier cities, 2) differentiated target customer group from major listed ladies footwear retailers, 3) shifting to the consumer-driven sales model, and 4) high proportion of street stores. Rating: Accumulate Initial 评级 : 收集 ( 首次研究 ) 6-18m TP 目标价 : HK$11.29 Revised from 原目标价 : HK$n.a. Since the dilution effect of the TPG investment is quite strong, we forecasts the fully diluted EPS to be HKD.627/.761/.914 in FY12/13/14, representing a 3-year CAGR of 2.5%. We believe the fundamental improvement of the Company continues to deliver decent results with expected SSSG of 12%, 1% and 1% in E. Coupled with the expected network addition of 65 stores and 5 stores for its self operated and franchised stores each year in E, we forecasts the core brand sales to deliver a 3-year CAGR of 23.1% during E. Due to the large opportunity of dilution effect for TPG s investment, we value the stock on fully diluted EPS. We set our target price of Daphne at 18x 212 fully diluted EPS, which corresponds to HKD11.29, representing a 22% discount to our 23x target price for Belle (188 HK). As Daphne is still on the way of rerating due to improving fundamentals, our rating for the company is Accumulate. Major risks include Chen s family exit, TPG exit and corporate governance issues. Share price 股价 : Stock performance 股价表现 HK$9.18 达芙妮主要从事核心品牌达芙妮和鞋柜以及其他中高端自有和授权品牌的零售和分销业务 我们认为公司在以下几个方面具有优势 :1) 受益于低层级城市强劲的收入增长 ;2) 和主流上市女鞋零售企业不一样的目标客户群 ;3) 转向以销定产的销售模式 ;4) 高比例的街边店 由于 TPG 投资于公司可转债和认股权证的摊薄效应巨大, 我们预期公司 FY12/13/14 年全面摊薄每股盈利分别为.627/.761/.914 港元, 对应 3 年年复合增长为 2.5% 我们相信公司基本面的改善将带来持续良好的同店增长预期, 其中 年分别为 12%,1% 和 1% 加上公司 年每年自营和分销预期将分别增加 65 和 5 家零售店铺, 我们预测核心品牌 年将带来 23.1% 的年复合增长 由于 TPG 投资带来大比例的摊薄效应, 我们用全面摊薄每股盈利来对公司估值 我们给予达芙妮 港元的目标价, 为 18 倍 212 年预测市盈率, 对应我们给予百丽 (188 HK)23 倍市盈率折让 22% 由于达芙妮的基本面在持续改善, 我们给予公司 收集 评级 主要风险包括陈氏家族的减持,TPG 的减持以及企业管治问题 Change in Share Price 股价变动 1 M 1 个月 3 M 3 个月 1 Y 1 年 Abs. % 绝对变动 % (11.4) (.5) 22.7 Rel. % to HS index 相对恒指变动 % (1.5) Avg. share price(hk$) 平均股价 ( 港元 ) Source: Bloomberg, Guotai Junan International Year End 年结 Turnover 收入 Net Profit 股东净利 EPS 每股净利 EPS 每股净利变动 PER 市盈率 BPS 每股净资产 PBR 市净率 DPS 每股股息 Yield 股息率 ROE 净资产收益率 3/31 (HKD m) ( HKD m) ( HKD) ( %) (x) ( HKD) (x) ( HKD) (%) (%) 21A 6, A 8, F 1,441 1, F 12,692 1, F 15,359 1, Shares in issue (m) 总股数 (m) 1,641. Major shareholder 大股东 Lucky Earn Intl 24.5% Market cap. (HK$ m) 市值 (HK$ m) 15,64. Free float (%) 自由流通比率 (%) month average vol. 3 个月平均成交股数 ( ) 5,523. Net gearing (%) 净负债 / 股东资金 (%) Net cash 52 Weeks high/low (HK$) 52 周高 / 低 / 5.89 FY11-14 PEG (X) 市盈率 / 增长率.8 Source.. the Company, Guotai Junan International. See the last page for disclaimer Page 1 of 16

2 Benefit from stronger income growth in lower tier cities Daphne is a leading ladies footwear retailer in China. Daphne is principally engaged in the retailing and distribution of its core brand business ( Daphne and Shoebox ), and other brand business mainly consists of mid- to high-end self-owned and licensed brands (i.e., AEE, Ameda, dulala, ALDO, Aerosoles, Sofft and Jessica Simpson ) as well as fashion brand Despina. In 199, the Company established its own brand Daphne, which has rapidly become one of the most well-known brands, in order to capture the growing potential of ladies footwear market in China. In 24, Daphne proactively widened its market share and at the same time, established its second own brand Shoebox to meet the customer demand of low-end ladies footwear. The Company has 2 production plants in Shanghai and 2 more in Fujian province. As at the end of 211, the Company had 4,547 directly-managed points-of-sale and 1,55 franchised outlets for its core brand business as well as 563 points-of-sale for its other brand business. Sales of core brand business and other brand business accounted for 88.6% and 6.2% of total sales in 211. Daphne also manufactures women s shoes for third-party retailers and wholesalers (engaged in OEM business), accounting for 5.2% of total sales in 211. Figure-1: Point of sales breakdown as of 31 December 211 1,55, 17.1% 563, 9.1% 4,547, 73.8% Directly managed core brand stores Franchise stores Figure-2: 211 sales breakdown (HKD mn) 53, 6.2% 45, 5.2% 7,597, 88.6% Core brand sales Other brand sales OEM Middle- and Low-end position of core brands. Daphne brand is well positioned as a middle-end ladies footwear brand with retail prices of around RMB3. While Shoebox is positioned as a low-end ladies footwear brand with retail prices of around RMB14. According to Euromonitor, the total sales of ladies footwear amounted to RMB119.1 billion in 21, accounting for 51.8% of total footwear retail sales in China. Moreover, low-end ladies footwear accounted for the largest proportion (4.2%) of total ladies footwear sales in 21 while middle-end ladies footwear accounted for the second largest proportion (3.2%). Daphne and Shoebox targets at the middle-end and low-end market, respectively, targeting lower income group and especially catering to consumption demand in lower tier cities. Figure-3: Retail sales of footwear in China (21) Figure-4: Breakdown of retail sales of women s footwear (21) 21 Retail sales of Footwear: RMB bn (RMB bn) Men's footwear, 84.8, 36.9% (RMB bn) Midpremium, , 27.8% Luxury, , 1.8% Low-end, , 4.2% Women's footwear, 119.1, 51.8% Children's footwear, 26., 11.3% Middle, , 3.2% Source: Euromonitor Source: Euromonitor See the last page for disclaimer Page 2 of 16

3 Higher rural income growth starting from 28. Daphne more leverages to China s lower tier cities and rural areas with 54.% of directly managed core brand stores located in tier 4-6 cities. Rural household income growth outpaced urban household disposable income from 28 due to lower base as well as stronger government support policy. Rural consumption was resilient, thanks to the strong income growth. Daphne continued to expand its retail distribution network in lower tier cities with 52.% addition of stores located in tier 4-6 cities in 211. We believe Daphne can benefit from the existing high proportion of lower tier city stores and the continued penetration into lower tier cities due to the resilient rural consumption growth. Figure-5: Higher rural income growth starting from 28 Figure-6: Resilient rural consumption % Urban household disposable income per capita Rural household cash income per capita % Urban Household Consumption Expenditure per Capita Rural Household Consumption Expenditure per Capita Source: National Bureau of Statistics of China Source: National Bureau of Statistics of China Table-1: Distribution network of core brand Tier city Store count as of 211 As % of total Additions in 211 As % of total Store count as of % % % % % % ,25 54.% % 2,661 Total 5,62 1.% 7 1.% 4,92 Differentiated target customer group from major listed ladies footwear retailer Differentiated target customer group. Major listed peers focus on the mid-premium ladies footwear markets. Belle (188 HK) had a dominant market share of 46.% in the mid-premium market in 21 according to Euromonitor. Major self owned brands Belle, Teenmix, Tata, Staccato, Basto, Joy & Peace, etc. all focus on mid-premium market. Other major listed competitors C.Banner International (128 HK), Le Saunda (738 HK) and Foshan Satruday (2291 CH) all focus on the mid-premium market with market shares of 6.5%, 3.2% and 3.7%, respectively, in 21 according to Euromonitor. Daphne has a differentiated target customer group and enjoys a much less competitive environment among listed companies. Also as shown in Figure 7, Daphne enjoys strong brand recognition compared to other leading ladies footwear brands, such as Belle, C.Banner and ST&SAT, according to Baidu Index, which tracks popular keywords search on the portal. Daphne brand had the largest single brand retail distribution network with over 4, retail stores as at the end of 211. Table-2: Market segmentation of ladies footwear Retail price Sales channel Brands Low-end <3 hypermarkets Shoebox supermarkets independent multi-brand footwear stores Middle 3-6 chained specialty stores Daphne middle-end department stores Comrade Walker Shop See the last page for disclaimer Page 3 of 16

4 Mid-to-premium 6-2, mid-end department stores Belle high-end department stores C.banner chained specialty stores ST&SAT Luxury >2, specialty stores in high-end department stores Louis Vuitton mono-brand specialty stores Salvatore Ferragamo Dolce & Gabbana Source: Euromonitor, Guotai Junan International Figure-7: Baidu index one year average (Feb Feb 212) 达芙妮 /Daphne 百丽 /Belle 天美意 /Teemix 思加图 /Staccato 他她女鞋 /Tata 红蜻蜓女鞋 /Red Dragonfly 千百度女鞋 /C.Banner 星期六女鞋 /ST&SAT 百思图 /Basto 莱尔斯丹 /Le Saunda 森达 /Senda 哈森 /Harson 接吻猫 /Kisscat 妙丽 /Millie's 真美诗 /Joy&Peace Source: Baidu, Guotai Junan International Figure-8: Market shares of mid-to-premium ladies footwear in China by estimated retail sales (21) Others, 4.6% Le Saunda, 2.2% Basto, 2.3% Harson, 2.4% Source:Euromonitor ST&SAT, 3.1% Belle, 17.% Teenmix, 9.8% Tata, 9.6% C.banner, 5.% Staccato, Kisscat, 4.1% 4.2% Different Competition Landscape for channel expansion of Daphne. Belle (188 HK) had a dominant market share in the mid-premium market with 1,27 footwear retail stores as at the end of 211, of which around 8% were department store counters. C.Banner International (128 HK) had 1,311 self-operated retail outlets as at the end of 211, of which over 9% were department store counters based on our estimation. Foshan Saturday (2291 CH) had 1,517 self-operated retail stores and 444 franchised stores as at the end of 211, with major distribution channel in department stores. As these listed peers targeted the mid-premium income group, the department store became the most suitable and important sales channel for them. Belle (188 HK) has a dominant position in the mid-premium ladies footwear market with strong distribution channel in department stores. The strong bargaining power of Belle (188 HK) places itself in a favorable position to secure best locations for its brand portfolio with good location and sizeable counters to attract the best customer traffic. Other mid-premium players are facing fierce competition from Belle (188 HK) in department stores. Daphne started setting up counters in department stores in 199 in Shanghai. But given more intense competition from other brands, Daphne counters were forced to relocate to smaller counters with lower customer traffic. Finally Daphne was forced to leave some department stores from 2 due to unclear brand positioning, low product quality and heavy discount, which was blamed by other brands. Since then, Daphne continued to leave department stores but increasingly focused on the fast development of standalone stores outside department stores. Life was tough for Daphne, especially on the location selection of new store addition. The Company used to use the strategy of opening retail stores next to Kentucky to utilize the good customer traffic of the fast food retailer. Also the fast expanding walking streets in China provide the Company good opportunity and feasibility to open its retail stores. Now Daphne is the single brand with the largest distribution network of over 4, retail stores as at the end of 211 in China. To further enhance the growing awareness of the brand among mass consumers, the Company strategically set up low-end brand Shoebox in 24. Now the Company tries to open the Shoebox brand retail stores next to the retail stores of Daphne brand. This approach accommodates the Company to meet expansion and operating leverage. See the last page for disclaimer Page 4 of 16

5 Figure-9: Market shares of mid-to-premium ladies footwear Company in China by estimated retail sales (21) Others, 36.3% Belle, 46.% Source:Euromonitor Le Saunda, 3.2% Foshan Saturday, 3.7% Kisscat Co, 4.2% Hongguo, 6.5% Improving fundamentals Shareholding structure. Daphne is now controlled by Chen Ying-cheih, Chang Chih-Kai (Chang Wen-I s children), Chang Chih-Chiao (Chang Wen-I s children) and Chen Yi-hsun (Chen Hsien-min s children). In May 29, Daphne issued RMB5 mn convertible bonds with an exercise price of HKD3.5 and RMB1 mn warrants with an exercise price of HKD4. to TPG. The convertible bonds with annual coupon of 3.125% and warrants can be fully converted to 178,51,572 and 1,, shares, representing approximately 14.3% of the enlarged share capital. Figure-1: Shareholding structure Chang Wen-i s (co-founder) children Chen Hsien-min s (co-founder) children Chen Ying-cheih and his brothers Chang Chihkai (ED) Chang Chih- Chiao (ED) Chang Wen-i s two daughters Chen Yihsun (ED) Chen Yichen Chen Ying-cheih (chairman & CEO) Chen Ying-cheih s two brothers TPG 5% 5% 33.3% 66.7% 26% 26% 48% Lucky Earn International 24.3% (2.8%)* Top Glory 1.4% (8.9%)* Pushkin 9.% (7.7%)* Premier China 1.2% (15.5%)* Public investors 55.1% (47.2%)* Daphne International (21 HK) ; *after the full conversion of convertible bonds and warrants (post dilution) Substantial change of management team. After the investment in 29, TPG was entitled to: 1) nominate one Director to the Board and each of the audit committee, the nomination committee and the remuneration committee of the Board; 2) designate one observer to Daphne s board meetings; 3) nominate candidates to be appointed as the chief financial officer of the Company and the head of supply chain. So Jerry Lin was appointed as the CFO and Michael Hu was appointed as the Chief Operating Officer in January 21. Moreover, Daphne appointed other senior executives including Chief Human Resources Officer, Chief Product Officer, Chief Strategy Officer, Chief Information Officer, Chief Development Officer, Chief Marketing Officer, Chief Sales Officer after January 21. We are positive on the changes of senior management in order to change Daphne to a stronger profit generating ladies footwear company. The board seats also increased from six to eight after TPG s investment. The current board comprises four executive directors from Chen s family, one non executive director from TPG and three independent directors. We are concerned on all the executive directors as well as the majority of board seats is occupied by Chen s family. But generally speaking, the current change of management team of the Company may See the last page for disclaimer Page 5 of 16

6 reflect the improvement after TPG s involvement in the company s development. Switch to the customer-driven sales model due to the improvement in supply chain management. The Company started to change from the traditional production-driven sales model to customer-driven sales model in 21. Daphne started with an OEM business and gradually participated in the retail sales of self-owned brands and licensed brands. The production driven-sales model typically has prepared plenty of inventories to wait for sales and it relies on the right bet on the popular design due to early preparation of stocks. So the Company may need to clear end of season inventory with strong promotion because it s difficult to capture customer demand. On the other hand, the production-driven sales model may lose sales of best selling products due to a lack of stocks. The customer-driven sales model relies on the fast response to the best selling products and requires very short replenishment lead time to meet market demand. The customer driven sales model has obvious advantage over the production-driven sales model as it can generate more sales from best selling products and avoid large stock of unpopular products. But the customer-driven sales model calls for higher requirements on the responsive supply chain from procurement, manufacturing, inventory management as well as logistics and distribution. The shift of supply chain management model is a proactive approach for Daphne to meet consumer needs and to improve sales and gross profit margin. Shortening lead time. Behind the switching of distribution model, Daphne is building up the capability to shorten lead time from 45 days in 21 to the current 35 days, according to the management. The shorter lead time is one of the most important keys to success of the customer-driven model. The shorter lead time of Daphne enables the Company to increase the sales from replenishment orders as well as the best selling products. The replenishment order now accounts for 3% of sales compared to only 1% in 21, according to the management. But the current proportion of replenishment order of 3% is still lagging behind the 4% of C.Banner international (128 HK) as well as the 5% of Belle (188 HK) for their footwear business. As most senior management is on board for a short time, we see more improvement after newly appointed management members work closely with one another. Results have the final say. Daphne brand is a mature brand so the Same Store Sales Growth (SSSG) is 8.8%, 8.2%, 2.8% and 2.5%, respectively, for the years Shoebox brand demonstrated much more robust performance with SSSG of 11.1%, 22.6%, 14.9% and 12.7%, respectively, for the years Daphne has grouped the Daphne brand and Shoebox brand as the core brand since 211. We did see the SSSG improvement from 1Q11 as compared to Belle (188 HK) footwear business as well as C.Banner International (128 HK). The improvement of SSSG may be attributable to the robust sales for street level shops, change of management, a more responsive supply chain model as well as the shorter lead time. Figure-11: SSSG of Daphne and Shoebox Figure-12: SSSG Comparison 25% Daphne Shoebox 22.6% 2% 21.% 14.9% 15% 12.7% 1% 11.1% 5% % 8.8% 8.2% 2.8% 2.5% ; Note: the Company disclosed the combined SSSG of Daphne and Shoebox starting 211 Comparison with peers High operating leverage among peers. We compare the operating and return profile of Daphne with listed peers Belle (188 HK), C.Banner International (128 HK) and Foshan Saturday shoes (2291 CH). Among the peers, Daphne has the highest operating leverage because around 8% of the retail stores are street level stores and thus are paying rentals that are not See the last page for disclaimer Page 6 of 16

7 linked to sales. But the Company may suffer when the retail sales are weak given high fixed costs. Brand portfolio. Daphne has 3 self-owned brands, compared to 1 of Belle (188 HK), 4 of C.Banner International (128 HK) and 5 of Foshan Saturday Shoes (2291 CH). Also Daphne has 4 licensed brands, compared to 15 of Belle, 1 of C.Banner International (128 HK) and 1 of Foshan Saturday Shoes (2291 CH). Major sales of Daphne are generated from the Daphne and Shoebox brands. Also C.Banner International and Foshan Saturday Shoes are highly dependent on the single brand sales of C.Banner brand and ST&SAT brand, respectively. Belle has a diverse sales mix, given its strong brand portfolio and the fast growth of Staccato, Senda, Basto, Millie s and Joy & Peace, etc, thus providing Belle (188 HK) with a much better position in a longer term. Table-3: Brand portfolio comparison Company Belle Daphne C.Banner International Foshan Saturday Shoes Ticker (188 HK) (21 HK) (128 HK) (2291 CH) Self-owned brands Belle Daphne( 达芙妮 ) C.Banner ST&SAT( 星期六 ) Tata Shoebox( 鞋柜 ) EBLAN FBL( 菲伯丽尔 ) Teemix Dulala Fabiola SAFIYA( 索菲娅 ) Staccato Sundance MOOFFY Joy & Peace, etc Rizzo Licensed brands Nike Aldo Naturalizer Killah Adidas Aee Claks Aerosoles Geox, etc Ameda Retail network. Daphne had the largest number of single brand store with more than 4, Daphne brand stores and nearly 1,5 shoebox stores as at the end of 211. Belle (188 HK) had the largest footwear distribution network with 1,27 footwear retail stores, which nearly doubled the number of Daphne. Belle brand had the largest number of stores of around 1,9 as at the end of 211, which was still far less than the number of Daphne brand. C.Banner International (128 HK) and Foshan Saturday Shoes (2291 CH) each had around 2, stores as at the end of 211. Table-4: Retail network comparison Belle Total number of stores 6,9 9,169 9,612 11,967 14,95 Footwear stores 3,732 6,5 6,75 8,312 1,27 Sportswear stores 2,358 3,119 2,862 3,655 4,68 Daphne Total number of stores 2,72 3,411 4,12 4,92 5,62 Self-operated core brand stores 2,441 2,993 3,377 3,918 4,547 Franchised stores ,55 C.Banner International Total no. of retail stores 928 1,45 1,289 1,748 Self-operated stores ,311 Franchised stores Foshan Satruday Total no. of retail stores 1,177 1,293 1,49 1,713 1,961 Self-operated stores ,517 Franchised stores Superior SSSG of Daphne in 211 and 1Q12. Daphne had superior SSSG than Belle (188 HK) s footwear business and C.Banner International (128 HK) in 211 and 1Q12. We believe the improvement of SSSG of Daphne may be attributable to the robust sales for street level shops, a more responsive supply chain model to increase best selling products, which carry See the last page for disclaimer Page 7 of 16

8 lower discounts. Figure-13: SSSG Comparison 25% Belle footwear Daphne core brand C.Banner 2% 21.% 22.% 17% 15% 15.% 11.7% 14.6% 1% 12.3% 8% 5% 4.6% 3.6% 1.% 2.8% % Q12 Figure-14 Gross profit margin comparison 75% Belle footwear Belle sportswear Daphne core brand C.Banner 7% 68.% 68.8% 64.9% 65.4% 65% 61.7% 63.5% 6% 57.7% 58.5% 62.5% 6.2% 55% 5% 54.1% 5.7% 45% 4% 35% 3% Lowest gross profit margin due to lower brand positioning. Daphne core brand generates thinner gross profit margins than Belle s footwear business and C.Banner international in 21 and 211. We believe the main reason behind this is the lower brand positioning than that of Belle (188 HK) and C.Banner International (128 HK), both of which targets the mid-premium ladies footwear market. Also Daphne has the lowest net profit margins compared with Belle (188 HK) and C.Banner International (128 HK). Best cash conversion cycle among peers. Belle has the average inventory days of 22 days and 137 days for the ladies footwear business and sportswear business in 211. Daphne has lower average inventory days than that of Belle s ladies footwear business, which we believe is in part due to the much lower self production ratio than that of Belle (188 HK). Daphne also has much lower account receivable turnover days than that of Belle (188 HK) and C.Banner International (128 HK) as around 8% of retail networks are street level shops, which typically have no credit period. Daphne has longer account payables days than that of Belle but shorter than that of C.Banner International (128 HK). In brief, Daphne has the best cash conversion cycle among peers. Table-5: Financial comparison (FY211) Ticker 188 HK EQUITY 21 HK EQUITY 128 HK EQUITY 2291 CH EQUITY Company name Belle Daphne C.Banner Foshan Saturday shoes Currency CNY mn HKD mn CNY mn CNY mn Revenue 28, , ,43.7 1,339.9 Gross profit 16, , , SG&A 11, , Operating profit 5, , Net profit 4, Profitability and Cost Analysis Gross profit margin 57.2% 61.1% 63.5% 48.1% SG&A as % of total revenue 39.4% 45.7% 43.7% 37.3% Operating profit margin 18.2% 16.% 19.8% 1.8% Net margin 14.7% 1.9% 14.2% 7.4% Growth Analysis (YoY) Revenue growth 22.1% 29.5% 29.8% 17.3% Gross profit growth 25.3% 38.% 33.5% 23.3% SG&A growth 22.7% 33.9% 2.9% 3.6% See the last page for disclaimer Page 8 of 16

9 Operating profit growth 33.5% 49.6% 69.5% 3.4% Net profit growth 24.2% 56.7% 7.8% -.9% Other Financial Ratios A/R turnover days A/P turnover days Inventory turnover days Cash conversion cycle ROA 18.3% 16.2% 19.% 5.2% ROE 23.3% 26.1% 2.7% 6.6% Forecast a 3 year diluted EPS CAGR of 2.5% Forecast a 3-year total revenue CAGR of 21.4%. Daphne generated 21% SSSG for 211 after the 2-year weak performance during We believe the improvement was attributable to the change of management, switching to the customer-driven sales model due to the improvement in supply chain management as well as a low sales base in 21. We believe the fundamental improvement of the Company continues to deliver decent results with expected SSSG of 12%, 1% and 1% in E. Coupled with the expected network addition of 65 stores and 5 stores for its self operated and franchised stores each year in E, we forecasts the core brand sales to deliver a 3-year CAGR of 23.1% during E. Also we expect the OEM and other brand sales to deliver a 3-year CAGR of -15% and 19.2% during E. As a result, we forecasts the total turnover to grow at a 3-year CAGR of 21.4% during E. Figure-15: Core brand SSSG 25% 21.% 2% 15% 12.% 1.% 1% 9.5% 1.% 5% 4.6% 1.% % 28A 29A 21A 211A 212F 213F 214F Figure-16: Retail network expansion 7, Self operated core brand stores 6,497 Franchised stores 5,847 6, 5,197 5, 4,547 3,918 4, 3,377 3, 2, 984 1,55 1,15 1,155 1,25 1, A 21A 211A 212F 213F 214F Figure-17: Sales breakdown 16, Core brand sales 14, Other brand sales H 12, OEM K 1, D 8, 6, m n 4, 2, 29A 21A 211A 212F 213F 214F Figure-18: GPM breakdown % A 1A 11A 12F 13F 14F Core brand Other brand OEM Blended Slight gross margin expansion. Gross profit margin of core brand expanded by 2.3pts yoy to 62.5% in 211 from the 6.2% in 21. We believe it s due to the good consumer market sentiment as well as change from a production-driven sales model to a consumer-driven sales model, which is a proactive approach to meet consumer demand and to improve sales with the 61.6 See the last page for disclaimer Page 9 of 16

10 best selling products at smaller discounts. We have conservatively modeled a flat gross profit margin for the core brand business in 212 but it would slightly decrease in due to the increasing production cost in China. The Company is still attempting to run the other brand business with higher brand positioning so we have modeled a slight improvement of other brand business gross profit margin in Falling sales of the thinner-margin OEM business should also improve the blended gross profit margin of the Company. All in all, we forecast the overall gross profit margin to improve slightly from the 61.1%% in 211 to 61.6% in 214. Operating margin pressure. Employee benefits expense and operating lease rentals accounted for 14.2% and 19.7%, respectively, of total turnover in 211. We have seen the employee expenses as a percentage of total turnover increased steadily from 1.4% in 29 to 14.2% in 211. We believe it was mainly driven by the increasing labor and staff costs in China, rising option expenses and strengthening of the management team. The labor and staff costs are expected to increase continually in the foreseeable future in China. The operating lease rentals as a percentage of total turnover decreased slightly from the 19.8% in 21 to the 19.7% in 211, which was driven by the strong sales growth in 211. The absolute dollar amount of the operating lease rentals still increased by 28.4% yoy in 211. Going forward, we expect the operating lease rentals as a percentage of total turnover to increase continually in Thus, we have modeled the SG&A expenses as a percentage of total turnover to increase from the 45.7% in 211 to the 46.9% in 214. As a result, we are expecting the basic EPS to be HKD.75/.859/1.35 in FY12/13/14. Since the dilution effect of the TPG investment of convertible bonds and warrants are quite strong, we also calculated the fully diluted EPS to be HKD.627/.761/.914 in FY12/13/14, representing a CAGR of 2.5% during Figure-19: Employee benefits expenses Employee benefits expense 1,4 % of total turnover 1,2 H K 1, 12.6% D 8 1.4% m n A 21A 211A Figure-21: SG&A H K D m n 7, 6, 5, 4, 3, 2, 1, 4.7% 44.2% 45.7% 46.4% 46.7% 14.2% 46.9% 29A 21A 211A 212F 213F 214F Selling & Distribution Expenses Administrative expenses % of total turnover % of total turnover % SG&A of turnover 16% 14% 12% 1% 8% 6% 4% 2% % 5% 45% 4% 35% 3% 25% 2% 15% 1% 5% % Figure-2: Operating lease rentals Operating lease rentals 2, H K D m n 1,5 1, % 19.8% 29A 21A 211A Figure-22: Operating profit H K D m n 3, 2,5 2, 1,5 1, % 14.7% 6.8% 9.% 2% 2% 19.7% 2% 19% 19% 19% 18% 16.% 15.9% 15.9% 15.8% 16% 14% 11.1% 1.9% 11.1% 12% 11.1% 1% 29A 21A 211A 212F 213F 214F Profit from operations Operating margin Net profit margin 8% 6% 4% 2% % Table-6: Major assumptions (HKD mn) 21A 211A 212F 213F 214F Total Revenue 6,624 8,577 1,441 12,692 15,359 Core brand sales 5,647 7,597 9,41 11,582 14,186 Other brand sales See the last page for disclaimer Page 1 of 16

11 OEM Gross Profit 3,81 5,244 6,384 7,798 9,466 Operating Profit 972 1,369 1,663 2,2 2,428 Net Profit ,157 1,41 1,699 Basic EPS (HKD cents) Diluted EPS (HKD cents) Gross Profit Margin 57.4% 61.1% 61.1% 61.4% 61.6% % SG&A of total turnover 44.2% 45.7% 46.4% 46.6% 46.9% Operating profit margin 14.7% 16.% 15.9% 15.9% 15.8% Effective tax rate 28.1% 28.5% 27.5% 27.5% 27.5% Net profit margin 9.% 1.9% 11.1% 11.1% 11.1% Initiate Coverage with an Accumulate rating and target price of HKD11.29 Initial coverage with Accumulate rating and TP of HKD As of 26 April 212, the stock price of Daphne was trading at 15.4x and 17.3x of 212 PE and 212 fully diluted PE based on our estimation. Due to the large opportunity of dilution effect for TPG s investment, we value the stock on fully diluted EPS. We set our target price of Daphne at 18x 212 fully diluted EPS, which corresponds to HKD11.29, representing a 22% discount to our 23x PER valuation for Belle (188 HK). As Daphne is still on the way of rerating due to its improving fundamentals, our rating for the company is Accumulate. Table-7: Valuation Comparison Ticker Company Closing Price (HKD) EPS CAGR (%) Dividend ROE (%) Mkt Cap Yield (%) PE (X) PB (X) PEG (X) FY12E FY13E FY14E FY12E FY13E FY14E FY12E FY12E Clothing 188 HK Equity BELLE INTERNATIO , HK Equity DAPHNE INTERNATI , HK Equity CHINA LILANG LTD , HK Equity TRINITY LTD , HK Equity EVERGREEN INTERN , HK EQUITY BOSIDENG INTL , HK EQUITY ESPRIT HLDGS ,879 Mkt Cap Wght Avg Sportswear 22 HK EQUITY ANTA SPORTS PROD (.9) (9.) , HK EQUITY LI NING CO LTD , HK EQUITY CHINA DONGXIANG , HK EQUITY XTEP INTERNATION (.8) (8.2) , HK EQUITY 361 DEGREES (8.2) (.4) , HK EQUITY PEAK SPORT (9.4) (.5) ,895 Mkt Cap Wght Avg (4.5) (HKD mn) Overall Mkt Cap Wght Avg (.1) Source: Bloomberg, Guotai Junan International. Closing prices were as at Major risks Chen s family exit. The Company is controlled by the Chen s family with 9 family members (as shown in figure 5). Chen Hsien-min s children did a share placement of 3 mn shares right after releasing 1Q12 operational data in April 211. Given See the last page for disclaimer Page 11 of 16

12 the historical high of the stock price, the potential exit of Chen s family remains an overhang. TPG exit. TPG has nearly tripled its investment since May 29. As TPG is holding 15.5% of the enlarged share capital of Daphne with market value of HKD3.2 billion, the potential exit of TPG will always remain an overhang on the stock performance. Corporate governance. The current board comprises four executive directors from Chen s family, one non executive director from TPG and three independent directors. We are concerned on all the executive directors as well as the majority of board seats is occupied by Chen s family. Also, the directors high compensation is also our worry. The directors emoluments accounted for 1.6% and 9.9% of corresponding net profit in 211 and 21, respectively, which are much higher than the.4% and the.7% of Belle (188 HK) in 211 and 21, respectively. Table-8: Directors emoluments comparison 211 Daphne HKD (') Salary, bonus and other cash payment Share-based payment expense Total Belle RMB (') Salary, bonus and other cash payment Share-based payment expense Mr Chen Ying-Chieh 15,232 9,351 24,583 Tang Yiu 3,888 3,888 Mr Chang Chih-Kai 7,494 3,799 11,293 Sheng Baijiao 7,616 7,616 Mr Chang Chih-Chiao 7,494 3,215 1,79 Tang King Loy 2,764 2,764 Mr Chen Hsien Min 33,988 7,14 41,2 Sheng Fang 2,856 2,856 Mr Chen Tommy Yi-Hsun 8,495 2,446 1,941 Yu Mingfang Other directors Other directors Total 73,4 25,825 98,865 Total 18,15 18,15 % of net profit 7.8% 2.8% 1.6% % of net profit.4%.%.4% 21 Daphne Belle HKD (') Salary, bonus and other cash payment Share-based payment expense Total RMB (') Salary, bonus and other cash payment Share-based payment expense Mr Chen Ying-Chieh 9,782 13,396 23,178 Tang Yiu 7,661 7,661 Mr Chang Chih-Kai 2,887 5,442 8,329 Sheng Baijiao 7,628 7,628 Mr Chang Chih-Chiao 2,883 4,65 7,488 Tang King Loy 4,36 4,36 Mr Chen Hsien Min 9,766 1,47 19,813 Yu Mingfang 2,67 2,67 Other directors Other directors Total 25,534 33,49 59,24 Total 22,382 22,382 % of net profit 4.3% 5.6% 9.9% % of net profit.7%.%.7% Total Total See the last page for disclaimer Page 12 of 16

13 Income Statement Yr end 31 Dec (HKD mn) 21A 211A 212F 213F 214F Turnover 6,624 8,577 1,441 12,692 15,359 YoY 13.6% 29.5% 21.7% 21.6% 21.% Cost of sales (2,823) (3,333) (4,57) (4,893) (5,893) YoY 7.5% 18.1% 21.7% 2.6% 2.4% Gross profit 3,81 5,244 6,384 7,798 9,466 Gross margin 57.4% 61.1% 61.1% 61.4% 61.6% Other revenue Selling & Distribution Expenses (2,485) (3,366) (4,164) (5,96) (6,22) Administrative expenses (444) (556) (677) (823) (996) Other Gains(Losses)-Net 12 (74) Profit from operations 972 1,369 1,663 2,2 2,428 Net Finance income (costs) (45) (47) (48) (51) (55) Fair value loss on derivative financial instrument warrants (77) Share of profit of an associated company 1 Profit before taxation 85 1,322 1,616 1,969 2,373 Income tax (239) (377) (444) (541) (652) Profit for the year ,171 1,427 1,72 Profit attributable to: Equity holders of the Company ,157 1,41 1,699 Non-controlling interests Basic EPS (HKD) Diluted EPS (HKD) Balance Sheet Yr end 31 Dec (HKD mn) 21A 211A 212F 213F 214F Fixed assets ,1 1,87 1,19 Available-for-sale financial assets Land use rights Interest in an associated company Intangible asset Deferred tax asset Long-term rental deposits and prepayments Deposits paid for acquisition of fixed assets Total non-current assets 1,123 1,447 1,542 1,66 1,616 Inventories 1,84 2,59 2,286 2,859 3,445 Trade receivables Other receivables, deposits and prepayments ,111 1,294 1,499 Bank deposit with maturity over three months 35 Cash and cash equivalents 2,24 1,796 2,331 2,83 3,526 Total current assets 3,926 5,55 6,72 7,373 8,976 Total assets 5,49 6,51 7,614 8,979 1,592 Trade Payables ,11 1,273 Other payables and accrued charges Income tax payable Bank Loans 11 7 Total current liabilities 1,16 1,64 1,855 2,127 2,43 Convertible bonds See the last page for disclaimer Page 13 of 16

14 License fee payables Deferred Tax Liabilities Other non-current liabilities 16 Total non-current liabilities Total liabilities 1,741 2,27 2,532 2,855 3,214 Share capital Reserves 2,961 3,872 4,77 5,732 6,965 Total shareholders' equity 3,124 4,36 4,872 5,896 7,129 Minority interest Total equity 3,38 4,232 5,82 6,124 7,378 Total liabilities and equity 5,49 6,51 7,614 8,979 1,592 BPS (RMB) Cash Flow Statement Yr end 31 Dec (HKD mn) 21A 211A 212F 213F 214F Operating activities Profit before taxation 85 1,322 1,616 1,969 2,373 Depreciation and amortisation Finance costs Interest income (37) (63) (59) (76) (92) Others Changes in working capital 18 (1,3) (26) (557) (576) Cash (used in)/generated from operations 1, ,618 1,7 2,124 Income tax paid (264) (367) (444) (541) (652) Operating cash flow ,174 1,158 1,472 Investing activities Dividend received from an associated company 1 1 Interest Income Received Payment for land use rights (4) Purchase of fixed assets (273) (392) (321) (327) (319) Others 1 5 Investing cash flow (229) (323) (262) (251) (227) Financing activities Dividends paid (18) (231) (321) (385) (466) Dividends paid to minority shareholders (4) (4) Interest paid (21) (22) (48) (51) (55) New bank loans raised 89 (7) Repayment of bank loans (123) (4) Others 3 19 Financing cash flow (236) (242) (376) (436) (521) Net increase in cash 427 (322) Cash at beginning of year 1,545 2,24 1,796 2,331 2,83 Effect of Foreign Exchange Rate Change Cash at end of year 2,24 1,796 2,331 2,83 3,526 See the last page for disclaimer Page 14 of 16

15 Financial Ratios Yr end 31 Dec 21A 211A 212F 213F 214F Revenue growth (%) Net profit growth (%) Gross margin (%) Operating margin (%) Net profit margin (%) ROE (%) ROA (%) Inventory turnover days Account receivable days Account payable days Current ratio (x) Payout ratio (%) Source: The Company, Guotai Junan International. See the last page for disclaimer Page 15 of 16

16 Company Rating Definition The Benchmark: Hong Kong Hang Seng Index Time Horizon: 6 to 18 months Rating Definition Buy Relative Performance >15%; or the fundamental outlook of the company or sector is favorable. Accumulate Relative Performance is 5% to 15%; or the fundamental outlook of the company or sector is favorable. Neutral Relative Performance is -5% to 5%; or the fundamental outlook of the company or sector is neutral. Reduce Relative Performance is -5% to -15%; or the fundamental outlook of the company or sector is unfavorable. Sell Relative Performance <-15%; or the fundamental outlook of the company or sector is unfavorable. Sector Rating Definition The Benchmark: Hong Kong Hang Seng Index Time Horizon: 6 to 18 months Rating Definition Outperform Relative Performance >5%; or the fundamental outlook of the sector is favorable. Neutral Relative Performance is -5% to 5%; or the fundamental outlook of the sector is neutral. Underperform Relative Performance <-5%; or the fundamental outlook of the sector is unfavorable. DISCLOSURE OF INTERESTS (1) The Analysts and their associates do not serve as director in the issuer mentioned in this Research Report. (2) The Analysts and their associates have no financial interests in the issuer mentioned in this Research Report. (3) Except for Shandong Chenming (1812), Guotai Junan and its group companies do not hold more than 1% of the market capitalization of issuer in this Research Report. (4) Guotai Junan and its group companies have not had investment banking relationships within the preceding 12 months for the issuer in this Research Report. DISCLAIMER This Research Report does not constitute an invitation or offer to acquire, purchase or subscribe for securities by Guotai Junan Securities (Hong Kong) Limited ("Guotai Junan"). Guotai Junan and its group companies may do business that relates to companies covered in research reports, including investment banking, investment services and etc. (for example, the placing agent, lead manager, sponsor, underwriter or invest proprietarily). Any opinions expressed in this report may differ or be contrary to opinions or investment strategies expressed orally or in written form by sales persons, dealers and other professional executives of Guotai Junan group of companies. Any opinions expressed in this report may differ or be contrary to opinions or investment decisions made by the asset management and investment banking groups of Guotai Junan. Though best effort has been made to ensure the accuracy of the information and data contained in this Research Report, Guotai Junan does not guarantee the accuracy and completeness of the information and data herein. This Research Report may contain some forward-looking estimates and forecasts derived from the assumptions of the future political and economic conditions with inherently unpredictable and mutable situation, so uncertainty may contain. Investors should understand and comprehend the investment objectives and its related risks, and where necessary consult their own financial advisers prior to any investment decision. This Research Report is not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject Guotai Junan and its group companies to any registration or licensing requirement within such jurisdiction. 212 Guotai Junan Securities (Hong Kong) Limited. All Rights Reserved. 27/F., Low Block, Grand Millennium Plaza, 181 Queens Road Central, Hong Kong. Tel.: (852) Fax: (852) Website: See the last page for disclaimer Page 16 of 16