Performance review

The results of FY23 (April 2022 to March 2023) were higher than our expectations that the company's FY23 revenue fell 12% to 1.7 billion yuan, and the net profit returned to 110 million yuan (loss of 1.8 billion yuan in the same period last year), which was higher than our expectations, mainly due to better-than-expected earnings from the investment segment. The company plans to pay a final dividend of RMB 0.49 per share, corresponding to an annual dividend rate of about 85%.

The 3QFY23 pandemic had an adverse impact, and the children's clothing business switched to a licensing model. 2HFY23Kappa's oversized revenue fell 6% to 860,000 million yuan, mainly due to fluctuations in the 3QFY23 epidemic, which led to a 20-30% drop in turnover, but the improvement in the retail environment since the beginning of 2023 has led to a 10-20% increase in turnover in the medium to low range. 1) By business, retail/wholesale revenue was -16%/+18%, respectively, accounting for 59%/36% of the company's total revenue. The company continued to promote channel optimization and efficiency improvement, and closed 60 retail/wholesale stores respectively during the period. 2) By channel, offline/online revenue fell 4%/14% respectively, accounting for 78%/17% of the company's total revenue. Revenue from children's clothing and other businesses also fell 71% to 0.5 billion yuan, accounting for 5% of the company's total revenue, mainly because the children's clothing business switched to a licensing model.

Earnings in the investment segment improved significantly. By the end of March, the company held a total of 8.7 billion yuan in cash and investments, of which 57% were financial asset investments, cash and equivalents accounted for 26%, and the asset structure was optimized (cash and equivalents accounted for 16% at the end of FY22). The 2HFY23 Investment Division earned $490 million (loss of $840 million in the same period last year), including $450 million on changes in fair value of financial assets.

The profit margin of 2HFY23 increased significantly, and inventory and cash flow improved year over year. The 2HFY23 company's inventory impairment was set back 100 million yuan (2HFY22 provided 100 million yuan), and the gross profit margin before deduction of the inventory impairment provision was 63%, which was basically the same as the previous year (same increase of 11 ppt after deducting the provision). The sales and management expenses rate dropped by 2.7ppt to 66%, mainly because the company strengthened cost control and organizational optimization, saving advertising and personnel expenses. Operating profit margin increased 151 ppt to 59% (same increase of 14 ppt to 1% after excluding the investment segment). By the end of March, net inventory value had decreased by 16%, and the number of inventory turnover days had increased by 3 days to 206 days. FY23 net operating cash flow inflow was $1.0 billion (FY22 net outflow was $210 million).

Development trends

The Kappa brand saw a double digit increase in turnover in April-May. Since June, sales growth has been under some pressure due to the high base for the same period last year and the impact of the Dragon Boat Festival holiday season. Management said it will continue to consolidate the positioning of the Kappa brand as a high-end fashion sports brand and continuously optimize the operating efficiency and inventory management of offline and online channels.

Profit forecasting and valuation

Considering the improvement in the operation of the garment division and the improvement in investment business income, the FY24/25 EPS forecast was raised to 0.05/0.06 yuan (previously 0.03/0.04 yuan). The current stock price corresponds to 6/5 times the price-earnings ratio of FY24/25, maintaining an outperforming industry rating. We gave the company's apparel business a price-earnings ratio of 7 times FY24. Taking into account the value of the investment business after the valuation discount, we maintained a target price of HK$0.39 based on the division plus total valuation, with room for 26% upward.

risks

Competition in the industry has intensified, the terminal retail environment has fallen short of expectations, reforms have fallen short of expectations, and investment returns have fluctuated.