Continue to face a difficult situation

In the face of the mild sales environment in Europe and the United States, Xinxing shoes Group continues to promote the development of leisure footwear products in the direction of high value and high quality. Although the average selling price of the group's 1HFY2019 products rose 8.1 per cent year-on-year and its revenue increased by 8.4 per cent, the group's gross profit margin continued to be under pressure, excluding the net income of about HK $174 million from the sale of Shunxing shoes (Zhongshan), its recurrent profit fell 23 per cent to HK $37.6 million. We expect the retail environment in the US and Europe to remain weak, so we lowered our target share price from HK $2.16 to HK $1.79 and maintained our "hold" rating.

The Group's assets have great potential for re-development and may be sold at a high price: as more and more production orders are transferred from China to Vietnam and Cambodia, the Zhuhai plant has gradually transformed into a strategic center for the development and production of new footwear products. The Group will continue to expand and evaluate the potential value of the Zhuhai plant. According to the data of Zhuhai Land and Resources Bureau, land prices in Zhuhai have remained weak, with a significant increase after 3Q17. The Group's two factory sites in Zhuhai are adjacent to each other, with a floor area of about 39025 square meters and 9223 square meters respectively. The factory site is about 7.4 kilometers away from Gongbei Port, Zhuhai and Macao entry Port, so we believe that the factory site will continue to increase in value.

The Group has a strong balance sheet: Xinxing Group maintains a strong net cash position and no debt, which is the key for the Group to maintain its operation in a depressed economy. We believe that the group has the ability to maintain a positive cash flow situation and maintain a dividend payout rate of 40% and 60%. Based on the current share price, the group's dividend yield of 4.6 per cent is still attractive.

Market demand is weak and profit margins are under pressure. Under the influence of the Sino-US trade war, the market uncertainty has increased, and we cannot guarantee whether the footwear industry can pick up quickly. At present, the group has a small volume of business and low capacity utilization (1HFY2019VR 41.5%), resulting in a low profit margin. In addition, the minimum wage in Vietnam and Cambodia is growing rapidly, reaching nearly 2/3 of the minimum wage in the Chinese market.

Downgrade the target share price and maintain the "hold" rating. We believe that order demand will remain weak, so we downgrade the earnings forecasts for FY2019E and FY2020E, and based on the DDM valuation model, we reduce the target share price from HK $2.16 to HK $1.79. The target share price implies a price-to-earnings ratio of 15.7 times for FY19E and 1.1 times for FY19E.