The rating was downgraded to hold and the target price was lowered to HK $22.84, based on a price-to-earnings ratio of 33 times for the 20 fiscal year (due to a slowdown in future growth, which was previously based on a 2-year PEG of 1.3 times). We believe that Prada will be negatively affected by novel coronavirus in China and overseas (especially Japan and Italy) in the first half of FY20, and is likely to be further dragged down in the future. We believe that its price-to-earnings ratio of 36 times for fiscal year 20 is quite high (29 times for the industry average), while the PEG is 2.0 times (the median for the industry is 1.6 times).
The impact is more negative than in the SARS era, because: 1) China accounts for a higher proportion of sales, and 2) there has also been an outbreak in overseas markets. Based on the performance of the SARS period, the luxury industry's share prices adjusted by an average of 27 per cent from November 2002 to April 2003, while sales fell by an average of 9 per cent in the first half of 2003 compared with the same period a year earlier. We believe that the negative impact will be more serious during COVID-19 's period, because: 1) China's sales contribution is much higher than before, accounting for about 20% of total sales (we estimate that it has doubled compared with 2003). And 2) Coronapneumonia has broken out overseas since late February and is increasing rapidly in South Korea, Italy, and even Germany and France. It is worth noting that Japan, China and Italy together accounted for 49 per cent of Prada sales in fiscal 18, according to estimates by China Bank International.
We expect the recovery to be slow and gradual after that. Looking back at the SARS period in 2003, sales of luxury brands did not return to positive growth soon. Sales of major brands (median) fell 2.2% year-on-year in the second half of fiscal 2003, compared with a 9.4% year-on-year decline in the first half, as it takes time for the economy and consumer confidence to recover. In addition, we believe that the travel restrictions imposed by governments and the recommendations of the World Health Organization (in China, South Korea, Italy and other countries) will deal a great blow to global tourism. According to research by ForwardKeys, a travel data analysis company, which analyzes millions of daily flight and hotel bookings, it says flights from China fell by 58 per cent (between January 20 and February 9) and 56 per cent (future bookings between March 1 and April 30), making it clear that tourist spending is likely to continue to decline in the second quarter of fiscal year 20.
We think it's a good thing to have Ralph Simmons as co-creative director. RafSimons will join Prada on April 2, 2020 (previously expected). Raf Simons, who previously worked at Christian Dior and Calvin Klein, is one of the most influential designers today.
Although some people say that he is too artistic, we think this is probably exactly what Prada needs. Still, Dior and PVH Corp shares performed well during his tenure.
Downgrade to hold and target price to HK $22.84. We adjusted our forecast for fiscal year 19 / 20 / 21 by 0.5% /-18.4% /-14.3%, taking into account the following factors: 1) losses on sales in China and overseas plus negative operating leverage, and 2) a decline in global tourist consumption. We downgraded Prada to hold and lowered the target price to HK $22.84, based on a price-to-earnings ratio of 33 times 20 fiscal years, while adjusted earnings per share grew at a compound annual growth rate of 18 per cent. The old target price is based on 1.3x 2-year PEG, implying a price-to-earnings ratio of 37 times for FY20.