We are amazed by Topsport’s strong cash flow management in FY2/20 and believed its efficient digital transformation will lead to effective recovery in 2H21E. Despite a relatively high valuation at 18x FY2/22E P/E (44% premium over int’l peers’ avg. of 12x, but JD sports (JD LN) is at 19x), we still expect further re-rating aided by better sentiment, as double digit growth is likely to return in 2H21E.
- FY2/20 net profit inline while sales missed by 5%. Topsports’s NP rose by 5% YoY to RMB 2.3bn, inline with BBG est. while sales only increased by 3% YoY to RMB 33.7bn, 5% below cons. We attributed this to: 1) slightly weaker direct retail sales (8% decline vs 35% growth for wholesales in 2H20) but 2) better GP margin even with COVID-19 (only 0.4ppt YoY drop to 40.5% in 2H20). Remarkable momentum prior COVID-19. According to mgmt., sales/ operating income growth were 13%+/ 20%+ YoY during Mar 2019 - Jan 2020 (excluding Feb), better than 12%/ 18% YoY in 1H19.
- Inevitable pressure on cash flow, but we are confident due to: 1) excellent working capital, 2) support by principal brands and 3) its digital edge. Sales was terrible in Feb 2020 and inventory days was rising (from 104 in FY2/19 to 120 in FY2/20), but operating cash flow can still grow by 105% YoY in FY2/20, helped by better payables (from 10 to 16 days) and receivable (from 29 to 22 days) conditions because of its unmatched relationship with landlords. Moreover, principal brands are highly supportive by: 1) allowing order cancellation (mostly in 1Q and 3Q, in our view), 2) providing a more flexible return policy, 3) giving out higher rebates for inventory clearances, even with deep retail discounts and 4) wider use of digital tools for procurement, e-commerce, etc. Digital sales contribution climbed to 10-20% (of total direct retail sales) during Mar-May 2020, much higher than the mid- to high-single digit % before COVID-19 crisis thanks to different digital initiatives, such as mini-programs, mobile payment at physical stores and more inventory sharing.
- Positive growth in May 2020 and business will be normalized from Jul 2020. According to management, positive growth was recorded in May 2020, while both sales and retail discounts can be normalized from Jul 2020.
- Target stable store numbers in FY2/21E but area growth and store revamps will continue. Overall store count may not change much in FY2/21E, but there will be more: 1) renovation (more stores being upgraded and filling with trendier products) and 2) larger sized stores (to replace smaller ones). Note that gross selling area went up by 10.6% YoY (vs FY2/19’s 9.3%) while store count was only up by 0.6% (+52 to 8,395) in FY2/20.
- Recovery trend to drive sentiment improvement despite valuation premium. In general, we are optimistic and expect future sales recovery to boost sentiment, even though we see potential cut in consensus sales after a 5% miss. Based on BBG’s est. Topsports is trading at 18x FY2/22E P/E (44% over int’l distributors avg. of 12x), relatively high but still justifiable.
