Daphne (210.HK):Disappointing 1Q15;Downgrade to Sell

What’s new.Daphne reported worse-than-expected 1Q15 operation data. SSSG of its core brands was down 15.9% y/y in 1Q15, following a 7.5% y/y decrease in 4Q14. Revenues of core brands decreased atlow-teen percentage y/y decrease in 1Q15, dragged by deterioratingretail sales growth in March. Management attributed the weak sales growth to fierce competition from regional brands in its mass market segment and adverse weather that impactedstoretraffic. Gross margin saw improvement on a better product mix. Online salescontinued to record strong growth in 1Q15. Daphne opened 24 directly-managed stores and closed 38 franchised stores for its core brands, resulting in a net decrease of 14 stores in 1Q15.

Weaker-than-expected 1Q15.Company recorded high single-digit percentage drop in January-February, whiledeterioratingsales in March brought down 1Q15 SSSG to -15.9%. This was lower than the -9.5% SSSG in 1Q14, which was the trough in FY14. Higher comparables for the next two quarters imply SSSG recovery willremain muted in FY15. Sell-through in 1Q15 was weaker than management’s expectation, and company considers scale back its store opening plan for FY15 from previously planned ~150 new stores.

Discounts may turn heavier in following quarters.Management indicated that the sales decline was mostly driven by volume decrease, ascompany did not follow competitors’discounts sales but held up prices for in-season products in 1Q15 due to less inventorypressure after the clearance sales in 4Q14. The more favourable product mix (more new products) also resulted in gross margin improvement in 1Q15. However, deterioratingsales in March suggestsinventories to be carried into 2Q15and weaker outlook for the Spring/Summer season. Company may have to trade margins for volume under the weak sell-throughenvironment.

Diversetrends of online and street store.According to company’s announcement, Daphne’s online sales continue to growstrongly, while sales of brick and mortarstores are struggling. We believethe diverseperformance reflects the cannibalizationfrom online retailers against traditionalchannels in the industry. The trend is likely to continue, particularly in theprice-sensitive mass market whereDaphne is situated. We consider on-line footwear retailer major threattothe firm.

Estimates and valuation.We trimour EPS forecasts for FY15E and FY16E by 27.7% and 22.7% to HK￠12.5 and HK￠19.7 respectively, mainly onweakening SSSG outlook for FY15 and lower EBIT margins. We expect SSSG for FY15E to be muted and earnings recovery to be delayed to FY16E. We also lower our target FY16E P/E multiple from 10X to 9X, its historical lower range,to reflect the prolongedturnaround ofthemass footwear market in China. This gives us a new TP of HK$1.77, representing 22% downside from current level. WedowngradeDaphnefrom Neutral to Sell.Risks for our TP include faster-than-expected SSSG and consumer sentiment recovery.