Bad start:1Q profit down 44% vs 20% expected; reiterate SELL

Prada reported revenues up 6% (vs an expected 4% increase) with a12% boost from FX, implying sales on a constant FX basis were down6%. Ebit fell by 42% vs our estimate of -16%. Net profit was down 44%vs -20% expected. Management expects continued strength in Europeand Japan and hopes greater China improves in 2H. CLSA remains quitebearish on Hong Kong retail overall. We cut our FY net profit estimates by22%, and price target from HK$41.50 to HK$30 based on an 18x CY16 PE(previously 20x).

Mixed performance across channels, regions, and products

Sales at constant a FX were down 6% in 1Q. SSS appears to be down highsingle-digits. Wholesale was worse than retail, as expected. Europe was thestrongest region, benefiting from more tourism, with HK/Macau sufferingweaker tourist flow. Greater China was down 23% with the mainland better.Footwear was very strong, up 19%, while leather goods were down 10% dueto weakness in Asia. On a very bright note, Miu Miu performed very well, up5% in retail.

Ebit down 42% YoY

GP was up 4% vs +1% expected. However, high advertising expenses, whichare partly one-off, and higher selling expenses caused Ebit to fall 42%. Theluxury goods industry has high fixed costs so negative SSS results insignificant operating deleveraging. An unfavourable geographic mix (lesssales in Asia) and product mix (less leather goods) also hurt margins.

Initiatives to reinvigorate growth

The company has been working hard on new product launches and animproved pricing architecture with a wider pricing range. Where possible,prices are being marginally adjusted with some increases in Europe. However,management sees scope for better price harmonization with the launch ofnew products. Some of the mainland weakness was due to customersdeferring purchases in anticipation of price cuts which did not materialize.

Reiterate SELL rating with a new target price of HK$30

While we continue to like the luxury goods sector in the medium term andbelieve Prada is one of the stronger players, we believe earnings are unlikelyto recover quickly due to severe operating deleveraging in sector, an ongoingregional mix shift from higher margin Asia to lower margin Europe, and amore competitive landscape will push up reinvestment costs into productdesign, supply chain efficiencies, advertising and other marketing costs.