Li Ning:On track

Improving cash flow and balance sheet, BUY

Although Li Ning’s 2H16core Ebit was a miss, we believe an improvinginventory structure (old-new mix) and tighter working capitalmanagement are the more important drivers of a business “turnaround”.A healthier balance sheet and more disciplined channel management arecritical to improve the profitability of the eco system, paving the way forlong-term growth. We maintain 18CL EPS and BUY on continued marginrecovery potential. TP of HK$6.3(was HK$6.28) is set at 16x 18CL PE.

2H16core Ebit was a miss

We believe 2H16NP was a low-quality beat helped by a lower tax rate andhigher write-backs from earlier provisions. The core Ebit was a miss largelydue to a slower GPM expansion. Sales growth was strong at 13% YoY in 2H16and E-commerce growth accelerated to c.90%+ in 2H16. Management didcaution the overall sales trend in 1Q17so far is a bit soft but still maintainedits full-year guidance of low-teens top-line growth for the group in 2017.

Cash flow was solid, indicating high-quality earnings

Cash flow continued to increase with OCF rising 45% YoY to Rmb1bn in 2016,1.6x net profit. Working capital as a percentage of sales improved to 24% in2016vs 31% in 2015and the peak of 50% in 2013. The channel inventorymix (old vs new) was further optimised with new products accounting for64% in 2016(61% in 2015). Although tightening those measures mightimpact short-term sales/profit growth, we think they are critical to a healthyeco system and can help to drive long-term sustainable growth.

Margin expansion trend likely to remain intact, BUY

We believe the margin expansion trend will remain intact in 2017-18, drivenby operating leverage as well as a revenue mix shift towards the highermarginbusinesses of E-commerce and direct retail. We forecast NPM toexpand from 4.1% in 2016to 5.5%/8.3% in 2017/18. The key risk is anindustry-wide de-stocking exercise that drags down overall retail pricing butshould that happen, it would only delay, not deter, the margin expansiontrend, in our view. We have factored in an Rmb80m bottom-line impact for2017from new business investments but the drag is likely to be much less in2018when the new business ramps up. Our 18CL earnings are largelyunchanged and our TP of HK$6.3(was HK$6.28) is still based on 16x 18CLPE, a discount to Anta to reflect both liquidity and execution risks. With 34%upside potential, we maintain BUY.