Li Ning’s earnings drop 49% to RMB 294m in 1H11

While Li Ning is taking proactive steps to clear its excess retail inventory, we are concerned that this painful process may require more inventory buybacks from distributors, which could negatively affect the group’s sales and margins.

We project its net profit to fall by 55% in 2011, followed by a 2% earnings recovery in 2012. Our earnings estimates for 2011-13 are 14-23% below consensus.

Excess inventory is still high
Management indicated that excess inventory at the retail end is still high and it does not expect this to normalise until 2H12. It has started to take back old logo products from distributors and has opened more discount stores. It has also bought back around RMB100m of returned goods in
1H11 and expects to increase this to RMB200m in 1H11. For 2012, there is no specific guidance on the amount of inventory buyback but management indicated it should be less than 2011.

Valuation and risks
Our target price of HKD7.5 is based on 13x 12- month forward EPS of HKD0.58, which is derived from around 1.5 standard deviation below the group’s historical average PE of 23x.

Under our research model, for China stocks with a volatility indicator, the Neutral rating band is 10 percentage points above and below the hurdle rate of 10%. This translates into a Neutral band of 0-20% above the current share price. Our target price implies a negative potential return of 16.5% , which is below the Neutral band; thus, we have an Underweight rating.

Key upside risks include: 1) a stronger consumption environment and faster-than- expected distribution channel reform; and 2) lower-than-expected operating expenses and effective tax rate.